Global Monetary System- Evolution and Policies

Posted in Finance Articles, Total Reads: 604 , Published on 01 December 2016
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In the global scenario, there is no country which is independent or which does not affect the economy of the other countries or which is not affected by the economies of other countries. This fact makes it imperative that there should be an effective global monetary system. The global monetary system is designed with mutual consensus of the countries to promote free international transactions. The main task of the global monetary system is to provide adequate liquidity, smooth and transparent adjustment of global transaction and to build confidence in the monetary system.

In the 19th century, London had a great influence on global monetary system. Bank of England was considered as the supreme authority. But the time took a grand turn and today America has a dominant position in the global monetary system.


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Most of the monetary systems have been the result of accident rather than a planned design. The old gold standard in 19th century was developed in Britain during industrialization phase. This system worked as the lubrication for international trade. The exchange rates were decided among the countries and there was smooth flow of goods among different economies. This system had a very big lacuna. The free flow of capital made the currencies very much vulnerable. But due to the government support to the gold system, it survived for many decades. The gold standard of the 19th century collapsed in 1930s. The Bretton Woods system of fixed exchange rates failed in 1970s, to be replaced by a freewheeling system of floating currencies and mobile capital. The support was mainly due to the influence of the working people on the political leaders. However the gold standard system lost its significance in 1930 thanks to the depression and the global chaos. After the First World War, the countries started controlling the capital flows and printed a lot of money to make payments for the wars. The reserves of gold started becoming unbalanced. America, in order to control Wall Street movements, didn’t expand its money supply at the cost of increase in price. Under the pressure of depression, the system was affected badly. By the end of year 1936, the gold standard was collapsed.


At Bretton Woods conference in 1944, there was a major transformation in global monetary system. The countries reached on a consensus to fix the value of their currencies in terms of dollar which was further pegged into gold. The countries laid down the foundation of IMF which was designed to take care of economies which were in crises situation. The World Bank was assigned the responsibility to take care of financial need of the poor countries. GATT (General Agreement on Tariffs and Trade) was also developed to promote global trade talks. The developing countries found no reason to resist against the system. It was believed that the fixed exchange rate system would help in solving the problem of inflation and promote monetary discipline among the countries. But the countries which had high debts could not keep up with the system. Some countries like China were not in the condition to accept this system. Whenever America planned to increase the interest rates, it hurt the exports badly. After the Asian financial crisis of 1997-98, the situation became worse. The confidence in the fixed exchange rate system was lost. In 1967, Britain was forced to devalue its currency. Late in 1970s, the Bretton Woods system of fixed exchange rate collapsed.


After the Asian crises, the countries agreed that they should allow their currencies float freely in the international market. At that time, most of the countries had built high gold reserves and were focusing on balancing their current accounts. But this system has its own disadvantages. Free capital flows can lead to uncertainty and create chaos. Floating exchange rate system remained unpopular in the global monetary system. Instead of flexible exchange system, the countries prefer managed exchange rates. China is very much reluctant to abandon the system of managed floats.


History has proved multiple times that a global monetary system survives with support from political environment in the world economies. There have been dramatic changes in the global monetary system thanks to the volatility in the political environment.


America plays an important role in today’s global monetary system. America also feels that it has a great privilege in the global monetary system due its ability to make international trade transactions in its own currency freely. It is assumed that the recovery in American economy would help the other economies also. It would help the emerging economies by boosting their exports. During 2007-08 crises, the Eurodollar market was in a fix. The fed had to provide liquidity by lending to the foreign banks which made available the dollars to various foreign banks. The situation was calmed by their mere presence. As the economies are getting bigger, their use of dollars is also increasing significantly. The crisis situation in 2007-08 clearly proves that the U.S. economy collapse can badly affect the entire global monetary system.


The current global monetary system suffers from three main problems. The first and foremost problem is to reduce the imbalances in the economies. There are a lot of countries which are struggling with their current account deficits while some other have huge current account surplus. If the countries with deficit in their current accounts decrease their imports to manage the situation, it will affect the world output. If these countries devalue their currencies to boost exports, it will result in loss to other countries. For example the recent devaluation of currency by China affected the neighboring countries very badly. The second problem is related to the gross capital flows in the global market. The third problem is the position and influence of America and more specifically dollar in the global monetary system. The other currencies like Euro, Yen, and Yuan etc. have failed miserably in the global market. Dollar is at the dominant position which gives a privilege to America over other countries. The Fed makes its policy in favor of America even at the cost of other countries. Those countries which peg their currencies to dollar have to follow Fed policies. The big global investment banks, generally having their headquarters in America, go according to the Wall Street rhythm.


There is a lot of uncertainty in the global markets today. The exchange rates fluctuate unpredictably with no linkage to any macroeconomic concept. Each country is setting its monetary policy in favor of its economy without taking much care of other economies. Think of how bad those workers feel when they manufacture good quality products and are not able to sell it in global markets owing to the exchange rate fluctuations. How much longer will we continue such a scenario? We have to find ways to correct such a situation. The currencies should not be used as a tool to compete with the other economies. Money is meant to serve the purpose of exchange rather than serving the selfish interest of government policies. But the efforts of a few countries would not be suffice to handle the current situation. All the countries should act in their moral capacity and help in the implementation of a fair and transparent global monetary system.

 

This article has been authored by Sourav Saha from IIM Raipur


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