International European and Romanian Monetary System Outline q

International, European and Romanian Monetary System Outline q International Monetary System q European Monetary System q Romanian Monetary System

Emerge of International Monetary System Until 1944, the monetary relations among countries were realized on a bilateral basis. Nevertheless: Ø in late 18 th century – a few monetary unions (e. g. Latin Monetary Union and Scandinavian Monetary Union) to remove the shortcomings of bimetallism or silver standard; Ø between the two World Wars – few monetary zones (e. g. dollar’s zone, franc’s zone, pound’s zone). But these arrangements did not lead to the international regulation of monetary relations, which were supposed to solve three important issues: ü to ensure the stability of the exchange rates among domestic currencies; ü to ensure sufficient monetary reserves and liquidities; ü to adopt some mechanisms for adjusting the balance of payments in the case of a high deficit of surplus.

Latin Monetary Union It was formed in 1865 between France and the closely linked economies of Belgium, Italy and Switzerland. Greece joined in 1868. It was a bimetallic union. All of them used the franc as currency: Ø Each member country would have identical coinage made from gold and silver. While the names of the individual currencies were kept, the weights were identical, so 5 French francs were worth exactly the same as 5 Italian lire and could be used throughout the Union like national currency. Each country could mint as many coins as it wanted, there being no risk of inflation due to the intrinsic worth of the metal. World War I ended with neutral Switzerland in a far better economic position than other countries in the union, further weakening the basis of agreement. The agreement ended with the reorganization of depreciated currencies after 1925.

Scandinavian Monetary Union It was formed by Sweden and Denmark in 1873 by fixing their currencies against gold at par to each other. Norway entered in 1875 by pegging its currency to gold at the same level as Denmark and Sweden. The monetary union was one of the few tangible results of the Scandinavian political movement of the 19 th century. The union provided fixed exchange rates and stability in monetary terms, but the member countries continued to issue their own separate currencies. This was the most stable of all the unions, benefiting from economic and political stability and common policy objectives. The suspension of the gold standard at the outbreak of the First World War led to volatility in real exchange rates and provided the trigger for the gradual collapse of the Union in 1920.

International Monetary System of Bretton Woods (I) IMS was created in 1944 at the Monetary and Financial Conference of Bretton Woods, being a gold exchange standard system. These principles of IMS were introduced in the statute of the International Monetary Fund (IMF), a new permanent institution established to promote consultations on international monetary problems and to lend funds to its members in need due to recurring balance of payments deficits. International Bank for Reconstruction and Development (World Bank): Ø to collect financial resources from developed countries and provide lowinterest loans, interest-free credit, and grants to developing countries. World Bank was completed with the other three institutions: Ø International Finance Corporation (1956) Ø International Development Association (1960) World Bank Group Ø Multilateral Investment Guarantee Agency (1961)

The principles of IMS of Bretton Woods (I) Monetary standard: ü This role was fulfilled by the US dollar and gold. ü US dollar became the international reserve and payment currency. Exchange rates stability: ü Each fund member would establish, with the approval of IMF, a par value for its currency in gold or dollar and would maintain its exchange rate against other currencies within +/-1% (since 1971 within +/-2. 25%) ü US was the only country which was not expected to intervene on foreign exchange markets. ü Other countries would intervene by buying or selling dollars against its own currency to keep their rates within the +/-1% of their parities with the dollar. ü Members would change their par values only with the approval of IMF, which would be granted only if there was evidence that the country was suffering from a fundamental disequilibrium in its balance of payments.

The principles of IMS of Bretton Woods (II) Currencies’ convertibility : ü US dollar remained the single currency convertible in gold, since US authorities agreed to exchange gold for its own currency with other CBs, upon demand, at the fixed price of $35/ounce. ü For the other currencies there was an official convertibility (between CBs) and a market convertibility (for the public); these currencies could be indirectly converted in gold through the US dollar. Monetary reserves: ü Special Drawing Right (SDR) was created in 1970 as a basket currency, in order to ensure international liquidity. ü Each country had to hold sufficient reserve assets to intervene on the market in order to support its exchange rate; besides gold, these were made of, especially, US dollars. ü Member countries also maintained funds in the form of SDRs, on deposit with the IMF, proportionally with their contribution to the Fund.

The principles of IMS of Bretton Woods (III) Equilibrium of balance of payment: ü Each member would have to be concerned with the assurance of the equilibrium of its balance of payments. Doing that: § Members would change their par values only with the approval of IMF, and only in the case of a fundamental disequilibrium in its balance of payments. § Members could also borrow funds from IMF in order to solve recurring balance of payments deficits. ü Because the US dollar played the role of reserve currency, US balance of payments deficits were necessary in order to increase international liquidity. ü The US financed its balance of payments deficits through the issuing of its own currency: § This practice supported the assurance of the international liquidity and, thus, favored the increase in the role of the US dollar as the reserve currency. § International liquidity depended on the evolution of the US’s balance of payments.

The breakdown of the Bretton Woods system Due to the increasing role of dollar as the reserve currency, US liabilities to foreign CBs grew. Confidence in the convertibility of dollars into gold wavered as US gold reserves were becoming a decreasing fraction of foreign liabilities. This method of providing international liquidity could continue only as long as no foreign CB attempted a run on the US gold reserves. This led to the introduction of a new international reserve asset administrated by the IMF (SDRs) and the usage of other currencies as reserve assets (British pound, Japanese yen, German mark, or France franc). In 1971, the U. S. decided to suspend the dollar's convertibility into gold and let the dollar float against other currencies. In 1972, the Bretton Woods system of pegged exchange rates broke down forever and was replaced by the system of managed floating exchange rates that we have today.

The new principles of IMS Monetary standard: purchasing power Exchange rates system: ü It is a floating exchange rates system: a nation manages the value of its currency by buying or selling it on the foreign exchange market. ü If a nation’s CB buys its currency, the supply of that currency decreases and the supply of other currencies increases relative to it. This increases the value of its currency. ü If a nation’s CB sells its currency, the supply of that currency on the market increases, and the supply of other currencies decreases relative to it. This decreases the value of its currency. Reserve currency : many currencies, besides the US dollar, play the role of reserve currency, such as British pound, Japanese yen, and Euro. Currency convertibility : today there is only convertibility in other currencies. Equilibrium of balance of payment: the increase of the role played by IMF in providing financial assistance to members in order to offset their deficits.

Emergence of European Monetary System 1957 – Treaty of Rome – creation of European Economic Community (EEC): Ø it brings together France, Germany, Italy and the Benelux (Belgium, Netherlands and Luxemburg) countries in a community; Ø aiming to achieve integration via trade with a view to economic expansion. Ø 1992 – Treaty of Maastricht – EEC became the European Union (EU): § aiming to expand the Community’s powers to non-economic domains. Ø the objective of EEC was the creation of a general common market, by removing the obstacle of free circulation of goods and services, capital and people among them. 1970 – Werner Plan (Werner Report): Ø proposed to prepare a plan for implementing an economic and monetary union in Europe, after 1980, through the assurance of currencies convertibility, reduction of exchange rate fluctuations towards fixed parities and liberalization of capital flows.

European snake in the tunnel On 24 April 1972 – the EEC countries agreed to maintain stable exchange rates by preventing exchange fluctuations of more than 2. 25%. This mechanism was called “European snake in the tunnel” because: Ø the community currencies floated as a group (like a snake) within narrow limits against the dollar (the tunnel); Ø CBs could buy and sell European currencies, provided that they remained within the fluctuation margins. Exchange rates between the currencies of the Member States had to be fixed before a common market could be created. The Ireland, UK, Denmark and Norway joined the snake on 1 May 1972. “Snake” mechanism's failure in 1978, because of: the first oil crisis (1973); several “speculative attacks” on currencies; week countries’ compliance and frequent Member States departures from the arrangement.

European Monetary System (EMS) 1979 – EEC established EMS and created the European Currency Unit (ECU), a basket currency (a weighted average of the participating currencies). Characteristics of EMS: ü Adoption of Exchange Rate Mechanism I (ERM I): each currency had a central rates expressed in ECUs, and currency fluctuations had to be maintained within a margin of +/-2. 25% on either side of the bilateral rates, calculated on the basis of these central rates (exception: the Italian lira, the Spanish peseta, the Portuguese escudo and the pound sterling, which were allowed to fluctuate by ± 6%). ü When exchange rate between two countries’ currencies moved outside these limits, the CBs of both countries were supposed to intervene in the foreign exchange market. ü Allocation of ECUs by the European Monetary Cooperation Fund to members’ CBs in exchange for gold and dollar deposits. ü ECU was an artificial currency used in all settlements of intrasystem balance of payments. ECU was replaced by euro (at 1: 1) on January 1, 1999.

Economic and Monetary Union (I) 1987 –Single European Act (SEA) – to establish a single market by 1992. 1988 – European Council confirmed the objective of the progressive realization of Economic and Monetary Union (EMU): Ø It mandated a committee chaired by Jacques Delors to study and propose concrete stages leading to this union. Ø The resulting Delors Report (1989) proposed that EMU should be achieved in three discrete but evolutionary steps: Stage One of EMU (1 July 1990 – 31 December 1993): ü The Maastricht Treaty was signed in 1992. § On this date, in principle, all restrictions on the capital movements between Member States were abolished. ü The Committee of Governors of the CBs of the EEC Member States, created in 1964, was given additional responsibilities: § promoting the coordination of the monetary policies of the Member States, with the aim of achieving price stability.

Economic and Monetary Union (II) Stage Two of EMU (1 January 1994 – 31 December 1998): ü On 1 January 1994 – the establishment of the European Monetary Institute (EMI) – with this date the Committee of Governors ceased to exist: ü The EMI had no responsibility for the conduct of monetary policy in the EU nor had it any competence for carrying out foreign exchange intervention. ü Tasks of the EMI: q to strengthen CB cooperation and monetary policy co-ordination; q to make the preparations required for the establishment of the European System of Central Banks (ESCB), for the conduct of the single monetary policy and for the creation of a single currency in the third stage; q to carrying out preparatory work on the future monetary and exchange rate relationships between the euro area and other EU countries – the new exchange rate mechanism (ERM II). ü On December 1995 the European Council agreed to the name of “Euro”. ü The European Council adopted the Stability and Growth Pact in June 1997, which aimed to ensure budgetary discipline of EMU.

Economic and Monetary Union (III) Stage Three of EMU, starting in 1999: ü On 1 January 1999 the third and final stage of EMU began with: q the introduction of Euro: Ø for the first three years it was a scriptural money, only used for accounting purposes; Ø Euro cash (coins and banknotes) was introduced on January 2002, when it replaced, at fix conversion rates, the national currencies; q the implementation of a single monetary policy under the responsibility of the ECB. ü On 1999, ERM II replaced the original ERM I: q the currencies are allowed to float within a range of ± 15% with respect to a central rate against the euro. In 1998 the Council of the EU decided that 11 Member States had fulfilled the conditions necessary for the participation in the third stage of EMU and the adoption of the Euro on 1 January 1999.

Euro area On 1 January 1999, 11 countries adopted euro: Belgium, Germany, Spain, France, Ireland, Italy, Luxembourg, the Netherlands, Austria, Portugal and Finland. On 1 January 2001 Greece entered the third stage of EMU as it fulfilled convergence criteria. Since then, on the basis of convergence criteria fulfillment, other countries have also adopted euro: Slovenia (2007), Cyprus and Malta (2008), Slovakia (2009), Estonia (2011), Latvia (2014), Lithuania (2015). Today, the euro area numbers 19 EU Member States. There are some countries that use euro, but they do not formally belong to the euro zone and do not have representation in the ECB: Ø Andorra, Monaco, San Marino, and the Vatican City also use the euro, on the basis of a formal agreement with the EU. Ø Kosovo and Montenegro as well use the euro, but without formal agreements. .

Convergence criteria for the adoption of the euro The Maastricht Treaty specified that for adopting the euro a EU member state would have to meet just criteria for nominal convergence. Ø The Maastricht Treaty does not make reference to the real convergence criteria to ensure a high degree of similarity among the economic structures of the EU member states, given the fact that before the early 90 s the EU comprised only countries with relative similar economic systems. Ø Real convergence became an important issue only when the accession of the Central and Eastern European countries was considered. Real convergence is as important as nominal convergence, as, according to the Optimal Currency Area Theory: Ø the states in a group cannot mutually gain from a common currency unless their economic structures are similar and when there is no risk of asymmetric shocks to affect only some of these countries. The convergence criteria are meant to ensure that economic development within EMU is balanced and does not give rise to any tensions between the Member States.

Nominal convergence criteria Inflation rate criterion: Ø the inflation rate, measured by Harmonized Index of Consumer Prices, should be no more than 1. 5% higher than the average inflation rate of the three bestperforming EU members in terms of price stability; Long-term interest rate criterion: Ø long term interest rate should not exceed more than 2% the average rate of the three best-performing EU countries in terms of price stability; Budgetary deficit criterion: Ø budgetary deficit should not exceed 3% of GDP; Government debt criterion: Ø government debt should not exceed 60% of GDP; Exchange rate criterion: Ø exchange rate should remain within the normal fluctuation margins (+/-15%) of the ERM II without severe tensions for at least two years.

Real convergence criteria The criterion for real convergence refers to: ü Degree of economic openness – is expressed by the proportion of a country’s exports and imports in the GDP. ü Proportion of bilateral trade with the EU member states in the whole volume of international trade. ü Economic structure - is expressed in the contribution of the principal sectors (agriculture, industry and services) to the creation of GDP. ü Level of GDP/capita is the most synthetic criterion of real convergence and can be evaluated either at the nominal value or through the parity of the purchasing power. European integration requires the simultaneous achievement of both nominal convergence (the Maastricht criteria) and real convergence (improvement of living standards, sustainable economic growth, decrease in the discrepancy among EU countries). After the states become EU members, they will participate in ERM II, and then, after they fulfill the nominal convergence criteria, they can adopt the euro.

ECB, ESCB and the Eurosystem (I) European Central Bank ü Since 1 January 1999 the European Central Bank (ECB) has been responsible for conducting monetary policy for the euro area – the world’s largest economy after the United States. ü The euro area came into being when responsibility for monetary policy was transferred from the national central banks of EU Member States, adopters of Euro, to the ECB. ü The ECB was established as the core of the Eurosystem and the European System of Central Banks (ESCB). ü The ECB has legal personality under public international law. European System of Central Banks ü The European System of Central Banks (ESCB) comprises: Ø the ECB Ø and the national central banks (NCBs) of all EU Member States whether they have adopted the euro or not.

ECB, ESCB and the Eurosystem (II) Eurosystem ü comprises: Ø the ECB Ø the NCBs of those countries that have adopted the euro. ü On the day each country joined the euro area, its CB automatically became part of the Eurosystem. ü The Eurosystem has as primary objective the maintenance of price stability for the common good. ü Acting also as a leading financial authority, it aims to safeguard financial stability and promote European financial integration. ü The Eurosystem and the ESCB will co-exist as long as there are EU Member States outside the euro area. Euro area ü consists of the EU countries that have adopted the euro.

Romanian Monetary System (I) First Romanian Monetary System was established in 1867 (10 years after the establishment of the first bank – National Bank of Moldavia), as a bimetallism system. The monetary unit – leu – was defined by 0. 290 grams of gold and 4. 175 grams of silver, the exchange rate of gold to silver being fixed at 1: 14. 38. In 1877 there the first paper money was issued under the form of mortgage notes by the Finance Ministry in order to finance some state expenditure. In 1880 the National Bank of Romania was founded as a mixed-capital company, with 1/3 state capital and 2/3 private capital. Its profile was similar to that of the issuing banks in Europe. NBR functioned as the single issuing bank and the central commercial bank. The first banknotes put in circulation were the mortgage notes issued by the Finance Ministry, turned into banknotes by the application of the central bank stamp. In 1890 the gold standard was adopted, our currency being defined by 0. 290 grams of gold. In 1901 the state withdrew its participation in the NBR’s capital.

Romanian Monetary System (II) The period between the 1901 -1914 was characterized by the good functioning of gold standard and the development of banking system. Romanian’s economy and financial situation was affected during the First World War, although our country was neutral at the beginning of the war. The increased issuance of money by NBR in order to finance the war expenditure, which were guaranteed by Treasury securities, and the issuance of the “war lei” by the German occupants, which were guaranteed by a German state’s deposit with the Reich Bank in Berlin, generated the first serious inflation in the history of our national currency. This resulted in the collapse of the gold standard and the suspension of the convertibility in gold in 1917. Because after the war and the Great Union in 1918 many types of currencies circulated in Romania, a Monetary Unification was imperative. Monetary Unification was realized in 1920 -1921 through two steps: ü announcement of the amounts held in foreign currencies ü exchange of the amounts held in foreign currencies in NBR’s notes.

Romanian Monetary System (II) To reduce the inflation after the First War a monetary reform was implemented in 1925 that consisted in the revalorization through deflation, but this attempt failed. On this occasion, the Romanian state subscribed again to the NBR’s capital. Due to the continuous depreciation of the leu, in 1929 another monetary reform took place based on Monetary stabilization. Its main features were: ü Our currency was devalorized, being defined by 0. 009 grams of gold. ü It confirmed for the very first time the withdrawal of the gold and silver coins from circulation. ü It introduced currency’s convertibility in gold with two restrictions: convertibility was possible only in the NBR’s head office in Bucharest, and the amount accepted for convertibility could not be less than 100, 000 lei. Monetary stabilization was affected by the effects of world crisis of 1929 -1933. As a result, convertibility in gold was suspended in 1932.

Romanian Monetary System (III) Although between 1934 -1941 Romanian economy was subordinated to Germany, it reached a high growth level, being supported by the banking system and NBR in particular. This period was characterized by the concentration of banking capital, the 5 biggest banks accounting for 80% of banking activity. The alliance between Romania and Germany in the Second World War allowed the Germans to have the NBR issue money at their disposal in order to finance Germany’s “military mission” in Romania and its war expenditures. This led again to a high inflation. After the war, a solution for the reduction of inflation was the association of the “Loan for National Recovery” with the issuance of commemorative gold coins, which was applied in December 1944 – January 1945. Without this association, no one would have subscribed to the loan, given the considerable depreciation of leu. The persons who subscribed 50, 000 to this loan were the only ones allowed to purchase a gold coin of 15, 000. This solution did not have the expected result. In 1947 the consumer prices were 8, 000 times higher than in 1938. NBR issued banknotes of 5 million lei, but it did not put it in circulation.

Romanian Monetary System (IV) Monetary reform in 1947 was characterized by: ü Devalorization of leu: 1 leu = 6. 6 milligrams of gold; ü The “new lei” were introduced in the form of banknotes and metallic coins of BNR and Treasury bills of Finance Ministry. ü The exchange rate of “old lei” to “new lei” was at 20. 000 to 1, but the amounts were limited depending on the occupation of physical and legal persons. In 1946 NBR was nationalized and thus became a state-owned bank. In 1848, the nationalization of all private companies took place, including banking companies. The majority of the banks were dissolved, and later four specialized banks were established: Agricultural Bank, Romanian Bank for Investments, Romanian Bank for Foreign Trade and Savings Bank. All of them belonged to the state and supported the activity in the respective domains. NBR began to plan and supervise the lending activity and monetary circulation.

Romanian Monetary System (V) Transition to socialist economy was marked by two monetary actions: ü The Monetary Reform in 1952 characterized by: q Revalorization of leu: 1 leu = 79. 346 milligrams of gold, which was in discrepancy with its purchasing power. q Introduction of three new categories of money: banknotes and metallic coins of BNR and Treasury bills of Finance Ministry. q Unlimited exchange of “old lei” to “new lei”, with smaller amounts benefiting from favorable conditions of exchange. ü The increase in the gold content of leu in 1954 at 148. 112 milligrams of gold. This was the last definition in gold of our currency. In 1965 NBR was transformed into the National Bank of the Socialist Republic of Romania. Since 1966 there have been only banknotes and metallic coins of BNR in circulation. On 1 July 2005 the denomination of Leu was applied (1 RON = 10, 000 old lei).