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

The Politics of International Economic Relations:

Session 75 December 2006

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

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

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

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)

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

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?

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)

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

Impossible Trinity

Capital Mobility

Fixed Exchange RatesAutonomy of

Monetary Policy

Gold Standard Since 1970s

Bretton Woods

Contemporary issues of the financial and monetary system

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

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

Frequency of Financial Crises

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

Frequency of Financial Crises

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

Crises Prevention and Crises Management

• Crisis management:– Emergency lending– Debt rescheduling and restructuring

A new global architecture?– Unilateral– Multilateral– Supranational

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

Voting power

IMF and WB as an IO

Woods 2005