International_Monetary_System

The International Monetary System in the 21st Century: Could Gold Make a Comeback' This case study gave us the explanation of how gold will intersect with the international monetary system in the next century. Since 1960s gold has been an important feature in monetary system, shown by monetary authorities who only held gold, the only commodity, as reserve. A substitute of gold is called Special Drawing Right (SDR), created by IMF in 1968. In contrary, during an attemp to encourage the acceptance of SDR, gold was still significant in international monetary measurement. GOLD’S MYSTIQUE Gold has been desired since ancient world, for even then many empires used gold as reserves; a commodity they held in readiness to support their economy. Clay notes and seals were convertible to represent the exchange of gold, so the real valuables can be kept in someplace safe. These notes and seals soon needed a replacement that had same value and can be used in many places. Therefore there was a need to standardize the medium of exchange which marked the birth of coins. Ancient people made coins to gain profits, they marked up the face value of the metal plate; the value of gold represented by the coins are actually smaller than what was stated in the coins. These gain were used by kings to achieve their goals, such as conquering other empires. But overvalued coins could not be in free market forever, this condition means there were false scarcity, monopoly and goverment control, for gold and silver mines controlled by government. THE LACK OF AN INTERNATIONAL MONETARY SYSTEM Before 1971, international monetary system was linked to gold, such as US dollar, anchored to gold and then other currencies should each stabilize their currencies to the anchored dollar. As a result, this gold standard system created an interdependence of the currency system, fixed exchange rates, and stabilized inflation. But after 1971, the gold standard broke down and international monetary system was scrapped for flexible exchange rates, where the external value of a currency more or less started to be determined by the market supply and demand. A Brief History Why There is a Shift from Fixed to Flexible Exchange Rates (source: Fixed or Flexible' Getting the Exchange Rate Right in the 1990s; IMF Publications, www.imf.org) The shift from fixed to more flexible exchange rates happened gradually. It started from the breakdown of the Bretton Woods system of fixed exchange rates in the early 1970s, after president Nixon took the dollar off gold, thus caused the world’s major currencies began to float. At first, most countries continued to peg their exchange rates to those anchored currencies (US dollar or French franc) either in single or basket pegs. Then, they shifted to peg to only basket of currencies in the late 1970s, such as to the IMF’s Special Drawing Right (SDR). At the end, they totally shifted to flexible exchange rate arrangements in the early 1980s. (See attachment: table of exchange rate arrangements). The considerations behind these shifting vary widely. For instance, many countries shifted from US dollar pegs to basket pegs because the dollar was appreciating rapidly. Moreover, the rapid acceleration of inflation in many developing countries during the 1980s also triggers many countries to adopt flexible exchange rate. Since countries did not anchor their currencies to one of precious metals or to another currency, there was no international monetary system which manages the interdependence of currencies and stabilizes prices anymore. Whereas, this interdependence is really important considering the fact that the balance of payment of each country is connected together. When one country has a balance of payments surplus, the rest of the world has a balance of payments deficit, and vice versa. The one country’s monetary policy would affect the others. A THEORY OF SUPERPOWER INFLUENCE “The bargaining power relies on the strongest”. In international monetary case, this condition is likely to apply in a situation where one country with strong political power would play its dominance to determine which monetary system benefiting its currency, mainly to sustain its hegemony. From Babylonian shekel to the French livre, those were the artifacts of the superpower on its time. Thus, as Mundell mentioned on his paper, the superpower always has interest in vetoing any kind of global collaboration that would replace its own currency with an independent international currency. During war-machines expansion to the post war era, the role of currency as hegemony of superpower has already played sensitive issues to be brought up in international roundtable: if there’s an act to replace it, it’s a disaster for the superpower, and on the other hand a gate of a hope for the other countries to be released from invisible modern occupation of economy. Just like how Britain vetoed no to international monetary reform proposed by the American and French, the scenario of superpower’s effort to maintain its market would never been as dramatic as how America and The British altered vis-a-vis at The Bretton Woods in 1944. The Bretton Woods: H.D. White VS. J.M. Keynes source: A History of the Modern World Issues; Palmer & Colton) Franklin Delano Roosevelt knew that he left the rest of the world devastated in post war regime in Europe and other third world countries under British Empire. In order to achieve his mission to promote equality among others as well as empower US economy, Roosevelt, under Morgenthau and White, came up with the plan to finance large scale projects in post war countries, but the international monetary currency should be fixed to US dollar, and dollar to the gold, to maintain dollar stability in the country. In contrary, Keynes, sensing threat of hegemony from America, came up with the idea of ICO (International Currency Organization), where he promoted a world currency, bancor, which latter with the American’s acknowledged as unitas. The ICO system implied the debtors’ countries to borrow money from the ICO, based reserve in gold, and with uniform currency. The idea was simple: no country could export more than it could import, and vice versa. And if any country did so, it had to pay certain level of interest to the ICO. However, America saw that ICO could not support large scale projects to rebuild the devastated countries. With huge finance needed to re build infrastructures there would be not enough gold to reserve these large projects, and more countries would be in death to the ICO. In Bretton Woods, nor bancor or unitas agreed on one word. However, the British commonwealth in devastating post-war condition, were trying to support H.D. White idea, which latter be agreed: to borrow the finance in US dollar, and later dollar measured to the gold. These countries latter had to peg currencies against the US dollar. No country could devalue its currency against the gold more than 1.5 point without the agreement of IMF & World Bank as creations after Bretton Woods, and other 44 allies. At the end, the Bretton Woods was a starting point where US dollar began its hegemony abroad. PRICE STABILITY AND GOLD Price stability was not quite good along 20th century. The opening of World War I in Europe and Federal Reserve System in United States induced the great inflation in 1914. The price level doubled during World War I and caused the great depression in 1930-1934. With the onset of the great depression, pound sterling lost its gold base. Although in 1934 the price level returned back to the pre-war equilibrium level, the inflations which happened since England left gold in 1931 and especially since the breakup of the anchored dollar system in 1971, have been the highest in England’s history. Once England had lost control of its monetary stability, it was hard for pound sterling to return back the chair. Beside pound sterling, most currencies lost their gold base too in 1930s, except US dollar. Therefore, until 1971, dollar became an anchored currency which was linked to gold and the Federal Reserve System (U.S. central bank) and got the power to manage the price level of the world economy. Dollars at that time became the reserve money that was used by the rest of the world and the new forms of international money emerged such as US government treasury bills and bonds. After 1971, when the gold standard broke down, inflation control was entirely depended on the Federal Reserve discipline. At the end of 1973, there was a spike of oil price. That quadrupled and created deficits in Europe and Japan. To be able to fulfill the oil supply, Europe and Japan were financed by Eurodollar credits in which the edges were covered by the US monetary. Due to these financing, the money supply amount rose and induced the inflations. A HISTORICAL VIEW The international monetary system development was divided into several stages. The first being the bimetallic system stage around 1815 to 1873, in which gold and silver served as the basic reserve assets. However, in the 1870s, following the US inflation and France being at war, this system was somehow abandoned. The world economy split into two, the international gold standard and the international silver standard. The second stage was the period of populist revolt in the Midwest around 1873 to 1896. When the countries shifted to gold standards from bimetallism, this created a deflation in gold-using countries, but inflation in silver-using countries. The third stage was from 1914 to 1924, where other countries started to use US dollars as their currency base rather than gold. But between 1924 and 1926, Germany, followed by Britain and France, went back to gold causing deflation by creating large demand on gold. This move that led into deflation contributed a lot to the 1930s depression. In 1936, France, Britain, and the US signed an international monetary agreement known as The Tripartite Agreement to stabilize their currencies because the devaluation had raised import prices and lowered export prices, which of course is not good for the countries’ economy. Through this agreement, these countries pledged to maintain their currencies so it would not interfere with internal prosperities. In 1970s, the pure dollar standard system was established. By February 1973, the Eurodollar market had gotten stronger, with Deutsche mark as the most important currency in Europe. In June 1973, Committee of Twenty, decided to move to flexible exchange rates from the International Monetary System. However, inflation in the US rose to the point that other countries feared that the depreciation of US dollars would continue. Therefore, in 1978, Helmut Schmidt and Giscard d’Estaing agreed to form the European Monetary System. In 1985, another agreement between France, West Germany, Japan, the US, and Britain took place. The agreement was made to depreciate the US dollar in relation to the Japanese yen and the Deutsche mark. The devaluation of US dollar would make the US exports cheaper for its trading partners. INTERNATIONAL MONETARY REFORM' International monetary reform is seen as necessary action by a superpower only if there is collaborative action which indicated as a threat to superpower’s currency in the market. Mundell predicted, after long years of being ping-pong from gold to dollars, the European countries are in huge need of union: union of power and economy. The Europeans need these to be able to help themselves stay out of the wave of unstable dollar which had affected Europeans markets, as well as declaring their leadership identity. Following the European Union, in 2002 the Euro currency introduced, and in the next five years, it had successfully appreciated against dollar. The U.S., so far, has not made any attempt to do the reform. It doesn’t see the European union as a threat of the dollar and as the article argued, the number of seigniorage which U.S. have collected since the pre-World War era had been well maximized. Japan, despite its economic boom in 1975, is in the position of unable to affirm monetary reform due to its political reliance to the U.S. after Nagasaki fell down in 1945. If only this Asian tiger could bring up monetary reform, the purpose would be to secure their exports paid and imports financed in yen, making this currencies as hegemony in the region and avoiding speculation on US dollars’ fluctuation. Economic power doesn’t mean one country dominates political power in certain region-though it may lead to- but for sure, the existence of political power in certain region grants the economic power. SYMMENTALLISM vs BIMETALLISM Since early history coins had been used for trades. The country of Lidya created a mix of gold and silver coins, called the electrum coins. According to a 19th century great writer, Alfred Marshall, these electrum coins would avoid the defects of gold standard deflation and silver standard inflation. Lydia had been using a symmetallism system for quite some time until the rule of Croesus. He changed the monetary system into bymetallic by creating pure gold and also pure silver coin, which remained implemented even after his death. Julius Caesar also set the Roman monetary system according to the bimetallic system. However, he overvalued the Roman gold standard at almost 100% from the market price. In 1666, Charles II of England introduced the free coinage, where gold and silver were worth the same, thus the bimetallism was dominated by silver. THE EVOLUTION OF THE DOLLAR STANDARD From 1966 to 1934, there were seven great powers existed. Mundell illustrates the connection between gold and those superpowers as solar system, in which gold acted as the sun and the superpowers as the planets orbiting around the sun. If one planet gets bigger, it would be possible that it would take the position of the sun as the center of the system. The international monetary system in the 20th century was associated such above illustration, when US dollar became so strong, even stronger than gold, it would become the basis of monetary (currency) policy. Any currency tried to break down from this center, would be unstable from the orbit, just like countries that were trapped in the need of more reserve in US dollar when they previously tried to move to flexible exchange rates in 1970s. MISSING DOLLAR' There is a question remaining: where is all the money the Federal Reserve had created' United States currency counted nearly $400 billion outside banks, but because Americans are inclined to have more credit cards and bank accounts, they hold smaller amount of money compared with their income. An IMF staff assumed that only 10 – 15% of the gigantic $400 billion are circulating inside US. Most of the people can only guess the remaining money are used as the international currency of the world, making dollars as everybody’s second currency. These conditions are making international monetary reform has a close relationship with the United States. THE LONG RUN PROSPECTS Seeing Europe as an integrated community with monetary and security policy would be a tremendous benefit, not only for the country members but also the region close by such as the former Soviet Unions, the Middle East, and the Africa. Geographically, EU is closer to these regions in which if economic growth achieved, it would become a spider web for the surroundings. The Maastricht treaty, despite of refusal of the third stage (union currency) by the UK, has forged EU to meet stronger economic power and avoiding dispute economic policy because the Central European Bank would be in charge as independent monetary policy maker. After series of back-and-forth fixing currency to the gold, the society understood that there would be much incentive to devalue currency toward the gold as a mantra of expectation for raising interest rate. The gold will be a viable reserve asset for long time. Mundell sees that one day, in efforts of being rational, the US and the EU will perhaps acknowledge gold as a transactional commodity in a market; not as fixed price, but flexible one. Actually with the launch of Loco London (Danpac) system where gold are being traded in investment security, Mundell’s view has been co close to reality. Though the more countries who pivot their currencies to the gold meaning that the more intervention from the central bank to tighten the inflation, this close view might be a solution for the EU to avoid high speculation on Euro-Dollar. Will it be the US dollar, the Euro, or the Pound sterling rule the battlefield' Too early to decide since we also have to look to the Far East where the largest communist country, independent from any foreign political power, has started to double digit its growth and a solid buyer of US bonds. Just the 19th century was for the Britain, the 20th century was for the America, many parties expected the 21st century is going to be the Asia. CONCLUSION The role of gold as an anchored exchange rate for international monetary system has took place over the centuries. In the nineteenth century, precisely from 1815 to 1873, gold and silver became the basic reserve assets. With this bimetallic system, the world monetary system became one unity which gave a fixed exchange rate between countries with the silver standard and countries with gold standard. In twentieth century, the United States appeared as a superpower. This caused US dollar became an anchored currency because the United States was the only major currency on gold and the other countries started to peg their currencies more on the dollar than on gold. Beside that, the creation of Federal Reserve System as a vehicle for the spread of dollar created the greatest inflation that ever happened. Today, in twenty-first century, gold still plays a role in international monetary system but not in the way it has been in the past. More likely, gold will be used as an asset that can circulate and be measured at market price, not at a fixed price. Moreover, gold probably will be used as an index or a warning signal of inflation to help keeping the monetary stability. ATTACHMENT Table of Exchange Rate Arrangements Pegged | Single currency | Currency composite | U.S. dollarAngola Antigua and Barbuda Argentina Bahamas, The4 Barbados Belize Djibouti Dominica Grenada Iraq4 Lithuania Marshall Islands11 Micronesia, Federated States of11 Nigeria4 Oman Panama11 St. Kitts and Nevis St. Lucia St. Vincent and the Grenadines Syrian Arab Republic4 | French francBenin Burkina Faso Cameroon Central African Rep. Chad Comoros Congo, Rep. of Côte d’Ivoire Equatorial Guinea Gabon Guinea-Bissau Mali Niger Senegal Togo | OtherBhutan    (Indian rupee) Bosnia and Herzegovina   (deutsche mark) Brunei Darussalam   (Singapore dollar) Estonia    (deutsche mark) Kiribati11   (Australian dollar) Lesotho   (South African rand) Namibia   (South African rand) San Marino11   (Italian lira) Swaziland   (South African rand) | SDRLatvia Libyan Arab Jamahiriya3,4 Myanmar4 | OtherBangladesh Botswana4 Burundi Cape Verde Cyprus6 Czech Republic8 Fiji Iceland10 Jordan Kuwait Malta Morocco13 Nepal Seychelles Slovak Republic14 Solomon Islands Thailand Tonga Vanuatu Western Samoa | Flexibility Limited vis-à-vis a Single Currency or Group of Currencies | More Flexible | Single currency1 | Cooperative arrangements2 | Other managed floating | Independently floating | Bahrain5 Qatar5 Saudi Arabia5 United Arab Emirates | Austria Belgium Denmark Finland France Germany Ireland Italy Luxembourg Netherlands Portugal Spain | Algeria Belarus Brazil4 Cambodia4 Chile4,7 China, People’s Rep. of Colombia9  Costa Rica Croatia Dominican Republic 4 Ecuador4,12 Egypt4 El Salvador Georgia Greece Honduras4,12 Hungary15 Indonesia Iran, Islamic Rep. of4 Israel14 Kazakhstan Kyrgyz Republic Lao P.D.R. Macedonia, former Yugoslav Rep.of Malaysia | Maldives Mauritius Nicaragua Norway Pakistan4 Poland14 Russian Federation Singapore Slovenia Sri Lanka Sudan4 Suriname Tunisia Turkey Turkmenistan4 Ukraine Uruguay Uzbekistan4 Venezuela8 Vietnam | Afghanistan, Islamic State of4 Albania Armenia Australia Azerbaijan Bolivia Bulgaria Canada Eritrea Ethiopia Gambia, The  Ghana Guatemala Guinea Guyana Haiti India Jamaica Japan Kenya Republic Korea Lebanon Liberia Madagascar Malawi | Mauritania Mexico Moldova Mongolia Mozambique New Zealand Papua New Guinea Paraguay Peru Philippines Romania Rwanda São Tomé and Príncipe4 Sierra Leone Somalia South Africa Sweden Switzerland Tajikistan, Rep. of4 Tanzania Trinidad and Tobago Uganda United Kingdom United States Yemen, Rep. of Zaïre4 Zambia4 Zimbabwe | 1In all countries listed in this column, the U.S. dollar was the currency against which exchange rates showed limited flexibility. 2This category consists of countries participating in the exchange rate mechanism (ERM) of the European Monetary System (EMS). In each case, the exchange rate is maintained within a margin of ±15 percent around the bilateral central rates against other participating currencies, with the exception of Germany and the Netherlands, in which case the exchange rate is maintained within a margin of ±2.25 percent. 3The exchange rate is maintained within margins of ±47 percent. 4Member maintained exchange arrangement involving more than one market. The arrangement shown is that maintained in the major market. For Zaïre, note that the official name was changed to Democratic Republic of the Congo on May 17, 1997. 5Exchange rates are determined on the basis of a fixed relationship to the SDR, within margins of up to ±7.25 percent. However, because of the maintenance of a relatively stable relationship with the U.S. dollar, these margins are not always observed. 6The exchange rate, which is pegged to the European currency unit (ECU), is maintained within margins of ±2.25 percent. 7The exchange rate is maintained within margins of ±12.5 percent on either side of a weighted composite of the currencies of the main trading areas. The exchange arrangement involves more than one market. 8The exchange rate is maintained within margins of ±7.5 percent. 9The exchange rate is maintained within margins of ±7 percent. 10The exchange rate is maintained within margins of ±6 percent. 11Country uses peg currency as legal tender. 12The exchange rate is maintained within margins of ±5 percent. 13The exchange rate is maintained within margins of ±3 percent. 14The exchange rate is maintained within margins of ±7 percent with regard to the currency basket. 15The exchange rate is maintained within margins of ±2.25 percent with regard to the currency basket.