ferent brands of money (see Exhibit 1-1). If the world has a single currency ortrade does not cross national borders, the forex disappears.
Money versus Forex
Settlement of international trade requires two elements: international mon-ey and
an “adjustment” mechanism to correct trade imbalances among n
a-tions. Experience shows that the first is less important and that the second hasbeen the source of much trouble. The evolution and the timeline of internation-al payment systems are reviewed below.
1.1. Gold Standard: 1870
Under Gold Standard, central banks issued paper money and held gold (or sil-ver or both) in reserve to back the paper money. The international paymentssystem was built on the following features.
Export and import of gold was freely allowed
Currencies were valued in gold at a fixed rate (“mint par rate”)
Convertibility of currency to gold at mint par rate was guaranteed bycentral banksThe mint par rates of a national currency determined its value against othercurrencies. For example, if mint par rates of US dollar and Indian rupee were$100 and Rs 4,000 per unit amount of gold, respectively, then dollar-rupee fo-rex price would be: Rs 4,000 / $ 100 = Rs 40 per $. The forex price would be
at this level, regardless of demand-supply for the currency. If it were not,there would be an opportunity for arbitrage profit by converting currencies intogold at mint par rates, and moving gold between the two countries. In practice,the arbitrage rate level would be slightly off the mint par rate because of trans-
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Analects Spring in a Small Town Arthashastra Mughal-e-Azam