The Convertible Currency System With the fall of gold as a means of payment and as a unit of account (but not yet as a store of value) in international commerce, and with the failure of any international bureaucracy to provide a generally acceptable fiat money, the world monetary system is not easy to understand. At least conceptually, the pre-1914 gold standard was simple: the domestic and international means of payment were the same.

But in the modern world, a curious melange of national currencies determines the efficiency of multilateral trade in goods and services on an enormous and increasingly global scale. Transfers of capital from one country to another hinge on financial markets whose efficiency is also dependent on the international qualities of national money(ies). Understanding how individuals, firms, banks, and governments so utilize national currencies in foreign trade is necessary to avoid unwise policies that would provoke instability and conflict.

Insofar as its national currency is externally "convertible"-a term continually metamorphosing and for which a precise working definition is provided below-each country contributes to the availability of international forex money. A convertible currency can be held and used by foreigners, even those from countries whose own currencies are inconvertible. In this important respect, therefore, the provision of a convertible currency is an international "public good"; reciprocal access to convertible foreign currencies can, in turn, benefit domestic nationals.
 
Unlike most public goods, however, providing an attractive convertible currency to the rest of the world need not be costly for the donor country except, perhaps, in the case of centrally planned "command" economies. This is demonstrated in Chapter 3. In general, neither communist states in Eastern Europe or Asia, nor most less developed countries in Asia, Africa, and Latin America, have convertible currencies with international qualities, although they themselves benefit from the presence of international money. Here our conceptual search for international money is confined to the 40 or so countries, including the major Western industrial economies, providing currencies that the International Monetary Fund (IMF) currently deems convertible-what I shall call the convertible currency system.For organizational convenience, the nature of the demand for international money is differentiated quite sharply according to the viewpoint and utility of the principal economic agents in the foreign exchanges: nonblank firms and individuals;commercial banks; and national governments, normally represented by their central banks.

Under carefully specified conditions, firms and households need hold only domestic money for international transactions; whereas the peculiar role of commercial banks requires a broad portfolio of foreign monies, while central banks typically hold a much narrower portfolio of foreign exchange. But this remains to be demonstrated in the course of outlining the necessary "rules of the game" for clearing international payments and setting foreign exchange rates within the convertible currency system.

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