Title: Cat for Lesson 10 - The Evolution of the International...
Course: 383-303-FD-55-01 • International Economics

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Question

In 1944, certain countries met in Bretton Woods and established operational rules for an international monetary system. Explain how this system works.

Entrez votre réponse ci-dessous.
Feedback: In 1944 in Bretton Woods, the countries agreed on the following points: - Each country must gradually establish the convertibility of its currency with the dollar and other currencies. - The exchange rates must be fixed. Monetary authorities defined parity and maintained it until they decided to change it. They had reserves to intervene. - The US dollar was convertible into gold at the fixed rate of $35 an ounce. The central banks recognized two assets to pay international transaction balances: the US dollar and gold. - A supranational institution was created. The IMF's main purpose was to help countries maintain fixed exchange rates. Member states were assigned a quota that determined the amount of their contribution and set the proportion of voting rights they were granted.
Feedback: In 1944 in Bretton Woods, the countries agreed on the following points: - Each country must gradually establish the convertibility of its currency with the dollar and other currencies. - The exchange rates must be fixed. Monetary authorities defined parity and maintained it until they decided to change it. They had reserves to intervene. - The US dollar was convertible into gold at the fixed rate of $35 an ounce. The central banks recognized two assets to pay international transaction balances: the US dollar and gold. - A supranational institution was created. The IMF's main purpose was to help countries maintain fixed exchange rates. Member states were assigned a quota that determined the amount of their contribution and set the proportion of voting rights they were granted.

Question

From 1958 to 1973, the system created in Bretton Woods was not functioning properly. Present three main points that show that the IMS was not functioning properly.

Entrez votre réponse ci-dessous.
Feedback: Your answer should include the following points: 1. The United States had an almost permanent deficit in their trade balance, i.e., they imported more than they exported and no action was taken to change the situation. The system created in Bretton Woods allowed this to happen and other countries accepted this situation for the time being. 2. A large amount of US dollars were found in Europe (eurodollars). Until 1971, the US dollar was convertible into gold. However, the European countries only once requested gold in exchange for their US dollars, preferring to keep US dollars as reserves in their central banks. The US central bank reserves were very low at that time, and the Federal Reserve did not have enough reserves to convert all the US dollars that were circulating in Europe into gold. Confidence in the value of the US dollar was shaken. 3. A fixed exchange rate system was implemented in Bretton Woods; a decline in confidence in a currency should cause its devaluation. Two gold markets emerged: a formal market directed by the central banks, where the price was maintained at US$35 an ounce, and a free gold market, where its price was determined by supply and demand. The price rose much higher on the free gold market than on the central bank market, so it was advantageous to buy gold on the central bank market (at US$35) and resell it on the free market. The rise in the open market price of gold meant that the US dollar was overvalued. This two-tier gold market illustrates how the system was not working properly: the US dollar should have been devalued, but the Americans did not devalue it. It was only in 1971 that the US dollar was devalued for the first time since Bretton Woods. Americans viewed the devaluation of their currency as an attack on their monetary supremacy.
Feedback: Your answer should include the following points: 1. The United States had an almost permanent deficit in their trade balance, i.e., they imported more than they exported and no action was taken to change the situation. The system created in Bretton Woods allowed this to happen and other countries accepted this situation for the time being. 2. A large amount of US dollars were found in Europe (eurodollars). Until 1971, the US dollar was convertible into gold. However, the European countries only once requested gold in exchange for their US dollars, preferring to keep US dollars as reserves in their central banks. The US central bank reserves were very low at that time, and the Federal Reserve did not have enough reserves to convert all the US dollars that were circulating in Europe into gold. Confidence in the value of the US dollar was shaken. 3. A fixed exchange rate system was implemented in Bretton Woods; a decline in confidence in a currency should cause its devaluation. Two gold markets emerged: a formal market directed by the central banks, where the price was maintained at US$35 an ounce, and a free gold market, where its price was determined by supply and demand. The price rose much higher on the free gold market than on the central bank market, so it was advantageous to buy gold on the central bank market (at US$35) and resell it on the free market. The rise in the open market price of gold meant that the US dollar was overvalued. This two-tier gold market illustrates how the system was not working properly: the US dollar should have been devalued, but the Americans did not devalue it. It was only in 1971 that the US dollar was devalued for the first time since Bretton Woods. Americans viewed the devaluation of their currency as an attack on their monetary supremacy.

Q: Question

Which year marked the end of the Bretton Woods system?
- 1944 (The year 1973 actually marked the end of the international monetary system that was established by the Bretton Woods Agreement.)
- 1971 (The year 1973 actually marked the end of the international monetary system that was established by the Bretton Woods Agreement.)
- 1973 (That's correct. The year 1973 marked the end of the international monetary system that was established by the Bretton Woods Agreement.)
A: 1973

Question

The IMF plays an important role in the operation of the IMS. Describe this role by showing the responsibilities and interventions that this organization carried out over the years.

Entrez votre réponse ci-dessous.
Feedback: Created in Bretton Woods, the IMS established a compulsory fixed exchange rate system for participating countries. When it was created, the IMF's main purpose was to help countries maintain fixed exchange rates by providing them with necessary cash reserves. In terms of granting credit to member states, the IMF's action was much weaker than Keynes had projected. Under the pretext that it had insufficient resources or that there was a risk of inflation, only very small withdrawals (actually loans) from the IMF were authorized. The IMF was thus doomed to play a very modest role in the international monetary system during the first post-war decade. In an attempt to reform the international monetary system in order to increase international liquidity, in 1969, the IMF issued a new currency: special drawing rights (SDRs). SDRs were considered credits for IMF member states to finance their balance of payments deficits. The beginning of the 1970s was a particularly inappropriate time to create the first SDRs. At that time, countries around the world were facing a surplus of international liquidity rather than a shortage. Nevertheless, SDRs were an important innovation as they consolidated the creation and management of world reserves under one supranational institution in an orderly fashion. After 1973, a shift in power took place in the IMF in favour of the G5 in the beginning, and then the G7. These countries had already held a side meeting at the IMF annual general meeting in 1973, and they continued to meet thereafter on a regular basis to coordinate their strategy to control the world recession. In fact, after 1975, all major international economic decisions were made at the Group of Seven before being submitted to the IMF for ratification. The United States exerted a significant influence in the Group of Seven and this was reflected in the decisions made by the Group. The first concrete change was the strengthening of the dollar as the reserve's main currency. To do so, they decided to weaken the position of gold and SDRs, its two rivals in the international monetary system. The total amount of SDRs was restricted to $21.5 billion. Countries accepted the idea that gold would no longer play a role in the international monetary system; this process was referred to as the "demonetization of gold." With the deregulation of the financial markets in the 1980s, it was clear that even the G7 would be powerless if the money and financial markets raced out of control. At meetings toward the end of the century, the IMF, aware of its intervention limitations on the volatile exchange market, took action to minimize the disastrous consequences of crises resulting from this lack of control. Therefore, in 2001, the structure of the financial and monetary system was strengthened. The IMF increasingly involved the private sector in managing crises and set goals to: - Promote transparency and responsibility, particularly with regard to countries' international reserve and foreign debt declarations. - Strengthen the financial system, in particular by more closely monitoring financial markets. - Pursue the orderly liberalization of financial markets. - Collaborate more closely with the private sector to prevent and resolve crises. - Ensure that the IMF resources are adequate.
Feedback: Created in Bretton Woods, the IMS established a compulsory fixed exchange rate system for participating countries. When it was created, the IMF's main purpose was to help countries maintain fixed exchange rates by providing them with necessary cash reserves. In terms of granting credit to member states, the IMF's action was much weaker than Keynes had projected. Under the pretext that it had insufficient resources or that there was a risk of inflation, only very small withdrawals (actually loans) from the IMF were authorized. The IMF was thus doomed to play a very modest role in the international monetary system during the first post-war decade. In an attempt to reform the international monetary system in order to increase international liquidity, in 1969, the IMF issued a new currency: special drawing rights (SDRs). SDRs were considered credits for IMF member states to finance their balance of payments deficits. The beginning of the 1970s was a particularly inappropriate time to create the first SDRs. At that time, countries around the world were facing a surplus of international liquidity rather than a shortage. Nevertheless, SDRs were an important innovation as they consolidated the creation and management of world reserves under one supranational institution in an orderly fashion. After 1973, a shift in power took place in the IMF in favour of the G5 in the beginning, and then the G7. These countries had already held a side meeting at the IMF annual general meeting in 1973, and they continued to meet thereafter on a regular basis to coordinate their strategy to control the world recession. In fact, after 1975, all major international economic decisions were made at the Group of Seven before being submitted to the IMF for ratification. The United States exerted a significant influence in the Group of Seven and this was reflected in the decisions made by the Group. The first concrete change was the strengthening of the dollar as the reserve's main currency. To do so, they decided to weaken the position of gold and SDRs, its two rivals in the international monetary system. The total amount of SDRs was restricted to $21.5 billion. Countries accepted the idea that gold would no longer play a role in the international monetary system; this process was referred to as the "demonetization of gold." With the deregulation of the financial markets in the 1980s, it was clear that even the G7 would be powerless if the money and financial markets raced out of control. At meetings toward the end of the century, the IMF, aware of its intervention limitations on the volatile exchange market, took action to minimize the disastrous consequences of crises resulting from this lack of control. Therefore, in 2001, the structure of the financial and monetary system was strengthened. The IMF increasingly involved the private sector in managing crises and set goals to: - Promote transparency and responsibility, particularly with regard to countries' international reserve and foreign debt declarations. - Strengthen the financial system, in particular by more closely monitoring financial markets. - Pursue the orderly liberalization of financial markets. - Collaborate more closely with the private sector to prevent and resolve crises. - Ensure that the IMF resources are adequate.

Question

Why did the European countries create the EMS?

What are its characteristics?

Entrez votre réponse ci-dessous.
Feedback: EEC countries unenthusiastically observed the dollar's success as the central figure in the new international monetary system established after 1973. For one thing, the United States, which controlled the issuance of that currency, served as the world's banker, enabling it to play a decisive role in the direction of international monetary policy. It also played a very active role in the dollar exchange rate, often basing its actions on domestic economic policy objectives, without considering the international impact of its initiatives. In light of these facts, the European countries recommended that the EEC establish its own monetary system. The EMS came into force at the beginning of 1979. The characteristics of the EMS are as follows: The European Monetary System made it possible to achieve two main objectives: to strengthen solidarity in monetary matters among the European countries and to introduce greater flexibility in the mechanism to adjust the exchange rates of European currencies in relation to one another. To achieve these goals, three new instruments were created: a European currency, then called the European Currency Unit (ECU); a provision permitting the flexible adjustment of reciprocal exchange rates; and the European Monetary Co-operation Fund (EMCF). When it came into force in 1979, the EMS greatly improved price stability in participating countries as well as the relative stability in the internal EEC exchange rate and with third-party countries. It also promoted the convergence of the economic performances of member countries, the intensification of reciprocal consultations and the strengthening of economic policy. This enabled the European Union to implement a common currency. The desire to further stabilize exchange rates became a reality when the Maastricht Treaty was signed. This Economic and Monetary Union (EMU) program adopted in February 1992 led, in three stages, to the creation of a single currency and a European Central Bank, which manages the monetary policy of countries that use the single currency. The ECU became the euro, the name of the single currency. The last stage began on January 1, 1999. It led to the creation of a single currency used by a group of 12 countries. The countries had to meet certain criteria to be eligible for the single currency: reduced inflation and reduced interest rates; a low budget deficit; and a low national debt. As already mentioned in Lesson 5, these criteria were demanding restrictions for certain countries. In January 1999, the euro was launched on the foreign exchange market with a starting quotation of 1 euro = US$1.18. The markets subsequently found that this quotation was overvalued. In February 2002, the euro was worth US$0.87; it rose subsequently, reaching a peak of nearly $1.60 in July 2008 before dropping slightly.
Feedback: EEC countries unenthusiastically observed the dollar's success as the central figure in the new international monetary system established after 1973. For one thing, the United States, which controlled the issuance of that currency, served as the world's banker, enabling it to play a decisive role in the direction of international monetary policy. It also played a very active role in the dollar exchange rate, often basing its actions on domestic economic policy objectives, without considering the international impact of its initiatives. In light of these facts, the European countries recommended that the EEC establish its own monetary system. The EMS came into force at the beginning of 1979. The characteristics of the EMS are as follows: The European Monetary System made it possible to achieve two main objectives: to strengthen solidarity in monetary matters among the European countries and to introduce greater flexibility in the mechanism to adjust the exchange rates of European currencies in relation to one another. To achieve these goals, three new instruments were created: a European currency, then called the European Currency Unit (ECU); a provision permitting the flexible adjustment of reciprocal exchange rates; and the European Monetary Co-operation Fund (EMCF). When it came into force in 1979, the EMS greatly improved price stability in participating countries as well as the relative stability in the internal EEC exchange rate and with third-party countries. It also promoted the convergence of the economic performances of member countries, the intensification of reciprocal consultations and the strengthening of economic policy. This enabled the European Union to implement a common currency. The desire to further stabilize exchange rates became a reality when the Maastricht Treaty was signed. This Economic and Monetary Union (EMU) program adopted in February 1992 led, in three stages, to the creation of a single currency and a European Central Bank, which manages the monetary policy of countries that use the single currency. The ECU became the euro, the name of the single currency. The last stage began on January 1, 1999. It led to the creation of a single currency used by a group of 12 countries. The countries had to meet certain criteria to be eligible for the single currency: reduced inflation and reduced interest rates; a low budget deficit; and a low national debt. As already mentioned in Lesson 5, these criteria were demanding restrictions for certain countries. In January 1999, the euro was launched on the foreign exchange market with a starting quotation of 1 euro = US$1.18. The markets subsequently found that this quotation was overvalued. In February 2002, the euro was worth US$0.87; it rose subsequently, reaching a peak of nearly $1.60 in July 2008 before dropping slightly.

Question

Describe the characteristics of the international monetary system from 1985 to present.

Entrez votre réponse ci-dessous.
Feedback: During this most recent period, the Plaza Accord (1985) and the Louvre Accord (1987) were signed. The IMS now relies on authorities and agreements with no constraining legal existence. The markets determine the exchange rates of various currencies and the central banks try to influence them. Their intervention capacity is limited by the amount of their reserves, so they rely on the credibility of their countries' economic policies. However, the money and financial markets are still very powerful and the IMF is seeking to restructure the international financial system by increasing the involvement of the private sector in managing crises.
Feedback: During this most recent period, the Plaza Accord (1985) and the Louvre Accord (1987) were signed. The IMS now relies on authorities and agreements with no constraining legal existence. The markets determine the exchange rates of various currencies and the central banks try to influence them. Their intervention capacity is limited by the amount of their reserves, so they rely on the credibility of their countries' economic policies. However, the money and financial markets are still very powerful and the IMF is seeking to restructure the international financial system by increasing the involvement of the private sector in managing crises.