A Brief History of the International Monetary System
Kenneth N. Matziorinis
The international monetary system is the structure of financial payments, settlements, practices, institutions and relations that govern international trade and investment around the world. To understand the international monetary system, we can start by looking at how a domestic monetary system is structured. The Canadian financial system, for instance, is composed of a) a currency; b) a central bank which issues that currency; c) financial deposit-taking and lending institutions such as commercial banks and d) the Canadian Payments Association. The currency used in Canada is the Canadian dollar. It is the means of payment, store of value and unit of account for all transactions conducted within Canada. It is the currency in which all assets and liabilities are measured. As such, exchange rates are not an issue in our domestic transactions. The country’s central bank, is the Bank of Canada. Its role is to issue the currency of the land, the Canadian dollar, to manage the supply of money to ensure that there is neither too much of it that could cause inflation, nor too little that could cause recession and to oversee the financial system, acting as a lender of last resort when the need arises. Commercial banks and other non-bank financial institutions are the main players in the financial system. They engage in the process of financial intermediation, which is the taking of deposits from the private public that has a surplus of money and making loans to the public that has a shortage of money. In addition, commercial banks provide payment services such as chequing accounts, bank drafts, debit cards, credit cards, electronic payments, wire transfers and engage in the purchase and sale of foreign exchange. The Canadian Payments Association (CPA) is the payment system that provides the legal framework, the technological and communications infrastructure for the efficient operation of the payment system, like cheque clearing and reconciliation amongst the banks, electronic forms of payments, the shared automated bank payment system known as Interac, point of sales transactions, and other forms of payment. Internationally, countries require the same infrastructure and institutions but there are two major differences between the domestic and the international monetary systems:
1) Each country uses its own currency. This creates a need for a mechanism to convert each country’s currency to that of another and to determine the value of each country’s currency against the other. The role of determining the relative value of each country’s currency, what is known as the exchange rate, is performed by the foreign exchange market. 2) The international monetary system needs a payment system that is efficient and secure, this role is performed by commercial banks, which are the major players in the foreign exchange market. Corporations and individuals are the secondary players, they buy and sell through the banks. The international financial system relies on the domestic financial networks of each country to make it work. Since each country operates a different financial system there is no homogeneity in the international level. Banks in different countries are structured differently and they are regulated by different sets of rules and standards. This, in fact is one of the key challenges that the international financial system faces. Complicating the above is the fact that different countries pursue different monetary, trade and economic policies that cause the demand and supply of their currencies to diverge, which in turn cause continual fluctuations in the value of exchange rates. The monetary system is based on money. Economists define money as a: a. medium of exchange, i.e. a payment instrument b. store value, a saving and investment instrument; and c. unit of account, an accounting and measuring instrument For centuries,...
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