Historical Background of the IMF

 

IMF was established in 1945 in Breton Wood, New Hampshire (USA). He was assigned the task of reconstructing the international payment system of the world (international monetary system), supervising the rules and regulations agreed by the international community to conduct commercial and financial transactions and help to overcome the problems of B.O.P.

The IMF was conceived in July 1944, when representatives of 45 countries gathered in the city of Bretton Woods, New Hampshire, agreed on a framework for international economic cooperation, which will be established after the Second World War. They believed that such a framework was necessary to avoid a repetition of the disastrous economic policies that had contributed to the Great Depression.

The allied powers met in Bretton Woods and created a post-war international monetary system. The agreement established a monetary system based on the US dollar. In accordance with the original provisions, all countries fixed their currencies in terms of gold, but were not required to change their currencies. Only the US dollar remained convertible into gold (at $ 35 / oz with central banks, not individuals).

Bretton Woods System:

 

The Bretton Woods system was a gold exchange standard. The United States had to keep the price of gold set at $ 35 per ounce and be ready to exchange dollars for gold at the price without restrictions. Other nations fix (parity) the price of their currencies in dollar terms (implicitly in terms of gold) and intervene to prevent the exchange rate from moving more than 1 percent above or below the nominal value.

Within this permitted range of fluctuation, the exchange rate was determined by demand and supply. For example, the parity of the pound sterling was set at 12.5 per ounce of gold. The price of gold in dollars was $ 35 per ounce. This implicit and official exchange rate between the dollar and the pound of dollar 35 / pound 12.5 = $ 2.8. In case of BOP imbalance, up to 10% devaluation was allowed.

Fixed exchange rates, 1945-1973:

 

Bretton Woods and the IMF functioned well after the Second World War, but divergent fiscal and monetary policies and external shocks led to the demise of the system. The US dollar remained the key to the exchange rate network

The strong capital outflows in dollars required to meet the needs of investors and the deficit led to an excess of dollars in the hands of foreigners, which created a lack of confidence in the ability of the United States to meet its obligations.

This lack of confidence forced President Nixon to suspend official purchases or gold sales on August 15, 1971. The exchange rates of most major countries could float relative to the US dollar. By the end of 1971, most of the major commercial currencies had appreciated against the US dollar; that is, the dollar depreciated. A year and a half later, the dollar was attacked again and lost 10% of its value. At the beginning of 1973, a fixed-rate system no longer seemed feasible and the dollar, along with the other major currencies, was allowed to float. By June 1973, the dollar had lost another 10% in value.

By joining the IMF, each nation was allocated a quota based on its economic importance and the volume of its trade. The size of a nation’s quota determined its voting power and ability to obtain loans from the fund. The United States was assigned the highest quota, 31 percent. When joining the IMF, a nation had to pay 25 percent of its quota to the fund in gold and the rest in their own currencies approved by the fund in exchange for depositing an equivalent amount (additional) of their own currency in the fund, until that the fund did not have more than 200 percent of the nation’s share in the nation’s currency. If a nation borrows up to 200% of its quota, the fund will continue to follow up the program until the loan level falls to a level.

A member nation could borrow no more than 25 percent of its quota in any year, up to a total of 125% of its quota over a 5-year period. The nation could borrow the first 25 percent of its quota, the gold tranche, without restrictions or conditions. To obtain more loans in the following years, the fund charges ever higher interest rates and imposes more and more conditions. The net IMF position of a nation is given by the size of its quota minus the holding of its currency by the fund. The amount of gold reserve paid by a nation when joining the fund was called the reserve position of the country in the fund and was added to the country’s other international gold reserve.

 

The Special Drawing Right (SDR):

  • It is an international reserve asset created by the IMF to supplement existing foreign currency reserves.
  • It serves as a unit of account for the IMF and is also the basis against which some countries set their exchange rates.
  • Defined initially in terms of a fixed amount of gold, the SDR has been redefined several times. An SDR was valued equal to $ 1.00 until 1971 and increased to $ 1.2064 in 1973 due to the devaluation of the dollar.
  • Currently, it is the weighted average value of the currencies of the 5 IMF members that have the largest exports
  • Individual countries maintain SDRs in the form of deposits in the IMF and settle IMF transactions through SDR transfers.
  • The IMF today is composed of national currencies, artificial coins (such as SDR), (Euro).

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