Review: Globalizing Capital

Globalizing Capital
Globalizing Capital: A History of the International Monetary System
Barry Eichengreen
Princeton University Press, Princeton, New Jersey, 1996

Review Copyright © 1999 Garret Wilson — January 22, 1999, 12:00pm

Globalizing Capital really is A History of the International Monetary System, as its front-page subtitle asserts. In a succinct, straightforward style, Barry Eichengreen tells the story of the evolution of the modern-day international monetary system. From the prehistory of money to the first gold standard, through two world wars to the currency flotation trend that continues today, the story of modern money comes to life.

Well, "come to life" is a bit of an overstatement. In fact, although "story" is technically true, the term, "history" in the subtitle captures the essence of the book more precisely. Globalizing Capital, for all of its briefness, could almost be considered a reference book more than anything else. It is heavily footnoted and well-documented. This is a book that you’ll want to keep on a shelf close by to reference, or maybe to read again after to understand what exactly is going on.

Eichengreen assumes quite a bit about the reader. This is no tutorial on free trade or a primer of foreign exchange. If you understand a certain level of economics and finance, you’ll get a lot out of this book, but Eichengreen makes no attempt to reach out to novices. The latter type of reader will still benefit from the book, but only because Eichengreen’s to-the-point not-overly-complicated accounts will over time merge to give the reader an impression — not an explanation — of more basic economic concepts. Once the novice reaches the end, he/she will have gained enough to start the book.

Since I’m more a novice than an expert, I’ll have to rely on the impressions that seemed to seep into my mind the more I read. The main points seem to be that the "gold standard" as some eternal, perfect entity is pure fiction. Societies long ago started out using bimetallist systems, in which several types of metals (gold, silver, etc.) were used as currencies. If prices of these different metals differed, one could, through these differing prices, repeatedly trade metals so that they accumulated one metal in particular. In fact, differing prices would cause this to happen automatically, making "bad money" drive out the "good money," making the higher-priced metal leave the country (11).

Before the rise of the steam-driven press, coinage produced a variable imprint, which was easy to counterfeit (14). Eventually, a gold system was made possible. It was made stable only by a specific economic and political situation in which European central banks worked together to uphold gold convertibility (38). During World War I many countries abandoned the gold standard because of economic hardships, and after the war everyone tried to return to the gold standard on approximately the same conditions as before. This proved not to work well, and World War II again brought chaos into the international financial system.

After World War II the Bretton Woods system concocted a series of adjustable pegged rates. Eichengreen assumes you know what the Bretton Woods system was in general, and he also assumes that adjustable pegs will be understood by a very brief description. Again, this is less of a tutorial than a history.

In the end, the Bretton Woods system collapsed, with mostly everyone resorting to floating exchange rates. Some smaller countries pegged their rates to the dollar or the pound, and still other countries put such a maintaining of pegs into their constitution or other legal framework, setting up currency boards. Eichengreen sees that the international financial system is still evolving (the floating of the Brazilian real last week proves him correct), and he sees further instability ahead.

Globalizing Capital is well-written and chock-full of information with plenty of references. As long as you don’t expect the book to hold your hand, its tendency to get to the point, while not providing a tutorial as such, still provide many clear overviews. In Eichengreen’s to-the-point style, these lucid points are many times made in very few sentences. Here are some major, concise points I found:

"[William Jennings] Bryan had campaigned for unlimited silver coinage, imploring the electorate not to crucify the American farmer and worker on a ‘cross of gold’" (41).

"As the gold discoveries of the 1890s receded, concern resurfaced about the adequacy of gold supplies to meet the needs of the expanding world economy" (43).

"If France's stabilization in 1926 is taken to mark the reestablishment of the gold standard [after WWI] and Britain's devaluation of sterling in 1931 its demise, then the interwar gold standard functioned as a global system for less than five years" (48).

"By 1932 the international monetary system had splintered into three blocs: the residual gold-standard countries, led by the United States; the sterling area (Britain and countries that pegged to the pound sterling); and the Central and Eastern European countries, led by Germany, where exchange rates prevailed" (49).

One of FDR's first actions after winning in 1932 "was to take the United States off gold in an effort to halt the descent of prices," which "helped to contain the crisis in the American banking system and to launch the United States on the road to recovery" (50).

"...the faster central banks injected liquidity into the financial system, the faster it leaked back out via capital flight. In these circumstances, lender-of-last-resort intervention might be not only difficult but counterproductive" (75).

(Credit Anstalt, by the way, was apparently Austria's largest deposit bank (78).)

"By selling sterling in sufficient quantities to force interest-rate increases of a magnitude that no democratically elected government facing 20 percent unemployment could support, they precipitated the abandonment of a parity that would otherwise have remained viable" (85).

"Britain's suspension of convertibility on September 19, 1931, more than any other event, symbolized the interwar gold standard's disintegration" (85).

"An internationally coordinated program of macroeconomic reflation would have been better still: had all countries agreed to reduce interest rates and expand their money supplies, they could have stimulated their economies more effectively and done so without destabilizing their exchange rates" (88).

"Thus, currency depreciation in the 1930's was part of the solution to the Depression, not part of the problem" (88).

"The development of the international monetary system between the wars can be understood in terms of three interrelated political and economic changes." They were "growing tension between competing economic policy objectives," international capital movements in the new interwar circumstances, and the "changing center of gravity of the international system" shifting its weight "away from the United Kingdom and toward the United States" (89).

"The compromise between the U.S. insistence that exchange rates be pegged and British insistence that they be adjustable was, predictably, the ‘adjustable peg’" (97).

"There was more enthusiasm in the Congress for the trade-promoting thrust of the Bretton Woods Agreement than for its abstruse monetary provisions..." (99).

"As long as other countries retained inconvertible currencies, it made sense for each individual country to do so, even though all countries would have been better off had they shifted to convertibility simultaneously. The framers of the Bretton Woods Agreement had sought to break this logjam by specifying a schedule for the restoration of convertibility and by creating an institution, the IMF, to oversee the process" (102).

In 1947, the British sterling "devaluation had the desired effects... British reserve losses halted immediately, and the country's reserves tripled in two years" (106).

"In effect, oversight of the restoration of convertibility and the rehabilitation of trade was withdrawn from the Bretton Woods institutions, whose authority was diminished as a result" (108).

"The authority of the Bretton Woods institutions was weakened not just by the stillbirth of the ITO but by the decision of the IMF and World Bank to distance themselves from postwar payments problems" (108).

"The [International Monetary] Fund had been created to oversee the operation of convertible currencies and to finance temporary payments imbalances; it was slow to adapt to a world of inconvertibility and persistent payments problems" (108).

"Together, devaluation and fiscal rentrenchment had the desired effect. France's external accounts swung from deficit to surplus, and in 1959 the country added significantly to its foreign reserves" (113).

"The architects of the [Bretton Woods] system, worried about the disruptions to trade that might be caused by frequent parity adjustments, had sought to limit them. Requiring countries to obtain Fund approval before changing their parities discouraged the practice because of the danger that their intentions might be leaked to the market" which would cause speculators to remove currency. Small devaluations, which didn't have to be reported ahead of time to the IMF, caused people to think that more devaluations might be coming. "And permitting a country to devalue by a significant amount only if there were evidence of a fundamental disequilibrium precluded devaluation in advance of serious problems" (122).

In the British currency crisis of the 1960's, "the United States urged the British to resist devaluation, fearing that speculative pressures would spill over to the dollar, and took the lead in organizing foreign support" (127). Contrast this with Brazil, whom the US urged to float its currency on January 15, 1999 instead of postponing problems, even though this might hurt US trade in the short term.

"The inadequacy of the available adjustment mechanisms and the very great difficulty of operating a system of pegged exchange rates in the presence of highly mobile capital is a first lesson of Bretton Woods. That this system functioned at all is a testimony to the international cooperation that operated in its support. This is a second lesson of Bretton Woods. A third lesson of Bretton Woods is therefore that cooperation in support of a system of pegged currencies will be most extensive when it is part of an interlocking web of political and economic bargains. The inevitability of [limits to adjustment] in a politicized environment is a fourth lesson of Bretton Woods" (135).

"The other options [besides a freely floating currency] was to move further in the direction of hardening the exchange rate peg[, something] a few countries... did... by establishing currency boards. They adopted parliamentary statutes or constitutional amendments requiring the government or central bank to peg the currency to that of a trading partner. A monetary authority constitutionally required to peg the exchange rate was insulated from political pressure to do otherwise and enjoyed the confidence of the markets" (139).

"The IMF is portrayed in the academic literature as a mechanism for applying sanctions and rewards to encourage countries to follow up on cooperative agreements. In practice, the fact that the Fund was an unattractive venue in which to conduct negotiations, and that none of the countries concerned drew on Fund resources to finance their foreign-exchange-market intervention, prevented it from effectively carrying out this role" (151).

"This postwar trend toward greater exchange rate flexibility is most immediately a consequence of rising international capital mobility" (192).

In the aftermath of WWII, "controls on capital movements were also seen as necessary for the reconstruction of international trade" (192).

"[A]s international transactions were liberalized, it became impossible to keep domestic markets tightly regulated" (194).

Before WWI, under the gold standard, it was easier to maintain stable rates even with high international capital mobility, because "before World War I there was no question in most countries of the priority attached to the gold standard peg. There was only limited awareness that central bank policy might be directed at targets such as unemployment," so that "there being no question about the willingness and ability of governments to defend the currency peg, capital flowed in stabilizing directions in response to shocks"" This all brought a credibility to the pegged rates which "obviated the need for capital controls to insulate governments from market pressures that might produce a crisis" (195).