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Chapter Contents
Introduction
Conclusion
Readers Guide
The international monetary and financial system plays a central role in the global
political economy. Since the late nineteenth century, the nature of this system has
undergone several transformations in response to changing political and economic
conditions at both domestic and international levels. The most dramatic change was the
collapse of the integrated pre-1914 international monetary and financial regime during
the inter-war years. The second transformation took place after the Second World War,
when the Bretton Woods order was put in place. Since the early 1970s, another period
of change has been under way as various features of the Bretton Woods order have
unravelled: the gold exchange standard, the adjustable peg exchange-rate regime, the US
dollars global role, and the commitment to capital controls. These various changes have
important political consequences for the key issue of who gets what, when, and how in
the global political economy.
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Introduction
It is often said that money makes the world go
around. In this age of globalization, the saying
appears more relevant than ever. International
flows of money today dwarf the cross-border trade
of goods. And the influence of these flows seems
only to be enhanced by their unique speed and
global reach.
If money is so influential, it is fitting that it
should have a prominent place in the study of
global political economy, and scholarly research on
the political economy of international monetary
and financial issues has indeed grown very rapidly
in recent years. While perspectives vary enormously
within this literature, scholars working in this field
share the belief that the study of money and finance
must adopt a wider lens than that adopted by most
economists.
Economists are trained to view money and finance primarily as economic phenomena. From their
standpoint, money serves as a medium of exchange,
a unit of account, and a store of value, while financial
activity allocates credit within the economy. Both of
these functions are critical to large-scale economic
life, since they facilitate commerce, savings, and
investment.
These descriptions of the economic role of money
and finance are certainly accurate, but they are also
limiting. Money and finance, after all, serve many
political purposes as well (not to mention social
and cultural ones). In all modern societies, control
over the issuing and management of money and
credit has been a key source of power, and the
subject of intense political struggles. The organization and functioning of monetary and financial
systems are thus rarely determined by a narrow
economic logic of maximizing efficiency. They also
reflect various political rationales relating to the
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Debates about contemporary economic globalization often note that this trend had an important
precedent in the late nineteenth and early twentieth
centuries. This is certainly true in the monetary and
financial sector (see McGrew, Chapter 9, and Hay,
Chapter 10 in this volume). Cross-border flows of
money increased dramatically in this earlier period
and, according to some criteria, even surpassed
those in the current era in significance for national
economies. Some of these flows involved short-term
capital movements that responded primarily to interest rate differentials between financial centres
around the world. Others involved long-term capital exports from the leading European powers to
international locations. The United Kingdom, in
particular, exported enormous amounts of longterm capital after 1870, sums that were much larger
as a percentage of its national income than any creditor country is exporting today (James 2001: 12).
These capital flows were facilitated by the emergence of an international monetary regime that
was also highly integrated, indeed much more so
than in the current period. By 1914, the currencies of most independent countries and colonized
regions around the world were linked to the same
gold standard (see Box 7.1). The result was a
fixed exchange-rate regime with an almost global
reach. Indeed, some European countries went even
further, to create regional monetary unions in
which the currencies of the member countries could
circulate in each others territory. Two such unions
were created: the Latin Monetary Union (LMU)
in 1865 (involving France, Switzerland, Belgium,
and Italy) and the Scandinavian Monetary Union
(SMU) in 1873 (involving Sweden and Denmark,
plus Norway after 1875). A high-level international conference was held in 1867 to consider
the possibility of a worldwide monetary union of
BOX 7.1
The Theory of the Adjustment Process Under the International Gold Standard
In theory, the international gold standard was a
self-regulating international monetary order. External
imbalances would be corrected automatically by domestic wage and price adjustments, according to
a process famously described by David Hume: the
pricespecie flow mechanism. If a country experienced a balance of payments deficit, Hume noted,
gold exports should depress domestic wages and
prices in such a way that the countrys international competitive positionand thus its trade positionwould be improved. Humes model assumed
that most domestic money was gold coins, but the domestic monetary system of most countries on the gold
standard during the late nineteenth and early twentieth centuries was dominated by fiduciary money in
the form of bank notes and bank deposits. In this
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world currency. New York also began to rival Londons position as the key international financial
centre. In these new circumstances, the United
States might have taken on the kind of leadership
role that the United Kingdom had played before
the war. But it proved unwilling to do so because
of isolationist sentiments and domestic political
conflicts between internationally orientated and
more domestically focused economic interests. The
resulting leadership vacuum is blamed for the
instability and eventual breakdown of the gold
standard and integrated financial order during the
inter-war period.
Hegemonic stability theorists criticize several aspects of US behaviour during the 1920s and early
1930s. Its capital exports during the 1920s were
pro-cyclical; they expanded rapidly when the US
economy was booming in the mid-to-late 1920s,
but then came to a sudden stop in 1928, just as the
growth of the US economy was slowing down. The
collapse of US lending generated balance of payments crises for many foreign countries that had
relied on US loans to cover their external payments
deficits. The United States then exacerbated these
countries difficulties by raising tariffs against imports with the passage of the 1930 SmootHawley
Act. As confidence in international financial markets collapsed in the early 1930s, the USA also
refused to take on the role of international lenderof-last-resort, or even to cancel the war debts that
were compounding the crisis.
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downwards. A depreciation of the national currency provided a quicker, less painful, manner of
adjusting the countrys wages and prices vis-`a-vis
those in foreign countries in order to boost exports
and curtail imports.
A floating exchange rate also provided greater
policy autonomy to pursue expansionary monetary policies that could address pressing domestic
economic needs. While on the gold standard, a
government wishing to bolster economic growth
by lowering interest rates would experience capital flight and an outflow gold of and would be
forced to reverse the policy in order to restore
the stability of the currency. With a floating exchange rate, the government could simply let the
exchange rate depreciate. The exchange rate would
adjust to the changing level of domestic prices and
wages instead of the other way around. This depreciation would also reinforce the expansionary
intent of the initial policy, since exports would be
bolstered and imports discouraged. More generally,
it is worth noting that a floating exchange rate was
also attractive to many governments in the early
1930s because it could insulate the country from
monetary instability abroad, particularly from the
deflationary pressures emanating from the USA at
this time.
In addition to abandoning the gold standard,
many governments during the 1930s turned to
capital controls to reinforce their national policy
autonomy. With this move, they insulated themselves from the disciplining power of speculative
cross-border financial movements. If, for example,
a government wanted to bolster domestic economic
growth by lowering interest rates or engaging in deficit spending, it no longer had to worry about
capital flight. For this reason, it was natural to
find John Maynard Keynes, the leading advocate
of such domestically-orientated, activist macroeconomic management, emerge as one of the strongest
supporters of capital controls in the early 1930s.
As Keynes put it, let finance be primarily national
(Keynes 1933: 758).
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KEY POINTS
provision of stable international lending, the maintenance of an open market for foreign goods, and
the stabilization of financial markets during crises.
Embedded liberalism
At the time, it was clear that the United States would
emerge from the war as the dominant economic
power, and US policy-makers were determined to
play a leadership role in building and sustaining
a more liberal and multilateral international economic order than the one that had existed during the
1930s. The closed economic blocs and economic instability of the previous decade were thought to have
contributed to the great depression and the Second
World War. But US policy-makers did not want
to see a return to the classical liberal international
economic order of the pre-1930s period. Instead,
they hoped to find a way to reconcile liberal multilateralism with the new domestically orientated
priorities to combat unemployment and promote
social welfare that had emerged with the New Deal.
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speculative financial flows, and the general breakdown of international economic integration.
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BOX 7.2
KEY POINTS
Governments joining this order committed themselves to currency convertibility for current account
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KEY POINTS
In 1971, the United States ended the gold convertibility of its currency, and, by extension, that of all
other currencies. The US decision reflected its desire to free itself from the growing constraint on its
policies that gold convertibility was imposing.
International exchange-rate
management: the Plaza to the
Louvre
One of the more dramatic episodes of a longterm misalignment involved the appreciation of the
US dollar in the early-to-mid-1980s. This currency
movement was not responding to a US current
account surplus; indeed, the country experienced
a growing current account deficit at the time. Instead, the dollars appreciation was caused by very
large inflows of foreign capital, attracted by the
countrys high interest rates and rapid economic
expansion after 1982. The appreciation proved to
be very disruptive; it exacerbated the US current
account deficit and generated widespread protectionist sentiments within the USA by 19845.
This episode led the USA and other major industrial countries to consider briefly a move back towards more managed exchange rates. In September
1985, the G5 (the United States, the United Kingdom, the Federal Republic of Germany, France, and
Japan) signed the Plaza Accord which committed
these countries to work together to encourage the
US dollar to depreciate against the currencies of its
major trading partners. After the dollar had fallen almost 50 per cent vis-`a-vis the yen and Deutschmark
by February 1987, they then announced the Louvre
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competitiveness vis-`a-vis the United States. The effectiveness of this dollar weapon rested on the US
dollars key currency status and the fact that the
US market remained such an important one for
Japanese and German businesses in this period. It
was a strategy that met with some success for the
USA in both instances, although it also left the USA
vulnerable to a crisis of confidence in the dollar at
some key moments.
BOX 7.3
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by certain political conditions. Particularly important in that case have been the power and political
interests of France in the colonial and post-colonial
context (Stasavage 2003).
Another region where interest in monetary union
has grown is the Americas. Beginning in 1999, many
policy-makers in that region began to debate the
idea of creating a currency union that would be
based on the US dollar. Two countriesEcuador
and El Salvadorwent beyond talk to action and
introduced the US dollar as their national currency,
in 2000 and 2001, respectively. The new interest
in dollarization across Latin America is partly a
product of the ascendancy of neo-liberal monetary
ideas there. As in Europe, many neo-liberals in the
region see the abandonment of the national currency as a way of importing price stability; in this
case, from the US Federal Reserve. Advocates of
dollarization have also argued that it will help to
insulate countries from speculative financial flows,
and will attract stable long-term foreign investment.
The dollarization debate also emerges from a
context where many Latin-American countries have
experienced a kind of informal, partial dollarization
since the 1970s. Local residents have often turned to
the US dollar as a store of value, a unit of account,
BOX 7.4
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BOX 7.5
What is Seigniorage?
Seigniorage is usually defined as the difference
between the nominal value of money and its cost
of production. This difference is a kind of profit
for the issuer of money. In medieval Europe, this
source of revenue was often very important for ruling authorities. They could earn it either openly by
adding a seigniorage charge (above the normal mint
charge that offset the cost of minting) when producing metallic coin, or more secretly by debasing their
coin through a reduction of its weight or its fineness
(by increasing the proportion of non-precious alloy).
If the surreptitious strategy were to be detected by
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KEY POINTS
Some of the same factors that prompted the decision to create a European monetary union have
triggered proposals for monetary unions elsewhere,
most notably in the Americas. But a dollar-based
monetary union in the Americas is not likely unless
the United States becomes more supportive of the
idea.
Floating exchange rates have performed an important role in facilitating balance of payments
adjustments, but critics argue that they have also
been subject to short-term volatility and longerterm misalignments.
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of the euro in Europe. Some European policymakers have supported the euros creation for
this reason: they have seen it as a tool to bolster Europes power in the global political economy
(Henning 1998: 563565). In outlining the official
rationale for monetary union in its One Market,
One Money report, the European Commission
(1990: 194, 191), for example, praised how the
euro would bring greater symmetry to the global
monetary order, and force the United States to become more conscious of the limits of independent
policy-making.
What kind of a challenge will the euro pose to
the US dollar? In 1990, the European Commission
(1990: 182) predicted that the euro would be a particularly attractive international currency because
it would be backed by a conservative central bank
dedicated to price stability, and because it would
be able to be held in unified European money markets that would be the largest in the world. At
the time of writing, however, the euros challenge
to the dollar has proved to be less significant than
this prediction. One reason has been that European
financial markets remain highly decentralized and,
in the words of Fred Bergsten (1997: 88), there is
no central government borrower like the US Treasury to provide a fulcrum for the market. Cohen
(2003) also argues that the euros international use
is held back by uncertainties regarding the governance structure, and thus the broader political
credibility of the whole initiative.
The European Commission (1990: 183) noted
a second way in which the euros creation might
threaten the dollar. It observed that, with no more
intra-EC foreign exchange intervention necessary,
an estimated $230 billion of the total $400 billion
of foreign exchange reserves of EC member states
would no longer be needed, the majority of which
was held in dollars. If these excess reserves were
suddenly sold, Pauly (1992: 108) has predicted, the
result would be destabilizing in the extreme for
the dollar. Again, however, European governments
have so far shown little interest in provoking this
kind of monetary confrontation with the United
States.
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Recently, the US dollars global role is beginning to be challenged by the euro and the yen,
although these challenges should not be overstated.
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Implications of financial
globalization for national policy
autonomy
What have been the implications of the globalization of finance? One set of implications is addressed
in the next chapter: the vulnerability of global
financial markets to financial crises. A second
set of implications relates to the concerns of the
Bretton Woods negotiators. As noted above, they
worried that a liberal international financial order
would undermine their efforts to create a stable
exchange-rate system and to protect the autonomy
of national policy. We have already seen how financial globalization has indeed complicated the task of
maintaining fixed exchange rates. But what about its
implications for the autonomy of national policy?
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KEY POINTS
Conclusion
The international monetary and financial system
has undergone three important transformations
since the late nineteenth century, in response to
changing economic and political conditions. During the inter-war years, the global integrated monetary and financial order of the pre-1914 period
broke down. At the Bretton Woods conference of
1944, a new order was built on embedded liberal
QUESTIONS
1.
Does historical experience suggest that a hegemonic leader is necessary for a stable international monetary and financial system to exist?
2.
For how much longer will the US dollar remain the worlds key currency?
3.
Has the floating exchange-rate system created a kind of casino capitalism which is creating an
increasingly unstable global political economy? Should the leading powers attempt to stabilize
the relationship between the values of the major currencies?
4.
Has the creation of the euro been a positive move for Europeans? Should other regions emulate
the European example, and are they likely to do so?
5.
To what extent has financial globalization undermined the power and policy autonomy of
national governments? Is financial globalization irreversible?
6.
How important has financial globalization been in influencing class, sectoral, and gender
relations within countries? What are its environmental consequences?
FURTHER READING
Andrews, D. (ed.) (2006), International Monetary Power (Ithaca, NY: Cornell University Press). A
collection of essays concerning the relationship between state power and international money.
Cohen, B. (1998), The Geography of Money (Ithaca, NY: Cornell University Press). An analysis of
the ways in which national currencies are being challenged in the current age by one of the pioneers
of the field of the political economy of international money.
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Cohen, B. (2004), The Future of Money (Princeton, NJ: Princeton University Press). A kind of
sequel to his The Geography of Money, which addresses key policy questions relating to the changing
nature of money in the contemporary world.
Eichengreen, B. (1992), Golden Fetters: The Gold Standard and the Great Depression: 19191939
(Oxford: Oxford University Press). An analysis of international monetary and financial relations
during the inter-war years.
Gallarotti, G. (1995), The Anatomy of an International Monetary Regime (New York: Oxford University
Press). A survey of the political economy of the international gold standard.
Germain, R. (1997), The International Organization of Credit (Cambridge: Cambridge University
Press). An analysis of the evolution of the international financial system since the early modern age.
Henning, C. R. (1994), Currencies and Politics in the United States, Germany and Japan (Washington,
DC: Institute for International Economics). An analysis of the politics of exchange-rate policy-making
in the three leading economic powers.
Kirshner, J. (1995), Currency and Coercion: The Political Economy of International Monetary Power
(Princeton, NJ: Princeton University Press). An analysis of how monetary relations are used as an
instrument of state power.
(ed.) (2002), Monetary Orders (Ithaca, NY: Cornell University Press). An edited collection that
highlights the political foundations of national and international monetary systems.
Pauly, L. (1997), Who Elected the Bankers? Surveillance and Control in the World Economy (Ithaca,
NY: Cornell University Press). A study of the evolution of global financial and monetary governance
throughout the twentieth century.
Porter, T. (2006) Globalization and Finance (Oxford: Polity Press). An overview of the politics and
governance of global financial markets.
Strange, S. (1998), Mad Money: When Markets Outgrow Government (Ann Arbor, Mich.: University
of Michigan Press). A survey and critique of the contemporary international monetary and financial
system.
WEB LINKS
www.attac.org The website of a leading international lobby group pressing for global financial
reform.
www.bis.org The website of the Bank for International Settlements. The Bank is the central
bankers bank and it provides detailed analyses of international monetary and financial developments.
www.eurodad.org The website of a leading non-governmental organization based in Europe that
addresses international financial issues relating to poorer countries.
www.imf.org The website of the International Monetary Fund.
www.oxfordtextbooks.co.uk/orc/ravenhill2e/