Ansgar, Kerstin & Ferdinand (2011) defines the international monetary system (IMS) as a set of rules and conventions as well supporting institutions established on a global platform with the primary objective of facilitating global trade, cross-border investment as well as capital reallocation between different states. In addition, the rules and practices established under the international monetary system play a crucial role in governing how the debts are paid and honoured among and between countries with different national currencies. Atish, Ostry & Charalambos (2010) assert that the international monetary system offer a means of international payment that is acceptable between sellers and buyers from different countries as well as deferred payment. In order for the IMS to function effectively, the rules and conventions ought to nurture confidence, guarantee adequate liquidity for the varying levels of trade and offer a mechanism that can be used to rectify global imbalances. The underlying goal of the IMS is to promote global economic exchange. This is because the national currencies of most countries are not accepted as a form of legal payment beyond their borders. In addition, Auboin & Ruta (2011) asserts that international trade transactions are only probable in the presence of an inexpensive means for currency exchange. In this regard, the IMS offers a mechanism that can facilitate this requirement of international trade. Bacchetta & Van Wincoop (2000) also points that the IMS can grow organically following several individual agreements existing between international economic entities that are observed for several decades. Similarly, the IMS can emerge from a single architectural vision, which is similar to system developed by Bretton Woods during 1944.
Since people from different nations speak dissimilar languages, trade transactions between different countries involve different countries, which pose the need to convert one currency to another in order to facilitate international trade (Bacchetta & Van Wincoop 2000). In this regard, there is no doubt that an international monetary plays a pivotal role in encouraging international trade and investment. According to Bilge & José (2012), when the IMS functions smoothly, countries benefit from the ensuing global flows of capital, service and goods. Essentially, the IMS is perceived as an international public good. However, when the IMS becomes poor organized or breaks down, countries will not be able to maintain high amounts of global trade and investment. In the light of this view, this paper discusses the ways in which stability in the IMS is important for international business.
D’Arista (2001) points out that there are three mechanisms through which a stable IMS promotes international business, which include through exchange rates, exchange rate systems, and the balance of international payments. The following subsections discuss these mechanisms, with a focus on significance of a stable IMS in promoting international business.
Overview of the Importance of a Stable IMS
Bush, Farrant & Wright (2011) posits that a well-functioning international monetary system is the essential nexus with regard to the international economy; this is because it plays an integral role in facilitating the growth of international trade, worldwide interdependence and foreign investment. Huchet-Bourdon & Korinek (2011) asserts that establishing a sound IMS is a requirement for a flourishing global economy; this is evident in the case where the breakdown of the IMS played a central role in the 1930s Great Depression. This point out the pivotal role that a stable IMS plays in the global economy. In the contemporary global trade environment, monetary stability is increasingly becoming important. Financial and money flows are becoming the most vital linkage between national economies; therefore, the stability and efficiency of the IMS are critical success factors in the global political economy.
Huchet-Bourdon & Korinek (2011) points that a stable IMS should resolve the three technical issues: confidence, adjustment and liquidity. In order to guarantee liquidity, the IMS should offer sufficient (but no inflationary) currency supply aimed at financing trade, offer financial reserves and enable adjustment. In order address the adjustment problem, the IMS should outline the methods used in resolving the disequilibria between national payments. The three mechanisms that can be used to facilitate this include changes in the exchange rates, imposing direct controls over global transactions, and expansion/contraction of domestic trade activities. Ensuring confidence can be achieved by mitigating destabilizing shifts with respect to the composition of the national reserves. Loss of confidence in a reserve currency can lead to these destabilizing shifts. Huchet-Bourdon & Korinek (2011) emphasizes that the IMS must resolve this issues to be deemed efficient and stable.
Reza (2011) defines the exchange rate as the price of the currency of one nation, say A, measured against another nation’s currency, say B. The exchange rate can be used to convert one currency to another currency. The exchange rate for a currency is an important factor in international trade, and is often influenced by the interaction existing between the demand for and supply of currencies in the foreign exchange market. When one currency increases its value against another currency, it is said to have appreciated. Similarly, when the value of a currency decreases with respect to other currencies, it is said to have depreciated. The IMS comprises of an exchange rate system, which constitutes a set of rules used to determine the extent to which national currencies can either depreciate or appreciate in the FOREX market. Kenen, Francesco & Saccomanni (1994) outlines two exchange rate systems, which include the floating exchange rate system and the fixed exchange rate system. Under a fixed exchange rate regime, governments are only allowed to make relatively small changes to the exchange rate of their currency. As a result, governments can opt to set up a fixed price for the exchange rate their national currency using either the gold standard or the currency of another country. The government can then maintain the established fixed price through selling and buying currencies in the FOREX market. Under the floating exchange rate regime, there are no restrictions regarding to the extent to which a currency can depreciate or appreciate in the FOREX market. In the contemporary IMS, governments make use of various exchange rate arrangements, with a number of governments using the floating exchange rate system, others using fixed exchange rate systems (Huchet-Bourdon & Korinek 2011). Nevertheless, the competing currencies, the yen, euro and the dollar are supposed to float against each other.
With regard to exchange rates, a stable IMS guarantees exchange rate stability with minimal instances of volatility. There is no doubt that exchange rates determine the volume of international trade. For instance, Auboin & Ruta (2011) points out that, exchange rates play a pivotal role in connecting a nation to the international supply chains. The relationship is simple; a stable exchange rate crates a favourable environment for international trade and investment. This is contrary to the case of exchange rate volatility and uncertainty, which hampers global trade. In this regard, a stable IMS guarantees stable currency exchange rates, which results in a favourable environment for global trade. For instance, the increased trade ensuing the adoption of a single currency can be used to justify the claim that exchange rate stability, facilitated by a stable IMS, increases global trade. Another case in point relates to the International Monetary Fund member states, which strives to ensure that member states collaborate with the main aim of ensuring orderly exchange arrangements in order to establish a stable monetary system characterized by exchange rate stability that promotes international trade (Bacchetta & Van Wincoop 2000).
Balance of International Payments
Atish, Ostry & Charalambos (2010) define the balance of international payments as a summary statement outlining all the imports of capital, services and goods, paid for by a country measured against its exports of capital items, services and goods. According to Huchet-Bourdon & Korinek (2011), when the foreign receipts are more than the payments made by the country to foreign nations, then the balance of international payment is considered favourable. However, when the payments to foreign countries are more than foreign receipts, then the balance of payment is considered unfavourable to the nation. With respect to the balance of international payments, a stable IMS plays a pivotal role in providing the mechanisms that can be used to rectify the imbalances, which are unfavourable to international trade and investment. According to the classical trade theory, international trade could only beneficial if it is managed properly; as a result, the balance of payments systems provide a mechanism through which the IMS can properly manage international trade to ensure that all countries benefit. There is no doubt that countries have the tendency to adopt trade policies that may favour them at the expense of other countries. Take this example; conventional knowledge holds that a country increases its wealth through exports. For instance, if British merchants sell their services/goods/capital items to Spanish consumers, their wealth would increase (Bilge & José 2012). As a result, the amount of money available in Britain will increase, whereas the Spanish consumers will have less money but more goods. The policy implication of this approach is that countries adopt policies aimed at increasing their exports while discouraging imports, which is likely to create imbalances in the international trade system. In addition, trade imbalances have adverse impacts of exchange rate stability, which is likely to hamper international trade, investment, and capital flows. In this regard, a stable IMS, through its mechanism, can help rectify these potential trade imbalances in global trade, which results in international trade that is beneficial to participating countries. The following subsection discusses the mechanisms that a stable IMS can used to adjust the trade imbalances between countries (Bacchetta & Van Wincoop 2000).
Balance of Payment Adjustment
Bilge & José (2012) point out that a stable IMS provides the suitable mechanisms that can be used to adjust the trade imbalances. Kenen, Francesco & Saccomanni (1994) asserts that there are three feasible mechanisms that can be used to rectify imbalances in the balance of payment, which include the exchange rates adjustment; adjustment of the country’s internal prices in accordance with the demand levels; and establishing rules for adjustment. Through exchange rate adjustment, increasing the value of a country’s currency with respect to other currencies is likely to make the exports of that country less competitive while at the same time making imports cheaper; this can be helpful in correcting the current account surplus. Correcting a trade deficit requires a downward shift of a country’s currency value in order to make imports expensive and enhance the exports’ competitiveness. D’Arista (2001) points out that government can adjust exchange rates for the case of a rules-based IMS. Nevertheless, in the IMS where the exchange rate floats freely, the rate tends to change in a manner that restores balance. Under a rules-based adjustment mechanism, countries can arrange to adjust their exchange rates in order to rectify any trade imbalances using negotiated exchange rate adjustments.
This paper has highlighted the significance of a stable IMS in promoting global trade as well the mechanisms that a stable IMS uses to achieve this goal. There is no doubt that a well-functioning IMS is an essential prerequisite in the contemporary international economy; this is because it plays an integral role in facilitating the growth of international trade, worldwide interdependence and foreign investment. The three mechanisms through which a stable IMS promotes international business include through exchange rates, exchange rate systems, and the balance of international payments. Stability in IMS guarantees exchange stability, which in turn, creates a favourable environment for global business. The balance of payment mechanisms can be used to eliminate any potential trade imbalances that are likely to hamper trade between countries; through this, a stable IMS provides appropriate mechanisms that are effective in addressing imbalances in the international trade system.
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