Evolution of International Monetary System

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The International Monetary System
Chapter Objective:

This chapter serves to introduce the student to the institutional framework within which:

INTERNATIONAL FINANCIAL MANAGEMENT

Chapter Two

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a. International payments are made. Fourth Edition b. The movement of capital is accommodated. EUN / RESNICK c. Exchange rates are determined.

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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights res

Chapter Two Outline
      

Evolution of the International Monetary System Current Exchange Rate Arrangements European Monetary System The Mexican Peso Crisis The Asian Currency Crisis The Argentine Peso Crisis Fixed versus Flexible Exchange Rate Regimes

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Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights res

Evolution of the International Monetary System
Bimetallism: Before 1875  Classical Gold Standard: 1875-1914  Interwar Period: 1915-1944  Bretton Woods System: 1945-1972  The Flexible Exchange Rate Regime: 1973Present 

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Bimetallism: Before 1875
A “double standard” in the sense that both gold and silver were used as money.  Both gold and silver were used as international means of payment and the exchange rates among currencies were determined by either their gold or silver contents. 

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Bimetallism: Before 1875 Gresham’s Law
Phenomenon experienced by the countries that were on the bimettalic standard.  Since exchange rate between two currency was fixed officially, only the abundant metal was used as money, driving more scarce metal out of circulation.  

Gresham’s Law: “Bad” (abundant) money drives out “Good” (scarce) money

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Classical Gold Standard: 1875-1914


During this period in most major countries:
 



Gold alone was assured of unrestricted coinage There was two-way convertibility between gold and national currencies at a stable ratio. Gold could be freely exported or imported.



The exchange rate between two country’s currencies would be determined by their relative gold contents. 2-6

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights res

Classical Gold Standard: 1875-1914
For example, if the dollar is pegged to gold at U.S.$30 = 1 ounce of gold, and the British pound is pegged to gold at £6 = 1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents: $30 = £6 $5 = £1 2-7

Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights res

Classical Gold Standard: 1875-1914
Highly stable exchange rates under the classical gold standard provided an environment that was favorable to international trade and investment.  Misalignment of exchange rates and international imbalances of payment were automatically corrected by the price-specie-flow mechanism. 

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Price-Specie-Flow Mechanism


Suppose Great Britain exported more to France than France imported from Great Britain. 



Net export of goods from Great Britain to France will be accompanied by a net flow of gold from France to Great Britain. This flow of gold will lead to a lower price level in France and, at the same time, a higher price level in Britain.



The resultant change in relative price levels will slow exports from Great Britain and encourage exports from France.

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Classical Gold Standard: 1875-1914


There are shortcomings:




The supply of newly minted gold is so restricted that the growth of world trade and investment can be hampered for the lack of sufficient monetary reserves. Even if the world returned to a gold standard, any national government could abandon the...
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