international financial system has been radically altered since the worldwide
depression of the late 1920’s and early 1930’s. This change is due in large
part to the inception of the International Monetary Fund (IMF) and its
subsequent control over the international financial system. In this paper I will
examine the extensive role of the Bretton Woods system of exchange rates and the
gold standard. Additionally, I will examine the role that the IMF has taken on
since the demise of the gold standard. To begin, we must examine the
circumstances that surround the creation of the IMF, who the actors are and what
each of their roles are as member countries. The IMF was created as a result of
the worldwide market collapse that took place initially in October of 1929. The
domino effect that took place when the first market crashed was seen to be a
situation so severe that world powers felt that drastic measures needed to be
taken to ensure that this was the last global financial crisis that the world
would face. Its creation in 1944 was the beginning of a new era for the
international financial system. The creation of the IMF occurred at Bretton
Woods along with the World Bank and the system of fixed exchange rates and the
gold standard for currency. Under this system, the US dollar was tied to gold by
a United States government commitment to buy it at $35.00 and ounce and sell to
central banks at the same price (excluding handling and other charges). Other
participating countries maintained the exchange values of their currencies at
prices which were almost fixed in terms of the dollar (the values fluctuate
normally not more than one percent on either side of their parities), with the
result that exchange rates were almost universally fixed. Other governments
carried out their commitments by selling internationally acceptable liquid
resources when there was an excess demand for foreign currencies in terms of
their own currencies, and by buying liquid resources when there was an excess
supply. What constituted internationally acceptable resources for this purpose
were gold, and other liquid assets denominated in “key” or reserve
currencies, principally US dollars or UK pounds sterling. The IMF was to ensure
that these standards were being followed as well as being the lender for
temporary deficits, and balance of payment problems. Each member country
contributed a predefined amount, or quotas, of national currencies and gold.
This quota also determines the voting power on the IMF and the amount of
resources that they may draw on from the Fund. Designed to foster monetary
cooperation, the IMF sought to enforce strict rules of behaviour in a world
based on the gold standard and fixed currency-exchange rates. The Fund had, in
theory, strict rules regarding how much to lend and when it was to be repaid. In
reality, however, the Fund had discretion to waive any normal limitations. In
1961 with the advent of the General Arrangements to Borrow (GAB), the Fund
increased its ability to lend through arrangements to borrow from 10 major
industrial countries. At the time, these agreements had enabled the IMF to have
and additional $6 billion at its disposal. The Gold Standard, in theory,
functioned to limit the ability of governments to issue currency at will, hence
decreasing the purchasing power of money. It existed before the Bretton Woods
agreement, but was suspended for reasons that we will see later. If, for
example, the US dollar were defined as equal to 1/20 of an ounce of gold, then
the number of dollars that the United States could issue would be constrained by
its holdings of gold reserves. Moreover, if the UK defined its currency, the
pound sterling, as 5/20 of an ounce of gold, the fixed exchange rate between the
US and the UK, quite obviously would be $5 USD=£1 sterling. One specific
problem with specie standards (that is a currency convertible into a
standardised unit of a non-monetary commodity) is that the value of money is
only as valuable as the specie backing it. When worldwide gold production was
low in the 1870’s and 1880’s, the money supply grew slowly, leading to a
general deflation. This situation changed radically in the 1890’s following
the discovery of gold in Alaska and in South Africa. The result was rapid money
growth and inflation up until the outbreak of World War I. Furthermore, linking
currencies to gold did not totally restrain governments from manipulating the
value of their currencies. First, in order to finance expenditures by printing
money, governments would frequently suspend the gold standard during times of
war. Second, even without officially abandoning gold, some nations periodically
redefined the value of their currencies in terms of gold. Instead of allowing
for gold or foreign reserves to be consistently depleted, the countries would
choose instead to devalue their currencies. It might seem, by this previous line
of argument that countries had no real restrictions on their behaviour when it
came to currencies, since they could devalue them at will. However, there was a
serious price to pay for devaluation. Should a country threaten to devalue its
currency, a speculative attack on that country’s currency would surely follow
as investors attempted to rid themselves of that currency. Such countries would
ultimately lose large amounts of reserves. This is exactly what occurred in the
UK in 1966 and 1967. Confidence in the value of the pound sterling crashed and
the subsequent loss of gold reserves amounted to 28 million ounces. In one day
alone (November 17, 1967) the British government lost reserves valued at over $1
billion. On August 15, 1971, in the midst of a major international monetary
crisis, President Richard M. Nixon announced a new policy suspending
indefinitely the U.S.'s commitment to redeem gold for dollars. This commitment
was the lynchpin of the international monetary system in which the U.S. dollar
served as the key currency by which the value of other currencies would be
determined. Nixon's decision to break the link between the dollar and gold
effectively pulled the rug out from under the other world currencies, forcing
them to re-determine their values, and thus forcing devaluation of the dollar.
This event is generally regarded as marking the demise of the system of fixed
exchange rates. The fall of the Bretton Woods system represents an important
transitional stage in the history of international economic relations. It
represents a change from a hegemonic system dominated by the U.S. intended to
lay the foundation for an open, competitive world economy to the current system
of floating exchange rates and expanding global capitalism. The Fall of the
Bretton Woods System President Nixon's announcement in 1971 and then the
subsequent collapse of the system in 1973 were hardly spontaneous occurrences.
The fall of Bretton Woods was simply the culmination of a chain of economic and
political developments that were quite predictable. From flaws in the design of
the system that made it inherently unstable, to the spin-off of international
capital markets that exploited its weaknesses, the collapse of Bretton Woods was
inevitable. Because of the U.S. pledge to back dollars with gold, the stability
of the system was based on the ratio of foreign-held dollars to the value of
gold held by the United States. If the amount of foreign dollars exceeded the
amount of U.S. gold, the U.S. could not pay all of its claimants without
changing the price of gold. So as the ratio of foreign dollars to U.S. gold
increased, so did pressure to devalue the dollar. As such, the stability of the
system was gauged by the U.S. balance of payments. Considering this, confidence
in the dollar became an essential element of the Bretton Woods system. The
decade following the signing Bretton Woods agreement would see the U.S. balance
of payments shift from surplus to deficit, producing new pressures on the
system. From 1948 to 1958, several new and significant features surfaced in the
international system. These features included development of new institutions
for economic cooperation, dramatic economic growth in Europe, rising U.S.
military spending, U.S. foreign aid to the Third World, and the emergence of
U.S.-based multinational corporations (MNCs). These new additions to the
international landscape "helped to generate the stability and prosperity
that gave nations the confidence to participate in this liberal system."
But at the same time, each factor contributed to an outflow of dollars, pushing
the U.S. balance of payments in the direction of larger deficits, meaning more
dollars abroad and more potential claimants on U.S. gold, thereby destabilizing
the system. The balance of payments difficulties posed a unique problem for the
United States. As the hegemon of the system, the U.S. had an obligation to
provide economic and military security for itself, its allies, and the system.
In the 1960s U.S. leaders faced the dilemma of trying to solve the balance of
payments problem while still fulfilling the country's responsibilities as
hegemon. The initial deficits of the 1950s, which were created through military
and economic aid, were actually seen as beneficial at the time in that they
"helped close the gap with the still economically weak Europeans." By
the end of the 1950s, Europe had recovered and the deficit became a problem.
Before 1958 and 1959, large surpluses in goods and services and investment
income had helped to offset the costs of providing foreign aid, military
expenditures abroad, and private overseas investment. When the U.S. surpluses
suddenly shrank, the payments deficit became even wider. Clearly the burden of
hegemony was taking its toll on the United States. One of President John F.
Kennedy's economic advisers warned, "[we] will not be able to sustain in
the 1960s a world position without solving the balance of payments
problem." This assessment proved to be accurate as U.S. efforts to meet its
global responsibilities further damaged its balance of payments, undermining its
ability to act as hegemon." The increase in U.S. deficits meant money was
leaving the country and as such, it had to go somewhere. This is evidenced by
the surpluses experienced by Japan and Western European countries, such as West
Germany, which were growing rapidly. The surpluses, combined with the U.S.
deficit, meant decreasing liquidity in the world economy, as the U.S., in its
role as central banker to the world, had supplied much of the liquidity from its
reserve assets, mainly gold. To remedy this situation, a devaluation of the
dollar would have been seemingly appropriate. However, the U.S. could not
devalue the dollar without horribly upsetting the other currencies of the world.
Another way to help correct the disequilibrium in world payments would have been
to have surplus countries like Germany and Japan revalue their currencies,
effectively devaluing the dollar in the process. Because these countries were
persistently reluctant to change their own rates, the payments imbalances
increased until a breaking point was reached in 1971. The fact that the surplus
countries did not wish to revalue their currencies emphasizes an important flaw
in the design of the Bretton Woods system. Orin Kirshner writes, "It was
becoming uncomfortably clear that a system of fixed exchange rates, in which
gold and the dollar...were the main components, was rather asymmetrical in its
pressures for adjustment. The deficit countries were under pressure to adjust
when they ran out of reserves and had to go to the [IMF] or to the central
bankers for aid; but there were no similar pressures on the creditors to reduce
their surpluses." Another interesting development that played a large part
in the breakdown of the Bretton Woods system is the Eurodollar phenomenon. The
Eurodollar, or Eurocurrency (other currencies were also involved), market was a
by-product of the large-scale accumulation of dollars in foreign banks following
the shift from a dollar shortage (U.S. payment surplus) to a dollar surplus
(U.S. payments deficit) in 1957-1958. It was then that London bankers decided to
lend these dollars out, rather than return them to the U.S. (which would have
helped to stabilize the situation by improving the U.S. balance of payments).
"Thus," Lairson says, "was born the Eurodollar...market --
essentially an unregulated money supply." When the U.S. government acted in
1963 to address this problem by enacting the interest equalization tax to slow
the outflow of dollars for loans, U.S. banks then opened overseas 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 IMF’s lending practices in the SSA region. Whether
or not the IMF has focused enough on LDC’s 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.

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