In reality the leading monetary powers had not reformed the system of international
monetary management; they merely codified the prevailing non-system
Just as any national economy needs generally accepted money to serve as a medium of exchange, unit of account and standard of value, so the international economy requires an accepted means for trade, payments and services. Unlike the national economies, however, the international economy lacks a central government that can issue currency and regulate its use. Historically, this problem has been resolved through the use of gold and national currencies; gold was used to back currencies and settle international accounts.
After World War II, in addition to gold, the US dollar became the key international currency. Dollars were held as reserves by central banks; and the dollar became the unit of international trade, investment and finance. Although the use of the dollar eventually became a central problem for managing the system, efforts to replace it including the creation of international money (Special Drawing Rights) failed.
In the post World War II era, the Anglo-American plan approved at Bretton Woods in 1944 became the first publicly managed international monetary order. This new order was intended to be a system of limited management by two international organisations, the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) better known as the World Bank.
Under the system of weighted voting, the United States exerted a preponderant influence in the IMF. IMF approval was necessary for any change in exchange rates and it advised countries on policies affecting their monetary system. It could also advance credits to countries with payments deficits. The IMF was provided with a fund contributed by member countries in gold and in their own currencies.
From 1945 to 1960, the United States was both able and willing to manage the international system. The Europeans and the Japanese willingly accepted US management. Economically exhausted by the war, they needed US assistance to re-build their economies and provide a basis for political stability.
In the late 1940s, it also became clear that the only currency strong enough to meet the rising demand for international liquidity was the US dollar. The strength of the US economy, the fixed relationship of the US dollar with gold ($35 for an once) and also the commitment of the US government to convert dollars into gold endowed the dollar with its unique status. In fact dollar was better than gold as it earned interest.
In the middle of 1960s, however, the United States was no longer the sole dominant economic power it had been for almost two decades. Europe and Japan with higher rates of growth and per capita income approaching that of the United States were narrowing the gap between themselves and the United States. A more pluralist distribution of economic power led to increasing dissatisfaction with US dominance of international monetary system and in particular with the privileged role of the dollar as the international currency.
From 1968 to 1971, the international monetary system was paralysed; central banks were unable to control the large currency flows and contain the currency crises. The United States abdicated monetary leadership and pursued a policy of “benign neglect”. It let others to defend the exchange rate system, permitted a huge dollar build up abroad and remained passive during currency crises.
By late summer 1971, benign neglect was no longer a sustainable policy. In the spring and summer of 1971, there was a run on the dollar and for the first time in 20th century, the United States showed a trade deficit.
The US gold stock declined to US $10 billion versus outstanding foreign dollar holdings estimated at $80 billion. Inflation was rampant and unemployment widespread. All these problems forced the US to do something.
On august 15, 1971, President Nixon announced a new economic policy; henceforth, the dollar would no longer be convertible into gold and the United States would impose a ten per cent surcharge on dutiable imports. August 15, 1971 marked the end of the Bretton Woods system.
The shock of August 15 was followed by efforts of the Group of Ten (Belgium, Canada, France, Italy, Japan, Netherlands, Sweden, the UK, the USA and the Federal Republic of Germany) under US leadership to patch up the system of international monetary management. In 1972, a committee on reforms of the international monetary system and related issues was set up.
The efforts of the committee (known as the committee of twenty) to achieve reforms were unsuccessful. While the committee debated, massive changes occurred in the international monetary system. Fixed exchange rates were replaced by the float. Inflation erupted combined with an enormous dollar outflow from the United States and worldwide commodity shortages. Different inflation rates made stability impossible and increased national desires for floating exchange rates to enable a degree of isolation.
The float, inflation as well as the monetary consequences of the dramatic rise in the price of petroleum, engineered by the Organisation of Petroleum. Exporting Countries (OPEC) dominated the exertions of the committee of twenty. In 1974, the committee concluded that because of the turmoil in international economy, it would be impossible to draw up and implement a comprehensive plan for monetary reform.
At the IMF meeting in 1976, however the final details were hammered out on the Second Amendment to the articles of the International Monetary Fund.
On paper, the second amendment seemed a signal return to multilateral public management of the international monetary system. It legitimised the de facto system of floating exchange rates and permitted return to fixed exchange rates if an 85 per cent majority approved such a move and it called for greater IMF surveillance of the exchange rate system and management of national economic policies.
In reality the leading monetary powers had not reformed the system of international monetary management; they merely codified the prevailing non-system.
The Second Amendment signalled the beginning of a period characterised as much by national and regional as by multilateral management.
The period since 1976 has been one of muddling through. The leading monetary powers have cooperated during periods of crisis and have periodically sought to coordinate economic policies in order to achieve medium tern stability. Policy coordination has, however, been limited in scope and success.
Given the potential of the exchange rates to de-stabilise economic and financial system not only within a particular country but also in several other parts of the world; the IMF at its interim committee in May 1993 took an important decision to control the violent fluctuations in exchange rates. This was the first time since break-up of the Bretton Woods system that the IMF was again being asked to interfere in the exchange rates and save the different countries from instability stemming from their international trade. Central banks were told in advance about the steps they need to take to ensure that they avoid difficult situations.
Globalisation has increased the premium on the economic and financial integration of countries in the mainstream of international trade and financial flows and also on the soundness of countries’ economic policies.
It has, however, been pointed out by noble laureate Prof. Joseph Stiglitz in has learned book ‘Globalisation and its Discontents’, that the IMF and its sister organisations have taken several wrong-headed actions in the past decade based on the fallacious presumption that markets by themselves lead to efficient outcomes, Prof. Stiglitz maintains that the benefits of globalisation – removal of barriers to free trade and closer integration of national economies – have gone disproportionately to the better off pauperising those at the bottom of the society.
An IMF occasional paper, “Improving the international monetary system, constraints and possibilities” reviews the performance of the current system and examines proposals for improving it, including more formal exchange rate arrangements. The study quite rightly comes to the conclusion that in present circumstances a return to greater fixity of exchange rates is neither feasible nor desirable; however, the present system can be improved through stronger policy efforts and an enhanced role for the IMF in supporting these cooperative efforts.
The IMF is of the view that exchange rate stability should not be seen as an end in itself, but as an objective, which can be achieved through improvements in national economic policies fostered by meaningful international cooperation.
In a world in which monetary power is more widely dispersed, sound international monetary management cannot depend on preferences of a single dominant power, but on the negotiations of several powers, primarily the United States, the European Union Japan, China and Russia.
So far as developing countries are concerned, notwithstanding the fact that the IMF has introduced greater flexibility in its programmes in recent years and has emphasised helping debtor counties achieve durable growth and reduce poverty, the main thrust of its policies is on demand management and an analysis of the social and political impact of its programmes has got to be formally incorporated in the framework of its operations. The desirability of conditionalities is not questioned. It is, however, the nature of the conditionalities and the manner these are administered that is objectionable.
In a poor developing country with a significant proportion of the population living below the poverty line, shock treatment in the form of sharp and sudden reduction in domestic absorption may be successful in achieving fiscal improvement and a sustainable balance of payments, but it could be at the cost of distress to weaker sections of the population and de-stabilising social and political tensions.
In view of dissatisfaction with the functioning of IMF, the developing countries have often proposed a re-structuring of decision making process within it.
Aside from the re-structuring of the IMF, the following issues need priority attention from the viewpoint of less developed countries: (a) the implementation of decisions designed to make Special Drawing Rights (SDRs), the principal reserve asset of the international monetary system to ensure that world liquidity does not originate in the payments deficits of a few countries; (b) more flexible conditionality in the use of IMF resources so that developing countries can count on maintaining their trade and employment and their development efforts at a high level; (c) mechanism for a fair sharing of the burden of adjustment especially in regard to surplus countries should be explored again taking into account the need to diminish inflationary pressures; (d) improvement in compensatory financing facilities; (e) sympathetic treatment of debt service problems, particularly for low income developing countries; (f) linking the creation of new SDRs to the provision of economic aid to developing countries; and (g) assisting developing countries to ease the transition to the new international trading system by providing policy advice, financial support and technical assistance in order to maximise their gains from new market opportunities.
Source: The News, 19-Jan-09