International Finance 04/15/24 Liquidity
International Finance refers to the exchange This refers to any assets available in order to
rates system, international financial institutions finance international transactions of a certain
(i.e., IMF and the World Bank), and the country. These assets are usually in the form of
international monetary system. currencies.
The international monetary system is a system Other than the local currency (PHP) of BSP, it
that adopts a so-called international medium of also has foreign currency reserves (EU, USD,
exchange. International mediums of exchange RMB). These currencies can be used in order to
can be major currencies such as the dollar. finance the international transactions of the
country.
For instance, during the second half of the 20th
century, the main medium of exchange or the All countries have liquidity, any international
monetary system was the US Dollar. finance/monetary system should have liquidity.
Definition of “Money”
Money is a widely accepted good that is used to Adjustment Mechanisms
exchange with other goods and services. If a certain country suffers from an Imbalance of
An example of money that is used to exchange Payments.
with other goods and services is Cash. Balance of payments is the balance between the
Back in the ancient epoch, money was not in the assets and liabilities of a certain country
form of bills or paper but rather Commodities respective of other foreign countries.
(i.e. gold, silver, cowrie (kapinan) shells). Assets exceed Liabilities = Favorable Balance of
3 Functions of a Money Payment
1. As Medium of exchange Liabilities exceed Assets = Unfavorable Balance
- It can be used to buy goods and of Payment
services
2. As Unit of Account Under the Bretton Woods System, it is the IMF
- It can be used to measure the worth of that will provide financial assistance to
goods and services (i.e. Price) countries.
3. As Store of Value
- Money is an important tool to store Confidence
wealth
Countries must have confidence or must trust
International Financial or Monetary System the system otherwise when they abandon the
system, it will collapse.
3 Main Requirements of Financial or
Monetary System History is a witness to how many times the
international finance/monetary system
1. Liquidity
collapsed after countries abandoned the system
2. Adjustment Mechanism
(i.e. Classical Gold Standard, Gold Exchange
3. Confidence
Standard, and the Bretton Woods System). In this
case, Confidence is equally necessary to the other
two requisites.
From there, it commenced another financial
revolution; from specie money to fiat money or
Importance of the International Monetary
political money.
System
The Era of Political Money / Fiat Money
If the world is bereft of an international
monetary system, international development and Under the Political Money, there are two specific
trade will not exist or prosper because it is types:
deprived of resources to facilitate international
1. Commodity-backed currency
development and trade.
For instance, 1 Dollar is equivalent to a
Different International Finance or Monetary certain amount or grams of gold.
System
2. Fiat Money or Non Commodity-backed
The Era of Specie Money/ Era of Commodity
currency
Money
For instance, 1 Dollar is no longer pegged
The Era of Political Money or equivalent to a certain amount or
grams of gold or any commodity.
Classical Gold Standard
Under this category, the face money of a
Gold Exchange Standard certain currency is derived from the
relationship between supply and demand
Bretton Woods System and the stability of the issuing
Flexible Exchange Rates System government, rather than the worth of any
commodity.
The Era of Specie Money/ Era of Commodity The main element under this category is
Money the influence or control of the
government issuing such legal tender
This era was marked by which the people used currency.
commodities as a medium of exchange to
facilitate transactions (i.e. gold, silver, cowrie In juxtaposition, in the past, the
shells, etc.). government could not intervene or
For example, in the Philippines, there was a point control the commodity-backed currency
in its history when Cowrie Shells or Kapinan was to encourage economic activity because
used as the medium of exchange. such commodities could not be produced
more.
In the Roman period, their medium of exchange
was precious metals like gold and silver. But now, in order to promote economic
The era of specie money ended because the transactions or activities, the government
commodities utilized were scarce. The absence can simply mint or print money.
or scarcity of these commodities limits economic
growth or at some point discourages economic The financial revolution emphasized
activity. The scarcity or rarity of commodities to herein is that the government under the
facilitate economic activity, regimes or era of political money now acquires
governments at that time started printing or control over monetary supply. This results
minting money. in Monetary Policies (i.e. increase money
supply thereby encouraging economic
activities or decrease thereby reducing In this system, the UK first initiated to peg the
economic activities.). value of its currency against gold (i.e. 1 Pound is
equivalent to a certain gram of gold). Other
countries appreciated and thereby followed suit
Difference between Expansionary and
UK also pegged their currencies against gold.
Contractionary Economic Policies
This commenced the Classical Gold Standard.
This financial revolution allows the government
The Classical Gold Standard was not established
to acquire extensive control over monetary
out of negotiations or agreements among the
supply even until now.
countries. Rather it coincided with Pax
Because governments under the era of political Britannica whereby the UK first initiated and the
money could now control the monetary supply rest of the countries followed suit.
by printing or minting more money, this era also
The Classical Gold Standard had two main
revolutionized monetary policies in the form of
features:
Expansionary and Contractionary policies.
1. Fixed Exchange Rate System
Expansionary Policies mean that the
government encourages more economic Countries pegged their currencies to a
activities because maybe the economic growth is commodity which is gold.
not sufficient or satisfactory. In specific, for the
UK Pound: 1 Pound = 2oz of Gold
government to achieve higher GDP growth, it
must adopt expansionary policies. US Dollar: 1 Dollar = 1oz of Gold
Examples of Expansionary Policies are increased Exchange Rate = 2 US Dollars for 1 UK Pound
Consumption, Investments, Government
spending, and Exports.
2. Transferability of Gold
Expansionary policies may also lead to inflation
UK will accept US Dollars. The US government on
or an increase in overall prices. As a result, the
its part should keep its Dollar convertible to gold.
government adopted Contractionary Policies.
Likewise, vice-versa on the part of the UK.
This is much more crucial especially since the
Classical Gold Standard nature of transactions now is international, we
should expect the transferability of gold from
This system was adopted during the period of
one country to another.
Pax Britannica. This period marked the relative
peace during the reign of the UK as the The Classical Gold Standard commenced late 19th
superpower. Century until before WWI (1914).
During the period of Pax Britannica, particularly The Era of the Classical Gold Standard eventually
during the Industrial Revolution, there was a rise ceased or collapsed because countries no
in international trade or exchanges of goods longer had Confidence in the system ( refer to
across territories. This led to a conundrum on the 3 Main Requirements of the Financial or
how to determine the relative worth or the value Monetary System).
of each country’s currencies. In other words, that
More specifically, countries did not anymore
is to determine what is the exchange rates of the
follow the Fixed Exchange Rate System under the
currencies among different countries (i.e. British
Classical Gold Standard because they
Pound value against French currency).
safeguarded their gold reserves, especially
during WW1.
During WWI, the prevailing system was UK government, it has to keep its currency
Bullionism which a certain country’s wealth was convertible or backed to gold. Under this system,
dependent on the amount of gold reserves it had. the UK Pound is the pegged currency.
In effect the more gold reserves or bullion a
Classical Gold Standard = pegged commodity
country has, the richer or the more powerful it is.
which is gold
Naturally, especially considering the advent of
Gold Exchange Standard = pegged currency
WWI, countries did not allow or protect their
which is the UK Pound.
gold to be transferred to another countries. This
was an example of Economic Why pegged currency?
Nationalism/Protectionism under International
UK at the time of WWI is declining yet its
Finance.
economy is still strong. And at the same time,
As a result, the Classical Gold Standard collapsed they wanted to prevent an instance in which
because warfare countries or States during WWI countries would automatically abandon the
safeguarded or protected their gold reserves or system.
assets. In other words, they no longer had
By using a gold-backed currency as a pegged
Confidence in the system.
currency, countries tend to sustain the exchange
rate system, unlike the previous system of the
Classical Gold Standard in which all countries
The Gold Exchange Standard
pegged their currencies to gold.
The Gold Exchange Standard was the standard
But now under the Gold Exchange Standard, only
that emulated, but not outright, the Classical
one country will peg its currency to gold and the
Gold Standard. This system was in place or
rest of the currencies of other countries will peg
commenced during the Interwar Period or
their currencies not to gold but to that of
Interregnum Period (a gap in continuity when
commodity-backed or gold-backed currency.
there is no ruler or clear governance) between
WWI and WWII. The Gold Exchange Standard collapsed because
of WWII and particularly the Great Depression.
The difference between the Classical Gold
The Great Depression was the series of financial
Standard and the Gold Exchange Standard was
recessions that countries experienced from the
the idea behind the “exchange” of
1930s to 1940s (i.e. Inflation and Economic
money/currency.
Stagnation – lack of economic growth/ Inflation =
Under the Gold Exchange Standard, a certain Economic Stagnation = Stagflation). The remedy
currency, say, US Dollars is not directly therein was to encourage economic activity, say,
convertible to Gold. However, under this system, for instance, increasing Government Spending on
the US Dollar is first pegged or valued to a public works or infrastructures.
specific commodity- or gold-backed currency
The Stagflation during the Great Depression
before it is convertible into gold. It is a form of
abetted with the advent of WWII ultimately
indirect gold exchange rate.
catalyzed the collapse of the Gold Exchange
Under the Gold Exchange Standard, countries not Standard.
only use gold ultimately as a pegged commodity
but they also use commodity- or gold-backed
currency as its pegged currency. In effect, the
country has to fix first its currency to a
commodity-backed currency, say, UK Pound,
before it is convertible to gold. On the part of the
