International Finance: International Monetary System and Balance of Payment

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The international monetary system is a mechanism that allows international companies and investors to perform financial transactions. In other words, it refers to the environment in which global entities deal with each other and carry out business and other activities. Thus, a comprehensive definition of the international monetary system is given as “the institutional framework within which international payments are made, movements of capital are accommodated, and exchange rates among currencies are determined” (Eun & Resnick, 2015, p. 27). It has evolved over many centuries as individuals used different modes of payment to carry out transactions among them. The evolution of the international monetary system is discussed in the following:

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Bimetallism (Before 1875)

The earliest international monetary system used gold and silver as forms of payment. The use of two naturally extracted metals for determining the value of international transactions and their settlements are the reason that this period is referred to as “bimetallism” (Eun & Resnick, 2015)

Classical Gold Standard (1875-1914)

There were wide-scale acceptance and use of gold as a standard coinage for determining the value of transactions between counties and also between countries. The value of gold was standardized, and there were no restrictions on the flow of gold across borders. Furthermore, the exchangeability between gold and national currencies was accepted (Eun & Resnick, 2015). The reason for using gold as an exchange medium was its determinable value as a natural resource that had a limited supply, which also helped in controlling inflation. Moreover, the balance of payments between countries was regulated by transferring gold to ensure that they did not have a prevailing trade deficit or surplus. However, this system soon became incapable of dealing with the increase in international trade and investments, and countries with low gold reserves were forced to exit for protecting their national interests (Eun & Resnick, 2015).

Interwar Period (1914-1944)

There was a high level of uncertainty during this period as countries involved in combats and conflicts pursued their national economic interests and focused on the stabilization of their economies. International investments and transactions slowed down drastically, and investors withdrew from an opponent or conflict-inflicted countries (Eun & Resnick, 2015). The uncertain situation in the global economy led by political upheavals and lack of a coherent monetary framework did not allow a single monetary system to prevail. Thus, this period was marketed with low levels of internal trade and investment.

Bretton Woods System (1945-1972)

The Bretton Woods System for monetary management was motivated by the emergence of the United States as a global military and political power. The value of gold was pegged to the US dollar at $35 per ounce, and only allowed the exchangeability of gold and US dollar (Eun & Resnick, 2015). This means that countries could only trade by using gold or the US dollar. The dollar-gold-exchange based system required countries to give their gold in exchange for the US dollar for carrying out international transactions. This strengthened the position of the US dollar in the international monetary system, accompanied by the decision that all oil-related transactions would be carried out in this currency only.

Flexible Exchange Rate Regime (Since 1973)

Flexible exchange rate system was adopted by the members of International Monetary Fund (IMF), which resulted in the abolishment of the gold exchange system and gold held by IMF was either returned to its members or sold to generate proceeds for helping poor countries. This system allowed countries to have their own currencies whose values would be determined by the free market. It means that their values would be affected by the demand and supply for these currencies. Central banks can intervene in the market and control the price of the currency for managing their monetary policies (Eun & Resnick, 2015). The flexible exchange rate system has given independence to countries to manage their fiscal and monetary policies but has increased volatility in the global market. Moreover, most of the international trade is still carried out in major currencies such as US Dollar, Euro, Swiss Francs, and others.

Criteria for a “Good” International Monetary System

The criteria for a “good” international monetary system can be identified on the basis of the definition given above. The system should:

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  1. adequately provide capital for international investment and trade, which means that it should ensure sufficient liquidity to the global economy,
  2. should allow countries to manage their balance of payments efficiently,
  3. mitigates uncertainties and the boost confidence of investors to increase their economic activities
  4. safety mechanism for protecting smaller economies that do not have enough resources.

The justification for this criteria is based on the desired role of the international monetary system that is to facilitate all countries to participate in the global economic activity. Furthermore, there should be equal opportunities for developing nations for attracting investment from international investors.

The balance of payment is referred to as the net of payment and receipts of a country arising from its international transactions, including “import and export of goods and services, services and cross-border investments in businesses, bank accounts, bonds, stocks, and real estate” (Eun & Resnick, 2015, p. 62). A positive balance of payment means that the country has higher inflows than its outflows of capital. The capital account represents purchases and sales of capital assets, including business, stocks, land, and others. This is a positive economic indicator, which helps the country to invest in infrastructure and generate internal economic growth and opportunities. On the other hand, a country which has a negative balance of payment would need to borrow from other countries and international lenders. It could face severe problems when the balance of payment grows significant that makes it impossible to provide basic human rights, including food, safety, health and others. Eswatini, which is a landlocked country located in Africa, has balance on its current account of $657 million (CIA, 2020) and its balance of payment is -$1,049,360.385 (The World Bank, 2020). The current account is a part of the balance of payment which also includes capital accounts and financial accounts. The positive balance on current account indicates that the country generated more inflows from its exports than its import-related cash outflows. It also that the people living in the country had enough funds to purchase goods and services. However, the balance of payment is negative by a small figure, which means that the country had greater outflows related to its cross-border capital investment and financial obligations. The negative balance of payment also implies that the country had to borrow from lending institutions such as the IMF to fulfill its budgetary requirements to manage inflation and devaluation of its currency.

References

Eun, C. S., & Resnick, B. G. (2015). International financial management (7th ed.). McGraw-Hill Education.

The World Bank. (2020). Net capital account (BoP, current US$) – Eswatini. The World Bank. Web.

CIA. (2020). Country comparison :: Current account balance. CIA. Web.

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BusinessEssay. (2022) 'International Finance: International Monetary System and Balance of Payment'. 16 January.

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BusinessEssay. 2022. "International Finance: International Monetary System and Balance of Payment." January 16, 2022. https://business-essay.com/international-finance-international-monetary-system-and-balance-of-payment/.

1. BusinessEssay. "International Finance: International Monetary System and Balance of Payment." January 16, 2022. https://business-essay.com/international-finance-international-monetary-system-and-balance-of-payment/.


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