Summary of the International Monetary System Finance Essay

The issues with globalization are not new and those issues associated with trade and how to pay for the transferred goods has definitely been around for a while. Currently the International Monetary Fund (IMF) is the organization that has been tasked with stabilizing the international monetary system, which can fluctuate at any time of the day. If the monetary system were allowed to fluctuate on its money countries would find themselves in a difficult situation, which they would have, very little impact on their own. The world has seen a number of different systems over the last 150 years, from the Gold Standard to the systems we have in place today. So far the IMF has been the most successful, but even it has had to make some drastic decisions, like the one in Argentina in 1991 the IMF ruled that it would not bail them out again. “The Argentinean Economy was teetering and the IMF ruled that more loans would be futile.

Argentina’s money was tied to the US dollar, 1 for 1, but the system was failing and the IMF ruled that drastic measures would be needed, before more help could be provided. In the aftermath the economy and stability of the Argentine nation crashed” (Blustein, 54). This is a drastic case, but the IMF must provide financial stability, it cannot just provide loans through the World Bank to hold off the inevitable. Before I get into the real mission of the IMF lets first take a look at a few of the international monetary systems that were used in the past. The first adoption of many of the functions of the modern international monetary system can be traced back to the gold standard. The gold standard was the system that was in use from the late 19th until early in 20th century up until just after World War I. The gold standard was based on the free circulation between nations of gold coins of standard specification, mainly based on the gold coins produced by the Royal Mint in England. Under the gold standard system, gold was the only standard of value; in short all currency and trade goods were fixed on the value of gold. The reason the gold standard collapsed was the lack of liquidity; the world’s supply of money in circulation was limited by the world’s supply of gold.

The discovery of a new gold field could cause prices to rise. The increase in trade and other problems with the system caused the international gold standard break down in 1914. The gold standard was replaced by the gold bullion standard during the twenties under which nations no longer minted gold coins but backed their currencies with gold bullion and agreed to buy and sell the bullion at a fixed price.

Similar issues caused the gold bullion standard system to collapse, and it only lasted about ten years. Gold continued to play an important part in the monetary system with the adoption of the Gold-Exchange System used in the period after World War II, trade was conducted according to the gold-exchange standard. The participating nations fixed the value of their currencies not with respect to gold, but to some foreign currency, which is in turn fixed to and redeemable in gold. Most nations fixed their currencies to the U.S. dollar and retained dollar reserves in the United States, which became known as the “key currency” country. The decision to go to ultimately go to the Gold-Exchange System was made at the Bretton Woods international conference in 1944. The result of the conference ultimately led to the creation of the International Monetary Fund (IMF). The IMF would be tasked with maintaining a stable exchange rate on a global level (Galbraith, 160). The IMF continues to the present day and the world does not seem to be moving away from its support of the IMF. The IMF has dealt with two key changes in the way the monetary system has been dealt with, both involved US currency. The first led to the Two-Tier System which was occurred during the sixties, as U.S. commitments drew gold reserves from the nation.

This caused the dollar to weaken, leading some countries exchange dollars for gold, this led to a drain on U.S. gold reserves. The two-tier system was created in 1968, In the official tier, consisted of central bank gold traders, in this tier the value of gold was set at $35 an ounce, to keep gold reserves stable gold payments to no central bankers were prohibited (Mayer, 1). The second tie was the free-market tier, mainly all nongovernmental gold traders; gold’s price fluctuated like a normal market, through supply and demand. Gold and the U.S. dollar continued to be the major reserve asset for the world’s central banks. This system did not stop the drain on U.S. gold reserves; in 1971 the United States was forced to abandon gold convertibility. This action left the world without a single, unified international monetary system.

This is considered to be the end of the fixed rate system, which evolved from the collapse of the gold standard way back in 1914 (Greider, 251). With the end of the two tiered system, there was a period of high inflation after the United States abandoned gold convertibility. This action forced the IMF to agree (1976) to a system of floating exchange rates, this formally ended the gold standard. The values of various currencies were to be determined by the market. This is something we experience today as we convert currency during international travel; it changes on a regular basis.

The US dollar was and is still seen as the “key currency”, the Japanese yen and the German Deutschmark strengthened and became increasingly important in international financial markets. The introduction of the “euro” was introduced in financial markets in 1999 as replacement for eleven mainly European currencies (including the Deutschmark). It began circulating in 2002 in 12 EU nations; the euro replaced the European Currency Unit, which had become the second most commonly used currency after the dollar. Today, though in a downward trend, many large companies use the euro rather than the dollar in bond trading (Greider, 24). Now that I have explained the evolution of the monetary system, you might be asking what does the IMF do? The IMF is the world’s central organization for international monetary cooperation and is headquartered in Washington, DC. The organization depends on cooperation of all participating countries in the world to work together to promote the common good of the monetary system. The IMF’s primary purpose is to ensure the stability of the international monetary system; which currently is a system of exchange rates and international payments that enables countries (and their citizens) to buy goods and services from each other. This action is essential for sustainable economic growth and to raise the living standards of the world’s population (IMF.COM). The IMF is currently trying to maintain economic stability and to prevent financial crises in the international monetary system.

The IMF continuously reviews national, regional, and global economic markets for financial developments. It also provides advice to member countries, encouraging them to adopt policies that foster; Economic stability throughout the world Reduced the vulnerability to economic and financial crises Raise living standards The IMF also provides a forum where member countries can discuss the national, regional, and global consequences of their policies. The IMF also makes temporarily financing available to member countries to help them address balance of payments problems; when countries are short of foreign exchange because their payments to other countries exceed their foreign exchange earnings.

This is the situation that Argentina found itself in, when the IMF denied them short term loans, like a banker the IMF must ensure they can repay the loan. The IMF also provides technical assistance and training to help countries build the expertise and institutions they need for economic stability and growth (IMF.COM). Obviously the as seen in the current recession the IMF cannot avoid every financial crisis, but it can help ensure that money is available to keep it spiraling out of control, much like the Great Depression of the 1930’s. As I have stated the IMF is an organization of cooperating member countries. Crucial to the monetary system is the World Bank, they both have similar functions and the actions of each often appear as one, the Bank and the IMF are separate entities. To clear up the confusion it essential that the following differences are noted; The Bank is primarily a development institution. The IMF is a cooperative institution that seeks to maintain an orderly system of payments and receipts between nations. The IMF and the World Bank have and serve different purposes, they each have a distinct structure, funding is from different sources, assists different categories of members, and each have distinct goals(Greider, 75). To further help distinguish the IMF and the World Bank, the bank has one primary goal; it promotes economic and social progress in developing countries. They accomplish this by helping to raise productivity so that their people may live a better and fuller life.

This does not happen overnight and is not continuous, the general upward rise in the standard of living around the world since WW II is testament to the success of the World Bank. On the other hand remember the IMF tries to stabilize sudden and unpredictable variations in the monetary exchange values of national currencies. The IMF mainly functions on trust and cooperation, while the World Bank is the investment arm of the monetary system(Greider, 236). To help further define the World Bank it is made up of two organizations: the International Bank for Reconstruction and Development and the International Development Association (IDA). It should be noted to that another organization that has a role to play in the international monetary system is the International Finance Corporation it provides funding for private enterprises in developing countries. The World Bank is the primary source of funding for countries, to help with the mission of the World Bank it employs an expertise in the following areas: economists, engineers, urban planners, agronomists, statisticians, lawyers, portfolio managers, loan officers, project appraisers, as well as experts in telecommunications, water supply and sewerage, transportation, education, energy, rural development, population and health care (IMF.Com). Since the demise of the fixed exchange rate system in 1971, primarily the flexible exchange rate system has been used to manage the international monetary system. The flex rate system seems to be more adaptable, to handle the constant changing landscape of the global economy. I think the fixed rate system is just too simple to handle the complexities of the modern system. The rate, at which news travels today, can be devastating on slow fixed rate system.

The flexible system also allows for countries to pursue an independent monetary policy, rather than have it set by a “key currency” such as the US Dollar. So far the flexible exchange rates have been more adaptable and have been able to distribute the burden of adjustment between the foreign economies and the domestic economy. A fixed rate system may be useful in a developing economy such as the previously mentioned Argentine case, but the change in the base currency (US Dollar) caused the devaluation of the Argentine peso. The Argentinean government was not able to recover fast enough to head off the economic collapse; in flexible system they may have been able to take proactive measures to avoid the situation they found themselves in. That is just a theory and it is yet to be seen if the Flexible system is better that the fixed rate system, but I am sure as there already has been changes that will impact the financial system, that will cause it adapt to some other policy.

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