CHAPTER 17 From Bretton Woods to the Information Age The general evolution of the international monetary system since the Bretton Woods conference has been a movement away from rules and toward cooperation. Increased information has played the role previously occupied by a legal or quasi-legal framework. This development constitutes the funda- mental challenge, and opportunity, faced by international financial institu- tions. The satisfaction of this demand for the reliable provision of information and analysis will become their principal raison d'etre. The Historical Argument The construction of the postwar international monetary system came as a result of a general agreement that a repetition of the economic and political nationalism of the 1930s could and should be avoided. The interwar experi- ence had provided a vivid and terrifying demonstration of how the collapse of the economic order could bring political and social fragmentation. In the new order, a commitment to keep stable but adjustable exchange rates would eliminate the temptation to engage in competitive devaluation. Controls on capital movements would eliminate the big speculative flows that had de- stroyed the exchange rate regime of the interwar period. The essential insight of the new vision was that harmonious interstate relations involved a willing- ness to agree on the surrender of some aspects of national sovereignty. The agreements produced at Bretton Woods combined a vision of a liberal world economy with a rule. The rule's primary purpose was to constrain 586 "I seem to be without any small change. Would you accept a 'Special Drawing Rights' voucher?" 588 INTERNATIONAL MONETARY COOPERATION national economic policies in cases where otherwise the interaction of differ- ent national strategies might cause disaster for the world as a whole (in currency policy, competitive devaluations; in trade policy, the application of protectionism). Apart from this, it would preserve the policymaking options ("sovereignty") of nation-states. At the time of Bretton Woods, a vivid memory of the 1930s saw the requirements of the international order as frequently in conflict with the imperative of building a more just and stable domestic order. The conference aimed at providing a solution to this di- lemma. The main attraction of the rule was that it was impersonal and largely automatic. States were obliged under the terms of their legislation accepting Bretton Woods to maintain fixed exchange rates. The pursuit of inappropriate policy would lead to danger signals, in the form of balance of payments imbalances. A state could then either take corrective action (adjustment), if necessary with the assistance of the resource pool created in the IMF; or, if it was judged that the imbalance reflected a fundamental disequilibrium, the exchange rate could be altered with the approval of the Fund. The commitment to keep the exchange rate fixed would by itself provide sufficient limitation of the room for national policy maneuver. A further function of the Fund was to create through the quota mechanism an additional pool of reserves (it functioned analogously to a credit union). The goal was to ensure that, in a period in which outside the United States a general shortage of reserves existed, this limitation would not stand in the way of the movement to liberalized trade and exchange convertibility. This system had a strong element of automaticity, but one that would and could never be total. The principle of surveillance by the Fund developed out of the necessity of judging whether a member country's needs and policy objectives corresponded to a situation in which the use of the Fund's resources would be appropriate; as well as out of the commitment of members to consult if they maintained the transitional regime (under Article XIV of the Articles of Agreement) in which exchange controls might still be tolerated. In other words, the Fund as a financial institution was required to use its lending to promote a specific outcome. Its resources were to be used "to facilitate the expansion and balanced growth of international trade, and contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members." The Articles also recognized the importance of the new body in the exchange of information and views. Its purposes had already been defined as "to promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems." 17 From Bretton Woods to the Information Age 589 The basic commitment to rule-guided liberalization inherent in the accep- tance of convertibility laid the foundations for a system that created unprece- dented rates of economic growth and increased prosperity throughout much of the world. However, there were two major surprises. First, the new institu- tion never controlled world liquidity (and indirectly the world money supply) in the way originally envisaged. As the global economy grew, IMF quotas accounted for ever smaller shares of international reserves. Even the new IMF "money" of the 1960s, the SDR, which actually reproduced quite faithfully the intentions of the founders of Bretton Woods, came to represent only a very small part of the world's reserves. Instead national authorities, and increasingly also the substantially uncontrolled operations of the Euromar- kets, created their own money. The second development, largely unforeseen at Bretton Woods, was one that both contributed greatly to the dynamism of the world economy and also altered the character of the monetary order. This development was the emergence of large capital movements, freeing money from national control. The original agreements had involved an obligation to liberalize current accounts, but—among other considerations—the primary rule (fixed ex- change rates) involved the necessity, or at least the possibility, of controlling capital flows. When the world returned after the war to nearly general convertibility at the end of the 1950s, and accepted the corresponding Article (Article VIII) of the Fund's Articles of Agreement, this meant convertibility on current account only. However, even at this early stage, substantial capital movements developed. The access to resources they brought constituted one of the main incentives to many countries to adopt convertibility. Capital movements brought not just the possibility of increasing national investment levels, they were also often associated with flows of skills and technology. This was true of Spain in the late 1950s, and then of Latin American countries (where the initial experiment in convertibility was often unsuccessful) and East Asia (where some spectacular successes occurred). As capital flows developed, the problems of monetary management became more complex. One instance of the new difficulties was the effect of capital inflows on the domestic money supply. Another example was that capital flows allowed a financing of current account deficits. Initially, current account deficits were believed to be the major problem requiring international action; but capital flows might make them less of a problem. Inflows—foreign bor- rowing—could offer an easy and at least temporary alternative to immediate adjustment. Obviously, such flows depend on the verdict of the lenders— the market—and cannot necessarily be maintained indefinitely (particularly if the resources are chiefly used to pay for increased consumption). The 590 INTERNATIONAL MONETARY COOPERATION availability of capital often simply offered the possibility of making a choice about a time frame for adjustment; but governments (with often limited political time horizons reaching to the next elections) wanted to take advan- tage of such a choice, and defer the adjustment as a problem to bequeath to their successors. As a result, there were temptations not to recognize underlying economic problems. The new difficulties were the underlying rationale for the extension of IMF consultations to include also the member countries that had gone over to full convertibility under Article VIII of the Articles of Agreement. Such consultations might give advance notice of the likely emergence of economic problems. Throughout the 1960s the international community repeatedly tried to develop a systematic approach to "early warning signs." At the same time, the availability of funds on capital markets altered the demand for liquidity. In cases when confidence was maintained, there would be sufficient liquidity as a consequence of private lending. Such funds, how- ever, would not be available exactly when they were needed—in a crisis. In cases where confidence disappeared, the Fund became more necessary than ever as a substitute for the private market, as a way of financing imbalances and restoring expectations of stability: in short, as a reserve center or a lender of last resort. There are two ways of providing such assistance: the first, immediate support in the case of a market panic, in order to forestall an imminent market failure, is undertaken by central banks or (for many indus- trial countries) by the central bankers' central bank, the Bank for Interna- tional Settlements (BIS). The second, in which policy changes as well as a persuasion of financial markets are required to restore confidence, after a market failure has already taken place, has been the domain of the IMF. (The IMF could potentially play a larger role in the former operation also— perhaps not so much directly, by trading on its own account, but by using its resources to help to unwind the substantial swap positions built up by central banks in cases of intervention, when they are not unwound as an immediate consequence of the re-establishment of confidence.) The flows of capital brought an increasing instability to the system, and eventually destroyed the par value system between 1971 and 1973. As the instability became more apparent in the late 1960s, the transfers of funds across frontiers increased dramatically; once the system was evidently in crisis, between 1971 and 1973, they became even larger.