Lack of confidence in the international monetary system


Nature

Under the present international monetary system, countries hold their external monetary reserves partly in gold and partly in foreign exchange. In the past, the latter have consisted mainly of gold-backed dollars and pounds as reserve currencies. The present more complex system requires political as well as economic cooperation and a greater reliance on the 'good intentions' of the USA and its now unbacked dollar. Confidence is very fragile, as both unilateral and regional actions are always possible. A weakening of confidence in the reserve currencies may affect the behaviour of both official and private holders of these currencies, inducing them to convert their existing stock of reserve currencies into gold or into other currencies considered to be stronger. A large-scale conversion of any principal OECD nation's currency into gold would not only tend to reduce the total of existing international liquid reserves, without any reduction in the need for such reserves but, by lowering the reserve assets of the reserve currency countries, might force them to undertake domestic adjustments which would be harmful to the level of world economic activity as a whole. A drastic devaluation, for example, by one of these countries could destabilize world trading patterns.

Incidence

The present international monetary system remains highly vulnerable to sudden shocks of confidence. Despite the impressive strength of the defences that have been erected against shifts in confidence, the problems of the reserve currency system have yet to be solved. Crises of confidence cause large-scale movements of capital far in excess of the ability of any one country to deal with them by normal means. The system of floating rates of currency lead to improper allocation of the factors of production, anxiety in financial markets, a rise in interest rates and a slowdown in growth. The emergence of the ECU in Europe as a reliable common currency is still problematical as this unit of currency has not had time yet to prove itself .

Claim

  1. The world lived with the gold standard before World War I. The world economy was then marked by the dominance of one country, the UK, which was the industrial, commercial and financial capital of the world. When that monopoly was called into question, after the first World War, the system ceased to function. Then there was the gold exchange standard, or the Bretton Woods system, proposed by the USA at the end of the war. The adjustment mechanisms which were provided did not work or worked too late and the system broke down. Each of these systems worked well in the beginning because they corresponded well to their economic environment, in which there existed one dominant economic pole. The world today is multipolar. No unipolar system works. It is foolish to expect anything but instability in a monetary system which depends on one currency--the dollar--as a basis for stability.


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