International monetary system refers to a system that forms rules and standards for facilitating international trade among the nations.
It helps in reallocating the capital and investment from one nation to another.
It is the global network of the government and financial institutions that determine the exchange rate of different currencies for international trade. It is a governing body that sets rules and regulations by which different nations exchange currencies with each other.
With the growing complexity in the international trade and financial market, the international monetary system is necessary to assign a standard value of the international currencies. The rules and regulations set by the international monetary system to regulate and control the exchange value of the currencies are agreed upon by the respective governments of the nations. Thus, the government’s stand may affect the decision making of the international monetary system. For example, change in the trade policy of a government may affect the international trade of goods and services.
International monetary system motivates and encourages the nations to participate in the international trade to improve their BOP and minimize the trade deficit. It has grown over the years as a single architectural body with a vision to integrate the global economy. Some of the important achievements of the international monetary system over the years have been the establishment of World Bank and International Monetary Fund in the year 1944.
The establishment of IMF and World Bank is the result of the agreement among nations to set a body, which promotes and supports the international trade. Now, let’s discuss the evolution of international monetary system. Earlier in 1870 to 1914, trade was carried with the help of gold and silver without any institutional support. At that time, monetary system was decentralized and market based and money played a minor role as compared to gold in international trade.
The use of gold declined after World War I as war increased expenditure and inflation. In such a scenario, countries planned to revive the standard of gold but failed due to great depression. Thus, in 1944, 730 representatives of 44 nations met at Bretton Woods, New Hampshire, United States to create a new international monetary system.
This was called as the Bretton Woods system, which became a turning point in the history of international trade. The aim of new international monetary system is to create a stabilized international currency system and ensure a monetary stability for all the nations.
It was decided that since the United States held most of the world’s gold, thus all the nations would determine the values of their currencies in terms of dollar. The central banks of nations were given the task of maintaining fixed exchange rates with respect to dollar for each currency.
The Bretton Woods system ended in 1971 as the trade deficit and growing inflation undermined the value of dollar in the whole world. In 1973, the floating exchange rate system, also known as flexible exchange rate system was developed that was market based.