International monetary regime is that whole set of internationally accepted rules, agreements
and the institutes that support the International trade, cross border investment and the capital
relocation between the countries. The main purpose of an International monetary regime is to
provide guidelines that governs the international payments, exchange rates and capital
movements. International monetary system can be considered as the operating system or the
base system of the International financial environment that determines how the things will
operate in financial environment. (Mikita, 2015)
Different countries use different currencies and for the trade to happen those currencies should
be converted. If there is no monetary system countries would have to use only balanced
bilateral trade. (Persson, 2010) And it could decrease the efficiency of the economy by
interfering the free trade. Countries try to keep a balanced trade balance by imposing tariffs
and duties and this may lead to a trade war. (ohannes Eugster, Florence Jaumotte, Margaux
MacDonald, Roberto Piazza, 2019) There we find the importance of international monetary
system. International trade organizations, such as World trade organization, which is a part of
international monetary system limits the excessive tariffs and duties that would harm the
overall efficiency of the economy thus international monetary system helps to maintain a good
trade competition that would be advantageous to the economy as a whole.
In addition to decreasing the overall efficiency of the economy, balanced trade could also
discourage the foreign investments. In a balanced trade, since the exports are equal to imports,
net exports becomes zero hence the foreign investment also becomes impossible. But
international monetary system regulates the cross country trade, limiting the possibility of
balanced trade and it makes the way for foreign investments (Johannes Eugster, Florance
Jaumotte, Margaux Macdonald, Roberto Piazza, 2019)
Throughout the history metals like gold and silver has been used for trade. According to the
book “money in Mesopotamia” by Marvin A. Pawel , the earliest use of metals as currency has
been reported in Mesopotamia and in Egypt in 3rd million century. The time period before
1870th is considered as bimetallism era, just like the name explains itself, during the bilateral
era the two metals; gold and silver has been used for trade. (Kusimba, 2017)
The International Gold Standard came in to force in 1875. During that period gold was
considered to be the only form of currency. The exchange rates of the countries were solely
determined by the gold content they had and there were no restrictions for importation and
the exportation of gold. By 1870, most of the countries has been using gold as the base of their
currency.
However after the World War I, the gold standard era ended. With the fall of gold standard
most of the countries banned the exportation of gold and also redeeming the exchange notes
for gold. During the interwar period of 1914 to 1944 countries followed sterilization policy
where the central banks of the countries govern the inflow and the outflow of the gold.
(Persson, 2010)
In 1944, the Bretton wood system was established and a new postwar International monetary
system was created. With the establishment of Bretton wood agreement each country
established a par value for their currencies against the US dollar and one ounce of gold was
valued to be 35 US dollars. However, the dollar based exchange system also ended up being
unsuccessful.
In 1973 euro and Japanese yen became free floating currencies. In 1976 IMF enacted “Flexible
exchange rate system” where the countries was advised to intervene in exchange markets to
protect them from economically harmful fluctuations in exchange rates. (Persson, 2010)
The impossible trinity or the Trilemma is a condition where an economy has to choose 1 from
the 3 main options of, setting a fixed exchange rate, allowing the free flow of capital or
following an independent monetary policy. Since achieving all three at once is impossible most
countries tend to choose the options of independent monetary policy and free flow of capital.
The attempt to combine these 3 policies can cause financial crisis. According to the historical
data, the Mexico peso crisis, 1997 Asian financial crisis and the Argentinian financial collapse in
2001 happened as a result violating of trilemma. (J.O.S, 2016)
In 1873, during the gold standard era Denmark and Sweden fixed a currency valuing against
gold and named it as krona. In 1975 Norway also joined this and altogether they made the
Scandinavian monetary union. Even after the collapse of Scandinavian monetary union in 1914,
the currency those 3 countries used; krona, remained unchanged.In 1994, Sweden joined
European Union and according to the rules of European Union a country that joins the union
has to adopt euro as the currency in that country. In regard to this Sweden held a referendum
and most of the citizens voted “no” for adopting euro as the official currency of Sweden. As a
consequence, Sweden did not adopt euro as their official currency. (Seth, 2017)
Similar to Sweden, Denmark also joined European Union in 1973 but at the referendum which
was held in 2000, the majority of Danish nationals voted not to adopt euro as their official
currency and the Maastritcht treaty of 1992 allowed Denmark to use Danish krona as its official
currency.
One of the main reasons for Denmark and Sweden to not to use euro was to maintain its
economic independence. Countries that use euro has to adapt to the monetary policies
imposed by the European central bank. Sweden and Denmark believed this would limit their
economic independence. This could be best explained through the simple example of financial
crisis in 2007-2008. During the financial crisis Countries that did not use Euro including
Denmark and Sweden suffered less in comparison to the countries that used euro and did not
have independence in making monetary policies. (Seth, 2017)
However, even though Denmark has opted out from using euro, the national bank of Denmark
kept using a monetary policy that keeps the Danish krona stable against euro. In other words,
Denmark has practiced a fixed exchange rate. In a fixed exchange rate policy the exchange rate
of the currency of one country is kept stable against the value of another currency. The reason
for Denmark to use a fixed exchange rate policy is to keep the inflation low that would lead low
and stable prices in the market.
In addition to the modern usage of fixed exchange rate in Denmark, an example from the
history for fixed exchange rate can be found under Bretton wood agreement where the
exchange rates of currencies was set against US dollar.
In contrary to Denmark, Sweden uses a free floating exchange rate policy, hence the rate of
Swedish krona against euro is not fixed. In a free floating exchange rate policy, the central bank
of the country does not attempt to control the exchange rate, it is solely determined by the
supply and the demand of the currencies. (Coppola)
Throughout the history, there has been examples for both advantages and disadvantages of
using a fixed exchange rate. A fixed exchange rate keeps the stability of the economy and also
makes the economy more attractive for investors. But it also prevents the ability to adjust the
over or undervalued currencies.