International Monetary System

International Monetary System

International monetary systems are sets of internationally agreed rules, conventions
and supporting institutions, that facilitate international trade, cross border investment and
generally the reallocation of capital between nation states.

They provide means of payment acceptable between buyers and sellers of different
nationality, including deferred payment.

To operate successfully, they need to inspire confidence, to provide sufficient liquidity for
fluctuating levels of trade and to provide means by which global imbalances can be
corrected.

The systems can grow organically as the collective result of numerous individual
agreements between international economic factors spread over several decades.

Alternatively, they can arise from a single architectural vision as happened at Bretton
Woods in 1944.
Role of International Monetary System
The international monetary system (IMS) is analogous to the domestic monetary system. It
caries out similar functions. In the domestic monetary system the functions that must be
carried out include:
1) providing for the transfer of the purchasing power, that is, money payments to cover
transactions,
2) providing a stable unit of value, and
3) providing a standard for deferred payments.

The IMS operates in a manner analogous to the domestic system. The same basic functions
must be served by the IMS, namely, making payments to cover transactions, providing a
stable unit of account, and providing a standard of deferred payments. The major difference
in the IMS is that cross-border payments generally involve a foreign currency transaction for
at least one of the parties involved in the transaction.
Key Performance Characteristics
For the IMS to operate effectively, key performance characteristics are required. These
characteristics are as follows:

1. Provision of adequate liquidity
This provision takes the form of adequate units of official reserves held by governments of
countries involved in foreign trade. It also requires incentives for commercial banks
operating as foreign exchange dealers to hold sufficient foreign exchange reserves to satisfy
the requirements of the private sector.

2. Operation of a smooth adjustment mechanism
This objective requires that individual nations carry out economic and financial policies
conducive to maintaining reasonable well balanced international payment systems, or that
financial mechanisms operate to provide payments adjustment, or that governments act to
preserve equilibrium in the foreign exchange markets.

(Adjustment mechanisms: Processes in the economy that work to assure a nation's external
economic equilibrium)

3. Confidence in the system
If private sector business firms and investors believe that governments will follow policies
conducive to a well-balances international payments system, they will have confidence in
the system. International organizations such as the International Monetary Fund (IMF) seek
to promote such policies on the part of governments. In addition, governments undertake
cooperative arrangements with one another to build confidence in the existing system.

Principal Components of the IMS
The present IMS possesses five important operation components:
1. International Monetary Fund
The International Monetary Fund (IMF) is an international organization that was created
on July 22, 1944 at the Bretton Woods Conference and came into existence on December
27, 1945 when 29 countries signed the Articles of Agreement. It originally had 45 members.
The IMF's stated goal was to stabilize exchange rates and assist the reconstruction of the
worlds international payment system post-World War II. Countries contribute money to a
pool through a quota system from which countries with payment imbalances can borrow
funds temporarily. Through this activity and others such as surveillance of its members'
economies and policies, the IMF works to improve the economies of its member countries.
The IMF describes itself as an organization of 188 countries, working to foster global
monetary cooperation, secure financial stability, facilitate international trade, promote high
employment and sustainable economic growth, and reduce
2. Foreign Exchange Market
The foreign exchange market is the framework for trading foreign currencies. Financial
centers around the world function as anchors of trading between a wide range of different
types of buyers and sellers around the clock, with the exception of weekends. EBS and
Reuters' dealing 3000 are two main interbank FX trading platforms. The foreign exchange
market determines the relative values of different currencies.



The foreign exchange market is unique because of the following characteristics:
1. its huge trading volume representing the largest asset class in the world leading to high
liquidity;
2. its geographical dispersion;
3. its continuous operation: 24 hours a day except weekends;
4. the variety of factors that affect exchange rates;
5. the low margins of relative profit compared with other markets of fixed income; and
6. the use of leverage to enhance profit and loss margins and with respect to account size.

Additional readings if you want to learn more about forex. The following link/video are not
really required but can help you understand the forex market better. We'll go through the
details of the forex market in the next chapter/lesson.

You can learn more about forex in an easier language. Just go to babypips.

You can also watch the following video clips.
Introduction to Forex and Forex Terms (includes how you can start forex trading)

3. Official Reserves
Governments hold official reserves, international money in various forms. Official reserves
only refer to foreign currency held by a country. These function like international money by
their general acceptability. Official reserves consist of four separate and distinct
components.

1.The first component is the IMF Reserve Positions. This represents quotes of IMF
member countries freely available to them to supplement their liquid resources.

2. The smallest component is the special drawing rights (SDR), also referred to as paper
gold. SDRs were created to supplement international liquidity at a time when it was thought
official reserve growth would be inadequate to meet global needs. SDRs reflect bookkeeping
entries within the IMF, which members in deficit can use to settle international payment at
the official level (central bank of one country transferring SDRs to central bank of another
country)

3. The largest component consists of foreign exchange held by governments and their
central banks.

4. Finally, a part of official reserves is held in the form of monetary gold. A gold reserve is
the gold held by a central bank or nation intended as a store of value and as a guarantee to
redeem promises to pay depositors, note holders (e.g., paper money), or trading peers, or
to secure a currency.

Governments hold official reserves for numerous reasons. Some governments are more
concerned with the need to cover external debt payments, while others are more interested
in being able to cover the cost of necessary imports such as food and fuel. Factors
influencing governments to hold official reserves include:
1. to be able to carry out international transactions including imports without any delay in
payments;
2. to improve the international credit standing of the nation;
3. to provide resources for foreign exchange market intervention, when needed; and
4. to assure and facilitate external debt service payments.

If you're interested here is a listing of countries by their amount of official reserves.
4. Private Demand for Foreign Exchange
The private demand for foreign exchange refers to the foreign currency balances held by
foreign exchange banks. The term private demand is used in contrast with official demand,
where official reserves are held by the governments. Private demand result from the risk
versus profit judgments of the private trading banks. When a large number of dealing banks
become uncertain of the near future prospects for a currency in the market, they may
shorten their deposit holdings
5. Intervention and Swap Network
A swap involves a standby credit arrangement between two (or more) countries. The swap
is used to borrow or lend foreign currency in exchange for domestic currency with a
commitment to reverse the exchange in three months. A foreign exchange swap is a sport
purchase of a currency coupled with a forward sale. Central banks use swaps to provide
foreign currency resources to one another, which are used to intervene in the foreign
exchange market.