1. The End of Money Lecture 15 – Thursday, 28 October 2010 J A Morrison 1

2. Lec 15: The End of Money I. After Bretton Woods II. Explaining Foreign Monetary Policy III. The Future of Money 3

3. Lec 15: The End of Money I. After Bretton Woods II. Explaining Foreign Monetary Policy III. The Future of Money 4

4. I. After Bretton Woods 1. What Changed? 2. The Reinvention of the IMF 5

5. The BWS was an attempt to secure the benefits of openness without sacrificing monetary policy autonomy (control over domestic price level). Keynes & White wanted to avoid the experience of the 1930s: policy autonomy secured by competitive devaluations (adjustable ERs) and protectionist trade policy. 6

6. So, the BWS attempted to reconcile openness on trade and ER stability with policy autonomy by… (1) Erecting moderate capital controls (on “speculative” capital) (2) Managing small imbalances through the IMF 7

7. Summary of the Bretton Woods System 8 Stable ERs –ERs fixed within narrow band –No ER adjustments without consent of IMF –IMF makes loans to resolve imbalances  stops price- specie-flow Open Trade & Commerce –IMF created alongside Int’l Trade Organization ITO –IMF embraces burgeoning GATT regime Capital Controls –Currency convertible into gold or dollar –Limits on “speculative capital”

8. But in August 1971, Nixon “closed the gold window,” meaning: he unilaterally devalued the dollar and he suspended convertibility. After several successive conferences failed to preserve the system, the Bretton Woods System was essentially dissolved. 9

9. What changed? 10

10. Post-BW Monetary System Disorderly ERs –Increasing Number of States Float –Others choose to fix (some controversially so, like China) –Slower reactions to crises: 1994, 1997, 2008 Regional currency agreements (Euro, CFA) –Decline of multilateralism Challenge to US power –Euro, Yen, & Yuan aspire to be Nth Currency 11

11. Official ER Regimes of Major Currencies 12 Fixed ER RegimeFloating ER Regime China; Hong Kong; Saudi Arabia US; Euro; Britain; Russia; Japan; India; Australia; Poland; Switzerland Note: These are the de jure (official) ER regimes. The regimes may not reflect market ER stability!!

12. I. After Bretton Woods 1. What Changed? 2. The Reinvention of the IMF 13

13. Remember that the IMF was created principally to manage the BWS. One of its purposes was to reconcile imbalances of payments. 14

14. But with the transition to floating ERs, the IMF became an institution without a mission. How did the IMF react? 15

15. Simply put, the IMF reinvented itself. 16

16. It went from trying to alleviate illiquidity to attempting to resolve insolvency. It went from trying to manage imbalances of payments to redressing the supposed underlying causes of those imbalances. 17

17. The Washington Consensus 1989: Formulated by John Williamson in context of Latin Amer crises & Post-Soviet Transition Supported by IMF, World Bank, & US Treasury 3 Pillars –Macroeconomic Discipline –Market Economy –Openness to World Economy (trade & FDI) 18

18. The New IMF: For Better or Worse Variable Track Record –Good: Eastern Europe & Mexico (1994) –Questionable: 1997 East Asian Financial Crisis Gate Keeper for International Funding –Independent monitoring & rating –Potential tool of powerful countries 19

19. So now we know the broad contours of the history of the international monetary system. Let’s turn to consider how we, as social scientists, explain this empirical record... 20

20. The End of Money I. After Bretton Woods II. Explaining Foreign Monetary Policy III. The Future of Money 21

21. How do we explain states’ foreign monetary policies?  Well, let’s return to Topic 3: Explaining Foreign Economic Policy 22

22. Types of Explanations of FEP Systemic/Structural Explanations –Variables: Distribution of Power; International Regimes/Institutions –Examples: Steve Krasner; David Lake Domestic Explanations: 3 I’s –Ideas (Irwin) –Interests (Rogowski) –Institutions (North; Bailey, Goldstein, & Weingast) 23

23. We’ve already applied these frameworks to explain trade policy. Now, we’ll employ them to explain some of the “critical junctures” in the history of foreign monetary policy (FMP). 24

24. Remember that our mode here is to simultaneously... (1) use the theories to explain the empirics; and (2) use the empirics to test the theories. 25

25. First… Charles Kindleberger, The World in Depression, 1929-39, (1973). 26

26. “The explanation of this book is that the 1929 depression was so wide, so deep and so long because the international economic system was rendered unstable by British inability and United States unwillingness to assume responsibility for stabilizing it in three particulars: (a) maintaining a relatively open market for distress goods; (b) providing counter-cyclical long-term lending; and (c) discounting in crisis.” (p 291) 27

27. Structural Theory Hegemonic Stability Theory: Hegemon provides vital public goods –Openness –Lender of last resort –Liquidity Theorists: –Steve Krasner: Trade openness –Charles Kindleberger: Stable international financial system –Keohane: Int’l Regimes may stand in place for hegemon 28

28. Second… Jeff Frieden, “Exchange Rate Politics.” 29

29. “[I]ncreased levels of financial and commercial integration drive monetary policy toward the exchange rate, make the exchange rate more distributionally divisive, and lead to a more politicized context for the making of macroeconomic policy…All else equal, domestically oriented producers prefer a flexible exchange rate, internationally oriented ones a fixed exchange rate. Tradables producers prefer a weak (depreciated) currency, non-tradables producers and overseas investors a strong (appreciated) one.” (261) 30

30. Frieden: Domestic Interests Increasing integration  sharper political divisions –(Sound like Rogowski?) Map Interests onto preferences (p 260) –(1) ER Stability versus MPA –(2) High versus Low ER 31

31. So, FMP can be seen as a tool to serve domestic interests—just like trade. But FMP is far blunter an instrument than trade. What are the implications of that for the usefulness of this type of explanation for FMP? 32

32. Third… Karl Polanyi, The Great Transformation (1944). 33

33. (You’ve only had this in lecture, so I’ll recap it now.) 34

34. Polanyi: Domestic Institutions GS ideal sacrifices MPA Practical Implications –Deflationary bias –Does not respond to unemployment Why would a state give up MPA?  Serves capital at the expense of labor! Polanyi’s Historical Shift: democratization –Prewar: poor weren’t represented  GS –1930s Forward: poor stop putting up with GS 35

35. Fourth… G John Ikenberry, “Keynesian ‘New Thinking’ and the Anglo- American Postwar Settlement.” 36

36. “I argue that a transatlantic group of economists and policy specialists, united by a common set of policy ideas and a shared view that past economic failures could be avoided by innovative postwar economic arrangements, led their respective governments toward agreement by identifying a set of common Anglo-American interests that were not clearly seen by others.” (59) 37

37. So, Keynesian “New Thinking” pointed the way to some kind of compromise between US and GB. (Ikenberry, however, isn’t completely consistent on the nature of that compromise.) 38

38. So, in Topic 2, we developed several different ways to explain foreign economic policy: int’l structure, domestic institutions, interests, & ideas. We considered their explanatory power with respect to Trade Policy. And now we’ve done the same with Foreign Monetary Policy. 39

39. The End of Money I. After Bretton Woods II. Explaining Foreign Monetary Policy III. The Future of Money 40

40. III. The Future of Money 1. Managing Monetary Systems 2. Money Without Monetary Sovereignty 41

41. States face a number of constraints in governing their monetary systems… 42

42. Counterfeiting Problem with fiat currency: giant seigniorage! John Locke’s fear –States don’t fear some dude in his garage; states fear other states! –international norms are insufficient to prevent economic warfare Examples: –Nazi Germany: Operation Bernhard (see Counterfeiters, 2008) –North Korean Superdollars (or is it the CIA?) 43

43. Hoarding Sometimes specific units of currency are hoarded and/or disappear from circulation Reasons: –Better Media: Small denominations can purchase more than large (“Big problem of small change”) But 10% charge at Coinstar machines! Can’t use $100 bills at gas stations at night Argentina: need coins for buses –Intrinsic value surpasses exchange value: US penny and the rising price of copper Speculation: Argentina’s small coins today 44

44. Currency Competition Previously, we assumed monetary sovereignty But not all states have monetary sovereignty –Germany, 1923 –Zimbabwe today Even the US dollar faces competition at home –Alternative Currency: foreign currency use at home –Complementary Currency: Middlebury Money, Ithaca Hours, Berkshares, E-gold, Bitcoin 45

45. Speculative Attacks Predominantly affects leveraged, fixed regimes –Leverage: ratio of liabilities (circulating cash) to reserves –Greater leverage  greater risk May be organized or disorganized –Disorganized: panic  run on the bank –Organized: coordinated attack by entities with market power 46

46. 47 Hmm. I wonder if I might try that… George Soros, “The Man who Broke the Bank of England”

47. Breaking the Bank of England GB joined European ER Mechanism (ERM) in 1990 –Obliged to maintain ER within 6% band of European currencies By 1992, Pound was overvalued; despite 15% interest rates Soros bet on devaluation: borrowed £6.5bn to buy Deutschmarks & Francs  effect: market ER of GBP vis-à-vis DM fell Black Wednesday (16 Sept 1992): GB devalued GBP Soros converted back into GBP at new, lower ER, getting approximately £7.5bn  Soros then repaid £6.5bn loans, netting £1bn !! 48

48. Contagion Currency values are often linked –Fixed: US & Hong Kong –Trade: Brazil & Argentina; US & Canada –Investment: 1997 East Asian Financial Crisis Problems with one currency spread to linked currencies even if linked economies have no other problems 49

49. III. The Future of Money 1. Managing Monetary Systems 2. Money Without Monetary Sovereignty 50

50. Remember that we’ve been assuming that states enjoy monetary sovereignty--the ability to control the market value of domestic currency, currency used within their borders. 51

51. Jerry Cohen, however, reminds us that this assumption has rarely held true. Across most of history, the “one- country, one-currency” correlation has not been the rule. Strong currencies have traveled abroad while weak currencies have struggled to circulate even in their home markets. 52

52. This raises two questions: (1) What determines the geography of money? (2) What is the future of money? 53

53. The answer to both questions turns, in large part, on the operation of currency hierarchy. 54

54. Currency Hierarchy Currency Hierarchy: some currencies perform the functions of money better than others Medium of Exchange: –Transactional Liquidity: easy to exchange –Transaction Network: lots of goods to purchase Store of Value: –Capital Certainty: reasonable predictability of asset value –Return: real rate of interest (controlling for inflation) 55

55. Benefits of Monetary Sovereignty Monetary Policy Autonomy Seigniorage Political Symbolism Insulation (Independence from Foreign Influence) 56

56. But if monetary sovereignty is so great, why have several European countries given that up to adopt the Euro? 57

57. McNamara on the Euro New ideas lowered benefits of monetary sovereignty –States coordinated MPA around German practice: low inflation New ideas raised benefits of cooperation –Insulation was increasingly viewed as fruitless –Emphasis on benefits of integration 58

58. Are such currency unions the wave of the future?  Europe might be special. Cohen thinks so. But McNamara seems to disagree. 59

59. The answer might well depend on whether the Europeans save the Euro! 59

60. What we Did Today (1) Finished History of the International Monetary System (2) Used frameworks from Topic 3 to explain Foreign Monetary Policy (3) Considered the potential future trajectory of the international monetary system 60