Text II. International monetary system

In 1994, at the height of World War II, representatives from 44 countries met at Bretton Woods, New Hampshire, to design a new international monetary system. With the collapse of the gold standard and the Great Depression of the 1930s fresh in their minds, these statesmen were determined to build an enduring economic order that would facilitate post war economic growth. There was general consensus that fixed exchange rate were desirable. In addition the conference participants wanted to avoid the senseless competitive devaluations of the 1930s, and they recognized that gold standard would not assure this. The major problem with the gold standard as previously constituted was that there was no multinational institution that could stop countries from engaging in competitive devaluations.

The agreement reached at Bretton Woods established two multinational institutions-the International Monetary Fund (IMF) and the World Bank. The task of the IMF would be to maintain order in the international monetary system, and that of the World Bank would be to promote general economic development. The Bretton Woods agreement also called for a system of fixed exchange rates that would be currency in terms of gold but were not required to exchange their currencies for gold.

The fixed exchange rate system collapse in 1973, primarily due to speculative pressure on the dollar following a rise in U.S. inflation and a growing U.S. balance-of-trade deficit.

Since 1973 the world has operate with a floating exchange rate regime and exchange rates have become more volatile and far less predictable. Volatile exchange rate movements have helped reopen the debate over the merits of fixed and floating systems.

The collapse of the Bretton Woods system left the IMF and World Bank with diminished roles in the international monetary system. In response, both the IMF and the World Bank have developed into global macroeconomic police. Today they lend money to countries with balance-of-payments, debt, or development problems, extracting promises to adopt specific macroeconomic policies as a condition.

One function of the foreign exchange market is to convert the currency of one country into the currency of another.

International business participate in the foreign exchange market to facilitate international trade and investment, to invest spare cash in short-term money market accounts abroad, and to engage in currency speculation.

A second function of the foreign exchange market is to provide insurance against foreign exchange risk.

Foreign exchange risk can be reduced by using forward exchange rates. A forward exchange rate is an exchange rate governing future transactions.

The most common approach to exchange rate forecasting is fundamental analysis. This relies on variables such as money supply growth, inflation rates, nominal interest rates, and balance of payments positions to predict future changed in exchange rates.

In many countries, the ability of residents and nonresidents to convert local currency into a foreign currency is restricted by government policy. A government restricts the convertibility of its currency in attempting to protect the country’s foreign exchange reserves and to halt capital flight.