International Monetary System Essay

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Success or failure of an international monetary system depends upon the extent to which it can fulfill these goals without  allowing conflicting  goals of national governments  to undermine the system. While many international arrangements have tried to fulfill these goals over the  past  century,  three  systems  deserve special mention.

One  type  was  the  gold  standard   (1879–1913). More  by convention  than  through  an international agreement, most countries had based their monetary system on gold in the 19th century.  Value of a currency was fixed in terms of gold and the supply of a currency depended  upon the gold reserves held by a country. Payments between countries  were achieved easily through  shipments  of gold, and exchange rates were effectively fixed as a result  of each currency’s rigid link to gold. Trade  imbalances  between  countries  were  paid  for  in  gold that  could  be  shipped between countries without restrictions. An outflow of gold for a deficit country would reduce gold reserves and hence the money supply (automatically). This would put  downward  pressure  on  domestic  prices, while foreign prices  would be rising due  to consequences  of increased  gold reserves in that  country. These changes in relative prices set in motion the corrective forces that  eliminated  the trade  imbalances. Free flow of gold also ensured that capital was free to move from one country to another. Indeed, the global economy had reached very high levels of integration under this regime.

The downfall of the gold standard lay in its reliance on gold supplies. It left very little room  for governments to play an active role in their economies. With the start of World War I, that objective became more important than maintenance of fixed exchange rates.

Another type was the Bretton Woods system (1945–1972). Experience with the Depression  in the 1930s convinced  world leaders that  self-serving economic policies that  attempt  to transfer  costs of economic hardships to others do not necessarily work. The financial turmoil of the Depression era was replaced by a fixed exchange rate system in 1945 in which the dollar was to acquire a central role. Signatories to the Bretton  Woods  agreement  gave up their currencies’ links with gold and established fixed exchange rates against the U.S. dollar. In turn, the U.S. dollar was to have a fixed price in terms of gold and would be freely convertible into gold.

The international monetary system in effect became a dollar standard. The role of the dollar as a reserve and as a vehicle currency  increased significantly over the next three decades. The fixed exchange rates could only be changed  infrequently  with international consultations and only when fundamental economic situations warranted  such changes. The International Monetary Fund (IMF) was established to guide countries and to ensure stability in the international financial markets.

The IMF also became a source of funds for countries that were facing balance of payments imbalances.

The Bretton  Woods  system provided  an unprecedented stability in the financial markets for war-ravaged countries to rebuild their economies after World War II. The IMF was successful in persuading  more and more countries  to gradually open their financial markets and get rid of exchange controls. By the late 1960s, however, flaws of this system became increasingly apparent.  First, there  was a bias in the system against  allowing exchange  rates  to  change  quickly and  by small  amounts  when  economic  conditions warranted. This bias had led to a number  of speculative runs against a number  of currencies  as speculators could spot under or overvalued currencies  and could lay bets against those currencies.  Second, the resources of the IMF became inadequate as the industrialized  countries  grew in  size and  their  financial requirements grew far more  rapidly than  the funds available to the IMF. Third, and most important, the system  had  left no  room  for the  U.S. economy  to adjust  should  it have balance  of payments  difficulties. While all other countries  could use a change in their exchange rate as a policy tool, the U.S. economy was denied this possibility because it had become the anchor for the international monetary system.

A third  system  type  is the  floating  rate  system (1973–). In 1968, the U.S. government  withdrew the promise  to freely convert  U.S. dollars into  gold for nonofficial purposes.  A slight adjustment  was made to the price of gold in terms of dollars in 1971, and the gold window was completely closed. By early 1973, the fixed exchange rate system was abandoned  and most currencies  were allowed to float freely. Market  participants would determine  the values of currencies.

With  the  exception  of the  developments  in  the European  Monetary  System, most major currencies of the world continue to float. Central banks of some emerging  economies  “manage”  the  values  of their currencies  by intervening  in  the  foreign  exchange markets.  Some other  countries  link their currencies to that of a country on which their economies depend heavily. Most  industrialized   countries   today  allow unrestricted flow of capital between their economies and the rest of the world.


  1. Benjamin J. Cohen, Global Monetary Governance (Routledge, 2008);
  2. Benjamin  Cohen,  “The International Monetary  System: Diffusion and  Ambiguity,” International  Affairs (v.84/3, 2008);
  3. Barry J. Eichengreen, Globalizing Capital: A History of the International Monetary System (Princeton University Press, 2008);
  4. Barry Eichengreen and Raul Razo-Garcia, “The International Monetary System in the Last and Next 20 Years,” Economic Policy (v.21/47, 2006);
  5. Roland I. McKinnon, The Rules of the Game: International  Money and Exchange Rates (MIT Press, 1996);
  6. Robert A. Mundell, “The Significance of the Euro in the International Monetary System,” American Economist (v.47, 2003);
  7. Richard Samans, Marc Uzan, and Augusto Lopez-Claros, The International Monetary System, the IMF and the G20 (World Economic Forum, 2007).

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