9 evolution of forex

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International Monetary System- The stock International Monetary System- The stock

markets of today and the way countriesmarkets of today and the way countriesmaintain forex has not always beenmaintain forex has not always been

same.same. From the early 19th century till WorldWar I, countries traded with each other using

one important stock.



What is that?What is that?



GOLDGOLD!! Under this system, each nation definedUnder this system, each nation defined

its currency in terms of Gold (eg. $1 wasits currency in terms of Gold (eg. $1 was

equal to 1/20 of an ounce of gold whileequal to 1/20 of an ounce of gold whilethe British pound was 5/20 of an ounce of the British pound was 5/20 of an ounce of

gold)gold)

Every country was willing to convert itsEvery country was willing to convert its

currency to Gold on demand. Thus thosecurrency to Gold on demand. Thus those

countries which had high Gold reservescountries which had high Gold reserves

started prospering. Lot of researchersstarted prospering. Lot of researchers

started to find ways to produce artificialstarted to find ways to produce artificial

gold.gold.

Goods were traded between countries inGoods were traded between countries in

exchange for Gold. If a country importedexchange for Gold. If a country imported

goods worth more than those itgoods worth more than those it

imported, then it would have to pay theimported, then it would have to pay the

remaining in the form of Gold.remaining in the form of Gold.

The GOLD standard worked very well tillThe GOLD standard worked very well till

World War I when most countriesWorld War I when most countries

stopped trading in gold due to whichstopped trading in gold due to which

currencies became inconvertible. Aftercurrencies became inconvertible. After

the war, Gold exchange started again tillthe war, Gold exchange started again till

the great depression (1929- 1933)the great depression (1929- 1933)



THE BRETTON WOODS SYSTEMTHE BRETTON WOODS SYSTEM Since exchange of gold stopped, nations were not able to do easy trade with

each other. Some countries tried to stabilize exchange agreements and funds

but all that failed with the coming of World War II. While the war was going on, in 1944, a conference was held in Bretton Woods,

USA in which 44 countries participated and proposed establishing-

IMF-IMF- to achieve exchange rate

stability

World Bank-World Bank- to help in the

post-war reconstruction and

development of member countries

ITO- International TradeITO- International Trade

OrganizationOrganization for world trade(ITO did not work out, later came WTO)



AIMS-AIMS-(The maintenance of stable exchange rates and also a credit(The maintenance of stable exchange rates and also a credit

mechanism supervised by IMF)mechanism supervised by IMF)

This system was known as Pegged exchange rate system. Here each member country

was supposed to define the value of its currency in terms of gold or the US dollar or both. At the end of WWII, the US had over 74% of world’s monetary gold stock.

The US promised that all US dollars in the hands of foreign central banks would get gold inexchange at fixed price of $35 per ounce.

Because of US financial dominance, almost every country came to accept US dollar as theinternational money. As a result countries started accumulating dollars for reserves.

THE DOLLAR WAS NOT MERELY AS GOOD AS



THE DOLLAR WAS NOT MERELY AS GOOD ASGOLD, IT WAS BETTER THAN GOLD BECAUSEGOLD, IT WAS BETTER THAN GOLD BECAUSE

DOLLARS EARNED INTEREST WHILE GOLD DIDDOLLARS EARNED INTEREST WHILE GOLD DID

NOT!NOT!

The designers of this system knew that youcannot have a fixed system working smoothlyforever. But they hoped that changes would berare only when needed in emergency cases.

The IMF provided credit facilities to member

countries suffering from payment problems. Thecredit depended on the quota of the country i.e.member’s contribution to the fund, its trades etc.

The system started facing difficulties when theUS started finding it difficult in Gold for all dollarsfrom other countries. The US gold stock had

reduced from $25billion in 1949 to $10b in 1971.



THE END WAS NEAR……THE END WAS NEAR…… In 1971, the central bank of Germany

alone had enough dollars to buy all the

gold reserves of US at the current $35per ounce. This clearly showed that thepresent system was on the brink of collapse. The US could not continuebuying back dollars at the existing rate.

Other countries also started losing

confidence in the dollar’s power to doworld business. MNCs started trying toacquire other currencies instead of thedollar. Thus on the one hand there wasa tremendous desire to sell dollarseverywhere, but on the other hand, the

traditional buyers of these dollars(foreign central banks) were not willingto buy them anymore.



THE END.THE END.

On August 15, 1971 the American PresidentRichard Nixon withdrew US commitment to

buy and sell gold at $35 per ounce. Thus theIMF agreement became invalid. Foreigngovernments now had 2 choices- eithercontinue maintaining existing exchange rates(accumulating dollars without convertibility-

foolish) or to revalue the exchange rates. None of the countries wanted to revalue the

current rates. All the currencies (except thefrench franc) started to float the way theywished according to the dollar. Trade became

difficult and the world did not know how toproceed further.



A NEW BEGINNINGA NEW BEGINNING Since it was urgent to end this uncertain period, a

group of ten powerful countries got together andsigned the

Smithsonian agreementSmithsonian agreement. According to this

agreement the present exchange became $38 perounce of gold. Again fixed rates came back into thepicture with several countries appreciating their valueto the dollar.

This deal too did not last long. In 1973, Nixonannounced a new rate of $42.2 for an ounce of gold. The leading European countries reacted by bringing afloating rate to the outside world and a fixed rateamong their own currencies.

In 1976, the floating rate system

was finalized with the Jamaica

Agreement.



TODAY’S FOREX IS HERE!TODAY’S FOREX IS HERE!

Since 1972 the world can be said to befollowing varying levels of the floating

exchange rate system. The European countries that had fixed

a common fixed exchange rate amongthemselves and floating rates amongothers introduced a new arrangementknown as EMS (European Monetary

System) in 1979. Objectives of the EMS- Lasting

growth with stability, full employment,higher living standards, lessening of regional disparities. This was the firststep towards realizing the European

Union. A ECU (European Currency Unit) was

used to measure the value of eachcurrency with the others.



EURO!EURO! In 1991, the leaders of member countries of the

European community came to an agreement fora common European monetary policy. It was a 3stage transition plan:

Stage 1-Stage 1- The free internal market of EC would becomplete and obstacles to financial integrationremoved.

Stage 2-Stage 2- 1994, establishment of EMI (EuropeanMonetary Institute) bringing closer coordinationof monetary policies and establishment of theECB (European Central Bank)

Stage 3-Stage 3- Jan 1st , 1999 launch of a common

currency EURO by 11 of 15 members of the EU.

Only UK has kept away from all this.

9 evolution of forex

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