International Finance

Chapter 23The international financial system:past, present, and futureAnd Jesus entered the Temple of God and drove out all who sold and bought in the temple, and heoverturned the tables of the money-changers ... He said to them, ‘‘It is written, ‘My House shall becalled a house of prayer’, but you make it a den of robbers.’’Mathew 21:12In this chapter we follow a time line of theinternational financial system as it functioned fromthe latter half of the nineteenth century until today.This takes us on a journey through the four principaltypes of financial system we have experienced:gold standard; Bretton Woods standard; flexibleexchange rates; and cooperative intervention. Ourtravels take us through some remarkable territory,including the radical experiment of the creationof a new currency shared by many nations – theeuro. Many crises on different continents, in Asia,Central and South America, are visited alongthe way.After the historical tour, we extend the timeline into the future by looking at the problems theinternational financial system faces, and howthese are likely to affect the evolution of internationalfinancial arrangements. We focus on themounting debt of some key economic players, andshifting economic power from the industrial leadersof the twentieth century to a broader base of successfultrading nations. We also review the pros andcons of alternative arrangements for determiningexchange rates. By analyzing the advantages anddisadvantages of fixed and flexible exchange rates& 514we are forced to conclude that despite extensiveexperimentation with different international financialarrangements during this century, there is noobvious, dominant solution. Instead, differentcountries are likely to prefer different arrangementsdepending on their circumstances.THE PASTThe classical gold standard, 1870–1914For almost half a century before the First WorldWar of 1914–18, the international financial systemran according to the rules of the classical goldstandard. The success of this system has been tracedto the credible commitment represented by theunconditional guarantee to convert paper moneyfor gold at a fixed price. As we have seen in thepreceding chapter, such a commitment is the essentialelement of the classical gold standard. Few if anydoubted the willingness of governments to continueto exchange gold for fiat money, even after temporarysuspensions during periods of war. Not onlydid participating countries such as the United Statesand France gain the confidence of others, but