The terms “international monetary system”, “international monetary and financial system” and “international financial architecture” are frequently employed interchangeably and synonymously. It is crucial to be precise as well as comprehensive because the terminology includes de jure/de facto jurisdiction, legal authority, obligations, and surveillance pertaining to sovereign nations and international organisations. A solid CFO course will help you to better understand the concepts and effects of the international monetary system.
Read on to understand the intricacies of the international monetary system and what impact it creates on interest rates and exchange rates, how it facilitates various financial instruments to contribute to the financial stability, globally.
International Monetary System: Objective
The rationale behind executing the international monetary system is to contribute to economic growth and stable global financial standards while considering factors like financial stability and price structure. It is an important part of global economics. The international monetary system encompasses several official arrangements that are important to govern various financial dimensions and balance of payment. A major aspect of the international monetary system is to regulate the exchange of goods and services including capital among various nations.
However, the International monetary system mainly comprises four major factors that are enumerated as follows:
- Exchange arrangements and exchange rates.
- International payments and transfers with regard to current international transactions.
- International capital movements.
- International reserves.
Effect of International Monetary System on Exchange Rates and Interest Rates
The exchange rate is a very crucial aspect when considering a country’s economy and determining the level of trade and commerce it deals with. Especially for countries having a free market economy, determining exchange rates and their related aspects is a crucial task.
However, setting aside the impact of exchange rates on the economy at large, it also affects the portfolio of an investor on a smaller scale. Hence, understanding financial aspects is very important whenever an individual wants to invest, keeping in mind the current market conditions.
The international monetary system affects the exchange rate as it is a relative aspect that is expressed in terms of the comparison of the currencies of two or more countries. A country’s exports become more pricey in foreign markets, while its imports become less costly when its currency value increases. A solid CFO certification programme can help you learn all of this in more detail.
Factors that Determine Exchange Rates
There are multiple factors of the international monetary system that determine the exchange rate. This is an essential driving factor in corporate finance decisions. If you are a finance professional and want to dig deeper into this domain, then an effective CFO course can help you learn everything that you would require to flourish in this field.
The importance of the exchange rate is understood when the exchange of trade happens between two countries and the currency values of both countries are different. The following are major determinants of exchange rate:
Differentials in inflation
Generally, a country whose inflation rate is perpetually lower is likely to experience developing currency values as the value of the currency appreciates when compared to other currencies. For instance, countries like Germany, Switzerland and Japan were among those countries that had low rates of inflation in the latter half of the 20th century.
On the other hand, countries like the United States and Canada barely experienced low inflation, subsequently. Higher inflationary economies typically encounter a reduction in the exchange rate of their own currency, also experiencing low purchasing power when compared to those of their trading partners. Additionally, high rates of interest usually correspond with this phenomenon.
Difference in interest rates
There exists a significant connection between interest rates, exchange rates, and inflation. Financial institutions manage and regulate exchange rates and inflation via manipulation of exchange rates. Also, the variations in interest rates reflect an impact on exchange rates and inflation.
A robust economy with higher interest rates offers creditors greater returns compared to countries with lower interest rates. Therefore, higher interest rates attract foreign investments and enhance the worth of the currency. However, the impact of high rates of interest is mitigated if the country's rate of inflation is considerably higher compared to that of other countries. On the contrary, decreasing interest rates usually results in decreased exchange rates.
Current account deficits
The balance of trade among a country and its trading nations is known as the current account. This account provides the details of all the exchanges and payments between the nations in relation to goods, services, dividends, interest, etc.
However, the deficit balance in the current account of a country reflects that its spending on foreign investments or goods is more than that of its earnings. This implies that the country is borrowing money or capital from foreign countries to make up the deficit. As a result, the exchange rate of the country declines because of greater demand for foreign currency until foreign assets become far too expensive to produce sales for national interest and domestic goods and services become adequately affordable for foreigners.
Public debt
To make up the expenses of government, spending and public sector programmes, countries are going to generate immense deficits and debts. Despite the fact that this sort of activity improves the national economy, enormous public debt and deficits render nations less desirable and appealing to international investors.
This is because large debt stimulates inflation and in a circumstance of inflation, the depth will ultimately be paid with cheaper genuine currency. Hence, the debt rating of a country is a vital determinant in deciding its exchange rate.
Strong economic performance
International investors invariably seek steady and reliable countries with thriving economies whenever they want to invest their financial resources. Capital for investment tends to gravitate towards a country with advantages, traits and characteristics instead of moving towards other countries that involve greater risk potential.
For example, political turmoil in a country may give rise to a reduction in the value of its currency and capital moving to currencies of countries that have stable and strong economies.
Terms of trade
Exchange rate is very much associated and affected with the type and terms of trade the countries are dealing with. The terms of trade are decided by comparing a ratio between the export price and import price, and how well the country is performing in their import and export.
However, the terms of trade have a direct relationship with the balance of payment and current account. If there is an increase in the rate of exports in a country and the imports have not seen a huge rise, it means that the terms of trade have seen a favourable change and hence improved. If there is a greater amount of exports from a particular country, it means that the terms of trade have seen significant growth. This ultimately increases the value of the country’s currency. If there is only a small change in the export rate of a nation when compared to that of their import rate, that means that the value of the country’s currency has decreased.
Conclusion
There are various key ingredients for a stable international monetary system that includes domestic as well as international financial factors. The international monetary system helps to establish stability in the global financial sector as well as regulate finances in various other forms. Both for large-scale and small-scale investors, the principles and practises of the international monetary system are vital.
This is a very vast field encompassing a lot of crucial concepts. If you wish to become a pioneer in the field of finance and aim to become a successful CFO in the future, understanding the international monetary system and its related concepts is very important. You may sign up for the Chief Financial Officer Programme by Imarticus to become the best financial leader and stay ahead of your contemporaries. A holistic CFO certification can help you become an effective financial leader.
