Gold Standard & Bretton woods System
Presented By: Group II YMT MMS(Finance)
A Brief History of the International Monetary System
Pre 1875 Bimetalism 1875-1914: Classical Gold Standard 1915-1944: Interwar Period 1945-1972: Bretton Woods System 1973-Present: Flexible (Hybrid) System
The Gold Standard (Pre - 1914)
Gold has been a medium of exchange since 3,000 BC. Rules of the game were simple, each country set the rate at
which its currency unit could be converted to a weight of gold.
Currency exchange rates were in effect fixed. Expansionary monetary policy was limited to a governments
supply of gold.
Was in effect until the outbreak of WWI as the free
movement of gold was interrupted.
The Gold Standard (Pre - 1914)
An example:
US dollar is pegged to gold at $20.67 per oz. British pound is pegged to gold at 4.2474 per oz. Therefore, the exchange rate is determined by the relative gold prices: $20.67 = 4.2474 Then 1 = $4.8665
Misalignment in exchange rates and imbalances of payment
corrected by the price-specie flow mechanism. Suppose it is $4/ instead
Price-Specie Flow Mechanism
Keep difference and repeat until exchange rate is aligned.
Buy gold in England (cost = 4.2474 for 1 oz.)
Gold leaves England and enters U.S (English Central Bank sells gold in exchange for .)
Send those 5.1675 back to England
Under gold standard, any misalignment in the exchange rate will automatically be corrected by crossborder flows of gold.
Ship gold to U.S and Sell for $20.67
Convert at going exchange rate, get
5.1675
Gold is bought by the U.S. Central Bank and more $ are released.
Essentials elements for the success of gold standard system
y Ratio Parity y Unlimited Convertibility y No restriction on Transfer y Issue notes in Proportion to gold
Gold Standard: Why did the gold standard fail?
y The Automatic Adjustment Mechanism y Gold Standard was the Root of the Problem in the Great
Depression
y US Suffered 8 Depressions y Experienced Recessions Under the Gold Standard y No Government Control y Uncontrollable Swings in the Stock of Gold.
Gold Standard: Introduction to cons
y Too many problems y Too costly y Limited supply y Liquidity trap y Deflationary bias y Economic compromises y Difficult to maintain gold
parity. y Free trade of gold y Free convertibility
Historical precedent of failure
y Impact of World War I (191425)
The gold needed to finance the seemingly limitless demand for war equipment
y Federal Reserve was required by law to have 40% gold backing
of its Federal Reserve demand notes
y Fearing imminent devaluation of the dollar, many foreign and
domestic depositors withdrew funds from U.S. banks to convert them into gold or other assets.
Conclusion to the Cons
y Possibility of printing money to cover expenses y Unrealistic and Impractical to Effectively Stabilize an
Economy of Change.
y Nor does such a Standard Encourage Economic Development.
Bretton Woods Agreement
The Agreement signed in 1944 730 delegates from 44 Allied nations At the Mount Washington Hotel, situated in Bretton Woods, New Hampshire To regulate the international monetary and financial order after the conclusion of World War II.
Achievements :
Agreements were signed to set up The International Bank for Reconstruction and Development (IBRD), The General Agreement on Tariffs and Trade (GATT), The International Monetary Fund (IMF). The Bretton Woods system of exchange rate management was set up .
The main terms of this agreement
Formation of the IMF and the IBRD (presently part of the World Bank). Adjustably pegged foreign exchange market rate system: The exchange rates were fixed, with the provision of changing them if necessary. Currencies were required to be convertible for trade related and other current account transactions. The governments, however, had the power to regulate ostentatious capital flows. As it was possible that exchange rates thus established might not be favorable to a country's balance of payments position, the governments had the power to revise them by up to 10%. All member countries were required to subscribe to the IMF's capital.
Bretton Wood System
y Beginning of Bretton wood system. y Its a modified version of Gold Exchange standards. y $35= 1 ounce of gold ( 28.35 gms). y Other countries should maintain party with $. y To maintain this obligation the member countries can borrow
from IMF.
y If the problem is genuine in maintaining the parity of member
countries currency then they can change parity by 10%
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
Pound
Par value
Yen
Par value
US dollar
Pegged at $35/oz
Gold
International Monetary System
y The exchange rate determine by market forces y Demand for Foreign Currency for Import and proposed
Investments abroad
y Supply of a Foreign Currency is Export to other country
and Investment in our country
y Strengths of two Currency determined by Market equation
Types of Monetary System
y Freely Floating Exchange rate y Managed Float y Fixed with one currency y Fixed with Few currency y Limited Flexibility with one or basket currency y Crawling Peg y Co-operative
Current Exchange Rate Arrangements
The largest number of countries, about 49, allow market forces
to determine their currencys value.
Managed Float. About 25 countries combine government
intervention with market forces to set exchange rates.
Pegged to another currency such as the U.S. dollar or euro
(through franc or mark). About 45 countries.
No national currency and simply uses another currency, such as
the dollar or euro as their own.
Features of a good international monetary system
Adjustment : A good system must be able to adjust imbalances in balance of payments quickly and at a relatively lower cost; Stability and Confidence: The system must be able to keep exchange rates relatively fixed and people must have confidence in the stability of the system; Liquidity: The system must be able to provide enough reserve assets for a nation to correct its balance of payments deficits without making the nation run into deflation or inflation.
