International Monetary System: Rules, Principles, & Systems Governing Global Exchange - Essay Sample

Introduction

International Monetary System refers to rules, principles, and systems governing the exchange and use of cash across the globe between nations. It is the set conventionally agreed rules across global countries that facilitate trade between states. Initially, nations used silver and gold in bullion, especially from Egypt and Mesopotamia, to conduct international trade. The monetary system began in Rome's early history; regional rulers such as Servius Tullius, who created a primitive money system (Wray & Sardoni, 2007). The system expanded through coins exchanged by moneychangers, the predecessors of today's foreign exchange market. The primitive money system led to various nations' dominant currency until the early 19th century that linked monetary to Europe, India, America, and China that created large separate economies. The large economies created by these nations established a regional monetary system that led to European and American economies' integration. Later in the mid-19th century, the monetary system emerged that reflected current political and economic realities based on the gold standard.

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Currency Regimes and Examples

Currency regime refers to a state in which two or more states use similar currency based on conventional or control monetary authority. Within the spectrum of the monetary authority, such arrangements anchored by two significant types of exchange rates; flexible and fixed regimes. The current currency anchors include the U.S. dollar, Euro, Yen, or more. Fixed exchange rates refer to a currency regime applied by a state or central bank that ties a country's official exchange rate to another nation's currency or gold price. This type of regime aims at keeping a country's currency value within a narrower band. Flexible exchange rate refers to prices determined by global demand and supply of currency or overall market conditions. Often, these rates change due to market demand and supply not controlled by states or central banks.

The argument for Selecting Fixed Exchange Rate

Fixed exchange rates designed by specific states ensure that a particular currency stays within a narrow bound. It has various advantages primarily for developing economies because it provides certainty for them to export and import their domestically produced goods (Ndglela 2010). Hence, it encourages sizeable international investment or trade to enable most of these states to maintain reduced inflation rates. Reduced inflation rates have significant impacts on countries, such as minimized interest rates. Therefore, fixed exchange rates help various states avoid currency fluctuations that would hinder their domestic countries' progress. Fixed exchange rates also help nations create a stable currency that encourages foreign investment in import and export capacity. For instance, various Japanese investors indicated that the U.K.'s reluctance to join the Euro makes it undesirable for investment since id cannot afford stable exchange rates. Therefore, fixed exchange rates provide broader certainty that would encourage foreign firms to invest. Moreover, governments allowing fixed exchange rates may prevent the currency's devaluation by limiting inflationary pressure, such as an increase in aggregate demand.

The argument for Flexible Exchange Rate

One significant benefit that states obtain from a flexible exchange rate is the automatic adjustment of payment balance. Researchers have indicated that a freely fluctuating exchange rate corrects the balance of payment disequilibrium automatically. The balance of payment deficit would occur when there is an excess supply of domestic currency, leading to a fall in exchange rate because of market forces of supply and demand. Accordingly, it would cause exports cheaper and dearer import goods. In this case, export would increase while imports declines, hence removing the deficit in the balance of payment. When the balance of payment causes excess demand of the home currency, exchange rates will increase, thus discouraging exports while encouraging imports leading to a logical balance of payment equilibrium. In this case, a flexible exchange rate causes the automatic stabilization of the economy. In other circumstances, the external economic pressures might shock domestic economic activities that would threaten the importation of inflation from other countries. A flexible exchange rate absorbs this sudden shock to the economy.

Definition and Creation of Euro Currency

Euro refers to the official currency of the 19 member states of the European Union conventionally known as the Eurozone. It was established by the provisions in the 1992 Maastricht Treaty, and the name officially adopted in Madrid in 1995 (Coudert et al., 2013). Former French teacher in Belgium Esperantist Germain Pirlot named the currency as Euro by sending a notification to European Commission, Jacques Santer suggesting the name. During this period, exchange rates were determined by the Council of the E.U. based on the 1998 market rates. The Eurozone introduced the currency in the non-physical form in 1999, while member states' national currencies later ceased. Euro hence became the European Currency Unit's successor even though the old currencies continued until in 2002 when new notes emerged. The changeover for which the old notes changed for Euro lasted for about two months until the end of February in 2002.

Benefits of Euro

Euro eliminates fluctuations in the exchange rates, thus improving economic growth and stability. When a business or consumer decides to buy a commodity from another country at a future price, they can pay less as previously planned (Asonuma et al., 2018). The Euro eliminates currency value fluctuations across the Border States, creating a more integral financial market. Euro offers price transparency because nations have a great idea of commodity prices in another country because of price equalization that is more competitive. Price transparency offers greater security and vast opportunity for markets and businesses. Accordingly, it increases trade across the Border States because of price transparency that increases cross-border employment that encompasses a tangible sign for European identity. Cross-border employment also ensures stable prices for the respective states' citizens and consumers, hence expanding markets for businesses. The Euro also enables countries to establish a single central accounting bank, hence ensuring financial market stability in stock exchanges. In this case, Euro leads to structural reforms on the European economies creating lower interest rates enhancing macroeconomic stability.

Problems Associated with Creation of Euro

The larges limitation of Euro is the rigid monetary policy that does not fit local-economic conditions. The rigid monetary policy often leads to a high growth rate of unemployment with prolonged economic drawbacks (Meyer, 2015). It majorly based on a fiat currency that highly depends on the people's trust that led to European countries resorting to monetary emissions in the previous years. The most likely problem with the Euro has relationships with a fiscal policy that has led to slow macroeconomic adjustment. The slow macroeconomic adjustment linked to the sovereign default characterized by subsequent euro crisis and boom. Ever since Euro experiences financial stability issues introduced by the unstable banking sector for the Euro area leaders. Investors have also claimed that the Euro has a possible bias that favors Germany since it has the largest economy in the Eurozone with the enormous historical background of monetary policy since World War II. This favor roots back to the pegging exchange rate to the German mark that created fixing the European Exchange Rate Mechanism's financial prices.

References

Asonuma, T., Xin Li, M., Thomas, S., Papaioannou, M., & Togo, E. (2018). Sovereign Debt Restructurings in Grenada: Causes, Processes, Outcomes, and Lessons Learned. Journal Of Banking And Financial Economics, 2/2018(10), 67-105. https://doi.org/10.7172/2353-6845.jbfe.2018.2.4

Coudert, V., Couharde, C., & Mignon, V. (2013). On Currency Misalignments within the Euro Area. Review Of International Economics, 21(1), 35-48. https://doi.org/10.1111/roie.12018

Meyer, D. (2015). A concept of the Euro as a parallel currency—a gradual solution for the Eurozone's problems. Capital Markets Law Journal, 10(3), 390-409. https://doi.org/10.1093/cmlj/kmv027

Ndhlela, T. (2010). Currency Devaluation and the Credibility of Fixed versus Flexible Exchange Rate Regimes: The Case of Zimbabwe. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.1646434

Wray, L., & Sardoni, C. (2007). Fixed and Flexible Exchange Rates and Currency Sovereignty. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.960726