In, “The Challenge of Global Capitalism”, Robert Gilpin alludes to the isolation of monetary from financial affairs after World War II. The monetary system had fixed exchange rates which were frequently altered whereas International finance operated in a scenario different from the current system. The then system had countries maintain their capital controls. The two systems were blended after the global oil catastrophe and the financial surplus in the Organization of Petroleum Exporting Countries of 1973. Since then, the two systems interrelated and controlled one another. The financial system majors in the provision of capital in the economy while the monetary system focuses on easing transactions that affect the economy. Notably, the close relationship between them makes their responsibilities more complex since economic investments are monetary and any depreciation of the currency used in exchange rates increases the initial valuation of investment projects. On the same breathe, the global flow of foreign capital may appreciate the currency in use, as was the case for the dollar in the 1980s, leading to a decrease in the valuation of projects. Erroneous exchange rates can, therefore, affect both systems and this may lead to a global economic crisis as was witnessed in East Asia in the 1990s. Even though the two systems are intertwined, Robert Gilpin separates the two for analysis and entirely concentrates on the global monetary system in this chapter.
The global monetary system was designed after World War II. The architects of the system model it to ensure that it globally fixes challenges of exchange rates with the ultimate aim of solving the international debt crises of the 1930s which often caused anarchy in the global economy. To achieve this, the International Monetary Fund was also set to provide reserves that stabilize exchange rates and also avert global inflation. To further stabilize the system, all currencies were globally connected to a nonmonetary asset like gold and policies from individual countries were coordinated. This was achieved by binding all currencies to the dollar which was bound on gold. Autonomy and stability were achieved by fixing exchange rates and making them adjustable during disequilibrium situations. This enables nations to manage their crises without affecting the global economy.
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Fixed exchange rates came to a halt in the early 1970s due to the declined value of the dollar as a result of the Vietnam War and the start of the Great Society Program. The program, initiated by the Johnson Administration, sped up global inflation and, thereafter, the Nixon Administration engineered the devaluation of the dollar in 1971. The devaluation process met opposition due to its effects on exports. Nixon’s Administration countered the opposition by stopping the exchange of dollars for gold and the introduction of a 10% additional charges on imports. Devaluation of the dollar was successful by the end of 1971, marking the change from the International Monetary system of fixed exchange rates to flexible rates. Careless United States policies, global inflation and high rate of global capital mobility are recorded as main causes that terminated fixed exchange rates. Efforts to establish a new system with stable exchange rates failed to lead to the establishment of a period of flexible rates, effected at the Jamaica Conference of 1976.
After the conference, a financial revolution ensued. Minority economists outside America argued that failure to link currencies to a nonmonetary commodity risked global inflation and instability. American economists disregarded her minorities and this led to the revolution. Efforts to establish or reform the international monetary system meet both technical and political challenges. A Well thought the system may benefit every country but challenges still arise by complaints of states benefiting more than others. An agreeable system needs to fulfill mechanisms of efficiency. Mechanisms of a good system are; adjustment, liquidity, and confidence.
The adjustment mechanism requires that a monetary system sets measures into which nations may restore equilibrium when they face unprecedented challenges. Such measures define methods to decrease deficits, decrease surplus and the cost of the adjustments be minimal to prevent hurting individual economies. The liquidity mechanism provides that the monetary system allows economies to have reserves that are enough to meet deficits caused by economic shocks. Shocks are often caused by a sudden increase in the price of petroleum. Mechanism of confidence dictates that the country of reserve currency be capable to earn confidence and trust from other countries. The reserve country must make others confident that it will not deploy policies that might lead to inflation and devaluation of the reserve currency.
However, what stands in way for the devising of a system are differences in judgments, interests, and disagreements on the most accurate models to be deployed. Some economists prefer models that suggest increasingly stable exchange rates while others argue in favor of flexible exchange rates. The establishment of the European Monetary System and the euro as their common currency also casts doubt on their interest and unity towards an International Monetary System. There also exist other threats to a new system in dollarization practices among the less developed countries that tie their currency on the dollar or accept the dollar as their main currency. Some countries take the first option and disagree with the former while others accept the dollar as their currency.
In conclusion, Gilpin points out that less developed countries will continue to tie their currency on that of their major trade partners. This will lead to currency blocks thus making it essential that an International Monetary system is reformed to avert a global crisis.
