International monetary system structure and function

International Monetary System

In world trade, varied national currencies are swapped for each other by means of rules and procedures set by a system called the international monetary system. To delineate a general standard of value for the world's currencies, such a system is believed to be necessary.

The global monetary structure has always adhered to the organizational framework of the international discipline. In each stage of the financial capitalism there exists a corresponding monetary approach. The monetary structure during the postwar periods catered to the dominance of the United States. This was applied as a tool during the period to enforce the U.S. dominance over all its allies and the developing countries, irrespective of the socialist countries isolated themselves being unconnected from the influence of the financial and monetary disciplines of the global capitalism.

Gold standard was the first contemporary international monetary system. The gold standard contributed for the free exchange between nations of gold coins of standard specification during it operation in the late 19th and early 20th century. In that system, gold was the single standard of value. This system's control on steadiness was its merit. However, the world's delivery of money would essentially be restricted by the world's delivery of gold; this intrinsic lack of liquidity was a major flaw in such a system. In the period of 1920s, the gold standard was substituted by the gold bullion standard, in which nations no longer issued gold coins but backed their currencies with gold bullion and decided to buy and sell the bullion at a set price. In the 1930s, this system also was discarded. In the decades subsequent to World War II, international trade was carried out as per the gold-exchange standard.

With such a system, nations fix the value of their currencies not with regard to gold, but to some foreign currency, which is consecutively fixed to and exchangeable in gold. Most nations set their currencies to the U.S. dollar and maintained dollar reserves in the United States, which was recognized as the main currency country. At the Bretton Woods international conference in 1944, a system of fixed exchange rates was implemented, and the International Monetary Fund -IMF was formed with the mission of upholding steady exchange rates worldwide. During the 1960s, as U.S. obligations overseas pulled gold reserves from the nation, assurance in the dollar destabilized, directing some dollar-holding countries and speculators to look for substitute of their dollars for gold.

Extensive inflation after the United States discarded gold exchanges mandated the IMF, in 1976, to accept a system of floating exchange rates, by which the gold standard became outdated and the values of various currencies were to be decided by the market. In the latter part of 20th century, the Japanese yen and the German Deutschmark got stronger and became progressively more vital in international financial markets, while the U.S. dollar, though still the most important national currency, declined with regard to them and reduced in significance. In 1999, the euro was launched in financial markets as substitute for the currencies of 11 countries of the European Union; it started flowing in 2002 in 12 EU nations.

The latest wave of harsh financial predicaments has forced an attention in international monetary restructuring not seen since the breakdown of the fixed exchange rate system 30 years ago.

The wonder countries of Asia had experienced severe currency depreciation and profound economic dips, the chaos had leaked into Russia and Latin America, and a harsh liquidity disaster had temporarily endangered banking systems in the highly developed countries.

During the 1980s, the Latin debt crisis was generally regarded as the consequence of national policy errors and the innocence of U.S. banks rather than of faults in the international financial system.

The proceedings of the 1990s such as the European currency chaos early in the decade, the following introduction of the euro, the comparatively restricted Latin American crises of 1994-95, and the global financial outbursts of 1997-98, have forced many suggestions for restructuring. Whereas the current arguments on the international architecture have its heredity in the latest financial disasters of Mexico and East Asia, the fundamental problems have been challenged in some form or another for a very long time. For the past 150 years, suggestions for major restructuring of the international financial system have been many, with no scarcity of fine thoughts.

Regrettably, the most general result of these past discussions has been the limited fulfillment of impressive designs. The founding of the gold standard in the 1870s, for instance, was the offshoot of the more determined suggestion for a world currency union, advocated by Napoleon III in 1867. The suggestion had the support of Germany and United States, but ultimately not succeeded because Britain would not consent to a small change in the weight and value of the pound.

The latest chaos that began in paragon economies and took global dimensions has stimulated much introspection within the economics profession on top of substantial anxiety about international monetary preparations as such.

Economists and policymakers had started inquiring some of their most fundamental viewpoints about suitable international financial preparations. Obviously, as Paul Volcker was to note at the conference, the most horrible international financial disaster in 50 years happens about once a decade, but that reappearance expresses a powerful message about the effectiveness of available preparations.

The recent anxieties have really fashioned action in the multilateral institutions, the LDCs, and the investment community. For instance, International Monetary Fund members have set up a Supplemental Reserve Facility to permit a more quick distribution of large sums to countries confronting an abrupt loss of assurance; attempts to augment revelation and clearness are in progress; and private investors are reassessing their risk management models.

Whereas these proposals may stand for a helpful beginning on better avoidance and management of financial disasters, latest events in Mexico and East Asia have exposed impending faults in the current international monetary system that may necessitate more basic transform. Moreover, the huge reversals in temporary capital flows that activated these breakdowns have encouraged appeal for developing countries to re-evaluate the dangers of open capital markets and the advantages of capital controls. In fact, the latest predicaments have mandated both academic economists and policymakers to query some of their most fundamental notions about the suitable design of the international monetary system.

Economists have conflicting, even opposing, opinions about the principal problems and their clarifications, and they do not forever disclose a methodical approach to restructuring. For example, while some reformers sponsor more adaptable exchange rate arrangements, others look for permanently fixed regimes, at least for some countries. Additionally, while most policymakers continue to be staunch supporters of free capital markets, some emphasize that unstable temporary capital flows played a vital part in latest disasters and contend that capital controls just might be helpful. Spectators also hold utterly contrasting notions about the international lender of last resort. Some think that the lack of an effective international lender of last resort has resulted in current disasters, while others agreed that large international salvages have created moral danger and more regular disturbances.

As for policy surveillance, while some analysts contend that mounting integration needs enlarged policy coordination, they disagree as to whether such cooperation should be accomplished through enhanced openness and market regulation or stronger international governance.

However, spectators have already drawn a series of important lessons from current disasters. Specifically, it is very much clear that developing countries must be cautious of relaxing their capital accounts without sufficient institutions for checking the reliability of their banking sector. Furthermore greater openness, revelation, and governance are critically imperative to improving supervision and reducing moral danger.

The present international monetary structure has multiplicity of currencies along with the premiere one dollar that exhibited a secular decline in value in comparison to the two other currencies yen and deutschemark. As a consequence this exerts two major sources of deflationary pressure. By connecting, securing or simply floating with reference to the primary currency, the dependent countries are compelled to both adopt the monetary policy of the primary country and also to keep away from operating on an overall balance of payment of deficit. Similar to the Breton Woods systems the principles are more stringent in case of countries exhibiting deficit in balance of payments rather than in case of the countries exhibiting surplus countries. In comparison to the mark, the system exhibited major devaluations in Europe during the past few years. This resulted in decline in the domestic demand in the devaluing country, since it has squeezed the monetary and fiscal policy to become more stringent so as to reduce the apparent deficit and attract foreign investments.

An effective escalation of the primary currency effectively however, generates deflationary trends in the country. Such order has enhanced the significant integration of the inflation and the long-term interest rates in comparison to the circumstances in the 1980s; it has unquestionably led to the declined growth and enhanced unemployment in many countries. Many of the countries have been forced to twist the structural adjustments. The secular decrease in the dollar in comparison to the yen and deutschmark aggravated the deflationary pressures. The global pricing of the commodities in the international markets are still prevailing in terms of dollars and the lower dollar straightly reduces the intrinsic value of the commodity produced in under-developed countries.

Moreover, there prevailed many countries like France, with significant trade connections with the dollar area simultaneously with that of deutschemark area or the yen area. Such nations are exposed to the threat of adverse capital flows with the variations in the adverse capital flows since the exchange rates of the key currency countries vary. There also exist some financial influences in addition to such macro-economic pressures. The banks businesses and even governments in dependent countries has to confront the profound influence of key currency as it is considered cheaper due to declined interest rates and wider capital markets. When the dollar is weakened effecting their exports in terms of the yen or mark or with weakened own currency they are thrown to the loop of grave external debt problems. Indonesia is now in a crucial position, if the yen had not recovered from its ultimate overvaluation. Persistently, it is being visualized that the United Sates is spending more in international market that that it earns through exports of goods and services.

This will eventually expected to vary in the years ahead. When the efforts of the Congress to bring the federal deficit on a declining path the current account deficit is expected to squeeze considerably. Alternatively, the dollar appears to lose its special position as a reserve currency. This indicates in anyway the global necessity for a new source of global liquidity. Moreover, the fast growth in private international capital flow is generating a requirement for the further international liquidity. Besides, the global economy is experiencing some of the key structural variations. The economic integration of the markets is inducing a transition from general production in one country to a more specialized and large scale production in many countries. Such a methodology is considered to be more effective and less disruptive if enhanced stability exists in the exchange rates of the three major currencies. The Macroeconomic factors also advocates for more stability.

Moreover, all the industrialized nations are making their fiscal policies more stringent and with a view to maintaining the sufficient economic growth they are able to follow the easier policies without the threat of inducing an exchange rate disruption. This entails greater integration of monetary policies in the primary currency countries. This is therefore the right time to think of some modifications in the prevailing system so as to make more favorable to the economic growth worldwide and less critical to the financial accidents or policy errors in one particular country.

More basic transforms are required at present. Although free markets may encourage growth over the long run, capital flows can be extremely undermining in the short run; thus capital controls may be desirable both as a crisis measure and as a protection from general threat when financial supervision is restricted, private sector risk-management is insufficient, and financial markets are slim. Additionally, there is a requirement for designing an international lender of last resort that could alleviate financial fears by offering appropriate temporary liquidity to banking systems in need. Superior market oriented observation could help to regulate the extent for involvement of international lender of last resort and might provide more efficient oversight than multilateral institutions have normally accomplished.

Problems of international policy coordination and emergency liquidity are expected to become unmanageable as per Little and Oliveri, and unless some mixture of superior information, a more dependable international lender of last resort, and more efficient observation permits governments to attain better steadiness, some budding economies are expected to ask for defense by combining a currency bloc, even if these unions do not symbolize best possible currency areas. On the whole, Little and Olivei stressed the necessity to take a universal view on perfecting the international monetary system. So far, many suggestions for restructuring have concentrated on particular features of the problem, such as openness and control, which may decrease the regular occurrence and harshness of upcoming disasters, but will not completely settle the incompatible requirements of all countries to contribute in combined markets and to accomplish steady economic growth.

Toyoo Gyohten being critical of the advocacy of Little and Olivei is concentrated on the recent East Asian experience. Gyohten emphasized on the fact inducement to the prevailing argumentation on structural problems are mostly region-specific and it is therefore, significant to formulate methodologies meant to cater to the region specific needs. Most of the vulnerable economies in East Asia were encountering macroeconomic imbalances remarkably in terms of enhanced external deficits and inflationary trends and interest rates variations in comparison to that of the United States. Moreover, when the countries in the region are dollar secured, the currencies were still subject to large fluctuations against the yen that resulted in the worsening of the macro-economic environment. Gyohten advocated that the East Asian countries should be in perfect readiness to remain accommodative in their exchange rate approaches when large fluctuations are evident, however, it is equally significant that in the United States and Japan should collaboratively strive to attain the greater stability and predictability of the dollar exchange rate. Gyohten put forth an approach for systematizing the flexibility of the capital count along with a set of emergency capital control measures.