MONETARY AND FINANCIAL REFORM IN TWO ERAS OF GLOBALIZATION (pagg.

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INTRODUCTION
We want to analyze the history of successes and failures in international
monetary and financial reform in two eras of globalization (late XIX, late XX
century and period in between).
We propose a specific hypothesis: a consensus on the need for monetary and
financial reform is likely to develop when such reform is seen as essential for
the defense of the global trading system. So large-scale and discontinuous
reform at a more centralized level tend to occur only when problems in the
monetary and financial system are seen as placing at risk the global trading
system.
During the time period that we want to analyze there has always been a deep
faith in the advantages of trade for economic growth (only one exception for the
unusual circumstances of the 1930s).
In the XIX century, capital markets were viewed as benign.
The role of governments was limited to providing a framework for their
operation; the principle elements of the framework were the gold standard,
which provided stable exchange rates, and the national central bank, which
provided a uniform and elastic currency.
International economic policy was limited to supporting this regime in time of
crisis.
In the 1930s capital markets malfunctioned because of policy inconsistencies
between countries; as a result financial markets were suppressed and banks
became the agents of governments industrial policies. The role of policy
became to take the place of the markets instead of supporting them.
After 1945 internationalism revived, but policy at the international level largely
meant coordinating the financial restrictions imposed by governments.
But when memories of the Great Depression faded and the inefficiencies of
financial repression became evident, people understood again that the task for
the market was the allocation of financial resources and policy had the task of
providing a framework within markets to operate.
But how to do that? Its controversial.
Multilateral institutions (especially the International Monetary Fund (IMF)) made
efforts to structure and stabilize the operation of international financial markets
in order to diminish the incidence and severity of crises or hurt by aggravating
moral hazard.
The debate is about the need to limit the frequency and magnitude of IFM
rescue loans in order to contain moral hazard, and the need to encourage
adherence to international standards for sound financial practice.

In practice, the world economy has returned to a more XIX century style in
international financial system.
*** The focus is on the role of official lending and international standards in
structuring and stabilizing the operation of international financial markets. ***

XIX CENTURY
The first notable XIX century attempt to reform the international monetary and
financial system was in 1867 at a conference in Paris called by Emperor
Napoleon III.
There was substantial agreement about the desire of a common monetary
standard and some participants asked even standardized coinage.
We have to highlight that the desire for monetary standardization as a way to
promote international trade which was considered a high priority, in an era
when technology and policy were drawing national economies more closely
together (lets consider that the railway and the telegraph had already begun to
link national markets more deeply). The natural consequence is in 1860s and
1870s the drive for international standards and harmonized regulation, in fact
money is an obvious area where standardization promised major benefits.
There was, however, less agreement on the monetary arrangement; trade was
growing, independently of harmonization, but there was some inclination for
gold-based currencies even if no specific plan.
Great Britain has adopted the gold standard and this encouraged other
countries to do the same in order to be able to better access British markets, to
be able to borrow abroad (primarily from Britain) and, at the same time, adding
incentive to trade with other gold-standard countries.
On the European continent, the desire to emulate the first industrial nation thus
provided additional motivation for joining the gold standard club. Germany
adhered and the attraction increased (Germany emerged from Franco-Prussian
war as UKs leading industrial rival). US chose gold rather than bimetallism in
1873 as a way of restoring credibility in the disordered post-bellum
circumstances. With the three major industrial countries on gold, a new world
order was born.
The other element of the pre-war institutional framework was the national
central bank.
Precisely in the second half of the XIX century central banks developed their
distinctive profiles and responsibilities as bankers to the government and then
as stewards of the financial system (that is their role of lenders of last resort).
The new central banks, in particular the German Reichsbank and the US Federal
Reserve System, were also intended to deal with internationally transmitted
developments.
The coordination among National banks slowly becomes common and especially
the Bank of France, the Bank of England, the State Bank of Russia and other
central banks and governments were critical for regime maintenance when the
stability of the system was under threat.

FROM WWI TO THE GREAT DEPRESSION

The first reform efforts in the interwar years were an international conference in
Brussels in 1920 and then another one in Genoa in 1922 in which the purpose
was the reconstruction of Europe.
The worst threat came from countries that experienced exchange rate
depreciation and noticed benefits for exports and politically for employment.
But this exchange was not happily received abroad especially from UK, Canada
and the US.
For a country such UK, the center of the prewar trading system, this was
terrible; lets consider that at the beginning of 1922 Englands international
trade was -50% of its pre-war one and as a consequence millions of artisans
were workless and wageless.
During Genoa conference the main purpose was monetary, wanting to stop
currency depreciation.
Recommendations were directed at the restoration of gold convertibility, the
creation of independent central banks, fiscal discipline, financial assistance for
weak-currency countries and cooperative central bank management. All of this
in order to reconcile with the fluctuating financial needs of industry and trade.
The news of Genoa conference has been the introduction of the necessity to
stick to standards for policy and behavior beyond the strictly monetary; all
countries wanting to participate actively to the international system should
respect balanced budgets and fiscal transparency. Fiscal discipline had acquired
prominence when the budgets of the countries engaged in WWI fell into deficits
and it was impossible to restore fiscal balance.
The major drawback of the League system was the nonexistence of any
multilateral organization with the capacity (US couldnt participate).
The establishment of the Bank for International Settlements (BIS) called by
contemporaries world bank was a response and originated to solve the
postwar dispute over reparations and inter-allied debt payments in order to
prevent that dispute from becoming an obstacle to international trading system
reconstruction. All of South and Central America, Africa, UKs overseas
dominions, Asia (not Japan), Spain and (officially, because Federal Reserve
System was forbidden to participate) US were excluded. But BIS hadnt the
resources needed to keep up with a world financial crisis of unimagined
proportions.
The BIS should have played the role of international lender in order to do what
national central banks couldnt do (they were constrained by fixed exchange
rates and unable to print dollars), but, despite the proposes of some influential
components in order to response to the situation (e.g. the Norman-Kindersley
scheme to create an international corporation with a capital of 25-50 million
that could issue bonds up to three times its capital on behalf of national
governments, municipalities, railways and public utility companies; another and
more moderate idea was to supplement official contributions by speed up
private-sector lending and give new energy to financial markets). These
initiatives werent well received, especially by British, Germans and French.
In sum, the BIS lacked the finances and leadership to cope with a crisis of such
enormity.

THE 1930s
We saw that BIS wasnt able to enforce policies to solve the 1929 crisis, but
there was still hope that the international community would draw a constructive

lesson from it. The first opportunity to demonstrate it was the London
Conference in 1933.
The meeting was preceded by preliminary commissions and committees that
began in late 1932 under the auspices of the League of Nations. To work better
two specific committees were created, a financial one that agreed on the
necessity to reconstitute freer trade as a prerequisite of a return to normal
economic conditions and of a return to the gold standard, and a trade
committee which stated that a financial normalization was a pre-condition for
rebuilding trade.
On 12 June 1933 the conference finally met, but Chancellor Chamberlain
stressed that the conference wouldnt be successful if it did not resolve the war
debt issue (Germany hoped for a moratorium on debt, Roosevelts instructions
to the US delegation excluded formal and informal discussions on war debts as
well as disarmament instead).
President Roosevelts message was that US had no intention of stabilizing the
dollar because national stability should have priority over internationalism.
Rebuilding trade was desirable as a way of giving impetus to US exports, but
there was little chance to do it in such a depressed condition of 1930s, with
much of Central Europe under German domination and Latin America having
turned to import substitution.
The reasons for London conference failure are clear: Roosevelt recognized the
desirability of rebuilding world trade but, in the absence of international
cooperation, domestic stability appeared much more important than trade
reconstruction. This aspiration has been put on hold until currency depreciation
and monetary reflation had succeeded in recovery the situation.
Lets also consider that with Central and Eastern Europe under German
influence and strong protectionism in France, proposals for monetary and
financial stabilization as a way of rebuilding world trade met with limited
support.

BRETTON WOODS
Although there were 45 nations represented at Bretton Woods, only the US and
the UK played significant roles, in fact plans for the IMF and the World Bank had
already emerged from earlier Anglo-American discussions, which other
participants had no choice but to accept, the negotiation was fundamentally
bilateral.
The US had a preponderance of power, whereas the UK was short of money; this
imbalance of power shaped the negotiations in such a way that the Americas
White Plan was adopted with only minor modifications.
In addition, there was now more of a consensus regarding the economic basis of
the new world order: capital flows were destabilizing, competitive devaluations
a threat and discriminatory trade policies a danger.
Bretton Woods was a success because there was significant pressure to produce
a settlement (possibility of an early end of European war, US elections and
priority clear to everyone to reconstruction of trade), very different from 1933
attitudes toward trade liberalization.
In 1944, in contrast, there was no doubt about the US commitment to trade
liberalization and therefore about its preference for a monetary system that
guaranteed exchange rate stability and current-account convertibility as a way

of creating a trade-friendly financial environment. Other countries had no choice

but to agree, but fundamentally sharing the same priority.

AFTER BRETTON WOODS

In this period we can assist to the disintegration of Bretton Woods: according to
one because of the buildup of claims on the US that were needed for the
liquidity of the system, according to the other, as a result of US action in
response to a worsening trade position against Japan that refused to consider
any revaluation that might decrease its exports.
The Nixon package in 1971 ended the par value system and as a consequence a
modification of the monetary order was needed to prevent a trade war.
The 1970s witnessed a dramatic expansion in the new protectionism of
voluntary export restraints and devices to avoid GATT rules.
Some wanted a new Bretton Woods but the Committee of Twenty (C20) had the
agency for the process of evolution of the international monetary system.
France and Japan preferred a return to fixed exchange rates but in a contest of
constraints on the US; German policymakers were divided; British policymakers
were confused.
A solution came out from a bilateral agreement between US and France with a
formula of stable system of rates instead of a system of stable rates, the
only possibility at the time.
There was no threat to world trade from the increased variability of exchange
rates.
Meanwhile in Europe, where trade mattered most, Germany and France, at the
beginning with the UK, negotiate in a mini-Bretton Woods in order to create the
European Monetary System.
We have to highlight that after 1960s we see a continuing growth of
international capital movements, and none of 1980s discussions this point that
now appears to be the most important development of the post-Bretton Woods
years. Lets think about the fact that the private sector handled the imbalances
and liquidity problems of the 1970s sufficiently well that many commentators
concluded that the IMF and the World Bank would have more marginal
existence, catering only to poor countries excluded from the worlds capital
markets.
But this aspect came to light to the worlds attention in 1982 with the Latin
American debt crisis (threats of default by Mexico and Argentina) that required
new money from official as well as private sources in order to solve the
situation.
Although the IMF eventually came to play a central role to assist the banks, this
solution removed the threat of default at a time when the money-center banks
were heavily exposed yet.
The financial crisis of the early 1980s was a shock to international trade, but
ultimately the global trading system was not blocked so these events didnt
provoke fundamental monetary and financial reform.

THE 1990s
Globalization is the word of the 1990s, reflecting the rapid growth of
international financial transactions, the integration of developing countries into
the world economy, the information and communication revolution, and as a
consequence capital flows rose exponentially, enabling countries to finance

their development needs abroad, but also applying more pressure if things went
wrong.
Influencing and monitoring this market was no easy task.
In the debt crisis of the 1980s the situation for the IMF was simpler because
there were less creditors, during the next debt crisis in 1994-95, instead, the
progress of sicurization meant that the investor base was larger and more
heterogeneous and it was a difficult task to recognize the collective interest of
such a large number of creditors. This explains the dilemma facing the IMF of
how to ameliorate the severity of a crisis without abandoning investors and
aggravating moral hazard.
Capital-account liberalization allowed banks and corporations to fund
themselves offshore and currency mismatches to develop on their balance
sheets. This environment proved a situation easy for banking crises.
At the same time factors limited the capacity of central banks and governments,
unable to print dollars and worried about their credibility, to intervene in
stabilizing ways. It meant that IMF intervention to contain the consequences
might require unprecedented quantities of finance.
Moreover, the further growth of capital flows now complicated efforts to operate
bands and exchange rate target zones.
Floating rates appeared to many developing-country governments too risky to
domestic financial systems because it could expose to a mismatch between
liabilities (in dollars or other foreign currencies) and domestic currency assets.
Pegging the exchange rate, adopting a currency board, or dollarizing were still
regarded as valid devices where the crises was extreme, but there was
reluctance to adopt such policies.
One way of understanding the expanding scope of IMF conditionality is as a
search for new sources of credibility for national policy. The Fund might
condition its assistance on agreement to make the central bank independent, to
empower the prime minister or the finance minister to veto the spending
decisions of subcentral governments, or to make budgeting more transparent,
all as ways of enhancing the credibility of policy.
Critics of the IMF dismissed the Funds excessively intrusive structural
conditions because it moved into areas like corporate governance, accounting
methods and principles, attacks on corruption, etc unprecedented issues for
what was a financial institution.
Mexico in 1994-95 was the first test on this new approach; the Mexican crisis
was a debt crisis, but it was also a banking crisis. The Fund conditioned its
assistance on reform of the banking system as well as on the standard
macroeconomic measures. Moreover, the scale of the assistance needed for
large amounts of liquidity never imagined before to avoid default.
Every aspect of IMF intervention was called into question, but at the same time
it came to be seen as more vital than ever to the operation of the global

financial system. The obvious manifestation of this was the increase in the
funds resources (doubled) in the 1998-99 quota review.
The review had been stalled because of the reluctance of the US Congress, but
once Asian crisis of 1997-98, with repercussions in Brazil and Russias default,
threatened to reach US shores, debate quickly gave way to action.
There was little consensus on desirable directions for reform because there were
disagreement and confusion over the nature of recent crises. It was the
international spread of the crisis that was particularly perplexing.
The IMF instinctively prescribed the standard treatment, but it was forced to
admit that it had been ineffectual. The problem is that it isnt clear what
alternative course of treatment would have been better.
We can recognize that the role of international financial cooperation came back
as it was conceived in the XIX century, as supporting rather than superseding
the markets.
So the functions of the World Bank should be to subsidize investments in global
public goods like health and environment that private markets undersupply,
now that the growth of private capital markets has reduced the need for official
sources of development finance.
The IMF instead has accepted that its members should draw on its facilities
mainly in times of crisis and not borrow for extended periods.

CONCLUSION
Whereas in the XIX century adherence to the gold standard was regarded as
both necessary and sufficient for a country to be active on international
financial markets, adherence to a particular monetary standard is now seen as
insufficient. The change reflects the un-precedented extent of financial
integration, reflecting technology as well as policy, which has erased the line
between domestic and international financial markets and led to the recognition
that measures to strengthen and stabilize domestic financial markets are
prerequisites for international financial stability.