.. verseas branches to continue their foreign lending. Lairson writes, because no single state could regulate it effectively and because of the unceasing U.S. payments deficits, a Euromarket system developed consisting of the dollar and other currencies, a system of bank credit, and a Eurobond market (bonds denominated in dollars floated outside the United States). A massive volume of funds emerged that, without much restriction, could move across borders in search of the highest yields available on a global basis. The emergence of this new, unregulated concentration of capital made even more difficult than before for the U.S.
to get a handle on the system. Lairson suggests that two main reasons can be identified for the decline and fall of the Bretton Woods system. First, he writes, the system was inherently unstable because the mechanisms for adjustment of exchange rates were so inflexible. He states the economic relations that developed after 1948 were structured by these fixed values even as the shift from U.S. surplus to deficit increasingly demanded adjustment of exchange rates. He continues, the world of 1971 was significantly different from the world of 1945-1950, but the Bretton Woods system made few accommodations to that reality.
Lairson’s second reason, which he regards as perhaps most reflective of those changes, was the massive growth of the market power of international capital and its impact on fixed rates. The transnational actors who emerged over the years reflect this notion. By 1973, the Eurocurrency market had grown to nine times the size of U.S. reserves. Such an immense collection of resources, he says, was capable of overwhelming even concerted government action. The immense pressure these forces put on the dollar and the fixed-rate system itself finally led to an international monetary crisis, forcing Nixon to temporarily take the dollar off the gold standard.
Then on March 19, 1973, the system collapsed entirely, even while major efforts to reform the system were in progress. By this time, the powerful new transnational actors collectively lost confidence in the fixed-rate system and in the ability of governments to create any viable system. Finally, Kirshner states, financial officials of the main industrial countries, including the United States, found it preferable, and inevitable, to let their exchange rates float. The Bretton Woods system was at an end. In hindsight, it becomes apparent that the Bretton Woods system, by the 1970s, had served its purpose and the time had come for it to give way to a system better suited to the realities of the time.
The Bretton Woods’ agreements and institutions were designed to stabilize the world economy in the aftermath of World War II, so that countries could eventually interact, grow, and compete as equals in a world of open markets. This system, which was dependent on U.S. hegemony for its success, had progressed to the point where the distribution of economic and political power had become more widespread among other countries. This process can be viewed as a maturation of the international system as U.S. hegemony was no longer practical in the monetary system, and, as we would later see, it was becoming less necessary in other aspects of the international system.
The move to floating exchange rates in Western economies forced the IMF to end its role as traffic cop of the world monetary system and to concentrate instead on providing advice and information to its members, which in 1998 numbered 182 countries. That role was key in helping nations in Latin America, Africa, Asia, and Central Europe restructure their economies following the 1982 debt crisis. Here, we will focus on the effects of the debt crisis on Sub-Saharan Africa (SSA). Although much focus has been given to the effects of the 1982 debt crisis in Mexico and other Latin American countries, the effects on Africa have nonetheless been strongly felt, and the consequences of that period linger on today. In Mexico the crisis was solved in 1987 through the Baker plan, funded by the Japanese and private creditors.
The plan was targeted towards the commercial debt of the countries to which the banks were most exposed-middle income countries. As a result of this initiative, commercial activity was no longer at risk and the threat of the Latin American countries forming a debt cartel was assuaged. In SSA, however, the effects of the crisis have not yet been addressed as wholly as the Baker plan did for the Latin American countries. Some questions have arisen regarding the role of the IMFs lending practices in the SSA region. Whether or not the IMF has focused enough on LDCs development and growth as their main objectives. While this was not the purpose for the creation of the IMF, many have sought to make it so.
Later the IMF sought a more ambitious role as an international lender of last resort to the world economy. The lender of last resort is an institution that will lend during times of financial crisis that will allow the market to return to equilibrium through its lending practices. Allan Meltzer has established five criteria that a lender of last resort at the domestic level must adhere to. We will use the analysis of Stanley Fisher, an important figure with the IMF to determine how these characteristics apply to the international case later on. The first is that the central bank is the only lender of last resort in a monetary system such as that of the United States.
Second, to prevent illiquid organizations from closing, the central bank should lend on any collateral that is marketable in the ordinary course of business when there is no panic. It should not restrict lending to paper eligible for discount at the central bank in normal periods. Third, the lenders loans, or advances, should be made in large amounts, on demand, at a rate of interest above the market rate. This discourages borrowing by those who can obtain accommodation in the market. Fourth, the above three principles should be stated in advance and followed in a crisis. Finally, insolvent financial institutions should be sold at the market price or liquidated if there are no bids for the firm as an integrated unit. The losses should be borne by owners equity, subordinated debentures, and debt, uninsured depositors, and the deposit insurance corporations as in any bankruptcy.
The argument for the need of an international lender of last resort rests not only on the volatility of capital markets but on the inherent financial panics that ensue from them. The importance of regulating these volatile markets was seen at Bretton Woods through the controls over capital inflows, yet it could not regulate the capital outflows. Fisher argues that not only does there need to be an international lender of last resort, but that increasingly the IMF has been playing that role since it first assumed that position in the international bailout of Mexico in 1995. Fisher proceeds to dismiss the argument that the lender of last resort need necessarily be a central bank. He divides the category of lender into two when financial crisis occurs.
On the one hand, there are crisis lenders, who could be central banks. Fisher argues that there exists no requirement for them to be central banks. The only requirement is that enough liquidity exists within a particular institution such that it is able to supply the loans necessary to return the market to equilibrium. On the other hand we have crisis managers who are responsible for directly managing to whom the loans are given, and how best to deal with the crisis at hand. Fisher argues that in terms of international crises the IMF is perfectly suited to deal with such crises both as a crisis lender and as a crisis manager. Clearly the role of the IMF as international lender of last resort has presented itself, initially Mexico and as we will see the structure has been established for these activities to continue.
In return for the imposition of an economic austerity plan in Mexico, the fund, along with the U.S. and other major industrial countries’ central banks, provided credit lines and other facilities totalling $47.8 billion. Although the assistance gave rise to criticism that the IMF was bailing out international investors and not the Mexican economy, the fund in 1997 and 1998 increased the amount each member contributed and expanded its lending activities further by establishing a $47 billion line of credit–called the New Arrangements to Borrow–with two dozen countries. The increase in borrowing authority would allow troubled IMF members to draw well in excess of what would normally be allowed, a move that was well timed. In the 1990s capital had flooded into emerging economies–such as Thailand, Indonesia, and South Korea–with little attention to borrowers’ creditworthiness. When economic problems started to occur, foreign and domestic investors alike rushed to get their money out of those countries.
In the ensuing panic, currencies and stock and bond markets imploded, cutting off financing and swiftly throwing entire economies into recession. The crisis persisted, even amid billions of dollars in IMF and Western loan commitments. With the IMF estimating that world economic growth was only 2.2% in 1998, half what it had forecast in late 1997, it became apparent that more forceful moves would be required. Along with the IMF’s fortified capital base and widened lending authority, it still was unclear whether widening the disclosure of emerging economies’ foreign-currency reserve levels, publicizing their growth estimates, and announcing capital inflows and outflows would help forestall the next crisis–much less put a decisive end to the one that drew headlines in 1998. This was because the entire face of international finance had changed since the IMF was created.
Financial flows were once controlled by a handful of major banks that could be easily corralled into restructuring problem loans in cooperation with relatively modest IMF assistance. In the late 1990s, however, flows were dominated by thousands of banks; securities firms; and mutual, pension, and hedge funds that could move capital in and out of countries with a click of a computer mouse. The number of countries seeking international investment, meanwhile, had proliferated, as had the diversity of debt, equity, and other financial instruments. This array of investors and instruments made coordinating any response to financial crises extremely difficult, concluded Moody’s Investors Service Inc., a major global credit-rating agency. The IMF, meanwhile, continued to face criticism that it was secretive in its dealings, undemocratic in its makeup, and unresponsive to the needs of poorer members.
Many critics noted that the economic austerity programs that were typically attached to any IMF assistance were not always appropriate. In some cases spending cuts only deepened local recessions and made the task of necessary financial and industrial restructurings all the more difficult. Some economists, including Jeffrey D. Sachs, the director of the Harvard Institute for International Development, believed the IMF should permit countries to essentially go bankrupt, imposing formal suspensions of loan payments while creditors and debtors negotiated the value of the loans and determined whether any loans could be exchanged for equity. During the negotiations a troubled country could continue to obtain new financing and exporters could conduct business, selling their goods and earning foreign currencies vital to a country’s economic revival. Suggestions such as these, if they were accepted, might require years to be put into practice.
If the crisis of 1998 had one lesson, it was that nothing short of a cooperative effort by the entire world community is needed to repair the major shortcomings in the global system, according to IMF chair Camdessus . The question was whether the repairs would be performed quickly enough to enable the IMF and its backers to cope with the next financial implosion. Bibliography Bibliography 1. Haan, Roelf L., Special Drawing Rights and Development H.E. Stenfert Kroese N.V., Leiden, Netherlands, 1971 2.
Simha, S.L.N., Gold and the International Monetary System Rao and Raghavan, Mysore, India, 1969 3. Sharma, K.K., International Monetary System Meenakshi Prakashan, Meerut, India, 1983 4. Kenen, Peter B. et al, The International Monetary System Cambridge University Press, Cambridge, England, 1994 5. Hellmann, Rainer, Gold, the Dollar, and the European Currency Systems Praeger Publishers, New York, USA, 1979 Economics Essays.