An Introduction to the International Monetary System

1. An Introduction to the International Monetary System INTERNATIONAL BUSINESS ENVIRONMENT Course numbers STRT 571-44 & -45, Spring 2010, Mod 4 James Raymond Vreeland, School of Foreign Service Week 4 (Wednesday, 7 April; Monday, 12 April)

2. Tonight’s schedule • 6:30-7:30 • 5 minute break • 7:35-8:35 • 5 minute break • 8:40-9:40

3. Plan for tonight: • Why a “trilemma”? • Why were countries able to maintain fixed exchange rates with high capital mobility in the late 19th century but not the 20th? • Why did we ever invent an IMF? Do we need Regional MF’ers? (e.g., AMF, EMF) • What is the current international monetary system? • What is the future international reserve currency?

4. 1st: A reminder of The Inconsistent/Unholy Trinity Or “Trilemma”

5. Free Capital Flow Inconsistent/Unholy Trinity Or “Trilemma”: a country can only have 2 out of 3 of these Fixed Exchange Rate Sovereign Monetary Policy

6. Why would you want… • Free Capital Flow? • Draw on the savings of the rest of the world • Investment opportunities abroad • Fixed Exchange Rate? • Reduce uncertainty in trade • Sovereign Monetary Policy? • Address inflation/unemployment

7. And now a puzzle…

8. A puzzle Degree of global capital mobility Fixed exchange rates + Capital controls Floating exchange rates + Open capital flows 1971-3 1944

9. Conclusion: Cannot maintain (global) fixed exchange rates in the presence of high capital mobility…?

10. A puzzle Degree of global capital mobility * Fixed exchange rates + Capital controls Floating exchange rates + Open capital flows 1971-3 1870 1944

11. Keynes 1919 quote: • “The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery on his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprise of any quarter of the world. He could secure forthwith, if he wished it, cheap and comfortable means of transport to any country or climate without passport or other formality…. He regarded this state of affairs as normal, certain, and permanent.”

12. A puzzle:Why were countries able to maintain fixed exchange rates with high capital mobility in the late 19th century? Fixed exchange rates + Open capital flows Degree of global capital mobility Fixed exchange rates + Capital controls Floating exchange rates + Open capital flows 1870 Interwar period 1971-3 1944

13. Why?

14. Answer: Democracy Growing #’s of democracies Few democracies Fixed exchange rates + Open capital flows Degree of global capital mobility Fixed exchange rates + Capital controls Floating exchange rates + Open capital flows 1870 Interwar period 1971-3 1944

15. Growth of democracy (minimalist definition)

16. Why? • So, why do fixed exchange rates pose a problem for democracies in the face of highly mobile capital?

17. Pure gold standard • Country A imports from Country B • Gold moves from A to B (re-coined/minted) • Less money in A  lower prices • More money in B  higher prices •  Country B imports from Country A • Balance is restored

18. With paper money • Central Banks intervene by adjusting interest rates • So gold doesn’t actually flow • Gold Standard  strict discipline!

19. What is “discipline”? • What do “lower prices in Country A” mean? • Supply of money down • More expensive to borrow • Jobs cut! • People don’t eat!

20. Under authoritarianism: Let them eat cake Under democracy: Incumbents lose elections People don’t eat

21. Hazard Rate over Time for Democracies (Solid Line) & Dictatorships (Dotted Line) – Time in years

22. Stylized history • Late 19th century: • Mobile capital, authoritarian governments • Interwar years: • Mobile capital + democracy  beggar-thy-neighbor • Bretton Woods (1944-1971/3): • Capital controls + democracy • Post Bretton Woods: • Floating exchange rates

23. What was Bretton Woods And what was the IMF’s role?

24. 5 minute break

25. What is the IMF? • Like an international “credit union” • Almost all the countries in the world are members (186?) • All hold currency on reserve • The IMF can use these reserves to loan to countries in “crisis” • Moral Hazard?  Conditionality! • IMF programs = loans + conditions • Decisions at the IMF are by majority rule • Influence over decisions pegged to “economic size” • MAJOR SHAREHOLDERS • Votes are determined by contributions (“quota”), Quota set by an 85% majority rule • Most other decisions by simple majority rule (CONSENSUS)

26. Problem • Keynes Plan called for contributions totaling $26 billion (with $23 billion from the US) • The White Plan called for only $5 billion (with $2 billion from the US) • Compromise: • $8.8 billion, with just $2.75 billion from the US • The US would only provide Marshall Plan assistance to countries that did not seek additional assistance from the IMF • On the eve of the current crisis: • instead of having reserves approximating half of the value of global imports, the IMF holds on reserve a total of less than 2 percent of global imports

27. What were the goals of Bretton Woods? • Support Fixed XR’s with governments unwilling to sacrifice employment to address imbalances • 4 INNOVATIONS: • Some XR flexibility (fixed-but-adjustable “snake”) • Capital controls • A stabilization fund (held on reserve at the IMF) • The International Monetary Fund – authority over XR changes + conditionality attached to loans

28. Bretton Woods failed for several reasons • IMF lacked true authority over XR – governments did as they saw fit • Governments did not like IMF conditionality • The stabilization fund was never large enough to deal with the potentially massive imbalances that come with growing globalized economic integration • Straws that broke the BW back: • USA: VIETNAM + SOCIAL SPENDING + INTERNATIONAL RESERVE CURRENCY •  SPECULATION that the US cannot maintain the fixed convertibility to gold + the French – regularly demanded American gold from the US for the $’s they accumulated • http://www.youtube.com/watch?v=iRzr1QU6K1o

29. Recapping 1st session: • Normal trade  temporary imbalances • Fixed exchange rates  discipline • Democracy • IMF to the rescue!... Or not.

30. Taking a step back…Why is the IMF involved in the developing world? • Originally designed to help developed countries maintain fixed exchange rates • “Soften the blow” of adjustment • Did it ever do that? • So what did the IMF do?

31. Was there really a shift?

32. IMF effect in the developing world has been lackluster • Why? • Partial reform? • Bad policies? • International politics?

33. Partial reform? • Historically, lack of “ownership” & transparency • Governments push through some reforms but not others • Protect elite constituents at the expense of labor & the poor

34. Bad policies? • Crisis in the developed world? Stimulus! • Developing world? Contractionary policies: • Raise interest rates, limit credit, cut public spending, raise taxes, devalue the currency • Example: • Compare Mexico 1994 & Indonesia 1997 • South Korea spent 13 years under consecutive agreements from 1965 to 1977 • Zaire 14 years straight (1976-1989)

35. International Politics? • Sometimes the “major shareholders” use the IMF to pursue foreign policy goals • Friends get • Big loans • Fewer policy conditions • Or they ignore conditions with impunity • Loans prop up bad policies and corrupt governments

36. Bureaucratic story? • The IMF is like any other bureaucracy • Tries to make big loans to generate revenue • Does not care about enforcing conditionality

37. Evidence of political favoritism

38. Top 5 members: United States (16.8%) Japan (6.0%) Germany (5.9%) France (4.9%) UK (4.9%) Other important members: China (3.7%) Saudi Arabia (3.2%) Russia (2.7%) Belgium? (2.1%) Canada? (2.88%) Brazil? (1.4%) India? (1.9%) Korea? (1.3%)

39. UNSC IMF/WB project in Ghana IMF

43. So, how might programs hurt? • Sometimes partial reform • Sometimes bad policy advice • Sometimes good policy advice but ignored • Note: sometimes things work out! • Willing governments develop good policies with the IMF and follow through

44. IMF web page…http://www.imf.org/external/np/sec/memdir/eds.htmhttp://en.wikipedia.org/wiki/List_of_countries_by_GDP_(PPP)

46. Asian Monetary Fund Proposal? Going back to the aftermath of the US/IMF bailout of Mexico in 1995 Japanese policy-thinkers/makers begin thinking about an “Asian Monetary Organization” ($20 billion) Why? Believed that the US would not act as vigorously in the event of a crisis in Asia Then: East Asian Financial Crisis http://www.xtimeline.com/timeline/Asian-Financial-Crisis

47. Aug 1997 Japan facilitates bilateral commitments towards the IMF rescue package for THAILAND Japan commits $4 billion out of the $17.2 billion package (as much as the IMF’s contribution) US – conspicuously absent!  “Asian sense of solidarity”

48. AMF vision $100 billion 10 members: Australia, China, Hong Kong, Indonesia, Japan, Malaysia, Philippines, Singapore, South Korea, Thailand NOT the United States Secretary of State Summers to MOF official Sakakibara: “I thought you were my friend!”

49. US argument Moral hazard  postpone adjustment Duplication Add little to the pre-existing IMF system

50. US enticements Offer Asian countries increased IMF quotas What does this get them? More votes… and more rights to borrow (more larger loans) New arrangements to borrow CHINA: was lobbied regarding “Japanese hegemony”