International Monetary Fund Essay, Research Paper

The International Monetary Fund is an important function that makes world trade

less strenuous. The International Monetary Fund, or IMF as it is called,

provides support and supervision to nations in all stages of economic progress.

International trade is a key element to enable nations, large and small, to

strengthen their economic positions. Larger nations need the international

market to export their goods and services, and smaller nations also need this

world scale market to import products so they are able to produce more

efficiently. In order to achieve these goals, one major component must be in

place. The ability to value other nation’s currency. Throughout the years, many

different ways have been used to do this, mostly ending in failure. There is no

perfect way to accurately measure the true value of another country’s currency.

The International Monetary Fund is an effort to see each country’s economic

position, offer suggestions, and provide the fundamental economic security that

is essential to a thriving (world) economy. Many of the domestic economic goals

are reiterated by the INF on an international level. To understand the current

INF we will investigate the events leading up to its existence. Between 1879 and

1934 major nations used a method of international exchange known as the Gold

Standard. The Gold Standard was simply a fixed-rate system. The rate was fixed

to gold. In order for this system to function properly three things had to

happen. First, each nation had to define its currency to gold (this definition

then could not change). Second, each nation must than maintain a fixed

relationship to its supply of money and its amount of actual gold. Third, the

on-hand gold must be allowed to be exchanged freely between any nations

throughout the world. With all of those policies successfully in place, the

exchange rates of the participating countries would then be fixed to gold,

therefore to each other. To successfully maintain this relationship some

adjustments had to be made from time to time. For example, two countries A and B

are doing international business together and A buys more of B’s products than B

buys of A’s. Now B doesn’t have enough of A’s currency to pay for the excess

products purchased. B now has what’s called a balance of payment deficit. In

order to correct for this deficit the following must occur; Actual gold must now

be transferred to A from B. This transfer does two things. First, it reduces B’s

money supply (a fixed ratio must be maintain between the actual amount of gold,

and the supply of money) hence lowering B’s spending, aggregate income, and

aggregate employment, ultimately reducing the demand for A’s products. Second,

A’s money supply is now increased, raising A’s spending, aggregate income, and

aggregate employment, ultimately raising the demand for B’s products. These two

events happen simultaneously stabilizing the exchange rate back to its

equilibrium. The Gold Standard served the world’s economy very well until one

unfortunate event happened. The Great (worldwide) Depression of the 1930’s

presented the world with a new set of problems to be dealt with, not only

domestically, but throughout the entire world. The situation was bad, so bad

that nations would do anything to dig themselves out of economic disaster.

Nations now would break the biggest rule of the Gold Standard. Nations started

to redefine the value of there currency to gold. This act of devaluation, as it

was called, disrupted the entire world’s perception of the relationship of each

country’s currencies to there own. Bartering systems were tried, however,

eventually the Gold Standard failed. After The Depression international trading

was crippled. A new method of international currency exchange had to be

developed. Many ideas were listened to, but not until 1944 would a new entirely

accepted method be adopted. During this year in Bretton Woods, New Hampshire a

modified adjustable-peg system was formed, in addition to this new innovative

system, the International Monetary Fund was formed. For many years the Bretton

Woods adjustable-peg system worked well. This system became more and more

dependent of the United States currency’s value. Since from the inception of the

IMF in 1946 the United States government would exchange currency so that one

ounce of gold equaled 35 US dollars. As more and more people found that 1 ounce

of gold for 35 dollars was bargain, the supply of gold and US dollars became

scarce (many people were trading their US dollars for gold). Eventually the

general census of the world did not value 1 ounce of gold to 35 US dollars. The

value of the US dollar was now in question on an international scale. In 1970,

the United States declared that it would no longer offer 35 dollars for an ounce

of gold. The Bretton Woods system, that grew to value the entire economic

exchange values on the stability of the US dollar now lost its basic component.

What to do now? A new system of international currency exchange values was

inevitable. The IMF shortly after the discovery of the need for new currency

exchange values were evident decided to change its policies. Each country was

now able to define its own currency with a few exceptions. First, the nation

couldn’t be equated with gold. Second, the IMF had to know exactly how each

country calculated the value of its currency. There were and still are many

different ways to accomplish this. The free float method (a capitalistic market

system, where currency is freely exchanged), the managed float method (similar

to the free float, were the government buys or sells large quantities of its own

currency to effect the value), or it may be pegged to another nations currency

(a direct relationship to another country’s currency value). There are other

ways to define currency, the former methods are, by far, the most common. By

this change in policy, the IMF actually has more control, now the IMF has

intimate knowledge of other country’s economic systems. This knowledge is key in

improving international trade and the ultimate well-being of all nations. The

utilization of this newly obtained knowledge is known as surveillance. This

surveillance allows the IMF to supervise the economic policies of countries,

mostly the ones who are borrowing funds. And assure that funds of the IMF will

be paid back in a timely fashion, so that other countries are able to take

advantage of borrowing power in their time of need. The IMF as an organization

does several things. It provides technical counseling to nations with economic

problems where there are fundamental problems with the nations economy. It

provides a helping hand, financially, to nations that are experiencing economic

trouble. And it sets values to each of the participating members currency

through a series of policies. The nations that "own" the IMF are

members strictly by choice. Any nation that is willing and able to join is

welcome, however, there are some governing guidelines that must be followed,

included among other things is financial disclosure. When a nation decides to

join the International Monetary Fund there is a financial obligation. This cost

is in the form of a quota, this quota is individually set by the new nation’s

wealth and economic strength. 25 percent of this quota must be paid by gold or a

major convertible currency, the other 75 percent is paid by the nations own

currency. This quota is then used for several reasons. First, it weighs the

joining nation’s voting power (each nation’s contribution to the total fund’s

value is calculated as a percentage, the nation’s voting power is then equal to

the that percentage). Second, the quota contributes to the general funds’ value,

later used to lend currency to the countries in financial need. The nations

involved with the IMF reap many benefits. One of the hidden perks of the IMF is

its economic counseling and surveillance. Economic counseling takes place on a

yearly basis. Each year representatives of the IMF visit each participating

nation’s capitals and perform a series of tasks. They collect information

concerning the particular nation’s economic position. They collect data on the

country’s aggregate wages, prices, exports, along with how much currency is in

circulation, and other data relating to the economic well-being of the country.

The representatives then converse with the nation’s officials to investigate how

their economic policies have done during the last year, and what is the forecast

of new economic policies for the next year. With this information the IMF

representatives are able to compile a non-bias analysis of that nation’s

economic position. This non-bias compilation is than reviewed by other IMF

representatives and ultimately forwarded to the appropriate nation. This

analysis includes productive suggestions on how to improve strategies, and

formulate better economic goals. This analysis is just a suggestion and cannot

be enforced by any means. If the nation who receives the suggestion doesn’t like

it, it is their prerogative not to take its advice. When times are really in

dire straits for a nation the IMF gives the participating nation a sense of

security. The quotas mandatory to join the IMF now becomes the savior. Nations

in real need of financial assistance are welcome to money saved by the IMF.

There are guidelines of removing currency from the IMF, specifically a country

who cannot pay it’s debt to other nations can immediately withdraw twenty-five

(25) percent of its original quota that was paid by major convertible currency

or gold. If that amount is not sufficient to cover the debt, other options

become available to the country. A line of credit may be extended to a nation.

This line of credit is only extended if the borrowing country provides the IMF

with and abides by an economic policy that will in a specific time frame repair

the country’s current financial problem and repay the debt. If the expectations

have been meet, and the collective members of the IMF agree to lend money, the

county is able to borrow against a predetermined line of credit. Installments

may be withdrawn as long as the Executive Board of the IMF is satisfied that the

borrowing country is following the economic policy provided to receive the loan.

It is important to note, the economic policy is provided by the country who

wishes to borrow. The economic policy need only be approved and followed before

currency is released by the International Monetary Fund. The repayment of the

loan varies in a case by case fashion, generally it is paid back within three

(3) to five (5) years. The borrowing country may borrow up to three (3) times

the amount contributed by the respective country’s quota. This may seem a bit

unfair, because the borrowing country always demands major convertible currency,

in fact, only about 20 different currencies are borrowed in any one year, but

this borrowed currency is not interest free. The borrowing nation must now pay

back the principal and about 4 1/2 percent interest to the country whose

currency has been borrowed. A small service fee is also paid, this is used to

finance some of the IMF’s operation costs. To supplement the need for the

growing need for cash reserves, the IMF in 1969 decided to implement a need

means for exchange. The SDR (special drawing right) is a form of revenue that is

allocated to nations. These SDR units can be used to repay debts of currency

previously borrowed or, among other things, be used as tools to make payments to

other countries belonging to the IMF. The IMF can, with the consent of the Board

of Governors issue SDR units at any time in proportion to the members quotas.

This units are distributed to all nations belonging to the IMF at the time of

their issuing. The SDR units do not have a fixed value, in fact, their value is

based on the collective value of five major currencies. The US dollar, Deutsche

mark, French franc, Japanese yen, and British pound are the basis of the SDR

value. SDR’s may be exchanged directly for currency, the SDR units are in this

case shifted to the nation dispensing the currency, and currency is given to the

nation giving up there SDRs. SDR’s are simply a means of expanding mediums of

exchange in the international arena. SDRs allow nations to buy and sell goods on

paper while maintaining hard currency as cash reserves. To relate the entity of

the IMF to real personnel we must understand the structure itself. The IMF

currently employs over 2500 people. The most influential of these employees are

the representatives from each of the participating countries. Each nation has

two representatives, known as the Governor and the Alternate Governor. These

Governors make the votes for policies, and ultimately make the IMF what it is.

The Governors are the voices from each nation. These Governors are not without

assistance. In order to make economic decisions intelligently a special

committee of economic professionals are at the Governors’ disposal. This Interim

Committee, as it is called, advises the Governors, hence the individual nations,

on key economic issues that may arise. The Interim Committee has no direct power

over the Governor’s decisions, and acts strictly as an advisory tool. Other

personnel of the IMF include 24 Executive Directors, including a Managing

Director on staff in Washington D.C. These Executive Directors represent

individual countries or groups of countries and work full-time in enforcing the

policies set forth by the Governors. These executive directors make no policies,

rather keep existing policies enforced. The IMF is not exclusively a lending

organization. It is an organization that moderates world trade by defining

(through policy) international currency and provides suggestions which

under-developed countries can use to grow. However, in the interest of all

nations, countries who are unable to pay its debts may borrow currency. This

borrowing aspect keeps world wide currencies at a steady rate so that

international trade can proceed without question or delay. The IMF’s counseling

is equally beneficial to all nations. Not only to stimulate the growth of a

nation, but to stimulate world trade. Counseling does another valuable service.

Counseling tends to bring consistency on how each country reports its economic

progress. The ‘template’ provides clarification on the true economic position of

each nation, making it easier to understand our international neighbors,

ultimately making it easier to do business with them.