The Evolution of the

International Monetary and

Financial System
Chapter 8
Money
• It is often said that money makes the world go round
• Scholars of political economy share the belief that the study of
money and finance must embrace a wider lens than adopted by
economists
• Economists are trained to view money and finance primarily as
economic phenomena
• They highlight how money serves as a medium of exchange, a unit of
account, and a store of value
Money
• But money and financial systems are also designed to serve
many political purposes
• Including the pursuit of power, ideologies, and interests
• And their function has many political consequences
• These interrelationships are particularly evident at the
international level, where no single political authority exists
• What money should be used to facilitate international transactions?
• How should it be managed?
• What should the nature of the relationship between national currencies
be?
• The answers to these questions have profoundly important implications
for politics, not just within countries, but also between them
The Bretton Woods Institutions
• Bretton Woods established two multilateral financial institutions
• The International Monetary Fund and the International Bank for
Reconstruction and Development (World Bank)
• No institutions like these existed prior to their creation
• The only existing international financial institution was the Bank for International
Settlements, created in 1930
• The mandate of these two new institutions was to cultivate a more open
world economy
The Bretton Woods Institutions
• The Institutions were designed to play this role partly through
their lending activities
• The IMF was empowered to offer short-term loans to governments
whose countries were experiencing temporary external payment deficits
• With the loans, governments could finance the deficits instead of resorting to the
kinds of policies used in the 1930s
• The World Bank was designed to mobilize long-term capital for
reconstruction and development after the war
• It was designed to ‘promote the long-range balanced growth of international trade
and the maintenance of equilibrium in balances of payments
The Bretton Woods Institutions
• The legal obligations attached to these institutions were argued
to help with achieving a greater open world economy
• Two obligations in the IMF’s charter were particularly important
• To foster international trade, the IMF’s rules required members to keep their
currencies freely convertible into other currencies for trade payments
• To reduce currency volatility that disrupted international trade and investments
prior, member governments had to maintain a fixed value of their national currency
to that of the US dollar, which was convertible to gold ($35 to one ounce of gold)
• By requiring the pegging of all national currencies to gold via the US
dollar, the IMF rules created an international ‘gold exchange’ standard
Pre-1930s International Gold Standard
• In the last 3rd of the 19th century, an international gold standard
emerged
• It was a fixed exchange rate regime with an almost global reach
• The system broke down before WWI but was briefly resurrected in the
1920s
Pre-1930s International Gold Standard
• The Gold Standard is supposed to be a self-regulating international
order
• If a country experienced a trade deficit, the export of gold would depress
domestic wages and prices in such a way that the country’s international
competitive positions improved
• It was complicated by the fact that domestic monetary systems were
increasingly made up of bank notes and deposits rather than gold coin
• In that context, a national monetary authority which issued notes and
regulated the banking system was expected to simulate the automatic
adjustment process by following ‘rules of the game’
• In the event of a trade deficit, it would tighten monetary conditions by curtailing the issue of
notes and by raising interest rates
• Increasing interest rates would induce deflationary pressures by increasing the cost of
borrowing, but also by attracting short-term capital flows to help finance the payments
imbalance
The Bretton Woods Institutions
• A number of features highlight the endorsement of public
economic activism
• The IMF and WB were the leaders internationally
• IMF member governments were given the right to control all cross-
border capital movements
• Underlying the desire to protect policy autonomy was an
endorsement of public economic activism at the domestic level
• Delegates from the US and GB were interested in building welfare
states and pursuing new activist macroeconomic policies to promote full
employment
• Many governments from the developing world were also interested in
state-led industrialization
The Bretton Woods Institution
• A further innovation of Bretton Woods was a provision in the
IMF’s rules that allowed national governments to adjust the
pegged value of their national currencies whenever they
experienced a disequilibrium
• During the Classic Gold Standard, states were expected to address
issues through market dynamics
• The IMF rule enabled more government agency and activism in
resolving a payments imbalance
• A government could choose to devalue its national currency against the dollar as a
way to discourage imports (which would suddenly be more expensive for citizens)
and encouraging exports (which would suddenly be cheaper for foreigners)
Embedded Liberalism and Its Limits
• The innovations of Bretton Woods were termed embedded
liberalism by John Ruggie
• On the liberal side, this vision was centered around two new public
multilateral financial institutions whose activities and rules were meant
to promote an open world economy
• The commitment to a new kind of institutionalized liberal multilateralism
was embedded in social priorities also
Embedded Liberalism
• These were in many regards, competing objectives
1. Allow government to intervene in the domestic economy because
government was both useful and necessary to deal with the problems that
the invisible hand did not solve
2. Create an open international system in which market forces and free-trade
policies would play a major role
Embedded Liberalism
• The solution to these contradictory objectives was what is now
termed embedded liberalism
• Strong international markets would be subject to political restraints and
regulations that reflected domestic priorities
• The democratic state would intervene in the domestic economy and
place some limits on the international markets in order to protect
society, but it would also support a broadly liberal market economy and
relatively free trade
Embedded Liberalism
• Embedded liberalism was also based on a set of policies at the
domestic level called the Keynesian compromise
• Owners of capital would share gains from growth and rising productivity
with workers in the form of rising wages and benefits
• Workers would maintain social peace and accept the legitimacy of the
liberal capitalist system
• Both sides accepted significant intervention in the market economy by
the government
Implementing Bretton Woods
• Soon after the conclusion of the conference, it became clear that
some of the ambitions would not be easily realized
• The Soviet Union refused to join the system
• The Chinese revolution also led China outside the system
• Even for countries that remained members of the system, the IMF and
World Bank played very limited roles for the first decade and a half
• Many countries did not make their currencies convertible in this period
until 1958
• And imperial countries imposed monetary and financial policies on their
colonies that were not ‘embedded liberalism
Implementing Bretton Woods
• At the same time, some of the principles outlined at Bretton
Woods were endorsed by many governments outside the Soviet
and colonial context
• This included support for capital controls, the gold exchange standard,
and the maintenance of an adjustable peg exchange rate system
• And many actors outside of the Bretton Woods institutions acted in a
manner similar to aspirations
• The period between 1958 and 1971 is often described as the
heyday of Bretton Woods
• It is still sort of around today even
Explaining Financial Globalization
• Bretton Woods led to many major changes in the global political
economy
• Amongst those was in setting the expansion of investment flows globally,
but even they could not have seen the 24/7 investment flows we have now
• But how did we get from minimal investment to what we have
now?
• The growth of global telecommunications networks has enabled money to
be moved around the world much more easily and cheaply than in the
past
• The dramatic expansion of international trade and multinational corporate
activity in recent decades has also generated growing demand for private
international financial services
Explaining Financial Globalization
• Governments have also fostered the trend by supporting the
emergence of a more liberal environment for cross-border
financial flows
• A first step was taken by the British when it encouraged the growth of
the ‘euro-market’ in London during the 1960s
• After the 1970s, many governments began to fully dismantle capital
controls they had employed at various times also, led by the US and UK
• By the 1990s, an almost fully liberal pattern of financial relations had
emerged
• Simultaneously, many lower income countries also began to abolish
capital controls, including in many small jurisdictions like the Cayman
Islands
Explaining Financial Globalization
• What explains this?
• The increasing influence of more free market or neoliberal ideologies
among financial policymakers played a part
• There have also been efforts to codify the commitment to financial
liberalization in international rules
• The 1988 EU directive to liberal capital controls among its members
• The 1989 amendment to an OECD code committed all OECD members to
liberalize all financial flows
• There were even unsuccessful attempts in the mid-1990s to remove IMF
members’ right to control capital movements
Implications for National Policy Autonomy
• What have been the implications of post-war globalization of
finance?
• Some have argued that financial globalization has severely undermined
national policy autonomy by giving investors a powerful ‘exit’ option to
exercise against governments that stray to far from their preferences
• Proponents of this view argue that this discipline is felt particularly strongly by
governments that pursue policies disliked by wealthy asset-holders
• Less industrialized countries are seen to be especially vulnerable to the disciple of
global financial markets because their financial systems are often very small
relative to the enormous size of global financial flows
• If asset-holders lose confidence, these countries can experience an enormously
damaging flight of private capital
Implications for National Policy Autonomy
• This is termed ‘flight capital’
• Flight capital has triggered a number of financial crises, as speculators
lose faith in governments or the economy and pull money out
• Perhaps the most infamous is the Asian Financial Crisis of 1997
Implications for National Policy Autonomy
• Some suggest that the disciplining effect of global finance on
governments with high levels of government spending, high
taxation, or a more general left-of-center political orientation has
been exaggerated
• Some scholars have found that financial actors are concerned with
inflation rates and deficit levels rather than other aspects
• More recent scholarship has also shown how global financial markets
have not constrained governments in many places
• Some have also shown that policy autonomy has actually increased in
the US as a result
Implications for National Policy Autonomy
• Sovereign wealth funds have complicated this debate also
• These organizations blur the line between global financial markets and
governments’ policy autonomy
• An additional aspect is the impact that financial liberalization has
had on illicit financial activity
• Many scholars have highlighted how financial globalization has
encouraged a growth of illicit financial activity
• International capital mobility has enabled citizens to evade national
rules, particularly with access to offshore financial centers
Environmental and Social Implications
• Scholars have also been interested in the implications for the
environment
• Some argue that speculative and volatile international financial flows
reward instant economic results and short-term thinking
• This type of thinking can lead to damaging outcomes for the
environment
• The destruction of forests, the continued reliance on fossil fuels
• But in recent years, some actors have developed investment products
and private standards for sustainable finance (green finance)
The Global Power of New Private
Authorities and Practices
• Scholars have also been interested in how the globalization of
finance has empowered private authorities and practices
• As global financial markets assumed a more central place in the world
economy, private bankers have regained some of the influence they had
pre-Bretton Woods
• Examples of this include bond rating agencies like Moody’s and Standard and
Poor’s
• Another group that has emerged are the Big Four accountancy firms
• Deloitte, Ernst and Young, KPMG, and PricewaterhouseCoopers
• If they took climate risks very seriously, this could have a major impact on how
things are valued
The Global Power of New Private
Authorities and Practices
• Two other kinds of private authorities have emerged from the
post-2008 period
• Hedge funds are one
• BlackRock, Vanguard, and State Street are examples of very large ones
• They make an enormous amount of money and the statements of their leaders
carry huge weight
• The providers of the indices themselves have also assumed an
authoritative role
• Decisions to include or exclude certain countries or firms from an index steer large
volumes of capital in one direction or another
The Demise of Gold and the Future of the
Dollar
• The globalization of the financial market took place in a gradual
fashion
• But the breakdown of the gold exchange standard was sudden, taking
place on August 15, 1971
• The collapse of the gold standard could’ve been predicted as
early as 1960
• Triffin argued that in a system where the dollar was the central reserve
currency, international liquidity could be expanded only when the US
provided the world with more dollars by running larger external deficits
• But the more it did so, the more it risked undermining confidence in the dollar’s
convertibility into gold
Before and after the Nixon Shock
• This became known as the Triffin Dilemma
• And one potential solution was to create a new international currency
whose supply would not be tied to the balance of payment condition of
any one country
• John Maynard Keynes had proposed the ‘bancor’ in 1944
• In 1969, the IMF membership created the Special Drawing Rights to be used as
reserve assets for setting inter-country payments imbalances
Before and after the Nixon Shock
• As US external deficits grew during the 1960s, driven partly by
the costs of Vietnam, dollar holdings abroad increased
• Under the system, if all holders of dollars suddenly decided to convert
the US currency to gold, US officials would not be able to meet the
demand
• A crisis of confidence in the dollar’s convertibility into gold was
initially postponed by key foreign allies
• But other countries were more critical of US foreign policy and refused
adopt the practice of postponing convertibility
• France believed that the US gained more from being the world’s leading currency
than it was comfortable with
Before and After the Nixon Shock
• In 1971, France and others sailed into New York harbor in
expectation of exchanging dollars for gold
• This was the culmination of speculative pressures against the dollar
• Many had begun to doubt that the $35 equaled one ounce of gold
• Richard Nixon faced a choice in response to these actions
The End of Dollar-Gold
• The dollar-gold system was unique
• If currencies fluctuated beyond limits set by the system, countries were
required to buy up or sell dollars to bring their currencies into order
• And central banks were key for this system to work
• But confidence in the dollar was of the utmost importance
• The dollar had to equal $35 per ounce
• But there were major doubts by many countries of the true value of the dollar being weaker
than $35 to an ounce
• Which ultimately led to the demise of the system when President Nixon removed the US
from the dollar-gold standard in 1971
The End of Dollar-Gold
• When Nixon ended the dollar-gold system, some predicted that
the US currency’s role as the dominant currency would end
• But the dollar’s central role has endured to today
• This is partly due to the product of inertia and the enormous size of the
US economy
• There are network externalities that reinforce the continued use of the currency
• There is also the agreement made between the US and Saudi Arabia for
petrodollars that endures today
Emerging Challenges to the Dollar’s
Dominant Position
• Will the dollar’s global dominance continue?
• Right now, the euro is the second most widely used currency
internationally
• China’s significance in the global economy has increased
• And the renminbi could challenge the dollar
• But China is dependent on the dollar
• It has at times promoted the internationalization of the renminbi though
Emerging Challenges to the Dollar’s
Dominant Position
• Digital currencies could potentially threaten the dollar’s
international role
• Bitcoin was created in 2009 and at times has been viewed as a threat
• But it has had an unstable value and high transaction cost as a means of payment
• Facebook pursued Libra as a global currency for some time after 2019
• It was to be a stablecoin, which was fixed on leading national currencies and
backed up by reserves of assets
• Bank digital currencies could also challenge the dominance of the dollar
• China is the furthest in its pursuit of this type of currency backed by its central
bank
Emerging Challenges to the Dollar’s
Dominant Position
• US behavior itself could play a role in encouraging a downsizing
of the greenback’s international position
• US economic mismanagement could undermine confidence in the
currency
• An erosion of the dollar’s global role would have important
consequences for the US
• The US would lose an important foreign policy tool
• It would lose seigniorage revenue
• International prestige would diminish
Emerging Challenges to the Dollar’s
Dominant Position
• The erosion of the dollar’s central position would also have
consequences for the world as a whole
• It is likely that the erosion of the US monetary hegemony would
generate a more unstable global monetary system
• But this view, based on hegemonic stability theory, has been challenged
extensively by critics
Exchange Rate Regimes, Regionalization,
and Decentralization
• Another feature of the Bretton Woods monetary order was the
adjustable peg system that broke down in 1973
• In 1978, a new international exchange rate regime emerged based
upon floating of currencies
• This agreement stated that each country could choose its own
exchange rate regime
Floating Exchange Rates and Their Critics
• The end of the adjustable peg system was partly triggered by
the growing size of speculative financial flows
• It complicated governments’ efforts to defend their currency pegs
• Some began arguing that floating exchange rates could play a useful
role in facilitating smooth adjustments to external imbalances
• Prior to the end of dollar-gold, governments had been reluctant to make
adjustments due to the attached domestic political costs
• But going towards a floating exchange rate system would allow external
imbalances to be addressed more smoothly and continuously
Floating Exchange Rates and their Critics
• Since their introduction in the 1970s, floating exchange rates
have played a useful role in facilitating adjustments
• But as foreign exchange trading has grown dramatically, critics have
argued that exchange rates have also sometimes been subject to
considerable short-term volatility and longer-term misalignments
• In these circumstances, floating exchange rates have sometimes been
a source of-rather than the means of adjusting to—external economic
imbalance
• Some have suggested that a currency transaction tax should be levied
against all cross-currency transactions
Floating Exchange Rates and their Critics
• When speculative financial flows have exacerbated external
economic imbalances, there have been brief episodes when
leading economic powers attempt to collectively manage
exchange rates
• Between 1985-1987 in the G5 as an example
Floating Exchange Rates and their Critics
• Another criticism is that floating exchange rates have enabled
governments to undervalue their currencies for competitive
advantage
• One state that has continually been accused of this behavior is China
• It holds billions of dollars in reserve
• As well as trillions of dollars overall
• All designed to increase the strength of the reserve currencies in comparison to
the renminbi
Europe’s Monetary Union
• The creation of the euro represents the most ambitious and
successful attempt at coordinating financial relations between
states
• The euro was created in 1999
Regionalization and Decentralization
Elsewhere
• The euro’s creation in 1999 triggered some policy and scholarly
debate about the prospects of closer monetary cooperation in
other regions
• Some monetary unions already existed (Communaute Financier
Africaine)
• Another is the Eastern Caribbean dollar used by eight countries since
2021
• There has even been some debate over the creation of a monetary
union in North America or the Americas
• Some countries in the region already used the dollar officially
• There has been little talk of monetary union in East Asia, but they have
cooperated in other ways
• Chiang Mai Initiative