history of the international monetary system and its

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History of the international monetary system andits potential reformulationCatherine Ardra KarczmarczykUniversity of Tennessee, [email protected]

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mailto:[email protected]

HistoryoftheInternationalMonetarySystem

anditsPotentialReformulation

CatherineA.Karczmarczyk

HonorsThesisProject

Dr.AnthonyNownesandDr.AnneMayhew

02May2010

Karczmarczyk 2

HISTORYOFTHEINTERNATIONALMONETARYSYSTEMANDITSPOTENTIAL

REFORMATION

Introduction

Theyear1252markedthemintingoftheveryfirstgoldcoininWesternEurope

sinceRomantimes.Sincethislandmark,theinternationalmonetarysystemhas

evolvedandtransformeditselfintothemodernsystemthatweusetoday.The

modernsystemhasitsrootsbeginninginthe19thcentury.InthisthesisIexplore

fourmainideasrelatedtothishistory.

Firstistheevolutionoftheinternationalmonetarysystem.WithinthisIwill

explorethedifferenterasthatmakeupthistime.Firstistheclassicgoldstandard,

thentheinterwarperiod,andfollowedbyBrettonWoods.Thissectionconcludes

withadiscussiononthecurrentera,alsoknownasthedirtyfloat.

Thesecondsectionwillexplorethetransitionperiodofthe1990s.This

sectionexplorestheAsianFinancialCrisisindetailandalsodiscussestheoriginsof

theeurozone.Thesesectionsbegintheanalysisportionofthethesis,andwhilethey

dogiveacertaindegreeofbackground,thesectionlargelyservesasatransitional

section.

Thethirdsectionisananalysisofthecurrentmonetarysystem.Theworldis

facingtwomajorissuesrightnow,thepotentialcollapseoftheeurozoneandthe

ChineseholdingofUSTreasurydebt.Inthissection,Iwillexploretheseissuesin

Karczmarczyk 3

depthandhighlighthowthehistoryoftheinternationalmonetarysystemhasledus

tothispoint.

Inthefourthandfinalsection,Ihighlightseveralpossibilitiesforreform.This

isnotacomprehensiveplanofaction,butratherideasofwhereIseereformis

needed.Actualreformpossibilitieshavebeencirculatingforyears,andtheseideas

representacombinationofthese.

EvolutionoftheInternationalMonetarySystem

TheClassicGoldStandard(18701914)

Inthissection,IwilldiscusstheriseandimportanceofthegoldstandardinGreat

Britain,theBankofEnglandasalenderoflastresort,andtheresultsofthe

continentjoiningthegoldstandard.Iwillconcludewithabriefdiscussionoftheend

oftheprewargoldstandardandtheoverallimportanceofitsevolutiontoboththe

interwarandpostwarperiodsbutalsotothemodernmonetarysystemtoday.

TheRiseoftheGoldStandardinGreatBritain

Theclassicgoldstandardstartedformostcountriesinandaroundthe1870s,but

forGreatBritain,itwasfarearlier.Manydatetheadventofthegoldstandardin

Britainto1717,whenSirIsaacNewtonsetthepriceofgoldattoolowarate,

causingsilvertodisappearfromthecountryentirely.Theactualdateof

demonetizationdidn’toccuruntil1774,theyearwhengoldwasrecoined,silverwas

recognizedassubsidiary,andlimitsweresetontheuseofsilvercoinsinexcessof

25pounds.

Karczmarczyk 4

Intheyearsleadinguptotheadoptionofthegoldstandardbycontinental

Europe,Britainfacedseveralinstancesofconvertibilityissues.WhentheReignof

Terrortookplaceinearly1793,therewasasharpoutflowofcapitalintheformof

bothgoldandsilverfromFrance.Thisproducedlargeamountsofliquidityin

Britain,fuelinganongoingmaniatoitspeak.Eventuallytheassignat,theFrench

papercurrencyofthetime,collapsed,forcingareflowofmoney.TheBritishpeople

panicked,andabankrunensued.Inresponse,theBritishgovernmentorderedthe

BankofEnglandtosuspendconvertibility,wellbeforereservesranoutinaneffort

tokeepgoldreservesfrombecomingexhaustedifalltheincreasednotestofinance

thewarwerecashedin.In1825,notlongafterconvertibilityresumption,Britain

onceagainfacedthethreatofabankrun.TheBankofFrancesteppedintoaidthem

atthistime,easingthefearofsuspension.

Britainrecognizedtheneedtoact.Suspensionofthecurrencyledtoan

inconsistentsystemalwaysfacingbankruns.Atthistime,however,thereweretwo

schoolsofthought,theCurrencySchoolandtheBankingSchool,eachwithdiffering

ideasonhowthemoneysupplyshouldbehandled.Theintricaciesofthesetwo

schoolsarebeyondthescopeofthispaper,butletitsufficetosaythattheBanking

Actof1844wasacompromisebetweenthetwo.FortheBankofEngland,itcreated

anIssueDepartment,whichwasresponsiblefortheissueofpapercurrency,andit

wouldalsocreateaBankingDepartment,responsibleformakingloansand

discountsuptoamultipleofitsreservesofbanknotesthathadbeenproducedby

theIssueDepartment(Kindleberger59).

Karczmarczyk 5

ApartfromafixedinitialquantityofBanknotesbackedbygovernment

securities,“everynoteissuedhadtobebackedbybullioninthevaultoftheIssue

Department.ThislimitedthequantityofBanknotesinanefforttoadheretothe

principlethat“thewaytoassureasoundpapercurrencyistorequireanyincrease

initsquantitytobebackedpoundforpoundbyincreasesinbullionreservesheldby

thecentralbank”(Dillard378).Basically,atthispointinthehistoryofbankingin

England,securitywasmoresacredthanflexibility.Choosingthispath,however,

madeitdifficultfortheBankofEnglandtosupplycreditintimesofemergency.

WhentheCrisesof1847,1857,and1866erupted,theBankofEnglandwasgiven

permissionbygovernmenttobreakthelawbyissuingnotesnotbackedbybullion.

TheBankActof1844hadanevenmorefundamentalissuehowever.It

presumedthat“controlofthequantityofbanknotes,andthereservesbehindthem,

wasthechieffunctionofcentralbanking”(Dillard378).Britishbanking,however,

wasenteringanewphase,thecheckingsystem.

TheBankofEnglandasaLenderofLastResort

Inthenewcheckingphaseofbanking,“themostimportantfunctionoftheBankof

Englandwasastheholderofthecentralreservessupportingthecheckingsystem

andasalenderoflastresortinemergencies”(Dillard379).Therehadlongbeen

debateinEnglandoverwhetherthelenderoflastresortshouldbetheExchequeror

theBankofEngland,buttheactionsoftheBankActof1844,leftlittledoubtasto

whomthejobwouldfall.Itwasaroundthistimeofthisnewphasethatitbecame

startlinglyclearthattheBankofEnglandwasnolonger“justanyotherbank.”Its

Karczmarczyk 6

reservesweretoolargeanditsroleasacreditcustodiantoowidelyaccepted.Ithad

to“standreadytolenditsreservesfreelyincriticalcreditsituations;formere

reluctanceonitspartwouldmakecrediteventighterandprecipitateacrisisor

makeanexistingcrisisworse”(Dillard379).

Privatebanksandothersuchinstitutionsneededbanknotes(thelegal

tender)toprovidefortheircustomers.Inordertodothis,however,theyhadto

haveaccesstothecentralbank.SuchanecessitygavetheBankofEnglandacertain

degreeofpower.TheBankofEngland“couldmakethebankersandbillbrokerspay

fornewmoneybyraisingtherateofinterest,but[atthesametime]itcouldhardly

refusetolend,providedtheborrowershadgoodsecuritiestosellorpledgeagainst

theirloans”(Dillard379).Thepower,andresponsibility,comesinbecausenow

becausetheBankingDepartment(nowthepowerfuldepartmentduetotheriseof

checking)washeldresponsibleforthecreditofallbanks,astheirabilitiesdepended

ontheliquidityofthecentralbank.

ContinentalEuropeJoinstheGoldStandard

ThegoldstandardinEnglandhadbeenaroundforseveralyearsbeforecontinental

Europedecidedtoalsojoinin.DuringthetimethatBritainhadbeenbuildingand

redefiningit’s(andeventuallytheworld’s)bankingsystem,theyhadalsobeen

experiencingtheIndustrialRevolution.Thisindustrializationleftthemasthe

“world’sleadingeconomicpowerandthemainsourceofforeignfinance”

(Eichengreen17).Countriesdesperatelywantedtotradewithsuchaneconomic

resource,andthebimetallicstandardsofmanyofthesecountriesdidn’tfacilitate

Karczmarczyk 7

easytrade.Portugalhaddecidedearlyonin1854thatit’stradewithBritainwas

crucial,andtheyinresponseadoptedthegoldstandardin1854.Othercountries,

however,hadyettocometothatconclusion.

Whenaseriesofevents,includingabriefboutofinconvertibility(associated

withtheFranco‐PrussianWar),decliningtransportationcosts,andlargesilver

discoveriesinthe1850s(inplacessuchasNevada),considerationsofjoiningthe

goldstandardwerepushedevenfurther.Ultimately,thefinalincentivecamein

1871,whenGermany,theleadingindustrialpowerofcontinentalEurope,choseto

liquidateitssilverholdingsinanefforttoopenupmoretradewithGreatBritain.

Theresultwasachainreactioncausedby“theincentiveforeachcountrytoadopt

themonetarystandardsharedbyitscommercialandfinancialneighbors

(Eichengreen17).Bytheendofthenineteenthcentury,Spainwastheonly

Europeancountrystilloninconvertiblepaper.Intherestoftheworld,theUnited

States,Japan,Russia,India,andLatinAmericaallalsoinstitutedgoldconvertibility.

SilverremainedthemonetarysystemonlyinChinaandafewothersmallcountries.

Underthegoldstandard,“theexchangeratesofthesemajorindustrial

countrieswerefirmlypeggedwithinnarrowbands(thegoldpoints)inan

environmentfreeofsignificantrestrictionsoninternationalflowsoffinancial

capital”(Bayoumi165).Therateofconvertibilityandpriceofgoldwasfixed,and

underthisfixedsystem,theworldenteredaperiodoftradeandglobalization

previouslyunmatchedinhistory.Thestabilityofexchangeratesunderthissystem

ledtotheopennessofthemarketsandbuoyancyoftrade,whichinturnoffered

Karczmarczyk 8

supportwithinthemselvesofthegoldstandard.Therewere,however,pressureson

theBankofEnglandwiththisincreaseduseoftheirreserveservices.Sameasinthe

domesticmarket,theinternationalgoldstandardrequiredondemandpaymentto

depositors.AsBanknotesweren’tlegaltenderinthisnewfoundinternational

exchange,goldhadtobeexportedifsodesiredbythedepositor.Increasesinthe

rateofinterest“broughtaboutbyincreasesintheBankratewereusedtoattract

moneytoLondonandtopreventadrainofEnglishreserves”(Dillard379).

InstabilityandFailure

Theoperationofthegold‐standardsystemrestedoncentralbanks’overriding

commitmentto“themaintenanceofexternalconvertibility(Eichengreen34).There

was,however,akeyproblemwiththis.Notallcountrieshadestablishedcentral

banks.EvenintheUnitedStatesFederalReservewasn’testablisheduntil1913.This

resultedfrequentlyincountriesbeingforcedtosuspendgoldconvertibilitytoallow

theircurrenciestodepreciateproperly.Yetthiswasjustoneissue.

Thebiggesttensionandpressureassociatedwiththegoldstandardwasthat

oftheroleoftheBankofEngland.Aspreviouslymentioned,theBankofEngland

wasoperatingasthestewardofthegoldstandard,andthusBritishparticipationin

thesystemwascritical.Itisn’tcoincidentalthatontwoseparateoccasions,1890

and1907,Britainreceivedforeignsupportwhenfacedwithinconvertibility.Yetby

theturnofthecentury,Britain’srolewas“beingunderminedbythemorerapid

paceofeconomicgrowthandfinancialdevelopmentinothercountries”

Karczmarczyk 9

(Eichengreen42).LessofitslendingreturnedtoLondonintheformofforeign

deposits.

Ultimately,noneoftheseissuesresultedinthedeathofthegoldstandard

despitetheirincreasinglyworrisomepossibilities.InJulyof1914WorldWarIbroke

out,andwhenEuropebecameentrenchedinthewar,“goldexportsweresuspended

inordertopreventtheflightofgold…[and]moreover,theenormousincreasesin

thequantityofpapercurrencyandbankcreditmadeimpossibletheirfree

convertibilityintogold”(Dillard510).TherealityofWorldWarIwasacomplete

shutdownininternationaltradeandtheendofthegoldstandard.

TheInterwarPeriod(19191939)

Theevolutionofourmodernpoliticalsystemhasamarkeddiscontinuityduetothe

outbreakofwarin1914.Inanefforttobeconcise,Iwillnotdiscusstheeconomics

oftheactualwar,asitisbeyondthescopeofthispaper.Instead,Iwillmoveon

directlytotheInterwarPeriod,whichcanbedividedintofourdistincttimes:

RecoveryandReparations(1919‐1925),theBoom(1925‐1929),theCollapse

(1929‐1933),andStruggledRecovery(1933‐1939).

RecoveryandReparations(19191925)

Reparationpayments,territorialchanges,hyperinflation,andadesiretoreturnto

goldcharacterizedtherealityofthistimeperiod.IntheArmisticeConventionsigned

onNovember11,1918,“itwasagreedthatGermanywastopayreparationtothe

victoriousAllies”(Kindleberger290).Theamountofsuchreparationswasleft

Karczmarczyk 10

undecided,butGermanywasforcedtosignthetreaty,takingonanyandall

responsibilityforthewar.Itwasgenerallyagreeduponatthistimethatsince

Germanywasresponsibleforthewar,theyshouldberesponsibleafterthewar,

meaningthattheywouldberequiredtopayforit.Becauseofextremedifferencesof

opinionontheAlliedsideabouthowmuchthisshouldbe,aspecialReparations

Commissionwascalledupon.InApril1921,theReparationsCommissionfixedan

amountof132billiongoldmarksplus26percentinexporttaxesoveraperiodof

forty‐twoyears(Kindleberger290).Germansweren’thappywiththisarrangement

asitwas,butgiventheirrelativepositionintheworldatthistime,therewaslittle

thattheycouldsay.ThewilltopayonthesideofGermanywasweak,andattimes,

completelymissing.

TerritorialChanges.Typically,economicrelationsarenotbasedonsuch

internationalrelationsissuesasterritorychanges.TheaftermathofWorldWarI

wasanexception.Germanylostapproximatelyone‐thirdofitscoalresources,

locatedinthekeyareaoftheSaarandUpperSilesia(Dillard511).France,underthe

provisionsontheVersaillesTreaty,hadtakenoverthisareapostwarinorderto

providecoaltoproducesteelintheLorraine,anareatakenbyGermansduringthe

war.Additionally,GermanywasobligatedundertheTreatytosupplyadditionalcoal

toFrance“tocompensateforthewardamagetocoalmines(Dillard511).”Thiswas

partofthegeneralreparationsthatGermanywastopay,buttheremainingcoalleft

aftersuchrepaymentswasn’tenoughtosupplyGermany’srebuildingeffortsand

postwarindustry.Coalwasn’ttheonlyresourcethatGermanyoncehadbutnow

lacked.TheLorrainewasalsorichinironore.Thesepostwarchangeshadinterfered

Karczmarczyk 11

withtheproductionsystem,andtheresultwasdisorganizationandlossofefficiency

intheEuropeansteelindustry.

InJanuary1922,GermanscalledforaconferenceinCannestodiscussa

potentialmoratoriumandtoreopenthereparationquestion.Britainhadbeen

pushingforarevisedandreducedschedule,largelyinfluencebyKeynes,and

openedtheconferenceupfortheideaofaninternationalloantoGermany.InApril

theReparationsCommissionmettofurtherexplorethispossibility,butinJune,the

committeedecidedthat“giventhereparationschedule,Germany’screditwasnot

sufficientlyhightojustifyaninternationalloan(Kindleberger293).

Hyperinflation.Latethatsummerandintothefollowingfall,Germany’s

reparationpaymentsfellcompletelyoffschedule.Germanshadnowayofmeeting

thedemandsplaceduponthem.Theywerelackingterritory,andevenmore,the

Frenchdidn’twantthecompetitionofGermanworkerstakingjobsawayfrom

domesticworkersintheirreconstructionefforts(Mayhew1).Thesituation

worsened.FrenchandBelgiantroopsweresenttooccupytheRuhrinanattemptto

enforcereparationpaymentdelivery.ThisresultedonlyinastrikeofGerman

workers,andinanefforttoaidtheseworkers,theGermangovernmentsimply

beganprintingmoremoney.Averagewholesalepricesrose“fromanindexof1,400

(wherepricesweremeasuredas100in1913)to126,000,000,000,000inDecember

of1923”(Mayhew1).Themarkwasrenderedworthlessandwasreplacedin

November(aftergreatdamagetothemiddleclass)bytheRentenmark,anentirely

Karczmarczyk 12

newcurrency.TheGermangovernmentalsoraisedtaxesatthistime.The

RentenmarkwasthenlaterreplacedbytheReichsmarkwiththeDawesPlan.

TheDawesPlan,createdbyaninternationalcommitteeofbothmoderates

andextremists,waskeyforGermany.AnnouncedinApril1924,itcreateda

reparationschedulebeginningwith“1billiongoldmarksforthefirstyear,2.5

billioninthefifth…[and]providedroomforchangesifgoldpricesmovedupor

downby10percent(Kindleberger294).Theprovisionsincludedbotha

ReparationsAgency,establishedinBerlintooverseefinances,andareorganization

oftheReichsmark.Finally,andmostimportantly,theDawesPlancreateda

provisionthatallowed800Reichsmarktobesoldonvariousmarkets.Despite

protestsonthesideoftheFrench,thegovernmentsofbothFranceandBelgium

appliedheavypressuretoprivatebankerstohavethemhandlethesharesofthe

loan.Forawhile,thissolutionseemedtowork,andGermanywasabletomakeits

paymentsonschedule.

Asitturnsout,thiswasadeceptivereality.Americanprivateinvestors,

particularlyoutofNewYorkCity,hadbeenmakinglargedollarloanstoGermany.It

wasthesedollarsthatwereusedtomakereparationpayments,whichtheAlliesin

turnusedtomakewardebtpayments(Dillard520).Wardebtswere“incurredfor

assistanceandforshipmentfromtheU.S.ofgrain,cotton,andothersuppliesduring

thewar”(Mayhew2).TheAmericansinsistedonthese,notfromGermany,butfrom

theAlliedforces.TheAmericangovernmenthad,however,madeitabundantlyclear

thattheydidn’twishtoreceiverepaymentintheformofgoodsbyinstituting

Karczmarczyk 13

ridiculouslyhightariffs.Withthiscycleofloansandwardebtpayments,theUnited

Stateswasessentiallypayingitself.

ReturntoGold.Duringthisinterwarperiod,thegoldstandardhadbeenlargely

abandonedwithonlyUnitedStatesandafewothersmallcountriesstillmaintaining

it.Thereasonforthisisthatcrucialaspectofthegoldstandardnolongerexisted:

moneywasnolongerexchangeableintogold.However,therewasstillastrong

desiretoreturntotheprewarsystemduelargelytothefactthatithadfacilitated

largeamountsofinternationaltradeandglobalization.Sobetween1923and1928

morethanthirtynationsrestoredthegoldstandardinsomeform(Dillard538).

Thegreatestdecisionconcerningthis,however,wasnotwhethertorestore

thegoldstandard,butratheratwhatleveltosetit.InGreatBritainthisdebates

existedoverwhethertheyshouldfixthepoundsterlingtoitsprewargoldcontent

orattheexistingpostwarvalueinrelationtoothercurrencies(Dillard538).

EventuallyitwasdecidedthatBritainwouldreturntothegoldstandardatthe

prewarlevel.Theyweretodothisbypermittingfreeexportofgoldbullionafter

April1,1925.Yetwhenthisdecisionwasmade,thepoundwasnowhereasstrong

asithadbeenintheprewaryears.Prewar,thepoundwasvaluedat$4.40,butin

thisinterwarperiod,itwasaround$4.87(Dillard538).Toreturntogoldmeantthat

thepoundwouldhavetoappreciate,andsotorestoretheparratiobetweenthe

dollarandpoundmeantthatpricesneededtoeitherriseintheUSorfallinthe

UnitedKingdom.GiventhestabilityoftheUnitedStatesinthepostWWItime

Karczmarczyk 14

period,thisfelltoBritain.Essentially,inordertomakethegoldstandardwork,

GreatBritainwouldhavetodeflateitspricelevels.

TheBritishwereencouragedtothenrelymoreheavilyonimportsasthe

Britishpoundsterlingwouldnowbuy10percentabroadmorethanbeforeandvery

littlemoreathome(Dillard539).Thisledtoanadversebalanceoftrade,but

meetingthisadversebalancebypermittinggoldtobeexportedwasundesirabledue

tothelowlevelsofgold.SotheBankofEnglandthenoptedtoincreasethebankrate

inorder“toattractloanstoBritaintocoverthedeficitinthebalanceofpayments”

(Dillard539).Thisultimatelyledtohousingshortages,unemployment,andlittle

construction.TheBritisheconomy“didnotenjoytheexpansionofproductionthat

tookplaceelsewhere”(Mayhew3).

TheBoom(19251929)

Withmostcountriesnoweitheronthegoldstandardormovingtowardsit,

“normalcy”seemedtoberestored.Butthistimewasnotwithoutitstensions.Inthe

timebeforetheWorldWar,Londonhadbeenthecenterofthefinancialworld,and

theBankofEnglandwasthelenderoflastresort.Duringthe1920s,however,

Europebecameunabletofunctionastheworld’sbanker.Britainhadcontinual

difficultyofmaintainingthepoundat$4.87whilehighinterestandunemployment

ratespersisted.Importanttonoteisatthesametimeofthisovervaluationofthe

pound,therewasanunderevaluationoftheFrenchfranc,whichhadledtoapileup

ofsterlingintheFrenchmonetarysystem(Kindleberger354).

Karczmarczyk 15

RoleoftheUnitedStates.Inlightofthis,theUnitedStatessteppedinto

replaceBritainastheworld’sbankerbyofferinglong‐termloans.Americanbanks

lentinverylargesumsandtheseloansledtoahighdependencylevelofEuropeon

theUnitedStates.Atthesametime,however,Americaneconomicpolicy“placed

majorobstaclesinthewayofrepaymentofloans”(Dillard541).Havingbeenin

suchalargecreditorrole,theUnitedStatesshouldhaveincreaseditsimportsin

orderforforeignerstohavetheopportunitytoearndollarswithwhichtheycould

thenservicetheirdebt.Loweringtariffswouldhavedonethis.TheUnitedStates,

however,didjusttheopposite.Inboth1922and1930,tariffsreachedtheirhighest

pointinhistory.Thoseforeignerswhohadreceivedloanspaidtheinterestontheir

debtstemporarilyoutoffurtherloansratherthanfromincreasedproductivity

(Dillard541).

Theboom,however,existedbecauseofanddependedlargelyuponthe

UnitedStates,whoseeconomywasbeginningtoshowsignsofweakening.

Consumerbuyingwasslowing,debtreacheditshighestlevelyetseen,and

constructionslowedconsiderablyasthedemandofnewhousingevaporated

(Mayhew4).Theseconditionsontopofthehightariffsputtheportionoftheworld

thatdependedontheUnitedStates(whichatthetimewasaconsiderableamount)

inaprecarioussituation.

Reparations.Reparationswerealsobecomingincreasinglyworrisomeduring

thistime.Theywerebeingfinancedbyborrowing,buttheyremaineddifficultto

maintain.Germanyinparticularwasbeginningtocrackunderthestrain.Inorderto

Karczmarczyk 16

meettheimmenseobligationsofthereparationagreements,Germanywouldhave

to(1)builduptremendouslyitsindustrialproductivecapacity;(2)haveexportsin

excessofimportsbyatleasttheamountofreparations;(3)disposeofthehuge

exportsurpluseitherdirectlytotheAlliesorsellincompetitiveworldmarkets;(4)

keepdomesticconsumptionfarbelowdomesticproductionforseveralgenerations

byheavytaxation(Dillard517).Eachoftheseprovedtobeultimatelyimpossible,

anditwasn’tlonguntilGermanywasnolongerwilling“toproducegreatsurplus

wealthforthebenefitoftheirvictoriousenemieswhiletheGermanstruggledator

nearsubsistence”(Dillard519).Thesedeterioratingconditionsledtotensionsthat

wouldultimatelyresultinacollapse.

Primaryproductinventories.Asafinalnote,Europeanrecoveryinthe

productionofprimaryproducts,suchasgrain,hadledtopricesto“turnsoft”as

earlyas1925(Kindleberger355).Thismeansthatasinventoriesofsuchproducts

begantogrow,pricesbegantofall.Theconsequencesofthishadthegreatest

ramificationsincountriessuchasAustraliaandNewZealandwhodependedon

exportoftheseproductsandforagriculturalregionsoftheUS.Essentially,theworld

had“morecapacitytogrowfoodthanithadcapacitytobuyfood”(Mayhew4).

TheCollapse(19291933)

Thetensionsduringtheboomperiodwererealizedwhenin1928foreign

lendingfromtheU.S.begantodrop.Schacht’scampaign,anattemptagainstGerman

borrowinginNewYork,resultedinaswitchtoshort‐termloans.Depressionin

Germanyhadstartedalittleearlier(around1927)andthehigherinterestrates

Karczmarczyk 17

necessarytoattractshort‐termfundspushedproductionstilllower(Kindleberger

355).Unemploymentroseexponentially,andtheFrankfurtInsuranceCompany

failedinAugust1929.IntheUnitedStates,thestockmarket,despitetheFed’sbest

efforts,begantorise.Inanefforttocombatthis,theFedraisedthediscountrate.

ThisWallStreetboominU.S.stocksledtostillafurtherdropinlong‐termlending.

Aroundthesametime,theBankofFrancepulledgoldoutofLondondueto

irritationovertheYoungPlan,whichinturnresultedinatightersituationinBritain.

TheBankofEnglandraiseditsdiscountratefrom5½percentto6½percenton

September26,1929.ThisledtopressureinScandinaviawherediscountrateswere

alsoraisedinanefforttokeepinlinewithBritain.Therewasacertainworryatthis

pointthatGreatBritainwouldbeforcedoffthegoldstandard,butsuchfearswere

delayedwiththestockmarketcrashonOctober24andthesubsequentBlack

TuesdayonOctober29(Kindleberger355).

DeclineinProduction.Bymid‐1929productionofgoodsandservicesbegan

tofallsharplyworldwide(Mayhew5).Itbecameincreasinglydifficulttonegotiate

thetermsonwhichgoodscouldbeconvertedintomoney,andsoonlossesreplaced

profits,“meaningthatattheendofaturnoverofcapitaltheproducershadless

moneythanatthestartoftheturnoverperiod”(Dillard543).Thegoalbecameto

conserve,notexpand,andgoodswhichcouldnolongerbeconvertedeasilyto

moneybecame“worthless,”atleasttothecapitalisticnotionsofthistime.Thisidea

playedoutinternationallyintheformofgold.Creditwasnolongeraworthy

substituteofmoney,andthusproductionhaltedinanefforttokeepgoldcloseto

home.Thisledtohugedeclinesinproductionandinemployment.Asthecycle

Karczmarczyk 18

continued,thesituationworsened.Considerthefollowingchart(whichassumesa

standardproductionof100for1929):

Mayhew,Anne.“NotesontheInterwarEconomiesofWesternEurope.”

DeparturefromtheGoldStandard.Aslong‐termAmericanloansendedand

internationaltradefell,debtornationssoughttoborrowshorttermathighinterest

ratesinanefforttocovertheirdeficits.Suchactionsmighthavebeensuccessfulif

thedepressionhadendedsoonthereafter,butwiththecontinuationofsuchadeep

depression,thehighinterestratesonshort‐termloansjustdrovethedepression

deeper.

PanicreachednewlevelsintheworldmoneymarketsinMay1931whenthe

largestbankinAustriacrashedduetothebadloanstheyhadmadetothe

agriculturalregionsofcentralEurope.Thisinturncausedacompletelackof

confidence,andmoneymarketsbegantocrashallovertheworld.London,New

0

20

40

60

80

100

120

U.K. France Germany U.S.A.

1929

1932

Karczmarczyk 19

York,andBerlinwereamongthem.Priortothiscrash,itisimportanttonotethat

duringtheearlymonthsof1931,theReichsbankhadlostnine‐tenthsofitsgold

reserve,whichhadresultedinseveralGermanbanksclosureandadiscountrateof

15percent(Dillard542).Germanyundernormalcircumstanceswouldhavegone

offthegoldstandardandallowedthecurrencytoreachitsnaturallevelin

internationalexchanges,buttherecenthyperinflationkeptthispolitically

impossible.Instead,Germany“suspendedallforeignpaymentsandimposedrigid

exchangecontrols”(Dillard542).

SuspensionofpaymentsinGermanyhadramificationsinBritain,where

Britishcreditswerenowfrozenanduncollectable.DepositorsoftheBankof

Englandbecamealarmedandbegantowithdrawheavily,despitetheBankof

England’seffortsinraisingthediscountrate.Ultimately,theylostmorethan200

millionpoundswithinjusttwomonthsofGermany’sforeignpaymentsuspension

(Dillard543).ThefinalblowcameonSeptember20,1931,afteraweeklong“gold

rush”wheregoldreservesdroppedtodangerouslevels.TheBankofEngland

decidedtosuspendgoldpayments,andofficiallytooktheUnitedKingdomoffofthe

goldstandard.Reparationshadalsostoppedentirely.

ReactionandRecovery(19331939)

Manycountriesquicklyfollowedsuitandtookthemselvesoffofthegoldstandard.

By1932,thirty‐fivecountrieshadcomeoffofthegoldstandard,eachwithdifferent

results.IntheUnitedKingdom,therewasasighofrelief.Theyenteredaperiodof

milddomesticinflation,increasedemployment,andrisingbusinessexpectations

Karczmarczyk 20

(Dillard544).Ofthelargenations,onlyFranceandtheUnitedStatesattemptedto

stayongold,andthey,inturn,sufferedforit.FrenchandAmericanexportersfound

thatnoonewantedtobuytheirgoodsbecausetheircurrencywasvaluedmuch

higherthanothers,andwhentheyfuthererectedhightariffsandimportquotas,

theysealedthemselvesofffromworldtrade.Theyimposedonthemselves

“continuingdeflationofdomesticpricestotheaccompanimentofrising

unemploymentandstilldeeperdepression”(Dillard544).

TheUnitedStatesfaceddeeperproblemsstillwhenforeignwithdrawals

coupledwithincreasingdomesticdemandforgoldcausedagoldcrisisduetothe

lackofcredit(Dillard544).Bankrunsbecameincreasinglymorecommon,andin

turn,thehoardingofgoldledtoaliquiditycrisis.Whenmorethan5000banksfailed

intwoyears,theUnitedStatestemporarilyclosedallbanksinMarchof1933.Soon

thereafter,theU.S.suspendedgoldandwasforcedoffthegoldstandard.France

collapsedsoonafterward,anactionwhichwouldresultinadecadeofmoderately

inefficiencyonthepartoftheFrenchgovernment.SowithFranceandtheUnited

Statesnowofficiallyoffgold,thegoldstandardandinternationaltradecrumpled.

AroundthistimetheNazis,however,werebeginninganactiveprogramof

recoverytoadepressedaGermany.Theunemployedwereputtoworkbuildingup

domesticinfrastructure.UnderthesecondFour‐YearPlan,beginningin1937,

rearmamentbecamethemostimportantaspectofGermanpolicy.By1938,

Germany’sindustrialproductionhadmorethandoubledits1932output(Dillard

558).TheeconomyduringWorldWarIIisbeyondthescopeofthispaper,butletit

Karczmarczyk 21

sufficetosaythattheGermansgaveanincredibleeconomicperformanceduringthe

war.Theaftermath,however,leftEuropeonceagaininruins.

TheBrettonWoodsEra(19441971)

Inanefforttokeepthishistoryconcise,Iwillnotbediscussingthewartime

economy,asitwithinitselfhadnodirecteffectontheevolutionoftheinternational

monetarysystem.Iwillinsteadmovedirectlytothepost‐warperiod,whichbegan

in1944.TheBrettonWoodsEracanbedividedintothreesubperiods:

Preconvertibility(1944‐1958),thePrimeYears(1959‐1967),andtheCollapse

(1968‐1971).Beforeexploringeachofthese,Iwillfirstdiscussthevisionofthe

architectsofBrettonWoods,asitisatellingstatementofthementalityofthe

period.

TheVisionoftheBrettonWoodsArchitects

Thesituationdirectlyfollowingthewarandtheexperienceoftheprevious

monetarytimeshadadirecteffectontheideasaboutanewinternationalmonetary

order.TheoriginalgoaloftheBrettonWoodssystemwastocombinethe

advantagesoftheclassicalgoldstandardwiththeadvantagesoffloatingrates.At

thesametime,theplanningofanewinternationalorderwaspredicatedonthe

beliefthatthemistakesoftheinterwarperiodweretobeavoided.Europewasalso

strugglingwiththerecoveryfromthedevastationofthewar,andhavingjustcome

offatimeoftwoworldwars,theinternationalcommunitysoughtasystemthat

wouldpromotepeaceandinterdependence.

Karczmarczyk 22

WorldWarIIresultedinpowershiftsthatinturnslanteddiscussionsofthe

creationofanewsystem.TheUnitedStateshademergedfromthewarasthe

strongestandrichestpowerintheworld,butGreatBritainhadbeenseverely

weakened(Bordo31).Againstthebackdropofwartimediplomaticnegotiations,

thesetwocountriesagreedtobeofassistancetoeachotherinthepost‐warworld.

JohnMaynardKeynesoftheBritishTreasuryandHarryDexterWhiteofthe

AmericanFederalReserveeachdraftedtwoplansofwhattheybelievedthepost‐

wareconomyshouldlooklike.Acompromisebetweenthesetwoplans,followinga

periodoftoughnegotiations,ledtotheJointStatementbyExpertsonthe

EstablishmentofanInternationalMonetaryFund,whichinturnservedasthe

workingdraftattheBrettonWoodsconferenceandleddirectlytotheArticlesof

AgreementoftheInternationalMonetaryFund.AlongwiththeIMF,BrettonWoods

alsocreatedtheWorldBank.

TheArticlesofAgreement.TheArticlesofAgreementwasacompromiseand

incorporatedaspectsofbothplans,butultimately,duetoitsnewworldpower

status,theUnitedStatesdominatedtheconcerns.Theobjectivesofthefundwere

“topromoteinternationalmonetarycooperation,tofacilitatethemaintenanceoffull

employmentandrapidgrowth,toproveamultilateralpaymentssystemand

eliminateexchangerestrictions,toprovideresourcestomeetbalanceofpayments

disequilibria,andtoshortenthedurationandlessenthedegreeofpayments

disequilibria”(Bordo35).

Karczmarczyk 23

Themethodthatthissystemwastoworkwasthreefold.First,allcurrencies

weretobetreatedasequalinthearticles.Ideally,eachcountrywasrequiredto

maintainitsparvaluebyinterveninginthecurrencyofeveryothercurrency,butin

reality,theUnitedStateswastheonlycountrythatpeggeditscurrency(intermsof

gold).Theotherssimplyfixedtheircurrencyintermsofthedollarandintervened

onlytokeeptheirexchangerateswithin1%ofparitywiththedollar(Bordo37).

Second,countrieswouldusetheirreservesordrawreservesfromtheFundto

financepaymentsdeficits.Third,capitalcontrolswererequiredtoprevent

destabilizingspeculationfromforcingmembertoaltertheirparitiesprematurelyor

unintentionally(Bordo37).Intheend,however,thegoalsofBrettonWoodsrealin

manywaysnotrealized,andtheinternationalmonetarysystemevolvedintoagold

dollarstandard.

Preconvertibility(19461958)

Reparations,whichwereoneofthemostdifficultproblemsinpost‐WWI,were

mostlyeliminatedafterWorldWarII(Kindleberger413).Yetevenstillthe

transitiontofullconvertibilitywasmuchmoredifficultthanhadbeenpreviously

thought.Thiscanbeattributedinitiallytotwointerrelatedproblems:bilateralism

andthedollarshortage.

Bilateralism.Duringthewar,manycountrieshadutilizedasystemof

exchangecontrols,whichwasatechniqueusedtoregulateinternationaltradeand

capitalmovements.Governmentswouldrequiresuchactionsasrequiringexporters

tosurrendertheforeignmoneyreceivedfromsalesabroadandrequiringimporters

Karczmarczyk 24

topurchaseforeignexchangefromauthorizedbanks(Dillard546).Suchcontrols

tendedtopromotebilateralarrangementsinforeigntrade.Themottowas“ifwe

buyfromyou,youmustagreetobuyfromus”(Dillard547).NearlyallEuropean

countriesusedthissystem.

Withthecreationofanewinternationalorder,thegoalwastoeventually

eliminatethese.UnderArticleXIVoftheBrettonWoodsagreement,“countriescould

continuetouseexchangecontrolsforanindefinitetransitionperiodafterthe

establishmentoftheIMFof1March1947”(Bordo38).Therationalegivenfor

continuingtheseduringthistransitionperiodwastheshortageofinternational

reserves.Controlswereneededtoallocateashortageofbothimportsandexports.

AsianandEuropeaneconomieswereinruinsafterthewar,andinordertoincrease

theirexportcapabilities,theyneedednewandimprovedcapital.Atthesametime,

therewasashortageofimportsineverythingfromcapitalequipmenttothe

necessitiesoflife(i.e.food).Thebilateralagreementshelpedcreateatemporary

systemoflicensesandquotasforimportsandexportsthroughthecentralbank.

TheDollarShortage.Europe’spostwarbalance‐of‐paymentscrisiscame

aboutduetothebreakdownoftheinternationalfinancialsystem.Reasonsinclude

thestrengthoftheUnitedStates,theEuropeanliquidationofforeigninvestments

earlyinthewar,thecutofftoEurope’schiefsourceofprewardollarsupplyin

southeastAsia,increasesinpopulationinunderdevelopedareas,theriseofpricesof

theprimaryproductimportedrelativetopricesofthemanufacturedgoods

exported,andthesplitbetweenEasternandWesternEurope(Dillard657‐648).The

Karczmarczyk 25

shortenedversionbeingthatEuropehadforyearsbeendependentuponexternal

marketsforexportsandforeignsourcesofsupplyforfoodandrawmaterials,andit

wasarguedthatthebalanceofpaymentsdeficitsfacingmostcountriesreflectedthe

incapacityoftheirexportindustries(Dillard645).Sinceatthistime,theUnited

Statesheldtwo‐thirdsoftheworld’smonetarygoldstock,theysuppliedtheneeded

imports(Bordo38).TheIMFwasalsopressuringmemberstodeclareparvalues.

Manybelievedthissituationtobepermanentduetothelargeamountofreservesin

theUnitedStatesandthedepletedamountinEurope.Suchargumentswerebased

ontheideathatEuropewouldneverreachtherateofproductivityofthatofthe

UnitedStates.

SuchasituationwasnotpreferableforeitherEuropeortheUnitedStates.In

ordertoachieveastronginternationalsystemandrestoreEurope’sequilibriumin

internationalpayments,theUnitedStatesimplementedtheMarshallPlan.Shortly

thereafter,aEuropeanPaymentsUnionwasformed,dollarconvertibilitywas

restored,andthedollarbecamethekeycurrency.

TheMarshallPlan.InanefforttoaidEurope,theAmericanSecretaryofState,

GeorgeC.Marshall,proposedaboldplantorestoreEurope’sequilibriumthrough

“massiveAmericanfinancingandintra‐Europeanplanning”(Dillard648).All

Europeannations,withtheexceptionofGermanyandSpain,wereinvitedtojointhe

conference,atwhichthelogisticsoftheplanwouldbeworkedout.Itwaswell

receivedinWesternEurope,butinEasternEurope,theysnubbedtheidea,largely

duetoSovietinfluence.Thus,itbecameawesternEuropeanRecoveryPlan,whose

Karczmarczyk 26

maingoalwas“tocoordinatetherecoveryeffortsofseventeencountriesand

financetheirdollarneeds(Dillard649).

TheUnitedStatespassedtheEconomicCooperationActof1948,which

officiallycreatedtheMarshallPlan.Inordertoadministertheplanfromthe

Americanside,theEconomicCooperationAdministration(ECA)wascreated.The

MarshallPlanchanneledabout$13billioninaidtoWesternEuropebetween1948

and1952(Bordo41).Thiswasconsiderablylessthantheprojectedoutlaysof17

billion(Dillard649).Itspurposewasto“helptheEuropeancountriesexpandtheir

economies,restoretheirexportcapacity,andbycreatingeconomicstability,

preservepoliticalstability”(Bordo41).Itrequiredthatallparticipantscooperatein

tradeandpaymentliberalization.

Thus,aEuropeancounterparttotheECAwasneeded,andinresponsetothis

needtheOrganizationforEuropeanEconomicCooperation(OEEC)wascreated.Its

responsibilitywastocreateaprogramforachievingabalanceofinternational

paymentswithinthefouryearsallocatedintheMarshallPlan(Dillard649).It

managedtheallocationoftheborrowedmoniestotheindividualnations,whichwas

donebasedonsizeoftheiraccountdeficits.Therecipientswererequiredtothen

matchthefundsintheirlocalcurrencytohelpinproductivityinvestmentin

infrastructure,industry,andagriculture.Asafinaloverarchinggoal,theOEECtried

topromoteeconomicinterdependencewithinWesternEurope,anideathatwould

takeonmorecreditatalaterdate.TheEPUwasalsocreatedontheEuropeanside,

whichisanorganizationIwilldiscussinmoredetaillater.

Karczmarczyk 27

TheMarshallPlanwasincrediblysuccessfulinaveryshortamountoftime.

By1952,theOEECcountrieshadachieveda39%increaseinindustrialproduction,

adoublingofexports,anincreaseinimportsbyone‐third,andacurrentaccount

surplus(Bordo42).ThechartbelowshowsindustrialrecoveryinWesternEurope

from1938until1950.Itstartsatbasepoint100.

COUNTRY 1938 1947 1948 1949 1950

Belgium 100 106 114 116 120

France 100 92 108 118 121

Germany,West 100 33 50 75 96

Italy 100 86 91 96 109

Netherlands 100 95 113 127 139

UnitedKingdom 100 115 128 137 150

Average 100 88 101 111 122

Dillard,Dudley.“IndustrialRecoveryinWesternEurope.”

EuropeanPaymentsUnion.EuroperespondedtotheECArequirementofthe

liberalizationoftradebycreatingtheEuropeanPaymentsUnion(EPU)in

September1950.Itspurposewastosimplifybilateralclearingandmovetowards

multilateralism,whichitdidbyactingthepartofacommercialbankclearinghouse.

Meaningthatitprovidedeachmembercountrywithonlyonesinglenetcreditor

Karczmarczyk 28

debitwiththeEPU.CreditsearnedbysellingtooneEuropeanmemberoftheEPU

couldoffsetdebitsincurredinbuyingfromsomeothermember(Dillard649).The

formeroperationofbilateralagreementswassuppressed,asitdoesn’tfunctionas

wellwithaneconomicalallocationofresources.TheECAcontributed$350million

totheEPUtobeusedforinitialworkingcapital.

TheEPUwasincrediblysuccessfulandsoonbecamethecenterofa

“worldwidemultilateralsettlementarea”(Bordo43).Italsoprovidedthemiddle

steptowardcurrencyconvertibility.Europeancurrencyatthistimewasnoteasily

transferrableintodollarduetothepersistentdollarshortage.Sowhilethis

organizationfosteredintra‐Europeantrade,internationalworldtrade,particularly

withthosenationspeggedtothedollar,wasdifficult.

RestoringConvertibilityandtheRiseoftheDollar.Depreciationofthepound

sterling,theDeutschemark,andseveralothercurrenciesagainstthedollarin

September1949helpedmanyEuropeancurrenciesmovetowardsconvertibility.At

theendofthe1950s,thefinalstepwastaken.PresidentCharlesdeGaulle(France)

depreciatedthefrancandshiftedtothe“newfranc”(Kindleberger430).Britain

tookthisopportunitytorestorethepoundtoconvertibility.OnDecember27,1958,

eightcountriesdeclaredtheircurrenciesconvertibleforaccounttransactions

(Bordo43).Withthisnewconvertibility,theEPUwasnolongeruseful,andthe

EuropeanMonetaryArrangementwouldsoonreplacetheEPUasameansof

currencyconsultation.

Karczmarczyk 29

Sowiththis,thedollarbecamethecurrencyofchoice,anditwasfrequently

thoughtthatthedollarwas“asgoodasgold.”Theriseofthedollarcanbeattributed

tothesizeoftheroleoftheUnitedStatesinthisnewworldeconomy,itsimportance

inworldtrade,anditsopencapitalmarkets(Bordo47).Thedollarwastheofficial

internationalmoneyofthistime,anditsimportanttonotethesimilaritiesbetween

thisandthegoldstandard.Insteadofpeggingcurrenciestogold,countriespegged

themtothedollar,anditwasnolongerGreatBritainasthefinancialcenterofthe

world,buttheUnitedStates.Thesekeypointsareimportanttorememberandwill

shapetheremainderofthehistoryoftheinternationalmonetarysystem.Itisalso

importanttonotethattheoriginalvisionofthearchitectsattheBrettonWoods

Conferencewasnotmet.TheoriginalroleoftheIMFhadbeen,inmanyways,

replacedbytheEPU.Withconvertibilityrestored,however,thesystemseemedto

beoperatingsmoothly.

ThePrimeYears(19591967)

OneofthemostimportanteventstohappenduringtheprimeyearsofBretton

WoodswastheeconomicintegrationofEurope.Additionally,therewasaseriesof

issues,whichwouldleadtoanevenfurtherdeviationfromtheoriginalgoalsofthe

BrettonWoodsarchitects.Thesewereadjustment,liquidity,andconfidence.Inthis

section,IwillfirstexplorethebeginningsofEuropeaneconomicintegration,and

thenmovetodiscusstheseproblemsthatplaguedthis“heyday”era.

EuropeanIntegrationundertheCommonMarket.TheideaofEuropean

integrationhadbeenaroundformanyyears,butwiththenewpoliticalspheresafter

Karczmarczyk 30

thesecondWorldWar,thepossibilitybecamereality.Themostimportant

predecessoroftheEuropeanCommonMarketwastheEuropeanCoalandSteel

Community.Itwasestablishedin1952byFrance,Germany,Italy,Belgium,the

Netherlands,andLuxembourg.Theobjectivesetforthwas“themostrational

distributionofproductionatthehighestlevelofproductivity”(Dillard654).”They

didsooriginallybyabolishingallcustomsandtradebarriersamongthenations.

Tariffsatthebordersweremadeuniform,andownershipoffacilitiesinanyofthe

nationscouldbemadepublicorprivate(Dillard654).Politically,theunionfaced

difficulties,mostadamantlythatbetweentheoldrivalriesofGermanyandFrance.

Thesepoliticaldiscoursesarebeyondthescopeofthispaper,butletitsufficetosay

thattheeconomicintegrationlentapeacetothecountriesthathadyettobe

experienced.

ThisexperimentthenledtotheEuropeanEconomicCommunity(EEC),also

knownastheCommonMarket.ItincludedtheoriginalsixmembersoftheEuropean

CoalandSteelCommunity,butbroadeneditsscopebeyondcoalandsteel.Themain

purposesweretheeliminationsofcustoms,duties,andquantitativerestrictionson

importsandexports;acommonexternaltarifftotherestoftheworld;thefree

movementofproductionfactorswithinthesixcountries;andageneralclose

economicintegrationthroughdomesticpolicies,includingagriculture,employment,

andtaxation(Dillard565).

TheTreatyofRomesolidifiedtheseeconomicgoals,andwhileitdidn’t

specificallyprovideforpoliticalintegration,itdidprovidethepoliticalinstitutions

Karczmarczyk 31

forimplementingeconomicpolicies.TheseinstitutionsincludetheEuropean

Commission,aCouncilofMinisters,anAssembly(themoderndayParliament),and

aCourtofJustice.ThesecreatedthemoderndayBrusselsandhelpedfacilitatea

laterpoliticalintegration.

ProblemsofthePrimeYears.Thethreeproblemsofadjustment,liquidity,and

confidencewereallinterconnected.TheUnitedStateswasnotoverlyconcerned

withitsbalanceofpaymentsinthe1950s.Thecurrentaccountbalancewaspositive,

andtheexcessliquidityandlendingoftheearly1950sledtoastrongconfidencein

thedollarbytheendofthe1950s.Thisconfidence,however,wasbeginningtoebb.

EconomistsbegantoworrywhatwouldhappenwhentheUnitedStatescorrected

itsliquiditydeficit.Bythis,theymeanthatintheUnitedStates,noaccountwas

takenofU.S.short‐termorlong‐termclaimsontherestoftheworld.Itwas

implicitlyassumed“thatforeignclaimsonthedollarwerelikelytobeencashed

momentarily,whileU.S.short‐termassestswereilliquid”(Kindleberger453).Thisis

problematicbecauseunderaliquiditydefinition,theUnitedStateshadbeenina

balanceofpaymentsdeficitasearlyas1951.

Manyarguedthattheidealsolutionwasreplacingbothgoldanddollarswith

SpecialDrawingRightsfromtheIMF.Othersstillarguedthatthisbalanceof

paymentswasmisleading.Theysaidthat“bankingcenterswerenotindeficitwhen

theylentlongandborrowedshort,providingliquiditytotherestoftheworld”

(Kindleberger453).ThiswouldmeanthattheUnitedStatesitselfwasactingasa

bankandthatbankswerenotindisequilibriumwhentheirdepositsroseeachyear

Karczmarczyk 32

alongwiththeirloans.Overall,thesewerebothoverlyoptimisticideas.Inorderfor

thistooperateeffectively,bankswouldneedaparallelriseofreservesalongwith

theirincreasesinloansanddeposits.

Giventhelosstheconfidence,thisgolddidn’tresultinariseofreserves,but

insteadwassoldtohoarders.Centralbankstookadditionstoreservesandeven,at

somepoints,wereconvertingthedollarsintogold.CentralbanksacrossEurope,

andtheworld,withdrewfromthegoldpoolin1960toholddownthepriceofgold.

TheFrenchgovernmenttookparticularaction.Theyoptedto“convertdollarsinto

goldasameansofdiscipliningtheUnitedStates”(Kindleberger453).Thisworked

untiltheyfoundthemselvesindireneedofdollarsasameanstosupportthefranc.

Yettheywerestillhesitanttosellgoldfordollars,soinsteadtheyundertookofficial

borrowingofdollarsintheEurobondmarket.

TheCollapse(19681971)

IntheUnitedStates,itwasdecidedthattheidealactionwouldbetobreakup

thegoldpoolandadoptatwo‐tiersystemforgold.Thispermittedtheprivateprice

toriseabouttheofficial$35.00anounce.Atthesametime,strongforeingpressure

wasexertedagainstforeigncentralbankchangingdollarsforgold,and“anumber

offinancialinstrumentswithexchangeguaranteesweremadeavailablebytheU.S.

Treasurytoofficladollarholderstoforestallgoldpurchases”(Kindleberger453).

TheUnitedStateswasfacingaseriouslossofconfidencethatthreatenedto

underminetheentiresystem.

Karczmarczyk 33

Comparabletothesummerof1931thesmallcountriesofEuropewent

aheadwiththeconvertingofdollarstogold.ThisinturnledtotheConnollyshockof

August1971,whichthenledtothesecretaryofthetreasuryimposinga10percent

importsurtaxinanefforttodevaluethecurrency.TheUnitedStatesfirstraisedthe

goldpricethento$38.00andthento$42.50,anditalsowideneditspermissiable

rangeoffluctuationagainstthedollarfrom1.5%to2.25%.

Errorsinmonetarypolicyandalsotheenormousoutflowofdollarstothe

Eurocurrencymarketin1970contributedtothebreakdownofBrettonWoodsas

well.RichardNixon’sreelectioncampaignhadhiseconomistsveryanxiousabout

creatingaprosperouseconomyby1972.Tothisend,theFederalReservesystemin

1970startedtolowerinterestrates.Thishappenedatthesametime,however,that

theBundesbankofGermanywasseekingtorestrictinflationinWestGermany.They

didsobyraisingtheirinterestrate.Thesepoliciesweren’tseparatedbygeographic

region,butwereinsteadinterconnectedthroughtheEurodollarmarket.The

resultingflowofdollarsultimatelylefttheliquiditydefintionbalanceofpayments

deficitintheUnitedStatesatamuchhigherrate.It,infact,rosefroma“$2‐4billion

ayearaverageinthe1960stoa$20billionin1970anda$30billionin1971”

(Kindleberger454).

Noneofthemeasurestakencouldcombattheeventsunfolding.The

confidenceinthedollarhadfallentoanalltimelow.Thesepressureseventually

causedPresidentNixontoendallgoldconvertabilityonAugust15,1971.This

Karczmarczyk 34

effectivelyendedtheBrettonWoodsera.Severalattemptsweremadetofixthe

systeminthenextfewyearsbutwithoutanysuccess.

TheDirtyFloat(1971present)

Therecentyearshavebeenmarkedbyseverecrisesandunevenmonetary

policy.Manyofthesespecificsarebeyondthescopeofthispaper,butIwillinstead

giveabriefoverview.InFebruaryof1973,thecurrencywassetfreetofloat.This

meansthatnolongerwascurrencypeggedtogold,butinsteadtheexchangerates

againstothercurrencieswereallowedtobedeterminedbythemarket.Many

economistsweresurprisedbyitseffects.Manythoughtthatitwoulddothesameas

ithadinthe1930s,andthatflexibleexchangerateswouldinhibitcapitalflows

becauseoftheuncertaintyofexchangerisk.Thisturnedouttonotbethecase.Ifone

neededasubstantialamountofcapital,itwasnecessarytoborrowdollars

(Kindleberger455).Quantityturnedouttobemoreimportantthanquality.

Economistsalsothoughthatthefloatingdollarwouldloseitspreeminence

anditsroleoftheinternationalunitedofaccount,standarddeferredpayment,store

ofvalue,andmeansofpyaments.Again,thesepredictionswereprovedtobewrong.

Itwasperhapsnotasstrongasithadbeeninthepast,butintheimmediate

aftermathoffloatingexchangerates,thedollarstillmaintaineditsrole.TheSDRof

theIMF,whichwaspreviouslymentioned,neverwasseenassatisfactory

alternative,andnevergainedanypositionintheinternationalmonetarysystem.

Atthesametime,however,thisperioddidbeginatimeofseverecrisesand

monetaryupheaval.ItisimportanttonotethatEuropeandependenceonthedollar

Karczmarczyk 35

hadbeenwellnotedbytheEuropeansafterthecollapseoftheBrettonWoodsera.

Afterthisseriesofevents,theEuropeanideaofacurrency(theEuro)beganto

reallyformulate.TheEuropeanMonetarysystemwasbasedlargelyonGerman

fiscalsense,afactthatwillbecomeincreasinglyimportantinlateryears,andwillbe

discussedatalaterpoint.

Itsalsoimportanttonotethatworldbanks,whichwerefullofnewfunds,

afterthebalanceofpaymentsproblemintheUnitedStates,startedtolookfornew

opportunitiestolend.Thisinitiatedtheboominsyndicatedbankloanstosovereign

states,especiallyinLatinAmerica.Theboominlendingwentunnoticedthroughthe

1970s.Bankerstrustedthatthesedevelopingcountrieswouldnotrepudiateon

theirloans.ThisawakeningoccurredinAugust1982forthefirsttimewhenMexico

failedtomakeitsinterestpayment.

ConclusionsfromtheDirtyFloat.Overalltheinabilityoftheinternational

monetarysystemtoreconstructasystemofpeggedbutadjustableexchangerates

failedrepeatedly.Thesourceofthefailurewastheineluctableriseininternational

capitalmobility,whichmade“currencypegsmorefragileandperiodicadjustments

moredifficult”(Eichengreen183).Growingnumbersofgovernmentsfound

themselvesforcedtofloattheircurrenciesduetothe“heightenedreluctanceoftheir

strong‐currencycounterpartstoprovidesupport”(Eichengreen183).

Developingcountriesinparticularhavesuffered.Theyfounditverydifficult

inthesethinfinancialmarketstoendurethevolatileeffectsofrapidexchangerate

fluctuations.EvenEuropeandtheUnitedStateshavefelttheeffects.TheEuropean

Karczmarczyk 36

marketeffortswereinterruptedatvarioustimesduetothis.EventheUnitedStates

andJapantemporarilylostfaithintheabilityofthemarketstodrivetheirbilateral

exchangeratesto“appropriatelevelsintheabsenceofforeignexchangemarket

intervention”(Eichengreen184).Suchdissatisfactionsledtoavarietyofpartial

measurestolimitcurrencyfluctuations

TheFluctuationsofthe1990s

The1990swereahighlyturbulenttimeofglobalimbalancesandfinancialcrises.In

ordertounderstandthevolatilityoftoday,itisfirstnecessarytounderstandthe

transitionalperiod.InthissectionIwillbrieflyexaminetheAsianfinancialcrisis

andtheEuro.Thesesectionswillnotnecessarilybeanhistoricalbackground

section,butwillinsteadfocusonhowtheydirectlyrelatetheinstabilityofthe

systemtodayandhighlightitsneedforchange.Afterexaminingthetransitional

periodofthesetimes,Iwillthenmovetoanentirelynewsection,whichwill

examinethecurrentsituation.

TheAsianFinancialCrisis.Asiahadforalongtimeseemedveryinsulatedfromthe

exchangeratevolatilitythatwasaffectingtherestoftheworld.Stronggovernments,

capitalcontrols,andrapidgrowthledbyexportskeptconfidencehighintheregion.

TheremarkablepartofthiscrisisisthattheAsiancrisisoccurreddespitethese

securities.

ForeigninvestmentwashighlyfavoredinAsiaduetothisstrongeconomic

record.YetcapitalwasflowingtotroubledcountrieslikethePhillipines,which

indicatedthatadditionalfactorswereatplay.Themostimportantofthesewerethe

Karczmarczyk 37

lowinterestratesinthemajorfinancialcenters.Thecostofborrwinginyenfellto

lowlevelsasaresultof“depressedconditionsinJapan,whileyieldoninvestmentin

theUnitedStatesweredepressedbyasoaringstockmarket”(Eichengreen192).

Investorsturnedtotheseemergingmarketsasameansofreliefbyborrowingin

yenanddollarstoinvestinsuchhighyieldingAsiansecuritiesasthecarrytrade.Its

importanttonotethatbankswereusedasaninstrumentofeconomicdevelopment

inAsiaatthistime.Foreigninvestorsusedthistotheiradvantageandlent

extensivelytoAsianbanks,allthetimebelievingthattheywouldnotbeallowedto

fail.Theimportantthingtotakeawayhereisthatnotforthefirsttime,global

conditionshelpedsetthestageforproblems.

Theareawasalsoplaguedwithaninconsistencyofcapital‐accountpolicy,

exchange‐ratepolicy,andpoliticalinstability.Theregionhadlargeand

unmanageablecapitalflowsandrelaxedbankingregulations.Atthesametime,

governmentsalsoopenedthecapitalaccountbeforemovingtoamoreflexible

exchangerate.Economictheoryandhistoryitselfdictatesagainstthis.

Againstthisbackdropthecrisishitwithaseriesofshocks.Itbeganin

ThailandwiththefinancialcollapseoftheThaibaht.Thiswascausedbythe

decisionoftheThaigovernmenttofloatthebahtandcutitspegtothedollar.The

governmenthadinthepastoverextendeditselfinanefforttosupportitandcould

nolongeraffordtodoso.Thailandhadalsoacquiredalargeamountofforeigndebt,

whichessentiallybankruptedthecountryevenbeforeitscurrencycollapsed.The

IMFhadwarnedtheThaigovernmentthatitscurrencywasseverelyovervalued,but

Karczmarczyk 38

itcontinuedalongitspathofdestruction.TheThaicollapsewasnosmallsurpriseto

theinternationalcommunity.ThesurprisecamelaterwhenotherAsiancountries

followeditslead.

PressurewasimmediatelyfeltinthePhilippines,acountrythatwasultimatelynot

stabletobeginwith.Thecountrywashighlydependentuponcapitalinflowsand

hadaveryrigiddollarpeg(keepinmindthatatthistimemostcountrieswereno

longerpeggedtothedollar).ThePhilippineauthoritiesdecidedtofloatthepeso

onlytendaysafterthebaht.ThisthenputpressureonIndonesiaandMalaysia,

whereinvestorstherereallybegantofaceaconfidencecrisis.Koreaalsofaceda

panic,buttheG7helpedstopthiscrisisbyconvincinginternationalbankstoextend

shorttermloanstoKoreainanefforttorenewtheircreditsandeffectivelybuying

timeforthegovernmenttoputreformsinplace.Indonesia,however,faceda

completebankingandfinancialsystemfailure,resultinginadisruptionin

productionandapainfulrecession.OnlyChinaremainedimmune.

Thecrisishighlightsjusthowvolatilethemarketsareandhowcontagioncan

spreadthroughoutaregion.ThecrisiscausedsharpdropsinoutputallacrossAsia.

Avarietyofreformsresultedfromthecrisis,includingcurrencydevaluation,

recapitalizedandrestructedbanks,andenhancedlendingprocedures.Eventoday,

someoftheseeconomieshavenotrecoveredtotheirpre‐crisisstateofproduction.

YetoneinterestinginitiativethatcameoutofthecrisiswastheChiangMai

Initiative,orCMI.Underthisagreement,Asiancentralbanksagreedtoprovide

financialsupportfortheirneighborsinthesamewayoftheEuropeanMonetary

Karczmarczyk 39

Ssytem.Thegloalwasthatnexttimeacountrysufferedacpitalflowreversalandits

currencycameunderattack,officlafundingwouldbeavailabletoreplaceprivate

funding(Eichengreen197).Theproblemwithsuchasystemisthatgovernments

areoftenunwillingtolendwithoutassurances,asIwilldiscussinmoredetailandin

adifferentcapacityatalatertime.

Asiaisnottheonlyplacewehaveseensuchcrisesandvolatility.Theroleof

theexchangerateandthefalsesenseofsecurityisremarkablysimilarinother

emergingmarketcrisis.Eachnationalcontextisuniqueofcourse,butArgentina,

Brazil,andTurkeyhaveallexperiencedhighinflation“rootedinlargebudget

deficitsandcompoundedbystructuralproblems”(Eichengreen199).

TheEuro.AfterthecollapseofBrettonWoods,theneedanddesirefora

Europeancurrencywasincreased.Despiteearlyfinancialproblems,Europewasset

onthiscoursesincetheearly1990s.TheUnitedKingdomandDenmarkdropped

outoftheprocessearlyon,buttheotherspersistedandtheMaastrichtTreatywas

formed.AtGermaninsistence,theTreatysettargetsforinflation,interestrates,

exchangeratestability,andfiscalstabilityforcountriesseekingtoqualifyfor

particpationintheunion.Fiscalcriteriawassetatabudgetdeficitofnotmorethan

3percetnofGDPandapublicdebtofnotmorethan60percent.Thesewereinsisted

uponmoststringently.Theideabehinditwastopreventweakeconomiccountries

fromenteringandpossiblyendangeringtheentiresystem.

Thechangeoverfromdomesticcurrencytothissupranationalcurrencywas

plannedwithexcruciatingdetail.Theoriginalmonetaryunionwasverysmalland

Karczmarczyk 40

centeredonFranceandGermany.Yetthefinalplanwasmuchlargerthanplanned

andincludedcountriessuchasIreland,Italy,SpainandPortugal,whohadnot

alwayshadthestrongestfinancials.Despitethis,therewastobeaEuropeanCentral

BankandaStabilityPactthatwasdesignedtoprovidecontinuedoversightof

nationalbudgets.Theprospectivemembersoftheeuroareaagreedthat“they

wouldirrevocablylocktheirexchangeratesasofJanuary1999atthesamelevel

prevailinginmid‐1998”(Eichenreen221).Thechangeoverwascompletedatthe

beginningof2002.

Theeurowasweakagainstthedollarforitsfirstfewyears,andmany

complainedthatthecentralbankwastootightonitsrequirements.Despitethis,the

monetaryunionransmoothlyandseeminglycreatedasenseof“Europeanness”that

hadyettobeseen,despitetheeffortsoftheUnionitself,formedover40years

before.Theeuroultimatelyinthecomingyearsenhancedpricetransparency,

encouragedcrossbordertrade,andcreatedacurrencytoeventuallyrivaltheeuro.

Itseemedalmosttoogoodtobetrue,andasrecenteventshighlight,

TheCurrentSituation

Since1971,theworldhasbeeninaperiodoffloatingexchangerates,whichinturn

hasledtohighlevelsofinstabilityandincreasedfinancialcrises.Inorderto

illustratethis,Iwillexaminetwotroublingcurrenteventsinourmonetarysystem:

thecurrentcrisisintheEurozoneconcerninggovernmentdebtinGreeceandthe

ChineseholdingofU.S.Treasurydebt.Togetherthesetwoeventshighlighttheneed

Karczmarczyk 41

forchangeandunderlinethecurrentproblemsfacingoursystem.Iwilldothis

througheconomicanalysisofcurrentnewspaperarticles.

GermanyandGreece:StrugglesintheEurozone

EuropeanenlargementhasbeenachallengeplaguingEuropeforthepast50years.

Sincethe1958TreatyofRome,whichestablishedtheEuropeanEconomic

Community,Europehastakenleapsandboundstowardstheirgoaloffullpolitical

andeconomicintegration.TherecentcrisisintheEurozone,whichisthe16

countrieswithintheEuropeanUnionthatoperatewiththeEuroastheircurrency,

hashighlightedthesinglemostimportantproblemtheyhavealwaysfaced:the

absenceofasinglegovernment.Theeurozoneisnotan“optimalcurrencyarea,”

andthusitlackstheimportanttoolstodealwithasymmetricshocks,meaning

shocksthataffectsomemembersmorethanothers.Inthissense,Imeantoolstobe

a“treasurywithpowerstotaxandborrowandacentralbankthatcanactaslender‐

of‐lastresorttomemberbanks”(Skidelsky1).Soinanefforttoillustratethis

problem,Iwillfirstanalyzethecomingofthiscrisis,theGreeksituation,theGerman

response,thepossibilitiesandramificationsofIMFinvolvement,andfinallywhat

thismeansfortheworldasawhole.

TheEncroachingCrisis.TheEuropeanMonetaryUnion,whichformedthe

basisoftheeurozone,beganwithgrandideasandplans.Therewerecountriessuch

asAustria,Finland,theNetherlands,andGermanywhohadstrongcurrencies

domesticallyandinternationally,buttherewerealsocountriessuchasFrance,

Belgium,Italy,Portugal,Spain,Greece,andItaly,whosecurrencieswereconsistently

Karczmarczyk 42

depreciatinganddidnotmaintainahighvalueinternationally.Suchasituation

createdanaturalinequality,buttheEuropeanintegratorsinsistedandtheunion

wasdevisedas“one‐size‐fits‐all”(Sorkin1).

Thecriteriatoentertheunionwerestrict,duelargelytotheGerman

influence,andmanyofthesecountrieswithdepreciatingcurrencieswereunableto

fitthecriteriatoentertheunion.Instead,theyreliedonwhathascometobeknown

as“creativeaccounting,”andsomecountries,forexampleGreece,evenwentsofar

asto“falsifyitsdebtanddeficitnumbers”(Sorkin1).Inthebeginning,however,this

didn’tposemuchofaproblem.Theunionitselfismadeupof27countriesandhas

formedwhatmanycalledthe“world’smostformidableeconomicbloc,

incorporating491peopleinanintegratedmarketthatproducesnearlyathirdmore

thantheUnitedStates”(Erlanger1).Granted,theunionhaditsissues,butthey

weatheredthestorminadmirablefashion.Itwasn’tuntilthe2008financialcrisis

thatthecracksbegantoshow.

Beforebeginningthediscussionofthecrisisitselfitisimportanttorecognize

thatthecentraltensionintheEuropeanUnionhasalwaysbeenbetweennational

prioritiesandcentralinterests(Erlanger2).Theideaof“European”hasneverbeen

asstrongasnationalism,andtheideaofcedingnationalpowerswitheverything

fromcurrencytocustomshasneverbeenaneasyonetodealwith.Whencrisesor

panicshit,theautomaticreactionistoturnnationalbyprotectingtheirown

resourcesandindustries.Whilethishasn’tdelayedintegrationuptothispoint,it

hasrecentlybeguna“scalingdown”ofambitions(Erlanger2).

Karczmarczyk 43

TheGreekSituation.ThesemountingtensionshavebeenrealizedintheGreek

economyrecently.Aspreviouslymentioned,Greecebenttherulesoftheeurozone

inanefforttobeadmitted,andalltheyearsof“unrestrainedspending,cheap

lending,andafailuretoimplementanyfinancialreforms”havecaughtupwith

them.Inearly2010,theideaandfearofasovereigndebtcrisisreallybeganto

developinmanytroubledeurozonecountries,includingSpainandPortugal,butthe

crisisdevelopedmostfullyinGreece.Thecrisisthenledtoaconfidenceproblem,

whichasshowninthebackgroundsectionhascausedseriousproblemsinour

monetarysysteminthepast,andthiswasnoexception.Italsoledtothewidening

ofbondyieldspreadsandriskinsuranceoncreditdefaultswapswithintheeuro

zone.Thesituationwasfurtherworsenedwhena500milliongovernmentbond

auctioninPortugalfailedtoraisethatamount.Insteadofthe500million,the

Portuguesegovernmentonlysuccessfullyraised300million.Panicensued,and

thesefearscombinedtoaweakenedeuroandawidespreadglobalcommodity

selloff.

Withthissituationintheworld,Greece’sdebtandfiscalissuescametolight.

Nationaldebtissaidtobeataround300billion,whichislargerthanthenation’s

economyitself.Someeconomistsarepredictingthatthedebtwillreach“120

percentofgrossdomesticproductin2010”(CNN1).Thecountriesdeficit,meaning

howmuchmoreitspendsthanittakesin,isat12.7percent.Thesenumbersare

incrediblyhighandwellbeyondtheboundsoftheeurozone.Inresponse,Greece’s

creditratinghasbeendowngradedandisnowamongthelowestofallmembersof

theeurozone.Thisdoesn’tbodewellforGreece,asitisnowa“financialblackhole”

Karczmarczyk 44

toallforeigninvestors(CNN1).Thecountryisstrugglingtopayoffthesedebtsand

tomakegoodontheircurrentbills,butitsdifficultconsideringthatinterestrates

arerisingontheexistingdebts.TheGreekgovernmenthasrespondedthrough

PrimeMinisterGeorgePandreoubyimplementingspendingcuts,anactwhichis

incrediblyunpopularamongtheGreekpopulace.Theyhavealsoimplemented

austeritymeasuresaimedatreducingthedeficitbymorethan10billioneuro.Taxes

havebeenincreasedonsuchproductssuchastobaccoandalcohol,theretirement

agehasbeenraised,publicsectorpaycutshaveensued,andtaxevasionregulations

havebeenstrengthened(CNN2).LiquidityisamajorissueinGreececurrently,and

thesedomesticactionswon’tbeenough.Greecealonecannotpullitselfoutofthis

financialhole.

TheEuroZoneResponse.InanApril9,2010article,CNNwrotethatGreeceis“in

dangerofdefaultingonitsnationaldebtasitsbondmarketcomesunderincreasing

pressure,unlessitsEuropeanneighborsintervene”(Smith1).Thisstatementsums

upthethoughtsheldnotonlyacrossEuropebutalsoacrosstheglobe.Thepressure,

however,doesn’tfalluponeitherofthese,butinsteadonthemembersoftheeuro

zone,specificallyGermany.Greece’sfinanceministerhassaidthat“yieldofalmost7

percent[onthesebonds]arehighenoughtogiveinvestorsagoodreturnfortherisk

involved”(Sorkin2).Butevenasthiswassaid,theGreekgovernment,as

highlightedabove,wasraisinghalfofitsfundingrequirementof53billionEuros

throughoutthespring.Inamarketsuchastheprevailingone,thisisn’tgood.

Karczmarczyk 45

Originally,theEuropeanUnionsetoutwithachallengetotherelativelyweak

governmentstoimposehightaxesandspendingcuts,whichGreece,asstatedabove,

did.Theaction,however,provedtonotbeenoughtogettheirdeficitsdownfrom

“over10percentofGDPtothebenchmarklevelscloseto3percentofGDPascalled

forintheEuropeantreatythatcreatedtheeuro(Sorkin2).JosephStiglitz,an

economistandcurrentadvisortoGreece,pointedoutthehypocrisyofthesituation

here.RichercountriesinEuropehasbeenallowedtoborrowheavilytopull

themselvesoutofrecession,butthepoorercountrieswereforcedto“takeaknifeto

theveryprogramsintendedtosoftentheblowofaneconomicdownturn”(Sorkin

2).InsteadoftakingcareofthesolutiondomesticallyStiglitzproposesthatEurope’s

richestcountries,suchasGermanyandFrance,taketheleadinaidingGreece.

Stiglitz’sadvicewouldeventuallybetakentoheart,butnotwithoutmuch

debate.Afterafulltwomonthsofdiscussion,theEuropeanUnionunveiledthe

detailsofitsGreekfinancialrescueplanonApril11th.Itsinvolvedthe16eurozone

members,andofferedGreeceupto30billionEurosinbilateralloansinthefirst

year,withmoreavailableinsubsequentyears.Interestratesweretobesetaround

5%forthree‐yearloansinitially.Thenumberwasacompromisebetweenthesmall

ratesthatthemarketsaredemandingandtheinterestratesbeingpaidbythe

weakestmembersofeurozone,likePortugalorSpain.Themembersoftheeuro

zoneareremainingfirmthatthisisnotabailout,andthatthe“nobailout”clause

shouldremainintact.Theydothisbystatingthat“theloansarerepayableand

containnoelementofsubsidy(TheSkiesBrighten2).

Karczmarczyk 46

Ofallthecountriesoftheeurozone,Germanywillcontributethemost,an

actionthatcametopassafterconsiderableresistance.AngelaMerkel,theGerman

chancellor,ledatoughresistancetotheideaofthebailout.Merkelwasbackedby

bothAustriaandtheNetherlands.InBrussels,theEUgovernanceagreedthat“the

eurozonestandsbyitsfoundingprinciplethatprofligatememberscannotbebailed

out,butthatGreecewouldalsonotbeallowedtofallvictimtoasovereigncredit

crunch”(TheSkiesBrighten2).Ultimately,Germany,withthecurrentaccount

surplus,decidedtocontributetotheEuropeanproject,ifonlyduetotheclose

financialtiesbetweenthecountries.GermanbanksholdlargeamountsofGreek

governmentdebtandintheeventofaGreekdefaultwouldsufferlargely(TheSkies

Brighten2).

Thebailoutplanisbeingofferedasalastresort,andasidefromthebilateral

loans,theIMFhasofferedfundsandtechnicalassistance.ThedetailsofIMF

involvementwillbedetailedinthenextsection.

IMFInvolvement.TheGreekbailoutinvolvesfundsfrombothinternalsourcesand

alsotheIMF.IMFinvolvementwasheavilypushedbyAngelaMerkel,whowaseager

toshowGermanythat“theircountrywouldnothavetofoottheentirebilltohelp

Greece”(EUapproves1).Notallwereasexcitedover“substantialInternational

MonetaryFundfinancing,”however,astheGermans(1).EUleadershadbeen

hesitantuptothispointoverinvolvingtheFund,astheyweren’ttechnically

“European.”IMFinvolvementcouldweakentheeurofurther,resultinginitsfall

againstothercurrencies.

Karczmarczyk 47

Despitetherisk,theIMFispreparedtolendGreecearound10billionEuros.

EuropeanUnionnationsoutsideoftheeurozone,suchasHungaryandRomania,

haveallreceivedsupportfromtheIMF,whichthenpromptly“imposedvarious

fiscalrequirementsintendedtoinsuretheycanpaybacktheloans”(Sorkin3).The

differencenowistheeurozoneboundary,andIMFinvolvementmakestheEUlook

weak.MirandaXafa,aformerexecutiveboardoftheIMF,makesagoodpoint,

however.Shebelievesthat“thetimehascomeforEuropetoacknowledgethatithas

neitherthetechnicalexpertisetomonitorgovernmentbehaviornortheabilityto

raiserescuefunds”(Sorkin3).ItsbelievedbytheIMFthattheirinvolvementwould

helptheothercountriesandrestoreconfidence.InBrussels,theviewistheexact

opposite.

WhatThisMeansfortheFutureofEuropeandtheWorldasaWhole.ForGreece,the

bailoutwasanecessaryaction.Itcouldnothavealleviateditsdebtwithoutsome

formofinvolvementfromeithertheIMFortheEuropeanUnion.Inrecentdays

Greecehascontinuedtostruggle.MarketanxietyhaspushedGreece’slong‐term

bondyieldsto“theirhighestlevelssincethecountryjoinedthesinglecurrency

nearlyadecadeago”(TheSkiesBrighten2).Fitch,acredit‐ratingagencyalso

downgradedthecountry’sdebtbytwonotchestothelowestinvestmentgrade,one

gradeabove“junk”status.FitchhasalsorecentlycastdoubtontheGreek

government’spoliticalvowstocutthepublicdeficitbyathirdthisyear.Essentially,

therecessionisdeepeningandthecostsofservicingtheirhighdebtareincreasing.

So,asIseeit,itisonlyamatteroftimebeforeGreecemustimplementtheEuropean

rescuemechanism.OnceGreecehasdecidedthatthereisnothingmoretheycando

Karczmarczyk 48

domestically,officialsfromtheEuropeanCentralBankandtheEuropean

Commission“mustagreethatGreeceisoutofoptions”(TheSkiesBrighten3).Once

thisdecisionismade,theeurozonewillbewhippedintoafrenzyofaction,asthings

arepredictedtomoveveryfast.

Fortheeurozone,thishasplacedtensionontheinternalrelationships.

Germany,intheirreluctancetoaid,isturningevermoreinwarddomestically.As

theyhavesincethehyperinflationalwaysbeenveryfiscallysound,such

irresponsibilityfinanciallydoesn’turgethetypeofinternationalcooperationand

integrationthatispromotedbythetreatiesoftheEuropeanUnion.

Asthisisthefirsttimethishashappened,Germanydidprovidethereliefthat

Greeceneeded.Whathappens,however,ifthishappensagainandsoon?TheGreek

crisiscouldbeonlythefirstofpredictedmultipletremors.Theconfinesoftheeuro

zonehavecreatedproblems.IfGreecehadbeenoutsidetheeurozone,forexample,

itcould“devalueitscurrencytomakeitmorecompetitive,anditsforeigndebts

couldberenegotiatedinaninternationalconference(Starbatty1).Instead,wehave

enteredintoasovereigndebtcrisiswiththestrongestcurrencyintheworld

threateningtoplummet.SpainandPortugalaren’tfarbehindGreeceistheirrelative

weakness.Italyisalsoaconcernasitisthethirdlargestsovereigndebtor.Ifit

comestopassthatthesecountriesalsoneedabailout,andGermanyandFranceare

supposedtoprovide,whothenwillrescuetherescuers?

Inanefforttokeepthesecrisesfromhappeningagain,TheEuropean

CommissionisdiscussinggivingtheEUexecutivepowersto“recommendeconomic

Karczmarczyk 49

overhaulprogramstoindividualscountries,andtonameandshamelaggardsby

sendingwarningsincasesofinadequateresponses”(Taylor2).Ontheoutside,this

isasolidplan,butintherealitiesoftheeurozone,countriesdon’twanttocede

authoritytoalargersupranationalbody.GermanyasthebiggestEuropean

economy,has“madeitclearthatitdoesnotwantEUscrutinyofitsownexport

orientedpolicies,whichgeneratebigcurrentaccountsurplusesthateconomistssay

arepartlyresponsibleforwideningimbalancesintheeurozone”(Taylor2).

Furthermore,ithasbeensuggestedthattheEUneedstocreateaEuropean

monetaryfundwhosefunctionistooperatelikeanIMFstyleassistanceprogram,

butonlyforeurocountriesinfiscaldanger.Yet,thisrunsagainstthefoundingideas

oftheEuropeanUnion.ThetreatiesoftheEUforbidsuchbailoutactions,andasthe

recentLisbontreatyhasshown,itisnoteasytogetchangestotreatiespassedin

Europe.

Atthesametime,shouldGreecedefaultonitsloansandachainofbank

insolvenciesensue,perhapstheEuropeanUnionwouldbemadestronger.Nations

oftencometogetherintimesofcrisis,andahitontheEurowouldcertainlyqualify

asacrisisinthissense.Thisseemsoverlyoptimistic,however,asthetrendin

Europehasforyearsbeentoveertowardsnationalinterestsintimesofcrisis.

Despiteallofthis,itisunlikelythatanycountrywouldleavetheeurozone.The

effectsarenationalizedandthereforebeyondthescopeofthispaper,butletit

sufficetosaythattheseeffectswouldbedisastrousandenormousforthecountry

thatoptedtodoso.

Karczmarczyk 50

Overall,theGreekeconomy,asIseeit,willbeeventuallybailedoutbythe

plancreatedbytheEuropeansandtheIMF.IMFinvolvementiscrucialasitshows

thecontinuedusageoftheinstitution.Whenimplementinganypotentialreform,it

isnecessarytokeepthisideaofaninternationallenderoflastresortatthe

forefront.Itprovidesadegreeofstabilityandequalizationinthishighlyglobalized

world.TheeffectsandpossibilitiesoftheGreekbailoutarestillunfolding,asthe

crisisisongoing.Regardlessofwhathappens,however,ithighlightsadeeper

problemwithintheinternationalmonetarysystem.IftheEuroweretofail,itwould

causetremorsacrosstheglobe.Iftheeuroistomakeit,thenwillitsoonreplacethe

dollarastheprimarycurrency?Allofthesequestionsareunanswerablenow,but

theybearscrutinywhendiscussingtheformingofanewinternationalmonetary

system.

ChinaandtheUnitedStates:ToughEconomicRelations

Europeisn’ttheonlycountryfacingaformofdebtcrisis.TheUnitedStateshasa

verylargepublicdebt(ofwhichitisnotalone).Yetthisinandofitselfisn’t

concerning.Theconcerningfactoristhataroundtwentyfivepercentofthisdebtis

inthehandsofforeigninvestors,whomaychosetosellitoffatanygivenmoment.

Naturally,therearereasonsthatthishasn’thappenedyet,butasthefinancialcrisis

hitstherealityofthebusinessworld,theseconcernsarebecomingevermore

prevalent.Iftheseconcernswereevertobecomeareality,thenentireinternational

monetarysystemcouldcollapse.Theironyisthatit’sthecurrentinternational

monetarysystemthatledtothisprobleminthefirstplace.Inanefforttoillustrate

Karczmarczyk 51

thisissue,IwillfirstanalyzethenatureoftheUSpublicdebtanditsbuyers,other

factorsintheUS‐Chineserelationship,thecurrentsituation,theroleofsovereign

wealthfunds,andfinallywhatthismeansfortheworldasawhole.

TheNatureofUSPublicDebtanditsBuyers.ThebiggestholderofTreasury

debtistheUnitedStatesgovernment,witharound52percent(Schoen1).Mostof

theseholdingscomeintheformofSocialSecurityandMedicare.Thisleavestherest

inpublichands,ofwhichthelargestpercentageisheldbyforeigngovernments.In

2007,thiswasaround25%of$8.5trillion(Schoen1).Otherholdersincludestate

andlocalgovernmentsandindividualinvestors,butthesefactorsarebeyondthe

scopeofthispaper,asthissectionwillfocusontheinternationalsphere.Before

goingintothedetails,however,itisimportanttounderstandthebasicsofthe

treasurydebtbuyingprocess.SchoendescribesTreasurysecuritiesas“abigbatch

ofIOUsthatareauctionedoffeverythreemonths”(1).Thisistrueinitssimplest

form.Astheauctiondateapproaches,theTreasurydecideshowmuchitwillneedto

coverthegovernment’sneeds.Whentheauctionarrives,buyerssubmitbidsinthe

formoftheinterestratetheyarewillingtoaccept(1).Theyaregivenachoice

betweenmakingacompetitivebid,whichisaskingforaspecificrate,oranon‐

competitivebid,whichisacceptingtheaveragerateofotherwinningbids.Oncethe

bidsarein,theTreasurystartsacceptingthebidsatthebottomofinterestrate

spectrum,andcontinuestoacceptthemuntiltheyhaveenoughmoneytocover

theirborrowing.

Karczmarczyk 52

ThelifeoftheTreasurybonddoesn’tstopthere.Onceissuedatauction,

Treasurysecurities“enjoyahealthysecondlifewhenthey’retradedintheso‐called

‘secondarymarket(akathebondmarket)”(2).Thepricesofbondsboughtonthis

openmarketvaryasthemarketreactstooutsidefactors(includingspeculation,

inflation,etc).Oncethebondisbought,however,regardlessofthepriceaperson

paysforit,thegovernmentowesthefullamountthatwasborrowedwhenthedebt

wasfirstauctionedandborrowed.Thisfactisimportanttotherestofthissection.

Sothen,thequestionbecomeswhichforeigninvestorsexactlyownthese

Treasurysecurities.Inordertodisplaythisinformation,Ihavecompiledachart

fromtheTreasurywebsite:

MajorHoldersofTreasurySecurities(inbillionsofdollars)

Country Feb10 %ofTotal 9Feb %ofTotal

China 877.5 23.40% 744.2 23.54%

Japan 768.5 20.49% 661.9 20.90%

UnitedKingdom 231.7 6.18% 129 4.08%

OilExporters 218.8 5.83% 181.8 5.75%

Brazil 170.8 4.55% 130.8 4.14%

HongKong 152.4 4.06% 76.3 2.41%

CaribBankingCntrs 144.5 3.85% 189.5 5.99%

Karczmarczyk 53

Taiwan 121.4 3.24% 72.6 2.30%

Russia 120.2 3.20% 130.1 4.11%

Allothers 944.2 25.18% 845.3 26.74%

GrandTotal 3750.5 3161.5

MajorForeignHoldersofTreasurySecurities,www.treas.gov/tic/mfh.txt

Asthetableillustrates,ChinaandJapanarethetwolargestholdersofforeigndebt,

withatotalofaround44%.TheyallowtheUnitedStatestorunsuchahighdebt

becausetheUSissuchastrongeconomyandsuchalargecustomerthattheywant

themtocontinuebuyingexports.Overall,theamountofforeigninvestinginUS

Treasurysecuritieshasincreasedbyalmostdouble.Thecurrentfigure,as

previouslymentioned,is25%,butitwaslessthan13%in1988(TreasuryReport

5).Governmentdebtisinherentlynotaproblem.Theproblemiswhentheseforeign

securitiesturnintoanationaleconomicandsecurityissue.

ChinaandU.S.EconomicRelations.TheChineseeconomywasaround$8.8

trillionin2009,thusmakingChinatheworld’sthirdlargesteconomy,rightafterthe

UnitedStatesandtheEuropeanUnion(Amadeo1).Itisalsotheworld’ssecond

largestexporter(rightaftertheEU),andtheU.S.inparticularreliesheavilyonthe

Chineseexports.Reversely,theChinesealsorelyheavilyontheUnitedStates,butas

timegoeson,thislessens.ChinahasrecentlybeenincreasingtradewithHongKong

andJapan,aswellastheAfricanandLatinAmericancountries.Yetthestandardof

livingisrelativelylowinChina,whichtheyuseasamethodtokeeplabor,andin

Karczmarczyk 54

turnexports,cheap.Itdependsonkeepingthevalueoftheyuanlow,andinorderto

dothis,itneedstokeepthevalueofthedollarhigh.Alowyuanensurescheaplabor,

andtheChinesehavemanagedtokeepthisarealitydespiteUSpressuretoraisethe

competivenessoftheyuaninanefforttoimproveAmericancompetitiveness.China

hasalsofixedthevalueofitscurrencytothedollar.Currently,thedollarisworth

around6.8yuan(Amadeo1).IfChinaweretolettheircurrencyfloat,manyanalysts

believeitwouldbemorevaluablethanthedollarduetothestrongChinese

economy.YetChinakeepitspeggedinorderto,onceagain,ensurecheaperproducts

thantheUS,thuskeepingexportandtradedeficitwiththeU.S.

EvenbeyondtheUSTreasurysecuritiesdebate,theeconomicrelationship

betweentheUnitedStatesandChinaistense,atbest.Whilethedetailsofthese

tensionsarebeyondthescopeofthispaper,themoodsurroundingthesecurities

debateplayalargerole,andthepasttensionsplayaroleinthismood.Soits

importanttounderstandthelevelofcompetitionthatexistsbetweenthetwo

countries.TheUnitedStatesistheleadingworldpower,andChinaistherapidly

growingthreat.TheUnitedStateshasdevelopedtothepointthatitisnolongera

hugemanufacturerandisinsteadmovingtowardsaservicebasedsociety.China

manufacturersthegoodsthattheUnitedStatesneedsandatthesametime,relieson

themoneytheUSpaysforthegoods.CongressiscontinuallyaccusingChinaof

surpassingimportquotas,andChinaisconstantlyaccusingtheUnitedStatesof

protectionism.Thistenseeconomicrelationshipwillcontinuetoexistforsolongas

thetwocountriesneedeachother,butthequestioniswhathappenstotheUSif

ChinareachesapointwheretheynolongerareinneedoftheUS?

Karczmarczyk 55

TheCurrentSituation.Withallthesefactorscomingintoplay,thecurrent

situationisparticularlytense.Thefinancialcrisishashighlightedthesetensionsto

thepointthatmanyeconomistsareconcerned.Earlythisyear,Chinabegantosell

U.S.securities,andtheyhavecurrentlyfallenby$62.4billionsincelastJuly(Craft1).

Bondmarketshaven’tyetcrashedduetoJapan,theUK,andoilexportingcountries

pickinguptheslackandaddingaround$258billiontotheircombinedholdings

(Craft1).EvensorecentlyasFebruary,ChinatrimmeditsholdingofUSTreasury

debtby1.3percent,makingitthefourthconsecutivedecline(Crutsinger1).

InanarticlebytheAssociatedPress,WinThin,aseniorcurrencystrategistat

BrownBrotherHarriman&Companysaidthathebelieved“theMarchreportcould

wellshowareboundinpurchasesbyChina…[and]thatpartofthechanges[inthe

pastterms]reflectedadecisionbyChinatorebalanceitsholdingsawayfrom

shorter‐termTreasurybills”(Crutsinger1).HemaintainsthatChinais“stillastead

buyerofU.S.Treasurynotesandbondsbuthas[simply]beenparingbackits

Treasury‐billholdings”(1).AnotherexplanationisthatChineseinvestorsmaybe

simplybuyingtheirsecuritiesthroughBritainandHongKong(Crutsinger1).

Despitethesereassurances,however,theproblemremains.Unlessforeign

demandforU.S.Treasurydebtremainsstrong,theinterestratesthatthe

governmentpaysonthedebtcouldriseexponentially,thusmakingthedeficitofthe

UnitedStatesevenworse.Theserisinginterestrateswouldalsoputanupward

pressureonprivatedebt(Crutsinger1).Thisupwardtrendinborrowingcosts

wouldaffectU.S.businessesandconsumers.Highercostsleadtolowerconsumption

Karczmarczyk 56

andlowerborrowing/lending.Itcouldultimatelyfreezeupthecreditlanes,which

wouldaddanotherrisktotheU.S.economy.

Furthermore,asthedebateaboutwhatChinaisdoingwiththeir

holdingsragesonward,theUnitedStatesisalsoincreasinglyconcernedaboutthe

Chineseallowingtheyuantoriseinvalueagainstthedollar.Bydoingso,theyare

keepingthecurrencyartificiallylowandharmingUSeconomicinternational

growth.Itisestimatedthatbydoingso,itwouldaddanestimated$2.4trilliontothe

world’ssupplyofTreasurydebtthisyear(Craft1).PresidentBarackObamahas

addressedthisissue.HemetwithPresidentHuJintaoofChinatheweekofApril13th

inaneffortto“movetowardamoremarket‐orientedexchangerate”(MrObamaand

Mr.Hu1).Mr.HureportedlyrespondedthatChinadidplantomoveawayfromthe

fixedcurrencypeg,butdidnotsaywhen.Chinadidreportthattheywouldnotbe

respondingtoforeignpressure,thedecisionwouldbemadeontheirowntime

frame.

TheRoleofSovereignWealthFunds.Anotherpointofcontentionintermsof

Chinese‐USeconomicrelationsaresovereignwealthfunds.Untilrecently,China,

Japan,andotherexportershavebeencontentwithkeeping“mostoftheirtrillionsof

dollarsinreservesinsafeinvestmentslikebankdepositsandUnitedStates

Treasurydebt”(Times1).Aspreviouslydemonstrated,theseholdingsarecurrently

indoubt,butanalystsaren’tentirelysurewherethenextstepforChinawouldbe.As

theinvestmentinUStreasurydebtdeclines,theinvestmentintotheprivatesectors

forhigherreturnsisincreasing.Withthishugebase,governmentinvestorsdiversity

Karczmarczyk 57

moreandcanriskhigheryieldingoptions.Thesehighlydiverse,nationalfundsare

calledsovereignwealthfunds.

Theterm,accordingtotheNewYorkTimes,applies“togovernment‐owned

fundssetupbytheworld’sleadingexporters,especiallyChinaandthemajoroil

producers,thatarebeingemployedmoreassertivelyforinvestmentinbanks,

privatecompanies,equityfunds,realpropertyandotherassets”(1).Thefunds

gainedinpopularityduringthepre‐financialcrisisyearsof2006and2007.Many

sawthefundsasengagingin“crossbordernationalization”(SovereignWealth

Funds1).Thiswasconcerningduetothepowerthatthehomegovernmentofthe

sovereignwealthfundsmighthaveinthecountrieswheretheyinvest.TheWestern

worldisparticularlyconcernedduelargelytothefactthatthecountriesyielding

thesefundsaren’tthemoststable,orfriendly,ofallies.Politicalleadersare

concernedthatthesefundsareconcealingattemptstoinvestforpoliticalgainor

influence.

Theroleoftheseinstitutionshasbeenseverelydiminishedinthewakeofthe

financialcrisisof2008.Manyofthesesovereignwealthfundshadinvestedheavily

ininstitutionsthatwentsouth.OfparticularinteresthereistheChinaInvestment

Corporation,theChineseSWF.Theyoriginallyhada$3billioninvestmentin

BlackstoneGroup,butwhenthegroupturneddownward,theChinesegovernment

lostadegreeoflatitude.OtherSWF’shavedonemuchbetter.Thesovereignwealth

fundofKuwaitmade“aprofitof$1.1billiononits$3billioninvestmentin

Citigroup”(Times1).

Karczmarczyk 58

Concernstillexists,however,despitethedeclineofChina’sSWFinthe

aftermathofthe2008financialcrisis.ThePetersonInstituteofInternational

EconomicscurrentlysaysthatthebiggestSWF’sareownedrespectivelybyUnited

ArabEmirates,Singapore,Norway,Kuwait,Russia,andChina.Itwouldn’tbe

surprisingtoseeChinasoontaketheleadhereduetotheir$1.3trillioninforeign

exchangereserves.GiventheconcernsoftheWesternworldaboutthepolitical

influenceofsuchfunds,thisisnotanidealsituationfortheUnitedStates.The

Chinesegovernmentalreadyowns20%ofUnitedStatesforeigndebt,andto

increasetheirpowerwithpoliticallyplaced,powerfulfunds,wouldn’tbodewellfor

nationaloreconomicsecurity.

WhatthismeansfortheUnitedStatesandtherestoftheworld.Asofnow,

thereisnodangeroftheChinesesellingofftheircurrentholdofUSTreasurydebt.

TheUnitedStatesandChinaarestillheavilyreliantuponeachother,andtheUS

dollarmaintainsastrongholdintheworldeconomy.However,imaginingtheworst,

iftheChinesesoldalloftheirUSdebt,thedollarwouldcollapse,sendingtheUnited

Statesintoarecessionneverbeforeseen.Thisismostimprobable.

Therestoftheworldisalsoaffectedbythegrowingdebtproblemsofnot

justtheUnitedStates,butavarietyofcountries.Therehavebeensharprisesin

governmentdebtingeneral,notjustthechronicproblemoftheUnitedStates,and

manyinstitutions,theIMFincluded,areconcernedaboutgrowingsovereignrisk.

Slowgrowthintherealeconomyandhighlevelsofunemployment(andthe“jobless

Karczmarczyk 59

recovery”)willkeeptaxrevenueslowandthusrequirehighergovernmentspending

tohelpcounteractthis.

Iincludethisjusttoprovethepointthatdespiterecentimprovementsin

economicforecasting,thefinancialsystemhasyettoberestored.Qualitymustbe

improvedinavarietyofareas,butuntilitis,investorsremainjittery.Astheyworry

aboutlong‐rungovernmentsolvency,bondpricescoulddeclineinthemost

advancedeconomies.Ifthisweretohappen,banks,especiallythosejustrecovering

fromthemostrecentseriesofhits,couldfaceevennewhits.Risinginterestcostson

publicdebtalsofactorhereastheycouldflowthroughtheprivatesector,raising

borrowingcostsforallinvolved(Rowe1).TherelationswithChinaaffectallofthis,

andithighlightstheinterconnectednessoftheeconomiesandtheinternational

monetarysystemtoday.

AReformedMonetarySystem

Astheprevioustwosectionshighlight,theworldiscurrentlyundergoingaseriesof

changes.Europeisfacingitsowninternaldebtcrisis,butthefactthatitisthe

world’slargestexporter,andoneofthelargesteconomicblocsintheworld,make

theissueinternational.ThesameholdstrueforChinese‐U.S.economicrelations.The

financialcrisishasmadethissituationmuchworse,andtheinternationalmonetary

systemisteeteringontheedgeofcollapse.Asthebackgroundsectionhighlighted,

therehavebeendefinitivemomentsofchangeinthehistoryofthemonetary

system.Thisisoneofthosemoments.Beforethesystemcollapsesaroundus,anew

systemmustbeenacted.Theideasforsuchasystemhavelongbeendebated,but

Karczmarczyk 60

hereIwilloutlinewhatIseeassomeofthemorefeasibleoptions.Thebulkofmy

thesishasbeendevotedtoprovingthattherewasareasontochangesoalarge,

detailedsectionhereisbeyondthescopeofmyresearch.BecauseofthisIwill

highlightaonlyafewideas.

Theneedforarevisedsystemhasbeennotedbyseveralworldleaders.

NicolasSarkozyhassaid,“wemustrethinkthefinancialsystemfromscratch,asat

BrettonWoods”(Eurodad1).Furthermore,attheG20conferencethisyear,a

realignmentofcurrencyexchangerateswasdiscussed.Mostrecently,Prime

MinisterPapandreouofGreecewroteanop‐edintheInternationalHeraldTribune.

Hewrotethefollowing:

“Democraticgovernmentsworldwidemustestablishanew

globalfinancialarchitecture,asboldinitsownwayas

BrettonWoods,asboldasthecreationoftheEuropean

CommunityandEuropeanMonetaryUnion.Andweneedit

fast.Onlythiswillbuildanewconfidenceandfairnessthat

ourcitizenscantrust,andthatcanpreventeachnewcrisis

frombecominganepidemic”(Papandreou1).

Thedesiretorecreatetheinternationalmonetarysystemisthere,butnowthe

cooperationoftheworldisnecessary.

Karczmarczyk 61

ThefirstofthesereformationideaswaspromotedbyWorldBankpresident

RobertZoellick.Inaspeechduring2008,hecalledfora“newmultilateralnetwork

foranewglobaleconomy”(Eurodad1).Essentially,theG7isnotworking,anditis

anoutdatedmodeofviewingtheworld.Zoellicksuggestedanewsteeringgroup

includingthenationsofBrazil,China,India,Mexico,Russia,SaudiArabia,South

Africa,aswellasthecurrentG7members.Yetitisimportanttorecognizethat

simplyputtingnewcountriesonthe“steeringgroup”willnotremakethesystem.It

wouldsimplybeupdatinganoldandtiredsystem.Thesystemneedstobe

reevaluatedonaten‐yearbasisastonotethegrowthsintheworld.

TheIMFmustalsobereformed.Thefinancialsectorassessmentprogram

waslaunchedbytheIMFjustaftertheAsianfinancialcrisisinanefforttoidentify

therisksandproblemsinbankregulation.TheUnitedStatesprovedtobedifficultin

thesenegotiationsandonlysignedonaround2007.TheIMF,whichhasbeen

frequentlycriticizedforbeingunderthethumboftheUnitedStates,recognizedthe

slowdownintherecentUShousingmarketcollapsewellbeforethecollapseactually

tookplace.Itnotedthat“thisweaknesshasbeencontainedtocertainportionsofthe

subprimemarket…,andisnotlikelytoposeaseriessystematicthreat”(Eurodad1).

Obviously,thispredictionfailedtohappen.Developed,economicpowerhousesare

usedtoconductingtheworld’seconomicdirection,andtheinstitutionsdesignedto

helptheunderdeveloped,suchastheIMFandWorldBank,arereluctantorunable

topreventthis.TherecentFinancialStabilityReporthasindicatedthatthe“financial

crisisthatemergedfromtheUnitedStateshasestablishedaverychallenging

environmentforsomecountries,especiallythosewithagreaterrelianceonshort‐

Karczmarczyk 62

termfloworwithleveragedbankingsystemfundedinternationally”(Eurodad1).

TheIMFfailedtoactonwhatwouldeventuallybecometheglobalfinancialcrisisof

2008.Theactualitiesofreformarewellbeyondthescopeofthispaper,butthepoint

Ihopetomakeisthatcriticalneedwithwhichitmustbedone.

TheoriginalideasoftheIMFremainsound,however,andmanycountries

wouldliketoseeanenhancedrolefortheIMFjustinadifferentcapacity.TheIMF

couldbeusedto“improvesurveillanceofcomplexfinancialmarketsandhelp

preventsuchexcessesbuildingupinthefuture”(Seager1).TheroleoftheIMF

needstobeonceagainclearlydefined.Theyhaveinrecentyearsmorphedintoa

similarinstitutionastheWorldBankwheninrealitytheyweredesignedtodo

entirelydifferentthings.TheIMFshouldbeinchargeofregulatingthefinancial

markets,whichhaveinrecentyearsbeenfartooweak.Theresultingglobalfinancial

crisishasproventhis.YetsuchanorganizationastheIMFcould“forcebankstohold

greatercapitalcushionsormakethempaybonusesinsharesthatwouldbeheldina

company,forsayfiveyears,tomakesureitwasthelonger‐terminterestsofthe

shareholdersthatwasthefocusratherthanthebanker’sshortterminterests”

(Seager1).Basically,IseetheIMFperformingtheroleasaninternationalregulator.

TheWorldBankisalsoindireneedofreform.Manyofthepoliciesproposed

bytheBankforpovertyalleviationintheglobalsouthhavedisastrouseffectsonthe

environment.ThelargeinfrastructureprojectsitspromotesadheretoWestern

valuesandideals,andinmanycaseshaveprovedtobe“economicallyunsound,

destroyedpristinerainforest,rivers,andestuaries,andhaveuprootedthe

Karczmarczyk 63

livelihoodsofmillionsofThirdworldcitizenswhoareaffectedbythem(Chebucto

1).TheWorldBankStructuralAdjustmentProgramshavealsorecentlycomeunder

firefortheirenvironmentalunacceptabilityandtheiradherencetoWestern

economics.

Beforeimplantingthesereforms,however,wemustfirstridourselvesofthe

globalfinancialcrisisthatplaguestheworld.Unsustainabledebthasbecomea

problem,andthecountriesthathaveasurplus,i.e.Germany,muststepintohelp

solvethisshort‐termliquiditycrisis.Thisisobviouslyaverycomplexideaandissue

withmuchtobesaid.Yet,oncetheworldhasworkedthroughtheseissues,thenwe

canstepupanddothereformationsnecessary.

Inconclusionofthissection,Iwouldliketosaythatthesearesimplyideas,

notaconcreteplanofreformation.Aconcreteplanwouldrequireyearsofthought.

Apolicyideagonerightusuallytakestimeandmanysmallscaletests.Asthisisthe

entireinternationalmonetarysystemthatwearediscussion,Iwouldadvocate

nothingless.

Conclusion

Theinternationalmonetarysystemhascomealongwaysincetheearlydaysofthe

goldstandard.Itbeganwiththegoldstandardinthe1800s,hasbeeninterruptedby

twomajorworldwars,createdtwoofthelargestfinancialinstitutionstheworldhas

everseen,andweatheredmultiplefinancialcrises.Yetasweapproachthenextera,

itisquestionableastowhetherthesystemasitistodaycanexist.Theeurocrisis

andtheChineseholdingofUSTreasurydebtaretwoofthelargestissuesthesystem

Karczmarczyk 64

haseverfaced,andwhenwelookbackonthehistoryofthesystem,itcanbeseen

thatintimesofbigissues,thesystemchangesirrevocably.

Withthisinmind,itistimethatwebegintoformulatethesystemintheway

thatisbestfortheworld,andnotsimplyletwhathappenshappen.Asthe1970s

indicated,thisisnotnecessarilythebestmodeofaction.Wedidthatthenandended

upwiththehighlyvolatilesystemthatwehavetoday.Thetimeforactionand

creationisnow.

Theultimategoalofthisthesiswastohighlightthisurgency.Thesystemhas

evolvedconsiderablyanditisyettofinish.Solongasweliveinaglobalworld,there

willbeaneedforaglobalsystem,andunlikeeverbefore,itstimetocreateatruly

equalized,globalizedinternationalfinancialsystem.

Karczmarczyk 65

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history of the international monetary system and its

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