The Evolution of the International Monetary System Professor Keith Pilbeam City University, London
The Postwar International Monetary System some highlights Bretton Woods 1949-72 sets up IMF, fixes dollar to price of gold at $35 pere ounce and fixes major currencies to dollar ± 1% Floating Exchange Rates for Major Currencies 1973 legitimised at IMF conference in Jamaica 1976 Snake in Tunnel 1972-79 certain European currencies fixed against each other ± 1.25% (the snake) and joint float ± 2.25% against the US dollar (the tunnel) Oil Price shock 1973-74 oil quadrupled in price $3 to $12, global recession and pick up in inflation eg 25% inflation in UK and 26% inflation in Italy, steep rises in unemployment
The Postwar International Monetary System some highlights continued Second oil price shock 1979-80 pick up in inflation in many countries and global slowdown The European Monetary System 1979-99 fixed but adjustable system pegging of most EU currencies to each other in the ERM ± 2.25% (± 6.00% for Italian Lira), introduction of European currency unit the ECU The Dazzling dollar 1980-85 The dollar appreciates some 60 % in trade weighted terms and becomes heavily overvalued record US trade deficit and fiscal deficits
The Postwar International Monetary System some highlights continued Mexican Moratorium 1982 followed by the Latin American Debt Crisis 1982-94 Major problems for worlds banks with massive exposure concentrated to 4 key countries in Latin America Argentina, Brazil, Mexico, Venezuela. new role for IMF as international lender of last resort The Plaza Accord September 1985 G-5 Finance ministers meet in Plaza hotel and september followed by purchases of DM and Yen dollar declines dramatically by 60% in following 2 years. The Louvre Accord February 1987 The dollar depreciation of 60% over the previous 2 years prompts the G-7 ministers to coordinate purchases of dollars
The Postwar International Monetary System some highlights continued Speculative attack against Sterling 1992 Bank of England loses 5 billion trying to defend sterling followed by speculative attacks against other EMS currencies in 1992/93 leads to widening of bands in EMS to ± 15% 1994 Tequila Crisis Mexican devaluation Massive US sponsored bailout of Mexico of $48 billion Asian Financial Crisis 1997-98 Thai baht devaluation in July 1997 soon followed by massive financial crisis in Asia with large falls in Asian currencies, stockmarkets and real output. Most severely affected include South Korea, Indonesia, Malaysia, Singapore, Taiwan, Hong Kong (although it $HK/$ peg survives).
The Postwar International Monetary System some highlights continued 1998 LTCM/Russian Default European Monetary Union 1 January 1999 Euro makes it s debut at $1.17/ 1 with 11 founding members inlcluding Itlay but excluding UK and Greece! January 1999 Brazilian 8% devaluation the devaluation does not prove sufficient and real declines by 40% 9/11 2001 Attack on Twin Towers prompts large stockmarket falls
The Postwar International Monetary System some highlights continued 2001 Turkish Lira devaluation crisis Lira deprciates from 627 thousand to 1,600,000 to the dollar by May 1999 1 Jan 2002 euro hits street level! December 2001 Argentina defaults on its debt and in January 2002 Argentina ends 1 peso 1 dollar and defaults on its debts peso falls to 4 to the dollar! August 9 2007 Subprime crisis starts fall in dollar and stockmarkets and massive bank losses
The Present Exchange Rate System
The Evolution of Exchnage Rate Arrangements
The Bipolar View of either a Hard Peg or a Free Float
Some movement to managed floating 2001-7
More pegging to a single currency where pegging exists 2001-7
Increased Pegging to the Euro
Significant decline in volatility against the DM/Euro since 1990
Massive Reserve Accumulation since Asian financial Crisis
De Jure versus De Facto Floats
More and more countries accepting Article VIIII of IMF and free movement of capital
Low income countries still have most foreign exchange controls
Does the Choice of Exchange Rate Regime Matter?
Different Perspectives for Developing and Developed Economies! Evidence suggests that choice of exchange rate regime not too vital for developed economies so long as they have stable monetary/fiscal policy frameworks. However, for developing economies it seems that fixed exchange rates provide some macro stability but the degree of flexibility accorded to the exchange rate should increase as the country develops and the degree of freedom afforded capital movement should also be increased.
Proposals for Reform of the International Monetary System 1978 Tobin Foreign Exchange Tax small tax of around 1% to be levied on Forex transactions National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exchanges, without real hardship and without significant sacrifice of the objectives of national economic policy with respect to employment, output, and inflation. Specifically, the mobility of financial capital limits viable differences among national interest rates and this severely restricts the ability of central banks and governments to pursue monetary and fiscal policies appropriate to their national economies.
Reform of the International Monetary System McKinnon Global monetary Targeting 1982 Currency substitution the cause of exchange rate instability and can be offset by changing national money stocks to reflect changes in money demand. The Williamson Target Zone proposal 1985 To target fundamental equilibrium effective exchange rates (FEERS) within soft bands of ±15%.
Reform of the International Financial Architecture The aim of the debate on reform of the international financial architecture has been about reducing the frequency of crises and also the costs, both financial and economic when they do occur. Follows Rey Report of 1996 N]either debtor countries nor their creditors should expect to be insulated from adverse financial consequences by the provision of large-scale official financing in the event of a crisis. Markets are equipped, or should be equipped, to assess the risks involved in lending to sovereign borrowers and to set the prices and other terms of the instruments accordingly.
Reform of the International Financial Architecture continued In a speech in at the end of 2001 Anne Krueger, Deputy Managing Director of the IMF, put it this way We lack incentives to help countries with unsustainable debts resolve them promptly and in an orderly way. At present the only available mechanism requires the international community to bail out the private creditors. It is high time this hole was filled.
Key Proposals 1 Transparency Greater Transparency in provision of information, better banking systems operating with proper riskreturn criteria, combined with better regulation and supervision and improved corporate governance of the companies to which they lend. These should be coupled with sounder rules for public finances and independent central banks mandated to seek price stability, and so forth.
Key Proposals 2 The IMF Abolition or reform of the the IMF abolitionists argue IMF introduces moral hazard and we would be better off without it. Others argue IMF lacks funds to do its job properly. it is forced to require overly burdensome adjustment on the part of crisis afflicted nations since it simply does not have sufficient funds to grant them what they need to mitigate the crises they confront. Others argue that the IMF needs to redefine its role and show greater variety in its programmes than its standard deflationary packages. Some critics whilst acknowledging that the IMF has a valid role to play when crises occur, argue that it should restrict itself primarily to financial issues and keep out of areas such as structural reform requiring bank closures and privatization. It should also consider the social impact of its programmes; for example, the likely impact on unemployment rates and economic growth.
Key Proposals 3 Use of Capital controls Some well-known economists such as Jagdish Bhagwati (1998), Paul Krugman (1998) and Dani Rodrik (1998) have argued that the current IMF rules that require members to seek the ultimate goal of capital account convertibility should be relaxed developing and emerging market economies should be permitted to use capital controls so that they can regain some monetary and macroeconomic independence. Bhagwati is very critical of both the US Treasury and the IMF for rushing too many developing and emerging market economies into relaxing their capital controls without sufficient consideration of whether their domestic banking and financial systems were sufficiently strong and well-regulated to cope with the capital inflows and outflows to which they would be exposed.
Key Proposals 4 New International Lender of Last Resort New international lender of the last resort facilities some authors such as Mishkin (1994) and Fischer (1999) argue that there needs to be a new international agency with credit lines ready to make emergency loans to countries being subjected to unwarranted speculative attacks. The mere knowledge that such an agency exists would make speculators wary of taking on currencies where the fundamentals were relatively sound but which are vulnerable to a speculative attack because, for instance, they posses a low level of foreign exchange reserves or are stuck in a recession. Others are worried that such lender-of-last-resort facilities would merely exacerbate the problem of moral hazard and that the G-7 countries and the IMF countries already effectively provide such a facility.
Key Proposal 5 International Bankruptcy Court Some argue that certain countries have such high levels of external debt that they are effectively bankrupt or placed in a position where economic growth is severely constrained for the foreseeable future by the need to make debt repayments at the expense of living standards and investment in the country s future. It is argued that there may need to be an international bankruptcy court along the lines proposed by Sachs (1995) where nation states with excessive debt levels could go to seek some sort of protection from their creditors, akin to the use of Chapter 11 bankruptcy provisions that corporations frequently use in the United States, or Chapter 9 provisions which cover bankrupt local and state governments. The court would be able to grant the debtor nation a right to suspend payments to creditors and possibly mandate an orderly restructuring package and even debt relief. Such a court would need to be invested with powers that would be enforceable and possibly override conflicting national laws and existing debt clauses.
Conclusions While there are numerous proposals for reform of the international financial system, it is quite clear that there is no consensus concerning the best way to progress forward. As Eichengreen (1999) notes, some of the grander schemes, are: politically unrealistic, technically infeasible, or unlikely to yield significant improvements in the way crises are prevented, anticipated or managed. The differing proposals reflect differing views on what are the problems of the current system and even when commentators agree on the identification of a problem there is not necessarily an agreement on the best way to solve the problem. Often the views are diametrically opposite, some argue for floating exchange rates while others argue that fixed rates are best, some argue for an international lender of the last resort while others oppose it on the grounds that it will add to the problem of moral hazard.