What is an international monetary system? What have these monetary systems consisted of up to the present day?
In the first part devoted to the history of international monetary systems, you will learn that gold was the resource on which the first international monetary system was based, that the war destroyed this first system, and that in its ruins the American currency flourished as the new world reference. As with most economic crises, it was a loss of confidence in this American currency that led to currencies no longer having any fixed reference and thus fluctuating constantly.
In the second part, the case of Europe will be studied more precisely: in fact, several European countries joined forces to try to stabilize their currencies, their solution consisting in making each of their national currencies linked to the other neighboring currencies. Even if the disparities in economic development between European countries make this solidarity of currencies difficult, this system has the merit of giving credibility to European currencies. Pressed also by the freedom of trade established almost everywhere on the continent, European leaders agree to adopt a common currency, called “euro”.
History of international monetary systems
The gold standard as an international monetary system (until 1944)
Monetary systems are not new to the twentieth century, and according to the criteria selected can even date back to Isaac Newton who theorized in 1717 of the links between gold and silver, as acted by Queen Anne of his time. Numerous monetary unions, quite stable by the way, were also in use well before our century. This is the case of the Latin Union from 1865 to 1927, of the common currency of the German customs union called Zollverein, or for example the Scandinavian monetary union. Adopted by Germany in 1871, by the Latin Monetary Union (Belgium, Italy, Switzerland, France, Greece) in 1873, by the United States de facto the same year, and then by many other powers, it is the gold standard system that is in force. This system is particularly stable because it makes the value of the currency dependent on gold, as its name indicates (the word “standard” is a synonym for “standard”), which also maintains stable exchange rates.
The gold standard system broke down later, however, against the economic consequences of the First World War. The extraordinary expenses generated by the war led the states to abandon this system, stopping the possibility of converting banknotes and printing more money than they had gold, hoping to recover these sums through war reparations when they emerged victorious. Three consequences follow:
- Inflation, as a result of this enormous monetary creation, is very high in these belligerent states.
- The belligerent states were obviously ruined by the war.
- The United States, which had debts to the European countries, were now the creditors of these powers.
To replace the gold standard, which had just collapsed, a conference in Genoa in 1922 attempted a second version of this monetary system and encouraged the states to return to the gold standard. However, the extreme fragility of this initiative leads rather to isolationism, and instead of an international system, the reality consists rather of a plurality of economic zones: gold, dollar, pound sterling… It was at this point that the Great Depression occurred, which was dated from the stock market crisis of 1929 to 1939, the beginning of the Second World War.
The dollar: the new pivot of the international monetary system (1944-1971)
The stakes were therefore high at the Bretton Woods conference in July 1944, to restore confidence in a new international monetary system. The solution provided, under the influence of British economists J. M. Keynes and American economist H. D. White, was to link currencies to gold, but via the dollar. The dollar is the international currency of reference, since every currency is convertible with the dollar, but it finds itself the guarantee of its value thanks to gold (with an exact rate of 35 dollars per ounce of gold). This is possible thanks to the very important gold reserves, corresponding to about three quarters of the global stock. The United States came out economically stimulated by the war, they own most of the world’s capital, and are the largest exporters in the world with a gigantic production capacity. Two institutions were created at this time: the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD).
Trade in Europe resumed after the Second World War, and the countries rebuilt. However, in the middle of the 20th century, the European states were quickly faced with a lack of dollars. European currencies could not be converted into dollars, and consequently this lack of dollars was likely to be a major brake on the world economy. The term dollar gap refers to this phenomenon.
It is this problem that the European Payments Union (EPU) is trying to solve within the framework of the Organization for European Economic Cooperation (OEEC). As a reminder, the OEEC was an organization in charge of distributing and managing the United States’ aid to European states to recover from World War II, known as the Marshall Plan. The UEP achieved its objective and was dissolved at the very end of 1958, just eight years after its creation. It had thus made it possible to regenerate the mutual confidence of European countries in their commercial exchanges.
The dollar collapses and is replaced by a floating exchange rate regime (from 1971)
Given its very nature, the stability of the Bretton Woods international monetary system naturally depended on the United States’ currency, the dollar. However, it is precisely the fragility of this currency that will take the Bretton Woods system with it. It is possible to identify three factors in the loss of solidity of the American economy:
- U.S. financial and military aid to the rest of the free world remains substantial.
- Offshoring is on the rise, with companies making more profit by locating their operations abroad.
- Competition from the two other major economic centres, Japan and Europe, is also increasing.
This leads to deficits, which the United States of course pays for in dollars, since this is the international currency. Moreover, for the same reason that the dollar is the international currency, this currency is increasingly in demand on the European continent. Banks based in Europe began to offer loans in US currency, which, like all loans, involved the creation of money. These“euro-dollars“, which were growing much too fast, and largely exceeded the gold reserves in the United States (these reserves corresponded to 80% of the world’s stock in 1949, compared to only 31% in 1971), were therefore precisely what led to the collapse of the Bretton Woods system.
Indeed, the world’s economic actors feared that the dollar would no longer have the stable value promised by the authorities, and therefore preferred to convert their assets into gold rather than into dollars. Despite the brakes on the conversion of the dollar into gold, American gold reserves were declining more and more. Richard Nixon, then President of the United States, therefore made the decision to revoke the convertibility of the dollar in August 1971.
Two years later, in 1973, the fixed exchange rate system collapsed completely. It was replaced by a system of floating exchange rates: from then on, the values of currencies varied in relation to each other, depending on the market forces of the moment. Thus, a currency that is in high demand will appreciate (and therefore have a higher exchange rate), and vice versa for a currency that is more available. Gold is no longer a reference for currency, and there is no longer an official international currency. Theoretically based on the thinking of Milton Friedman, for whom only the market can achieve the economic optimum, the floating exchange rate system will balance itself out.
European countries in search of a more stable monetary system
Joint currencies for greater stability (1972-1993)
The European states are now seeking to provide their own stability solution, which should also support their common agricultural policy. Indeed, the six member states of the European Economic Community (EEC), which in 1968 had just created a customs union, i.e., established the same customs tariff outside their borders, while abolishing all customs duties within this community, wanted to give substance to their European project through a certain solidarity of their currencies (i.e., the currencies depended on each other). To this end, the European Monetary Snake was established in April 1972.
Through the European Monetary Snake (EMS), the European currencies were brought together in a tunnel. In figures, the European Monetary Snake imposed a ceiling of +2.25% and a floor of -2.25%. However, this new arrangement will not withstand the economic turmoil of this decade either. The dollar continued to depreciate, i.e. lose its value, dragging the European currencies individually down with it, and they were forced to leave the European Monetary Snake. The oil shock at the end of 1973 also caused inflation and trade deficits, requiring once again a new model: the European Monetary System.
Indeed, it was after heated negotiations and without real conviction that a new exchange rate mechanism, the European Monetary System, was announced in March 1979. This new system was intended as a response to the problems of currency floating since 1973, a source of great instability, a solution to the failures of the European monetary snake, but also a chance to revive the European construction project. French President Valéry Giscard d’Estaing and West German Chancellor Helmut Schmidt played a decisive role in bringing about this agreement on the European monetary system.
This Franco-German initiative, which was valid for the whole of the EEC, which consisted of nine members at the time, proposed linking European currencies to a reference standard, called the European Currency Unit (ECU). This ECU was based on a calculation between the currencies of all the member countries, but in proportion to their economic weight. Moreover, this ECU serves as a new currency between the central banks, which will have to offer guarantees to allow the issue of new ECUs. As a successor to the European monetary snake and opening the possibility of readjustments and a mechanism of solidarity between them, these central banks also undertake not to make the exchange rate fluctuate by more or less than 2.5%.
Although the parity had to be readjusted many times, the European monetary system held up against the world economic turbulence until its demise in 1993. In particular, it made it possible to curb the inflation of European cur rencies until the 2000s, and later to give the euro a real role on the international scene by freeing itself from the dollar. However, within the EMS, the gap between a currency as strong as the German mark and weaker currencies forced the other weaker European economies to implement an austerity policy, and this may have had a negative impact on growth. Finally, the fluctuation margins no longer held in 1993, and were then widened to more or less 15%.
The necessary cooperation in the euro zone (1960-1992)
As the Canadian economist Robert Mundell pointed out in the early 1960s, along with the British economist John Marcus Fleming, the freedom of capital movement is incompatible with the combination of freedom of sovereign monetary policy and a fixed exchange rate. This triangle of incompatibilities is the theory explaining that it will never be possible to combine these three dimensions simultaneously: 1) fixed exchange rate regime, 2) free movement of capital and 3) autonomy of monetary policies. This logic is the one that precipitated an in-depth cooperation of European states, which then had to organize themselves around a monetary union.
Studies are therefore multiplying to evaluate the advantages and disadvantages of a single currency:
Disadvantages of a single currency
On the one hand, such a decision would have the effect of making states lose their autonomy in terms of economic policy, imposing a unique and difficult collaboration between all the states adhering to this single currency; thus, it would no longer be possible for states to absorb shocks individually, or to adjust the value of their currency individually in order to make themselves more competitive internationally
Benefits of a single currency
On the other hand, the arguments in favour of a single currency point to the end of transaction costs, which are the costs applied by banks to conversion and which slow down the single market; the end of the instability of the values of the currencies of the member countries of this union among themselves (naturally, this does not apply outside the union, vis-à-vis the dollar for example); the gain in transparency and homogeneity, allowing economic actors to make decisions more easily, which should promote economic development; finally, the opportunity to gain international stature thanks to a large and credible currency.
It is especially with regard to the agricultural policy, which has been desired to be common since 1957, that the euro was encouraged, then totally approved and formalized by European leaders in 1992 by the Treaty of Maastricht, the same treaty that founded the European Union.
Convergence of European economies (1992-2021)
In order to maximize the benefits of the monetary union that was decided upon, the convergence of the economies seems to be an essential condition. This attempt by the members of the European Union to converge their economies, especially after the Maastricht Treaty signed in February 1992, corresponds to a policy called Economic and Monetary Union, abbreviated EMU (or European Monetary Union, abbreviated EMU).
The beginnings ofEconomic and Monetary Union, as a policy to bring European economies closer together, really date back to June 1989, when it was decided to make the movement of capital (possessions, such as money) free, a little before the euro.
The introduction of the euro is a new stage: this currency is created by the texts in 1992, named in 1995, introduced virtually in 1999, materialized by bills and coins on January1, 2002.
European economic union remains an issue at least until the decade beginning January1, 2021, with the main question being whether or not to have a single monetary or even fiscal policy, thanks to a hypothetical European economic government.
The global financial crisis from 2007 to 2010, followed by the debt crisis in certain eurozone countries, especially between 2010 and 2013, are the two markers by which governments interpret and propose the implementation of new solutions. Between 2020 and 2022, the covid health crisis hit the world economy in an unprecedented way.