Class 12th – Fixed Exchange Rate System | Economics | Tutorials Point

Fixed Exchange Rate System
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Lecture By: Ms. Madhu Bhatia, Tutorials Point India Private Limited

[sejalraj]

Thank You mam really explained so well.

[nanjappa]

When two countries trade, the value of goods and services is determined on the basis of exchange rate -the price of one currency in terms of another. But when a country trades with many others, it is not practical to fix the exchange rate for each currency. So it is fixed against a common item . Gold served as the common item before the First World War. Currencies of countries had backing in gold, so it was easy to do so. This was the Gold Standard. But it imposed an obligation- when a country gained in trade and had a surplus, there was a gold influx, it had to inflate its currency; when a country ran a deficit, it had to pay out gold, and deflate. This involved disturbance in output/employment, and consequent adjustment and hardship. It was said that the Gold Standard had an inherent tendency towards deflation. But the system worked remarkably well.
The First World War ended this system, when countries did not want to part with their gold. The UK attempted to restore the Gold Standard in the 20s, under Churchill, but it ended in disaster as he resorted to the old exchange rate, which was inappropriate in the changed conditions..
This was followed by the Great Depression, and the Second World War, when the system of multilateral trade collapsed. At the end of the War, most nations were broke, America being the sole rich super power. But the nations of Europe wanted to revive by trade, though they had no money to pay their way. The great economists and statesmen of the time were genuinely interested in the revival of world trade. They met at Bretton Woods and discussed matters. Lord Keynes proposed a system which did not depend on gold, or dollar either. He proposed a new international currency called Bancor. But this was not accepted. Finally, they settled on the US dollar, which was linked (convertible) to gold at the rate of $35 an oz under the IMF system. All member countries were required to declare the par value of their currency in terms of gold, and then this was linked to the dollar. This was the Gold Exchange Standard. Under the IMF system, the members were required to maintain stability and had only limited power to change the exchange rate in emergencies, beyond which they required the prior approval of IMF. They could not indulge in beggar my neighbour policies. Originally, 29 countries had signed the agreement by Dec, 1945. ( India was one of them. Though world trade expanded rapidly under this system, India did not take advantage as it followed restrictive socialist policies, and India's share in world trade actually shrank.)

This system worked well till August 1971. Due to the Vietnam war, America experienced acute inflation which affected the exchange rate and the price of gold in terms of dollar. America was not able to maintain convertibility of dollar into gold at $35 an oz- the open market price exceeding $100 at times. So, President Nixon suspended the dollar convertibility into gold on 15 August 1971. Thus ended the Fixed Exchange Rate System under IMF. The currencies started floating.- there being different kinds of 'float'. [ Indian Rupee was linked to a "basket" of currencies.]
( But this was a foolish decision. While the whole world currencies were floating, India introduced fixed exchange rate and tried to defend it through the foolish Exchange Control under FERA, 1973. ( As the Hindi saying goes, "Sare duniya ka insaan margaya, yeh ullu ka patta reh gaya. Indian economy suffered consequently, facing near bankruptcy on external account in 1991. The first act of reform was the dropping of fixed exchange rate, and letting the rupee value be determined by market.)

Since then, the world currency markets, financial systems and economies have undergone cyclonic changes. Today, about 98% of transactions in the international currency markets are due to speculation, not related to trade. The average daily volume of transactions in the international currency markets runs into trillions of $, while the (one time)reserves of Central Banks are a tiny proportion of it. There are also so many novel instruments, methods of trade. The markets are operating 24x7, the year round. The old time zones are gone.Thus today it is impossible for IMF or any Central Bank or groups to work a fixed exchange rate system. No one really knows how the exchange rates get fixed, but every country only tries to adjust to the dominant currency.

This is a very brief outline. For an in depth understanding of historical facts one should read old classics like Sir Geoffrey Crowther, R.G. Hawtrey. and others. As they say, Economics without history has no roots.

[AfsarAli-gyuy]

What about explanation of gold standard, I am not getting ur video

[gandhisiddharth]

Excellent explanation for B school students

[ansharora]

mam fixed rate system me govt exchange rate fixed krti hi