The gold standard

n Pegging currencies to gold and guaranteeing

convertibility is known as gold standard
n Roots in old mercantile trade , medium of exchange was

gold & silver

n Inconvenient to ship gold, changed to paper CURRENCY-

redeemable for gold.

The gold standard required a nation to fix the value of its

currency to an ounce of gold.

For ex: $20.67 = 1 oz gold , £4.25=1 oz gold

Value of currency exposed in terms of gold is called its par

value
To calculate the exchange rate, simply divide the par

value of the currencies.

Ex rate of $ and £ , 20.67/4.25 which is £1=$4.25
Fixed exchange rate
system
n

n Because the gold standard fixed

nation’s currencies to the value of
gold it is called fixed exchange rate
system
n Exchange rate for converting one
currency into another is fixed by
international governmental
agreement
n
n Worked well from 1870’s to ww I.
n Countries printed money, resulted in inflation
n Post WWI, war heavy expenditures affected
the value of dollars against gold
n In 1934, US raised dollars to gold from $20.67
to $35 per ounce - devaluation
 Other countries followed suit and devalued
their currencies

Bretton Woods
n In 1944, 44 countries met in New
Hampshire, in the town of Bretton
Woods
n Countries agreed to peg their currencies
to US$ which was convertible to gold
at $35/oz.
n Agreed not to engage in competitive
devaluations for trade purposes and
defend their currencies
n Weak currencies could be devalued up
to 10% w/o approval, in case of
emergency
IMF
n Created to police monetary system by
ensuring maintenance of the fixed-exchange
rate
n Promoting international monetary cooperation
and facilitate growth of international trade
n Promoting exchange stability, maintaining
orderly exchange arrangements and
avoiding competitive exchange devaluation
n Making the resources of the Fund temporarily
available to members
n Shortening the duration and lessening the
degree of disequilibrium in the international
balance of payments of member nations
Principles
n Surveillance of exchange rate policies (No
longer fixed rate exchange)
n Financial assistance (including credits and
loans)
n Technical assistance (expertise in
fiscal/monetary policy)
n Functions as a reservoir of currencies of
member countries and enables the
members to borrow other currencies
n Conducts short term courses on fiscal,
monetary and balance of payments for
employees of member countries
Membership in the IMF
n 185 members
n Open to any country willing to agree to its

rules and regulations

n Must pay a deposit (quota)

n Quota size reflects global importance of a

nation’s economy
n Quota determines voting powers

Voting right – each member country has 250

basic votes of rights (to bring about changes)

irrespective of its quota
India- quota is 4,158.2 (SDRs) , votes - 41,832


Quota
n The capital of the IMF is contributed by the quotas
allocated to the member countries.
n The quota determines the size of the subscription of the

member country to the IMF capital

n Determines the voting power and the drawing rights of

the member country

quotas are determined on the following criteria:

 2% of the national income of the member

country
 5% of the gold and US dollar reserve
 10% of average annual imports and 10% of the
maximum variation in annual exports of national income

SDR
Special Drawing Right:
When world financial reserves of dollars and

gold grew scarce, activities of IMF demanded

greater amount of dollars and gold
The IMF created SDR – an asset whose value is

based on a basket of its five biggest member’s

currencies (France, Germany, Japan, USA, UK)
Each country will contribute for the overall value

of the SDR.
Each nation is assigned a quota based on its

economy when it enters the IMF

SDR is the unit of account for the IMF

SDR
n International liquidity
n All Central banks have the stock of assets such
as commercial credit operations, hard
currencies, international borrowing etc. This
is called International liquidity
n Before, countries had gold as int.liquidity
n Gold standard collapsed and IMF created SDR
in 1969.
n Is also called “paper gold”
n Is an international reserve asset
n Purpose – trade should not suffer due to
liquidity problem
n
n SDR is a freely usable claim for foreign
currencies of IMF members
n Countries can exchange their sdrs for

foreign currencies
n Value of SDR keep changing- based on a

basket of key international currencies

SDR Rates for May 14

n 1 USD = SDR 0.659111

n
Biggest members
18.3
20

15

10 5.7 5.7 5.1 5.1 Percent

0
US Germany Japan Britain France
n IMF stood ready to lend foreign currencies to
members to tide them over during short periods
of balance of payments deficits
n IMF does not simply lend money to a country in
trouble
n In exchange it requires that government to adopt
policies designed to correct whatever economic
problems caused the depreciation in the nations
currency
n Ex: inflation – what steps can be taken to reduce
inflation
Changing role of IMF
n London G20 summit gave a mandate to IMF
n More concessional finance will be available for
low income countries
n International liquidity will be increased by
$250bl in SDR
n A new non conditional credit line was
introduced to well performing countries
n Mexico & Poland will be first to users for this
n New IMF will be a better communicator