  In principio - Gold
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Gold vs. fiat money
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 Commodity money
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Commodity backed money
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Paper - fiat
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Inexpensive to create
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Easy to manage
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But... The temptation to overcreate
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A medium of exchange
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Specie flow mechanism
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Gold but with parity rates
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Starting in 1830 and widespread by the 1870's
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Mint parity rates - the rate at which the currency can be converted to gold
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Commodity backed paper
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Each country defined its currency in terms of gold so the currency exchange rates were determined.
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USD $20.646/oz
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₤4.252/oz
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Therefore $20.646 per ounce of gold = ₤4.252/oz of gold or $1= ₤0.2059 (4.252/20.646)
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Gold points - the opportunity for arbitrage
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If the value of one currency fluctuated outside a certain range defined by the transaction costs, arbitragers would correct it.
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If the rate was ₤0.25 per dollar:
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Buy an ounce of gold in London, sell it in the US for $20.646.
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Convert the $20.646 to ₤'s at .25/$ ( 20.646 x .25 = 5.1615)
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You are ahead ₤5.1615 vs. 4.252, a gain of: ₤0.9095!
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As long as transaction costs were less than ₤0.9095, it was profitable.
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How successful was it?
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Pro:
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There was little inflation. Gold is scarce and hard to find
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It requires no central monetary authority (and during this period, the US had no central bank)
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It was a system of fixed exchange rates - this reduces the risks of international trade.
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Con:
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The supply of gold fluctuates - 49ers and Alaska 1870-1900
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Gold costs real resources to mine, transport, mint and store
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Gold forces prices to adjust
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The demise of the gold standard
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The BIS (Bank for International Settlements)
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Established to oversee reparations payments after WWI
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Facilitates transfers between central banks
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Overvalued and undervalued currencies
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Britain attempted to restore the prominence of the pound. It was overvalued.
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Depression in Britain 1926 and 1929 in the US
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Countries refused to convert their currencies at fixed prices.
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Bretton Woods - International Monetary and Financial Conference
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1944 as WWII was concluding
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The logic of the system - a response to the mistakes of the post-WWI period
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Rapid reconstruction and integration of Germany and Japan (Italy?)
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Fixed exchange rates to encourage trade
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Commitment to a set of rules including lowered tariffs
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The "new world order"
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World Bank (IBRD) - lending for long-term development.
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IMF
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There was a buy-in: 25% gold, the rest in their currency
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Lend foreign currency reserves to countries in foreign exchange crisis
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Supervise exchange rate changes
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GATT - dedicated to making trade more free
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Round after round
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Morphed into the WTO
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Fixed exchange rate system (pegged)
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A dollar-standard exchange rate system
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Values fixed within 1%
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Changes supervised by the IMF
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Clean float
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Dirty (managed) float
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What happened to Bretton Woods?
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The problem of US inflation in the 60's
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Dollars poured out as foreign goods looked cheaper
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The US was unwilling to subjugate domestic economic policy to its international obligations.
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By 1970 the dollar was not defensible
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Aug. 8, 1971 Nixon closed the gold window and the Bretton Woods system effectively ended.
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The Smithsonian Agreement (1971) was an attempt to revive the system
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Reestablished new parity values against the dollar.
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Permitted swings of up to 2.5% in currency values vs other currencies
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Revalued the dollar vs. gold
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It lasted 15 month
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The European snake
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After Bretton Woods a Floating Exchange Rate System
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The Jamaica Accords (1976)
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Changed the IMF constitution to allow each member nation to establish its own exchange rate system.
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The G's began: G5 - US, GB, Germany, France, Japan. G7 adds Canada & Italy. G8 adds Russia.
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A flexible exchange rate system
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Clean float
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Dirty float
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The Plaza Agreement and the Louvre Accord
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Plaza - by 1985 the dollar had risen to an "unsustainable value" and the G5 would intervene to reduce its value.
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Louvre - Feb 1987 - The G7 met and decided the dollar had fallen enough and they would now only intervene to maintain stability.
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With these markets at $1 Trillion per day, can the G99 have any real effect?
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Other Exchange Rate Systems
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Most - 44% of countries allow their currencies to float, 21% have a currency peg with the dollar or some currency basket. A few have crawling pegs or currency boards.
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Crawling Pegs
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Currency pegged to another currency, usually the dollar that is revalued regularly to account for the different inflation rates.
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Currency Baskets
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Pegs a currency to a basket of currencies.
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Less volatility with a basket (normally not more than 6 currencies)
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Independent Currency Authorities (ICA) - Currency Boards
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Substitutes for a central bank
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Buys or sells the foreign currency to maintain the value of the domestic currency.
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The domestic money supply is determined by the board buying and selling.
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The board does not do domestic monetary policy.
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Dollarization - the dollar becomes the currency.
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Ecuador and El Salvador
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Credibility
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Policy inflexibility and slower growth?
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Policy Notebook: Should Argentina Dollarize?
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Fixed or Flexible - if you had your druthers?
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Arguments on both sides.
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Neither is a substitute for proper economic management.
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