212 Module 8 The International Monetary System and Financial Forces sterling, and the U.S. dollar. The IMF uses the SDR as its unit of account, as do its 188 members and 16 other international institutions. Yet today, the SDR has limited use as a reserve asset, and its ability to serve as a safety net should the international monetary system run into serious difficulty has yet to be tested. You can check the daily valuation of the SDR at http://www.imf.org/external/np/fin/data/rms_sdrv.aspx/. THE CENTRAL RESERVE/NATIONAL CURRENCY CONFLICT Every member of the IMF keeps a reserve account, a bit like a savings account, with holdings the country can draw on when needed to finance trade or investments or to intervene in currency markets. The U.S. dollar has been the most used central reserve asset in the world since the end of World War II; at the end of March 2014, roughly 60 percent of the world’s reserve assets were held in dollars and 24 percent in euros. The dollars, held in the form of U.S. Treasury bonds, earn interest, so the more dollars held in a central reserve account, the better, from the holder’s perspective. But the countries holding those U.S. dollars in their foreign reserve accounts don’t want their central reserve asset to lose value, and therein lies a contradiction: at some point, holding large numbers of U.S. dollars (or any other product) causes them to lose value, per the Triffin paradox. At the same time, the U.S. dollar is the national currency of the United States, whose government must deal with inflation, recession, interest rates, unemployment, and other internal problems. The U.S. government uses fiscal and monetary policies to meet these problems by manipulating tax rates, spending available revenue, growing or contracting the money supply, and controlling the rate of that growth or contraction.10 It would be only accidental if the national interests of the United States coincided with the interests of the multitude of countries holding U.S. dollars in their central reserve asset accounts. For example, the United States might be slowing money supply growth and raising taxes to combat domestic inflation while the world needs more liquidity, in the form of U.S. dollars, to finance growth, trade, or investment. Or the United States might be stimulating its economy through faster money supply growth and lower taxes at a time when so many U.S. dollars are already outstanding that their value is dropping—not a happy state of affairs for countries holding U.S. dollars. It was a quirk of history that thrust the currency of the United States into this conflicting role. The IMF hoped a non-national asset, the SDR, would rescue the U.S. dollar and the world from this conflict, when nations would begin to use the SDR as their main reserve. That has not yet happened. Study Smart and Improve Your Grades Go to http://bit.ly/SmartBookNOW CCULTURE FACTS CULTURE FACTS @internationalbiz @brettonwoods What is so extraordinary about Bretton Woods is that it is the first time in the history of the world that people from cultures scattered all across the globe came together to set up a monetary system to support peaceful trade. #together #peacefultrade LO 8-2 Describe today’s floating currency exchange rate system, including the IMF currency arrangements. The Floating Currency Exchange Rate System In 1971 President Nixon announced that the United States would not exchange gold for the paper dollars held by foreign central banks, relieving the dollar of much of its role as a stabilizer for the international monetary system. The shock of Nixon’s announcement led currency exchange markets to remain closed for several days, and when they reopened, they began to develop a new system for which few rules existed. Currencies were floating, their values based on market forces, and the stated US$ value of $35 per ounce of gold was now meaningless, because the United States would no longer exchange any of its gold for dollars. Two attempts were made to agree on durable new sets of fixed currency exchange rates, one in December 1971 and one in February 1973, resulting in the Smithsonian Agreements. Both times, however, banks, businesses, and individuals felt the central banks had pegged the rates incorrectly, and they were right each time. By March 1973, the major currencies were floating in the foreign exchange (FX) markets, with their value determined by supply and demand, and this system of floating exchange rates still prevails. The floating exchange rates Exchange rates determined by supply and demand that allow currency values to float against one another
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