International Finance

1. International Finance Associate professor Codruţa Maria Făt

2. The International Monetary System Short history

3. Brief history of the international monetary system Contemporary currency regimes Emerging markets: currency boards,dollarization

4. The brief history of International Monetary System The Gold Standard 1879 – 1913 The Interwar years 1914 -1944 The Bretton Woods Agreement: 1945 The spirit of the treaty The Fixed-Rate Dollar Standard 1945- 1973 The Floating-Rate Dollar Standard 1973-1984 The Plaza – Louvre Accords 1985 – 1992 The European Monetary system 1979 An eclectic currency arrangement 1992- today

5. The gold standardRules of the game Fix an official gold price or “mint parity”. Convert freely the currency in gold at the official price; Do not restrict the export or import of gold by private citizens, nor impose other exchange restrictions; Back national currency with gold reserves. Condition long run growth in deposit money on availability of general gold reserve;

6. The gold standardRules of the game • In short-run liquidity crises from an international gold drain, have the central bank lend freely to domestic banks at higher interest rates (Bagehot’s Rule) • If the first rule is temporarily suspended, restore convertibility at traditional mint parity as soon as possible; • Allow the common price level (nominal anchor) to be endogenously determined by the worldwide demand for, and supply of, gold.

7. This sort of monetary system was accepted in western Europe in 1870s and in USA in 1879 Maintaining adequate reserves of gold to back the currency value was very important for the country who accept this system Any growth in the amount of money was limited to the rate which official authorities could acquire additional gold.

8. The interwar years and War World II 1914 – 1920 the currencies were allowed to fluctuate over wide ranges in terms of gold and each other. In theory supply and demand in a country exports and imports generate moderate changes in exchange rate about a central equilibrium value In practice international speculators sold the weak currencies short which caused their falling in future. Is the practice of short selling. In reverse the strong currencies were bought by speculators The effect: Fluctuations in currency values could not be offset by the relative illiquid forward market.

9. The interwar years and War World II • 1934 USA adopted a modified gold standard. USA had devalue the USD to 35USD per ounce of gold from 20.67USD and the US Treasury traded gold only with foreign central banks not private citizens • Until the end of WWII exchange rates remained theoretically determined by the mint parity. • During WWII many currencies lost their convertibility in gold.

10. The Bretton Woods Agreement: 1945 The spirit of the treaty Established a USD-based international monetary system and provided for two new institutions: IMF and IBRD IMF aids countries with balance of payments and exchange rates problems; International Bank for Reconstruction and Development (World Bank) helped fund postwar reconstruction and support until now the general economic development;

11. The Rules of Gold Exchange Standard All countries fixed the value of their currencies in terms of gold but were not required to exchange their currencies for gold. The USD remained the only currencies convertible into gold at 35$ per ounce; Each country established its exchange rate vis a vis the dollar, and then calculate the gold par value of its currency to create the desired dollar exchange rate. Each country who participate in this system agreed to try to maintain the value of their currency within 1% (later 2,25%) of par by buying or selling foreign exchange or gold as needed. Devaluation was not used as a competitive trade policy; If a currency become too weak to defend was allowed a devaluation of maximum 10% without the approval of IMF.

12. The Fixed Rate Dollar Standard 1950 - 1970 For other country than USA Fix a par value for the national currency with USD and keep exchange rate within 1% of this par value indefinitely; Free currency convertibility for current account payments. Use capital controls to insulate domestic financial markets, but begin liberalization; Use USD as intervention currency. Keep active official reserves in US Treasury Bonds. Subordinate long – run growth in the domestic money supply to the fixed exchange rate and to the prevailing rate of price inflation in USA (tradable goods). Bagehot’s Rule: Offset substantial short run losses in exchange reserves by having the central bank purchase domestic assets to partially restore the liquidity of domestic banks and the money supply.

13. The Fixed Rate Dollar Standard For USA Remain passive in the foreign exchanges: practice free trade with neither a balance of payments nor an exchange rate target. Do not hold significant official reserves of foreign exchange. Keep US capital markets open to foreign governments and private residents as borrowers or depositors. Maintain position as a net international creditor – in dollar denominated assets – and limit fiscal deficits. Anchor the dollar (world) price level for tradable goods by an independently chosen American monetary policy.

14. USD was the main reserve currency held by the central banks. Unfortunately USA ran persistent and growing deficits in its balance of payments which required a heavy capital outflow of dollars to finance these deficits and meet the growing demand for dollars from investors and businesses. The heavy overhang of dollars held by foreigners resulted in a lack of confidence in the ability of the US to meet its commitment to convert dollars to gold. This forced Richard Nixon to suspend official purchases or sales of gold by the US Treasury in 15august 1971. This was after USA suffered outflows of one third of its official gold reserve in the first seven month of the year.

15. Exchange rates were allowed o float in relation to the dollar and thus indirectly in relation to gold. In fact we speak about devaluation of the dollar. At the end of 1971 most of the currencies has appreciated in respect with dollar.

16. In February 1973 we assist at a new devaluation of the dollar 10% (42.22$ per ounce) • It was the final sign that this kind of arrangement is no more suitable. • In 12 February 1973 the foreign exchange market were closed until march and at reopening the currencies were allowed to float to levels established by the market forces.

17. The Floating Rate Dollar Standard 1973 - 1984 For another countries than USA Smooth near-term fluctuation in dollar exchange rate without committing to the par value or to long term exchange stability; Free currency convertibility for current payments, while eventually eliminating remaining restriction on capital account; Use USD as intervention currency and keep exchange reserves mainly in US Treasury bonds; Partially adjust short-run growth in the national money supply to support major exchange interventions: reduce when the national money weak against dollar and expand when it is strong; Set long-run growth in the national price level and money supply independently of USA and allow corresponding secular adjustments in dollar exchange rate.

18. The Floating Rate Dollar Standard 1973 - 1984 For USA Remain passive in the foreign exchanges: practice free trade with neither a balance of payments nor an exchange rate target. Do not hold significant official reserves of foreign exchange. Keep US capital markets open to foreign governments and private residents as borrowers or depositors. Pursue monetary policies independent of the foreign exchange value of the dollar and of the rate of money growth in other industrial countries – without trying to anchor any common price level.

19. The Plaza – Louvre Accords 1985 - 1992 For Germany, Japan and USA Set broad targets zones for the mark - dollar and yen – dollar exchange rates of +/- 12 %. Do not announce the agreed-on central rates, and leave zonal boundaries flexible. If disparities in economic ”fundamentals” among G-3 change substantially, adjust the (implicit) central rates; Intervene in concert, but infrequently, to reverse short – run trends in the dollar exchange rate that threaten to pierce zonal boundaries. Hold foreign exchange reserves symmetrically in each other’s currencies: US government to begin building up reserves in marks, yen and possibly other convertible currencies. Sterilize the immediate monetary impact of interventions by not adjusting short – term interest rates. In the long-run , aim each country’s monetary policy toward stabilizing the national price level in tradable goods thus indirectly anchoring the world price level

20. The European Monetary System Fix a par vale for exchange rate in terms of the European Currency Unit; Keep par value stable in the short-run by symmetrically limiting range of variation in each bilateral exchange rate to 2.25% on either side of its central rate; When the exchange rate threatens to break the bilateral limits the strong currency central bank must lend freely to the weak currency central bank to support the rate. Adjust par values in the intermediate term if necessary to realign national price levels

21. The European Monetary System • Keep free convertibility for current-account payments • Hold reserves mainly in ECU and reduce dollar reserves • Repay central bank debts quickly from exchange reserves or by borrowing from the European Fund for Monetary Cooperation within strict longer-term credit limits. • No member country’s money to be a reserve currency, nor its national monetary policy to be the nominal anchor for the group

22. Bibliography • Bourguinat Henri, „Finance Internationales”, Ed. PUF, Paris, 2000 • Eiteman David, Stonehill Arthur, Moffett Michael, “Multinational Business Finance”, Ed.Pearson International, 2007 • Halwood Paul, MacDonald Ronald, „ International Money and Finance”, Blackwell Publishing, 2007 • Krugman Paul, Obstfeld Maurice, „International Economics – Theory and Policy”, ed. V, Addison-Wesley Publishing Company, Massachusetts, 2000 • Levich Richard M., „International Financial Markets”, ed. 2, Ed. McGraw Hill International, Boston, 2001 • McKinnon Ronald, ‘The Rules of the Game: International Money in Historical Perspective’, Journal of Economic Literature, vol. XXXI, march, 1993 • Mishkin Frederik S., „The economics of Money, Banking and Financial Markets”, ed.7, Ed. Pearson-Addison Wessley, Boston, 2004