States and the Reemergence of Global Finance

From Bretton Woods to the 1990s

Eric Helleiner

• Publisher: Cornell University Press
• Year: 2015
• ISBN:
  9781501701979
• Topic: Economics
• Subtopic: Political Economy
• Index: Economics

Most accounts explain the postwar globalization of financial markets as a product of unstoppable technological and market forces. Drawing on extensive historical research, Eric Helleiner provides the first comprehensive political history of the phenomenon, one that details and explains the central role played by states in permitting and encouraging financial globalization.Helleiner begins by highlighting the commitment of advanced industrial states to a restrictive international financial order at the 1944 Bretton Woods conference and during the early postwar years. He then explains the growing political support for the globalization of financial markets after the late 1950s by analyzing five sets of episodes: the creation of the Euromarket in the 1960s, the rejection in the early 1970s of proposals to reregulate global financial markets, four aborted initiatives in the late 1970s and early 1980s to implement effective controls on financial movements, the extensive liberalization of capital controls in the 1980s, and the containment of international financial crises at three critical junctures in the 1970s and 1980s.He shows that these developments resulted from various factors, including the unique hegemonic interests of the United States and Britain in finance, a competitive deregulation dynamic, ideological shifts, and the construction of a crisis-prevention regime among leading central bankers. In his conclusion Helleiner addresses the question of why states have increasingly embraced an open, liberal international financial order in an era of considerable trade protectionism.

CHAPTER ONE

Introduction

The globalization of financial markets has been one of the most spectacular developments in the world economy in recent years. Although international financial markets flourished in the late nineteenth and early twentieth centuries, they were almost completely absent from the international economy during the three decades that followed the financial crisis of 1931. Beginning in the late 1950s, however, private international financial activity increased at a phenomenal rate. Global foreign exchange trading, for example, was negligible in the late 1950s but by the early 1990s had grown to a daily value of roughly $1 trillion, almost forty times the daily value of international trade. Similarly, gross international capital flows totaled $600 billion by the end of the 1980s, a figure almost twice the size of aggregate global current account imbalances.¹

Most explanations of the globalization of financial markets discount the role played by states. According to this view, unstoppable technological and market forces, rather than state behavior and political choices, were the prime movers behind the phenomenon. As Walter Wriston recently argued:

Today we are witnessing a galloping new system of international finance. Our new international financial regime differs radically from its precursors in that it was not built by politicians, economists, central bankers or finance ministers, nor did high-level international conferences produce a master plan. It was built by technology…[by] men and women who interconnected the planet with telecommunications and computers.²

In recent years, a growing number of scholars in the field of international political economy have challenged this historical account. They have not ignored technological and market developments, but they emphasize the importance of states in the process of globalization. Louis Pauly, for example, has argued that “a global village does not just spring up: it must be created. Politics within distinct state structures remains the axis around which international finance revolves.”³ Similarly, Jeffry Frieden has stressed that “political consent made the global financial integration of the past thirty years possible.”⁴ Susan Strange, too, has emphasized that “it is very easily forgotten that [international financial] markets exist under the authority and by permission of the state, and are conducted on whatever terms the state may choose to dictate, or allow.”⁵

Existing IPE studies of the globalization of financial markets, however, tend to concentrate on certain stages of the process or on the experience of individual countries. I attempt to provide here a more synthetic “political” history of the globalization process which focuses primarily on the crucial role played by advanced industrial states. In addition to assuming this historical task, I have sought to answer a key analytical question: Why has such an open international financial order emerged in an era when states have retained numerous restrictive trade practices? Indeed, the divergent experience in the areas of international trade and international finance in recent years has given considerable strength to the argument that the globalization trend in finance has somehow been beyond politics. If this view is to be successfully challenged, it is necessary to explain why state behavior in matters of international finance has been different from that pertaining to international trade. This explanation might also have broader relevance for IPE debates concerning state behavior relating to open, liberal international economic orders, debates that have until now focused primarily on state behavior with regard to the trade sector.

The book is organized in three parts, the first of which is an analysis of the relationship between the globalization process and the early postwar international economic order. The second part is an explanation of how and why states have promoted the globalization of financial markets since the late 1950s. The concluding chapter addresses the question of why state behavior in finance has been so different from that in trade in recent years. The arguments of each part are briefly summarized in this introductory chapter.

The Restrictive Bretton Woods Financial Order

Among policymakers and scholars concerned with international economic issues, there is a widely held view—even “an article of faith,” as Paul Volcker has described it—that the United States used its overwhelming power in the early postwar years to establish an open, liberal international economic order.⁶ Since the early 1980s, however, this conventional wisdom has come under attack. John Ruggie, for example, argued persuasively in an article published in 1982 that the United States did not in fact promote a purely liberal international economic order at the 1944 Bretton Woods Conference. Rather, it built an “embedded liberal” order in which restrictive economic practices required to defend the policy autonomy of the new interventionist welfare state were strongly endorsed.⁷ A second influential revisionist work was Alan Milward’s 1984 study, which asserted that the importance of Marshall Plan aid in the reconstruction of Western Europe had been greatly exaggerated.⁸ More recently, other scholars have also questioned the notion that the United States used its power in the early postwar years to build a liberal international economic order.⁹

The first part of this book provides strong support for the revisionist school by demonstrating that the globalization of financial markets should not be seen as a direct consequence of the international economic order established under U.S. leadership in the early postwar years. As explained in Chapter 2, the Bretton Woods negotiators, under American leadership, explicitly opposed a return to the open, liberal international financial order existing before 1931. Indeed, they constructed a decidedly nonliberal financial order in which the use of capital controls was strongly endorsed. As U.S. Treasury Department Secretary Henry Morgenthau told the conference, the goal of the Bretton Woods Agreement was to “drive the usurious moneylenders from the temple of international finance.”¹⁰ Chapter 3 makes clear that advanced industrial states remained strongly committed to this restrictive international financial order in the early postwar years, employing extensive capital controls throughout the 1940s and 1950s. Even U.S. policymakers, who chose not to use capital controls in this period, were remarkably accepting, and indeed supportive, of the use of capital controls abroad. In the late 1950s and early 1960s, when Western Europe and Japan finally restored the convertibility of their currencies, the United States also fully supported their decision not to extend convertibility to the capital account.

Four explanations can be given for the widespread use of capital controls and the wariness of states throughout the advanced industrial world to accept a liberal international financial order in the early postwar period. First, following Ruggie’s analysis, the use of capital controls was prompted in part by the prominence of an embedded liberal framework of thought in this period. Although they acknowledged the validity of the liberal case that some capital movements were beneficial, “embedded” liberals argued that capital controls were necessary to prevent the policy autonomy of the new interventionist welfare state from being undermined by speculative and disequilibrating international capital flows. The embedded liberal normative framework in finance was strongly backed by a new alliance of Keynesian-minded state officials, industrialists, and labor leaders who had increasingly replaced private and central bankers in positions of financial power in the advanced industrial world during the 1930s and World War II. Whereas the bankers continued to support a liberal ideology in finance, members of this new alliance favored more interventionist policies that would make finance the “servant” rather than the “master” in economic and political matters.¹¹

The second explanation of the support for the restrictive Bretton Woods financial order was the widespread belief in the early postwar period that a liberal international financial order would not be compatible, at least in the short run, with a stable system of exchange rates and a liberal international trading order. This belief stemmed from the experience of the interwar period, when speculative capital movements had severely disrupted exchange rates and trade relations. It also reflected early recognition of a point that has increasingly been emphasized in recent years by Robert Gilpin and others: that different elements of a liberal international economic order are not necessarily compatible.¹² Faced with a choice between creating a liberal order in finance and building a system of stable exchange rates and liberal trade, policymakers in the early postwar period generally agreed that free finance should be sacrificed. As Lawrence Krause notes, the financial sector was thus assigned a kind of “second-class status” in the postwar liberal international economic order.¹³

The third explanation concerns the sympathetic attitude adopted by the United States toward the use of capital controls in Western Europe and Japan. Although this stance in part reflected the first two factors, it also stemmed from American strategic goals in the cold war after 1947. On one hand, U.S. strategic thinkers were reluctant to alienate their West European and Japanese allies by pressing for unpopular liberalization moves. On the other, as Michael Loriaux has also recently pointed out, U.S. strategic thinkers actively supported financial interventionism abroad as part of a larger effort to promote economic growth in Western Europe and Japan.¹⁴ Indeed, U.S. officials were often more enthusiastic advocates of embedded liberal financial policies abroad than were the policymakers in these countries for this reason. The cold war thus prompted the United States to assume an accommodating or “benevolent” form of hegemony over Western Europe and Japan after 1947; it both yielded to their preference for capital controls and actively supported measures that might foster their prosperity.

There was, however, one brief interval after the Bretton Woods conference and before the onset of the cold war when U.S. foreign financial policy took a different tack. Between 1945 and 1947, leading members of the New York financial community dominated U.S. foreign economic policy and tried to create a more open international financial order by applying more aggressive pressure on Western European countries to liberalize their exchange controls and restore monetary stability. The 1947 economic crisis in Europe, however, marked the failure of the initiative. Although the crisis has usually been attributed to the severity of the economic dislocation in Europe following the war, Chapter 3 suggests that a key cause was the behavior of the New York bankers themselves. Their refusal to cooperate with West European governments in curtailing enormous, disruptive capital flight from Europe to the United States in this period contributed substantially to Europe’s economic difficulties. Their behavior stemmed primarily from their direct interest in receiving the capital as the leading international bankers after the war. This shortsightedness constitutes the final explanation for why a more open international financial order did not emerge in the early postwar years.

Explaining the Globalization of Finance

If states were so wary of international movements of private capital in the early postwar years, what explains the reemergence of global financial markets since the late 1950s? Most histories of the globalization of finance stress the influence of technological changes and market developments. The growth of global telecommunications networks is shown to have dramatically reduced the costs and difficulties of transferring funds around the world. At least six market developments are said to have been significant. The first was the restoration of market confidence in the safety of international financial transactions in the late 1950s. This confidence had been shaken by the 1931 crisis and the subsequent economic and political upheavals. The second was the rapid increase in the demand for international financial services that accompanied the growth of international trade and multinational corporate activity in the 1960s. Third, private banks responded quickly to the global financial imbalances caused by the 1973 oil price rise, encouraging enormous deposits by oil-producing states and the borrowing of those funds by deficit countries. Fourth, the adoption of floating exchange rates in the early 1970s encouraged market operators to diversify their assets internationally in the new volatile currency markets. Fifth, the disintegration of domestically focused postwar financial cartels throughout the advanced industrial world in the 1970s and 1980s forced financial institutions to enter the international financial arena to supplement their declining domestic profits; such a move also enabled them to evade remaining domestic regulatory constraints. Finally, the market innovations that were created in this increasingly competitive atmosphere, such as currency and interest rate futures, options and swaps, also reduced the effective risks and costs of international financial operations.

According to this interpretation, states have played only a minor role in the globalization process. In particular, they are said to have been unable to stop the trend because of the impossibility of controlling international capital movements, which in turn is said to have stemmed from two characteristics of money: its mobility and its fungibility. As Lawrence Krause explains, “[Money] can be transmitted instantaneously and at low cost—indeed, with the mere stroke of a hypothetical pen. It can be inventoried without physical deterioration and without warehousing cost. It can change its identity easily and can be traced only with great effort, if at all.”¹⁵ Increasing international economic interdependence and technological change only multiplied the opportunities for market operators to evade controls, particularly those in the form of “leads and lags” in current account payments. It has thus become common to argue that the endorsement of capital controls at the Bretton Woods Conference was largely useless in that it exaggerated the capacity of states to control capital movements.¹⁶

As will be discussed in Part 2, this attempt to downplay the importance of states is not convincing. International financial markets were able to develop only within what Stephen Krasner and Janice Thomson refer to as “a broader institutional structure delineated by the power and policies of states.”¹⁷ Two questions arise: How were the actions and decisions of states important to the globalization process? Why did states increasingly embrace an open liberal international financial order after having opposed its creation in the early postwar years?

What Role Did States Play in Globalization?

Advanced industrial states made three types of policy decisions after the late 1950s that were important to the globalization process: (1) to grant more freedom to market operators through liberalization initiatives, (2) to refrain from imposing more effective controls on capital movements, and (3) to prevent major international financial crises.

The policy decision to allow market operators a greater degree of freedom through liberalization moves has received the most attention in the growing body of IPE literature. It was first in evidence in the 1960s when Britain and the United States strongly supported growth of the Euromarket in London. This market served as an offs...

Table of contents

• Preface
• Abbreviations
• 1. Introduction
• PART I. THE RESTRICTIVE BRETTON WOODS FINANCIAL ORDER
• PART II. THE REEMERGENCE OF GLOBAL FINANCE
• PART III. CONCLUSION
• Works Cited