International Monetary System Analysis

The international monetary system can be traced back to ancient times when gold and silver where used for trading. The use of gold led to the establishment of an international monetary system called the gold standard. It was the prevailing monetary system before the First World War. Under this system, gold constituted an international reserve asset for countries that agreed to buy and sell paper currencies in exchange for gold that had a fixed value by a par value each country specified for its currency. This fixed exchange rate system connected the international currencies with an internationally accepted asset “gold” which eased trading between countries. The British pound (the United Kingdom’s currency) was the most used international currency

Under this international monetary system countries that were looking for foreign buyers to buy their domestic products wanted to have cheaper currency than other countries so that they can undercut the trade of nationally competitive products . This caused many countries to engage in selling their national currency at rates below its real value. A practice known as competitive devaluation.

Countries that were engaged in competitive devaluation stimulated their exports and reduced their imports, however, as more and more countries became part of this practice, uncertainty about the real value of currency resulted in reductions in the volume of international trade. The realized gains of the practice where diminished and offset, and for more, economic problems such as unemployment arose. Accompanying all of this, the Second World War came knocking the

Along with the World Bank, a new monetary system was developed by which the United States Dollar value was defined in terms of gold so that each 1 ounce of gold would equal 35 US dollars. The US dollars was the currency used because at that time it was one of the only two convertible currencies (the other was the Canadian Dollar). Other countries defined the value of their currencies in terms of dollar, therefore the par values were established by agreements with variation allowed by 1%. Any deviations beyond the established 1% limit call for intervention in the foreign exchange market. This resulted in a stable exchange rate