International Monetary System

Topics: Monetary policy, Bretton Woods system, Foreign exchange market Pages: 19 (5852 words) Published: November 2, 2010


International Monetary System refers to the system prevailing in world foreign exchange markets through which international trade & capital movements are financed & exchanges rates are determined.

MNCs operate in a global market, buying/selling/producing in many different countries. For example, GM sells cars in 150 countries, produces cars in 50 countries, so it has to deal with hundreds of currencies. What are the mechanics of how currency and capital flows internationally?

International Monetary System - Institutional framework within which: 1. International payments are made
2. Movements of capital are accommodated
3. Ex-rates are determined

An international monetary system is required to facilitate international trade, business, travel, investment, foreign aid, etc. For domestic economy, we would study Money and Banking to understand the domestic institutional framework of money, monetary policy, central banking, commercial banking, check-clearing, etc. To understand the flow of international capital/currency we study the IMS. IMS - complex system of international arrangements, rules, institutions, policies in regard to ex-rates, int'l payments, capital flows. IMS has evolved over time as int'l trade, finance, and business have changed, as technology has improved, as political dynamics change, etc. Example: evolution of the European Union and the Euro currency impacts the IMS. "Spontaneous Order."


1. BIMETALLISM (pre-1875)

Commodity money system using both silver and gold (precious metals) for int'l payments (and for domestic currency). Why silver and gold? (Intrinsic Value, Portable, Recognizable, Homogenous/Divisible, Durable/Non-perishable). Why two metals and not one (silver standard or gold standard vs. bimetallism)? Some countries' currencies in certain periods were on either the gold standard (British pound) or the silver standard (German DM) and some on a bimetallic (French franc). Pound/Franc ex-rate was determined by the gold content of the two currencies. Franc/DM was determined by the silver content of the two currencies. Pound (gold) / DM (silver) rate was determined by their ex-rates against the Franc.

Under a bimetallic standard (or any time when more than one type of currency is acceptable for payment), countries would experience "Gresham's Law" which is when "bad" money drives out "good" money.

The more desirable, superior form of money is hoarded and withdrawn from circulation, and people use the inferior or bad money to make payments. The bad money circulates, the good money is hoarded. Under a bimetallic standard the silver/gold ratio was fixed at a legal rate. When the market rate for silver/gold differed substantially from the legal rate, one metal would be overvalued and one would be undervalued. People would circulate the undervalued (bad) money and hoard the overvalued (good) money.

Examples: a) From 1837-1860 the legal silver/gold ratio was 16/1 and the market ratio was 15.5/1. One oz of gold would trade for 15.5 oz. of silver in the market, but one oz of gold would trade for 16 oz of silver at the legal/official rate. Gold was overvalued at the legal rate, silver was undervalued. Gold circulated and silver was hoarded (or not minted into coins), putting the US on what was effectively a gold standard.

b) France went from a bimetallic standard to effectively a gold standard after the discovery of gold in US and Australia in the 1800s. The fixed legal ratio was out of line with the true market rate. Gold became more abundant, lowering its scarcity/value, silver became more valuable. Only gold circulated as a medium of exchange.



The gold standard is a monetary system in which the standard economic unit of account is a fixed weight of gold. There are distinct kinds of gold standard. First, the gold...
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