The International Monetary System: History and Where we are Today

1
The International Monetary System History and
Where we are Today
2
Recall the Definition of an Exchange Rate Regime

• Defined The way in which a country manages its
  currency and thus the arrangement by the price of
  that countrys currency is determined on foreign
  exchange markets.
• Arrangements ranging from
• Floating Rate
• Managed Rate (AKA Dirty Float)
• Pegged Rate
• Arrangement is determining by governments.

3
History of Exchange Rate Regimes

• Over the past 200 years, the world has gone
  though major changes its global exchange rate
  environment.
• Starting with the gold standard regime of the
  latter part of the 19th century to todays
  somewhat mixed system we can identify there 3
  distinct periods
• Gold Standard 1816 - 1914
• Bretton Woods 1945 - 1973
• Mixed System 1973 the present

4
Gold Standard 1816 - 1914

• During the 1800s the industrial revolution
  brought about a vast increase in the production
  of goods and widened the basis of world trade.
• At that time, trading countries believed that a
  necessary condition to facilitate world trade was
  a stable exchange rate system.
• Stable exchange rates were seen as necessary for
  encouraging and settling commercial transactions
  across borders (both by companies and by
  governments).
• So by the second half of the 19th century, most
  countries had adopted the gold standard exchange
  rate regime.

5
Basics of the Gold Standard

• The gold standard regime required that domestic
  currencies (national money) be defined in terms
  of a specific weight of gold.
• For example
• The British pound was fixed at .23546 of an
  ounce of pure gold (in 1816).
• The U.S. dollar was fixed at 0.048379 of an
  ounce of pure gold (in 1879).
• Thus, the dollar pound parity (i.e., the
  exchange rate) was set at 4.867
• .23546/.048379 4.867
• The Gold Standard also required that each country
  adjust its domestic money supply in direct
  relation to the amount of gold it held.
• Increase in gold would increase the domestic
  money and a reduction in its gold supply would
  reduce the money supply.

• How it worked
• Assume the United Kingdom ran a trade deficit
  with the United States.
• As a result, gold would flow from the UK to the
  US (gold financed trade imbalances).
• Each countrys domestic money supply was tied
  into the amount of gold it held, thus the U.S.
  money supply would rise.
• The increase money supply would increase prices
  in the United States, which in turn would make
  U.S. goods less attractive to the UK.
• The net result was that the trade surplus of the
  US would decrease and the trade deficit of the UK
  would decrease.

6
World War I (1914) Through World War II (1944)

• World War I marks the beginning of the end of the
  Gold Standard .
• During the war, countries suspended the
  convertibility of their currencies into gold.
• After WW I, various attempts were made to restore
  the classical gold standard.
• 1919 United States returned to a gold standard.
• 1925 Great Britain joined, followed by France
  and Switzerland.
• These attempts proved unsuccessful.
• Why During this time, most countries were more
  concerned with their national economies than
  exchange rate stability.
• Especially during the Great Depression (1929
  1930s)
• As a result, countries abandoned their attempts
  to return to an interwar gold standard.
• Britain and Japan dropped it in 1931, the U.S. in
  1933.

7
Bretton Woods A Pegged Regime

• In July of 1944, as World War II is coming to an
  end, all 44 allied countries meet in Bretton
  Woods, New Hampshire for the purpose of
  establishing a new international monetary system.
  
• At Bretton Woods, countries agree that fixed
  exchange rates were necessary for restarting
  world trade and global investment (both of which
  had fallen dramatically).
• It is also obvious that the US dollar would
  become the cornerstone of any new international
  monetary system.
• Key points of the Bretton Woods were
• Pegging the U.S. dollar to gold at 35 per ounce
  (with the USD the only currency convertible into
  gold).
• All other countries peg their currencies to the
  U.S. dollar.
• Their par values are set in relation to the U.S.
  dollar
• GBP 2.80 JPY 360 (1in 1949)
• Countries agreed to support their exchange
  rates within or 1 of these par values.
• This is done through the buying or selling of
  foreign exchange when market forces needed to be
  offset.

8
The Yen During Bretton Woods
9
Sterling During Bretton Woods
10
The Seeds of Bretton Woods Demise

• In the 1960s, Bretton Woods begins to unravel.
• President Lyndon Johnson tries to finance both
  his Great Society programs at home and the
  American war in Vietnam.
• This produces a large US Federal budget deficit,
  which, coupled with easy monetary policy, results
  in
• High inflation in the United States and
• An increase in U.S. spending for cheaper imports
• As a result, the United States balance of
  payments moves from a surplus into a deficit.
• Dollar is seen by the market as overvalued.
• Foreigners become concerned about holding
  overvalued U.S. dollars at a rate of 35 an
  ounce.
• Markets are suggesting it should take more than
  35 to buy 1 oz of gold.

11
U.S. Balance of Payments 1965 -

• By the mid-1960, the U.S. balance of payment
  (e.g., trade balance) started to deteriorate (a
  declining surplus).
• By 1971, the U.S. merchandise trade balance moved
  into deficit.

12
The Last Years of Bretton Woods 1970 -1973

• By 1970, financial markets are reluctant to hold
  the overvalued U.S. dollar.
• Markets sell USD on foreign exchange markets.
• This puts downward pressure on the exchange rate
  for dollars.
• And upward pressure on the exchange rate for
  foreign currencies.
• Central banks engage in massive intervention in
  an attempt to hold their Bretton Woods par
  values.
• Central banks buy U.S. dollars as they are sold
  in markets.
• As a result, foreign holdings of dollars increase
  dramatically and eventually exceed U.S. gold
  holdings.
• By 1971, gold coverage for U.S. dollars had
  dropped to 22.
• In August 1971, President Nixon suspends dollar
  convertibility into gold.
• In response, more dollars are sold on foreign
  exchange markets pushing the dollar lower (and
  foreign currencies higher).

13
Smithsonian Agreements, December 1971

• In December 1971, ten major counties meet in
  Washington, D.C. with the aim of restoring
  stability to the international monetary system.
• Meeting concludes with the Smithsonian
  Agreements, whereby
• Key countries agree to revalue their currencies
  and in essence set new par values against the US
  dollar (e.g., yen 17, mark 13.5, pound and
  franc 9)
• The U.S. also agrees to raise the dollar price of
  gold from 35 to 38 an ounce (represents a
  further devaluation of the dollar).
• It was also agreed that currencies could now
  fluctuate or 2.25 around their new par
  values.

14
The Final Collapse of the Dollar, February 1973

• 13 months after the Smithsonian Agreements, the
  dollar comes under renewed attack for being
  overvalued.
• In February 1973, markets sell off dollars again.
• As before, central banks intervene and buy
  dollars.
• On February, 12th, 1973 the dollar is devalued
  further to 42 per ounce.
• But the price of gold on the London gold markets
  trades at 70 per ounce.
• Japan and Italy finally let their currencies
  float on February 13th.
• France and Germany continue to manage their
  currencies in relation to the dollar.
• In response to mounting speculative currency
  flows, foreign exchange markets are closed on
  March 1, 1973, and reopen on March 19, 1973.

15
The End of Bretton Woods

• On March, 19, 1973, when foreign exchange markets
  reopen, major countries announce that they are
  floating their currencies
• On March 19, 1973, the list of countries floating
  their currencies includes Japan, Canada, and
  those in Western Europe.
• The Bretton Woods fixed exchange rate system
  effectively ends on this date.
• Approximately 3 months later, by June 1973, the
  dollar has floated down an average of 10
  against the major currencies of the world.

16
Yen Immediately After the Collapse of Bretton
Woods

• 1971 - 1980

• Annual Data in USD

• 1971 349.33 -2.96
• 1972 303.17 -13.21
• 1973 271.70 -10.38
• 1974 292.08 7.50
• 1975 296.79 1.61
• 1976 296.55 -0.08
• 1977 268.51 -9.46
• 1978 210.44 -21.63
• 1979 219.14 4.13
• 1980 226.74 3.47

17
Sterling Immediately After the Collapse of
Bretton Woods

• 1971 - 1980

• Annual Data in GBP

• 1971 2.4336 1.41
• 1972 2.4975 2.62
• 1973 2.4497 -1.91
• 1974 2.3375 -4.58
• 1975 2.2124 -5.35
• 1976 1.7969 -18.78
• 1977 1.7443 -2.93
• 1978 1.9176 9.93
• 1979 2.1177 10.44
• 1980 2.3239 9.74

18
The Yen After Bretton Woods
19
Sterling After Bretton Woods
20
Exchange Rate Regimes Today

• Currently, current exchange rate regimes fall
  along a spectrum as represented by national
  government involvement in affecting (managing)
  their currencys exchange rate.

Very Little (if any) Involvement
Active Involvement
Forex Market is Determining Exchange rate
Government is Managing or Pegging Exchange rate
21
Where are we Today in Terms of Exchange Rate
Regimes?

• Mixed International Monetary System consisting
  of
• Floating exchange rate regimes
• Market forces determine the relative value of a
  currency.
• Managed (dirty float) rate regimes
• Governments managing their currencys value with
  regard to a reference currency.
• Market moves these currencies, but governments
  are managing the process and intervening when
  necessary.
• Pegged exchange rate regimes
• Government fixes (links) the value of its
  currency relative to a reference currency.
• Fewer of these regimes than in the past.

22
Post Bretton Woods Summary

• Since March 1973, the major currencies of the
  world have operated under a floating exchange
  rate system.
• While central banks of these major countries have
  occasionally interviewed in support of their
  currencies, this intervention has become less
  over the years.
• The US last intervened in 1998.
• In addition to the major currencies of the world,
  a growing number of other developing country
  currencies have also moved to a floating rate
  system.
• Thus more and more, market forces are driving
  currency values.
• The post Bretton Woods period has resulted
  exchange rates become much more volatile and ,
  perhaps, less predictable then they were during
  previous fixed exchange rate eras.
• This currency volatility complicates the
  management of global companies.

23
Freely Floating Currencies by Country or Region,
IMF data, 2006

• AlbaniaCongo, Dem. Rep. of IndonesiaUganda
• AustraliaBrazilCanadaChile IcelandIsraelKor
  eaMexicoNew Zealand

• NorwayPhilippinesPolandSouth
  AfricaSwedenTurkey United Kingdom
• Tanzania
• Japan SomaliaSwitzerland United States
• Eurozone

24
Useful Web Sites

• Link to the history of foreign exchange regime
  changes of many countries.
• http//intl.econ.cuhk.edu.hk/exchange_rate_regime/
  index.php?cid8
• Quarterly report on U.S. Intervention in foreign
  exchange markets
• http//www.ny.frb.org/markets/foreignex.html
• Go to archives, July 30, 1998 to view
  intervention activity.