An international monetary system comprises rules, institutions, and conventions that are agreed upon by countries of the world for the primary purpose of facilitating trade, capital reallocation, and cross-border investments. It provides a means through which buyers and sellers can trade, make and receive payments. The current monetary system was formed in the 1970s after the collapse of the Bretton Woods system, and it comprises two main institutions namely, The World Bank and The International Monetary Fund.
The failure of this system necessitated the establishment of a new monetary structure that would prevent fluctuations of more than 2.25% in bilateral exchanges with other countries. According to the current international monetary system, small countries should value their money relative to a major currency to ensure balanced trade. A small country is defined as a nation whose trade shares are below 1% of world trade.
Large countries that have trade shares exceeding 2% of world trade are required to adopt floating rates to prevent their economies from suffering shocks created by disparities in the value of foreign currencies. In that regard, 27 countries have floating exchange rates. Moreover, countries whose exports exceed 5% of world trade are allowed to adopt an exchange rate in which their currencies fluctuate in response to foreign-exchange market dynamics (Wang, 2015).
The current monetary system also requires the foreign exchange reserve of a nation to be less than 50% of its export volume. Sustained undervaluation of legal tender results in a reserve of overvalued currencies that cause huge losses due to market intervention (Wang, 2015). A majority of countries have a fixed exchange rate of 43%, while only 71 countries have floating exchange rates (Eckes, 2014). In the past decades, the United States Dollar (USD) was the dominant exchange rate determinant. However, the number of countries that peg their currencies to the USD has been on the decline. On the other hand, the number of countries that use the euro as their exchange rate anchor has remained stable at 13% (Wang, 2015).
The Bretton Woods monetary system failed because President Nixon ended the link between the dollar and gold as well as the abandonment of capital controls by the United States and the United Kingdom (Casella, 2015). In that regard, gold was discarded and the dollar was adopted as the global currency. Unlike the Bretton Woods monetary system, the current system is a managed float, and the largest holders of international reserve assets include the People’s Republic of China, Japan, Europe, Switzerland, Saudi Arabia, and Russia. The Woods system valued gold highly and allowed its use for international transactions while the creation of the current system downgraded its role in trade (Casella, 2015).
The current system legitimizes floating rates while the Woods system did not. All countries have the freedom to adopt an exchange rate system of their choice. The Bretton Woods system involved the maintenance of a fixed exchange rate between currencies and the dollar (Eckes, 2014). The current monetary system also designates the Special Drawing Rights (SDR) as the primary reserve asset that is used to supplement the coffers of member countries (Wang, 2015).
The SDR facilitated the move from a country-led monetary system (Bretton Woods) to a market-led system. The current monetary system has three main principles that were not included in the Woods system. First, it is illegal for countries to manipulate exchange rates. Second, intervention to counter disorderly conditions in the exchange market is allowed (Wang, 2015). Third, nations should take into account the interests of countries whose currencies are used to conduct interventions.
In conclusion, the current monetary system is different from the Breton Woods system. After the decline of the Woods system, the role of gold was downgraded and countries were given the freedom to adopt floating exchange rates. In today’s globalized world, the number of countries that peg their currency to the dollar has declined significantly. The current system does not allow currency manipulation even though it advocates for foreign exchange intervention to end disorder in the market.
References
Casella, M. (2015). Bretton Woods: History of a monetary system. New York, NY: Marco Casella.
Eckes, A. E. (2014). Bretton Woods and the international monetary system, 1941-1971. Austin, TX: University of Texas Press.
Wang, J. (2015). The past and future of international monetary system: With the performances of the US Dollar, the Euro, and the CNY. New York, NY: Springer.