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The international monetary system is the body of rules and procedures by which different national currencies are exchanged for each other in world trade. The global financial system (GFS) refers to those financial institutions and regulations that act on the international level. The main players are private (banks, hedge funds etc) and public (central banks and government departments) and international organizations (the IMF, Bank for International Settlements etc).
The three objectives however are incompatible, only two are achievable at the same time. Under Bretton Woods there was 1 and 2, but not 3. Currently most countries, have 2 and 3, but not 1. The Euro means that each UE member state enjoys 1 and 3, but not 2.
Return to gold. Advocated by extreme neo-liberals. Managed currencies. Imply limitations to the free flow of capital. see Tobin tax. Regional monetary Unions. Currency pegs.
Since the late 1980s the IMF became a strong supporter of free capital markets: it advised countries that came under its influence to dismantle controls over crossborder lending and borrowing. The removal of capital controls would increase the demand for services from the City and Wall Street. The US and Britain pushed for capital liberalization.
Cons International capital markets do not allocate resources efficiently. Speculators and investors tend to be irrational and short-term. Global finance is unregulated and lacks institutional support (standards, supervision, lenders of last resort.
Tobin tax
Already in 1978 James Tobin (a keynesian economist from Yale) criticized excessive financial capital mobility. These flows constrained the ability of governments to pursue adequate domestic economic policies. He recommended a tax on international currency transactions: consisting in a small levy on each transaction. Tobin met with considerable opposition but his suggestion is being reconsidered in the light of the recent massive global financial crises.
Speculation fuelled by euphoria over the performance of a single sector or of a particular countrys economy (herd psychology)
Rise in profits and in investment. Prices rise and the velocity of exchanges accelerates, generating a boom.
Financial crises
1970s- early 1980s: Crisis in developing countries, especially Latin America.
Build-up of high debt levels with Western banks, which had used their lines of credit to recycle Petrodollars.
Starting in 1979, Paul Volcker, the Fed Chairman, raised interests drastically to fight US inflation. International banks followed suit, raised interest rates and the unsustainable debt of many countries position was exposed.
Japan recovers?
First signs of recovery of the Japanes economy had to wait until 2003. In that year GDP grew by more than 2% and the deflationary spiral began to loosen. Japanese exports benefited from the rise in US trade deficit and from the strong performance of China. Big flows of Japanese FDI to China. Interest rates remained very low, leaving Japanese monetary policy almost defenceless against the new economic crisis of 2008.
August 1997- The IMF grants a 17 billion dollar loan to Thailand. Indonesia prime minister blames foreign speculators for the crisis
October 1997. The Hong Kong stock market falls by 25% over just 4 days and a few days later falls by another 5%. Shares fall all over the world, including on Wall Street. The IMF approves a rescue package of 42 billion dollars for Indonesia. November 1997: The crisis spreads to Brasil. The South Korean currency, the won, crashes. In Japan Yamaichi Securities collapse, revealing how the acute problems of the Japanese economy have not been solved.
December 1997 . Fears for the South Korean economy dramatize the crisis. The IMF grants a huge bailout loan of 58 billion $ to South Korea.
January 1998. The IMF and the Indonesian government agree on a package of economic reforms while Indonesia sinks deeper.
April 1998. Signs of crisis in Japan. New agreement between the IMF and Indonesia. The US Congress criticizes the IMFs role in the Asian crisis.
May 1998. Student revolts in Indonesia. Amidst further economic trouble, the Indonesian president, Suharto, resigns.
January 1998. One of the most important investment banks in Hong Kong, Peregrine Investments Holding folds. However despite renewed heavy losses on the stock markets in the entire region, the Hong Kong dollar resists.
Monetary policy in H.K is managed through a Currency Board, which backs the money supply with of US dollars. Also China is prepared to support the Hong Kong dollar with its own vast monetary reserves. Speculators retreat.
May 1998: devaluation of the ruble. Bad news from Russia sparks a wave of panic on world markets, with a sharp fall in Wall Street. Brazils currency, the real, comes under attack
October 1998. The IMF, strongly backed by the US Treasury, grants Brazil a huge, 40 bn. $ loan, demanding a change in Brazils economic policy and further market reform. January 1999: failure by Brazil to carry out economic reform leads to a 35% devaluation of the real and the flight of investors. China and India escaped the crisis. Their capital markets had remained closed
Domestic banks were exposed, having taken out large dollar loans; a weaker domestic currency meant paying a higher dollar rate.
Moreover they had borrowed short and loaned long-term to domestic businesses.
According to Stiglitz the Asian crisis was different from the financial crises in Latin America during the 1980s. Whereas in Latin America the problem had been inflation and debts in the public sector, in Asia public finances were in good shape, whereas the corporate sector was badly in debt.
The solution therefore should have been different, and should not have included budget cuts and austerity measures. It should have, instead, concentrated on macro-economic stability, and in corporate restructuring. Rather than imposing austerity, the IMF should have let corporations pay the price of their profligacy, by allowing exchange rate devaluation. Interest rates should not have been raised.
It remains true that the international financial system is the weakest link in the global economy and that its governance is very weak and contested.
Argentina 2001
Argentina had pegged its currency to the dollar, but the peso weakened and to sustain the peg it was necessary to raise interest rates, causing an economic recession. An aggravating factor was the fact that the Brazilian currency depreciated against the dollar, as did the euro, causing all kinds of problems for Argentinean exports. The peg could not be sustained, and the currency was devalued and following from that there the country defaulted on its debts.
What was the ERM (Exchange Rate Mechanism) and how did it work? What is the 1987 Single European Act ? How did the process of German unification affect the progress towards EMU? Why were convergence criteria established by the Maastricht Treaty ? How important has the enlargement of the EU from 15 to 25 members been for the global economy?
Was the creation of the Euro in 2002 beneficial both for the member states and for the global economy or was the Euro a flawed project from the start?