INTRODUCTION TO VALUE ADDED TAX VAT

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REFORM Project, USAID/India
Workshop on Macroeconomic Analysis and Policy
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Globalization International Monetary
SystemPresentation byDr. Pawan K
AggarwalDeputy Chief of Party and Senior Advisor
(Tax Policy)REFORM Project, USAID IndiaNew
DelhiWorkshop on Macroeconomic Analysis and
Policy Mo1-PKA-Jha-Globalization1
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Coverage

• Role of international monetary system
• Gold and sterling standards (1821-1918)
• The collapse of the gold standard (1918-1944)
• Bretton Woods System A Dollar-based gold
  standard (1945-1970)
• International Monetary Fund (IMF)
• World Bank (WB)

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Coverage

• The end of Bretton Woods System (1960-1971)
• Special drawing rights (SDRs) 1967
• US President Richard Nixons announcement (15
  August 1971)
• Smithsonian Consensus (December 1971)

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Coverage

• Developments since 1971
• Floating of currencies allowed (1972/1973)
• Emergence of flexible or floating exchange rate
  system (since 1973)
• Jamaica Agreement on exchange rates (January
  1976)
• Emergence of European Monetary System (1979) and
  single currency (the Euro) in 1999
• Concluding remarks

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Role of international monetary system

• It establishes rules by which countries value and
  exchange their currencies
• Further, it provides a mechanism for correcting
  imbalances between a countrys international
  payments and receipts
• IMS is necessary because
• Most countries have their own currencies, and
• A means of exchanging these currencies is needed
  if business is to be conducted across national
  boundaries

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Gold and sterling standards (1821-1918)

• Ancient reliance on gold coins as an
  international medium of exchange
• Silver, for example, was used in trade among
  India, Babylon, and Phoenicia as early as the
  seventh century B. C.
• In the 16th and 17th centuries, coins of modern
  national-states of Europe were traded on the
  basis of their relative gold and silver content

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Gold and sterling standards (1821-1918)

• Adoption of an international monetary system
  known as the gold standard
• Countries buy or sell their paper currencies in
  exchange for gold
• First country to adopt it U K (1821)
• Most other important trading countries joined in
  19th century
• Including Austria, France, Germany, Russia and
  USA

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Gold and sterling standards (1821-1918)

• Adoption of an international monetary system
  known as the gold standard
• Each country tied or pegged the value of its
  currency to gold
• For example, the countries pledged to buy or sell
  an ounce of gold for
• 4.247 Pounds (UK)
• 20.67 (USA)
• This implied a fixed exchange rate between the
  Pound and the Dollar as 14.867

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Gold and sterling standards (1821-1918)

• It created a fixed exchange rate system
• An exchange rate is the price of one currency in
  terms of another
• Fixed exchange rate system means that the price
  of a given currency does not change relative to
  another

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Gold and sterling standards (1821-1918)

• Dominating role of UK
• From 1821 until the end of World War I in 1918
• The most important currency in international
  commerce was the British Pound Sterling
• Most firms worldwide were willing to accept
  either gold or Pounds in settlement of
  transactions
• As a result, IMS during this period is often
  called a Sterling-based Gold Standard

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Gold and sterling standards (1821-1918)

• Dominating role of UK
• Because of the international trust in British
  currency,
• London became a dominant international financial
  center in the nineteenth century
• A position it still hold

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The collapse of the gold standard (1918-1944)

• During World War I, the sterling-based gold
  standard unraveled
• The economic pressure of war caused country after
  country to suspend their pledges to buy or sell
  their currencies at par value

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The collapse of the gold standard (1918-1944)

• Re-adoption of gold standard in 1920
• Conferences at Brussels (1920) and Genoa (1922)
  resulted in agreements among major economic
  powers to return to pre-war gold standard
• Most countries re-adopted gold standard in 1920
  despite the high levels of inflation,
  unemployment, and political instability
• But this was short lived
• On 21 Sept. 1931, The Bank of England allowed the
  Pound to float

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The collapse of the gold standard (1918-1944)

• Emergence of sterling area after UK abandoned the
  gold standard
• Members of British Commonwealth pegged their
  currencies to the Pound
• Other countries tied their currencies to US or
  the French Franc
• This led to floating exchange rate regime

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The collapse of the gold standard (1918-1944)

• Further, many countries engaged in a series of
  competitive devaluations of their currencies to
  stimulate their exports and check imports
• Any such gains were offset as other counties
  devalued their currencies
• Most countries raised the tariffs on imports to
  protect domestic jobs
• With adoption of these beggar-thy-neighbor
  policies, international trade contracted
• This economic conflict was soon replaced by
  international military conflict
• The outbreak of World War II in 1939

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Bretton Woods System A Dollar-based gold
standard (1945-1970)

• In 1944, the representatives of 44 countries met
  in Bretton Woods to create a postwar economic
  environment that would promote worldwide peace.
  They agreed to
• Renew the gold standard on a greatly modified
  basis
• Create two new international organizations to
  assist in rebuilding the world economy and
  international monetary system
• World Bank WB (official name The International
  Bank for Reconstruction and Development)
• International Monetary Fund (IMF)

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Bretton Woods System A Dollar-based gold
standard (1945-1970)

• WB focused on providing loans for productive
  purposes, and
• IMF focused on IMS, with its objectives as
• To promote international monetary cooperation
• To facilitate expansion and balanced growth of
  international trade
• To promote exchange stability
• To maintain orderly exchange arrangements among
  members

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Bretton Woods System A Dollar-based gold
standard (1945-1970)

• IMF objectives (Contd.)
• To avoid competitive exchange depreciation
• To assist in the establishment of a multilateral
  system of payments
• To build confidence to members
• By making resources of the IMF temporarily
  available to them and to correct maladjustments
  in their balances of payments
• To shorten the duration and lessen the degree of
  disequilibrium in the international balances of
  payments of its members

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Bretton Woods System A Dollar-based gold
standard (1945-1970)

• WB and IMF provided the institutional framework
  for IMS, in the post World War II scenario
• All countries agreed to peg the value of their
  currencies to gold
• US established it at 35 per ounce of gold
• However, only the US pledged to redeem its
  currency for gold at the request of a foreign
  central bank
• Thus, the US Dollar became the keystone of the
  Bretton Woods System

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Bretton Woods System A Dollar-based gold
standard (1945-1970)

• The Bretton Woods Agreement resulted in a fixed
  exchange rate system
• Each country established a par value for its
  currency
• Each country to maintain the value of its
  currency within 1 of its par value
• A country was obligated to intervene in the
  foreign-exchange market to maintain the range of
  1
• Under extraordinary circumstances a country could
  adjust its par value (implying adjustable peg
  system)
• Thus, the Bretton Woods System generally provided
  an assurance that the value of each currency
  would remain stable

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Bretton Woods System A Dollar-based gold
standard (1945-1970)

• Operations An illustration
• US Dollar at 35 for an ounce of gold
• British Pound at 2.80
• Bank of England was obligated to keep the Pounds
  value between 2.772 and 2.828 (1 of 2.80)
• In case the value of Pound falls below 2.772,
  the Bank would be required to sell some of its
  gold or US Dollars holdings to buy Pounds such
  that the value of Pound returns to the specified
  range

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The end of Bretton Woods System (1960-1971)

• Bretton Woods System worked well as long as
  pessimism about a countrys economy was temporary
  and people had faith in the Banks ability to
  owner the par value of currencies
• Special Drawing Rights (SDRs)
• In 1967, IMF members agreed to create SDRs to
  improve liquidity in the IMS
• SDRs could be used to settle official
  transactions at the IMF
• Thus SDRs could be called paper gold

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The end of Bretton Woods System (1960-1971)

• In Nov. 1967, The Bank could not counter flood of
  Pounds dumped by speculators and was forced to
  devalue Pound by 14.3
• In 1969, France had to devalue Franc
• In 1970, Dollar came under attack
• During the first 7 months of 1971, US was forced
  to sell 1/3rd of its gold reserves to maintain
  Dollars value

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The end of Bretton Woods System (1960-1971)

• In a dramatic address on 15 August 1971,
  President Richard M Nixon announced that the US
  would no longer redeem gold at 35 per ounce
• After Nixons speech most currencies began to
  float
• This brought an end to the Bretton Woods System
  of fixed exchange rate

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Smithsonian Consensus (December 1971)

• At the Smithsonian Conference held in Washington
  D.C., Central Bank representatives from the Group
  of Ten (see Table 1) agreed to restore the fixed
  exchange rate system with
• The US Dollar devalued to 38 per ounce of gold,
  but remained inconvertible into gold
• The par values of strong currencies like Yen were
  revalued upward
• Currencies were allowed to fluctuate around their
  par values by 2.25 , as against 1 under
  Bretton Woods System

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Developments since 1971

• Floating of currencies allowed (1972/73)
• Free market forces disputed the new set of par
  values established by Smithsonian Consensus
• Speculators believed that and were overvalued
• They sold both, and hoarded Swiss Franc and the
  German Mark

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Developments since 1971

• Floating of currencies allowed (1972/73)
• The Bank was unable to maintain the Pounds value
  within 2.25 band
• Finally, in June 1972 it had to allow the Pound
  to float downward
• The US devalued by 10 in February 1973
• By March 1973, the Central Banks conceded
  flexible exchange rate system

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Developments since 1971

• Flexible or floating exchange rate system (Since
  1973)
• Exchange rates among many currencies are
  established primarily by the interaction of
  supply and demand
• The qualifier primarily is used because Central
  banks some times try to affect exchange rates by
  buying or selling currencies on the
  foreign-exchange market
• Thus these arrangements are often called
• A managed float or
• A dirty float
• Because exchange rates are not determined purely
  by private sector market

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Developments since 1971

• Jamaica Agreement on exchange rates (January
  1976)
• An international conference held in Jamaica in
  January 1976, legitimatized the new flexible
  exchange rate system. As per the agreement
• Each country was free to adopt whatever exchange
  rate system best met its own requirements
• The US adopted a floating exchange rate
• Other countries adopted a fixed exchange rate by
  pegging their currencies to the Dollar or some
  other currency

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Developments since 1971

• Emergence of European Monetary System (1979) and
  single currency (the Euro) in 1999
• EU members believed that flexible exchange rates
  would hinder their ability to create an
  integrated European economy
• Therefore, in 1979, EU members created the
  European Monetary System (EMS) to manage currency
  relationships among themselves

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Developments since 1971

• Emergence of European Monetary System (Contd.)
• EMS contemplated
• Fixed exchange rates among EU member currencies
  within a range of 2.25 of par value
• Floating rate against the US and other
  currencies
• This facilitated creation of EUs single currency,
  the Euro, in 1999

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Concluding remarks

• The current IMS is an amalgam of fixed and
  flexible exchange rates
• Most members of the EU have adopted a common
  currency (the Euro)
• Most other countries have voluntarily adopted a
  fixed exchange rate against the US, the Euro, or
  some other currency
• Some countries have allowed their currencies to
  float, such as Canada, Japan, the UK, and the US

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Thank YouPawan K. Aggarwal