British monetary hegemony
Great Britain rose to the status of monetary hegemon in 1871 with widespread adoption of the gold standard. During the gold standard of the late nineteenth century, Britain became the greatest exporter of financial capital. Its capital city, London, also became center of the world gold, money, and financial markets. This was a major reason for states adopting the gold standard. For Paris, Berlin, and other financial centers to attract the lucrative financial business from London, it was necessary to emulate Britain's gold standard, for it reduced transaction costs, represented creditworthiness, and sound financial policy from government (Schwartz, 1996). The city of London was the leading supplier of both short term and long term credit, which was channeled abroad. Its extensive financial facilities provided cheap credit, which enhanced the strength of the pound through deepening its use for international payments. According to Walter (1991), during the decades of 1870–1913, "sterling bills and short-term credits financed perhaps 60 percent of world trade" (p. 88).
Britain's foreign investment cultivated foreign economies for the use of sterling. In 1850, Britain's net overseas assets grew from 7 percent of the stock of net national wealth to 14 percent in 1870, and to around 32 percent in 1913 (Edelstein, 1994). The world had never before seen one nation committing so much of its national income and savings to foreign investment. Britain's foreign lending practices possessed two technical aspects that gave greater credence to the prominence of sterling as a unit of storage and medium of exchange: first, British loans to foreigners were made in sterling, which allowed the borrowing country to service the debt more conveniently with its sterling reserves, and second, Britain’s use of written instructions to pay or bill exchanges were drawn in London to finance international trade.
More importantly, its unrivalled ability to run current account deficits through the issuance of its unquestioned currency and its discount rate endowed Britain with a special privilege. The effects of the discount rate had a "controlling influence on Britain’s balance of payments regardless of what other central banks were doing" (Cleveland, 1976, p. 17). When other central banks engaged in a tug of war over international capital flows, "the Bank of England could tug the hardest" (Eichengreen, 1985, p. 6). In this regard, British monetary hegemony was seldom threatened by crises of convertibility for its gold reserves were insulated by the discount rate and all foreign rates followed the British rate. The prominence of London's credit drains led Keynes (1930) to write that the sway of London "on credit conditions throughout the world was so predominant that the Bank of England could almost have claimed to be the conductor of the international orchestra" (p. 306–307). Karl Polanyi in his renowned work the Great Transformation states "Pax Britannica held its sway sometimes by the ominous poise of heavy ship’s cannon, but more frequently it prevailed by the timely pull of a thread in the international monetary network" (Polanyi, 1944, p. 24).
Britain's position waned due to inter-state competition, insufficient domestic investment, and World War I. Despite its economic weaknesses, British political sway continued after World War I, which led to the gold-exchange standard created under the Genoa Conference of 1922. This system failed, however, not only due to Britain's incapability, but to the growing decentralization of the international monetary system with the rise of New York and Paris as financial centers that resulted in the collapse of the gold exchange standard in 1931. The Gold Exchange standard of the interwar period, as Kindleberger cogently stated, collapsed because "Britain couldn't and America wouldn't." In fact, Kindleberger provides a slightly different variation of monetary hegemony that possesses five functions rather than three defined here.
American monetary hegemony
The end of World War II witnessed the recentralization of monetary power in the hands of a United States that had been left largely unscathed by the war. The United States had emerged from World War II with the ideals of economic interdependence, accountability, and altruism, expressed in the vision of universal multilateralism. Above all, multilateralism simply meant nondiscrimination via the elimination or reduction of barriers and obstacles to trade, but more importantly was the maintenance of barriers "that were difficult to apply in a nondiscriminatory manner" (Ruggie, 1982, p. 213). In essence, the term multilateralism differs today, compared to what it meant after World War II. US interests in a multilateral, liberal world economy would not be grounded entirely in idealistic internationalism. There was the cold, calculating necessity of generating a US export surplus. This would obviate government spending, stimulate the domestic economy, substitute for domestic investment, and avert reorganization for certain industries in the economy that were overbuilt during the war effort. For these reasons the "idea of an export surplus took on a special importance" (Block, 1977, p. 35) for the US. The production of an export surplus was therefore intimately connected with establishing a world economy that was free of imperial systems, as well as bilateral payments and trading systems. The US would therefore aim to open its predecessor's empire to American trade and to garner British compliance to create its postwar monetary system through financial leverage, namely the Anglo-American Financial Agreement of 1945.
This new vision of universal multilateralism was, however, forestalled by the new economic realities of a war-torn Europe, symbolized by Britain's financial inability to maintain sterling convertibility. Combined with this new economic reality was the political-military threat of the Soviet Union. On 29 December 1945, only two days before the expiration of Bretton Woods, Soviet Foreign Minister Vyacheslave Molotov notified George Kennan, "that for the amount [offered] the U.S.S.R. would not subscribe to the articles" (James et al., 1994, p. 617). Two months later, in February 1946, Kennan sent his famous telegram to Washington, which inquired into why the Soviet Union had not ratified the Bretton Woods Agreement. The telegram would later be regarded as the beginning of US Cold War policy (James et al., 1994).
The US thus altered its vision from universal multilateralism to regional multilateralism, which it would promote in Europe through the Marshall Plan, the European Recovery Program (ERP), and the European Payments Union (EPU). With the dissolution of the EPU came the prospect of a real multilateral world as the Bretton Woods monetary system came into effect in 1958. The same year marked the beginning of a permanent US balance of payments deficits.
Throughout the 1960s, the Bretton Woods system had permitted the US to finance approximately 70 percent of its cumulative balance of payments deficits via dual processes of gold demonetization and liability financing. The liability financing enabled the US to undertake heavy overseas military expenditures and "foreign commitments, and to retain substantial flexibility in domestic economic policy" (Gowa, 1983, p. 63).
In 1970, the US was at the center of international instability that was a consequence of its rapid monetary growth (James, 1996). The US, however, had learned from the fate of its predecessor's key currency (i.e. Sterling). Britain's experience as monetary hegemon demonstrated to the US the problems faced by a reserve currency when foreign monetary authorities, individuals, and investors chose to convert their reserves. In terms of monetary power defined by reserves, the US share of reserves had fallen from 50 percent in 1950 to 11 percent in August 1971 (Odell, 1982, p. 218). Although, the US had become considerably weak in defending convertibility, its rule-making power was second to none. Rather than being constrained by the system it created, the US moved to the conclusion that it "was better to attack the system than to work within it" (James, 1996, p. 203). This decision was based on the recognition of the inseparability between foreign policy and monetary policy. The termination of the Bretton Woods system signified the subordination of monetary policy to foreign policy. The closing of the gold window was a fix that was assigned to "free…foreign policy from constraints imposed by weaknesses in the financial system" (Gowa, 1983, p. 69).
US Monetary Hegemony persists as does the Bretton Woods System, as Dooley, Folkerts-Landau, Garber (2003) contend in their work An Essay on The Revised Bretton Woods System. The rules of the Bretton Woods system have stayed the same but the players have changed. The Post Bretton Woods system or Bretton Woods II has given rise to a new periphery for which the development strategy is export-led growth supported by undervalued exchange rates, capital controls and official capital outflows in the form of accumulation of reserve asset claims on the center country (i.e. US). In other words, Asia has replaced Europe in financing US balance of payments deficits.
A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from the late 1920s to 1932 as well as from 1944 until 1971 when the United States unilaterally terminated convertibility of the US dollar to gold foreign central banks, effectively ending the Bretton Woods system. Many states nonetheless hold substantial gold reserves.
The Bank for International Settlements (BIS) is an international financial institution owned by central banks that "fosters international monetary and financial cooperation and serves as a bank for central banks". The BIS carries out its work through its meetings, programmes and through the Basel Process – hosting international groups pursuing global financial stability and facilitating their interaction. It also provides banking services, but only to central banks and other international organizations. It is based in Basel, Switzerland, with representative offices in Hong Kong and Mexico City.
A reserve currency is a foreign currency that is held in significant quantities by central banks or other monetary authorities as part of their foreign exchange reserves. The reserve currency can be used in international transactions, international investments and all aspects of the global economy. It is often considered a hard currency or safe-haven currency.
The Bretton Woods Conference, formally known as the United Nations Monetary and Financial Conference, was the gathering of 730 delegates from all 44 Allied nations at the Mount Washington Hotel, situated in Bretton Woods, New Hampshire, United States, to regulate the international monetary and financial order after the conclusion of World War II.
The global financial system is the worldwide framework of legal agreements, institutions, and both formal and informal economic actors that together facilitate international flows of financial capital for purposes of investment and trade financing. Since emerging in the late 19th century during the first modern wave of economic globalization, its evolution is marked by the establishment of central banks, multilateral treaties, and intergovernmental organizations aimed at improving the transparency, regulation, and effectiveness of international markets. In the late 1800s, world migration and communication technology facilitated unprecedented growth in international trade and investment. At the onset of World War I, trade contracted as foreign exchange markets became paralyzed by money market illiquidity. Countries sought to defend against external shocks with protectionist policies and trade virtually halted by 1933, worsening the effects of the global Great Depression until a series of reciprocal trade agreements slowly reduced tariffs worldwide. Efforts to revamp the international monetary system after World War II improved exchange rate stability, fostering record growth in global finance.
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In macroeconomics and modern monetary policy, a devaluation is an official lowering of the value of a country's currency within a fixed exchange-rate system, in which a monetary authority formally sets a lower exchange rate of the national currency in relation to a foreign reference currency or currency basket. The opposite of devaluation, a change in the exchange rate making the domestic currency more expensive, is called a revaluation. A monetary authority maintains a fixed value of its currency by being ready to buy or sell foreign currency with the domestic currency at a stated rate; a devaluation is an indication that the monetary authority will buy and sell foreign currency at a lower rate.
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In macroeconomics and economic policy, a floating exchange rate is a type of exchange rate regime in which a currency's value is allowed to fluctuate in response to foreign exchange market events. A currency that uses a floating exchange rate is known as a floating currency, in contrast to a fixed currency, the value of which is instead specified in terms of material goods, another currency, or a set of currencies.
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The Triffin dilemma or Triffin paradox is the conflict of economic interests that arises between short-term domestic and long-term international objectives for countries whose currencies serve as global reserve currencies. This dilemma was identified in the 1960s by Belgian-American economist Robert Triffin, who pointed out that the country whose currency, being the global reserve currency, foreign nations wish to hold, must be willing to supply the world with an extra supply of its currency to fulfil world demand for these foreign exchange reserves, leading to a trade deficit.
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A fixed exchange rate, often called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed or pegged by a monetary authority against the value of another currency, a basket of other currencies, or another measure of value, such as gold.
An international monetary system is a set of internationally agreed rules, conventions and supporting institutions that facilitate international trade, cross border investment and generally the reallocation of capital between states that have different currencies. It should provide means of payment acceptable to buyers and sellers of different nationalities, including deferred payment. To operate successfully, it needs to inspire confidence, to provide sufficient liquidity for fluctuating levels of trade, and to provide means by which global imbalances can be corrected. The system can grow organically as the collective result of numerous individual agreements between international economic factors spread over several decades. Alternatively, it can arise from a single architectural vision, as happened at Bretton Woods in 1944.
The London Gold Pool was the pooling of gold reserves by a group of eight central banks in the United States and seven European countries that agreed on 1 November 1961 to cooperate in maintaining the Bretton Woods System of fixed-rate convertible currencies and defending a gold price of US$35 per troy ounce by interventions in the London gold market.
