Republic of the Philippines

University of Rizal System

Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

Module 10: The International Monetary System

Module Introduction:
“International monetary system” is often used interchangeably with terms such as
“international monetary and financial system” and “international financial architecture.”
Since the nomenclature involves de jure/de facto jurisdiction, obligations and oversight
concerning sovereign nations and multilateral bodies, it is important to be precise and
specific. The objective of the IMS is to contribute to stable and high global growth, while
fostering price and financial stability. The IMS comprises the set of official arrangements
that regulate key dimensions of the balance of payments. The essential purpose of the
IMS is to facilitate the exchange of goods, services, and capital among countries.
Module Objective:
1. Understand the role and purpose of the international monetary system.
2. Describe the purpose of the gold standard and why it collapsed.
3. Describe the Bretton Woods Agreement and why it collapsed.
4. Understand today’s current monetary system, which developed after the Bretton
Woods Agreement collapse.
Why do economies need money?
Money is define as a unit of account that is used as a medium of exchange in
transactions. Without money, individuals and businesses would have a harder time
obtaining (purchasing) or exchanging (selling) what they need, want, or make.
Money provides us with a universally accepted medium of exchange.
Understanding Evolution of Money

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

History shows that ancient Egypt and Mesopotamia—which encompasses the

land between the Euphrates and Tigris Rivers and is modern-day Iraq, parts of eastern
Syria, southwest Iran, and southeast Turkey—began to use a system based on the
highly coveted coins of gold and silver, also known as bullion, which is the purest form
of the precious metal. However, bartering remained the most common form of exchange
and trade.
Gold and silver coins gradually emerged in the use of trading, although the level
of pure gold and silver content impacted the coins value. Only coins that consist of the
pure precious metal are bullions; all other coins are referred to simply as coins. It is
interesting to note that gold and silver lasted many centuries as the basis of economic
measure and even into relatively recent history of the gold standard, which we’ll cover in
the next section. Fast-forward two thousand years and bartering has long been replaced
by a currency-based system. Even so, there have been evolutions in the past century
alone on how—globally—the monetary system has evolved from using gold and silver
to represent national wealth and economic exchange to the current system.
Throughout history, some types of money have gained widespread circulation
outside of the nations that issued them. Whenever a country or empire has regional or
global control of trade, its currency becomes the dominant currency for trade and
governs the monetary system of that time. In the middle of a period that relies on one
major currency, it’s easy to forget that, throughout history, there have been other
primary currencies—a historical cycle. Generally, the best currency to use is the most
liquid one, the one issued by the nation with the biggest economy as well as usually the
largest import-export markets. Rarely has a single currency been the exclusive medium
of world trade, but a few have come close.
Here is a quick look at some of some of the most powerful currencies in history:
Persian daric. The daric was a gold coin used in Persia between 522 BC and
330 BC.
Roman currency. Currencies such as the aureus (gold), the denarius (silver),
the sestertius (bronze), the dupondius (bronze), and the as (copper) were used during
the Roman Empire from around 250 BC to AD 250.
Thaler. From about 1486 to 1908, the thaler and its variations were used in
Europe as the standard against which the various states’ currencies could be valued.
Spanish American pesos. Around 1500 to the early nineteenth century, this
contemporary of the thaler was widely used in Europe, the Americas, and the Far East;
it became the first world currency by the late eighteenth century.

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

British pound. The pound’s origins date as early as around AD 800, but its
influence grew in the 1600s as the unofficial gold standard; from 1816 to around 1939
the pound was the global reserve currency until the collapse of the gold standard.
US dollar. The Coinage Act of 1792 established the dollar as the basis for a
monetary account, and it went into circulation two years later as a silver coin. Its
strength as a global reserve currency expanded in the 1800s and continues today.
Euro. Officially in circulation on January 1, 1999, the euro continues to serve as
currency in many European countries today.

What is International Monetary System?

The international monetary system refers to the operating system of the financial
environment, which consists of financial institutions, multinational corporations, and
investors. The international monetary system provides the institutional framework for
determining the rules and procedures for international payments, determination of
exchange rates, and movement of capital, (Kumar, R.).
International monetary system refers to the system and rules that govern the use
and exchange of money around the world and between countries. Each country has its
own currency as money and the international monetary system governs the rules for
valuing and exchanging these currencies.
Evolution of International Monetary System
1. The era of bimetallism
Before 1870, the international monetary system consisted of bimetallism, where
both gold and silver coins were used as the international modes of payment. The
exchange rates among currencies were determined by their gold or silver contents.
Some countries were either on a gold or a silver standard.
2. Gold standard
The international gold standard prevailed from 1875 to 1914. In a gold standard
system, gold alone is assured of unrestricted coinage. There was a two-way
convertibility between gold and national currencies at a stable ratio. No restrictions
were in place for the export and import of gold. The exchange rate between two
currencies was determined by their gold content.

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

The gold standard ended in 1914 during World War I. Great Britain, France,
Germany, and many other countries-imposed embargoes on gold exports and
suspended redemption of bank notes in gold. The interwar period was between
World War I and World War II (1915-1944). During this period, the United States
replaced Britain as the dominant financial power of the world. The United States
returned to a gold standard in 1919. During the intermittent period, many countries
followed a policy of sterilization of gold by matching inflows and outflows of gold with
changes in domestic money and credit.
The Advantages of the Gold Standard
The gold standard dramatically reduced the risk in exchange rates because it
established fixed exchange rates between currencies. Any fluctuations were
relatively small. This made it easier for global companies to manage costs and
pricing. International trade grew throughout the world, although economists are not
always in agreement as to whether the gold standard was an essential part of that
trend.
The second advantage is that countries were forced to observe strict
monetary policies. They could not just print money to combat economic downturns.
One of the key features of the gold standard was that a currency had to actually
have in reserve enough gold to convert all of its currency being held by anyone into
gold. Therefore, the volume of paper currency could not exceed the gold reserves.
The third major advantage was that gold standard would help a country
correct its trade imbalance. For example, if a country was importing more than it is
exporting, (called a trade deficit), then under the gold standard the country had to
pay for the imports with gold. The government of the country would have to reduce
the amount of paper currency, because there could not be more currency in
circulation than its gold reserves. With less money floating around, people would
have less money to spend (thus causing a decrease in demand) and prices would
also eventually decrease. As a result, with cheaper goods and services to offer,
companies from the country could export more, changing the international trade
balance gradually back to being in balance. For these three primary reasons, and as
a result of the 2008 global financial crises, some modern economists are calling for
the return of the gold standard or a similar system.
Collapse of the Gold Standard
If it was so good, what happened? The gold standard eventually collapsed from
the impact of World War I. During the war, nations on both sides had to finance their

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

huge military expenses and did so by printing more paper currency. As the currency in
circulation exceeded each country’s gold reserves, many countries were forced to
abandon the gold standard. In the 1920s, most countries, including the United Kingdom,
the United States, Russia, and France, returned to the gold standard at the same price
level, despite the political instability, high unemployment, and inflation that were spread
throughout Europe.
However, the revival of the gold standard was short-lived due to the Great
Depression, which began in the late 1920s. The Great Depression was a worldwide
phenomenon. By 1928, Germany, Brazil, and the economies of Southeast Asia were
depressed. By early 1929, the economies of Poland, Argentina, and Canada were
contracting, and the United States economy followed in the middle of 1929. Some
economists have suggested that the larger factor tying these countries together was the
international gold standard, which they believe prolonged the Great Depression. ( The
Concise Encyclopedia of Economics, s.v. “Great Depression,” accessed July 23, 2010,
http://www.econlib.org/library/Enc/GreatDepression.html.)

The gold standard limited the flexibility of the monetary policy of each country’s
central banks by limiting their ability to expand the money supply. Under the gold
standard, countries could not expand their money supply beyond what was allowed by
the gold reserves held in their vaults.
Too much money had been created during World War I to allow a return to the
gold standard without either large currency devaluations or price deflations. In addition,
the US gold stock had doubled to about 40 percent of the world’s monetary gold. There
simply was not enough monetary gold in the rest of the world to support the countries’
currencies at the existing exchange rates.
By 1931, the United Kingdom had to officially abandon its commitment to maintain
the value of the British pound. The currency was allowed to float, which meant that its
value would increase or decrease based on demand and supply. The US dollar and the
French franc were the next strongest currencies and nations sought to peg the value of
their currencies to either the dollar or franc. However, in 1934, the United States
devalued its currency from $20.67 per ounce of gold to $35 per ounce. With a cheaper
US dollar, US firms were able to export more as the price of their goods and services
were cheaper vis-à-vis other nations. Other countries devalued their currencies in
retaliation of the lower US dollar. Many of these countries used arbitrary par values
rather than a price relative to their gold reserves. Each country hoped to make its
exports cheaper to other countries and reduce expensive imports. However, with so
many countries simultaneously devaluing their currencies, the impact on prices was
canceled out. Many countries also imposed tariffs and other trade restrictions in an

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

effort to protect domestic industries and jobs. By 1939, the gold standard was dead; it
was no longer an accurate indicator of a currency’s real value.

3. Gold exchange standard

In the early 1940s, the United States and the United Kingdom began discussions to
formulate a new international monetary system. John Maynard Keynes, a highly
influential British economic thinker, and Harry Dexter White, a US Treasury official,
paved the way to create a new monetary system. In July 1944, representatives from
forty-four countries met in Bretton Woods, New Hampshire, to establish a new
international monetary system.
“The challenge,” wrote Ngaire Woods in his book The Globalizers: The IMF, the
World Bank, and Their Borrowers, “was to gain agreement among states about how
to finance postwar reconstruction, stabilize exchange rates, foster trade, and prevent
balance of payments crises from unraveling the system( .”Ngaire Woods, Globalizers: The
IMF, the World Bank, and Their Borrowers (Ithaca, NY: Cornell University Press, 2006),)

The resulting Bretton Woods Agreement created a new dollar-based monetary

system, which incorporated some of the disciplinary advantages of the gold system
while giving countries the flexibility they needed to manage temporary economic
setbacks, which had led to the fall of the gold standard. The Bretton Woods Agreement
lasted until 1971 and established several key features.
Fixed Exchange Rates
Fixed exchange rates are also sometimes called pegged rates. One of the critical
factors that led to the fall of the gold standard was that after the United Kingdom
abandoned its commitment to maintaining the value of the British pound, countries
sought to peg their currencies to the US dollar. With the strength of the US economy,
the gold supply in the United States increased, while many countries had less gold in
reserve than they did currency in circulation. The Bretton Woods system worked to fix
this by tying the value of the US dollar to gold but also by tying all of the other countries
to the US dollar rather than directly to gold. The par value of the US dollar was fixed at
$35 to one ounce of gold. All other countries then set the value of their currencies to the
US dollar. In reflection of the changing times, the British pound had undergone a
substantial loss in value and by that point, its value was $2.40 to £1. Member countries
had to maintain the value of their currencies within 1 percent of the fixed exchange rate.
Lastly, the agreement established that only governments, rather than anyone who
demanded it, could convert their US dollar holdings into gold—a major improvement

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

over the gold standard. In fact, most businesspeople eventually ignored the technicality
of pegging the US dollar to gold and simply utilized the actual exchange rates between
countries (e.g., the pound to the dollar) as an economic measure for doing business.
National Flexibility
To enable countries to manage temporary but serious downturns, the Bretton Woods
Agreement provided for a devaluation of a currency—more than 10 percent if needed.
Countries could not use this tool to competitively manipulate imports and exports.
Rather, the tool was intended to prevent the large-scale economic downturn that took
place in the 1930s.
Creation of the International Monetary Fund and the World Bank
"What Is the Role of the IMF and the World Bank?" looks at the International
Monetary Fund and the World Bank more closely, as they have survived the collapse of
the Bretton Woods Agreement. In essence, the IMF’s initial primary purpose was to help
manage the fixed rate exchange system; it eventually evolved to help governments
correct temporary trade imbalances (typically deficits) with loans. The World Bank’s
purpose was to help with post–World War II European reconstruction. Both institutions
continue to serve these roles but have evolved into broader institutions that serve
essential global purposes, even though the system that created them is long gone.
Section 6.2 "What Is the Role of the IMF and the World Bank?" explores them in greater
detail and addresses the history, purpose, evolution, and current opportunities and
challenges of both institutions.

Collapse of Bretton Woods

Despite a fixed exchange rate based on the US dollar and more national flexibility,
the Bretton Woods Agreement ran into challenges in the early 1970s. The US trade
balance had turned to a deficit as Americans were importing more than they were
exporting. Throughout the 1950s and 1960s, countries had substantially increased their
holdings of US dollars, which was the only currency pegged to gold. By the late 1960s,
many of these countries expressed concern that the US did not have enough gold
reserves to exchange all of the US dollars in global circulation. This became known as
the Triffin Paradox, named after the economist Robert Triffin, who identified this
problem. He noted that the more dollars foreign countries held, the less faith they had in
the ability of the US government to convert those dollars. Like banks, though, countries
do not keep enough gold or cash on hand to honor all of their liabilities. They maintain a
percentage, called a reserve. Bank reserve ratios are usually 10 percent or less. (The

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

low reserve ratio has been blamed by many as a cause of the 2008 financial crisis.)
Some countries state their reserve ratios openly, and most seek to actively manage
their ratios daily with open-market monetary policies—that is, buying and selling
government securities and other financial instruments, which indirectly controls the total
money supply in circulation, which in turn impacts supply and demand for the currency.
Before moving on, recall that the major significance of the Bretton Woods
Agreement was that it was the first formal institution that governed international
monetary systems. By having a formal set of rules, regulations, and guidelines for
decision making, the Bretton Woods Agreement established a higher level of economic
stability. International businesses benefited from the almost thirty years of stability in
exchange rates. Bretton Woods established a standard for future monetary systems to
improve on; countries today continue to explore how best to achieve this. Nothing has
fully replaced Bretton Woods to this day, despite extensive efforts.
Post–Bretton Woods Systems and Subsequent Exchange Rate Efforts
When Bretton Woods was established, one of the original architects, Keynes, initially
proposed creating an international currency called Bancor as the main currency for
clearing. However, the Americans had an alternative proposal for the creation of a
central currency called unitas. Neither gained momentum; the US dollar was the reserve
currency. Reserve currency is a main currency that many countries and institutions hold
as part of their foreign exchange reserves. Reserve currencies are often international
pricing currencies for world products and services. Examples of current reserve
currencies are the US dollar, the euro, the British pound, the Swiss franc, and the
Japanese yen.
Many feared that the collapse of the Bretton Woods system would bring the period of
rapid growth to an end. In fact, the transition to floating exchange rates was relatively
smooth, and it was certainly timely: flexible exchange rates made it easier for
economies to adjust to more expensive oil, when the price suddenly started going up in
October 1973. Floating rates have facilitated adjustments to external shocks ever since.
The IMF responded to the challenges created by the oil price shocks of the 1970s by
adapting its lending instruments. To help oil importers deal with anticipated current
account deficits and inflation in the face of higher oil prices, it set up the first of two oil
facilities.“The End of the Bretton Woods System (1972–81),” International Monetary
Fund, accessed July 26, 2010, http://www.imf.org/external/about/histend.htm.
After the collapse of Bretton Woods and the Smithsonian Agreement, several new
efforts tried to replace the global system. The most noteworthy regional effort resulted in

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

the European Monetary System (EMS) and the creation of a single currency, the euro.
While there have been no completely effective efforts to replace Bretton Woods on a
global level, there have been efforts that have provided ongoing exchange rate
mechanisms.

Jamaica Agreement
In 1976, countries met to formalize a floating exchange rate system as the new
international monetary system. The Jamaica Agreement established a managed float
system of exchange rates, in which currencies float against one another with
governments intervening only to stabilize their currencies at set target exchange rates.
This is in contrast to a completely free floating exchange rate system, which has no
government intervention; currencies float freely against one another. The Jamaica
Agreement also removed gold as the primary reserve asset of the IMF. Additionally, the
purpose of the IMF was expanded to include lending money as a last resort to countries
with balance-of-payment challenges.
The Gs Begin
In the early 1980s, the value of the US dollar increased, pushing up the prices of US
exports and thereby increasing the trade deficit. To address the imbalances, five of the
world’s largest economies met in September 1985 to determine a solution. The five
countries were Britain, France, Germany, Japan, and the United States; this group
became known as the Group of Five, shortened to G5. The 1985 agreement, called the
Plaza Accord because it was held at the Plaza Hotel in New York City, focused on
forcing down the value of the US dollar through collective efforts.
By February 1987, the markets had pushed the dollar value down, and some worried
it was now valued too low. The G5 met again, but now as the Group of Seven, adding
Italy and Canada—it became known as the G7. The Louvre Accord, so named for being
agreed on in Paris, stabilized the dollar. The countries agreed to support the dollar at
the current valuation. The G7 continued to meet regularly to address ongoing economic
issues.
The G7 was expanded in 1999 to include twenty countries as a response to the
financial crises of the late 1990s and the growing recognition that key emerging-market
countries were not adequately included in the core of global economic discussions and
governance. It was not until a decade later, though, that the G20 effectively replaced the
G8, which was made up of the original G7 and Russia. The European Union was
represented in G20 but could not host or chair the group.

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

Keeping all of these different groups straight can be very confusing. The news may
report on different groupings as countries are added or removed from time to time. The
key point to remember is that anything related to a G is likely to be a forum consisting of
finance ministers and governors of central banks who are meeting to discuss matters
related to cooperating on an international monetary system and key issues in the global
economy.
The G20 is likely to be the stronger forum for the foreseeable future, given the
number of countries it includes and the amount of world trade it represents. “Together,
member countries represent around 90 per cent of global gross national product, 80 per
cent of world trade (including EU intra-trade) as well as two-thirds of the world’s
population.”“About G-20,” G-20, accessed July 25, 2010, http://www.g20.org/en.

Fact:
G-ology
“At present, a number of groups are jostling to be the pre-eminent forum for
discussions between world leaders. The G20 ended 2009 by in effect replacing the old
G8. But that is not the end of the matter. In 2010 the G20 began to face a new
challenger—G2 [the United States and China]. To confuse matters further, lobbies have
emerged advocating the formation of a G13 and a G3. (” Gideon Rachman, “A Modern Guide
to G-ology,” Economist, November 13, 2009, accessed February 9, 2011,
http://www.economist.com/node/14742524.)

The G20 is a powerful, informal group of nineteen countries and the European
Union. It also includes a representative from the World Bank and the International
Monetary Fund. The list developed from an effort to include major developing countries
with countries with developed economies. Its purpose is to address issues of the
international financial system.

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

Today’s Exchange Rate System

While there is not an official replacement to the Bretton Woods system, there are
provisions in place through the ongoing forum discussions of the G20. Today’s system
remains—in large part—a managed float system, with the US dollar and the euro
jostling to be the premier global currency. For businesses that once quoted primarily in
US dollars, pricing is now just as often noted in the euro as well.
Some smaller nations have chosen to voluntarily set exchange rates against the
dollar while other countries have selected the euro. Usually a country makes the
decision between the dollar and the euro by reviewing their largest trading partners. By
choosing the euro or the dollar, countries seek currency stability and a reduction in
inflation, among other various perceived benefits. Many countries in Latin America once
dollarized to provide currency stability for their economy. Today, this is changing, as
individual economies have strengthened and countries are now seeking to dedollarize.

Summary
The international monetary system had many informal and formal stages. For
more than one hundred years, the gold standard provided a stable means for
countries to exchange their currencies and facilitate trade. With the Great
Depression, the gold standard collapsed and gradually gave way to the Bretton
Woods system.
The Bretton Woods system established a new monetary system based on the US
dollar. This system incorporated some of the disciplinary advantages of the gold
system while giving countries the flexibility they needed to manage temporary
economic setbacks, which had led to the fall of the gold standard.
The Bretton Woods system lasted until 1971 and provided the longest formal
mechanism for an exchange-rate system and forums for countries to cooperate on
coordinating policy and navigating temporary economic crises.
While no new formal system has replaced Bretton Woods, some of its key
elements have endured, including a modified managed float of foreign exchange, the
International Monetary Fund (IMF), and the World Bank—although each has evolved
to meet changing world conditions.

Module 10: The International Monetary System

 Republic of the Philippines
University of Rizal System
Province of Rizal
www.urs.edu..ph
Email Address: [email protected]

Self-Assessment Question:
1. What is International Monetary System?
2. What is the Bretton Woods Agreement?
3. What is G-ology? Who is in the current G20?

References:

Stock Markets, Derivatives Markets, and Foreign Exchange Markets

Author links open overlay panel Rajesh Kumar,
https://www.sciencedirect.com/science/article/pii/B9780124169975000051

International Monetary System, https://saylordotorg.github.io/text_international-

business/s10-01-what-is-the-international-mone.html

The International Monetary System: Where Are We and Where Do We Need to Go?
Rakes https://www.imf.org/external/pubs/ft/wp/2013/wp13224.pdfh Mohan, Michael
Debabrata Patra and Muneesh Kapur

Module 10: The International Monetary System