International Financial System: Origin of Money, Form and Value of Money and Bretton Woods System

Q1) Contrast and evaluate the chartalist and commodity view of how barter economies transformed into monetary ones?
Early civilise trading relations were established by barter exchange. Barter economy is a system of exchange by which goods or services are directly exchanged for other goods or services. This was an inefficient method of exchange due to double coincidence of wants: two people both would need to have the other want, the time and effort spent searching for trading partners increases transaction costs: the costs in time or other resources that parties incur in the process of agreeing and carrying out an exchange of goods and services. Other limitations of a barter economy are, it is difficult to create credit relationships and the absence of common measure of value; money plays a role of measure of value of all goods in a monetary economy, so product value can be measured against each other however this will be absent in a barter economy.
People exchanged goods and services that enabled division of labour and specialisation that was a key aspect of economic progress leading to a growth in economic output therefore exchanged became necessarily.
Therefore money was invented as a solution for exchange and has gradually replaced barter: there is still a debate amongst monetary theorists as to whether money was crated endogenously by the market participants themselves: commodity view or whether the origin was issued by the state/authorities in an exogenous sense: chartalist view.
A person’s view of the debate can impact their attitude towards monetary and financial policies today.
Chartalist will intend to favour a centralised, highly regulated system whereas commodity money view person will advocate monetary diversity and market solutions.

Q2) How are the form and value of currencies determined?
Currency is a system of ‘money’ in general use in a particular country.
Money is first and foremost a means of exchange – if an entity fails to fulfil this function it is not money.
In order for money to be acceptable it must therefore function as a store value, it must hold its value for a period of time: durable.
To be acceptable, in UK, ‘legal tender’ is used to describe the notes and coins that are produced by Royal Mint. This is the legitimisation role of the state in UK monetary system that the vendor involved in a transaction is legally bound to accept the currency for payment. (e.g. 10p – for any amount not exceeding £5). This helps to increase social confidence in a given currency.
Money should be portable and must have a function of divisibility, functioning as a unit of account. Also money must have a function to create credit relation. Credit essentially enables the redistribution of financial resources from surplus to deficit agents. Credit allows surplus to be recycled improving the real economy.
Money can appear in the form of common commodity such as gold, silver and bronze, paper notes also can be used to represent commodity, and are convertible in to them, this type of money is called symbolic money. Government can create and circulate a form of money that has no intrinsic value itself: this type of money is called fiat money.
In modern era most money is held in the form of bank deposits and transaction takes place through the electronic transfer of funds from one deposit to another. And this type of money is called credit money. Credit money is built upon some form of base money. Only 3% of UK money supply is not credit money that exists in the form of electronic bank deposits.
By the 19th Century, reliable convertibility of sterling to gold was well established in The British Empire (gold to paper money), Gold standard:-exchange rate of gold and paper money: countries that uses the gold standard sets a fixed price for gold which then the fixed price is used to determine the value of the currency, however all modern monetary systems are based on principles of fiat currency, which means that the value of money is derived not from any intrinsic value (as if it were made from precious metal such as gold and silver).
The government is partly responsible for setting its value, because if the fiat currency that is put into circulation and if the government does not back up the value of currency by appropriate tax level then the currency loses value. Therefore government deficit, national debts and central bank interest rates have an impact on what the currency is worth.
Exchange rates are expressed as a comparison of the currencies of different countries. There are numerous factors determine exchange rate.
Differentials in inflation:-
Inflation is the rate of change of prices for goods and services, so inflation means that there is a general increase in the price of level taking place. The price level is an average price across an economy. So a country with a consistently low inflation rate exhibits a rising currency value. But those countries with higher inflation typically see depreciation in their currency in relation to other trading currencies.
Differentials in interest rates- Central banks e.g. bank of England manipulate interest rates so CB exert influence over both inflation and exchange rates. And changing interest rates impact inflation and currency values.
High Interest Rates = Higher return in an economy = H I.R attract foreign capital causing exchange rate to rise.
Also market pressure (demand and supply) can cause exchange rate to either increase or decrease. If there are more demand for a currency e.g. US $, the value in US $ will go up pushing the US $ exchange rate to go up.
Classical economists argue that the value of a commodity is related to the labour needed to produce that commodity this is called the labour theory of value.
So value of a chair (3hrs labour) = 10CDs (3hrs labour)

Q3)
The political basis for the Bretton Woods system was in the confluence of the shared experiences of the Great Depression.
The Wall Street Crash of 1929 was the most devastating stock market crash in the history of United States. The Crash signaled the beginning of the 10 year Great Depression that affected all Western industrialized countries.
The growth of the large firm in the United States and the emerging consumer markets created a stock market bubble fuelled by easy credit in the 1920s. (Speculation thus fueled further rises and created an economic bubble) FED made a regulation that allowed ordinary people to buy stocks with 90% of the money borrowed however FED announced that the money supply should be contracted because of worries for inflation, and as a consequence the banks the lent money for stocks requested the money to be paid back and the commercial banks began calling in their loans causing panic selling of shares which lead to the Wall Street Crash.
And also Germany defaulting on reparation payment (WW1) to France, Britain and the US meant it broke the chain of international payments causing tension in international trade.
Then the crash instigated 10 years of first economic decline, investment and consumer demands were very low. Huge number of firms went bust causing rise in unemployment.
Classical Economist such as Hayek believe that the economy should be left to regulate itself however Friedman argued that the central banks made things worse with dear credit.
Keynes suggests that state intervention and cheap money in order to stimulate the stagnating economy.
The Golden Age capitalism also know as postwar economic boom occurred mainly in western countries following the end of World War 2 in 1945 and it ended with the collapse of the Bretton Woods system.
Bretton Woods Negotiation for the West (Allies), plans to create financial system involving international corporation. 44 countries were all keen to avoid the competitive devaluation of the 1930’s and policy recommended by Keynes was “Beggar thy neighbour”. Bretton woods negotiation was a exchange rate regime rather than a political regime.
This was to encourage trade and international relations; they agreed an international money, international use for the dollar and central banks to be able to convert gold at $35 per ounce. So each member state currency was to be fixed against the US $, and was allowed to fluctuate by +or -1%. Therefore countries were expected to adopt conducive fiscal, monetary and industrial policies and capital controls.
It was not sterling due to the decline of the British Empire which meant lowering trust even though £ was the biggest currency used.
The encouragement of trade with fixed rates led to biggest ever rise in trade volumes!
And the system worked well in the 1950’s and early 1960’s with US supplying capital exports $. In the 1950’s there was a shortage of US $ affecting liquidity, but the Marshal plan helped to relieve lack of liquidity for global trade. Fixed exchange rates were well managed by US and stable level.
However in 1958 the central role of $ became a problem as international demand eventually forced US into a trade deficit (which undermine confidence in $) and restricted capital exports which lead to a dollar glut in 1960 causing inflation, so liquidity was big problem. Also adjustment problem which was the main problem to Bretton woods system led to the demise of the financial order.
Inflation differentials start to become a problem, in 1970 inflation increased due to oil, which then put market pressure on the exchange rate to change which meant the government founded hard to fix the US$ exchange rate causing the $ to go down. Also there was an increase in capital flows other than trade in 1960’s which also led to market pressure for adjustments.
Robert Triffin identified the difficulty of ensuring liquidity whilst maintaining confidence in the stable value of international reserve currency: if the US runs a trade deficit (1960’s) there will be liquidity but loss of confidence in $, If they run a surplus, a scarcity may mean a less efficient trading global economy. So if a country uses its currency as international money, they must make sure that the currency is stable in that economy and making sure the currency is stable outside that country. This liquidity problem add additional difficulties for US and other countries.
Vietnam war was one of factors causing the breakdown of BRetton Woods, as the war costs led to falling confidence in the $, meanwhile Yen and Deytschmark appreciated but the state were reluctant to revalue.
So the rising inflation levels and increases capital flows led to market pressure for adjustments. 1971 Nixon closing gold window and the fixed exchange rates went in 1973 since, with the rise of oil prices, the system was untenable. The dollar had struggled throughout most of the 1960’s within the established at Bretton Woods – this crisis marked the breakdown of the system.
An attempt to revive the fixed exchange rate failed leading to major currencies began to float against each other. After the Bretton Woods system ended in 1973, most countries currencies were floating: A country’s exchange rate where its currency is set by the market through supply and demand for that currency