The Politics of International Economic Relations: Session 7 5 December 2006

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The Politics of International Economic
Relations Session 75 December 2006
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Evolution of the International Monetary and
Financial System

• Financial and monetary order prior to WW2
• Creation of the Bretton Woods Order Text
  Ikenberry
• Bretton Woods Order
• The 1970s crisis
• From floating exchange rates to monetary unions
• Contemporary issues of the financial and monetary
  system
• US declining role?
• International financial crises
• Crises prevention and crises management

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Financial and monetary order prior to WW2

• Capital flows in late 19th century
• Facilitated by integrated monetary regime (fixed
  exchange rate regime / gold standard)
• Regional monetary unions (LMU and SMU) and
  imperial currency blocs
• Prior to WW1 abandoning of gold standard
  (floating)
• 1920s attempt to restore gold standard
• 1930s financial crises (collapse of international
  lending and gold standard)
• Collapse of US lending and Smoot-Hawley Tariff
  Act
• Reintroduction of capital controls

4
Financial and monetary order prior to WW2

• HST why did US not take on leadership?
• Criticism
• Overstatement of UK leadership in pre-1914 order
• Cooperation between leading central banks
• Domestic politics (e.g. balance of payments
  deficits deflationary policies (press wages
  and prices downwards))
• instead depreciation of national currency

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Creation of the Bretton Woods Order

• Embedded Liberalism
• US leadership (liberal multilateralism and New
  Deal politics)
• Different kind of Gold Standard
• Gold-Dollar standard (35 per ounce)
• Adjustable Peg Exchange Rate Regime (Currency
  realignments)
• Acceptance of capital controls (targeting
  speculative flows, protecting against capital
  flight)
• Creation of IMF/World Bank (IMF lending
  -previously left to private banks WB long-term
  loans for reconstruction)

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Explaining Order (Ikenberry)

• Role of expert consensus
• How to explain the agreement (power distribution,
  interests, which of the postwar orders to
  choose)
• Hegemony, legitimacy?
• What was the glue that held the Anglo-American
  coalition together?
• Policy ideas inspired by Keynesianism embraced by
  British and US economists and policy specialists,
• Ideas resonated well with the larger political
  environment
• Not an epistemic community
• Constitutional moment

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The 1970s crisis

• Breakdown of gold exchange standard
• Triffin Dilemma (standard is unstable)
• Liquidity expands by running US balance of
  payments deficit, undermining confidence in
  convertibility
• (Special reserve currencies (e.g. special drawing
  rights))
• 1971 end of US convertibility of US into gold
• US financing through printing
• Decision cut back printing vs. ending
  convertibility
• End of benevolent hegemon? Declining hegemony?

8
The 1970s crisis

• Collapse of adjustable peg exchange-rate regime
• 1973 floating system (formalized in IMF in 1976)
• Problems of speculative money, heightened capital
  mobility and reconsideration of merits of
  floating (ideas)

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From floating exchange rates to monetary unions

• Exchange Rate Management (Plaza Agreement)
• 1980 Appreciation of US (large inflows, high
  interests rates, account deficit, protectionism)
• Short G5 management to depreciate US
• Creation of EURO
• 1979 European Monetary System (mini Bretton
  Woods), adjustable peg system
• 1988 capital controls eliminated, speculative
  attacks
• 1992/3 currency crises (need to give up monetary
  policy)
• Creation of monetary union (also role of
  neo-liberal ideas)
• Limits on budget deficits and public debts
  (Maastricht Criteria)
• Currency Unions elsewhere
• CFA Franc Zone, Dollarization (Ecuador, El
  Salvador)
• Cross-national regulatory coordination

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Impossible Trinity
Capital Mobility
Since 1970s
Gold Standard
Bretton Woods
Autonomy of Monetary Policy
Fixed Exchange Rates
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Contemporary issues of the financial and
monetary system

• US declining global role? (EU, Japan,
  internally?)

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International Financial Crises

• Global financial panic of the late 1990s (e.g.
  Thailand)
• In search for higher returns
• Heavy borrowing debt in local currency
• Confidence in countries ability to defend
  exchange rate
• Speculations
• Pull-back, liqudity crunch, currency devaluation
• Central bank tries to defend, sells foreign
  currencies
• Herding behaviour
• Bank runs
• IMF emergency funding borrowing with
  conditions attached
• Political and social unrest
• Spill-over contagion

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Frequency of Financial Crises

• Most damaging crises occur when banking system
  and currency markets simultaneously come under
  pressure

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Frequency of Financial Crises
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Crises Prevention and Crises Management

• Crises prevention
• Standards and well-functioning regulatory
  authorities (e.g. banking regulation, financial
  intermediaries)
• Cross-national coordination (IMF, BIS, IOSCO,
  G7/G8, FSF, G20etc)
• IMF early warning system
• Moral hazard

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Crises Prevention and Crises Management

• Crisis management
• Emergency lending
• Debt rescheduling and restructuring
• A new global architecture?
• Unilateral
• Multilateral
• Supranational

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Decision Making IMF/WB

• Consensus
• Shadow of Majorities (51, 66 or 85 is
  required)
• Voting Power
• US 16.83
• Japan 6.04
• Germany 5.90
• France 4.87
• United Kingdom 4.87
• China 3.67
• Saudi Arabia 3.17
• Russian Federation 2.70

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Voting power
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IMF and WB as an IO

• Woods 2005