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The International Monetary Fund (IMF) is the supervisor and safety net for the international monetary system: an international organization created in 1944 to eliminate foreign exchange restrictions, provide convertibility of currency and encourage exchange rate stability to promote trade. The Fund was set up at Bretton Woods, along with its sister institution the World Bank, to supervise the fixed exchange rate system.
The original IMF agreement was created to assist the functioning of an international gold standard system following the end of World War II. Each nation set an official par value for its currency in terms of gold or in terms of the US dollar. The US pledged to maintain the value of the dollar at $35 per fine ounce of gold by buying and selling gold at that price internationally. Some nations did not have enough gold for their currency to exchange freely for gold. Those nations set the par value of their money in terms of US dollars, using dollars for their currency reserves. Thus they were indirectly on the gold standard. Market exchange rates were to be kept within 1% of par value by the use of each nation\'s stabilization fund. If a nation developed a chronic deficit in its balance of payments and a steady drain on its foreign exchange reserves, it could propose a change in its official par value. It happened that, in practice, countries would devalue their currency without prior approval by the IMF, to prevent speculator profits from the advance notice that an approval process would provide.
The IMF provided for a fixed exchange-rate system based on a gold exchange standard in the short run, while in the long run, some flexibility was provided through a mechanism for changes in official par values. The IMF could also lend to countries with balance-of-payments deficits with funds from the IMF holdings of gold and currency. The holdings arose from subscriptions of member nations determined by their quotas, which reflected each nation\'s economic importance in the world economy.
On 1 January 1970, the IMF was authorized to create Special Drawing Rights (SDRs) as a reserve asset that countries could use to settle international accounts. This potentially turned the IMF into a world central bank with the ability to create international reserves. But SDRs are allocated among participating countries according to their quotas, so they have been of limited help in coping with balance-of-payments problems.
In 1971, the US stopped honouring its obligation to sell gold at $35 per ounce, an action which broke the dollar loose from its gold moorage. In 1973, European countries and Japan began to let their currencies float against the dollar, and the world was on a flexible exchange system.
With the end of fixed exchange rates, the International Monetary Fund lost an important part of its purpose and its mechanism for achieving its goals. The IMF continues to pursue foreign exchange stability by being a source of short-term credit to acquire foreign exchange to pay for imports when exports and capital movements are insufficient to generate enough foreign exchange. The borrowing country is expected to take steps to correct the imbalance and, also, countries with persistent trade surpluses are encouraged to take steps to correct this imbalance. TF |
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