History of the International Monetary System and Its Potential Re

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University of Tennessee, Knoxville Trace: Tennessee Research and Creative Exchange University of Tennessee Honors esis Projects University of Tennessee Honors Program 5-2010 History of the international monetary system and its potential reformulation Catherine Ardra Karczmarczyk University of Tennessee, [email protected] Follow this and additional works at: hp://trace.tennessee.edu/utk_chanhonoproj Part of the Economic History Commons , Economic Policy Commons , and the Political Economy Commons is Dissertation/esis is brought to you for free and open access by the University of Tennessee Honors Program at Trace: Tennessee Research and Creative Exchange. It has been accepted for inclusion in University of Tennessee Honors esis Projects by an authorized administrator of Trace: Tennessee Research and Creative Exchange. For more information, please contact [email protected]. Recommended Citation Karczmarczyk, Catherine Ardra, "History of the international monetary system and its potential reformulation" (2010). University of Tennessee Honors esis Projects. hp://trace.tennessee.edu/utk_chanhonoproj/1341

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History of the international monetary system and its potential

Transcript of History of the International Monetary System and Its Potential Re

  • University of Tennessee, KnoxvilleTrace: Tennessee Research and Creative

    Exchange

    University of Tennessee Honors Thesis Projects University of Tennessee Honors Program

    5-2010

    History of the international monetary system andits potential reformulationCatherine Ardra KarczmarczykUniversity of Tennessee, [email protected]

    Follow this and additional works at: http://trace.tennessee.edu/utk_chanhonoprojPart of the Economic History Commons, Economic Policy Commons, and the Political

    Economy Commons

    This Dissertation/Thesis is brought to you for free and open access by the University of Tennessee Honors Program at Trace: Tennessee Research andCreative Exchange. It has been accepted for inclusion in University of Tennessee Honors Thesis Projects by an authorized administrator of Trace:Tennessee Research and Creative Exchange. For more information, please contact [email protected].

    Recommended CitationKarczmarczyk, Catherine Ardra, "History of the international monetary system and its potential reformulation" (2010). University ofTennessee Honors Thesis Projects.http://trace.tennessee.edu/utk_chanhonoproj/1341

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  • HistoryoftheInternationalMonetarySystem

    anditsPotentialReformulation

    CatherineA.Karczmarczyk

    HonorsThesisProject

    Dr.AnthonyNownesandDr.AnneMayhew

    02May2010

  • Karczmarczyk 2

    HISTORYOFTHEINTERNATIONALMONETARYSYSTEMANDITSPOTENTIAL

    REFORMATION

    Introduction

    Theyear1252markedthemintingoftheveryfirstgoldcoininWesternEurope

    sinceRomantimes.Sincethislandmark,theinternationalmonetarysystemhas

    evolvedandtransformeditselfintothemodernsystemthatweusetoday.The

    modernsystemhasitsrootsbeginninginthe19thcentury.InthisthesisIexplore

    fourmainideasrelatedtothishistory.

    Firstistheevolutionoftheinternationalmonetarysystem.WithinthisIwill

    explorethedifferenterasthatmakeupthistime.Firstistheclassicgoldstandard,

    thentheinterwarperiod,andfollowedbyBrettonWoods.Thissectionconcludes

    withadiscussiononthecurrentera,alsoknownasthedirtyfloat.

    Thesecondsectionwillexplorethetransitionperiodofthe1990s.This

    sectionexplorestheAsianFinancialCrisisindetailandalsodiscussestheoriginsof

    theeurozone.Thesesectionsbegintheanalysisportionofthethesis,andwhilethey

    dogiveacertaindegreeofbackground,thesectionlargelyservesasatransitional

    section.

    Thethirdsectionisananalysisofthecurrentmonetarysystem.Theworldis

    facingtwomajorissuesrightnow,thepotentialcollapseoftheeurozoneandthe

    ChineseholdingofUSTreasurydebt.Inthissection,Iwillexploretheseissuesin

  • Karczmarczyk 3

    depthandhighlighthowthehistoryoftheinternationalmonetarysystemhasledus

    tothispoint.

    Inthefourthandfinalsection,Ihighlightseveralpossibilitiesforreform.This

    isnotacomprehensiveplanofaction,butratherideasofwhereIseereformis

    needed.Actualreformpossibilitieshavebeencirculatingforyears,andtheseideas

    representacombinationofthese.

    EvolutionoftheInternationalMonetarySystem

    TheClassicGoldStandard(18701914)

    Inthissection,IwilldiscusstheriseandimportanceofthegoldstandardinGreat

    Britain,theBankofEnglandasalenderoflastresort,andtheresultsofthe

    continentjoiningthegoldstandard.Iwillconcludewithabriefdiscussionoftheend

    oftheprewargoldstandardandtheoverallimportanceofitsevolutiontoboththe

    interwarandpostwarperiodsbutalsotothemodernmonetarysystemtoday.

    TheRiseoftheGoldStandardinGreatBritain

    Theclassicgoldstandardstartedformostcountriesinandaroundthe1870s,but

    forGreatBritain,itwasfarearlier.Manydatetheadventofthegoldstandardin

    Britainto1717,whenSirIsaacNewtonsetthepriceofgoldattoolowarate,

    causingsilvertodisappearfromthecountryentirely.Theactualdateof

    demonetizationdidntoccuruntil1774,theyearwhengoldwasrecoined,silverwas

    recognizedassubsidiary,andlimitsweresetontheuseofsilvercoinsinexcessof

    25pounds.

  • Karczmarczyk 4

    Intheyearsleadinguptotheadoptionofthegoldstandardbycontinental

    Europe,Britainfacedseveralinstancesofconvertibilityissues.WhentheReignof

    Terrortookplaceinearly1793,therewasasharpoutflowofcapitalintheformof

    bothgoldandsilverfromFrance.Thisproducedlargeamountsofliquidityin

    Britain,fuelinganongoingmaniatoitspeak.Eventuallytheassignat,theFrench

    papercurrencyofthetime,collapsed,forcingareflowofmoney.TheBritishpeople

    panicked,andabankrunensued.Inresponse,theBritishgovernmentorderedthe

    BankofEnglandtosuspendconvertibility,wellbeforereservesranoutinaneffort

    tokeepgoldreservesfrombecomingexhaustedifalltheincreasednotestofinance

    thewarwerecashedin.In1825,notlongafterconvertibilityresumption,Britain

    onceagainfacedthethreatofabankrun.TheBankofFrancesteppedintoaidthem

    atthistime,easingthefearofsuspension.

    Britainrecognizedtheneedtoact.Suspensionofthecurrencyledtoan

    inconsistentsystemalwaysfacingbankruns.Atthistime,however,thereweretwo

    schoolsofthought,theCurrencySchoolandtheBankingSchool,eachwithdiffering

    ideasonhowthemoneysupplyshouldbehandled.Theintricaciesofthesetwo

    schoolsarebeyondthescopeofthispaper,butletitsufficetosaythattheBanking

    Actof1844wasacompromisebetweenthetwo.FortheBankofEngland,itcreated

    anIssueDepartment,whichwasresponsiblefortheissueofpapercurrency,andit

    wouldalsocreateaBankingDepartment,responsibleformakingloansand

    discountsuptoamultipleofitsreservesofbanknotesthathadbeenproducedby

    theIssueDepartment(Kindleberger59).

  • Karczmarczyk 5

    ApartfromafixedinitialquantityofBanknotesbackedbygovernment

    securities,everynoteissuedhadtobebackedbybullioninthevaultoftheIssue

    Department.ThislimitedthequantityofBanknotesinanefforttoadheretothe

    principlethatthewaytoassureasoundpapercurrencyistorequireanyincrease

    initsquantitytobebackedpoundforpoundbyincreasesinbullionreservesheldby

    thecentralbank(Dillard378).Basically,atthispointinthehistoryofbankingin

    England,securitywasmoresacredthanflexibility.Choosingthispath,however,

    madeitdifficultfortheBankofEnglandtosupplycreditintimesofemergency.

    WhentheCrisesof1847,1857,and1866erupted,theBankofEnglandwasgiven

    permissionbygovernmenttobreakthelawbyissuingnotesnotbackedbybullion.

    TheBankActof1844hadanevenmorefundamentalissuehowever.It

    presumedthatcontrolofthequantityofbanknotes,andthereservesbehindthem,

    wasthechieffunctionofcentralbanking(Dillard378).Britishbanking,however,

    wasenteringanewphase,thecheckingsystem.

    TheBankofEnglandasaLenderofLastResort

    Inthenewcheckingphaseofbanking,themostimportantfunctionoftheBankof

    Englandwasastheholderofthecentralreservessupportingthecheckingsystem

    andasalenderoflastresortinemergencies(Dillard379).Therehadlongbeen

    debateinEnglandoverwhetherthelenderoflastresortshouldbetheExchequeror

    theBankofEngland,buttheactionsoftheBankActof1844,leftlittledoubtasto

    whomthejobwouldfall.Itwasaroundthistimeofthisnewphasethatitbecame

    startlinglyclearthattheBankofEnglandwasnolongerjustanyotherbank.Its

  • Karczmarczyk 6

    reservesweretoolargeanditsroleasacreditcustodiantoowidelyaccepted.Ithad

    tostandreadytolenditsreservesfreelyincriticalcreditsituations;formere

    reluctanceonitspartwouldmakecrediteventighterandprecipitateacrisisor

    makeanexistingcrisisworse(Dillard379).

    Privatebanksandothersuchinstitutionsneededbanknotes(thelegal

    tender)toprovidefortheircustomers.Inordertodothis,however,theyhadto

    haveaccesstothecentralbank.SuchanecessitygavetheBankofEnglandacertain

    degreeofpower.TheBankofEnglandcouldmakethebankersandbillbrokerspay

    fornewmoneybyraisingtherateofinterest,but[atthesametime]itcouldhardly

    refusetolend,providedtheborrowershadgoodsecuritiestosellorpledgeagainst

    theirloans(Dillard379).Thepower,andresponsibility,comesinbecausenow

    becausetheBankingDepartment(nowthepowerfuldepartmentduetotheriseof

    checking)washeldresponsibleforthecreditofallbanks,astheirabilitiesdepended

    ontheliquidityofthecentralbank.

    ContinentalEuropeJoinstheGoldStandard

    ThegoldstandardinEnglandhadbeenaroundforseveralyearsbeforecontinental

    Europedecidedtoalsojoinin.DuringthetimethatBritainhadbeenbuildingand

    redefiningits(andeventuallytheworlds)bankingsystem,theyhadalsobeen

    experiencingtheIndustrialRevolution.Thisindustrializationleftthemasthe

    worldsleadingeconomicpowerandthemainsourceofforeignfinance

    (Eichengreen17).Countriesdesperatelywantedtotradewithsuchaneconomic

    resource,andthebimetallicstandardsofmanyofthesecountriesdidntfacilitate

  • Karczmarczyk 7

    easytrade.Portugalhaddecidedearlyonin1854thatitstradewithBritainwas

    crucial,andtheyinresponseadoptedthegoldstandardin1854.Othercountries,

    however,hadyettocometothatconclusion.

    Whenaseriesofevents,includingabriefboutofinconvertibility(associated

    withtheFrancoPrussianWar),decliningtransportationcosts,andlargesilver

    discoveriesinthe1850s(inplacessuchasNevada),considerationsofjoiningthe

    goldstandardwerepushedevenfurther.Ultimately,thefinalincentivecamein

    1871,whenGermany,theleadingindustrialpowerofcontinentalEurope,choseto

    liquidateitssilverholdingsinanefforttoopenupmoretradewithGreatBritain.

    Theresultwasachainreactioncausedbytheincentiveforeachcountrytoadopt

    themonetarystandardsharedbyitscommercialandfinancialneighbors

    (Eichengreen17).Bytheendofthenineteenthcentury,Spainwastheonly

    Europeancountrystilloninconvertiblepaper.Intherestoftheworld,theUnited

    States,Japan,Russia,India,andLatinAmericaallalsoinstitutedgoldconvertibility.

    SilverremainedthemonetarysystemonlyinChinaandafewothersmallcountries.

    Underthegoldstandard,theexchangeratesofthesemajorindustrial

    countrieswerefirmlypeggedwithinnarrowbands(thegoldpoints)inan

    environmentfreeofsignificantrestrictionsoninternationalflowsoffinancial

    capital(Bayoumi165).Therateofconvertibilityandpriceofgoldwasfixed,and

    underthisfixedsystem,theworldenteredaperiodoftradeandglobalization

    previouslyunmatchedinhistory.Thestabilityofexchangeratesunderthissystem

    ledtotheopennessofthemarketsandbuoyancyoftrade,whichinturnoffered

  • Karczmarczyk 8

    supportwithinthemselvesofthegoldstandard.Therewere,however,pressureson

    theBankofEnglandwiththisincreaseduseoftheirreserveservices.Sameasinthe

    domesticmarket,theinternationalgoldstandardrequiredondemandpaymentto

    depositors.AsBanknoteswerentlegaltenderinthisnewfoundinternational

    exchange,goldhadtobeexportedifsodesiredbythedepositor.Increasesinthe

    rateofinterestbroughtaboutbyincreasesintheBankratewereusedtoattract

    moneytoLondonandtopreventadrainofEnglishreserves(Dillard379).

    InstabilityandFailure

    Theoperationofthegoldstandardsystemrestedoncentralbanksoverriding

    commitmenttothemaintenanceofexternalconvertibility(Eichengreen34).There

    was,however,akeyproblemwiththis.Notallcountrieshadestablishedcentral

    banks.EvenintheUnitedStatesFederalReservewasntestablisheduntil1913.This

    resultedfrequentlyincountriesbeingforcedtosuspendgoldconvertibilitytoallow

    theircurrenciestodepreciateproperly.Yetthiswasjustoneissue.

    Thebiggesttensionandpressureassociatedwiththegoldstandardwasthat

    oftheroleoftheBankofEngland.Aspreviouslymentioned,theBankofEngland

    wasoperatingasthestewardofthegoldstandard,andthusBritishparticipationin

    thesystemwascritical.Itisntcoincidentalthatontwoseparateoccasions,1890

    and1907,Britainreceivedforeignsupportwhenfacedwithinconvertibility.Yetby

    theturnofthecentury,Britainsrolewasbeingunderminedbythemorerapid

    paceofeconomicgrowthandfinancialdevelopmentinothercountries

  • Karczmarczyk 9

    (Eichengreen42).LessofitslendingreturnedtoLondonintheformofforeign

    deposits.

    Ultimately,noneoftheseissuesresultedinthedeathofthegoldstandard

    despitetheirincreasinglyworrisomepossibilities.InJulyof1914WorldWarIbroke

    out,andwhenEuropebecameentrenchedinthewar,goldexportsweresuspended

    inordertopreventtheflightofgold[and]moreover,theenormousincreasesin

    thequantityofpapercurrencyandbankcreditmadeimpossibletheirfree

    convertibilityintogold(Dillard510).TherealityofWorldWarIwasacomplete

    shutdownininternationaltradeandtheendofthegoldstandard.

    TheInterwarPeriod(19191939)

    Theevolutionofourmodernpoliticalsystemhasamarkeddiscontinuityduetothe

    outbreakofwarin1914.Inanefforttobeconcise,Iwillnotdiscusstheeconomics

    oftheactualwar,asitisbeyondthescopeofthispaper.Instead,Iwillmoveon

    directlytotheInterwarPeriod,whichcanbedividedintofourdistincttimes:

    RecoveryandReparations(19191925),theBoom(19251929),theCollapse

    (19291933),andStruggledRecovery(19331939).

    RecoveryandReparations(19191925)

    Reparationpayments,territorialchanges,hyperinflation,andadesiretoreturnto

    goldcharacterizedtherealityofthistimeperiod.IntheArmisticeConventionsigned

    onNovember11,1918,itwasagreedthatGermanywastopayreparationtothe

    victoriousAllies(Kindleberger290).Theamountofsuchreparationswasleft

  • Karczmarczyk 10

    undecided,butGermanywasforcedtosignthetreaty,takingonanyandall

    responsibilityforthewar.Itwasgenerallyagreeduponatthistimethatsince

    Germanywasresponsibleforthewar,theyshouldberesponsibleafterthewar,

    meaningthattheywouldberequiredtopayforit.Becauseofextremedifferencesof

    opinionontheAlliedsideabouthowmuchthisshouldbe,aspecialReparations

    Commissionwascalledupon.InApril1921,theReparationsCommissionfixedan

    amountof132billiongoldmarksplus26percentinexporttaxesoveraperiodof

    fortytwoyears(Kindleberger290).Germanswerenthappywiththisarrangement

    asitwas,butgiventheirrelativepositionintheworldatthistime,therewaslittle

    thattheycouldsay.ThewilltopayonthesideofGermanywasweak,andattimes,

    completelymissing.

    TerritorialChanges.Typically,economicrelationsarenotbasedonsuch

    internationalrelationsissuesasterritorychanges.TheaftermathofWorldWarI

    wasanexception.Germanylostapproximatelyonethirdofitscoalresources,

    locatedinthekeyareaoftheSaarandUpperSilesia(Dillard511).France,underthe

    provisionsontheVersaillesTreaty,hadtakenoverthisareapostwarinorderto

    providecoaltoproducesteelintheLorraine,anareatakenbyGermansduringthe

    war.Additionally,GermanywasobligatedundertheTreatytosupplyadditionalcoal

    toFrancetocompensateforthewardamagetocoalmines(Dillard511).Thiswas

    partofthegeneralreparationsthatGermanywastopay,buttheremainingcoalleft

    aftersuchrepaymentswasntenoughtosupplyGermanysrebuildingeffortsand

    postwarindustry.CoalwasnttheonlyresourcethatGermanyoncehadbutnow

    lacked.TheLorrainewasalsorichinironore.Thesepostwarchangeshadinterfered

  • Karczmarczyk 11

    withtheproductionsystem,andtheresultwasdisorganizationandlossofefficiency

    intheEuropeansteelindustry.

    InJanuary1922,GermanscalledforaconferenceinCannestodiscussa

    potentialmoratoriumandtoreopenthereparationquestion.Britainhadbeen

    pushingforarevisedandreducedschedule,largelyinfluencebyKeynes,and

    openedtheconferenceupfortheideaofaninternationalloantoGermany.InApril

    theReparationsCommissionmettofurtherexplorethispossibility,butinJune,the

    committeedecidedthatgiventhereparationschedule,Germanyscreditwasnot

    sufficientlyhightojustifyaninternationalloan(Kindleberger293).

    Hyperinflation.Latethatsummerandintothefollowingfall,Germanys

    reparationpaymentsfellcompletelyoffschedule.Germanshadnowayofmeeting

    thedemandsplaceduponthem.Theywerelackingterritory,andevenmore,the

    FrenchdidntwantthecompetitionofGermanworkerstakingjobsawayfrom

    domesticworkersintheirreconstructionefforts(Mayhew1).Thesituation

    worsened.FrenchandBelgiantroopsweresenttooccupytheRuhrinanattemptto

    enforcereparationpaymentdelivery.ThisresultedonlyinastrikeofGerman

    workers,andinanefforttoaidtheseworkers,theGermangovernmentsimply

    beganprintingmoremoney.Averagewholesalepricesrosefromanindexof1,400

    (wherepricesweremeasuredas100in1913)to126,000,000,000,000inDecember

    of1923(Mayhew1).Themarkwasrenderedworthlessandwasreplacedin

    November(aftergreatdamagetothemiddleclass)bytheRentenmark,anentirely

  • Karczmarczyk 12

    newcurrency.TheGermangovernmentalsoraisedtaxesatthistime.The

    RentenmarkwasthenlaterreplacedbytheReichsmarkwiththeDawesPlan.

    TheDawesPlan,createdbyaninternationalcommitteeofbothmoderates

    andextremists,waskeyforGermany.AnnouncedinApril1924,itcreateda

    reparationschedulebeginningwith1billiongoldmarksforthefirstyear,2.5

    billioninthefifth[and]providedroomforchangesifgoldpricesmovedupor

    downby10percent(Kindleberger294).Theprovisionsincludedbotha

    ReparationsAgency,establishedinBerlintooverseefinances,andareorganization

    oftheReichsmark.Finally,andmostimportantly,theDawesPlancreateda

    provisionthatallowed800Reichsmarktobesoldonvariousmarkets.Despite

    protestsonthesideoftheFrench,thegovernmentsofbothFranceandBelgium

    appliedheavypressuretoprivatebankerstohavethemhandlethesharesofthe

    loan.Forawhile,thissolutionseemedtowork,andGermanywasabletomakeits

    paymentsonschedule.

    Asitturnsout,thiswasadeceptivereality.Americanprivateinvestors,

    particularlyoutofNewYorkCity,hadbeenmakinglargedollarloanstoGermany.It

    wasthesedollarsthatwereusedtomakereparationpayments,whichtheAlliesin

    turnusedtomakewardebtpayments(Dillard520).Wardebtswereincurredfor

    assistanceandforshipmentfromtheU.S.ofgrain,cotton,andothersuppliesduring

    thewar(Mayhew2).TheAmericansinsistedonthese,notfromGermany,butfrom

    theAlliedforces.TheAmericangovernmenthad,however,madeitabundantlyclear

    thattheydidntwishtoreceiverepaymentintheformofgoodsbyinstituting

  • Karczmarczyk 13

    ridiculouslyhightariffs.Withthiscycleofloansandwardebtpayments,theUnited

    Stateswasessentiallypayingitself.

    ReturntoGold.Duringthisinterwarperiod,thegoldstandardhadbeenlargely

    abandonedwithonlyUnitedStatesandafewothersmallcountriesstillmaintaining

    it.Thereasonforthisisthatcrucialaspectofthegoldstandardnolongerexisted:

    moneywasnolongerexchangeableintogold.However,therewasstillastrong

    desiretoreturntotheprewarsystemduelargelytothefactthatithadfacilitated

    largeamountsofinternationaltradeandglobalization.Sobetween1923and1928

    morethanthirtynationsrestoredthegoldstandardinsomeform(Dillard538).

    Thegreatestdecisionconcerningthis,however,wasnotwhethertorestore

    thegoldstandard,butratheratwhatleveltosetit.InGreatBritainthisdebates

    existedoverwhethertheyshouldfixthepoundsterlingtoitsprewargoldcontent

    orattheexistingpostwarvalueinrelationtoothercurrencies(Dillard538).

    EventuallyitwasdecidedthatBritainwouldreturntothegoldstandardatthe

    prewarlevel.Theyweretodothisbypermittingfreeexportofgoldbullionafter

    April1,1925.Yetwhenthisdecisionwasmade,thepoundwasnowhereasstrong

    asithadbeenintheprewaryears.Prewar,thepoundwasvaluedat$4.40,butin

    thisinterwarperiod,itwasaround$4.87(Dillard538).Toreturntogoldmeantthat

    thepoundwouldhavetoappreciate,andsotorestoretheparratiobetweenthe

    dollarandpoundmeantthatpricesneededtoeitherriseintheUSorfallinthe

    UnitedKingdom.GiventhestabilityoftheUnitedStatesinthepostWWItime

  • Karczmarczyk 14

    period,thisfelltoBritain.Essentially,inordertomakethegoldstandardwork,

    GreatBritainwouldhavetodeflateitspricelevels.

    TheBritishwereencouragedtothenrelymoreheavilyonimportsasthe

    Britishpoundsterlingwouldnowbuy10percentabroadmorethanbeforeandvery

    littlemoreathome(Dillard539).Thisledtoanadversebalanceoftrade,but

    meetingthisadversebalancebypermittinggoldtobeexportedwasundesirabledue

    tothelowlevelsofgold.SotheBankofEnglandthenoptedtoincreasethebankrate

    inordertoattractloanstoBritaintocoverthedeficitinthebalanceofpayments

    (Dillard539).Thisultimatelyledtohousingshortages,unemployment,andlittle

    construction.TheBritisheconomydidnotenjoytheexpansionofproductionthat

    tookplaceelsewhere(Mayhew3).

    TheBoom(19251929)

    Withmostcountriesnoweitheronthegoldstandardormovingtowardsit,

    normalcyseemedtoberestored.Butthistimewasnotwithoutitstensions.Inthe

    timebeforetheWorldWar,Londonhadbeenthecenterofthefinancialworld,and

    theBankofEnglandwasthelenderoflastresort.Duringthe1920s,however,

    Europebecameunabletofunctionastheworldsbanker.Britainhadcontinual

    difficultyofmaintainingthepoundat$4.87whilehighinterestandunemployment

    ratespersisted.Importanttonoteisatthesametimeofthisovervaluationofthe

    pound,therewasanunderevaluationoftheFrenchfranc,whichhadledtoapileup

    ofsterlingintheFrenchmonetarysystem(Kindleberger354).

  • Karczmarczyk 15

    RoleoftheUnitedStates.Inlightofthis,theUnitedStatessteppedinto

    replaceBritainastheworldsbankerbyofferinglongtermloans.Americanbanks

    lentinverylargesumsandtheseloansledtoahighdependencylevelofEuropeon

    theUnitedStates.Atthesametime,however,Americaneconomicpolicyplaced

    majorobstaclesinthewayofrepaymentofloans(Dillard541).Havingbeenin

    suchalargecreditorrole,theUnitedStatesshouldhaveincreaseditsimportsin

    orderforforeignerstohavetheopportunitytoearndollarswithwhichtheycould

    thenservicetheirdebt.Loweringtariffswouldhavedonethis.TheUnitedStates,

    however,didjusttheopposite.Inboth1922and1930,tariffsreachedtheirhighest

    pointinhistory.Thoseforeignerswhohadreceivedloanspaidtheinterestontheir

    debtstemporarilyoutoffurtherloansratherthanfromincreasedproductivity

    (Dillard541).

    Theboom,however,existedbecauseofanddependedlargelyuponthe

    UnitedStates,whoseeconomywasbeginningtoshowsignsofweakening.

    Consumerbuyingwasslowing,debtreacheditshighestlevelyetseen,and

    constructionslowedconsiderablyasthedemandofnewhousingevaporated

    (Mayhew4).Theseconditionsontopofthehightariffsputtheportionoftheworld

    thatdependedontheUnitedStates(whichatthetimewasaconsiderableamount)

    inaprecarioussituation.

    Reparations.Reparationswerealsobecomingincreasinglyworrisomeduring

    thistime.Theywerebeingfinancedbyborrowing,buttheyremaineddifficultto

    maintain.Germanyinparticularwasbeginningtocrackunderthestrain.Inorderto

  • Karczmarczyk 16

    meettheimmenseobligationsofthereparationagreements,Germanywouldhave

    to(1)builduptremendouslyitsindustrialproductivecapacity;(2)haveexportsin

    excessofimportsbyatleasttheamountofreparations;(3)disposeofthehuge

    exportsurpluseitherdirectlytotheAlliesorsellincompetitiveworldmarkets;(4)

    keepdomesticconsumptionfarbelowdomesticproductionforseveralgenerations

    byheavytaxation(Dillard517).Eachoftheseprovedtobeultimatelyimpossible,

    anditwasntlonguntilGermanywasnolongerwillingtoproducegreatsurplus

    wealthforthebenefitoftheirvictoriousenemieswhiletheGermanstruggledator

    nearsubsistence(Dillard519).Thesedeterioratingconditionsledtotensionsthat

    wouldultimatelyresultinacollapse.

    Primaryproductinventories.Asafinalnote,Europeanrecoveryinthe

    productionofprimaryproducts,suchasgrain,hadledtopricestoturnsoftas

    earlyas1925(Kindleberger355).Thismeansthatasinventoriesofsuchproducts

    begantogrow,pricesbegantofall.Theconsequencesofthishadthegreatest

    ramificationsincountriessuchasAustraliaandNewZealandwhodependedon

    exportoftheseproductsandforagriculturalregionsoftheUS.Essentially,theworld

    hadmorecapacitytogrowfoodthanithadcapacitytobuyfood(Mayhew4).

    TheCollapse(19291933)

    Thetensionsduringtheboomperiodwererealizedwhenin1928foreign

    lendingfromtheU.S.begantodrop.Schachtscampaign,anattemptagainstGerman

    borrowinginNewYork,resultedinaswitchtoshorttermloans.Depressionin

    Germanyhadstartedalittleearlier(around1927)andthehigherinterestrates

  • Karczmarczyk 17

    necessarytoattractshorttermfundspushedproductionstilllower(Kindleberger

    355).Unemploymentroseexponentially,andtheFrankfurtInsuranceCompany

    failedinAugust1929.IntheUnitedStates,thestockmarket,despitetheFedsbest

    efforts,begantorise.Inanefforttocombatthis,theFedraisedthediscountrate.

    ThisWallStreetboominU.S.stocksledtostillafurtherdropinlongtermlending.

    Aroundthesametime,theBankofFrancepulledgoldoutofLondondueto

    irritationovertheYoungPlan,whichinturnresultedinatightersituationinBritain.

    TheBankofEnglandraiseditsdiscountratefrom5percentto6percenton

    September26,1929.ThisledtopressureinScandinaviawherediscountrateswere

    alsoraisedinanefforttokeepinlinewithBritain.Therewasacertainworryatthis

    pointthatGreatBritainwouldbeforcedoffthegoldstandard,butsuchfearswere

    delayedwiththestockmarketcrashonOctober24andthesubsequentBlack

    TuesdayonOctober29(Kindleberger355).

    DeclineinProduction.Bymid1929productionofgoodsandservicesbegan

    tofallsharplyworldwide(Mayhew5).Itbecameincreasinglydifficulttonegotiate

    thetermsonwhichgoodscouldbeconvertedintomoney,andsoonlossesreplaced

    profits,meaningthatattheendofaturnoverofcapitaltheproducershadless

    moneythanatthestartoftheturnoverperiod(Dillard543).Thegoalbecameto

    conserve,notexpand,andgoodswhichcouldnolongerbeconvertedeasilyto

    moneybecameworthless,atleasttothecapitalisticnotionsofthistime.Thisidea

    playedoutinternationallyintheformofgold.Creditwasnolongeraworthy

    substituteofmoney,andthusproductionhaltedinanefforttokeepgoldcloseto

    home.Thisledtohugedeclinesinproductionandinemployment.Asthecycle

  • Karczmarczyk 18

    continued,thesituationworsened.Considerthefollowingchart(whichassumesa

    standardproductionof100for1929):

    Mayhew,Anne.NotesontheInterwarEconomiesofWesternEurope.

    DeparturefromtheGoldStandard.AslongtermAmericanloansendedand

    internationaltradefell,debtornationssoughttoborrowshorttermathighinterest

    ratesinanefforttocovertheirdeficits.Suchactionsmighthavebeensuccessfulif

    thedepressionhadendedsoonthereafter,butwiththecontinuationofsuchadeep

    depression,thehighinterestratesonshorttermloansjustdrovethedepression

    deeper.

    PanicreachednewlevelsintheworldmoneymarketsinMay1931whenthe

    largestbankinAustriacrashedduetothebadloanstheyhadmadetothe

    agriculturalregionsofcentralEurope.Thisinturncausedacompletelackof

    confidence,andmoneymarketsbegantocrashallovertheworld.London,New

    0

    20

    40

    60

    80

    100

    120

    U.K. France Germany U.S.A.

    1929

    1932

  • Karczmarczyk 19

    York,andBerlinwereamongthem.Priortothiscrash,itisimportanttonotethat

    duringtheearlymonthsof1931,theReichsbankhadlostninetenthsofitsgold

    reserve,whichhadresultedinseveralGermanbanksclosureandadiscountrateof

    15percent(Dillard542).Germanyundernormalcircumstanceswouldhavegone

    offthegoldstandardandallowedthecurrencytoreachitsnaturallevelin

    internationalexchanges,buttherecenthyperinflationkeptthispolitically

    impossible.Instead,Germanysuspendedallforeignpaymentsandimposedrigid

    exchangecontrols(Dillard542).

    SuspensionofpaymentsinGermanyhadramificationsinBritain,where

    Britishcreditswerenowfrozenanduncollectable.DepositorsoftheBankof

    Englandbecamealarmedandbegantowithdrawheavily,despitetheBankof

    Englandseffortsinraisingthediscountrate.Ultimately,theylostmorethan200

    millionpoundswithinjusttwomonthsofGermanysforeignpaymentsuspension

    (Dillard543).ThefinalblowcameonSeptember20,1931,afteraweeklonggold

    rushwheregoldreservesdroppedtodangerouslevels.TheBankofEngland

    decidedtosuspendgoldpayments,andofficiallytooktheUnitedKingdomoffofthe

    goldstandard.Reparationshadalsostoppedentirely.

    ReactionandRecovery(19331939)

    Manycountriesquicklyfollowedsuitandtookthemselvesoffofthegoldstandard.

    By1932,thirtyfivecountrieshadcomeoffofthegoldstandard,eachwithdifferent

    results.IntheUnitedKingdom,therewasasighofrelief.Theyenteredaperiodof

    milddomesticinflation,increasedemployment,andrisingbusinessexpectations

  • Karczmarczyk 20

    (Dillard544).Ofthelargenations,onlyFranceandtheUnitedStatesattemptedto

    stayongold,andthey,inturn,sufferedforit.FrenchandAmericanexportersfound

    thatnoonewantedtobuytheirgoodsbecausetheircurrencywasvaluedmuch

    higherthanothers,andwhentheyfuthererectedhightariffsandimportquotas,

    theysealedthemselvesofffromworldtrade.Theyimposedonthemselves

    continuingdeflationofdomesticpricestotheaccompanimentofrising

    unemploymentandstilldeeperdepression(Dillard544).

    TheUnitedStatesfaceddeeperproblemsstillwhenforeignwithdrawals

    coupledwithincreasingdomesticdemandforgoldcausedagoldcrisisduetothe

    lackofcredit(Dillard544).Bankrunsbecameincreasinglymorecommon,andin

    turn,thehoardingofgoldledtoaliquiditycrisis.Whenmorethan5000banksfailed

    intwoyears,theUnitedStatestemporarilyclosedallbanksinMarchof1933.Soon

    thereafter,theU.S.suspendedgoldandwasforcedoffthegoldstandard.France

    collapsedsoonafterward,anactionwhichwouldresultinadecadeofmoderately

    inefficiencyonthepartoftheFrenchgovernment.SowithFranceandtheUnited

    Statesnowofficiallyoffgold,thegoldstandardandinternationaltradecrumpled.

    AroundthistimetheNazis,however,werebeginninganactiveprogramof

    recoverytoadepressedaGermany.Theunemployedwereputtoworkbuildingup

    domesticinfrastructure.UnderthesecondFourYearPlan,beginningin1937,

    rearmamentbecamethemostimportantaspectofGermanpolicy.By1938,

    Germanysindustrialproductionhadmorethandoubledits1932output(Dillard

    558).TheeconomyduringWorldWarIIisbeyondthescopeofthispaper,butletit

  • Karczmarczyk 21

    sufficetosaythattheGermansgaveanincredibleeconomicperformanceduringthe

    war.Theaftermath,however,leftEuropeonceagaininruins.

    TheBrettonWoodsEra(19441971)

    Inanefforttokeepthishistoryconcise,Iwillnotbediscussingthewartime

    economy,asitwithinitselfhadnodirecteffectontheevolutionoftheinternational

    monetarysystem.Iwillinsteadmovedirectlytothepostwarperiod,whichbegan

    in1944.TheBrettonWoodsEracanbedividedintothreesubperiods:

    Preconvertibility(19441958),thePrimeYears(19591967),andtheCollapse

    (19681971).Beforeexploringeachofthese,Iwillfirstdiscussthevisionofthe

    architectsofBrettonWoods,asitisatellingstatementofthementalityofthe

    period.

    TheVisionoftheBrettonWoodsArchitects

    Thesituationdirectlyfollowingthewarandtheexperienceoftheprevious

    monetarytimeshadadirecteffectontheideasaboutanewinternationalmonetary

    order.TheoriginalgoaloftheBrettonWoodssystemwastocombinethe

    advantagesoftheclassicalgoldstandardwiththeadvantagesoffloatingrates.At

    thesametime,theplanningofanewinternationalorderwaspredicatedonthe

    beliefthatthemistakesoftheinterwarperiodweretobeavoided.Europewasalso

    strugglingwiththerecoveryfromthedevastationofthewar,andhavingjustcome

    offatimeoftwoworldwars,theinternationalcommunitysoughtasystemthat

    wouldpromotepeaceandinterdependence.

  • Karczmarczyk 22

    WorldWarIIresultedinpowershiftsthatinturnslanteddiscussionsofthe

    creationofanewsystem.TheUnitedStateshademergedfromthewarasthe

    strongestandrichestpowerintheworld,butGreatBritainhadbeenseverely

    weakened(Bordo31).Againstthebackdropofwartimediplomaticnegotiations,

    thesetwocountriesagreedtobeofassistancetoeachotherinthepostwarworld.

    JohnMaynardKeynesoftheBritishTreasuryandHarryDexterWhiteofthe

    AmericanFederalReserveeachdraftedtwoplansofwhattheybelievedthepost

    wareconomyshouldlooklike.Acompromisebetweenthesetwoplans,followinga

    periodoftoughnegotiations,ledtotheJointStatementbyExpertsonthe

    EstablishmentofanInternationalMonetaryFund,whichinturnservedasthe

    workingdraftattheBrettonWoodsconferenceandleddirectlytotheArticlesof

    AgreementoftheInternationalMonetaryFund.AlongwiththeIMF,BrettonWoods

    alsocreatedtheWorldBank.

    TheArticlesofAgreement.TheArticlesofAgreementwasacompromiseand

    incorporatedaspectsofbothplans,butultimately,duetoitsnewworldpower

    status,theUnitedStatesdominatedtheconcerns.Theobjectivesofthefundwere

    topromoteinternationalmonetarycooperation,tofacilitatethemaintenanceoffull

    employmentandrapidgrowth,toproveamultilateralpaymentssystemand

    eliminateexchangerestrictions,toprovideresourcestomeetbalanceofpayments

    disequilibria,andtoshortenthedurationandlessenthedegreeofpayments

    disequilibria(Bordo35).

  • Karczmarczyk 23

    Themethodthatthissystemwastoworkwasthreefold.First,allcurrencies

    weretobetreatedasequalinthearticles.Ideally,eachcountrywasrequiredto

    maintainitsparvaluebyinterveninginthecurrencyofeveryothercurrency,butin

    reality,theUnitedStateswastheonlycountrythatpeggeditscurrency(intermsof

    gold).Theotherssimplyfixedtheircurrencyintermsofthedollarandintervened

    onlytokeeptheirexchangerateswithin1%ofparitywiththedollar(Bordo37).

    Second,countrieswouldusetheirreservesordrawreservesfromtheFundto

    financepaymentsdeficits.Third,capitalcontrolswererequiredtoprevent

    destabilizingspeculationfromforcingmembertoaltertheirparitiesprematurelyor

    unintentionally(Bordo37).Intheend,however,thegoalsofBrettonWoodsrealin

    manywaysnotrealized,andtheinternationalmonetarysystemevolvedintoagold

    dollarstandard.

    Preconvertibility(19461958)

    Reparations,whichwereoneofthemostdifficultproblemsinpostWWI,were

    mostlyeliminatedafterWorldWarII(Kindleberger413).Yetevenstillthe

    transitiontofullconvertibilitywasmuchmoredifficultthanhadbeenpreviously

    thought.Thiscanbeattributedinitiallytotwointerrelatedproblems:bilateralism

    andthedollarshortage.

    Bilateralism.Duringthewar,manycountrieshadutilizedasystemof

    exchangecontrols,whichwasatechniqueusedtoregulateinternationaltradeand

    capitalmovements.Governmentswouldrequiresuchactionsasrequiringexporters

    tosurrendertheforeignmoneyreceivedfromsalesabroadandrequiringimporters

  • Karczmarczyk 24

    topurchaseforeignexchangefromauthorizedbanks(Dillard546).Suchcontrols

    tendedtopromotebilateralarrangementsinforeigntrade.Themottowasifwe

    buyfromyou,youmustagreetobuyfromus(Dillard547).NearlyallEuropean

    countriesusedthissystem.

    Withthecreationofanewinternationalorder,thegoalwastoeventually

    eliminatethese.UnderArticleXIVoftheBrettonWoodsagreement,countriescould

    continuetouseexchangecontrolsforanindefinitetransitionperiodafterthe

    establishmentoftheIMFof1March1947(Bordo38).Therationalegivenfor

    continuingtheseduringthistransitionperiodwastheshortageofinternational

    reserves.Controlswereneededtoallocateashortageofbothimportsandexports.

    AsianandEuropeaneconomieswereinruinsafterthewar,andinordertoincrease

    theirexportcapabilities,theyneedednewandimprovedcapital.Atthesametime,

    therewasashortageofimportsineverythingfromcapitalequipmenttothe

    necessitiesoflife(i.e.food).Thebilateralagreementshelpedcreateatemporary

    systemoflicensesandquotasforimportsandexportsthroughthecentralbank.

    TheDollarShortage.Europespostwarbalanceofpaymentscrisiscame

    aboutduetothebreakdownoftheinternationalfinancialsystem.Reasonsinclude

    thestrengthoftheUnitedStates,theEuropeanliquidationofforeigninvestments

    earlyinthewar,thecutofftoEuropeschiefsourceofprewardollarsupplyin

    southeastAsia,increasesinpopulationinunderdevelopedareas,theriseofpricesof

    theprimaryproductimportedrelativetopricesofthemanufacturedgoods

    exported,andthesplitbetweenEasternandWesternEurope(Dillard657648).The

  • Karczmarczyk 25

    shortenedversionbeingthatEuropehadforyearsbeendependentuponexternal

    marketsforexportsandforeignsourcesofsupplyforfoodandrawmaterials,andit

    wasarguedthatthebalanceofpaymentsdeficitsfacingmostcountriesreflectedthe

    incapacityoftheirexportindustries(Dillard645).Sinceatthistime,theUnited

    Statesheldtwothirdsoftheworldsmonetarygoldstock,theysuppliedtheneeded

    imports(Bordo38).TheIMFwasalsopressuringmemberstodeclareparvalues.

    Manybelievedthissituationtobepermanentduetothelargeamountofreservesin

    theUnitedStatesandthedepletedamountinEurope.Suchargumentswerebased

    ontheideathatEuropewouldneverreachtherateofproductivityofthatofthe

    UnitedStates.

    SuchasituationwasnotpreferableforeitherEuropeortheUnitedStates.In

    ordertoachieveastronginternationalsystemandrestoreEuropesequilibriumin

    internationalpayments,theUnitedStatesimplementedtheMarshallPlan.Shortly

    thereafter,aEuropeanPaymentsUnionwasformed,dollarconvertibilitywas

    restored,andthedollarbecamethekeycurrency.

    TheMarshallPlan.InanefforttoaidEurope,theAmericanSecretaryofState,

    GeorgeC.Marshall,proposedaboldplantorestoreEuropesequilibriumthrough

    massiveAmericanfinancingandintraEuropeanplanning(Dillard648).All

    Europeannations,withtheexceptionofGermanyandSpain,wereinvitedtojointhe

    conference,atwhichthelogisticsoftheplanwouldbeworkedout.Itwaswell

    receivedinWesternEurope,butinEasternEurope,theysnubbedtheidea,largely

    duetoSovietinfluence.Thus,itbecameawesternEuropeanRecoveryPlan,whose

  • Karczmarczyk 26

    maingoalwastocoordinatetherecoveryeffortsofseventeencountriesand

    financetheirdollarneeds(Dillard649).

    TheUnitedStatespassedtheEconomicCooperationActof1948,which

    officiallycreatedtheMarshallPlan.Inordertoadministertheplanfromthe

    Americanside,theEconomicCooperationAdministration(ECA)wascreated.The

    MarshallPlanchanneledabout$13billioninaidtoWesternEuropebetween1948

    and1952(Bordo41).Thiswasconsiderablylessthantheprojectedoutlaysof17

    billion(Dillard649).ItspurposewastohelptheEuropeancountriesexpandtheir

    economies,restoretheirexportcapacity,andbycreatingeconomicstability,

    preservepoliticalstability(Bordo41).Itrequiredthatallparticipantscooperatein

    tradeandpaymentliberalization.

    Thus,aEuropeancounterparttotheECAwasneeded,andinresponsetothis

    needtheOrganizationforEuropeanEconomicCooperation(OEEC)wascreated.Its

    responsibilitywastocreateaprogramforachievingabalanceofinternational

    paymentswithinthefouryearsallocatedintheMarshallPlan(Dillard649).It

    managedtheallocationoftheborrowedmoniestotheindividualnations,whichwas

    donebasedonsizeoftheiraccountdeficits.Therecipientswererequiredtothen

    matchthefundsintheirlocalcurrencytohelpinproductivityinvestmentin

    infrastructure,industry,andagriculture.Asafinaloverarchinggoal,theOEECtried

    topromoteeconomicinterdependencewithinWesternEurope,anideathatwould

    takeonmorecreditatalaterdate.TheEPUwasalsocreatedontheEuropeanside,

    whichisanorganizationIwilldiscussinmoredetaillater.

  • Karczmarczyk 27

    TheMarshallPlanwasincrediblysuccessfulinaveryshortamountoftime.

    By1952,theOEECcountrieshadachieveda39%increaseinindustrialproduction,

    adoublingofexports,anincreaseinimportsbyonethird,andacurrentaccount

    surplus(Bordo42).ThechartbelowshowsindustrialrecoveryinWesternEurope

    from1938until1950.Itstartsatbasepoint100.

    COUNTRY 1938 1947 1948 1949 1950

    Belgium 100 106 114 116 120

    France 100 92 108 118 121

    Germany,West 100 33 50 75 96

    Italy 100 86 91 96 109

    Netherlands 100 95 113 127 139

    UnitedKingdom 100 115 128 137 150

    Average 100 88 101 111 122

    Dillard,Dudley.IndustrialRecoveryinWesternEurope.

    EuropeanPaymentsUnion.EuroperespondedtotheECArequirementofthe

    liberalizationoftradebycreatingtheEuropeanPaymentsUnion(EPU)in

    September1950.Itspurposewastosimplifybilateralclearingandmovetowards

    multilateralism,whichitdidbyactingthepartofacommercialbankclearinghouse.

    Meaningthatitprovidedeachmembercountrywithonlyonesinglenetcreditor

  • Karczmarczyk 28

    debitwiththeEPU.CreditsearnedbysellingtooneEuropeanmemberoftheEPU

    couldoffsetdebitsincurredinbuyingfromsomeothermember(Dillard649).The

    formeroperationofbilateralagreementswassuppressed,asitdoesntfunctionas

    wellwithaneconomicalallocationofresources.TheECAcontributed$350million

    totheEPUtobeusedforinitialworkingcapital.

    TheEPUwasincrediblysuccessfulandsoonbecamethecenterofa

    worldwidemultilateralsettlementarea(Bordo43).Italsoprovidedthemiddle

    steptowardcurrencyconvertibility.Europeancurrencyatthistimewasnoteasily

    transferrableintodollarduetothepersistentdollarshortage.Sowhilethis

    organizationfosteredintraEuropeantrade,internationalworldtrade,particularly

    withthosenationspeggedtothedollar,wasdifficult.

    RestoringConvertibilityandtheRiseoftheDollar.Depreciationofthepound

    sterling,theDeutschemark,andseveralothercurrenciesagainstthedollarin

    September1949helpedmanyEuropeancurrenciesmovetowardsconvertibility.At

    theendofthe1950s,thefinalstepwastaken.PresidentCharlesdeGaulle(France)

    depreciatedthefrancandshiftedtothenewfranc(Kindleberger430).Britain

    tookthisopportunitytorestorethepoundtoconvertibility.OnDecember27,1958,

    eightcountriesdeclaredtheircurrenciesconvertibleforaccounttransactions

    (Bordo43).Withthisnewconvertibility,theEPUwasnolongeruseful,andthe

    EuropeanMonetaryArrangementwouldsoonreplacetheEPUasameansof

    currencyconsultation.

  • Karczmarczyk 29

    Sowiththis,thedollarbecamethecurrencyofchoice,anditwasfrequently

    thoughtthatthedollarwasasgoodasgold.Theriseofthedollarcanbeattributed

    tothesizeoftheroleoftheUnitedStatesinthisnewworldeconomy,itsimportance

    inworldtrade,anditsopencapitalmarkets(Bordo47).Thedollarwastheofficial

    internationalmoneyofthistime,anditsimportanttonotethesimilaritiesbetween

    thisandthegoldstandard.Insteadofpeggingcurrenciestogold,countriespegged

    themtothedollar,anditwasnolongerGreatBritainasthefinancialcenterofthe

    world,buttheUnitedStates.Thesekeypointsareimportanttorememberandwill

    shapetheremainderofthehistoryoftheinternationalmonetarysystem.Itisalso

    importanttonotethattheoriginalvisionofthearchitectsattheBrettonWoods

    Conferencewasnotmet.TheoriginalroleoftheIMFhadbeen,inmanyways,

    replacedbytheEPU.Withconvertibilityrestored,however,thesystemseemedto

    beoperatingsmoothly.

    ThePrimeYears(19591967)

    OneofthemostimportanteventstohappenduringtheprimeyearsofBretton

    WoodswastheeconomicintegrationofEurope.Additionally,therewasaseriesof

    issues,whichwouldleadtoanevenfurtherdeviationfromtheoriginalgoalsofthe

    BrettonWoodsarchitects.Thesewereadjustment,liquidity,andconfidence.Inthis

    section,IwillfirstexplorethebeginningsofEuropeaneconomicintegration,and

    thenmovetodiscusstheseproblemsthatplaguedthisheydayera.

    EuropeanIntegrationundertheCommonMarket.TheideaofEuropean

    integrationhadbeenaroundformanyyears,butwiththenewpoliticalspheresafter

  • Karczmarczyk 30

    thesecondWorldWar,thepossibilitybecamereality.Themostimportant

    predecessoroftheEuropeanCommonMarketwastheEuropeanCoalandSteel

    Community.Itwasestablishedin1952byFrance,Germany,Italy,Belgium,the

    Netherlands,andLuxembourg.Theobjectivesetforthwasthemostrational

    distributionofproductionatthehighestlevelofproductivity(Dillard654).They

    didsooriginallybyabolishingallcustomsandtradebarriersamongthenations.

    Tariffsatthebordersweremadeuniform,andownershipoffacilitiesinanyofthe

    nationscouldbemadepublicorprivate(Dillard654).Politically,theunionfaced

    difficulties,mostadamantlythatbetweentheoldrivalriesofGermanyandFrance.

    Thesepoliticaldiscoursesarebeyondthescopeofthispaper,butletitsufficetosay

    thattheeconomicintegrationlentapeacetothecountriesthathadyettobe

    experienced.

    ThisexperimentthenledtotheEuropeanEconomicCommunity(EEC),also

    knownastheCommonMarket.ItincludedtheoriginalsixmembersoftheEuropean

    CoalandSteelCommunity,butbroadeneditsscopebeyondcoalandsteel.Themain

    purposesweretheeliminationsofcustoms,duties,andquantitativerestrictionson

    importsandexports;acommonexternaltarifftotherestoftheworld;thefree

    movementofproductionfactorswithinthesixcountries;andageneralclose

    economicintegrationthroughdomesticpolicies,includingagriculture,employment,

    andtaxation(Dillard565).

    TheTreatyofRomesolidifiedtheseeconomicgoals,andwhileitdidnt

    specificallyprovideforpoliticalintegration,itdidprovidethepoliticalinstitutions

  • Karczmarczyk 31

    forimplementingeconomicpolicies.TheseinstitutionsincludetheEuropean

    Commission,aCouncilofMinisters,anAssembly(themoderndayParliament),and

    aCourtofJustice.ThesecreatedthemoderndayBrusselsandhelpedfacilitatea

    laterpoliticalintegration.

    ProblemsofthePrimeYears.Thethreeproblemsofadjustment,liquidity,and

    confidencewereallinterconnected.TheUnitedStateswasnotoverlyconcerned

    withitsbalanceofpaymentsinthe1950s.Thecurrentaccountbalancewaspositive,

    andtheexcessliquidityandlendingoftheearly1950sledtoastrongconfidencein

    thedollarbytheendofthe1950s.Thisconfidence,however,wasbeginningtoebb.

    EconomistsbegantoworrywhatwouldhappenwhentheUnitedStatescorrected

    itsliquiditydeficit.Bythis,theymeanthatintheUnitedStates,noaccountwas

    takenofU.S.shorttermorlongtermclaimsontherestoftheworld.Itwas

    implicitlyassumedthatforeignclaimsonthedollarwerelikelytobeencashed

    momentarily,whileU.S.shorttermassestswereilliquid(Kindleberger453).Thisis

    problematicbecauseunderaliquiditydefinition,theUnitedStateshadbeenina

    balanceofpaymentsdeficitasearlyas1951.

    Manyarguedthattheidealsolutionwasreplacingbothgoldanddollarswith

    SpecialDrawingRightsfromtheIMF.Othersstillarguedthatthisbalanceof

    paymentswasmisleading.Theysaidthatbankingcenterswerenotindeficitwhen

    theylentlongandborrowedshort,providingliquiditytotherestoftheworld

    (Kindleberger453).ThiswouldmeanthattheUnitedStatesitselfwasactingasa

    bankandthatbankswerenotindisequilibriumwhentheirdepositsroseeachyear

  • Karczmarczyk 32

    alongwiththeirloans.Overall,thesewerebothoverlyoptimisticideas.Inorderfor

    thistooperateeffectively,bankswouldneedaparallelriseofreservesalongwith

    theirincreasesinloansanddeposits.

    Giventhelosstheconfidence,thisgolddidntresultinariseofreserves,but

    insteadwassoldtohoarders.Centralbankstookadditionstoreservesandeven,at

    somepoints,wereconvertingthedollarsintogold.CentralbanksacrossEurope,

    andtheworld,withdrewfromthegoldpoolin1960toholddownthepriceofgold.

    TheFrenchgovernmenttookparticularaction.Theyoptedtoconvertdollarsinto

    goldasameansofdiscipliningtheUnitedStates(Kindleberger453).Thisworked

    untiltheyfoundthemselvesindireneedofdollarsasameanstosupportthefranc.

    Yettheywerestillhesitanttosellgoldfordollars,soinsteadtheyundertookofficial

    borrowingofdollarsintheEurobondmarket.

    TheCollapse(19681971)

    IntheUnitedStates,itwasdecidedthattheidealactionwouldbetobreakup

    thegoldpoolandadoptatwotiersystemforgold.Thispermittedtheprivateprice

    toriseabouttheofficial$35.00anounce.Atthesametime,strongforeingpressure

    wasexertedagainstforeigncentralbankchangingdollarsforgold,andanumber

    offinancialinstrumentswithexchangeguaranteesweremadeavailablebytheU.S.

    Treasurytoofficladollarholderstoforestallgoldpurchases(Kindleberger453).

    TheUnitedStateswasfacingaseriouslossofconfidencethatthreatenedto

    underminetheentiresystem.

  • Karczmarczyk 33

    Comparabletothesummerof1931thesmallcountriesofEuropewent

    aheadwiththeconvertingofdollarstogold.ThisinturnledtotheConnollyshockof

    August1971,whichthenledtothesecretaryofthetreasuryimposinga10percent

    importsurtaxinanefforttodevaluethecurrency.TheUnitedStatesfirstraisedthe

    goldpricethento$38.00andthento$42.50,anditalsowideneditspermissiable

    rangeoffluctuationagainstthedollarfrom1.5%to2.25%.

    Errorsinmonetarypolicyandalsotheenormousoutflowofdollarstothe

    Eurocurrencymarketin1970contributedtothebreakdownofBrettonWoodsas

    well.RichardNixonsreelectioncampaignhadhiseconomistsveryanxiousabout

    creatingaprosperouseconomyby1972.Tothisend,theFederalReservesystemin

    1970startedtolowerinterestrates.Thishappenedatthesametime,however,that

    theBundesbankofGermanywasseekingtorestrictinflationinWestGermany.They

    didsobyraisingtheirinterestrate.Thesepolicieswerentseparatedbygeographic

    region,butwereinsteadinterconnectedthroughtheEurodollarmarket.The

    resultingflowofdollarsultimatelylefttheliquiditydefintionbalanceofpayments

    deficitintheUnitedStatesatamuchhigherrate.It,infact,rosefroma$24billion

    ayearaverageinthe1960stoa$20billionin1970anda$30billionin1971

    (Kindleberger454).

    Noneofthemeasurestakencouldcombattheeventsunfolding.The

    confidenceinthedollarhadfallentoanalltimelow.Thesepressureseventually

    causedPresidentNixontoendallgoldconvertabilityonAugust15,1971.This

  • Karczmarczyk 34

    effectivelyendedtheBrettonWoodsera.Severalattemptsweremadetofixthe

    systeminthenextfewyearsbutwithoutanysuccess.

    TheDirtyFloat(1971present)

    Therecentyearshavebeenmarkedbyseverecrisesandunevenmonetary

    policy.Manyofthesespecificsarebeyondthescopeofthispaper,butIwillinstead

    giveabriefoverview.InFebruaryof1973,thecurrencywassetfreetofloat.This

    meansthatnolongerwascurrencypeggedtogold,butinsteadtheexchangerates

    againstothercurrencieswereallowedtobedeterminedbythemarket.Many

    economistsweresurprisedbyitseffects.Manythoughtthatitwoulddothesameas

    ithadinthe1930s,andthatflexibleexchangerateswouldinhibitcapitalflows

    becauseoftheuncertaintyofexchangerisk.Thisturnedouttonotbethecase.Ifone

    neededasubstantialamountofcapital,itwasnecessarytoborrowdollars

    (Kindleberger455).Quantityturnedouttobemoreimportantthanquality.

    Economistsalsothoughthatthefloatingdollarwouldloseitspreeminence

    anditsroleoftheinternationalunitedofaccount,standarddeferredpayment,store

    ofvalue,andmeansofpyaments.Again,thesepredictionswereprovedtobewrong.

    Itwasperhapsnotasstrongasithadbeeninthepast,butintheimmediate

    aftermathoffloatingexchangerates,thedollarstillmaintaineditsrole.TheSDRof

    theIMF,whichwaspreviouslymentioned,neverwasseenassatisfactory

    alternative,andnevergainedanypositionintheinternationalmonetarysystem.

    Atthesametime,however,thisperioddidbeginatimeofseverecrisesand

    monetaryupheaval.ItisimportanttonotethatEuropeandependenceonthedollar

  • Karczmarczyk 35

    hadbeenwellnotedbytheEuropeansafterthecollapseoftheBrettonWoodsera.

    Afterthisseriesofevents,theEuropeanideaofacurrency(theEuro)beganto

    reallyformulate.TheEuropeanMonetarysystemwasbasedlargelyonGerman

    fiscalsense,afactthatwillbecomeincreasinglyimportantinlateryears,andwillbe

    discussedatalaterpoint.

    Itsalsoimportanttonotethatworldbanks,whichwerefullofnewfunds,

    afterthebalanceofpaymentsproblemintheUnitedStates,startedtolookfornew

    opportunitiestolend.Thisinitiatedtheboominsyndicatedbankloanstosovereign

    states,especiallyinLatinAmerica.Theboominlendingwentunnoticedthroughthe

    1970s.Bankerstrustedthatthesedevelopingcountrieswouldnotrepudiateon

    theirloans.ThisawakeningoccurredinAugust1982forthefirsttimewhenMexico

    failedtomakeitsinterestpayment.

    ConclusionsfromtheDirtyFloat.Overalltheinabilityoftheinternational

    monetarysystemtoreconstructasystemofpeggedbutadjustableexchangerates

    failedrepeatedly.Thesourceofthefailurewastheineluctableriseininternational

    capitalmobility,whichmadecurrencypegsmorefragileandperiodicadjustments

    moredifficult(Eichengreen183).Growingnumbersofgovernmentsfound

    themselvesforcedtofloattheircurrenciesduetotheheightenedreluctanceoftheir

    strongcurrencycounterpartstoprovidesupport(Eichengreen183).

    Developingcountriesinparticularhavesuffered.Theyfounditverydifficult

    inthesethinfinancialmarketstoendurethevolatileeffectsofrapidexchangerate

    fluctuations.EvenEuropeandtheUnitedStateshavefelttheeffects.TheEuropean

  • Karczmarczyk 36

    marketeffortswereinterruptedatvarioustimesduetothis.EventheUnitedStates

    andJapantemporarilylostfaithintheabilityofthemarketstodrivetheirbilateral

    exchangeratestoappropriatelevelsintheabsenceofforeignexchangemarket

    intervention(Eichengreen184).Suchdissatisfactionsledtoavarietyofpartial

    measurestolimitcurrencyfluctuations

    TheFluctuationsofthe1990s

    The1990swereahighlyturbulenttimeofglobalimbalancesandfinancialcrises.In

    ordertounderstandthevolatilityoftoday,itisfirstnecessarytounderstandthe

    transitionalperiod.InthissectionIwillbrieflyexaminetheAsianfinancialcrisis

    andtheEuro.Thesesectionswillnotnecessarilybeanhistoricalbackground

    section,butwillinsteadfocusonhowtheydirectlyrelatetheinstabilityofthe

    systemtodayandhighlightitsneedforchange.Afterexaminingthetransitional

    periodofthesetimes,Iwillthenmovetoanentirelynewsection,whichwill

    examinethecurrentsituation.

    TheAsianFinancialCrisis.Asiahadforalongtimeseemedveryinsulatedfromthe

    exchangeratevolatilitythatwasaffectingtherestoftheworld.Stronggovernments,

    capitalcontrols,andrapidgrowthledbyexportskeptconfidencehighintheregion.

    TheremarkablepartofthiscrisisisthattheAsiancrisisoccurreddespitethese

    securities.

    ForeigninvestmentwashighlyfavoredinAsiaduetothisstrongeconomic

    record.YetcapitalwasflowingtotroubledcountrieslikethePhillipines,which

    indicatedthatadditionalfactorswereatplay.Themostimportantofthesewerethe

  • Karczmarczyk 37

    lowinterestratesinthemajorfinancialcenters.Thecostofborrwinginyenfellto

    lowlevelsasaresultofdepressedconditionsinJapan,whileyieldoninvestmentin

    theUnitedStatesweredepressedbyasoaringstockmarket(Eichengreen192).

    Investorsturnedtotheseemergingmarketsasameansofreliefbyborrowingin

    yenanddollarstoinvestinsuchhighyieldingAsiansecuritiesasthecarrytrade.Its

    importanttonotethatbankswereusedasaninstrumentofeconomicdevelopment

    inAsiaatthistime.Foreigninvestorsusedthistotheiradvantageandlent

    extensivelytoAsianbanks,allthetimebelievingthattheywouldnotbeallowedto

    fail.Theimportantthingtotakeawayhereisthatnotforthefirsttime,global

    conditionshelpedsetthestageforproblems.

    Theareawasalsoplaguedwithaninconsistencyofcapitalaccountpolicy,

    exchangeratepolicy,andpoliticalinstability.Theregionhadlargeand

    unmanageablecapitalflowsandrelaxedbankingregulations.Atthesametime,

    governmentsalsoopenedthecapitalaccountbeforemovingtoamoreflexible

    exchangerate.Economictheoryandhistoryitselfdictatesagainstthis.

    Againstthisbackdropthecrisishitwithaseriesofshocks.Itbeganin

    ThailandwiththefinancialcollapseoftheThaibaht.Thiswascausedbythe

    decisionoftheThaigovernmenttofloatthebahtandcutitspegtothedollar.The

    governmenthadinthepastoverextendeditselfinanefforttosupportitandcould

    nolongeraffordtodoso.Thailandhadalsoacquiredalargeamountofforeigndebt,

    whichessentiallybankruptedthecountryevenbeforeitscurrencycollapsed.The

    IMFhadwarnedtheThaigovernmentthatitscurrencywasseverelyovervalued,but

  • Karczmarczyk 38

    itcontinuedalongitspathofdestruction.TheThaicollapsewasnosmallsurpriseto

    theinternationalcommunity.ThesurprisecamelaterwhenotherAsiancountries

    followeditslead.

    PressurewasimmediatelyfeltinthePhilippines,acountrythatwasultimatelynot

    stabletobeginwith.Thecountrywashighlydependentuponcapitalinflowsand

    hadaveryrigiddollarpeg(keepinmindthatatthistimemostcountrieswereno

    longerpeggedtothedollar).ThePhilippineauthoritiesdecidedtofloatthepeso

    onlytendaysafterthebaht.ThisthenputpressureonIndonesiaandMalaysia,

    whereinvestorstherereallybegantofaceaconfidencecrisis.Koreaalsofaceda

    panic,buttheG7helpedstopthiscrisisbyconvincinginternationalbankstoextend

    shorttermloanstoKoreainanefforttorenewtheircreditsandeffectivelybuying

    timeforthegovernmenttoputreformsinplace.Indonesia,however,faceda

    completebankingandfinancialsystemfailure,resultinginadisruptionin

    productionandapainfulrecession.OnlyChinaremainedimmune.

    Thecrisishighlightsjusthowvolatilethemarketsareandhowcontagioncan

    spreadthroughoutaregion.ThecrisiscausedsharpdropsinoutputallacrossAsia.

    Avarietyofreformsresultedfromthecrisis,includingcurrencydevaluation,

    recapitalizedandrestructedbanks,andenhancedlendingprocedures.Eventoday,

    someoftheseeconomieshavenotrecoveredtotheirprecrisisstateofproduction.

    YetoneinterestinginitiativethatcameoutofthecrisiswastheChiangMai

    Initiative,orCMI.Underthisagreement,Asiancentralbanksagreedtoprovide

    financialsupportfortheirneighborsinthesamewayoftheEuropeanMonetary

  • Karczmarczyk 39

    Ssytem.Thegloalwasthatnexttimeacountrysufferedacpitalflowreversalandits

    currencycameunderattack,officlafundingwouldbeavailabletoreplaceprivate

    funding(Eichengreen197).Theproblemwithsuchasystemisthatgovernments

    areoftenunwillingtolendwithoutassurances,asIwilldiscussinmoredetailandin

    adifferentcapacityatalatertime.

    Asiaisnottheonlyplacewehaveseensuchcrisesandvolatility.Theroleof

    theexchangerateandthefalsesenseofsecurityisremarkablysimilarinother

    emergingmarketcrisis.Eachnationalcontextisuniqueofcourse,butArgentina,

    Brazil,andTurkeyhaveallexperiencedhighinflationrootedinlargebudget

    deficitsandcompoundedbystructuralproblems(Eichengreen199).

    TheEuro.AfterthecollapseofBrettonWoods,theneedanddesirefora

    Europeancurrencywasincreased.Despiteearlyfinancialproblems,Europewasset

    onthiscoursesincetheearly1990s.TheUnitedKingdomandDenmarkdropped

    outoftheprocessearlyon,buttheotherspersistedandtheMaastrichtTreatywas

    formed.AtGermaninsistence,theTreatysettargetsforinflation,interestrates,

    exchangeratestability,andfiscalstabilityforcountriesseekingtoqualifyfor

    particpationintheunion.Fiscalcriteriawassetatabudgetdeficitofnotmorethan

    3percetnofGDPandapublicdebtofnotmorethan60percent.Thesewereinsisted

    uponmoststringently.Theideabehinditwastopreventweakeconomiccountries

    fromenteringandpossiblyendangeringtheentiresystem.

    Thechangeoverfromdomesticcurrencytothissupranationalcurrencywas

    plannedwithexcruciatingdetail.Theoriginalmonetaryunionwasverysmalland

  • Karczmarczyk 40

    centeredonFranceandGermany.Yetthefinalplanwasmuchlargerthanplanned

    andincludedcountriessuchasIreland,Italy,SpainandPortugal,whohadnot

    alwayshadthestrongestfinancials.Despitethis,therewastobeaEuropeanCentral

    BankandaStabilityPactthatwasdesignedtoprovidecontinuedoversightof

    nationalbudgets.Theprospectivemembersoftheeuroareaagreedthatthey

    wouldirrevocablylocktheirexchangeratesasofJanuary1999atthesamelevel

    prevailinginmid1998(Eichenreen221).Thechangeoverwascompletedatthe

    beginningof2002.

    Theeurowasweakagainstthedollarforitsfirstfewyears,andmany

    complainedthatthecentralbankwastootightonitsrequirements.Despitethis,the

    monetaryunionransmoothlyandseeminglycreatedasenseofEuropeannessthat

    hadyettobeseen,despitetheeffortsoftheUnionitself,formedover40years

    before.Theeuroultimatelyinthecomingyearsenhancedpricetransparency,

    encouragedcrossbordertrade,andcreatedacurrencytoeventuallyrivaltheeuro.

    Itseemedalmosttoogoodtobetrue,andasrecenteventshighlight,

    TheCurrentSituation

    Since1971,theworldhasbeeninaperiodoffloatingexchangerates,whichinturn

    hasledtohighlevelsofinstabilityandincreasedfinancialcrises.Inorderto

    illustratethis,Iwillexaminetwotroublingcurrenteventsinourmonetarysystem:

    thecurrentcrisisintheEurozoneconcerninggovernmentdebtinGreeceandthe

    ChineseholdingofU.S.Treasurydebt.Togetherthesetwoeventshighlighttheneed

  • Karczmarczyk 41

    forchangeandunderlinethecurrentproblemsfacingoursystem.Iwilldothis

    througheconomicanalysisofcurrentnewspaperarticles.

    GermanyandGreece:StrugglesintheEurozone

    EuropeanenlargementhasbeenachallengeplaguingEuropeforthepast50years.

    Sincethe1958TreatyofRome,whichestablishedtheEuropeanEconomic

    Community,Europehastakenleapsandboundstowardstheirgoaloffullpolitical

    andeconomicintegration.TherecentcrisisintheEurozone,whichisthe16

    countrieswithintheEuropeanUnionthatoperatewiththeEuroastheircurrency,

    hashighlightedthesinglemostimportantproblemtheyhavealwaysfaced:the

    absenceofasinglegovernment.Theeurozoneisnotanoptimalcurrencyarea,

    andthusitlackstheimportanttoolstodealwithasymmetricshocks,meaning

    shocksthataffectsomemembersmorethanothers.Inthissense,Imeantoolstobe

    atreasurywithpowerstotaxandborrowandacentralbankthatcanactaslender

    oflastresorttomemberbanks(Skidelsky1).Soinanefforttoillustratethis

    problem,Iwillfirstanalyzethecomingofthiscrisis,theGreeksituation,theGerman

    response,thepossibilitiesandramificationsofIMFinvolvement,andfinallywhat

    thismeansfortheworldasawhole.

    TheEncroachingCrisis.TheEuropeanMonetaryUnion,whichformedthe

    basisoftheeurozone,beganwithgrandideasandplans.Therewerecountriessuch

    asAustria,Finland,theNetherlands,andGermanywhohadstrongcurrencies

    domesticallyandinternationally,buttherewerealsocountriessuchasFrance,

    Belgium,Italy,Portugal,Spain,Greece,andItaly,whosecurrencieswereconsistently

  • Karczmarczyk 42

    depreciatinganddidnotmaintainahighvalueinternationally.Suchasituation

    createdanaturalinequality,buttheEuropeanintegratorsinsistedandtheunion

    wasdevisedasonesizefitsall(Sorkin1).

    Thecriteriatoentertheunionwerestrict,duelargelytotheGerman

    influence,andmanyofthesecountrieswithdepreciatingcurrencieswereunableto

    fitthecriteriatoentertheunion.Instead,theyreliedonwhathascometobeknown

    ascreativeaccounting,andsomecountries,forexampleGreece,evenwentsofar

    astofalsifyitsdebtanddeficitnumbers(Sorkin1).Inthebeginning,however,this

    didntposemuchofaproblem.Theunionitselfismadeupof27countriesandhas

    formedwhatmanycalledtheworldsmostformidableeconomicbloc,

    incorporating491peopleinanintegratedmarketthatproducesnearlyathirdmore

    thantheUnitedStates(Erlanger1).Granted,theunionhaditsissues,butthey

    weatheredthestorminadmirablefashion.Itwasntuntilthe2008financialcrisis

    thatthecracksbegantoshow.

    Beforebeginningthediscussionofthecrisisitselfitisimportanttorecognize

    thatthecentraltensionintheEuropeanUnionhasalwaysbeenbetweennational

    prioritiesandcentralinterests(Erlanger2).TheideaofEuropeanhasneverbeen

    asstrongasnationalism,andtheideaofcedingnationalpowerswitheverything

    fromcurrencytocustomshasneverbeenaneasyonetodealwith.Whencrisesor

    panicshit,theautomaticreactionistoturnnationalbyprotectingtheirown

    resourcesandindustries.Whilethishasntdelayedintegrationuptothispoint,it

    hasrecentlybegunascalingdownofambitions(Erlanger2).

  • Karczmarczyk 43

    TheGreekSituation.ThesemountingtensionshavebeenrealizedintheGreek

    economyrecently.Aspreviouslymentioned,Greecebenttherulesoftheeurozone

    inanefforttobeadmitted,andalltheyearsofunrestrainedspending,cheap

    lending,andafailuretoimplementanyfinancialreformshavecaughtupwith

    them.Inearly2010,theideaandfearofasovereigndebtcrisisreallybeganto

    developinmanytroubledeurozonecountries,includingSpainandPortugal,butthe

    crisisdevelopedmostfullyinGreece.Thecrisisthenledtoaconfidenceproblem,

    whichasshowninthebackgroundsectionhascausedseriousproblemsinour

    monetarysysteminthepast,andthiswasnoexception.Italsoledtothewidening

    ofbondyieldspreadsandriskinsuranceoncreditdefaultswapswithintheeuro

    zone.Thesituationwasfurtherworsenedwhena500milliongovernmentbond

    auctioninPortugalfailedtoraisethatamount.Insteadofthe500million,the

    Portuguesegovernmentonlysuccessfullyraised300million.Panicensued,and

    thesefearscombinedtoaweakenedeuroandawidespreadglobalcommodity

    selloff.

    Withthissituationintheworld,Greecesdebtandfiscalissuescametolight.

    Nationaldebtissaidtobeataround300billion,whichislargerthanthenations

    economyitself.Someeconomistsarepredictingthatthedebtwillreach120

    percentofgrossdomesticproductin2010(CNN1).Thecountriesdeficit,meaning

    howmuchmoreitspendsthanittakesin,isat12.7percent.Thesenumbersare

    incrediblyhighandwellbeyondtheboundsoftheeurozone.Inresponse,Greeces

    creditratinghasbeendowngradedandisnowamongthelowestofallmembersof

    theeurozone.ThisdoesntbodewellforGreece,asitisnowafinancialblackhole

  • Karczmarczyk 44

    toallforeigninvestors(CNN1).Thecountryisstrugglingtopayoffthesedebtsand

    tomakegoodontheircurrentbills,butitsdifficultconsideringthatinterestrates

    arerisingontheexistingdebts.TheGreekgovernmenthasrespondedthrough

    PrimeMinisterGeorgePandreoubyimplementingspendingcuts,anactwhichis

    incrediblyunpopularamongtheGreekpopulace.Theyhavealsoimplemented

    austeritymeasuresaimedatreducingthedeficitbymorethan10billioneuro.Taxes

    havebeenincreasedonsuchproductssuchastobaccoandalcohol,theretirement

    agehasbeenraised,publicsectorpaycutshaveensued,andtaxevasionregulations

    havebeenstrengthened(CNN2).LiquidityisamajorissueinGreececurrently,and

    thesedomesticactionswontbeenough.Greecealonecannotpullitselfoutofthis

    financialhole.

    TheEuroZoneResponse.InanApril9,2010article,CNNwrotethatGreeceisin

    dangerofdefaultingonitsnationaldebtasitsbondmarketcomesunderincreasing

    pressure,unlessitsEuropeanneighborsintervene(Smith1).Thisstatementsums

    upthethoughtsheldnotonlyacrossEuropebutalsoacrosstheglobe.Thepressure,

    however,doesntfalluponeitherofthese,butinsteadonthemembersoftheeuro

    zone,specificallyGermany.Greecesfinanceministerhassaidthatyieldofalmost7

    percent[onthesebonds]arehighenoughtogiveinvestorsagoodreturnfortherisk

    involved(Sorkin2).Butevenasthiswassaid,theGreekgovernment,as

    highlightedabove,wasraisinghalfofitsfundingrequirementof53billionEuros

    throughoutthespring.Inamarketsuchastheprevailingone,thisisntgood.

  • Karczmarczyk 45

    Originally,theEuropeanUnionsetoutwithachallengetotherelativelyweak

    governmentstoimposehightaxesandspendingcuts,whichGreece,asstatedabove,

    did.Theaction,however,provedtonotbeenoughtogettheirdeficitsdownfrom

    over10percentofGDPtothebenchmarklevelscloseto3percentofGDPascalled

    forintheEuropeantreatythatcreatedtheeuro(Sorkin2).JosephStiglitz,an

    economistandcurrentadvisortoGreece,pointedoutthehypocrisyofthesituation

    here.RichercountriesinEuropehasbeenallowedtoborrowheavilytopull

    themselvesoutofrecession,butthepoorercountrieswereforcedtotakeaknifeto

    theveryprogramsintendedtosoftentheblowofaneconomicdownturn(Sorkin

    2).InsteadoftakingcareofthesolutiondomesticallyStiglitzproposesthatEuropes

    richestcountries,suchasGermanyandFrance,taketheleadinaidingGreece.

    Stiglitzsadvicewouldeventuallybetakentoheart,butnotwithoutmuch

    debate.Afterafulltwomonthsofdiscussion,theEuropeanUnionunveiledthe

    detailsofitsGreekfinancialrescueplanonApril11th.Itsinvolvedthe16eurozone

    members,andofferedGreeceupto30billionEurosinbilateralloansinthefirst

    year,withmoreavailableinsubsequentyears.Interestratesweretobesetaround

    5%forthreeyearloansinitially.Thenumberwasacompromisebetweenthesmall

    ratesthatthemarketsaredemandingandtheinterestratesbeingpaidbythe

    weakestmembersofeurozone,likePortugalorSpain.Themembersoftheeuro

    zoneareremainingfirmthatthisisnotabailout,andthatthenobailoutclause

    shouldremainintact.Theydothisbystatingthattheloansarerepayableand

    containnoelementofsubsidy(TheSkiesBrighten2).

  • Karczmarczyk 46

    Ofallthecountriesoftheeurozone,Germanywillcontributethemost,an

    actionthatcametopassafterconsiderableresistance.AngelaMerkel,theGerman

    chancellor,ledatoughresistancetotheideaofthebailout.Merkelwasbackedby

    bothAustriaandtheNetherlands.InBrussels,theEUgovernanceagreedthatthe

    eurozonestandsbyitsfoundingprinciplethatprofligatememberscannotbebailed

    out,butthatGreecewouldalsonotbeallowedtofallvictimtoasovereigncredit

    crunch(TheSkiesBrighten2).Ultimately,Germany,withthecurrentaccount

    surplus,decidedtocontributetotheEuropeanproject,ifonlyduetotheclose

    financialtiesbetweenthecountries.GermanbanksholdlargeamountsofGreek

    governmentdebtandintheeventofaGreekdefaultwouldsufferlargely(TheSkies

    Brighten2).

    Thebailoutplanisbeingofferedasalastresort,andasidefromthebilateral

    loans,theIMFhasofferedfundsandtechnicalassistance.ThedetailsofIMF

    involvementwillbedetailedinthenextsection.

    IMFInvolvement.TheGreekbailoutinvolvesfundsfrombothinternalsourcesand

    alsotheIMF.IMFinvolvementwasheavilypushedbyAngelaMerkel,whowaseager

    toshowGermanythattheircountrywouldnothavetofoottheentirebilltohelp

    Greece(EUapproves1).NotallwereasexcitedoversubstantialInternational

    MonetaryFundfinancing,however,astheGermans(1).EUleadershadbeen

    hesitantuptothispointoverinvolvingtheFund,astheywerenttechnically

    European.IMFinvolvementcouldweakentheeurofurther,resultinginitsfall

    againstothercurrencies.

  • Karczmarczyk 47

    Despitetherisk,theIMFispreparedtolendGreecearound10billionEuros.

    EuropeanUnionnationsoutsideoftheeurozone,suchasHungaryandRomania,

    haveallreceivedsupportfromtheIMF,whichthenpromptlyimposedvarious

    fiscalrequirementsintendedtoinsuretheycanpaybacktheloans(Sorkin3).The

    differencenowistheeurozoneboundary,andIMFinvolvementmakestheEUlook

    weak.MirandaXafa,aformerexecutiveboardoftheIMF,makesagoodpoint,

    however.ShebelievesthatthetimehascomeforEuropetoacknowledgethatithas

    neitherthetechnicalexpertisetomonitorgovernmentbehaviornortheabilityto

    raiserescuefunds(Sorkin3).ItsbelievedbytheIMFthattheirinvolvementwould

    helptheothercountriesandrestoreconfidence.InBrussels,theviewistheexact

    opposite.

    WhatThisMeansfortheFutureofEuropeandtheWorldasaWhole.ForGreece,the

    bailoutwasanecessaryaction.Itcouldnothavealleviateditsdebtwithoutsome

    formofinvolvementfromeithertheIMFortheEuropeanUnion.Inrecentdays

    Greecehascontinuedtostruggle.MarketanxietyhaspushedGreeceslongterm

    bondyieldstotheirhighestlevelssincethecountryjoinedthesinglecurrency

    nearlyadecadeago(TheSkiesBrighten2).Fitch,acreditratingagencyalso

    downgradedthecountrysdebtbytwonotchestothelowestinvestmentgrade,one

    gradeabovejunkstatus.FitchhasalsorecentlycastdoubtontheGreek

    governmentspoliticalvowstocutthepublicdeficitbyathirdthisyear.Essentially,

    therecessionisdeepeningandthecostsofservicingtheirhighdebtareincreasing.

    So,asIseeit,itisonlyamatteroftimebeforeGreecemustimplementtheEuropean

    rescuemechanism.OnceGreecehasdecidedthatthereisnothingmoretheycando

  • Karczmarczyk 48

    domestically,officialsfromtheEuropeanCentralBankandtheEuropean

    CommissionmustagreethatGreeceisoutofoptions(TheSkiesBrighten3).Once

    thisdecisionismade,theeurozonewillbewhippedintoafrenzyofaction,asthings

    arepredictedtomoveveryfast.

    Fortheeurozone,thishasplacedtensionontheinternalrelationships.

    Germany,intheirreluctancetoaid,isturningevermoreinwarddomestically.As

    theyhavesincethehyperinflationalwaysbeenveryfiscallysound,such

    irresponsibilityfinanciallydoesnturgethetypeofinternationalcooperationand

    integrationthatispromotedbythetreatiesoftheEuropeanUnion.

    Asthisisthefirsttimethishashappened,Germanydidprovidethereliefthat

    Greeceneeded.Whathappens,however,ifthishappensagainandsoon?TheGreek

    crisiscouldbeonlythefirstofpredictedmultipletremors.Theconfinesoftheeuro

    zonehavecreatedproblems.IfGreecehadbeenoutsidetheeurozone,forexample,

    itcoulddevalueitscurrencytomakeitmorecompetitive,anditsforeigndebts

    couldberenegotiatedinaninternationalconference(Starbatty1).Instead,wehave

    enteredintoasovereigndebtcrisiswiththestrongestcurrencyintheworld

    threateningtoplummet.SpainandPortugalarentfarbehindGreeceistheirrelative

    weakness.Italyisalsoaconcernasitisthethirdlargestsovereigndebtor.Ifit

    comestopassthatthesecountriesalsoneedabailout,andGermanyandFranceare

    supposedtoprovide,whothenwillrescuetherescuers?

    Inanefforttokeepthesecrisesfromhappeningagain,TheEuropean

    CommissionisdiscussinggivingtheEUexecutivepowerstorecommendeconomic

  • Karczmarczyk 49

    overhaulprogramstoindividualscountries,andtonameandshamelaggardsby

    sendingwarningsincasesofinadequateresponses(Taylor2).Ontheoutside,this

    isasolidplan,butintherealitiesoftheeurozone,countriesdontwanttocede

    authoritytoalargersupranationalbody.GermanyasthebiggestEuropean

    economy,hasmadeitclearthatitdoesnotwantEUscrutinyofitsownexport

    orientedpolicies,whichgeneratebigcurrentaccountsurplusesthateconomistssay

    arepartlyresponsibleforwideningimbalancesintheeurozone(Taylor2).

    Furthermore,ithasbeensuggestedthattheEUneedstocreateaEuropean

    monetaryfundwhosefunctionistooperatelikeanIMFstyleassistanceprogram,

    butonlyforeurocountriesinfiscaldanger.Yet,thisrunsagainstthefoundingideas

    oftheEuropeanUnion.ThetreatiesoftheEUforbidsuchbailoutactions,andasthe

    recentLisbontreatyhasshown,itisnoteasytogetchangestotreatiespassedin

    Europe.

    Atthesametime,shouldGreecedefaultonitsloansandachainofbank

    insolvenciesensue,perhapstheEuropeanUnionwouldbemadestronger.Nations

    oftencometogetherintimesofcrisis,andahitontheEurowouldcertainlyqualify

    asacrisisinthissense.Thisseemsoverlyoptimistic,however,asthetrendin

    Europehasforyearsbeentoveertowardsnationalinterestsintimesofcrisis.

    Despiteallofthis,itisunlikelythatanycountrywouldleavetheeurozone.The

    effectsarenationalizedandthereforebeyondthescopeofthispaper,butletit

    sufficetosaythattheseeffectswouldbedisastrousandenormousforthecountry

    thatoptedtodoso.

  • Karczmarczyk 50

    Overall,theGreekeconomy,asIseeit,willbeeventuallybailedoutbythe

    plancreatedbytheEuropeansandtheIMF.IMFinvolvementiscrucialasitshows

    thecontinuedusageoftheinstitution.Whenimplementinganypotentialreform,it

    isnecessarytokeepthisideaofaninternationallenderoflastresortatthe

    forefront.Itprovidesadegreeofstabilityandequalizationinthishighlyglobalized

    world.TheeffectsandpossibilitiesoftheGreekbailoutarestillunfolding,asthe

    crisisisongoing.Regardlessofwhathappens,however,ithighlightsadeeper

    problemwithintheinternationalmonetarysystem.IftheEuroweretofail,itwould

    causetremorsacrosstheglobe.Iftheeuroistomakeit,thenwillitsoonreplacethe

    dollarastheprimarycurrency?Allofthesequestionsareunanswerablenow,but

    theybearscrutinywhendiscussingtheformingofanewinternationalmonetary

    system.

    ChinaandtheUnitedStates:ToughEconomicRelations

    Europeisnttheonlycountryfacingaformofdebtcrisis.TheUnitedStateshasa

    verylargepublicdebt(ofwhichitisnotalone).Yetthisinandofitselfisnt

    concerning.Theconcerningfactoristhataroundtwentyfivepercentofthisdebtis

    inthehandsofforeigninvestors,whomaychosetosellitoffatanygivenmoment.

    Naturally,therearereasonsthatthishasnthappenedyet,butasthefinancialcrisis

    hitstherealityofthebusinessworld,theseconcernsarebecomingevermore

    prevalent.Iftheseconcernswereevertobecomeareality,thenentireinternational

    monetarysystemcouldcollapse.Theironyisthatitsthecurrentinternational

    monetarysystemthatledtothisprobleminthefirstplace.Inanefforttoillustrate

  • Karczmarczyk 51

    thisissue,IwillfirstanalyzethenatureoftheUSpublicdebtanditsbuyers,other

    factorsintheUSChineserelationship,thecurrentsituation,theroleofsovereign

    wealthfunds,andfinallywhatthismeansfortheworldasawhole.

    TheNatureofUSPublicDebtanditsBuyers.ThebiggestholderofTreasury

    debtistheUnitedStatesgovernment,witharound52percent(Schoen1).Mostof

    theseholdingscomeintheformofSocialSecurityandMedicare.Thisleavestherest

    inpublichands,ofwhichthelargestpercentageisheldbyforeigngovernments.In

    2007,thiswasaround25%of$8.5trillion(Schoen1).Otherholdersincludestate

    andlocalgovernmentsandindividualinvestors,butthesefactorsarebeyondthe

    scopeofthispaper,asthissectionwillfocusontheinternationalsphere.Before

    goingintothedetails,however,itisimportanttounderstandthebasicsofthe

    treasurydebtbuyingprocess.SchoendescribesTreasurysecuritiesasabigbatch

    ofIOUsthatareauctionedoffeverythreemonths(1).Thisistrueinitssimplest

    form.Astheauctiondateapproaches,theTreasurydecideshowmuchitwillneedto

    coverthegovernmentsneeds.Whentheauctionarrives,buyerssubmitbidsinthe

    formoftheinterestratetheyarewillingtoaccept(1).Theyaregivenachoice

    betweenmakingacompetitivebid,whichisaskingforaspecificrate,oranon

    competitivebid,whichisacceptingtheaveragerateofotherwinningbids.Oncethe

    bidsarein,theTreasurystartsacceptingthebidsatthebottomofinterestrate

    spectrum,andcontinuestoacceptthemuntiltheyhaveenoughmoneytocover

    theirborrowing.

  • Karczmarczyk 52

    ThelifeoftheTreasurybonddoesntstopthere.Onceissuedatauction,

    Treasurysecuritiesenjoyahealthysecondlifewhentheyretradedinthesocalled

    secondarymarket(akathebondmarket)(2).Thepricesofbondsboughtonthis

    openmarketvaryasthemarketreactstooutsidefactors(includingspeculation,

    inflation,etc).Oncethebondisbought,however,regardlessofthepriceaperson

    paysforit,thegovernmentowesthefullamountthatwasborrowedwhenthedebt

    wasfirstauctionedandborrowed.Thisfactisimportanttotherestofthissection.

    Sothen,thequestionbecomeswhichforeigninvestorsexactlyownthese

    Treasurysecurities.Inordertodisplaythisinformation,Ihavecompiledachart

    fromtheTreasurywebsite:

    MajorHoldersofTreasurySecurities(inbillionsofdollars)

    Country Feb10 %ofTotal 9Feb %ofTotal

    China 877.5 23.40% 744.2 23.54%

    Japan 768.5 20.49% 661.9 20.90%

    UnitedKingdom 231.7 6.18% 129 4.08%

    OilExporters 218.8 5.83% 181.8 5.75%

    Brazil 170.8 4.55% 130.8 4.14%

    HongKong 152.4 4.06% 76.3 2.41%

    CaribBankingCntrs 144.5 3.85% 189.5 5.99%

  • Karczmarczyk 53

    Taiwan 121.4 3.24% 72.6 2.30%

    Russia 120.2 3.20% 130.1 4.11%

    Allothers 944.2 25.18% 845.3 26.74%

    GrandTotal 3750.5 3161.5

    MajorForeignHoldersofTreasurySecurities,www.treas.gov/tic/mfh.txt

    Asthetableillustrates,ChinaandJapanarethetwolargestholdersofforeigndebt,

    withatotalofaround44%.TheyallowtheUnitedStatestorunsuchahighdebt

    becausetheUSissuchastrongeconomyandsuchalargecustomerthattheywant

    themtocontinuebuyingexports.Overall,theamountofforeigninvestinginUS

    Treasurysecuritieshasincreasedbyalmostdouble.Thecurrentfigure,as

    previouslymentioned,is25%,butitwaslessthan13%in1988(TreasuryReport

    5).Governmentdebtisinherentlynotaproblem.Theproblemiswhentheseforeign

    securitiesturnintoanationaleconomicandsecurityissue.

    ChinaandU.S.EconomicRelations.TheChineseeconomywasaround$8.8

    trillionin2009,thusmakingChinatheworldsthirdlargesteconomy,rightafterthe

    UnitedStatesandtheEuropeanUnion(Amadeo1).Itisalsotheworldssecond

    largestexporter(rightaftertheEU),andtheU.S.inparticularreliesheavilyonthe

    Chineseexports.Reversely,theChinesealsorelyheavilyontheUnitedStates,butas

    timegoeson,thislessens.ChinahasrecentlybeenincreasingtradewithHongKong

    andJapan,aswellastheAfricanandLatinAmericancountries.Yetthestandardof

    livingisrelativelylowinChina,whichtheyuseasamethodtokeeplabor,andin

  • Karczmarczyk 54

    turnexports,cheap.Itdependsonkeepingthevalueoftheyuanlow,andinorderto

    dothis,itneedstokeepthevalueofthedollarhigh.Alowyuanensurescheaplabor,

    andtheChinesehavemanagedtokeepthisarealitydespiteUSpressuretoraisethe

    competivenessoftheyuaninanefforttoimproveAmericancompetitiveness.China

    hasalsofixedthevalueofitscurrencytothedollar.Currently,thedollarisworth

    around6.8yuan(Amadeo1).IfChinaweretolettheircurrencyfloat,manyanalysts

    believeitwouldbemorevaluablethanthedollarduetothestrongChinese

    economy.YetChinakeepitspeggedinorderto,onceagain,ensurecheaperproducts

    thantheUS,thuskeepingexportandtradedeficitwiththeU.S.

    EvenbeyondtheUSTreasurysecuritiesdebate,theeconomicrelationship

    betweentheUnitedStatesandChinaistense,atbest.Whilethedetailsofthese

    tensionsarebeyondthescopeofthispaper,themoodsurroundingthesecurities

    debateplayalargerole,andthepasttensionsplayaroleinthismood.Soits

    importanttounderstandthelevelofcompetitionthatexistsbetweenthetwo

    countries.TheUnitedStatesistheleadingworldpower,andChinaistherapidly

    growingthreat.TheUnitedStateshasdevelopedtothepointthatitisnolongera

    hugemanufacturerandisinsteadmovingtowardsaservicebasedsociety.China

    manufacturersthegoodsthattheUnitedStatesneedsandatthesametime,relieson

    themoneytheUSpaysforthegoods.CongressiscontinuallyaccusingChinaof

    surpassingimportquotas,andChinaisconstantlyaccusingtheUnitedStatesof

    protectionism.Thistenseeconomicrelationshipwillcontinuetoexistforsolongas

    thetwocountriesneedeachother,butthequestioniswhathappenstotheUSif

    ChinareachesapointwheretheynolongerareinneedoftheUS?

  • Karczmarczyk 55

    TheCurrentSituation.Withallthesefactorscomingintoplay,thecurrent

    situationisparticularlytense.Thefinancialcrisishashighlightedthesetensionsto

    thepointthatmanyeconomistsareconcerned.Earlythisyear,Chinabegantosell

    U.S.securities,andtheyhavecurrentlyfallenby$62.4billionsincelastJuly(Craft1).

    BondmarketshaventyetcrashedduetoJapan,theUK,andoilexportingcountries

    pickinguptheslackandaddingaround$258billiontotheircombinedholdings

    (Craft1).EvensorecentlyasFebruary,ChinatrimmeditsholdingofUSTreasury

    debtby1.3percent,makingitthefourthconsecutivedecline(Crutsinger1).

    InanarticlebytheAssociatedPress,WinThin,aseniorcurrencystrategistat

    BrownBrotherHarriman&CompanysaidthathebelievedtheMarchreportcould

    wellshowareboundinpurchasesbyChina[and]thatpartofthechanges[inthe

    pastterms]reflectedadecisionbyChinatorebalanceitsholdingsawayfrom

    shortertermTreasurybills(Crutsinger1).HemaintainsthatChinaisstillastead

    buyerofU.S.Treasurynotesandbondsbuthas[simply]beenparingbackits

    Treasurybillholdings(1).AnotherexplanationisthatChineseinvestorsmaybe

    simplybuyingtheirsecuritiesthroughBritainandHongKong(Crutsinger1).

    Despitethesereassurances,however,theproblemremains.Unlessforeign

    demandforU.S.Treasurydebtremainsstrong,theinterestratesthatthe

    governmentpaysonthedebtcouldriseexponentially,thusmakingthedeficitofthe

    UnitedStatesevenworse.Theserisinginterestrateswouldalsoputanupward

    pressureonprivatedebt(Crutsinger1).Thisupwardtrendinborrowingcosts

    wouldaffectU.S.businessesandconsumers.Highercostsleadtolowerconsumption

  • Karczmarczyk 56

    andlowerborrowing/lending.Itcouldultimatelyfreezeupthecreditlanes,which

    wouldaddanotherrisktotheU.S.economy.

    Furthermore,asthedebateaboutwhatChinaisdoingwiththeir

    holdingsragesonward,theUnitedStatesisalsoincreasinglyconcernedaboutthe

    Chineseallowingtheyuantoriseinvalueagainstthedollar.Bydoingso,theyare

    keepingthecurrencyartificiallylowandharmingUSeconomicinternational

    growth.Itisestimatedthatbydoingso,itwouldaddanestimated$2.4trilliontothe

    worldssupplyofTreasurydebtthisyear(Craft1).PresidentBarackObamahas

    addressedthisissue.HemetwithPresidentHuJintaoofChinatheweekofApril13th

    inanefforttomovetowardamoremarketorientedexchangerate(MrObamaand

    Mr.Hu1).Mr.HureportedlyrespondedthatChinadidplantomoveawayfromthe

    fixedcurrencypeg,butdidnotsaywhen.Chinadidreportthattheywouldnotbe

    respondingtoforeignpressure,thedecisionwouldbemadeontheirowntime

    frame.

    TheRoleofSovereignWealthFunds.Anotherpointofcontentionintermsof

    ChineseUSeconomicrelationsaresovereignwealthfunds.Untilrecently,China,

    Japan,andotherexportershavebeencontentwithkeepingmostoftheirtrillionsof

    dollarsinreservesinsafeinvestmentslikebankdepositsandUnitedStates

    Treasurydebt(Times1).Aspreviouslydemonstrated,theseholdingsarecurrently

    indoubt,butanalystsarententirelysurewherethenextstepforChinawouldbe.As

    theinvestmentinUStreasurydebtdeclines,theinvestmentintotheprivatesectors

    forhigherreturnsisincreasing.Withthishugebase,governmentinvestorsdiversity

  • Karczmarczyk 57

    moreandcanriskhigheryieldingoptions.Thesehighlydiverse,nationalfundsare

    calledsovereignwealthfunds.

    Theterm,accordingtotheNewYorkTimes,appliestogovernmentowned

    fundssetupbytheworldsleadingexporters,especiallyChinaandthemajoroil

    producers,thatarebeingemployedmoreassertivelyforinvestmentinbanks,

    privatecompanies,equityfunds,realpropertyandotherassets(1).Thefunds

    gainedinpopularityduringtheprefinancialcrisisyearsof2006and2007.Many

    sawthefundsasengagingincrossbordernationalization(SovereignWealth

    Funds1).Thiswasconcerningduetothepowerthatthehomegovernmentofthe

    sovereignwealthfundsmighthaveinthecountrieswheretheyinvest.TheWestern

    worldisparticularlyconcernedduelargelytothefactthatthecountriesyielding

    thesefundsarentthemoststable,orfriendly,ofallies.Politicalleadersare

    concernedthatthesefundsareconcealingattemptstoinvestforpoliticalgainor

    influence.

    Theroleoftheseinstitutionshasbeenseverelydiminishedinthewakeofthe

    financialcrisisof2008.Manyofthesesovereignwealthfundshadinvestedheavily

    ininstitutionsthatwentsouth.OfparticularinteresthereistheChinaInvestment

    Corporation,theChineseSWF.Theyoriginallyhada$3billioninvestmentin

    BlackstoneGroup,butwhenthegroupturneddownward,theChinesegovernment

    lostadegreeoflatitude.OtherSWFshavedonemuchbetter.Thesovereignwealth

    fundofKuwaitmadeaprofitof$1.1billiononits$3billioninvestmentin

    Citigroup(Times1).

  • Karczmarczyk 58

    Concernstillexists,however,despitethedeclineofChinasSWFinthe

    aftermathofthe2008financialcrisis.ThePetersonInstituteofInternational

    EconomicscurrentlysaysthatthebiggestSWFsareownedrespectivelybyUnited

    ArabEmirates,Singapore,Norway,Kuwait,Russia,andChina.Itwouldntbe

    surprisingtoseeChinasoontaketheleadhereduetotheir$1.3trillioninforeign

    exchangereserves.GiventheconcernsoftheWesternworldaboutthepolitical

    influenceofsuchfunds,thisisnotanidealsituationfortheUnitedStates.The

    Chinesegovernmentalreadyowns20%ofUnitedStatesforeigndebt,andto

    increasetheirpowerwithpoliticallyplaced,powerfulfunds,wouldntbodewellfor

    nationaloreconomicsecurity.

    WhatthismeansfortheUnitedStatesandtherestoftheworld.Asofnow,

    thereisnodangeroftheChinesesellingofftheircurrentholdofUSTreasurydebt.

    TheUnitedStatesandChinaarestillheavilyreliantuponeachother,andtheUS

    dollarmaintainsastrongholdintheworldeconomy.However,imaginingtheworst,

    iftheChinesesoldalloftheirUSdebt,thedollarwouldcollapse,sendingtheUnited

    Statesintoarecessionneverbeforeseen.Thisismostimprobable.

    Ther


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