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IPE – Week 10
The Evolution of the International Monetary and Financial System
Lecture Plan
• Introduction• Earlier Globally Integrated Order• The Bretton Woods Order• The Globalization of Financial Markets• The Collapse of the Gold Exchange Standard• The Evolving International Monetary Regime
Introduction (1)
• Money and finance can serve economic, as well as, political purposes
Introduction (2)
• At the international level, the answers to the following have profound political implications– What money should be used to facilitate
international economic transactions?– How should such money be managed?– What should the nature of the relationship
between national currencies be?– How should credit be created and allocated at
the international level?
Earlier Globally Integrated Order (1)
• In late-19th and early-20th centuries– Cross-border flows of money surpassed those in
current era in significance for national economies– The international monetary regime was much
more integrated than in the current period• The gold standard was established• Various currency blocs/unions were created
Gold certificates were used as paper currency in the United States from 1882 to 1933. These certificates were freely convertible into gold coins.
• During the First World War– Cross-border financial flows diminished
dramatically– Many countries abandoned the gold standard
Earlier Globally Integrated Order (2)
Earlier Globally Integrated Order (3)
• After WWI, the UK and US attempted to restore the pre-1914 international order
• In the early-1930s– A major international financial crisis triggered the
collapse of international lending and the international gold standard
– International monetary and financial system broke up into series of closed currency blocs• International flows of capital were limited• There were government controls on cross-border financial
movements and currency exchange
Earlier Globally Integrated Order (4)
• What explains this change in the international monetary and financial regime?
• Hegemonic stability theory– Pre-1914 regime was stable as it was sustained by
British hegemonic leadership– After WWI, the UK lost its hegemonic position to the
US but the US was unwilling provide leadership– The leadership vacuum led to instability and
eventually the breakdown of the international financial order
Earlier Globally Integrated Order (5)
• Alternative argument– The changing distribution of power within many
states, and not between them, led to the transformation of the international monetary and financial system• Increasing democratization and the growing power of labour
meant that governments could no longer fully commit to maintaining the gold standard
• This led to– Governments not playing by the rules of the gold standard
regime– Short-term capital flows becoming more volatile and speculative
The Bretton Woods Order (1)
• The goal of rebuilding the international monetary and financial order post-WWII was an embedded liberal international economic order– An attempt at reconciling commitment to an open
multilateral world economy with the new domestically oriented priorities of addressing unemployment and social welfare
The Bretton Woods Order (2)
• Key elements of the Bretton Woods agreement (1944)– “Gold exchange” standard: currencies were
pegged in relation to the gold content of the US dollar• This was an adjustable peg system as governments
could change the peg value of their currencies
– Currencies were convertible for current account (trade payment) transactions
The Bretton Woods Order (3)
• Key elements of Bretton Woods (cont.)– Capital movements were controlled• Designed to control speculative and
“disequilibrating” private financial flows– International Monetary Fund (IMF) role:• Provide short-term loans to help countries finance
temporary balance of payments deficits• Manage international economic imbalances
through oversight of adjustable peg system, leverage use of its lending capacity, and use of scarce currency clause
The Bretton Woods Order (4)
• Key elements of Bretton Woods (cont.)– International Bank for Reconstruction and
Development (IBRD, a.k.a. World Bank)• Provide long-term loans for reconstruction and
development after the war
The Bretton Woods Order (5)
• Until about 1958, the Bretton Woods system was in “virtual cold storage”– IMF and IBRD played limited roles– Currencies of European countries were not
convertible until 1958– US government and regional institutions played
the roles that the IMF and IBRD should have• From 1958 to 1971, the IMF and IBRD became
more active lenders
Globalization of Financial Markets (1)
• Financial globalization began in the 1960s but accelerated after the early-1970s
• How do we explain this phenomenon?– Improvements and growth of technology– Growth of international trade and MNC activity– Recycling of “oil-money” after 1973– Volatility of currency environment, after the
breakdown of Bretton Woods, encouraged international diversification of investments
– Innovation in the financial industry
Globalization of Financial Markets (2)
• Political choices by governments explain the emergence of a more liberal environment for cross-border financial flows– In 1960s, British government encouraged the
growth of the “euro-(dollar)market” in London– In 1974, US abolished national capital controls– In 1979, UK abolished national capital controls• Many other countries followed suit
Globalization of Financial Markets (3)
• Why did states support financial globalization?– Increasing influence of “neoliberal” ideology:
embedded liberalism under challenge– Liberalization of capital controls was a competitive
market strategy • To attract mobile financial business• To attract foreign capital• To develop leading financial centres• To keep up with developments in other countries
Globalization of Financial Markets (4)
• More liberal set of international rules to govern cross-border financial flows were codified in the European Union (1988) and OECD (1989) – An attempt to assign to the IMF the purpose of
promoting financial liberalization failed after the 1997-8 Asian Financial Crisis
Globalization of Financial Markets (5)
• Some argued that financial globalization has undermined national policy autonomy– Financial globalization gives investors a powerful
“exit” option if governments stray too far from investors’ policy preferences• Governments in the South are particularly vulnerable
– Policies “disliked” by holders of financial assets:• Large budget deficits• High taxation• Expansionary macroeconomic policies• Policies that reflect left-of-centre political values
Globalization of Financial Markets (6)
• Some scholars suggest that these arguments are overstated– Governments make trade-offs in choosing policy
• “Impossible trinity” of monetary policy autonomy, cross-border capital mobility, and stable exchange rates
– Studies suggest investors are concerned with inflation rates and aggregate levels of fiscal deficits (i.e.current account deficit) but not overall level of spending, taxation, or political orientation
Unholy trinity (Impossible Trinity)
Impossible to have all 3 at the same time If a nation were to adopt position a, for example, then it would maintain a fixed exchange rate and allow free capital flows, the consequence of which would be loss of monetary sovereignty.
Globalization of Financial Markets (7)
• Some scholars suggest that these arguments are overstated (cont.):– Other sources of funds for government, e.g.,
remittances– Increasing significance of sovereign wealth
funds allow governments to shape the behaviour of markets
Sovereign wealth fund
An investment pool of foreign reserves owned by a government. The largest investment pools are owned by countries that have a trade surplus, such as oil-exporting countries and China. These countries take in foreign currencies (primarily U.S. dollars) in exchange for their exports.
Globalization of Financial Markets (8)
• Distributive implications– Neo-marxists argue that financial globalization has
facilitated the emergence of a “transnational capital class” with “structural power”
– Political divisions within the business sector• Transnational corporations and owners of financial
assets and services vs. nationally-based businesses – Short-term orientation of financial markets vs.
long-term orientation of sustainable developmental policies (i.e.enviromental).
Collapse of Gold Exchange Standard (1)
• In 1960s, US currency abroad grew considerably larger than the amount of gold that the US government held to back it up– If holders of US dollars decided to convert dollars into
gold, US would not be able to meet demand– Some countries (notably France) and private
speculators targeted the US dollar• In August 1971, US suspended the convertibility
of the US dollar into gold– This signaled the end of gold exchange standard
Collapse of Gold Exchange Standard (2)
• Despite the end of gold exchange standard, US dollar’s central global role has endured– US dollar continues to be the currency of choice
for settling international economic transactions– US is the most popular anchor currency for fixing
exchange rates– US dollar is the most common currency held by
governments in their foreign exchange reserves– US dollar also used by market actors within the
economies of many poorer countries
Collapse of Gold Exchange Standard (3)
• Reasons for US dollar’s enduring role– Inertia in market behaviour– Economic and political ties with the US– US financial markets are the most liquid, large and
deep in the world– As yet, no serious alternative to the US dollar
Collapse of Gold Exchange Standard (4)
• Benefits to the US from the dollar’s central global role– International prestige– Seigniorage revenue– Facilitates the capacity of US to finance current
account deficits and deflect the cost of adjustment to others (by depreciating the US dollar)
– Provides leverage to encourage worldwide cooperation with US regulatory initiatives
– Ensures key role for US during financial crises
Evolving International Monetary Regime (1)
• In 1978, an amendment of the IMF’s Articles of Agreement came into force which legalized floating exchange rates, thus formally ending the adjustable peg system– Growing size of speculative international financial
flows had complicated governments’ efforts to defend currency pegs
– Policy-makers reevaluated the merits of floating exchange rates, taking a position that stood in contrast to that which prevailed at Bretton Woods
Evolving International Monetary Regime (2)
• Some argued that floating exchange rates have encouraged speculative currency trading– This has led to short-term volatility and longer-term
misalignments of exchange rates• In 1980s, longer-term misalignment led to
coordinated depreciation of US dollar & more managed exchange rates among G5– Plaza Agreement (1986) & Louvre Accord (1987)– West Germany and Japan argued that US was
shifting the cost of adjustment
Evolving International Monetary Regime (3)
• Bretton Woods II (Dooley et al. 2003)– Undervaluation of national currencies in East
Asia, particularly China, to support export industries• Leading to accumulation of US dollar reserves in
East Asia
– US gets cheap imports and low cost foreign funding of its trade and fiscal deficits
Evolving International Monetary Regime (4)
– There is currently a debate as to whether this is situation of “global imbalances” is sustainable• Calls for greater
macroeconomic coordination• G-20 Mutual
Assessment Process
Evolving International Monetary Regime (4)
• European Monetary System (1979) created mini adjustable peg regime: vulnerable to speculators
• Maastricht Treaty (1991) committed members to full monetary union by 1999 (economic and political motivations)
