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The paradox of international monetary affairs is not the difficulty of designing a stable international monetary system but that such systems have persisted for decades. Such systems require governments to forswear the temptation of beggar-thy- neighbour policies and to contribute voluntarily to the provision of on international public good, global monetary stability. In the absence of binding agreements, monetary systems, like cartels, are plagued by the temptation to defect. Specialists in international relations have argued that international monetary regimes operate smoothly only when dominated by a 'hegemon', a single, exceptionally powerful economy. Such a dominant economy, it is argued, can reap the benefits of the public good- monetary stability and so will have an incentive to supply such stability to the system. The survival of the Bretton Woods System until 1972, for example, is ascribed to the economic power of the United States, while the persistence of the classical gold standard is similarly ascribed to Britain's dominance of nineteenth century international financial markets. In Discussion Paper No. 193, Research Fellow Barry Eichengreen assesses whether hegemonic stability theory can usefully be applied to international monetary relations, drawing on the evidence from the classical gold standard, the interwar gold-exchange standard, and the Bretton Woods system. The paper's first version was presented at a CEPR conference in November 1986 (see Bulletin No. 18). Eichengreen adopts the economist's definition of economic, or market power. He defines a hegemon analogously to a dominant firm: as a country whose size is sufficient in the relevant market to influence prices and quantities and whose market power in this sense significantly exceeds that of its rivals. Eichengreen argues that many of the theoretical implications of this concept of power are difficult to reconcile with hegemonic stability theory. Although a hegemon is unlikely to defect from an established international monetary system, the hegemon is also unlikely to use its retaliatory power to deter defection by other countries: such sanctions hurt the hegemon more than the targets of the action. Just as in a cartel with a dominant firm, the larger the dominant firm, the less it is inclined to retaliate against price cuts by the smaller firms by reducing its own prices, since the costs it incurs from lower prices on its existing sales are larger than the benefits of regaining the incremental market share. The theoretical analysis therefore provides only weak support for hegemonic stability theory: the hegemon itself is unlikely to engage in destabilizing actions, but it is unlikely to be able to deter smaller participants from doing the same. Eichengreen finds that much of the historical evidence, and in particular the long-run evolution of the international monetary system, is also hard to reconcile with simple versions of hegemonic stability theory. An international monetary system whose smooth operation at a point in time is predicated on the dominance of one powerful country may in fact be dynamically unstable: either the system itself might evolve in directions which attenuate the hegemon's stabilizing capacity or its operation might influence relative rates of economic growth in such a way as to reduce progressively the economic power and hence the stabilizing capacity of the hegemon. As early as 1947 Robert Triffin suggested that the Bretton Woods System was dynamically unstable. Because dollars were the main source of new liquidity in Bretton Woods, the system's viability hinged on the willingness of foreign governments to accumulate dollars, a willingness that depended in turn on confidence in the maintenance of dollar convertibility. Yet the share of dollars in total reserves could only increase under Bretton Woods, since the supply of gold was insufficiently elastic to keep pace with the growth in demand for liquidity. Consequently an ever-growing volume of foreign dollar liabilities would be based on a shrinking US gold reserve, undermining the ability of the system to provide international liquidty. In addition if the dollar was systematically overvalued for a significant portion of the Bretton Woods era, this could have reduced the competitiveness of US exports and stimulated foreign penetration of US markets. The growth of the US economy relative to the rest of the world would have fallen, eroding US economic dominance and the stability of the system. The historical evidence, Eichengreen concludes, suggests that the hegemon's willingness to stabilize the system tends to undermine its continued capacity to do so. Since hegemony is transitory, it would seem unwise to establish a new monetary system on such an ephemeral basis.
Barry Eichengreen Discussion Paper No. 193, July 1987 (IM) |
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