Looking into the International Monetary System

Looking into International Monetary System

Introduction

International monetary system plays an important part in world trade, investment and other international transactions and payments. The three facts in international monetary system are adequate liquidity, timely adjustment and confidence. These elements help the whole system to work smoothly relative evenly and sustainably. From the Bretton woods system to the policies at the moment, all of the countries are pursing for the optimization of the monetary system that requires for the compromises and relative hurt to the interest of an individual state in political especially. Although the reasonable and effective monetary system can bring economic development in the long run, few nations are willing to sacrifice the short-term progress. This article will introduce the evolving history of international monetary system in three phases respectively as well as the crises that arose because of lack of confidence. Then, the article will discuss the role the monetary system plays in international relations from two aspects.

History of international monetary system

The Bretton woods system (1945-1971)

Great depression resulted in the collapse of gold standard. After the Second World War, it became clear that gold and British pound cannot take the possibility to be the world key currency since Britain weakened in the war destruction. In fact, the frequent economic crises and damage all over the world especially in the European countries that are significant in world economy and political led to the trade protection, which harmed to the world economic recovery.

In order to rebuild the world economic order and reconstruct the European countries and Japan, world needed a new system to regular and balance the policy of different countries. While the states such as Britain and France cannot take over the issue, America became the world leader to rebuild world economic order because of the advantage of national economy political and military.

Before the end of the Second World War, the basic content of the new system settled down. Since then, dollar became the world key currency. Dollar got the equal positon to gold and the exchange rate between dollar and gold was fixed as $35=1 ounce while the other currencies were required to exchange with dollar and the rate fluctuation was restricted in one percent. What’s more, the system also created IMF (the International Monetary Fund) to supervise and regular the economic order and provide with short-term loans to help countries cover their payments deficits. While its twin institution offered loans to promote a speedy recovery and development.

Nevertheless, the damaged countries could not obtain sufficient dollar by exporting since the destruction of productivity. The institutions cannot afford the huge amount of money to support the reconstruction for these countries either. Facing of the situation, to facilitate the system, America put forward the foreign aid and military expenditures such as Marshall Plan and in NATO (North Atlantic Treaty Organization). At that time, America received huge trade surplus that supported all of these plans.

One of the necessary conditions of the system was the confidence of dollar that required that the volume of dollar in foreign countries cannot exceed the gold reverse in America. However, in 1960, for the first time, foreign dollar holdings exceeded U.S. gold reverse, which harmed people’s confidence to dollar. With the recovery of European countries and Japan, they were not willing to the unilateral management of America. After 1960, cooperation among central banks of different countries and establishment of the Group of Ten promote the process of multilateral management. The new management mechanisms helped to prevent currency crises and promote the reform of the system.

In fact, the key conflict and also the basic principle resulted in the disruption of the system. In order to make the system work regularly, America had to give attention to both liquidity and confidence. That means America should increase the volume of dollar to satisfy the need of international settlement and reverse that require trade deficit. While America were also supposed to stabilize the currency value which request for trade surplus. With the recovery and development of Europe and Japan and the dilemma of Vietnam War, the trade deficit expanded heavily. After the Nixon Shock, the fixed exchange rate between dollar and gold broke down.

Interdependence (1971-1989)

After 1971, many countries tried to maintain the Bretton woods system to compensate the influence of the disruption of fixed exchange rate. At that time, the increasing amount of capital that flowed in the international market and the incompact regulations of capital flow among nations became more important problems.

As the U.S. balance of payments weakened dramatically the currencies such as Yen and Mark occupied an increasingly important position in world economy while dollar still was the strong currency. Floating exchange rate settle in the Second Amendment became a new characteristic in this period.

Carter tended to prevent the recession through the cooperation among industrial countries. In 1979, the Federal Reverse turned instead to monetarism to manage the growth of the nation’s money supply and tightened the money supply, thereby promoting the interest rate to release inflation. With the election of Reagan, the policy concentrated on controlling inflation. While adopting the tight monetary policy, America also increased military expenditures and reduced taxes to stimulate economy. These measures reduced inflation rate and did good to the recovery of confidence. While the high interest rate attracting capital to flow in the other countries also increase the interest rate.

In the 1980s, America experienced twin deficits. The budget deficit was the result of lowering taxed without reducing government spending and the trade deficit resulted from increasing demand imports, overvalued dollar and strong U.S. growth. The trade deficit could damage the dollar confidence and the short-term capital flow harmed the economic system. In 1985, dollar up valued dramatically leading to the expansion of trade deficit because the tight monetary policy and expansionary fiscal policy.

The meeting held by the G5 concluded the Plaza Agreement, America agreed to reduce government expenditures to cut down the deficit on current account while other countries came an agreement to adopt related policies to promote the world economic development. After the meeting, Yen up valued dramatically and Japan came into the management system.

Globalization (1989- )

In this period, the cooperation among G-7 finance ministers and central banks played a significant role in managing the monetary system especially the U.S., Japan and Germany.