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Prolegomena to the choice of an international monetary system

Published online by Cambridge University Press:  22 May 2009

Richard N. Cooper
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The international monetary system—the rules and conventions that govern financial relations between countries—is an important component of international relations. When monetary relations go well, other relations have a better chance of going well; when they go badly, other areas are likely to suffer too. Monetary relations have a pervasive influence on both domestic and international economic developments, and history is strewn with examples of monetary failure leading subsequently to economic and political upheaval. Recent years have seen considerable turmoil in international monetary relations, and a marked deterioration in relations between Europe, Japan, and America. Ideally, monetary relations should be inconspicuous, part of the background in a well-functioning system, taken for granted. Once they become visible and uncertain, something is wrong.

Type
Section II
Information
International Organization , Volume 29 , Issue 1 , Winter 1975 , pp. 63 - 97
Copyright
Copyright © The IO Foundation 1975

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References

1 A particularly poignant example of the severe limits a given regime can impose on the use of instruments of policy, and of the psychological hold a regime of long standing can have on even well-informed observers, is the surprised anguish of Fabian socialist Sidney Webb when, in 1931, in the face of enormous unemployment, Britain abandoned the fixed price of gold and allowed the pound to float: “No one told us we could do this.” ( Taylor, A. J. P., English History, 1914–1945 [New York: Oxford University Press, 1965] p. 297Google Scholar, cited in Hirsch, Fred, Money International [Garden City, N.Y.: Doubleday, 1969], p. 4.)Google Scholar

2 Harry G. Johnson has pointed out that in the final equilibrium it is possible for one country to be left better off than in the free trade situation; but both countries taken together will certainly be worse off, and I judge that in most circumstances each country taken separately would be left worse off. See his “Optimum Tariffs and Retaliation,” in his International Trade and Economic Growth: Studies in Pure Theory (Cambridge, Mass.: Harvard University Press, 1967)Google Scholar.

3 Herbert G. Grubel. “The Distribution of Seigniorage from International Liquidity Creation,” and Johnson, Harry G., “A Note on Seigniorage and the Social Saving from Substituting Credit for Commodity Money,” in Mundell, R. A. and Swoboda, A. K., eds., Monetary Problems of the International Economy (Chicago: University of Chicago Press, 1969), pp. 269–82, 323–29Google Scholar.

4 These arguments require some qualification. If competitive banks are subject to non-interest-bearing reserve requirements, as they are in the United States, then the interest rate on their certificates of deposit will be correspondingly reduced, and some seignorage does arise. Furthermore, from 1963 to 1974, the United States imposed taxes (the Interest Equalization Tax) and other restrictions on capital outflow from the United States, with the encouragement and approval of many European countries, and such restrictions on financial intermediation would again give rise to some seigniorage.

5 For a convenient summary of the debate, with extensive references to the literature, see Park, Y. S., The Link Between Special Drawing Rights and Development Finance, Essays in International Finance, no. 100 (Princeton, N.J.: Princeton University, 09 1973)Google Scholar.

6 As James Tobin, writing in 1964, put it: “if the financial ship has weathered the storm [of the dollar crisis], it has done so only by jettisoning much of the valuable cargo it was supposed to deliver.” See his “Europe and the Dollar,” Review of Economics and Statistics 46 (05 1964): 123CrossRefGoogle Scholar.

7 For an explanation of how this occurs, see Cooper, Richard N., “Dollar Deficits and Postwar Economic Growth,” Review of Economics and Statistics 46 (05 1964): 155–59CrossRefGoogle Scholar.

8 But see the discussion of status in a related context in Frank and Baird's essay in this volume.

9 With evident resentment, de, Gaulle wrote of the “monumentally overprivileged position that the world had conceded to the American currency” (Memoirs of Hope: Renewal and Endeavor [New York: Simon & Shuster, 1971], p. 371)Google Scholar.

10 In certain circumstances, these broad objectives need not conflict: social organization can be arranged to achieve maximum economic efficiency, and then the fruits of that efficiency can be distributed through lump-sum transfers to satisfy the desired distribution. But in practice lump-sum transfers are difficult to achieve, and other forms of redistribution almost inevitably impinge adversely on efficiency. Thus a trade-off arises and compromises must be made.

11 For an analytical summary of the discussion on optimal currency areas, see Grubel, Herbert G., “The Theory of Optimum Currency Areas,” Canadian Journal of Economics 3 (05 1970): 318–24CrossRefGoogle Scholar.

12 This, of course, need not actually be the case. Countries may implicitly agree on certain conventions governing behavior even when they are unable to reach explicit agreement, thus avoiding the disadvantages of a complete free-for-all.

13 Several interpretations are possible for the numbers entered in the payoff matrix. If the gains are commensurable, they can be added together according to some common unit of measurement and compared. Net increase in GNP would be an example. It is clear from the discussion above, however, that not all the advantages and disadvantages of alternative monetary regimes can be expressed in commensurable units. Status and maneuverability of action would be examples. In that case, each country must weigh for itself the various advantages and disadvantages of each configuration according to some utility index, and the entries in figure 1 then represent a scaling for each country according to its own utility index. But in that case, the gains to A as perceived by A, while comparable with one another, are not comparable with the gains to B as perceived by B. Entries for B in the four boxes can be compared with one another, and those for A can be compared, but entries for B cannot be compared with entries for A. Indeed, it is quite possible that country B will perceive the gains to A differently from the way A perceives them, and vice versa. For example, on B's utility scale the entry for A in the southeast box might be 8 instead of 5. This kind of difference is especially likely if status is an important consideration for B.

The payoff matrix is also drawn showing no net gain for either country in the case of disagreement on regime. If the payoffs to each country are commensurable, the payoff need not be the same for both countries in cases of disagreement. For example, B might actually lose in comparison with A, so that the entries for B in the northeast and southwest boxes would be negative. B would then have a stronger incentive to reach agreement than would A. If the payoffs are not commensurable, then the possibility of loss is merely a matter of choice of scale for each country. The lowest entry for each country can be arbitrarily chosen to equal zero, and the other entries for that country are then scaled to it.

14 For a brilliant exploratory treatment of many similar decision units confronting binary choices, see Schelling, Thomas C., “Hockey Helmets, Concealed Weapons, and Daylight Savings: A Study of Binary Choices with Externalities,” Journal of Conflict Resolution 17 (09 1973): 381–427CrossRefGoogle Scholar.

15 The standard source is League of Nations [Ragnar Nurkse], International Currency Experience (New York: League of Nations, 1944)Google ScholarPubMed.

16 Wallich, Henry, “Why Fixed Rates?,” Committee for Economic Development, New York, 1973. (Mimeographed.)Google Scholar

17 Mundell, Robert A., “Monetary Relations between Europe and America,” in Kindleberger, Charles P. and Shonfield, A., eds., North American and Western European Economic Policies (London: Macmillan & Co., 1971Google Scholar; New York: St. Martin's Press, 1971).

18 Kindleberger, Charles P., “The Case for Fixed Exchange Rates, 1969,” in The International Adjustment Mechanism (Boston: Federal Reserve Bank of Boston, 1970)Google Scholar; and Laffer, Arthur, “Two Arguments for Fixed Rates,” in Johnson, Harry G. and Swoboda, A., eds., The Economics of Common Currencies (London: Allen & Unwin, 1973), pp. 25–34Google Scholar.

19 Cooper, Richard N., The Economics of Interdependence (New York: McGraw-Hill, 1968)Google Scholar, chapter 9; and Cooper, , “Issues in the Balance of Payments Adjustment Process,” Committee for Economic Development, New York, 1973 (mimeographed)Google Scholar.

20 McKinnon, R. I., Private and Official International Money: The Case for the Dollar, Essays in International Finance, no. 74 (Princeton, N.J.: Princeton University, 04 1969)Google Scholar; also Mundell.

21 Bold and interesting attempts for the United States have been made by Aliber, Robert Z., Choices for the Dollar (Washington, D.C.: National Planning Association, 1971)Google Scholar, and Bergsten, C. Fred, The Dilemmas of the Dollar: The Economics and Politics of United States Inter-national Monetary Policy (New York: Praeger for the Council on Foreign Relations, 1974)Google Scholar. A more formal attempt at one component of the payoff is in Hamada, K., “Alternative Exchange-Rate Systems and the Interdependence of Monetary Policies,” in Aliber, Robert Z., ed., National Monetary Policy and the International Financial System (Chicago: University of Chicago Press, 1974)Google Scholar.

22 Some interpretations of postwar international monetary history can be found in Cohen, Stephen D., International Monetary Reform, 1964–69: The Political Dimension (New York: Praeger, 1970)Google Scholar; Richard N. Cooper, The Economics of Interdependence, chapter 2; Horsefield, Keith and others, The International Monetary Fund 1945–1965, 3 vols. (Washington, D.C.: IMF, 1969)Google Scholar; Machlup, Fritz, Remaking the International Monetary System (Baltimore, Md.: The Johns Hopkins Press, 1968)Google Scholar; Bergsten, The Dilemmas of the Dollar, chapters 2–3.

23 Cooper, Richard N., “Dollar Deficits and Postwar Economic Growth,” Review of Economics and Statistics 46 (05 1964): 155–59CrossRefGoogle Scholar.

24 See also the views on this issue of Carlos Diaz-Alejandro in this volume.

25 John F. Kennedy feared that the gold issue could be successfully used against him by political opponents, and this view led to his conservative approach to international financial questions. See Sorensen, Theodore C., Kennedy (New York: Harper and Row, 1965), pp. 405–8Google Scholar.

26 See “Flexing the International Monetary System: The Case for Gliding Parities,” in Federal Reserve Bank of Boston, The International Adjustment Mechanism, reprinted in Harry G. Johnson and A. K. Swoboda, eds., The Economics of Common Currencies (London: Allen & Unwin, 1973), pp. 229–43; US Congress, Joint Economic Committee, International Monetary Reconstruction, Hearings before the Joint Economic Committee, February 22, 1973, 93d Cong., 1st sess.; and Towards a Renovated World Monetary System, a report to the Trilateral Commission, the Triangle Papers, no. 1, New York, 1973Google Scholar.

27 Even without such bargaining across arenas, the attempt to achieve universalism may weaken an organization's effectiveness at task performance because its principles or procedures are diluted to accommodate the diverse circumstances of the enlarged membership. One of the factors weakening the General Agreement on Tariffs and Trade during the 1960s was the insistence by some new members that as less developed countries they were subject not only to different rules (which was generally agreed) but also were not bound by the GATT's procedures for settling disputes. No organization can maintain its function in the face of erosion of its internal procedures. The weakening of the GATT (which also has other sources) has redounded to the disadvantage of all countries, new as well as old members.

28 See Cooper, Richard N., “Eurodollars, Reserve Dollars, and Asymmetries in the International Monetary System,” Journal of International Economics 2 (09 1972): 325–44CrossRefGoogle Scholar.