What is International Money ?

Investment decisions must increasingly be made with an eye on what is happening throughout the world economy. As barriers to trade and financial flows between countries have come down, the global movement of goods, services and capital has made national economies more and more interdependent. Daily currency flows approximate four months of world trade. A single country's long-term financial plans can be swamped in a few days by ravenous traders sensing weakness. And watertight doors of credit agreements and domestic central banks collapse under the weight of collective monetary movements.

In these circumstances, it is no longer possible for governments and central banks to conduct monetary policy at the national level: policy cooperation through international bodies like the IMF and the G-7 has become essential. And it seems certain that a crisis in one part of the world will ultimately affect everyone else. One senses that the private view of government officials and bankers is that something has to be done. But what? Disagreements that were previously guarded now flare in public. Yet all that can be agreed is to form a new committee or meeting group.

The forces of globalization and liberalization have led to major changes in the way central banks go about their principal tasks. Markets have become much more powerful: they discipline unsustainable policies; and they give participants ways to get round administrative restrictions on their freedom of action. This means that central banks have to work with rather than against market forces. Maintaining low inflation requires the credibility to harness market expectations in its support. And effective prudential supervision involves incentive-compatible regulation.

In monetary policy, attempts to exploit a supposed trade-off between inflation and unemployment have given way to a focus on achieving price stability as the best environment in which to pursue
sustainable growth. The intermediate goals of monetary policy have also changed. Monetary targets and exchange-rate pegs have proved difficult to use in practice, and an increasing number of countries have adopted inflation targets, backed up by transparency in the policy-making process and independence of action for central banks.

The objective of financial stability has acquired much more prominence in recent years, following various high-profile mishaps at individual institutions and severe problems in some financial systems. It has become harder to segment different types of financial activity or to apply restrictions to the activities of individual institutions. Systemic stability requires ensuring that financial institutions properly understand and manage the risks they acquire, and hold an appropriate level of capital against them.

The international monetary system has been through a major transformation in the past 25 years. The Bretton Woods system developed at the end of World War II was government-led: official bodies decided on exchange rates and the provision of liquidity, and oversaw the international adjustment process. Now, the system is market-led: major exchange rates are floating; liquidity is determined by the market; and the adjustment mechanism operates through market forces. The job of central banks is to see that market forces work efficiently and that any instability is counteracted. This seems to mean stable and sustainable macroeconomic policies, and, where possible, action to ensure that inevitable changes in the direction and intensity of capital flows do not destabilize financial systems.

Changes in interest rates, inflation rates and exchange rates across the international monetary system are likely to have a significant impact on investments of all kinds. But of overriding importance at this turn of the century is what has become known as the global crisis. What started in the summer of 1997 as a regional economic and financial crisis in Asia had developed into global financial turmoil by the summer of 1998. The troubles spread to Russia with its debt default and currency devaluation; and they have since threatened Latin America. Meanwhile, Japan, the number two
economy in the world, has sunk into a depression from which it seems powerless to recover.

Despite the respite seemingly provided by coordinated interest rate cuts led by the US Federal Reserve, the global crisis is still with us. It seems unlikely that the United States can continue for long to be "an island of prosperity in a sea of depression." In a new and increasingly unstable system, the benefits gained by quickly grasping the dynamics are huge. A scholarly and instinctive approach is needed.