Chapter 7 - The Evolution of the International Monetary and Financial System PDF

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CHAPTER 7 The Evolution of the International Monetary and Financial System 1. Introduction Money and finance can serve political, as well as economic, purposes. In current society control over the issuing and management of money has been a key source of power. At the international level, the answers...

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CHAPTER 7 The Evolution of the International Monetary and Financial System 1. Introduction  

Money and finance can serve political, as well as economic, purposes. In current society control over the issuing and management of money has been a key source of power. 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?

2. Earlier Globally Integrated Order 

In late-19th and early-20th centuries  Cross-border flows of money increased  Exceeded those in current era in significance for national economies  The international monetary regime was much more integrated than in the current period  Some of these flows involved shot term capital movement and other involve long term capital exports from the lending European powers in international locations.  The gold standard was established  Various currency blocs/monitory unions were created

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During the First World War: End of globalization  Cross-border financial flows diminished dramatically  Many countries abandoned the gold standard  The international monitory system broke up in a series of relatively closed currency blocs  Even though there were some lending continued within the blocks, it was limited

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Hegemonic stability theory  UK lost its ability to perform its leadership role in stabilizing the global monitory and financial order  US replaced it as the lead creditor to the world economy, USD emerge as strongest and trustworthy world currency  New York began to rival London’s position as the key international financial center  The leadership vacuum blamed for the instability and eventually the breakdown of the international financial order  Increasing democratization the growing power of labour meant that governments could no longer fully commit to maintaining the gold standard 

Short-term capital flows becoming more volatile. Investors lost the confident in governments’ commitment to maintain fixed rates

3. The Bretton Woods Order 

US policy makers did not want to see a return to the classical liberal international economic order. Instead they attempt at reconciling commitment to an open multilateral world economy with the new domestically oriented priorities of addressing unemployment and social welfare

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The goal of rebuilding the international monetary and financial order post-WWII was an embedded liberal international economic order

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  Capital movements were controlled  This provision was designed to control speculative and “disequilibrating” private financial flows   

International Monetary Fund (IMF) 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

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International Bank for Reconstruction and Development (IBRD, World Bank) Provide long-term loans for reconstruction and development after the war

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

4. Globalization of Financial Markets 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 (stocks, Options, Swaps)

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Globalization of finance was also a product of, political choices by governments explain the emergence of a more liberal environment for cross-border financial flows  British government encouraged the growth of the “euro-market” in London  US & UK stopped national capital controls  Many other countries followed suit

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Why did states support financial globalization?  Increasing influence of “neoliberal” ideology  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 2|Page

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An attempt to assign to the IMF the purpose of promoting financial liberalization failed after the 1997-8 Asian Financial Crisis Some argued that financial globalization has undermined national policy autonomy  Financial globalization gives investors a powerful “exit” option if governments going 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-center political values 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 but not overall level of spending, taxation, or political orientation  Increasing significance of sovereign wealth funds allow governments to shape the behaviour of markets

Distributive Implications  Neo-marxists argue that financial globalization has facilitated the emergence of a “transnational capital class” with “structural power” through its new ability to ‘exit’.  Also highlighted Political divisions that emerge within the business sector  Transnational corporations (TNC) and owners of financial assets and services gained from financial globalization. But nationally-based businesses, often have not.  Financial globalization is likely to have a negative impact on women. Cutbacks: government spending areas such as health, education, public transportation and other social services.  Short-term orientation of financial markets vs. long-term orientation of environmental policies

5. Collapse of Gold Exchange Standard    

In 1960s, USD 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 (France) refused to adopt this practice, seeing it’s as a reinforcement of US hegemony. In August 1971, US suspended the convertibility of the US dollar into gold. This signaled the end of gold exchange standard

US dollar’s central global role  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 Reasons for US dollar’s enduring role  Inactivity in market behaviour  Economic and political ties with the US  US financial markets are the most liquid, large and deep in the world 3|Page

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As yet, no serious alternative to the US dollar

Benefits to the US from the dollar’s central global role  International prestige  Seigniorage revenue (profit made by a government by issuing currency)  Facilitates the capacity of US to finance current account deficits and bounce the cost of adjustment to others (by depreciating the US dollar)  Use the dependence of market actors on USD to encourage worldwide cooperation with US regulatory initiatives. As well as to enforce sanctions on other states  Ensures key role for US during financial crises, as the sole producer of the key currency of the world

6. Evolving International Monetary Regime 

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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 (A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime where a currency's value is fixed against either the value of another single currency, to a basket of other currencies, or to another measure of value, such as gold) 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

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Some argued that floating exchange rates have encourage speculative (hypothetical) 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

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West Germany and Japan argued that US was shifting the cost of adjustment. Seemed designed to reduce its own external deficit by encouraging policy coordination Undervaluation of national currencies in East Asian, particularly China, to support export industries China is the leading to accumulation of US dollar reserves in East Asia

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