The main evolutions of the international monetary system are listed below:
1. Gold Standard:
Britain adopted gold standard in 1816 and were followed by Germany in 1871. USA adopted it in 1873. Most countries of the world adopted gold standard till it was suspended at the time of First World War in 1914. World War-I disrupted the currencies of many gold standard countries inducing them to adopt the inconvertible paper money standard.
The attempts towards the restoration of the gold standard in the post-war period lacked uniformity resulting ultimately in the breakdown of the gold standard.
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(i) Definition of Gold Standard:
A gold standard is a monetary system in which the unit of value which prices and wages are customarily expressed and in which the debts are usually contracted consist of the value of a fixed quantity of gold in an essentially free gold market.
(ii) Adjustment Mechanism:
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A country with high price level will import more than export. Importers have to pay in gold or its equivalent value and exporters receive gold or its equivalent value. A country which imports more than export will have “Balance of Payment” deficit. This will lead to outflow of gold to foreign countries which have surplus balance of payment. Outflow of gold leads to decrease in price level as a result of which imports decreases and export increases.
Similarly a country with surplus balance of payment will have gold inflow into the country, which will increase money supply. This will increase price level leading to decrease in exports and increase in imports. Thus, gold movement acts as a catalytic force.
By generating the deflationary process in countries with deficit in the balance of payment and the inflationary process in countries with surplus in the balance of payment, they become instrumental in restoring equilibrium in the balance of payments of the gold standard countries. These gold movements automatically balance the ‘Balance of Payment’ without the need for Government intervention.
2. Evolution of the International Monetary System:
The pre-1914 gold standard was a fully fledged gold coin standard. The unit of account and the standard of value were set by law as a fixed weight of gold of specified fineness. Gold standard was abandoned in 1914 because of disorganisation of many currency system. The uneven magnitude of inflation that caught different countries during the war badly distorted the equilibrium of international prices. Before the war, Britain was the financial leader.
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After the war, America emerged as the financial leader. Another problem in reintroducing gold standard was the increasing Government intervention in the economic system, whereas smooth functionary of gold standard required laissez-faire without Government intervention. , Although with great difficulty, gold standard was fully restored by 1928 but it never functioned smoothly.
Gold standard was abandoned by England in 1931. Onset of the great depression led to general abandonment of gold standard by most nations. Most nations shifted to paper standard. After the break down of gold standard till 1944, there was no international monetary arrangement in place.
Instead, each country dealt with its external balance of payment deficit in its own way. Countries resorted to exchange clearing arrangement, blocked accounts, multiple exchange rates practices and import restriction.
To create an international monetary arrangement and encourage international trade, nations gathered in 1944 at Bretton Woods, New Hampshire and reached an agreement that led to the formation of IMF, World Bank and G ATT for the first time, nations jointly signed an agreement to set up a system for regulating international financial transaction.
3. Bretton Woods System:
This system replaced the gold standard and established a parity for each currency in terms of both the US dollar and gold. It introduced a new exchange rate system, viz, the adjustable peg system. This meant that exchange rates were fixed but adjustable from time to time.
When one currency deviated markedly from its fundamental value, parity would be adjusted. Exchange rate changes would be worked out among countries in a cooperative manner so that one nation did not gain at the expense of others and there was no need for competitive devaluation to restore parity.
Bretton Woods’s system created an adjustable system which achieved the best for the world. It could maintain the stability of the gold standard which would encourage trade and capital flows by making it possible to predict exchange rates.
At the same time, this system would stimulate the adoptability of flexible exchange rates; under which persistent relative price differential among countries could be adjusted to by exchange rate changes rather than by the painful deflation and unemployment necessary under the rigid gold standard of the earlier days.
From 1945 to 1970, the world was on a dollar standard. Under Bretton Woods, the US dollar was the key currency. Most of the world trade and international finance were carried out in dollars and payments were made in dollars.
But the system broke down in 1970 because of USA’s trade deficit and budgetary deficit due to overvalued currency and the huge accumulation of dollar with Germany and Japan. It became difficult for USA to defend the official parity. Germany and Japan lost confidence in dollar and asked USA to exchange gold for accumulated dollar. USA refused to buy its dollar by paying in gold. In 1971, the dollar was delinked from gold bringing the Bretton Woods era to an end.
Since 1971, world has been operating under hybrid system of clean floating, dirty floating, crawling peg, currency block etc.
4. The International Monetary Fund (IMF):
Main function of IMF is to manage international equality and finance short term balance of payment problems of member nations so that need for devaluation of foreign currency is decreased. Member countries subscribe by lending their currencies to the fund.
These funds are then used by IMF to lend to member countries that are facing deficit in the balance of payment. The IMF makes conditional loans requiring debtor countries to implement macroeconomic policies or structural reforms that will alleviate balance of payments problems.
In the Latin American Countries’ debt crisis, IMF played a proactive role to reschedule the debt and thus avoided the international financial crisis. IMF is also helping the new born post-socialist countries like Russia to make the transition to the market.
Due to high rate of growth of world economy, international liquidity could not keep pace. In order to improve international liquidity position, IMF created Special Drawing Rights (SDRs). Under the Second Amendment of the Fund’s Article of Agreement in 1978, SDR became the principal reserve asset in the international monetary system. Many countries have pegged their currencies to the SDR’s.
5. World Bank:
The World Bank was created at the Bretton Woods conference in 1944. It raises capital by borrowing funds in capital market. It is a profit making institution that provides loans to less developed countries for specific development projects. Such loans are provided for building infrastructure. Duration of the loan is as long as 25 years.
World Bank provides loan to developing countries at concessional rates of interest for projects which can’t get private-sector funding. The World Bank also provides technical assistance on projects where developing countries lack expertise.
6. World Trading Orders:
World is divided between developed countries of North and underdeveloped countries of South. There should be some institution which can remove this gap of North-South divide. The Cairo conference of the developing countries held in 1962 on the problems of economic development passed the ‘Cairo Declaration’ on developing countries calling for the convening of the United Nations Conference on Trade and Development.
(i) Functions of UNCTAD:
(a) Promote speedy development of the underdeveloped countries by expanding their export, reduce their deficit in the Balance of Payment and help in reducing the excessive burden of foreign debt.
(b) Harmonise the trade-related development policies of Government and regional economic grouping in pursuance of the United Nations charter.
(c) Facilitate the coordination of activities of other institutions within the United Nations system in the field of international trade and related problems of economic development and in this regard to cooperate with the General Assembly and the Economic and Social Council in respect of the performance of their charted responsibilities.
(ii) Achievements of UNCTAD:
(a) UNCTAD succeeded in increasing the interest in developed countries regarding the problem of the developed countries.
(b) Countries with free market economies and the centrally planned economies came together and cooperated in examination of the problems of the developing countries.
(c) Asked developed countries to contribute one percent of GNP in the form of grants and loans.
(d) Helped in introducing Generalized System of Preference in GATT. This gave additional benefit to developing countries to export products to developed countries.
7. GATT:
The General Agreement on Tariff and Trade is not an organisation but just a multilateral treaty which was signed by 92 countries in 1948. It was a forum where the contracting parties met from time to time to discuss and solve their trade problems. Objectives of the GATT included expansion of world trade 3nd to enable full use of the world’s resources.
Most successful round of GATT was the eighth round of GATT held in Uruguay in 1986, when Arthur Dunkel was the director-general of GATT. He submitted a comprehensive document known as Dunkel Draft in December-I 991.
Dunkel Draft apart from covering traditional subjects of discussion such as tariff and non-tariff measures, subsidies, etc. also covered new areas such as ‘Trade Related Intellectual Properties Rights’, (TRIPs), ‘Trade Related Investment Measures’ (TRIMS) and General Agreement on Trade in Services (GATS).
8. World Trade Organisation:
In 1948, it was decided to set up a permanent body named International Trade Organisation (ITO) to promote international trade and reduce tendency of nations towards protectionism. ITO could not be set up at that time because of lack of consensus.
It was thought proper to postpone the setting up of permanent body to a later time. Till permanent body was set up, it was decided to promote free trade through nations entering multinational treaty called GATT. In 1994, it was thought proper that time is right to have a full-fledged permanent body to promote free trade.
Hence WTO was set up. The WTO is permanent body with its own dispute settlement mechanism. Scope of WTO has been broadened by inclusion of services, intellectual property rights and investment measures into it, which were not the case with GATT.