Unit Six: Global Politics of Money
Dr. Russell Williams
Required Reading:
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Cohn, Ch. 6.
Class Discussion Reading:
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Niall Fergusson, “The euro's big chance,” Prospect, May 27,
2004.
Benjamin J Cohen and Paola Subacchi, “A One-and-a-half
Currency System,” Journal of International Affairs,
Fall/Winter2008, Vol. 62 Issue 1, pp. 151-163.
Outline:
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Introduction - International Monetary System
Central mechanisms
Breton Woods System
Contemporary System
Current Controversies
Further Reading
1) Introduction - International
Monetary System
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Why is it important to study this???
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Key to facilitating all international exchange
Important domestic politics ramifications
Major site of theoretical debate
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Liberals emphasize role of markets in monetary
system
Realists and Historical Structuralists emphasize role
of states in creating/managing system
Current debates?
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Should exchange rates float (liberals) or be
“Pegged” (anti-liberals and Keynesians)
2) Three Central Mechanisms:
A)
B)
C)
Exchange Rate System
Balance of Payments
Balance of Payments Adjustment
A) Exchange Rate System:
 Exchange Rates/Foreign Exchange Markets
 Based on price of one currency in terms of
another
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“Price” determined by:
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Floating System = supply and demand of currency
Fixed or pegged systems = state intervention
“Ideal Types” of Exchange Rate System:
i) Fixed or “pegged” system: currency pegged in
relation to key (or “benchmark”) currencies or
gold

Gold Standard (19th Century) - states guarantee
value of currency against gold = convertibility
 Currencies should not fluctuate in value . . .
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Non-Gold standard “pegged” systems
 Currencies “fixed” in value against other currencies
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States defend currency value through market intervention
Without convertibility speculators may not accept official
exchange rates
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“Market Interventions” in a Fixed Exchange Rate
System:
1) Capital controls - Prevent currency trading
and speculation
2) Trading of state reserve currencies
3) Domestic policy adjustment
 E.g. Lower or raise interest rates
ii) Floating System/Free-Floating System: States
allow exchange rates to change
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Markets determine daily value of currency
Supply and demand
Modern “real world” systems:
i) “Fixed, but Adjustable” exchange rate systems:
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States peg rates but can adjust them if necessary
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Requires international cooperation to prevent “beggar thy
neighbor” policies
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E.g. Breton Woods (1945-1972)/Europe(1974-1990)
ii) “Managed Floating”: (Current “non system”)
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Exchange rates float in theory, but, states intervene to reduce
exchange rate changes bad for economy
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i.e. Canada since 2005 . . . .
No agreed rates, states make own choices . . .
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Can lead to “Manipulative or Dirty Floating” – States artificially
reduce exchange rate through “pegs” etc. for export advantage
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Requires Considerable political coordination
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E.g. China/US
Key Point: In modern system - states pursue different
approaches, some fix, some float etc.
Why do states choose to “fix” or “float”?
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Economic Theory: “The Unholy Trinity”
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States have three potential monetary goals:
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Fixed exchange rate = Good for firms and international trade
Autonomy over domestic monetary and fiscal policies = Good for
domestic politics . . .
Capital mobility = Access to foreign investment
Economists say you can only have two at once
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E.g. Fixed exchange rates and autonomy only if capital mobility
is low
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State must control short term “Portfolio Investment” capital flows
(Breton Woods System)
E.g. Autonomy and capital mobility, but exchange rates must
float (Theoretically, the current “non system”)
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However do states have autonomy in current system?
 Only if they are unconcerned about exchange rates . . .
Three Central Mechanisms:
B) “Balance of Payments”: E.g. US (2003)
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“Current Account” and “Capital Account” 
 Implications:
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US is borrowing capital to finance imports
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 Key
Over long term this will further hurt “Current Account”
US becomes “debtor nation” and foreigners own more US assets
Points:
US account balances, but reveals potential long term
problem
 Situation is only sustainable as long as foreigners
perceive the health of the US economy which makes it an
attractive place to invest.
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Or as long as people perceive the health of the US dollar . . .
Three Central Mechanisms:
C) Balance of Payments Adjustment:
“Current Account” and “Capital Account”
don’t balance – country has an “imbalance of
payments”
 If
 E.g.
If no one wants to lend to or invest in US
=Downward pressure on value of US dollar
 States
must adjust policies to remedy situation
 Adjustment
limited by Exchange Rate System . . .
Balance of Payments Adjustment:
In
a Fixed Exchange Rate System:
 Imbalance creates pressure on exchange rate =
States must intervene in market to offset
imbalance
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E.g. US problem – current account deficit – leads to
declining interest in US dollar
 Options:
1.
“Financing” - Use reserves and IMF lending
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Can exceed capacity – under fixed Breton Woods system
states helped one other through IMF lending
Adjust domestic “Monetary Policy” and “Fiscal
Policy”
3. Impose tariffs (!)
2.
Balance of Payments Adjustment:
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In a Floating Exchange Rate System:
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Imbalance creates pressure on exchange rate,
but adjustment occurs through exchange rate
changes
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I.e. US dollar falls relative to other currencies
 “Depreciation”
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vs. “Appreciation”
Resolves current account deficit – makes:
 US
exports cheaper
 Foreign imports more expensive
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What has happened to the US dollar since 2003????
3) Breton Woods System:
=“Fixed but Adjustable” gold exchange standard: Most
currencies fixed to US dollar which was fixed to gold (35$
an ounce). US guaranteed convertibility
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System was Keynesian/Embedded Liberal - wanted
exchange rate stability and domestic policy autonomy
=Stability good for international trade
=Domestic autonomy good for Keynesianism and full employment
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“Unholy trinity”????
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Balance of payments problems fixed by:
= Capital controls
A) “Financing” (IMF increased reserves available)
B) Agreed exchange rate adjustments
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“Devaluation” and “Revaluation”
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Option for all states - except the US!
System worked well for a time . . .
Restarted economic globalization (good for liberals)
 High growth rates, rapid increases in standards of
living
 Good for US allies
 Also, good for US as hegemon?
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“Seignorage”: Benefits that go to the issuer of
currency
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Under system US $ is “global reserve currency”
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US firms get to do business in US$ - Reduces risks and
cost of currency volatility
Cheaper to buy foreign goods - No exchange costs
Increased macroeconomic autonomy - People always want
your money (artificially high demand)
Lower inflation
Key financial centre – New York = Source of power?
Problems:
1) Central role of US dollar:
versus “confidence” – “Triffin Dilemma” – one
currency can’t do both
 System required US to run capital account deficits
 “Liquidity”
Money
must flow out of US to rest of world = US needed trade
surpluses . . . . (Current account problems???)
 No
adjustment for US:
US
could not reduce value of currency - Other countries take
advantage (West German and Japan)
 Trade and Convertibility problems
2) Globalization:
 Growth
of short term financial flows/eroding of capital controls
(1970s)
“Eurocurrencies”/“Euromarkets”/Eurodollars
 Increased pressure on fixed exchange rates
E.g.
 Major
debate in IPE – Why did this happen?
Technology
or choice of UK and US
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Collapse!
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French attack on US hegemony (liquidity
versus confidence)
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1970s US current account deficit – US
needed to adjust (= needed “Depreciation”)
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“Nixon Shocks” (1971)
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Ends convertibility to gold
Imposes tariffs to restore trade surplus
Depreciates US dollar
OECD states began to abandon capital
controls and float exchange rates
5) Contemporary System:
Current “Managed Floating” System is confused =
management problems
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Major countries “float” currencies (US, EU, UK, Japan,
Canada)
 Often intervene to keep currencies in desired ranges
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Smaller European states, East Asia, developing nations
often peg currencies
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US $ remains key currency of exchange but world is
subjected to challenges caused by US policies
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E.g. Current US strategy of “Depreciation”
Problems:
 Financial flows bigger then expected
 More volatility – rapid shifts in exchange rates
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Creates need for private “Hedging”
volatility – Speculative runs on currency
 Less autonomy
Not all states float – possibility of manipulative or “Dirty
Floating”
 E.g. China
Misalignment and irrationality
 E.g. US dollar often overvalued - role as key currency
 E.g. Canadian dollar often undervalued - Not clear
why
 More
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Problems require state management and international
cooperation
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Despite floating system states remain important actors in
monetary system
6) Current Controversies:
a) Speculation and exchange rates:
Particular problem for small economies and
developing nations
 Solutions?
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i) “Tobin Taxes” -restore some state autonomy
ii) World Bank and IMF Reform
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More aid for developing nations with short term problems
iii) “Currency Unions”: (E.g. Euro)
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Reduces impact of volatility and speculation
“Optimal Currency Area”
 Match the coverage of the currency to the area of
economic integration – less “trade” in foreign currency
b) Impact of the “Euro”:
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Small states lose or gain autonomy?
 Exchange
rate no longer a policy instrument
 Limited “say” over Europe-wide policy
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E.g. Greece versus Argentina
b) Impact of the “Euro”:
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Europe and US dollar? Many predict Euro
will supplant US dollar as key currency
 Euro
area is larger economy
 US economic problems
 Impact?
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US will lose seignorage benefits?
Current account deficit harder to finance
 Skeptics
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suggest US still has advantages
Better financial markets
Europe not a single state – fragmented/less influence
over IMF/World bank
c) China/US Financial Relations:
US
argues Chinese RMB/Yuan pegged too low
relative to US$
Results:
Massive
trade deficit with China = Outsourcing debate
China holding huge US dollar reserves
Inflating value of US dollar?
Large pool of FDI – China becoming a huge capital
exporter
=China following path of Europe and Japan in
1960s?
Arguments:
Use
US power to force revaluation?
US benefits from situation?
Situation is going to take care of itself (US
Depreciation)
D) “Sovereign Wealth Funds (SWF)”:
 State
controlled investment vehicles
Control large amounts of global finance, but may not
behave like market participants
Transparency
Political agendas
Further Reading:
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Eric Helleiner, “Still An Extraordinary Power, But for
How Much Longer? The United States in World
Finance,” in Lawton, and Verdun, eds., Strange
Power: Shaping the Parameters of International
Relations and International Political Economy,
(Ashgate, 2001), pp. 229-247.
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Benjamin J. Cohen, “Can the Euro Ever Challenge
the Dollar?,” Journal of Common Market Studies,
41-4 (September 2003), pp. 575-595.
For Next Time:
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Unit Seven: Money Problems - The “Debt
Crisis” and Financial Crises
Required Reading:
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Cohn, Ch. 11.
Class Discussion Readings:
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Sohan Sharma and Surinder Kumar, “Debt Relief –
Indentured Servitude for the Third World,” Race &
Class, 43-4 (April-June, 2002), pp. 45-56.
Kenneth Rogoff, “The IMF Strikes Back,” Foreign
Policy, No. 134, (January/February 2003) pp. 38-46