1-s2.0-016gfdgdffdgd189389500053V-main - Copy

NORTH- HOLLAND

The International Monetary System: The Missing Factor

Robert A. Mundell , Columbia University

Are present international monetary arrangements optimal? My answer is no. There is a missing ingredient in the international monetary system. The missing ingredient is a world currency, and until such a facility is created, the existing arrangements, while likely to continue, will be, at best, second best. Restoration of the gold standard at the current dollar price of gold, however, would result in deflation if the restoration led to an increase in the demand for gold (as it undoubtedly would). Gold would again become a standard of value if and only if it were made stable in terms of currencies.

1. INTRODUCTION

Some 50 years ago, preparations were being made for postwar international monetary arrangements. One of the instructions laid down by President Roosevelt's Treasury Secretary, Henry Morgen- thau Jr., to Harry Dexter White and his staff was "to provide for a postwar international currency." Plans were made for such a currency, both in White's unitas and Keynes' bancor proposals. But neither materialized. An international currency was rejected, and the architects of the Articles of Agreement of the International Monetary Fund and International Bank for Reconstruction and Development created Hamlet without the Prince of Denmark.

It is not hard to discover the reasons for the rejection. In the recently published Robbins-Meade diaries, Robbins notes:

"Keynes then in a bri l l iant speech expounded the case for making Unitas into a real transferable money, and dealt with all the main British points . . . . He argued that all these and many other points could be allowed for with much more ease and neatness if Unitas was made a real money. Bernstein seemed

Address correspondence to Prof. Robert A. Mundell, Department of Economics, Colum- bia University, New York, NY 10027.

Received December 1994; final draft accepted May 1995.

Journal of laolicy Modeling 17(5):479-492 (1995) 0161-8938/95/$9.50 Society for Policy Modeling, 1995 SSDI 0161-8938(95)00053-V

480 R.A. Mundell

willing to consider all these points seriously except the making o f Unitas into a real money. ,,1

The United States, the overwhelmingly dominant power at the Bret- ton Woods meeting, did not want a world currency

2. REFORM AND THE SUPERPOWER

The negative attitude of the United States toward a world currency at the time of the Bretton Woods conference is typical of the superpower in history. The creation of a world currency is likely to reduce the role of its currency in international finance. It has no interest in creating an international money that will undermine the demand for its own currency.

When sterling was the most important currency in the latter half of the 19th century, there were several international conferences on the international monetary system. The two major proposals for reform were a return to bimetallism, often advocated by the United States (the coming superpower) and a common international gold unit, as advocated by France (the former superpower). Britain was in every case the main obstacle to reform.

When the mantle of financial leadership had passed to the United States after World War I, and the dollar was the only major currency fixed to gold, the main initiative for change came from Britain and France. Rather than accept an anchored dollar standard, they refixed their currencies to gold, bringing about the sequence of events that led to the Great Depression. Again, in 1933, after Presi- dent Roosevelt had taken the dollar off gold, it was Britain and France that wanted to reform the international monetary system; the United States refused, and the World Economic Conference broke up without a solution.

I have already noted the U.S. rejection of a world currency at the time of the Bretton Woods negotiations. It might seem, however, that U.S. acceptance of the creation of the SDR constitutes an exception to the rule. However, the SDR that the United States endorsed was a gold-weight-guaranteed SDR, which would have been a substitute for gold, not the dollar. When, however, the SDR was t ransformed- some would say transmogrif ied- into the basket SDR (a European brain child), that new instrument was subjected

~Susan Howson and Donald Moggridge (eds.) The Wartime Diaries of Lionel Robbins and James Meade 1943-45. London: Macmillan, 1990, p. 114 (my italics).

THE INTERNATIONAL MONETARY SYSTEM 481

to benign neglect, and has since become increasingly unimportant as a reserve asset in the international monetary system. 2

A case could be made, of course, that the monetary technology for creating a world currency did not exist in the 1940s. The Articles of Agreement of the IMF- the outcome of compromises-d id not reflect the reality of the international monetary system as it had evolved into an anchored dollar standard. Article IV-4 (a) required that every member country keep the currency of every other member country within one percent of its par value, an absurd clause that, had it been adhered to, would have created a transactions nightmare) The United States (a country that did not usually inter- vene in the foreign exchange market) escaped the requirement by inserting into the Articles, at the last moment, the gold clause of Article IV-4 (b). According to this clause, a country that was buying and selling gold freely was deemed to be satisfying the exchange rate clause. Yet it was this subclause-inserted almost as an after- thought - that was needed to bring the charter into conformity with the reality of the asymmetrical system based on the anchored dollar. Given the confusion at the conference about the then-current system, it is extremely doubtful that the expertise existed to create a workable world currency in 1945.

Had a world currency been created after the war, the international authorities would have confronted a number of difficult questions. How would the transfer of monetary sovereignty and power to an international authority be managed? What criteria would govern the rate of expansion of the international currency? How would currency prices be established in terms of the international currency? What assets would the world central bank hold? How

2A more recent example of the tendency of the dominant power to reject reform or integration is provided by the European Monetary System in which Germany is the regionally dominant economy. In the debates over European monetary integration in the 1970s and 1980s, Germany took the position of the "economists" advocating policy convergence with flexible exchange rates before fixing rates; whereas France took the position of the "moneta- fists" who advocated fixing exchange rates as a means of imposing convergence. As it turned out, the "economist" position became a codeword for rejecting, and the"monetarist" position for pursuing, European monetary union. Chancellor Helmut Kohl, it is true, accepted monetary union but it was a quidpro quo for German unification; in any case Maastricht was saddled with the "economist" Bundesbank's entry requirements that, unless altered, will make monetary union impossible.

3 Instead of fixing every currency as required by the articles, countries fixed a major "convertible" currency (usually the dollar), a practice that the the Fund justified as a "multi- ple-currency" practice.

482 R .A . Mundell

would the seigniorage from the issue of money be distributed? Into what assets would the world currency be convertible? How would the credibility of the international money be protected from shocks like major exchange crises, supply disturbances, debt crises, or wars? How would the assets of the international authority be divided up in the event of its abolition? There was little chance of consensus on the answers to these questions within the framework of the Bretton Woods conference.

Even if these problems could have been solved in the abstract, reality in the form of the Gulliver Problem - the dominant position of the dol lar -would have intervened. Governor Marius Holtrop of Holland once told me, with respect to plans for an international currency unit, that whatever it is called, it will be a dollar! It is easy to imagine a monetary integration under the aegis of the dollar in the postwar decades, but not an integrated monetary world that does not reflect the dollar. Remember Joan Robinson's perceptive observation that the IMF is just "an episode in the history of the dollar."

It could also be (and probably was) argued, that an international currency would not be needed in the postwar world. At that t ime- and since 1934-the dollar was externally convertible into gold at $35. As long as that relationship held, dollars and gold could be used interchangeably, with the dollar as the medium of exchange, and gold as the unit of account and final settlement. The international monetary system that prevailed in the years up to 1971 did indeed prove to be satisfactory-judging from the performance criteria of low inflation, unemployment, and rapid growth. The main problem with the system was that it would not last.

The reason the system was expected to -and d id -break down was much the same as the reason the restored gold-exchange standard of the 1920s broke down: Wartime and postwar inflation, combined with a fixed dollar price of gold, had led to the undervalu- ation and hoarding of gold. In the 1920s there was no mechanism available for raising in a concerted way the price of gold; 4 with gold undervalued, countries that stayed on the gold standard suffered deflation in the 1930s. After Bretton Woods, however, the situation was different. There was a provision in the Articles of Agreement

4Although gold was undervalued, in the sense that its scarcity was creating deflation, no economist at the time advocated a solution through raising its price. Even Gustav Cassel, the Swedish economist who, alone among economists in the late 1920s, predicted the coming deflation, thought that the gold scarcity could be eliminated by economizing on it.


for a universal reduction in par values) In the 1960s, however, the United States rejected that solution to the convertibility problem for good or bad reasons: It would help South Africa, the home of apartheid; it would help the Soviet Union, NATO's enemy in the Cold War; and it would reward countries that had cashed in their dollars for gold and penalize countries that had held onto dollars.

3. THE CREATION OF THE SDR

In one important respect the situation of the 1960s was unlike the interwar period. With memories of the Great Depression still fresh and a new commitment to full employment, no government was willing to accept deflation as an alternative to devaluation. With deflation and a general increase in the price of gold ruled out, emphasis was put on international monetary reform, resulting in the creation of a new international reserve asset, the gold-guaranteed SDR.

The gold-guaranteed SDR had the merit that it was a substitute for gold and thus addressed the major problem of the system; it could be argued that it was a cheaper alternative to raising the price of gold. But it was a case of too little and too late. A substantial increase in gold liquidity was needed. Had the (almost) 10 billion SDRs been allocated at once, gold liquidity would have increased by one third. Had allocations of the same size been made twice, and earlier, and if the United States had adhered to monetary re- straint, the crisis in the system could have been avoided and the anchored dollar standard been prolonged:

The fact is, however, that the postwar system broke down. The breakdown occurred in three steps: In March 1968, the private and official gold markets were separated, and gold ceased to circulate among central banks; in August 1971, the dollar was declared in- convertible; and in June 1973, the dollar standard erected at the Smithsonian Institution in December 1971 was scrapped for flexible exchange rates.

5 Par values for currencies in the Fund were defined in terms of gold (e.g., the par value of the dollar was 1/35 ounces of gold) so that a universal reduction in par values amounted to an increase in the official price of gold in terms of all currencies, leaving exchange rates unchanged.

6 It would, however, be a mistake to think that monetary policies were completely indepen- dent of the level of gold liquidity. The risk from an excessive allocation of SDRs was that the monetary policies of the United States and other countries would become too expansionary.

484 R .A . Mundell

How effectively a regime of flexible exchange rates works depends on the size configuration of the currency areas. Imagine the chaos that would result if the world economy were divided into hundreds of nation-states and currency areas of approximately equal sizes. If this were the case, the need for a world currency would be abun- dantly obvious. Instead, the trading world is (and was) divided into an assortment of powers of very different sizes: a superpower, a few oligops, and a large number of mini-powers. Flexible exchange rates in effect gravitated toward a system of currency areas, with the dollar maintaining its role as the principal provider of international money. Flexible exchange rates did not, therefore, result in the chaos that some economists expected.

Although the dol lar- later supplemented by the mark and the yen-cont inued to serve as international currency in the regime of flexible exchange rates, the break of the link between gold and the dollar made it less attractive in this role. Gold itself became unstable, and monetary discipline-including, crucially, that of the United States-was undermined. Consumer prices tripled in the 15 years between 1968 and 1983, by far the greatest inflation in U.S. peacetime history.

With gold unstable, the dollar became even more important in international reserves. Far from flexible exchange rates ending the need for international reserves, the latter exploded.7 Another conse- quence was that the International Monetary Fund, no longer charged with managing a system of fixed exchange rates, lost its sense of purpose. In 1974, the SDR was demoted from its position as a gold-guaranteed asset, and after 1975, the IMF's role at the center of the international monetary system was increasingly taken over by the G-7. 8

The elimination of the gold guarantee from the SDR revealed a defect in its original construction. Because there were no assets backing the gold-guaranteed SDR, its value depended on the commitment of countries to accept it as it was defined. Astonishingly, the gold guarantee was stripped away without an amendment to the (amended) Articles of Agreement.

An attempt was made to salvage something out of the disaster by the creation of an entirely new facility, the basket SDR. The only feature it shared in common with its predecessor was the name.

7Foreign exchange reserves, measured in SDRs, tripled between 1973 and 1983. aThe managing director of the Fund was, however, a participant at the G-7 meetings.


The new SDR started off as a basket of 16 currencies whose share in world exports averaged more than one percent between 1968 and 1972. On July 1, 1978, the basket was changed to a combination of the currencies of the top five exporting countries weighted as follows: the dollar, 42 percent; the mark, 19 percent; and the franc, the yen and pound, 13 percent each. On January 1, 1986, the SDR basket weights were altered to promote the yen and downgrade the franc and pound- to 42 percent for the dollar, 19 percent for the deutsche mark, 15 percent for the yen, and 12 percent each for the franc and the pound. On January 1, 1991, the basket was changed again with new weights as follows: dollar, 40 percent; the deutsche mark, 21 percent; the yen, 17 percent; and the pound and the franc, l l percent each. These weights continue through December 31, 1994.

The SDR is a derivative of the U.S. dollar. In calculating it, the currencies of the basket are valued at their market exchange rates for the U.S. dollar, and the U.S. dollar equivalents of each of the currencies are summed to yield the rate of the SDR in terms of the U.S. dollar. From its beginning "parity" at $1' -- 1 SDR = 1/35 ounce of gold, the SDR appreciated against the dollar to $1.086 through January 1973, to $1.206 through June 1974, and to $1.3015 in 1981, only to fall to $1.025 by 1984, and then rise again to $1.408 in 1991 and to nearly $1.50 in December 1994. Except for its appreciation in the early 1980s, the dollar has fallen against the SDR, reflecting mainly the very substantial appreciations of the yen and the mark.

The SDR is at best a reserve asset and an index. It is not a real currency, and it can never be "undervalued" or "overvalued." It is an index of five currencies, all of which have depreciated substantially against commodities. The five-currency-basket SDR has lost two thirds of its value against commodities since 1974.

The solution to the world currency problem cannot be found in the SDR as it is presently constituted. What about other possibilit- ies? There was once a possibility that the dollar could serve as the international currency. But the share of the United States in world output, once over 40 percent, is now closer to 20 percent. The United States is still by far the largest economy, and its currency is still widely used as the most important reserve asset in invoicing and in capital transactions. Unfortunately, U.S. monetary policy, once it was released from the discipline of convertibility, became too inf lat ionary-at least for a few of the surplus countries. The U.S. price level rose fivefold in the three decades between 1964 and

486 R .A . Mundell

1994, most of the rise occurring since 1968. The United States had gone too far in its exploitation of the international inflation tax, 9 provoking Europe into creating an alternative to the dollar.

Unfortunately, the other two national currencies that are candi- dates for an international currency, the yen and the mark, would not be satisfactory. Japan represents 12 percent of the world economy and Germany, 8 percent - neither of which in isolation represents a large-enough economic base for a world currency. An imple- mentation of the Maastricht Treaty would make the ECU (or whatever the European currency comes to be called) a worthy con- tender for an alternative to the dollar, but it is as yet a completely untried alternative. No other national currency would receive seri- ous consideration for the role of world currency.

4. COULD GOLD MAKE A COMEBACK?

Could gold make a comeback? The case for gold rests on a large number of factors: its historic stability; its reputation as a symbol of confidence; its tradition as an international money; its role in the Bretton Woods Agreements; the vast holdings of gold as a reserve of central banks, the EMCF and the IMF. As Harry Johnson once quipped, gold is nobody's liability and nobody can print it!

The long-run stability of gold has been documented by Roy Jas- trom in his book The Golden Constant; Jastrom's data span four centuries. Of course the stability of gold is not unqualified. There are long waves a h~ Kondratief that show long if moderate cycles of inflation and deflation over the centuries; inflation from the 1780s to 1815; deflation until 1850; inflation until 1873; deflation until 1896; inflation until 1920; and deflation until 1935. Despite these disturbing cycles, gold was stable in the long run because the price increases during the expansionary phases were offset by price decreases during the contractionary phases (Table 1).

A distinction must be made between the period up to 1873, when bimetallism was the ruling system, and the gold period from 1873 to 1971, when gold eventually became the exclusive monetary metal. In the first period the shocks were dampened by the bimetallic system, with gold and silver shocks alternating. In this period, the main shocks to the stability of the system came from countries

9 For a discussion of the optimum international inflation tax, see my paper, "The Optimum Balance of Payments Deficit," in Stabilization Policies in Interdependent Economies (Pascal Salin and Emil Claassen, eds.) Amsterdam: North-Holland Press, 1972, pp. 69-86.

Ta

ble

1:

Ph

ase

s of

the

Inte

rna

tio

na

l Mo

ne

tary

Sy

ste

m

Syst

em

T

ime

Pe

rio

d

Res

erve

Ass

ets

K

ey

Co

un

trie

s

1

Bim

eta

llis

m

18

15

-18

73

g

old

& s

ilve

r Fra

nce

, U.S

., U

.K.

2

Inte

rna

tio

na

l Go

ld

Sta

nd

ard

1

87

3-1

91

4

go

ld &

s

terl

ing

U

.K.,

U.S

., F

ran

ce

3

An

cho

red

Do

lla

r S

tan

da

rd

19

15

-19

24

g

old

, $,

, U

.S.

4

Inte

rna

tio

na

l G

old

E

xch

an

ge

S

tan

da

rd

19

25

-19

36

g

old

, $,

U

.S.,

U.K

., F

ran

ce

5

An

cho

red

Do

lla

r S

tan

da

rd

19

36

-19

71

g

old

, $,

U

.S.,

U.K

. 6

U

na

nch

ore

d

Do

lla

r S

tan

da

rd

19

71

-19

73

$

, go

ld

U.S

. 7

Fl

exib

le Ex

cha

ng

e

Ra

tes

19

73

-19

79

$

, go

ld

U.S

. 8

"O

pti

mu

m" C

urr

en

cy

Are

as

19

79

-19

85

$

, go

ld, D

M

U.S

., G

erm

an

y

9

Ma

na

ge

d Do

lla

r S

tan

da

rd

19

85

-19

93

$

, DM

, g

old

U

.S.,

Ge

rma

ny

, Jap

an

10

"Op

tim

um

" Cu

rre

ncy

A

rea

s 1

99

4-2

00

5?

$, D

M,

go

ld

U.S

., G

erm

an

y, Ja

pa

n

11

Ha

rd S

DR

Go

ld

Sta

nd

ard

? 2

00

5?-

? $

, ha

rd SD

R, E

CU

U

.S.,

Eu

rop

e, Ja

pa

n

,.-]

Z

-]

rd

-]

Z

r-

Z

-]

oo

488 R .A . Munde l l

entering or joining the monetary standard, usually during or after wars. Thus, the French Revolution took France and eventually Holland and Britain and other countries off their specie standards, leading to a fall in the value of gold (hence inflation), followed, after the war, by a rise when Britain, Austria-Hungary, Russia, and other countries returned to specie (hence deflation).

A new period of instability began with the abandonment of bimetallism in 1873. t Countries jumping onto the gold standard bought gold and sold silver, creating inflation for countries remaining on silver and deflation for countries on gold. The deflationary wave ended only when new gold supplies from South Africa (greatly augmented by the adoption of the cyanide process) caught up and overtook the increases in demand for gold. So productive were the South African mines that the inflationary wave lasted through 1920, checked only by the rising costs of World War I inflation.

The deflationary wave of the 1920s and 1930s occurred as a result of the fascinating mistake made by Germany, Britain, France, and other countries in returning to the gold standard at a time when gold was already undervalued. The return to gold brought new requirements and aggravated an already-apparent scarcity. The great deflationary depression of the 1930s was an immediate conse- quence of that return to gold. In this sense the deflation of the 1930s was caused by the same circumstances as the deflationary wave that began in 1873, and the deflationary wave that followed the Napoleonic Wars. All three deflations occurred because countries shifted back to specie standards without prior allowance for the artificial scarcity that such a return would bring about.

Gold would today make an excellent unit of value for the world economy if the conditions for its stability still existed. One of the bases for its historic stability was not only the huge quantity of gold held in stocks (industry, jewels, and money) relative to current

~Bimetallism was doomed after the two large bimetallic powers, the United States and France, suspended specie payments, the former in 1861 with the Civil War, and the latter in 1870, during the Franco-Prussian War. The dating for the demise of bimetallism to 1873 is based on three considerations: (1) this was the year when France's smaller colleagues in the Latin Monetary Union ceased to buy and sell silver; (2) the "crime of '73," by which President Grant signed a bill that failed to provide for coinage of a silver dollar; and (3) 1873 was the year when, for the first time since 1815, the bimetallic ratio diverged from its range between 15:1 and 16:1.


flows, 1~ but also that gold was widely dispersed in private hands. Today the stock of gold is over 100,000 tons, and annual gold production is less than 2,000 tons; so the first condition holds. However, there is a problem with the distribution of gold. Over one third of the stock is held by central banks and international institutions. Another third is embedded in industry and jewelry, and the remaining third is in speculative hoards. Any concerted movement of gold into or out of central bank stocks- or even the expectation of such a move-would destablize gold in terms of the commodity price level.

5. IS GOLD STABLE?

In short, whether gold is stable or not depends inter alia on the gold policies of governments. It is not enough to rely upon the recent quasi-stability of gold in real terms because gold might become destabilized by the very actions involved in returning to a gold standard. If any country returned to the gold standard today, its price stability could be upset by changes in the gold preferences of other countries.

The United States today, for example, holds about a quarter of the central bank stocks of gold, and seven European countries hold over half. If the United States unilaterally restored the gold standard, its price level could be destabilized by gold dumping in Europe; similarly, if powerful countries with low gold stocks began to accumulate them, the United States would suffer deflation.

It is conceivable that European countries, with their huge gold stocks, could re-establish gold as a vehicle for the promotion of their European currency. A gold ecu, or euror could conceivably provide an alternative route to European Monetary Union.Z2 But it would be a great mistake to embark on such a course unilaterally without agreement from other countries-especially the United States-about their gold policies. In short, a unilateral restoration of the gold standard by the United States or by Europe (or any country) would be an unwise policy that ignored the lessons of history and the implications of international interdependence.

N This feature ensured that normal changes in current supplies and demands had only a small effect on its value and therefore changed the gold-price level only slowly.

~21 have discussed the implications of a European Currency in EMUand the International Monetary System: A Transatlantic Perspective. Austrian National Bank Working Paper No. 13, July 1993.

490 R .A . Munde l l

What about a concerted movement to the gold standard by the major countries, including especially the United States, Europe, and Japan? Alas, restoration of the gold standard at the current dollar price of gold would result in deflation if the restoration led to an increase in demand for gold (as it undoubtedly would). To avoid deflation, there would have to be an agreement on a higher price of gold at which restoration would take place. This price would have to be higher, the more countries went back to the gold standard, and the higher their gold reserve ratios. But an initial price might be rendered incorrect by the addition or remission of more countries to or from the gold brigade. A mere agreement to restore the gold standard without developing the machinery to make it stable would be a grave mistake.

Gold would again become a good standard of value i f and only i f i t were made stable in terms of commodities. Under the anchored dollar standard, as it existed for two decades after 1936, the United States Treasury acted in effect ,".s a buffer stock agency. In 1995, with its diminished gold position, it could not do so. What about Europe? It is conceivable that the EMCF could perform this func- tion for the European Monetary System, but extremely unlikely that they would do so on its own. Stabilization of gold would therefore require the creation of a Gold Stabilization Fund to man- age the international interdependence.

6. TOWARDS A HARD SDR

A rival, or complementary, approach to creating the precondi- tions for a gold standard is to create an international paper currency with a constant purchasing power. Consider, for example, a repre- sentative basket of goods such as that which makes up the cost-of- living index 13 in the United States. An asset could be created that appreciates against the dollar at a rate equal to the rate of change of the Consumer Price Index (CPI). Such a "hard dollar" would satisfy the requirements of a standard of value for the world economy if the basket of goods represented by the CPI of the United States were satisfactory to the international community.

A closely related alternative would be the proposal for a hard SDR. 14 Under this agreement, the hard SDR would appreciate

13For some purposes, the GDP deflator or even the wholesale price index might be a preferable index of inflation.

14For a good discussion of alternative hard SDR proposals, see Subhash Thakur, "The Hard SDR," IMF Staff Papers 41, No. 3 (September 1994): 460-487.


against the (soft) SDR by the average rate of inflation of SDR countries. The existing currency weights of the SDR, however, would create a distortion insofar as they do not reflect the relative sizes of the national GDPs.

The creation of a stable international currency would be a great benefit to the world community. It it were integrated with a proposal for stabilizing the real value of gold, the hard SDR or "intor" could be used interchangeably with gold, thus activating for use the gold reserves held in central bank stocks.

Another variant, in some ways better than the hard SDR, would be to use a basket of all the Fund currencies, weighted either by GDP or by quotas in the IMF, indexed for the rate of inflation. All countries would deposit their currencies in the world central bank that produced the international asset, and supplement their deposits of national currency to maintain their real value as defined in terms of the international unit. This variant would have the constitutional merit of including in the international standard of value all the members of the financial community, without sacrific- ing the stability of the unit.

The political difficulties, however, should not be underesti- mated. 15 The creation of a world currency would confer power on an international bureaucracy, and the major powers may not be willing to take such a step. A major change in the international monetary system could come about only if it were strongly endorsed by at least one of the major powers. No doubt Japan would find international reform compatible if only as an alternative to U.S. monetary bilateralism; but Japan is not likely to take the initiative. Nor is it likely that Europe, caught up in the enthusiasm of EMU, would become an advocate of an international plan in the near future. This leaves the United States. Since the Baker initiative in 1987, there has been no interest in international monetary reform on the part of the United States. But this may change with the new-outlook Congress in 1995. In the political change, the international monetary system should not be excluded.

7. CONCLUSION

The stimulus to reform stems partly from unsatisfactory performance of the international monetary system. Performance was unsatisfactory in the extreme in the 1970s. But, given the mistake of

~ I have discussed some of the political difficulties as well as other matters in Prospects for the International Monetary System, New York: World Gold Council. Research Study No. 8, September 1994.

492 R .A . Mundell

inflationary monetary policy in the 1970s, the dollar fluctuations of the 1980s worked to the advantage of the United States. The appreciation of the dollar in the early 1980s helped the U.S. disinflation program without impairing growth and employment; ~6 and the depreciation of the dollar in the last half of the 1980s helped to prolong the Reagan-Bush growth boom-the longest in U.S. peacetime history.

In recent years inflation has been kept below 4 percent, and exchange rate volatility has greatly diminished. No longer does the dollar gyrate wildly against other currencies. The impetus to reform the system has therefore diminished.

Nevertheless, if the urgency for reform has abated, it remains important, especially for the lesser powers. A universal currency would be of great benefit to the lesser powers that, one by one, might stabilize and enter the world system. The official system of managed flexible exchange rates is not adapted to the developing countries or to those new republics in Eastern Europe and the former Soviet Union that are seeking ways to stabilize their currency. What kind of an anchor is a regime of flexible exchange rates? At the present time the transition economies can fix to the dollar, mark, or yen, but that is less satisfactory, for both economic and political reasons, to stabilizing their currency in terms of a universal standard of value.

Let me conclude, therefore, with an answer to the question posed. Are present international monetary arrangements optimal? My answer is no. There is a missing ingredient in the international monetary system. The missing factor is a stable world currency. Until such a facility is created, the existing arrangements, while likely to continue, will be, at best, second best.

J6To be sure, the combined effect of the inflation in the 1970s and disinflation in the 1980s laid the seeds for both the debt crisis and the collapse of saving-and-loan institutions.

Documents

1-s2.0-016gfdgdffdgd189389500053V-main - Copy