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.
This period was a good chance for developing countries to be globalized and attract foreign investment. Combined liberalization and privatization, these countries supported free trade and opened capital market. The currencies of most of these countries were linked to one of the major of world currencies. In order to work well in the international system, the developing countries needed to establish the convertibility of their currencies through reducing budgetary and balance-of-payment deficits. The effort got response from the developed countries, which increased the international capital flow.
On European land, after the SEA (the Single Europe Act) and the Maastricht Treaty on European Unity, Europe took important steps to liberalize monetary. Firstly, the countries opened the capital market. Then, they settled the related fixed exchange rate to complete the currency convertibility. At last, the organization established the central institution and emitted the unified currency. The newly elected Clinton administration focused on reducing of budget deficit. Due to the deficit legislation and the economy boost because of Infobahn, America got budget surplus in 2000.
However, the dollar remained weak while the economy prospected. At the meanwhile, the other currencies such as yen were strong. After 1995, things changed, yen and Euro were weak although they experienced trade deficit. Thus, the countries started to reduce budget deficit to ease inflation. Dollar kept the position of official reverse currency followed by mark and yen. At the late 1990s, Euro became a choice of official reverse currency. In Japan, yen up valued dramatically after the Plaza Agreement.
This country once regulated the capital market strictly and kept the domestic market closed. In 1980s, Japan opened it market gradually and its economy got prospective progress. The bubble economy began to collapse in 1990, the prices of land and stocks fell. The overheated economy made lots of the enterprises to hold capital and estate. Banks could not be paid and exposed bad debt. The banks rejected to provide loans, which contributed to the difficulty of recovery. Furthermore, the overvalued added pressures to Japanese export-relied economy.
The government released the monetary policy while in 1991 and Japan remained a low growth rate in 1990s. Retrospection of crises in 1990s The free flow of capital also brought the crises across the world. When the economic fluctuation occurs in one country, the influence can expand to the rest of the world through monetary system and world trade. Between 1994 and 1995, the Mexican Peso crisis threatened financial market worldwide. After 1990s, the economy boosted in at a high speed because of the inflow of foreign capital and the policy of privation and liberalization.
However, due to the excessive dependence on short-term capital inflows which came from the rapidly growing securities markets and the overvalued currency which had been remained as a problem for long time, the prospective economy encountered a serious problem. In 1994, the financial minister claimed that peso was devalued by 15. 6 percent, which resulted in the panic of citizens to purchase dollars leading to the ungorier devalue of peso. The second day, the government declared the floating exchange rate without intervene of the central bank, which added to the turbulence in financial market.
This crisis resulted from a series of reasons including the unpredictable events in political and the inherent problem in the economic structure. The impact soon expanded to the Latin America and the rest of the world. The crisis broke out in Thailand by mid-1997 owned the similar reason. With the strong economic boost in 1980s, export growth of the tigers and the Southeast Asian countries shrank because the import demands decline in Japan and the competence of China. Besides, dollar became stronger while the currencies of these countries were tied to dollar.
Thus, the up value in currency aggravated the trade deficits. The crony capitalism also contributed to the crisis. Banks and other financial institutions lacked risk management and lend fund to their favored institutions without adequate attention to their financial soundness. At last, the crisis erupted in Thailand where the weak government could not remit the problem effectively. Then, Indonesia failed to keep the economy in order with the uncertainty about the stability of political system. It is worthwhile to mention that IMF played a key part in the two crises.
In other word, America devoted itself to help the damaged countries through aid from its budget and WB, IMF and other countries such as Japan. After the crisis in Mexico, G-7 proposed some regulations to manage and supervise the policies in domestic to prevent future crises. Besides, there are some similarities in the two crises. First, the developing countries and regions witnessed a rapid economic growth and benefit from the world trade and liberalized capital markets. Second, the myopic policies such as the monetary policies in these two crises account a part of the damage.
Government and central banks focused on the former monetary policy without considering about other facts which resulted in currencies to be overvalued harmed the international trade. Finally, political elements also should take the responsibility in the two examples. Therefore, effective and accurate economic policy and aid measures are based on the powerful governments and stable political environment. Valuation of the international monetary system It is hard to deny that the international monetary system contribute to the world free trade and economic recovery in the worldwide.
After the Second World War, the Bretton woods system help to stabilize the exchange rate and reduce the trade protective measures among the destructive states. With the help of America, Europe and Japan recovered gradually. In fact, the exchange rate was kept stable while the world trade developed at a high speed under the system. With the privation and liberalization in the developing countries in the interdependence and global stages, the less developed economies experienced rapid growth with the capital inflow and export revenues.
Capital flows around the world in a larger scale freely, which improve the condition of poverty. What’s more, the closer relationships among different countries stimulate the solution of international monetary problem. The establishment of the international institutions such as IMF and WB regular and supervise the word financial order as well as provide related loans and aid for the countries in need. The regular meeting of the developed countries such as G-5, G-7 and G20 now proposed effective some measures to the world economic problem which can prevent the future economic crises.
Unfortunately, the substantial conflict between American policies as analyzed above determined that the system cannot work in the long term. The floating exchange rate after the disruption of the system brought turbulence in the emerging market economies. In fact, the loans from IMF and WB could not satisfy the demand of reconstructions and recovery. Most of the money was provided by the national programs of America. Besides, in the global age, lots of the developing countries opened their capital market. The big amount of capital that flows in international market accelerates the speed of crisis spread.
At the moment, once the economic fluctuation appears in one country, the impact can spread not only to the near regions but also the rest of world. After all, exchange rate and capital connect the nations together. Apart from the drawbacks in economy, there are issues that need to be improved in international regulations. The developed countries occupied a large part in constituting the world economy structure and rules. With the blossom of the less developed countries, the international institutions also need these developing countries other than dominated by the powerful states.
Finally, it is hard to balance the international economic order with nation interest. The “begin neglect” policy displayed the essence of America in that period to solve national problems. For other countries, it is hard to make national policies apparent to be suit for international order. Conclusion The international monetary system changed a lot after the Second World War. Capital flows freely in a larger scale in the international market. The system protects the stability of exchange rate and world trade. The constitutions in the system provide aids and regulations for the countries and the international market, respectively.
In the decades, nations has been connected tightly and tends to meet together to discuss the issue concerning all of the countries. Although the monetary system has brought some problems such as the crisis among different countries, the benefit both developed and developing nations have obtained is spectacular. International trade and transactions are based on the system. In other word, the monetary system seems to provide a standard for the market engaging countries to obey as well as to protect and support some of the countries. Thus, the system can also contribute to the world peace and development.