Study Notes for Globalizing Capital: A History of the International Monetary System - Chapter 5 Summary

Globalizing Capital: A History of the International Monetary System by Barry Eichengreen

Chapter 5: After Bretton Woods

Overview

  • The phrase "It’s our currency but it’s your problem." attributed to U.S. Treasury Secretary John Connally, encapsulates the U.S. perspective post-Bretton Woods.

  • The transition post-1973 from the Bretton Woods system marked a significant shift in international monetary affairs, allowing exchange rates to float.

Historical Context

  1. Demise of Bretton Woods (1973)

    • End of fixed exchange rate system, allowing currencies to float freely.

    • Exchange rate stability had been primarily the focus of monetary policy.

    • Capital controls previously insulated governments from balance-of-payments pressures.

  2. Rise of International Capital Mobility

    • The effectiveness of capital controls deteriorated.

    • By the 1960s, international financial markets had begun to recover.

    • New techniques emerged to evade restrictions on capital flows.

Impact on Monetary Policy

  1. Issues with Pegged Exchange Rates

    • Countries became hesitant to consider changes in exchange rate parities due to fears of capital outflow when contemplating parity changes.

    • Defense of pegged rates required unprecedented foreign-exchange interventions, which became increasingly untenable.

    • Large countries (U.S., Japan) opted to float their currencies, while smaller, open economies often faced volatility and preferred fixed pegs.

  2. Development of Financial Markets

    • Escalated tensions as capital mobility increased, limiting governments' abilities to manage their economic policies.

    • Instances of crisis in Europe necessitated realignments within the framework of arrangements like the European Monetary System (EMS).

European Monetary System (EMS) and Response to Capital Mobility

  1. Overview of EMS

    • Initiated in reaction to difficulties faced in maintaining fixed exchange rates.

    • Established in the 1980s to contain exchange rate fluctuations in Europe.

    • Responded to the increasing volatility of exchange rates due to higher capital mobility, particularly post-Bretton Woods.

  2. Challenges Encountered by EMS

    • The removal of capital controls at the end of the 1980s made operating the EMS increasingly challenging.

    • The inability to maintain stable exchange rates led to financial crises in the early 1990s.

  3. Interventions Under EMS

    • German Bundesbank's pivotal role as a stabilizing force in the EMS.

    • Conflicts between monetary authorities highlighted diverging economic policies and interests.

Transition to Floating Exchange Rates

  1. Decisions and Impacts

    • Post-Bretton Woods transition was initially tumultuous; floating currencies were seen as a leap into uncertainty.

    • Efforts to restore a system of par values were unsuccessful; the U.S. preferred floating rates to defend dollar stability.

  2. Market Reactions and Adjustments

    • Market volatility often necessitated interventions by strong-currency countries to stabilize weaker currencies.

    • Changes in government policies and macroeconomic conditions influenced currency strength.

  3. Self-Fulfilling Currency Attacks

    • Speculative attacks can create crises where currencies could have remained stable.

    • Example: anticipation of currency shifts could trigger shifts that would not have occurred without outside pressure.

Practical Implications for Developing Countries

  1. Adoption of Currency Boards

    • Some countries established currency boards or similar arrangements to maintain stability.

    • Currency boards tie local currencies to foreign currencies (often a strong currency), restricting central banks' ability to act as lenders of last resort.

    • Successful use of currency boards in small, open countries indicated potential benefits, though risks remained.

  2. Trend to Pegging vs. Floating

    • Developing countries faced challenges in fully liberalizing their financial markets while managing exchange rate volatility.

    • Diverging experiences among developing countries highlighted the complex interplay of inflation control, currency stability, and economic policy credibility.

Key Takeaways

  • The shift from the Bretton Woods system to floating rates reshaped investment, trade, and economic policies globally.

  • The EMS provides key lessons on the volatility inherent in pegging currencies without sufficient intervention resources or fiscal adjustments.

  • Countries must adapt and evolve financial systems responsive to changing international monetary conditions, balancing the pressure of capital mobility with domestic economic needs.