International Monetary Standards - Research Paper Example

?Insert Question # 2 International Monetary Standards International monetary standards are sets of agreed regulations, treaties and supporting bodies, which are accepted by the international community to enhance international trade, and inter-state investment. Fleming noted that between 1870 and 1914, otherwise referred to as the first era of globalization, the world witnessed the expansion of a well-integrated economic system (59). Financial institutions were liaising well, a development that effectively enabled members to give in to each other's medium of exchange as binding tender. These included the entry of the Scandinavian monetary union and the Latin Monetary Union into the spectrum. In case a country was lacking in the membership of any of the international unions, trading operations were facilitated by common involvement in the gold systems by the international partners, regardless of their independence and colony status. Great Britain became top on the economic list of best performing countries. The country had developed massive economic, political, industrial influence, and was technically controlling more of the global market. According to Forbes (22), whereas capital controls similar to the Bretton Woods System had not yet been implemented, imbalances in capital flows were rarer than the post 1970 era. In light of its economic dominance, Britain's investment in other countries helped to control any imbalances across the world; the capital exports continued to grow when Britain's financial system hit a crisis, thus enabled other nations to recover revenue lost from commodity exports. In light of this, this period witnessed mostly consistent economic growth and fairly infrequent economic crises. Unlike the Bretton Woods standards, the global financial order witnessed between 1870 and 1914 was not established at a common high level meeting; rather it underwent natural growth. In light of this, the Gilded Age that witnessed rapid economic development in North America squarely contributed to the stability of the monetary standard. After World War I The era between the two World Wars (1919-1939) witnessed a slump in the world economic status (White 411). Between 1919 and 1939, major economic players concentrated on their internal policies at the expense of global economy. Basically, both international business activities and capital flows reduced like never before. During the First World War nation-states had technically steered clear from the gold standard. Only the United States saw its significance, albeit temporarily, especially in mid-1920s. Notably, within the first half of 1930s, the common standard was basically a disjointed system of using exchange rates. Forbes noted that in this period, major global economic powers such as Great Britain and the United States realized that the internationally accepted gold standard practically deviated from the widely acceptable national policy of retaining autonomy (23). To safeguard their gold reserves, nation-states, sometimes saw it wise to increase interest rates and adopt a general deflationary economic policy. This policy was aimed at averting a downturn, in cases where countries had reduced interest rates to trigger more investment and growth. Heston and Summers (97) argued that the need to reintroduce the gold standard in Britain may have been driven by the financial institutions to hurt the local working class. Great Britain emerged from the World War I financially weaker than the United States, allowing the latter to substitute her as the top-most financial giant in the world. America however was hesitant to take over her trading partner’s leadership role, because of isolationism and the need to concentrate on local issues. In contrast to Great Britain’s economic strength before the 1914, US capital exports were not counter cyclical. Fleming indicated that they grew faster in line with the America’s economic development until 1928, when the pangs of Great Depression began to bite (61). The intensification of the Great Depression two years later, extended to financial institutions and massively hurt international trade. For instance, in 1930 alone, more than 1300 banks in the US closed shop. In response, the United States imposed stricter barriers to trade, declined to play ball as a globe’s ultimate lender, and rejected calls to waive war debts (White 413). The non-committal stance taken by the United States exacerbated the global economic crisis. Economic impacts of the conflict As a result, nations faced with the necessity to foot high levels of unsettled budgets, but with small amounts of tax revenue, shelved conversion of money into gold as they did during the 1800s crises (White 414). Great Britain and the US abandoned the gold standard in the face of the Napoleonic wars, and the Civil War respectively White. Ugolini noted that in both cases, the governments resumed convertibility after the conflict (17). The real challenge, however, visited the two Western giants in the World War I, when the gold convertibility policy arguably failed. According to Heston and Summers, for a country to finance the resulting expenditures occasioned by war, the bulk of belligerent nations who abandoned the gold standard of exchange in the course of the conflict, experienced sharp inflation (98). Owing to the different degrees of inflation across the countries, their return to the gold standard after the conflict was fraught with losses. For instance, whereas some countries returned to pre-war prices, others were hugely suffered from changing value of goods. Eventually, the standard as it existed could not handle effectively the huge shortfalls and surpluses occasioned by the trade imbalances (Heston and Summers 100). According to White (415), commodity values had not hit equilibrium in the wake of the economic crisis, which triggered a complete destruction of the system. Germany, for example, had chosen to abandon the gold standard as soon as World War I started, and experienced challenges reverting to it, as the country had depleted large amounts of its gold reserves through reparations (Ugolini 12). The country’s economic policy authorized unfettered purchase of foreign currency to aid more reparations and to settle employment debts, finally sparking off hyperinflation in the aftermath of the conflict. The decline of the gold standard The gold standard collapsed in Great Britain at around 1914 (Forbes 21). Treasury notes substituted the use of the gold. The change happened despite the continued existence of the law supporting gold specie standard. The country effectively did away with the gold standard through appeals by the Bank of England to influence citizens that it was proper to refrain from redeeming cash for gold. In mid 1920s, Britain temporarily reverted to the gold standard to facilitate her trade with Australia and South Africa, before officially ending its use. The introduction of the British Gold Standard Act 1925 served two purposes: it affected the gold bullion standard and amended the gold specie standard. The new legislation compelled the government to place a fixed value on the gold bullion and sell them on demand (Forbes 22). According to White, the fine gold was supposed to be sold in blocks containing about 400 troy ounces (412). This standard was maintained until early 1930s when it was found to conflict the pound, prompting Britain to abandon the gold standard. Heavy loans from financial institutions could not reverse the ensuing economic slumps. In light of this, by the beginning of the last quarter of 1931, Britain had abandoned the new gold standard due to heavy outflows of the precious commodity. The ensuing widespread use of currency enabled the country to implement monetary policy and rejuvenate the economy via the low interest rates (Forbes 24). Additionally, the rest of Western countries under the commonwealth banner, such as Australia, Canada, and New Zealand had been prompted to abandon the gold standard following the same economic challenges associated with the severe economic crises. The 1919-1939 period, lent credence to the theory that the gold standard was naturally unstable. Heston and Summers pointed to the two-prong conflict between the major Western currencies as the main reason for discarding the gold standard (99). The increase in liabilities associated with the dollar and sterling during exchange in other foreign banks; and the ensuing degradation in the reserve ratio of the major English, and US federal financial institutions triggered huge imbalances. This imbalance was exacerbated by the massive gold outflows from Britain, and the hyped pound currency aimed at taming Paris. France was trying to transform itself into a global financial giant, in order to outdo the United States and England. Forbes cited the devastating speculation, stemming from fading levels of confidence in the trading partners’ dedication to convertibility of currency as the main reason behind the termination of the gold standard (22). In mid-1931, Austria's biggest commercial bank had a run, which led to the failure of the bank. The crisis extended to Berlin, collapsing Germany’s central bank. It is notable that the affected countries' central banks traded away high amounts of gold reserves, but unfortunately international loans could not solve the economic crisis because most of the affected countries thought of a bailout after the problem was already out of control. For stability purposes, most of Western nations eventually abandoned the gold standard for currency. The era of Bretton Woods Following the devastating economic losses and unreliable gold-based exchange systems, American and British governments began to strategize on a better post war global monetary system. The aim of such a move was to establish a system which would integrate the favorable qualities of a universal and fairly liberal global mechanism and premised on national autonomy (Forbes 24). Harry White and John Keynes are the main policy makers who came up with the new idea that was welcomed by 42 nations at Bretton Woods in 1944 (Fleming 65). The proposal involved countries endorsing a method of consistent but flexible exchange rates where the national currencies were valued against the dollar. The dollar was then convertible into an agreed amount of gold. The idea culminated into the dollar being used as a standard of exchange for gold. Moreover, the creation of the World Bank and the International Monetary Fund (IMF) at shortly thereafter, was a tremendous step from the previous gold exchange era. The two global financial institutions were basically meant to substitute previously unstable private source of finance for investment in under-developed countries (Ugolini 11-13). At the time, Germany and Japan who would be outdone in the quest for economic power were seen as the likely beneficiaries of the funds in the short run. The new exchange rate enabled the IMF to authorize the devaluation of currencies of countries that are facing economic crises, as this would keep such weak economies in the gold standard economy. In light of this, White suggested that capital control measures were brought up to cushion economies from the devastating impacts of capital flight, and to enable countries to enjoy autonomy as far as macroeconomic policies are concerned (418). Under the new system, countries would welcome flows based on productive investment. Although some of the architects of the monetary policy argued in favor of a universal currency playing a central role in the mix, proponents of the dollar overruled the bancor currency proposal. Regardless of the choice of currency, the late 1960s witnessed the primary role of the American currency become problematic. The issue was compounded by massive international demand for the pricey commodity, which eventually prompted the United States to incur a constant trade deficit and grapple with increasing lack of faith in the dollar. The lack of confidence, together with the growth of better market alternatives for gold, resulted in speculators depleting the American gold reserves for export to countries such as France as the expense of the former’s economy. Conclusion Generally, between 1870 and 1914, most of Western countries built their economies on a proper integrated system, which marked the first era of globalization. The period witnessed gold specie being used as the global standard of exchange. The First World War reversed the well-meaning international cooperation among global powers, however. After the conflict, many countries abandoned global trade, and mainly concentrated on local economic policies. Meanwhile, the gold standard was seldom in use, and eventually led to economic conflict and trade imbalances arising from improper valuation of the gold. In 1944 Bretton Woods provided solutions by introducing the dollar as the global standard currency that would be used to substitute gold, while allowing countries the autonomy to implement domestic policy. However, alternative markets for gold, and hoarding of the precious commodity by some players created negative implications, which complicated the realization of ultimate solution to global monetary policy. Works Cited Fleming, Harold. Let's Bury the Gold Standard. Harvard Business Review, 30.6 (1952): 59-68. Forbes, Steve. Golden Rule for Prosperity. Forbes, 189.11 (2012): 21-25. Heston, Alan, and Summers, Robert. Comparative Indian Economic Growth: 1870 to 1970. American Economic Review, 70.2 (1980): 96-101. Ugolini, Stefano. The Bank of England as the World Gold Market-Maker during the Classical Gold Standard Era, 1889-1910. Norges Bank: Working Papers, 15 (2012): 1-22. White, Lawrence H. Making the transition to a new Gold Standard. CATO Journal, 32.2 (2012): 411-421. Read More