Fall 2023

INTERNATIONAL POLITICAL
ECONOMY

Dr. H. Kürşad Aslan

CHAPTER 8:
THE INTERNATIONAL
MONETARY AND FINANCE
STRUCTURE
International financial structure &
Political Power
Finance, money, interest rates and debt are
interrelated in a structure that shapes cross-border
flows of capital, the relative value of national
currencies as expressed in foreign exchange rates,
and government borrowing.
 International financial structure &
Political Power

 Most states are very reluctant to hand

responsibility for managing their financial,
monetary, and economic affairs over to other states
or international organizations.
 Why do states guard this sovereign power so
jealously?
 International financial structure &
Political Power
 Monetary integration involves a consideration of two
quite different dimensions of sovereignty:

1-) policy sovereignty

2-) legal sovereignty

 Policy sovereignty refers to the ability to conduct
policy independent of commitments to other
countries.
 Legal sovereignty refers to the ability of a state to
make its own laws without limitations imposed by
any outside authority.
 International financial structure &
Political Power
 “In all modern societies, control over the
issuing and management of money and credit
has been a key source of power and
distributional consequences have been
immense.”
 For this reason, the global finance and
monetary structure is often full of tensions.
 It is difficult to manage this system effectively
due to different interests.
 Key Terms
 Balance of Payments
 Bretton Woods System
 Capital Account
 Conditionality
 Current Account
 Devaluation
 Exchange-Rate System
 Fixed Exchange-Rate System
 Floating Exchange-Rate System
 Foreign Exchange Reserves
 Speculative attack
 Currency crisis
 Crony capitalism
 Hard currency
 Soft currency
 Hot money
 Reserve currency
 Private capital flows
 Official capital flows
 European Monetary Union (EMU)
 Mundell Trilemma
 Lender of last resort
 Capital flight
 Contagion crisis
YOUTUBE VIDEO

 Let’s remember our ECON 101 knowledge.

 (Macro) Episode 32: Monetary Policy

 https://www.youtube.com/watch?v=HdZnOQp4S
mU
 (Macro) Episode 33: Exchange Rates
 https://www.youtube.com/watch?v=xwtgByffoU
w
A Brief History of
the International Monetary System
 Pre 1870: Bimetalism
 1870-1914: Classical Gold Standard
 1915-1944: Interwar Period
 1945-1972: Bretton Woods System
 1973-Present: Flexible (Hybrid) System
International Macroeconomic Policy
Under the Gold Standard, 1870-1914

 Origins of the Gold Standard

 The gold standard had its origin in the use of gold
coins as a medium of exchange, unit of account,
and store of value.
 The U.S. Gold Standard Act of 1900
institutionalized the dollar-gold link.
The Gold Standard(1870-1914):
two essential features
 Nations fixed the value of the currency in terms of Gold which
was freely transferable between countries.
 Essentially it was a fixed rate system (Suppose the US announces
a willingness to buy gold for $200/oz and Great Britain
announces a willingness to buy gold for £100.
 Then £1=$2)
International Macroeconomic Policy
Under the Gold Standard, 1870-1914

 External Balance Under the Gold Standard

 Central banks
 Their primary responsibility was to preserve the official parity between
their currency and gold.
 They adopted policies that pushed the nonreserve component of the
financial account surplus (or deficit) into line with the total current plus
capital account deficit (or surplus).
The Interwar Years, 1918-1939
 With the eruption of WWI in 1914, the gold standard was
suspended.
 The interwar years were marked by severe economic
instability.
 The reparation payments led to episodes of
hyperinflation in Europe.
 The German Hyperinflation
 Germany’s price index rose from a level of 262 in
January 1919 to a level of 126,160,000,000,000 in
December 1923…
 1918-1939
 The Fleeting Return to Gold
 1919: U.S. returned to gold
 1922: A group of countries (Britain, France, Italy, and Japan) agreed on a
program calling for a general return to the gold standard and cooperation
among central banks in attaining external and internal objectives.
 1925: Britain returned to the gold standard
 1929
 The Great Depression was followed by bank failures throughout the
world.
 1931
 Britain was forced off gold when foreign holders of pounds lost
confidence in Britain’s commitment to maintain its currency’s value.
1918-1939

 International Economic Disintegration

 Many countries suffered during the Great Depression.
 Major economic harm was done by restrictions on
international trade and payments.
 These beggar-thy-neighbor policies provoked foreign
retaliation and led to the disintegration of the world
economy.
 All countries’ situations could have been bettered
through international cooperation.
 The Bretton Woods System
(1944-1971)

 U.S.$ was key currency valued at $1 = 1/35 oz. of

gold
 All currencies linked to that price in a fixed rate
system.
 In effect, rather than hold gold as a reserve asset,
other countries hold US dollars (which are backed by
gold)
 FIXED (PEGGED)
EXCHANGE SYSTEM
 FLOATING
EXCHANGE SYSTEM
 Bretton Woods System: 1944-1972

German
British mark French
pound franc
r Par P
Pa lue Va ar
Value lue
Va
U.S. dollar

Pegged at $35/oz.
Gold
 The Bretton Woods System
and the International Monetary Fund
 International Monetary Fund (IMF)
 In July 1944, 44 representing countries met in Bretton Woods, New Hampshire
to set up a system of fixed exchange rates.

 All currencies had fixed exchange

rates against the U.S. dollar and an
unvarying dollar price of gold ($35 an
ounce).
 It intended to provide lending to countries with current account deficits.
 It called for currency convertibility.
 The Bretton Woods System
and the International Monetary Fund
 At Bretton Woods the Great Powers created the
International Monetary Fund (IMF), the World Bank,
and what would later become the General Agreement on
Tariffs and Trade (GATT).
 The World Bank was to promote economic recovery
immediately after the war and then turn its energies to
addressing long-term economic development issues.
 The IMF to ensure a stable international monetary
system.
 The Bretton Woods System
and the International Monetary Fund
 At the center of this modified gold standard was a fixed
exchange rate mechanism that set the value of an ounce of
gold at U.S. $35.
 The values of other national currencies would fluctuate
against the dollar as supply and demand for those
currencies changed.
 These goals complemented U.S. liberal values and policy
preferences at little cost to the United States.
 Goals and Structure of the IMF
 The IMF agreement tried to incorporate sufficient
flexibility to allow countries to attain external balance
without sacrificing internal objectives or fixed
exchange rates.
 Two major features of the IMF Articles of Agreement
helped promote this flexibility in external adjustment:
 IMF lending facilities
 IMF conditionality is the name for the
surveillance over the policies of member
counties who are heavy borrowers of Fund
resources.
 Adjustable parities
 Speculative Capital Flows and Crises
 Current account deficits and surpluses took on added
significance under the new conditions of increased
private capital mobility.
 Countries with a large current account deficit might
be suspected of being in “fundamental
disequilibrium”under the IMF Articles of Agreement.
 Worldwide Inflation and
the Transition to Floating Rates
 The acceleration of American inflation in the late 1960’s
was a worldwide phenomenon.
 It had also speeded up in European economies.
 When the reserve currency country speeds up its
monetary growth, one effect is an automatic increase in
monetary growth rates and inflation abroad.
 U.S. macroeconomic policies in the late 1960s helped
cause the breakdown of the Bretton Woods system by
early 1973.
Collapse of Bretton Woods (1971)

 U.S. high inflation rate

 U.S.$ depreciated sharply.
 1973 The US dollar is under heavy
pressure, European and Japanese
currencies are allowed to float
 Gold abandoned as an international
reserve
 Robert Gilpin and other realists make a strong case
for the connection between the diffusion of
international wealth at the time and the emergence of
a new multipolar security structure that would be
cooperatively managed by the United States, the
Soviet Union, the EU, Japan, and (later) China.
 The rise of OPEC and large shifts in the pattern of
international financial flows after oil price increases
in 1973–1974 and 1978–1979 helped produce a
global financial network.
 As OPEC states demanded dollars as payment for
newly expensive oil, the demand for U.S. dollars
increased, which helped maintain the dollar as the
top currency in the international economy.
 Many of the OPEC “petrodollars” were then
deposited back into Western banks, from which they
were recycled in the form of loans to developing
countries.
 However, between 1973 and 1982, the debt of non-
oil exporting developing nations increased from
$130 billion to $612 billion, generating debt crises
in Latin America and Africa in the 1980s.
 In the 1970s and early 1980s, trade imbalances in the
developed countries contributed to “stagflation”
(slow economic growth accompanied by high
unemployment and inflation).
 In the early 1980s the governments of Prime
Minister Margaret Thatcher and then President
Ronald Reagan privatized national industries,
deregulated financial and currency exchange
markets, took steps to weaken labor unions, cut taxes
at home, and liberalized trade policy.
 Theoretically, these measures were supposed to
produce increased savings and investments that
would stimulate economic growth.
 In 1983, economic recovery did begin, but many
experts suggest that growth was due more to a
significant drop in world oil prices than neoliberal
policies.
 Despite his laissez-faire rhetoric, Reagan raised
defense spending significantly as part of a renewed
Western effort to contain the Soviet Union.
 A larger defense budget and a strong dollar led to
record U.S. trade deficits, especially with Japan.
 Instead of cutting back on government spending or
raising taxes in order to shrink the U.S. trade deficit,
the Reagan administration pressured Japan and other
states to revalue their currencies.
 By 1985, the United States had become the world’s
largest debtor nation, financing its deficits by
borrowing some $5 trillion from other countries.
 U.S. companies complained that the overvalued
dollar caused a flood of cheap imports that was
destroying domestic industries, and demands for
protectionism grew.
 The United States pressed the other G5 states (Great
Britain, West Germany, France, and Japan) to meet in
September 1985 in New York, where they agreed to
intervene in currency markets to collectively manage
exchange rates and lower U.S. trade deficits.
 The Plaza Accord committed the G5 to work together to
“realign” the dollar so that it would depreciate in value
against other currencies.
 Economic liberal policies and development strategies
served as the basis of the “Washington Consensus” and
the globalization campaign.
 Emerging countries became convinced that the
IMF’s prescriptions for budget cuts, higher taxes,
unregulated financial flows, and privatization were
inappropriate for a country during a financial crisis.
 It was not until the global financial crisis of 2008
that developed countries would begin to understand
why emerging markets rejected their Washington
Consensus and neoliberal policies.
Three major international financial
crises

 the Mexican “peso crisis” in 1994,

 the Asian financial crisis in 1997,
 the global financial crisis in 2008
 When a currency’s exchange price rises—that
is, when the currency becomes more valuable
relative to others—we say that it appreciates.
 When its exchange price falls and it becomes
less valuable relative to other currencies, we
say it depreciates.
 Exchange rates are often set by supply and demand
in the market.
 However, a central bank can also intervene in
currency markets, buying up its country’s own
currency or selling it in an attempt to alter its
exchange value.
 Undervaluation can also reduce living standards and
contribute to inflation.
 Sometimes LDCs intentionally overvalue their
currency to make imported goods such as machinery,
arms, food, and oil cheaper, but at the expense of
making the country’s exported goods less
competitive abroad.
 Two other important variables that impact
exchange rates are
1.) inflation
2.) interest rates.
 Finally, one of the major currency and finance issues
is speculation.
 Many individuals and financial institutions look to
make profits by trading in currencies based on
expectations of future foreign exchange rates.
 Capital that moves quickly in and out of a country is
called hot money.
 When foreign investments pour into a country, they
often push up prices for stocks, bonds, and houses
well beyond what is reasonable. These price bubbles
can burst when investors rapidly pull their money out
in anticipation that market prices will fall.
 The balance of payments
 The balance of payments registers all of the international
monetary transactions between the residents of one country and
those of other countries in a given year.
 These inflows and outflows are recorded in the current account
and the capital and financial account.
 These transfers include foreign aid, money migrants send home.
Outflows in the current account are foreign trade plus payments
of profits and interest to foreign investors, and unilateral transfers
to other nations.
 Responding to balance-of-payments crises requires states and
their societies to make difficult political and social choices about
who will benefit and lose.
 During the 2000s many mortgage companies and big banks
earned big profits from the fast-growing home real estate
market in the USA.
 They offered subprime mortgage loans to attract first-time
buyers, many of whom had weak credit scores and unstable
incomes.
 By early 2007 a slew of large mortgage companies with
portfolios of subprime loans worth $13 trillion—20 percent
of U.S. home lending—filed for bankruptcy.
 By the end of 2007, the U.S. Federal Reserve and the
European Central Bank attempted to stabilize the financial
system by injecting several hundred billion dollars into the
money supply for banks to borrow at a low rate.
 In November 2008, leaders of the G20—a group of
twenty countries with the world’s largest economies—
met in Washington, DC.
 Although they failed to agree on detailed proposals to
reform international financial markets, it marked the
first time that leaders of emerging countries such as
the BRICs, South Korea, and Saudi Arabia were
invited to work closely with the United States, Japan,
and Europe to address global financial problems.
 In the first year few years of the Obama administration,
neo-Keynesian economists such as Paul Krugman, Robert
Reich, Brad DeLong, and Joseph Stiglitz argued that
government must correct the fundamental flaws of
unregulated capitalism.
 Increased state investments in education, infrastructure,
and renewable energies produce more long-term growth.
The wealthy and major corporations should be forced to
pay higher taxes.
 Structuralists such as Robert McChesney argued that the
United States was stuck with an undemocratic system of
influence peddling—a “dollarocracy”—whereby corporate
lobbies got favorable treatment from lawmakers that
exacerbated political and economic inequality.
 In 2007, some OPEC members— especially Venezuela and
Iran—pushed for oil to be priced in euros or a basket
(weighted average) of currencies. Only Saudi Arabia’s
intervention on behalf of the United States prevented this.
 USA label China as a currency manipulator; yet many U.S.
companies operating in China benefited from the
undervalued yuan.
 China, Brazil, France, Japan, Russia, and some Persian
Gulf countries thought the possibility of pricing oil in a
basket of currencies or gold instead of the U.S dollar.
 The global finance and monetary structure is
inherently susceptible to shocks that could quickly
cause a great recession or even a great depression.
Just some of the potential triggers of a financial
shock.
 The global financial crisis did not significantly
transform global economic governance.
 One reason for a lack of change is that no other
country has the level of military power, importance
in trade, or deep financial markets as the United
States.
 Second, because U.S. financial markets are so big,
the United States (with support from the United
Kingdom) was able to ensure that reforms to
international financial standards reflected U.S.
interests.
 Over time, a more multipolar and multilateral
system might produce a new order that satisfies their
interests.
 Debt Trap

 Many believe that Beijing has perfected the art of loans, credits, and
donations so that governments become indebted to China. This infamous
“debt trap” has been successfully applied in Pakistan, Kenya, Sri Lanka,
Mongolia, and Zambia, among other countries.
 According to several media reports, Kyrgyzstan reportedly has a total
debt of around $5 billion, of which between 40-50 percent is owed to
China, notably the Export-Import Bank.
 Tajikistan’s situation is similarly problematic: the country’s debt is $3.3
billion, with around 60% owed to Beijing.