FINA4810 CH.2 VERIFIED QUESTIONS
AND ANSWERS(A+)
International monetary system - ✔✔a complex set of agreements, rules, and
mechanisms regarding exchange rates, international payments, and capital flow
- it is the institutional framework within which international payments are made,
movements of capital are accommodated and exchange rates among currencies are
determined
International monetary system went through several distinct stagesof evolution -
✔✔Bimetallism: Before 1875.
- Classical gold standard: 1875 to 1914.
- Interwar period: 1915 to 1944.
- Bretton Woods system: 1945 to 1972.
- Flexible exchange rate regime: Since 1973.
Bimetallism: Before 1875 - ✔✔a "double standard" in that free coinage was maintained
for both gold and silver
- exchange rates among currencies were determined inedible by their gold or silver
- countries on the bimetallic standard often experienced the well-known phenomenon
referred to as the Gresham's law
Gresham's law - ✔✔since the exchange ratio between the two metals was officially
fixed, the abundant metal was used as money while the scarce metal was driven out of
circulation
Classical Gold Standard: 1875 to 1914 - ✔✔- an internal gold standard exists when:
- gold alone is assured and unrestricted coinage
- there is two-way convertibility between gold and national currencies at a stable ratio
- gold can be freely exported or imported
- under the gold standard the exchange rate between any two currencies will be
determined by the gold contents
- London became the center of the international financial system during the classical
gold standard era
classical gold standard: an example - ✔✔Suppose the pound (£) is pegged to gold at
six pounds(£6) per ounce, whereas one ounce of gold is worth 12francs (₣).
- £6 = 1 oz. gold.• ₣12 = 1 oz. gold.
- Deducing from the information above, £6 must equal ₣12.
- £6 = ₣12; therefore £1 = ₣2.
• Exchange rate between the pound and the franc should then be two francs per pound.
, Classical Gold Standard: Advantages - ✔✔- highly stable exchange rates that are
conducive for international trade
- money supply cannot get out of control and cause inflation because gold is naturally
scarce
- no country can have a persistent trade deficit or surplus because countries balance of
payments will be regulated automatically via movements of gold
Classical gold standard: shortcomings - ✔✔- lack of sufficient monetary reserves due to
the restricted supply of newly minted gold can hamper the growth of world trade and
investment
- no mechanism to compel each major country to abide by the rules of the game
Interwar Period:
1915 to 1944 - ✔✔- World War I ended the classical gold standard in august 1914
- attempts were made to restore the gold standard, but they ultimately failed
- period marked by the Great Depression and other economic and political instabilities
- no coherent international monetary system during this period, with detrimental impact
on international trade and investment
Bretton woods system: 1945 to 1972 - ✔✔- named for the July 1944 meeting of 44
nations at Bretton woods, new Hampshire
Bretton Woods System purpose - ✔✔to design a postwar international montary system
that would provide exchange rate stability without the gold standard
Britton Woods System result - ✔✔Dollar-based gold exchange standard: U.S. dollar
was pegged to gold and other currencies were pegged to the U.S. dollar. U.S dollar was
the only currency fully convertible to gold
- dominance of U.S. dollar as the global currency
- creation of the IMF and the World Bank
The Design of the Gold-Exchange System - ✔✔The U.S. dollar was pegged to gold at
$35/ounce and other currencies were pegged to the U.S. dollar.
Britton Woods System advantages - ✔✔- economized on gold
- countries can earn interest on FX holdings
- lower transaction costs without the transportation of gold
- stable exchange rates
Bretton woods system shortcomings that lead to the collapse of the system in the early
1970s: - ✔✔- the reserve currency country has to run a balance of payments deficit to
satisfy the growing need for reserves from the rest of the world
- it can decrease confidence in the reserve currency and lead to the downfall of the
system
AND ANSWERS(A+)
International monetary system - ✔✔a complex set of agreements, rules, and
mechanisms regarding exchange rates, international payments, and capital flow
- it is the institutional framework within which international payments are made,
movements of capital are accommodated and exchange rates among currencies are
determined
International monetary system went through several distinct stagesof evolution -
✔✔Bimetallism: Before 1875.
- Classical gold standard: 1875 to 1914.
- Interwar period: 1915 to 1944.
- Bretton Woods system: 1945 to 1972.
- Flexible exchange rate regime: Since 1973.
Bimetallism: Before 1875 - ✔✔a "double standard" in that free coinage was maintained
for both gold and silver
- exchange rates among currencies were determined inedible by their gold or silver
- countries on the bimetallic standard often experienced the well-known phenomenon
referred to as the Gresham's law
Gresham's law - ✔✔since the exchange ratio between the two metals was officially
fixed, the abundant metal was used as money while the scarce metal was driven out of
circulation
Classical Gold Standard: 1875 to 1914 - ✔✔- an internal gold standard exists when:
- gold alone is assured and unrestricted coinage
- there is two-way convertibility between gold and national currencies at a stable ratio
- gold can be freely exported or imported
- under the gold standard the exchange rate between any two currencies will be
determined by the gold contents
- London became the center of the international financial system during the classical
gold standard era
classical gold standard: an example - ✔✔Suppose the pound (£) is pegged to gold at
six pounds(£6) per ounce, whereas one ounce of gold is worth 12francs (₣).
- £6 = 1 oz. gold.• ₣12 = 1 oz. gold.
- Deducing from the information above, £6 must equal ₣12.
- £6 = ₣12; therefore £1 = ₣2.
• Exchange rate between the pound and the franc should then be two francs per pound.
, Classical Gold Standard: Advantages - ✔✔- highly stable exchange rates that are
conducive for international trade
- money supply cannot get out of control and cause inflation because gold is naturally
scarce
- no country can have a persistent trade deficit or surplus because countries balance of
payments will be regulated automatically via movements of gold
Classical gold standard: shortcomings - ✔✔- lack of sufficient monetary reserves due to
the restricted supply of newly minted gold can hamper the growth of world trade and
investment
- no mechanism to compel each major country to abide by the rules of the game
Interwar Period:
1915 to 1944 - ✔✔- World War I ended the classical gold standard in august 1914
- attempts were made to restore the gold standard, but they ultimately failed
- period marked by the Great Depression and other economic and political instabilities
- no coherent international monetary system during this period, with detrimental impact
on international trade and investment
Bretton woods system: 1945 to 1972 - ✔✔- named for the July 1944 meeting of 44
nations at Bretton woods, new Hampshire
Bretton Woods System purpose - ✔✔to design a postwar international montary system
that would provide exchange rate stability without the gold standard
Britton Woods System result - ✔✔Dollar-based gold exchange standard: U.S. dollar
was pegged to gold and other currencies were pegged to the U.S. dollar. U.S dollar was
the only currency fully convertible to gold
- dominance of U.S. dollar as the global currency
- creation of the IMF and the World Bank
The Design of the Gold-Exchange System - ✔✔The U.S. dollar was pegged to gold at
$35/ounce and other currencies were pegged to the U.S. dollar.
Britton Woods System advantages - ✔✔- economized on gold
- countries can earn interest on FX holdings
- lower transaction costs without the transportation of gold
- stable exchange rates
Bretton woods system shortcomings that lead to the collapse of the system in the early
1970s: - ✔✔- the reserve currency country has to run a balance of payments deficit to
satisfy the growing need for reserves from the rest of the world
- it can decrease confidence in the reserve currency and lead to the downfall of the
system
