Functions of the International Monetary System

Why an International Monetary System is Necessary

The necessity of an international monetary system is driven mainly by three core problems:

a) The Problem of the Exchange Rate

When economic transactions result in international payments, the currency of that country must be exchanged. Exporters tend to demand that they are paid for their products in the currency of their own country. All this leads to the problem of the exchange rate; specifically, the differences between operating in a system of fixed exchange rates versus a flexible exchange system.

When operating in a system of fixed exchange rates, the importer knows the exact price to pay when buying foreign currency. In a flexible exchange rate system, one must take into account the continuous fluctuations in the value of the currencies.

b) The Problem of Currency Liquidity

International transactions result from payments between residents of different countries. Any increase in international trade implies that the evolution of international money must grow. If international money grows at a slower pace than international trade, this will lead to a lack of liquidity, and eventually, trade will be deterred.

The liquidity problem is linked to the problem of convertibility. Any international currency that aspires to be part of international reserves should be convertible. This set of currencies indicates how international reserves constitute international liquidity.

c) The Imbalance of Payments

The problem of imbalance involves surpluses and deficits. The situation most damaging to a country is a deficit because it means that the country is borrowing internationally. That debt involves increasing debt service and puts pressure on its currency. All this leads to an imbalance problem that we must try to fix.

Causes and Objectives of the System

These three problems arise from three primary causes: the absence of a single global currency, the lack of a single monetary authority, and the fact that imbalances are inevitable, requiring adjustment and the financing of those imbalances.

The International Monetary System (IMS) should aim to solve these three problems of international concern:

• Regulate the creation of international money: It must manage liquidity to enable the harmonious growth of transactions while avoiding the appearance of global inflation tensions.
• Correct imbalances: An international monetary system must establish the methods by which we must correct financial imbalances.
• Establish financing mechanisms: Since the emergence of external imbalances is inevitable, the system must establish the financing mechanisms necessary to make the global economy stronger.