The international monetary system refers to rules, conventions, and institutions that govern foreign exchange to support global trade and investments. According to Trace (2009), the system has moved through three significant evolutions, namely: the gold exchange standard (1925-33), Bretton's Woods system (1944-71), and floating exchange system (1971-current). The paper details the evolution and characteristics of every regime.
The gold standard was unplanned and required countries to define the value of their currencies relative to the value of gold. The system allowed cross-border movement of gold, and the value of a currency was dependent on a nation's gold stock (Li, 2015). The gold standard managed volatility and automatically adjusted to maintain the balance of payments (Trace, 2009). World War 1 discouraged international trade triggering the great depression of the 1930s, which led to the abandonment of international rules and institutions' collapse. In 1944, an agreement to create a world fixed exchange rate system under the monitoring of the newly developed international monetary Fund was reached in the Bretton Conference (Li, 2015). The new system pegged all currencies to the US dollar, whose price was fixed at $35 per ounce of gold. The value of the US dollar would, however, change in the event of significant disequilibrium (Trace, 2009). Therefore, the system worked well in limiting competitive devaluation, inflation, and effects of the balance of payment on exchange rates.
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Bretton's system collapsed in 1971 due to an increase in global trade, the popularity of free trade ideology, the difficulty of implementing capital controls, and instability created by shock on price oils. The collapse paved was for the current floating exchange rate regime in which the foreign exchange market sets the prices of currencies based on the forces of demand and supply (Li, 2015). The regime provides for automatic stabilization of balance of payments and control of inflation. The floating exchange system, however, comes with uncertainty due to volatility in foreign exchange rates.
In conclusion, the gold exchange standard and Bretton's Woods system provided stability in exchange rates relative to the floating exchange system. Although the flexible exchange rate regime helped free up international trade, there is a need for an updated system that can stabilize currencies' prices.
References
Li, R. (2015). Reform of the international monetary system and internationalization of the renminbi. World Scientific.
Trace, K. (2009). Evolution of the International Monetary System. International Economics, Finance, and Trade.
