Inadequacies of the international monetary system

The international monetary system is fundamentally one that is used for payments in world trade. Big trading countries have strong voices in monetary affairs and their currencies are therefore "hard" (capable of use in world trade without restrictions). Countries with small shares in world trade and weak agricultural economies have "soft" currencies, which are not accepted in payment for their imports. Their trade is limited by the amount of "hard" currencies they can earn at any given time by their exports. As the world has become more interdependent, these guidelines of an earlier era are too simple to accommodate the complexities of international trade.

The external financial pressures on developing countries are of an unparalleled intensity. Severe difficulties in meeting debt service payments are widespread. Some statistics indicate a net flow of resources from the less developed countries to the developed countries, as efforts to repay years of credit continue.

The contraction in international liquidity and the continuing wide fluctuations in exchange rates among major currencies have dramatized the many inadequacies of the international monetary system that have emerged with the demise of the fixed exchange rate regime established at Bretton Woods. The domestic policies of individual major industrial countries and the operations of private international banks have become the major determinants of key international monetary variables such as exchange rates, interest rates and international reserves. No mechanism has served to bring such unilateral actions into a self-adjusting integrated system. During the crisis in the Gulf in 1990, the Bank for International Settlements warned that it could pose a serious threat to the world financial system. The danger of cumulative interaction between a deteriorating economic environment (caused by the surge in oil prices) and a continuing constraint on the ability of banks to lend at a time of high demand for credit were likely to bring about an international credit squeeze.

In 1993 the Commission on the Future of the Bretton Woods Institutions established that the international monetary system in its current form, with freely floating exchange rates, had encouraged short-term volatility and currency misalignments. The instabilities had become especially apparent in 1992 and 1993 with the expensive ejection of the UK from the European exchange rate mechanism and the effective breakup of the latter in August 1993. These events were largely due to failure to coordinate financial and economic policies of Europe, North America and Japan and severely affected all the countries concerned.