Isard: Globalization and the International Financial System

Isard, P. 2005. Globalization and the international financial system. Cambridge New York.

Ch. 2: The Evolution of the International Monetary System

"At the core of the international financial system is a set of official institutions and arrangements that govern payments between nations and exchange rates among currencies--a core referred to as the international monetary system" (13).

This system promotes stable exchanges of currencies, which is seen to expand international trade, which is then seen as driving economic growth and improved living standards.

The policy trilemma was explored explicitly by Mundell and Flemming in papers written in the early 1960s, but also must have been at least tacitly held by the framers of the IMF in the 1940s: the system was designed to achieve fixed exchange rates, domestic monetary and fiscal autonomy and constrained capital mobility.

The Gold Standard system that existed from 1870-WWI was based on convertibility of currency to gold reserves. This system suffered crises, which were mitigated in part through the cooperation of major players in the monetary system. "As these episodes suggest, preservation of the international gold standard regime required the core countries of the system not only to cooperate to help each other in times of crisis but also to accommodate over time the growing and somewhat volatile demand for gold in countries on the periphery of the system, including the United States...A second factor that contributed importantly to the credibility and longevity of the gold standard regime was a social and political environment in which it was feasible for national monetary authorities to give the maintenance of currency convertibility precedence over other possible goals of economic policy" (17).

After WWI, and a temporary stoppage of currency convertibility, countries began to return to the gold standard. First the US, and then other European countries pegged their currencies to gold and established currency exchanges, etc. The US left in 1933.

Then, after 1929, a global depression took hold, with production falling by a full 26%. "At least seven countries left the gold standard between 1929 and August 1931" (24).

During WWII, there were very tight exchange pegs.

At the end of WWII, the Bretton Woods institutions were formed, with an eye towards bridging the divide between those who ardently supported free trade agendas, and those who believed in full employment and government spending. "The outcome was a managed multilateral system that left individual countries with considerable autonomy to pursue domestic economic policy objectives but subjected their exchange rate practices and international trade and payments restrictions to international agreement" (28).

"Through period adjustments of exchange rates pegs and a resort to capital controls, the Bretton Woods system survived for a quarter century. The demise came after internationally mobile private capital had grown substantially in both volume and agility, thereby becoming a major force that was difficult to control" (30).

"The policy-oriented literature of the 1960s characterized the prevailing international monetary system as incapable of simultaneously resolving the problems of liquidity, adjustment, and confidence. With the production of new gold being inadequate to meet the increasing demand for official international reserves in a growing world economy, and with gold and reserve currencies comprising the principal reserve assets in the international monetary system, the liquidity problem could be solved, or so it was perceived, in only two ways: by continuing to increase the liabilities of the reserve-currency countries, especially those of the United States, or by raising the purchasing power of gold. This choice presented what was known as the Triffin dilemma. The first solution would lead to a persistent balance of payments deficit for the United States on an official settlements basis, which many economists viewed as an adjustment problem. The second solution, moreover, would create a confidence problem, undermining faith in the reserve system. In particular, an increase in the official dollar price of gold...could induce attempts by foreign governments to convert their dollar reserve holdings into gold and would also induce speculative investments in gold by private market participants. This would rapidly drain the gold reserves of the United States and destroy the ability of the US authorities to defend any fixed gold parity for the dollar" (32-3).

In order to solve this conundrum, special drawing rights (SDRs) were created. This was a new asset held by the IMF in reserve.

The Euro-Dollar market was created. These were dollars held in banks primarily in Britain. This eventually led to speculation on the dollar that caused Nixon to suspend convertibility in 1971. By 1973 the international monetary system had moved to a floating exchange rate system.

In the 70s, the countries of Europe moved towards creating a monetary union.

The remainder of the chapter deals with the different kinds of forms that monetary systems and policies can take in the post-Bretton Woods system, as well as the implications of moving to fiat money and relatively floating exchange rates.

Ikenberry: A World Economy Restored

GJ Ikenberry, “A World Economy Restored: Expert Consensus and the Anglo-American Postwar Settlement,” International Organization 46, no. 1 (1992): 289-321.

How was it possible for the post war international economic order to emerge from the chaos of WWII? This article explores how British and American experts found areas of consensus in order to push forward a vision of the world that was neither emphasized old imperial economic orders or entirely free trade.

"I argue that the policy ideas inspired by Keynesianism and embraced by a group of well-placed British and American economists and policy specialists were crucial in defining government conceptions of postwar interests, building coalitions in support of the postwar settlement, and legitimating the exercise of American power. By shifting the focus from trad3e issues, which were highly contentious, to monetary issues, about which there was an emerging 'middle ground' created by Keynesian ideas, these experts helped overcome political stalemate both within and between the two governments. Put simply, this group of British and American experts intervened at a particularly fluid moment in history to help the British and American political establishments identify their interests, thereby creating the basses of postwar economic cooperation" (291).

Ikenberry goes on to list seven key features of this group of policy experts and the context in which they were making decisions.

"The group of economists and policy specialists involved in the postwar settlement, however, did not fully constitute an epistemic community, nor did the manner in which these experts influenced the terms of the settlement conform to the strict logic of epistemic community influence that is proposed elsewhere in this volume" (293). Firstly, this was not a scientific community affecting policy, but a group brought together in the interest of solving a problem. Secondly, the ideas of the group were not as homogenous or as deeply rooted in tenants of a theory as would be the ideas of an epistemic community. Thirdly, this group did not drive policy adoption, but rather, political needs drove the selection of this group.

This story is then told in great detail and I skimmed it.