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International Monetary System

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International Monetary System

International Monetary System is a set of internationally agreed rules, conventions and supporting institutions, that facilitates international trade, cross border investment and generally there allocation of capital between nation states.

It also refers to the system prevailing in world foreign exchange markets through which international trade and capital movement are financed and exchanged rates are determined.

International Monetary System is also a part of the institutional framework that binds national economies, such a system permits producers to specialize in those goods for which they have a comparative advantage and serves to seek profitable investment opportunities on a global basis.


International Monetary System evolved through the years.  International Monetary System started 1875 until present.  

Bimetallism was the first International Monetary System used around the world on 1875.  During the bimetallism, all nations are using gold and silver as money and they call it “Double Standard”.  In Bimetallism, Gresham’s Law was commonly applied.  This is a monetary principles stating that “Bad money drives out good”, example, if there are two forms of commodity money in circulation, which are accepted by the law having similar face value, the more valuable commodity will disappear from circulation.

After Bimetallism, Classic Gold Standard was born.  During this period gold alone was assured of unrestricted coinage. Gold could be freely exported or imported.  There are two-way convertibility between gold and national currencies at a stable ratio.  The exchange rate between two country’s currencies would be determined by their relative gold contents. Example, if the US dollar rate to gold is $30 = 1 ounce of gold and British pound rate is £ 6=1 ounce of gold, it must be the case that the exchange rate is determined by the relative gold contents ($30 =  £ 6 ; $5  =  £ 1).

Highly stable exchange rates provided an environment that was conducive to international trade and investment.  Misalignment of exchange rates and international imbalances of payment were automatically corrected by the Price-Specie-Flow Mechanism.  Price-Specie-Flow Mechanism is a logical arguments by David Hume against the Mercantilist idea that a nation should strive for a positive balance of trade, or net experts.  The argument considers the effect of international transaction in Gold Standard.

During the world war the Classic Gold Standard were abolished. In interwar period exchange rates fluctuated as countries widely used “predatory” depreciation of their currencies as a means of gaining advantage in the world export market. The result for international trade and investment was profoundly detrimental.

After the war, nations decided to create a strong and stable international monetary system and the Bretton Woods System was made.  The system was named after the 1944 meeting of 44 nations at Bretton woods, New Hampshire. The purpose was to design a postwar international monetary system.  The goal was to stabilize the exchange rate without the gold standard.  One of the accomplishments of Bretton Woods System was the creation of the International Monetary Fund and World Bank.  U.S. dollar was the basis of international monetary system were all currencies is rate under the U.S. dollar’s equivalent and because of this the Bretton Woods System was also called as “Dollar-Based gold exchange standard.  Example, 1 ounce of gold is equivalent to $35 while other currencies ware rate to the U.S. Dollar.  Each country was responsible for maintaining its exchange rate within + 1% of the adopted par value by buying or selling foreign reserves as necessary

Flexible exchange rates were declared acceptable to the IMF members.  The Central Bank were allowed to intervene in the exchange rate market to iron out unwarranted volatilities.  Gold was abandoned as an international reserve asset.  Non-oil-exporting countries and less-developed countries were given greater access to IMF Funds.


Free float was referred to as clean or pure float.  Determined by market forces of demand and supply of foreign and domestic currency and where government intervention is totally inexistent.

Managed float was referred to as dirty float.  Government or the country’s central bank may occasionally intervene in order to direct the country’s currency value into a certain direction.  This is generally done in order to act as a buffer against economic shocks and hence soften its effect in the economy.

No National Currency, some countries do not bother printing their own currency they just use the U.S. Dollar. For example, Ecuador, Panama and El Salvador have dollarized


Exchange rate is the price of a nation’s currency in terms of another currency.  There are two components of exchange rate, the Domestic Currency and the Foreign Currency.  

Domestic Currency is the primary currency that is used to conduct business within a country’s borders.  Example, Dollar is the domestic currency of the United States.  Peso is the domestic currency of Philippines.

Foreign Currency is the currency of an overseas country which is purchased by a particular country in exchange for its own currency, which then used to finance trade and capital transaction between two countries.


Country’s exchange rate regime under which the government or central bank ties the official exchange rate to another country’s currency or to the price of gold.  The purpose of fixed exchange rate system is to maintain a country’s currency value within a very narrow band.



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