Wednesday, 23 November 2011

Write a note on mechanism free gold standard and special drawing rights

When gold is allowed to move freely from one country to another country, it is called free gold standard. There is no room for Govt. or private authority over the media of exchange. The exchange rates are determined among the gold standard countries close to the gold parties. The gold moves inside the country according to its import and export condition. As the imports one country increases, its out flow of gold will also increase on other side if exports exceeds then the imports the inflow of gold will increases. When two gold standard countries are on full gold standard and their merchants are doing a free trade then mechanism takes place which restores the equilibrium in their balance of payment.
As the exports of one country will exceed than imports, we will say that its balance of payment is favorable. Due to this there will be inflow of gold. So total quantity of money in circulation will expand. Incomes and prices will rise. When prices of goods will increase, the demand for goods from other country will fall. So exports will be reduced. On other side imports will increase and there will be rise in the out flow of gold. The balance of payment will be in equilibrium position.
There is an opposite effect on the other country. As one country balance of payment is favorable it has a negative effect on the balance of payment of other country. There will be an outflow of gold. Supply of money, prices, incomes will fall. Again exports will increase, imports will fall and balance of payment will become favorable. So there is an automatic system which brings an equilibrium in the balance of payment of both the countries.
Following conditions are necessary for the success of this system.

1. Free trade between the two countries.

2. Economic structure of both the countries should be very elastic.

3. There should be contraction of credit when there is out flow of gold.

4. There should be expansion when there is inflow of gold.

It is a new type of international money. In 1967 International Monetary Fund (IMF) created this scheme. It was introduced to solve the problem of international liquidity. Anew reserve asset of gold was established by the IMF in addition to the traditional asset. This money is allocated to the member countries according to their quotas.

1. These are issued by IMF.

2. IMF creates the SDR's as the central bank issues its currency.

3. These are paper substitute for gold.

4. These are used only to settle the international payments.

5. These are allocated to the member countries according to their quotas.

6. Every member can use 70% of its quota during the five years. While 30% is a reserve quota which can be used in case of emergency.

7. IMF pays interest if any country holds excess than its quota.

8. IMF charges interest if any country holds less than its quota.

9. IMF can create new SDR's according the requirements.

10. The SDR's are transferable assets.

11. A country can use it to meet the deficit in the balance of payment.


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