Chapter 2: The International Monetary System
INTRODUCTION This chapter is devoted to a study of the structure and history of the international monetary system and exchange rate arrangements for the purpose of putting things into perspective when we discuss Chinese policies in Chapter 8. As we saw in Chapter 1, some economists argue that China is hurting the world economy by adopting an exchange rate arrangement that represents a violation of the IMF rules (Mussa, 2007; Bergsten, 2010a). To answer the question of whether or not China has the right to choose the exchange rate arrangement it deems suitable for its economy, we need to understand the developments that have led to the rules and regulations governing the present international monetary system. The international monetary system (IMS) is a framework of rules, regulations and conventions that govern financial relations among countries. It is so important and crucial for the world economy and international economic relations that Adam Smith described it as the “Great Wheel” because “when it does not turn well it adversely affects the welfare of nations” (Smith, 1776). Rules and conventions govern the supply of international liquidity and the adjustment of external imbalances as well as exchange rate and capital flow regimes. CLASSIFICATION OF INTERNATIONAL MONETARY SYSTEMS International monetary systems can be classified according to two criteria: the nature of the reserves held by central banks and the degree of flexibility of exchange rates. Reserves may be commodities (metals, such as gold and silver, to be precise) or currencies, which presently cannot be converted...
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