Questions:
Briefly describe the current International Monetary System. How does the Current system differ from the system that was in place prior to August 1971?
Prior to 1971, the world operated on a fixed exchange rate system. The value of the U.S. Dollar was linked to gold at the fixed price of $35 per ounce, and the values of other currencies were then tied to the dollar. For example, in 1964, the British pound was fixed at $2.80 for 1 pound, with a 1 percent permissible fluctuation around this rate. Thus, the British government had to regularly intervene in the foreign exchange Market to keep the pound in the range of $2.77 to $2.83. When the pound fell, the Bank of England had to buy pounds, offering either foreign currencies or gold in Exchange. Conversely, if the pound reached the top of the range, the Bank of England would sell pounds. The official exchange rates were occasionally "reset" to reflect changing economic conditions.
The current international monetary system for most industrialized nations is a floating rate system. In this system, currency exchange rates are allowed to fluctuate in response to market conditions with a minimum of governmental intervention. Changes in currency demand can be due to trade deficits (i.e., one nation imports more from another nation than it exports, causing there to be higher relative demand for the currency of the bigger exporter). It can also be due to capital movements. For example, if interest rates are relatively high in one country, then investors might seek to purchase that country's securities, which increases demand for that country's currency?