International Financial System

international financial system has been radically altered since the worldwide
depression of the late 1920s and early 1930s. This change is due in large
part to the inception of the International Monetary Fund (IMF) and its
subsequent control over the international financial system. In this paper I will
examine the extensive role of the Bretton Woods system of exchange rates and the
gold standard. Additionally, I will examine the role that the IMF has taken on
since the demise of the gold standard. To begin, we must examine the
circumstances that surround the creation of the IMF, who the actors are and what
each of their roles are as member countries. The IMF was created as a result of
the worldwide market collapse that took place initially in October of 1929. The
domino effect that took place when the first market crashed was seen to be a
situation so severe that world powers felt that drastic measures needed to be
taken to ensure that this was the last global financial crisis that the world
would face. Its creation in 1944 was the beginning of a new era for the
international financial system. The creation of the IMF occurred at Bretton
Woods along with the World Bank and the system of fixed exchange rates and the
gold standard for currency. Under this system, the US dollar was tied to gold by
a United States government commitment to buy it at $35.00 and ounce and sell to
central banks at the same price (excluding handling and other charges). Other
participating countries maintained the exchange values of their currencies at
prices which were almost fixed in terms of the dollar (the values fluctuate
normally not more than one percent on either side of their parities), with the
result that exchange rates were almost universally fixed. Other governments
carried out their commitments by selling internationally acceptable liquid
resources when there was an excess demand for foreign currencies in terms of
their own currencies, and by buying liquid resources when there was an excess
supply. What constituted internationally acceptable resources for this purpose
were gold, and other liquid assets denominated in “key” or reserve
currencies, principally US dollars or UK pounds sterling. The IMF was to ensure
that these standards were being followed as well as being the lender for
temporary deficits, and balance of payment problems. Each member country
contributed a predefined amount, or quotas, of national currencies and gold.

This quota also determines the voting power on the IMF and the amount of
resources that they may draw on from the Fund. Designed to foster monetary
cooperation, the IMF sought to enforce strict rules of behaviour in a world
based on the gold standard and fixed currency-exchange rates. The Fund had, in
theory, strict rules regarding how much to lend and when it was to be repaid. In
reality, however, the Fund had discretion to waive any normal limitations. In
1961 with the advent of the General Arrangements to Borrow (GAB), the Fund
increased its ability to lend through arrangements to borrow from 10 major
industrial countries. At the time, these agreements had enabled the IMF to have
and additional $6 billion at its disposal. The Gold Standard, in theory,
functioned to limit the ability of governments to issue currency at will, hence
decreasing the purchasing power of money. It existed before the Bretton Woods
agreement, but was suspended for reasons that we will see later. If, for
example, the US dollar were defined as equal to 1/20 of an ounce of gold, then
the number of dollars that the United States could issue would be constrained by
its holdings of gold reserves. Moreover, if the UK defined its currency, the
pound sterling, as 5/20 of an ounce of gold, the fixed exchange rate between the
US and the UK, quite obviously would be $5 USD=1 sterling. One specific
problem with specie standards (that is a currency convertible into a
standardised unit of a non-monetary commodity) is that the value of money is
only as valuable as the specie backing it. When worldwide gold production was
low in the 1870s and 1880s, the money supply grew slowly, leading to a
general deflation. This situation changed radically in the 1890s following
the discovery of gold in Alaska and in South Africa. The result was rapid money
growth and inflation up until the outbreak of World War I. Furthermore, linking
currencies to gold did not totally restrain governments from manipulating the
value of their currencies. First, in order to finance expenditures by

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