The international monetary system refers to the system and rules that govern the use and exchange of money around the world and between countries.
History of the International Monetary System
There have been four phases/ stages in the evolution of the international monetary system:
- Gold Standard (1875-1914)
- Inter-war period (1915-1944)
- Bretton Woods system (1945-1972)
- Present International Monetary system (1972-present)
1) Gold standard
The gold standard is a monetary system in which each country fixed the value of its currency in terms of gold. The exchange rate is determined accordingly.
Let’s say- 1 ounce of gold = 20 pounds (fixed by the UK) and 1 ounce of gold = 10 dollars (fixed by the US).
Hence, the dollar-pound exchange rate will be 20 pounds = 10 dollars or 1 pound = 0.5 dollars
The Gold standard created a fixed exchange rate system.
There was free convertibility between gold and national currencies.
Also, all national currencies had to be backed by gold. Therefore, the countries had to keep enough gold reserves to issue currency.
One advantage of the gold standard was that the Balance of payments (BOP) imbalances were corrected automatically.
Let’s say- there are only two countries in the world – The UK and France. The UK runs a BOP deficit as it has imported more goods from France. France runs a BOP surplus.
This will obviously result in the transfer of money (gold) from the UK to France as payment for more imports.
The UK will have to reduce its money supply due to a decline in gold reserves. The reduction in the money supply will bring down prices in the UK.
The opposite will happen in France. Its prices will increase.
Now, the UK will be able to export cheaper goods to France. On the other hand, the imports from France will slow down. This will correct the BOP imbalances of both countries.
Another advantage was that the gold standard created a stable exchange rate system that was conducive to international trade.
2) Inter-war period
After the world war started in 1914, the gold standard was abandoned.
Countries began to depreciate their currencies to be able to export more. It was a period of fluctuating exchange rates and competitive devaluation.
3) Bretton woods system
In the early 1940s, the United States and the United Kingdom began discussions to rebuild the world economy after the destruction of two world wars. Their goal was to create a fixed exchange rate system without the gold standard.
The new international monetary system was established in 1944 in a conference organised by the United Nations in a town named Bretton Woods in New Hampshire (USA).
The conference is officially known as the United Nations Monetary and Financial Conference. It was attended by 44 countries.
India was represented in the Bretton-woods conference by Sir C.D. Deshmukh, the first Indian Governor of RBI.
[The conference also led to the creation of the International Monetary Fund (IMF), World Bank, and GATT. GATT is the predecessor of WTO. Read: WTO: Meaning, Origin etc.}
The Bretton-woods created a dollar-based fixed exchange rate system.
In the Bretton-woods system, only the US fixed the value of its currency to gold. (The initial peg was 35 dollars = 1 ounce of gold). All the other currencies were pegged to the US dollar instead. They were allowed to have a 1 % band around which their currencies could fluctuate.
The countries were also given the flexibility to devalue their currencies in case of an emergency.
It was similar to the gold standard and was described as a gold-exchange standard.
There were some differences. Only the US dollar was backed by gold. Other currencies did not have to maintain gold convertibility.
Also, this convertibility was limited. Only governments (not anyone who demanded it) could convert their US dollars into gold.
4) Present International Monetary system
The Bretton Woods system collapsed in 1971. The United States had to stop the convertibility to gold due to high inflation and trade deficit in the economy.
Inflation led to an increase in the price of gold. Hence, the US could not maintain a fixed value of 35 dollars to 1 ounce of gold.
In 1973, the world moved to a flexible exchange rate system.
In 1976, the countries met in Jamaica to formalize the new system.
The floating exchange rate system means that the exchange rate of a currency is determined by the market forces of demand and supply.
India’s Monetary Policy system
Managed float.
India has managed floating exchange rate system. The exchange rate is determined by market forces. But, the RBI intervenes in the currency market to curb volatility.
That’s all
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Please explain why the gold price rises when dollar value falls.
This is because prices of goods are often denominated in US dollars. It is the benchmark currency.
Let’s say the price of gold is $1 and 1$ = Rs.60. India has to pay Rs. 60 to buy gold.
For some reason, the value of the US dollar falls. It implies that the other currencies (including rupee) appreciate with respect to the dollar and now we assume 1 $ = Rs.50. India has to pay only Rs.50 to buy gold.
It becomes cheaper to buy gold in other currencies. It causes demand to rise. Hence, the price of gold increase.(let’s say from $1 to $2).
Another reason is that people view the US dollar as a safe investment instrument. However, if the value of the dollar declines, people switch to alternative investment options like gold. It leads to increase in demand for gold.
when currency appreciates, you can buy more goods. which means imports become cheaper.
That’s right. I have edited my previous comment accordingly.
For the benefit of other readers, let’s say the price of a good imported from the USA is $1 and 1 dollar is equivalent to Rs.60. You have to pay Rs.60 to buy that product. If the value of the rupee appreciates to Rs. 50 with respect to the US dollar, now you will have to pay only Rs.50 to buy the product.
Hence, imports become cheaper and exports become more expensive.
Thanks for such simple and easy explanation.
You are welcome!
Why don’t India follow free float exchange rate system and America does?
No country in the world maintains a completely floating exchange rate system (known as clean float). The Central bank intervenes in the FOREX market, but the extent of intervention differs.