Architects of the International Financial System

Anthony Endres

• Publisher: Routledge
• Year: 2005
• eBook ISBN: 9781134347094
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Who were the great thinkers on international finance in the mid-twentieth century? What did they propose should be done to create a stable international financial order for promoting world trade and economic growth?

This important book studies the ideas of some of the most innovative economists in the mid-twentieth century including three Nobel Laureates; great thinkers who helped shape the international financial system and the role of the World Bank and the International Monetary Fund.

Covering the period from the late 1940s up until the collapse of the fixed US dollar-gold link in 1971, the impact of Hansen, Williams, Graham, Triffin, Simons, Viner, Friedman, Johnson, Mises, Rueff, Rist, Hayek, Heilperin and Röpke is assessed. This outstanding book will prove invaluable to students studying international economics, economic history and the history of economic thought.

1 Essential elements of a doctrinal approach

The primacy of ideas

From the mid-twentieth century the clash of ideas on the organization of the international financial system became more amplified than at any time in history. Controversies in international finance seem to reach a crescendo when evoked by war, impending or actual depressions and financial crises. Only then is the viability of existing international financial relationships called vigorously into question. The range and diversity of proposals on international financial reform offered by economists from about the mid-twentieth century were unprecedented.

The merits of particular forms of international financial arrangements have been debated on and off for centuries. Events such as the economic depression of the 1930s and economic reconstruction following the Second World War placed international financial reform squarely in front of politicians and policymakers concerned to increase or reduce, as they saw fit, international economic interactions such as free trade and cross-border investment. More recently these issues have resurfaced under the guise of ‘international economic integration’ or ‘globalization’.

International economic events and associated monetary upheavals in the twentieth century have been accorded much analysis in some outstanding economic histories (e.g. Solomon 1977, 1999).¹ The genesis of international financial arrangements in the second half of the twentieth century in both their economic and political dimensions has also been given considerable research attention. For instance, retrospectives on the performance of the 1944 Bretton Woods Agreement and the international financial system established thereafter are widely available (Scammell 1975; Tew 1988; Bordo and Eichengreen 1993). Two magisterial studies covering events and policies from 1944 to the 1970s deserve special mention. First, there is J.K. Horsefield's (1969) three-volume study of the International Monetary Fund (IMF) which concentrated on the institutional evolution of that organization in the context of an international financial system governed by rules established at Bretton Woods. Second, there is Harold James's superb International Monetary Cooperation Since Bretton Woods (1996) which highlights actual experience in financial arrangements between countries, ongoing amendments to the Bretton Woods (BW) system and the effects of events and institutional changes on the evolution of international finance up to the 1970s.

Notwithstanding the important contribution made by these studies, along with the vast array of monographs, journal articles and conference compendia which have improved understanding of international monetary events and reforms in practice, a crucial dimension of the subject remains blurred. No searching study has been conducted on the development of international financial ideas and doctrines since the Second World War.² Doubtless the neglect of doctrinal research may be ascribed to a decline in the popularity of intellectual history in the discipline of economics since the 1970s.³

This book will examine competing economic doctrines embodied in plans, blueprints and proposals offered by prominent economists for international financial reform following the Bretton Woods Agreement in 1944 and concluding at the point where the Bretton Woods arrangements were dissolved in the 1970s. The substantive ideational content of the Bretton Woods Agreement which established codes of conduct for participants in the international financial system has been widely discussed. Doctrinal studies on the 1940s concentrate almost exclusively on the Keynes and White plans which formed the initial basis for negotiation over the final Bretton Woods structure (Gardner 1969; Mikesell 1994; Eichengreen 1994). Key proposals and ideas contributed by luminaries in the economics profession in the 1944–74 period have been neglected; many of these vigorously opposed the Bretton Woods arrangements. It will be the purpose of this book to make these ideas accessible, give the reader an appreciation of their richness, subtlety and intellectual strength. The latter turns pre-eminently on the internal logical basis of each set of ideas and the originality or innovativeness of the principles, concepts and analytical frameworks made available by the authors concerned. To the extent that originality and innovativeness also related to specific policy implications for governments and international financial organizations charged with managing the international financial system, the empirical relevance and practicability of the ideas will also provoke discussion and comment in the following chapters. Intellectual rigour will constitute only one element in the exposition of each doctrine; consideration of feasibility, taking account of political constraints, will also have a place. In short, the propagation of a particular set of ideas cannot be fully understood without an appreciation of their practical policy implications.

We aim to describe how and why different ideas on international finance were formulated, who formulated them, and why certain doctrines enjoyed more commanding positions in the debate among economists and policymakers at particular times; why other ideas fell from favour, appeared too idealistic, obscure or radical, or were regarded as unfeasible or at worst downright cranky and idiosyncratic. This book's preoccupation with ideas will remedy the forementioned imbalance in the literature produced by economists and economic historians; it will treat ideas first and foremost as abstract considerations relating to issues in international finance without direct reference to events and immediate policy pressures. In this we shall be following the recommendations of some of the most celebrated thinkers in twentieth-century economics. John Maynard Keynes announced in his General Theory of Employment, Interest and Money (1936: 383) that there were two principal reasons for reflecting on economic ideas in their own right: first, because ‘the ideas of economists . . . are more powerful than is commonly understood’ and, second, because ‘the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas’. And we also follow Friedrich Hayek who wrote in Monetary Nationalism and International Stability (1937: 94) that one is justified in confining attention at least provisionally to ‘theoretical problems’ in the monetary field because ‘in the long run human affairs are guided by intellectual forces. It is this belief which . . . gives abstract considerations of this sort their importance, however slight may be their bearing on what is practicable in the immediate future’. In his monumental History of Economic Analysis (1954) Joseph Schumpeter also endorses the study of economic ideas in the purest sense. What all this means for the evolution of ideas on international financial problems is that the origin, motivation, scope and content of economic ideas should be understood first. In reflecting on the Bretton Woods international financial arrangements so widely accepted in principle in the 1960s, Herbert Grubel (1963: 11) recognized that

the dreams and impractical plans of one generation are often the political and economic dogma of the next. The present international monetary system is itself the outcome of plans developed by men who analyzed what was wrong with the system of the 1930’s. Resistance to change now makes us the slaves of ideas worked out twenty years ago.

On the intellectual architecture of the international financial order

The quest for national and international economic stability from the 1940s to the 1970s prompted many economists to act as ‘architects’ of international financial reform. Various blueprints, nostrums and pragmatic schemes for reconstructing or renovating the ‘system’ have recently been likened to architectural projects (Bank for International Settlements 1998; Eichengreen 1999; IMF 1999). Like architects, economists have drawn up plans – some with a clear conception of an extant structure in mind, others with a stated desire to modify key pillars of a current structure. Still other economists have designed structures beginning with a clean slate of possibilities, without appreciating the need to account for the merits of an existing structure, and with scarce respect for immediate practical contingencies such as national political imperatives and international financial diplomacy.

Certainly material presented in this book may usefully be considered as sets of intellectual constructs or designs with contrasting features, advantages and disadvantages. As purely intellectual creations they may be propounded and subsequently studied and appraised for their relative aesthetic appeal, just as the art of designing physical structures may be undertaken for aesthetic reasons rather than for immediate functional purposes. However, architecture as a discipline is also pursued with a view to rendering buildings comfortable and secure under special environmental conditions (Ballantyne 2002b: 2). Likewise, the architecture appropriate for particular observable international financial conditions may need to have more than purely aesthetic appeal. Therefore, many of the ideas examined below will make references to functions as well as logical form, that is to existing circumstances which make the design relevant and more appealing as a resolution to a problem with an existing structure.

Important clarifications must be made at the outset concerning the notions of ‘doctrine’, ‘system’ and ‘order’ used in the following chapters. Intellectual constructs proposing to change or remake international financial arrangements resemble what Schumpeter (1954: 38) called ‘political economy’; they involve articulation of a doctrine: a ‘comprehensive set of economic policies’ advocated by their authors ‘on the strength of certain unifying (normative) principles’. Now the doctrine may comprise ideas on the essential structure of an international financial ‘order’ and the financial ‘system’, to use Robert Mundell's (1972: 92) terminology. An order ‘represents the framework and setting’ in which international financial arrangements – the financial system – operate. Many of the Schumpeterian doctrines on international political economy surveyed in this book are concerned not with the system, that is with the modus operandi of the international financial order. Instead, they consider the

framework of laws, conventions, regulations and mores that establish the setting of the system and the understanding of the environment by the participants in it. A monetary order is to a monetary system somewhat like a constitution is to a political or electoral system.

(Mundell 1972: 92)⁴

When passing from the formulations of the architects about the international financial order to their advocacy of policies to be adopted within that order, the precision of highly technical economic analysis must usually be abandoned. For policy discussion invariably deals with a world resonant with imperfections and approximations.⁵ At any one time, any real international financial system is a hybrid form of the architects’ ideal construct; it possesses attributes of the ideal financial order in varying degrees. In other words the architects produce stylized ‘schemes of interpretation’ explaining many features of a real, evolving financial system, though ideal-typical examples of their construction can never be observed in reality (Machlup 1978: 251). The architects of international finance write down thought experiments or generalized abstractions and much of the discussion that follows in subsequent chapters will consider these abstractions. As abstractions, they constitute variegated types of economic theory constructed with reference to the broad contours of an existing economic epoch. The general rules of each international order so constructed may be fully outlined by each architect and interpreted with detailed provisions and contingencies relevant to contemporary circumstances or an imagined set of future circumstances. Often reference to concrete circumstances overshadows reference to general abstract principles governing an international financial order, to the extent that the architect will appear to offer an eclectic plan or proposal for financial reform.

Overall, the aim of the following chapters is to compare ideas on financial orders and associated systems. The orders constitute formal rules of the game guiding each nation's participation and operation in an observable, historically specific international financial system. In the discussion that follows it should be kept in mind that use of the term system will apply to the day-to-day ‘mechanisms governing the interaction between trading nations, and in particular the money and credit instruments of national communities in foreign exchange, capital, and commodity markets’ (Mundell 1972: 92).

Choice of great architects

In explaining the essence of each doctrine on international finance this book will use the following questions for guidance:

1. What are the expected objectives and requirements of a genuinely international financial order and its associated systems?
2. What key aspects of the existing system were targeted for reform (e.g. exchange rate regime; capital account liberalization, role of international financial institutions and so forth)?
3. In the immediate period after the Bretton Woods Agreement, did economists’ interpretations of interwar experience influence their proposals and how did their expectations of the postwar world influence their ideas?
4. How well, if at all, did the economists’ doctrines identify defects in the existing Bretton Woods financial order that would lead to serious problems later and how might their proposals have avoided these problems?
5. In different doctrinal traditions on international financial reform, what were the normative bases of reform proposals?

Not all doctrines expounded in the 1944–71 period will be considered in the light of the foregoing questions. The choice of doctrine and ‘great’ representative architect(s) of that doctrine rests on several considerations. First, the doctrine must be significantly differentiated from others, differentiation implying either major framework changes incommensurable with another architectural form or major changes in the existing system which were controversial and extensively debated at the time. Second, the leading architect or group of architects must be associated with a tradition or school of economic thought and policy which has long standing in the discipline of economics and may have received a distinctive title (e.g. Austrian, Chicagoan, Keynesian). Third, the doctrine must have had a dominant intellectual influence in the sense that it has been widely recognized and cited by contemporaries and subsequent commentators. Fourth, the cosmopolitan nature of international political economy demands that the coverage of ‘great’ doctrines must go beyond Anglo American economic thought in the period under review; thinkers of continental European origin (and perhaps resident in Europe) will be chosen where appropriate.

This book will present a procession of leading ideas – a historical array of doctrines – mostly in chronological order and classified where possible by school of thought on the subject. As for possible omissions from the ‘great architect’ category, it should be realized that major contributors to the pure economics of international money may not have reflected extensively on order or system reform issues. In that case they will not be given special attention here. Account must be taken of M. June Flanders's International Monetary Economics 1870–1960 (1989), which treats pure economic analysis and does not study the relationship between relevant ideas and policy questions connected to the international monetary order or system. Thus James Meade, an influential contributor to the economics of the balance of payments in the 1950s and 1960s, figures in Flanders's work as an economist who made notable analytical advances, but that does not in itself qualify him for ‘great architect’ status.⁶ By contrast, Roy Harrod's contributions, while not given much space by Flanders, will be given careful treatment here because he wrote extensively on system reform and international financial policy.

Crucial to the doctrinal orientation adopted here is the need to preserve ideas about international financial orders and systems that appeared irrelevant or unfeasible at the time they were articulated. Mundell's valuable distinction between financial orders and systems permits consideration of alternative orders even if they were constructed to house a hypothetical international financial system. Our story will begin with the Bretton Woods international order already in place. The plans of J.M. Keynes and H.D. White – great architects of the Bretton Woods order – will not be considered in detail. Instead, the fundamental ideational features of Bretton Woods will be outlined in the next chapter. The Bretton Woods outline will function as a benchmark for subsequent architectural projects beginning in Chapters 3 and 4 with two Harvard University-based contributions: Alvin Hansen's American Keynesian reinterpretation of Bretton Woods and John H. Williams's key currency approach which proposes an alternative financial order to that constructed at Bretton Woods. In Chapter 5 we shall see how Frank Graham at Princeton offered a wholesale rejection of Bretton Woods, and his broad commodity reserve currency proposal later drew support in Europe from Nicholas Kaldor and Jan Tinbergen. The plans and arguments of Robert Triffin produced at Yale University in the 1950s and 1960s also attract full consideration in Chapter 6. Triffin salvaged what he thought were the best elements of the Bretton Woods order and reworked some of its central principles. Well-known economists at the University of Chicago – notably Henry Simons, Milton Friedman and Harry Johnson – railed against the Bretton Woods order for over two decades; their Chicagoan alternative is discussed in Chapter 7. Perhaps a more radical approach than that of the Chicagoans was taken by the Austrians – Ludwig von Mises and Friedrich Hayek together with some prominent continental European economists – Charles Rist, Jacques Rueff, Michael Heilperin and Wilhelm Röpke. These Austrian and other European writers wished to design the international financial architecture around the automatic gold standard, and their views are explored in Chapter 8. When the ‘Bellagio Group’ of leading thinkers on international financial reform reported in 1964 (after several conferences in Princeton University and in Bellagio, Italy), a general consensus was forming around reworking the BW architecture though the fixed exchange rate pillar remained a preferred feature (Machlup and Malkiel 1964). Two proponents of both fixed exchange rates and the role of gold in the international order are considered in Chapter 9: the ideas of Oxford economist, Roy Harrod and Canadian (later Nobel laureate) Robert Mundell. Harrod's doctrine exemplified a distinctive British Keynesian approach laced with sentimentality towards gold while Mundell, in producing a critique of the BW order, also offered innovative options for policymakers wishing to preserve the basic Bretton Woods structure.

Chapter organization will conform broadly to the following pattern: (i) introducing the leading architect or group of architec...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Tables
• Preface
• Abbreviations
• 1: Essential elements of a doctrinal approach
• 2: The Bretton Woods financial order
• 3: Alvin Hansen's Keynesian interpretation of Bretton Woods
• 4: John Williams's ‘key currency’ alternative for the international financial order
• 5: Frank Graham on international money and exchange rates
• 6: Robert Triffin's supranational central bank
• 7: A Chicagoan international financial order
• 8: Reconstructing the international gold standard
• 9: Salvaging the fixed exchange rate architecture
• 10: The plurality of international financial architectures in the BW era
• Notes
• Bibliography