– V.Srinivas IAS –
I have reached the 10th article in the series of Major Financial Crisis, which is the concluding piece for this series of articles. The series that commenced with the Great Depressioncovered the Suez Crisis, the International Debt Crisis, the East Asian Crisis, the Russian Crisis, the Latin American Debt Crisis, the Great Recession and the European Crisis. I have tried to give a broad overview of the key events that shaped the international monetary system over the past century.
Pre-World War I, the highly credible gold standard provided long-term exchange rate stability and eliminated exchange rate risk. The October 1929, the Great Depression meant a sudden stop of foreign capital flows to United States and Europe. As the pound was devalued, massive capital flight occurred resulting in competitive devaluations, exchange restrictions, capital controls and trade barriers. The 1944 Bretton Woods Conference resulted in the creation of the International Monetary Fund and formulation of a set of rules to address the challenges. By 1972, the Bretton Woods Agreement had collapsed and the IMF’s Articles of Agreement were amended to legitimize floating exchange rates. Capital account crises were witnessed in several emerging market countries in 1980s, 1990s to 2000s like the International Debt Crisis 1982-1989, Latin American Countries – Mexico, Brazil and Argentina 1994-2003, the East Asian Economies in 1997-1998, the Russian Federation in 1998, and the European Countries – Greece, Portugal and Ireland in 2010-2012. Each of these crisis caused immense hardships – from 15 million Americans were unemployed in the Great Depression, to every person under 25 being unemployed in Greece in the European Crisis – millions suffered. The Great Recession occurred in 2008. During the Great Recession, as in the Great Depression, the world economy witnessed volatile capital flows, scramble for reserves, an asymmetric burden of adjustment and concerns about currency wars.
In a world of increasing capital flows, regulatory challenges have thrown up policy trilemmas. The first trilemma is the incompatibility of capital flows with monetary policy autonomy and fixed exchange rate. The second trilemma is the incompatibility between financial stability and capital mobility. The third trilemma is the interplay between fiscal policy, monetary policy and capital mobility. The East Asian crisis had its origins in the financial liberalization in Thailand when the Bangkok International Banking Facility was established which allowed a substantial number of foreign banks to operate an international banking business. These banks engaged in heavy foreign exchange borrowing which they then used to expand credit domestically. A banking crisis resulted. The Great Recession and the European crisis were also in the backdrop of liberalized financial systems, weakened financial institutions, which provided more room for the buildup of financial imbalances.
There are parallels between the Great Depression and the Great Recession. There are challenges arising from unemployment, economic frustration and social tension: all of which are a legacy of the financial crisis. There is a scramble for international reservesand risk of secular stagnation becoming a world of currency wars. With monetary policy at its limits, fiscal policy hobbled by high debt and political constraints, it is very tempting to boost aggregate demand through currency depreciation. The issue of international policy coordination requires increased multilateralism. One of the steps for increased multilateralism is the cooperation through the BRICS framework – the BRICS countries established a Contingent Reserve Arrangement (CRA)which is a foundation for protection of their economic from a financial crisis. The CRA along with Chiang Mai initiative are efforts to establish monetary cooperation without the United States. That said, the financial leadership of the United States cannot be substituted. Financial crisis require foreign exchange reserves to cope with the global vicissitudes of dollar denominated global monetary and financial infrastructure. Otherwise Nations have to turn to the IMF, which was built as a cornerstone of the international financial system. However in a world of increasing private capital flows, the IMF itself faced an existential crisis in 1990s and had to sell gold reserves for operational viability. The Great Recession and the European Crisis brought forth the multilateral cooperation efforts to address imminent global financial meltdowns. The G20 framework representing 19 of the world’s largest economies and the European Union became the coordinating body for handling the global crisis. Collectively the global comity of Nations was successful in building firewalls, overcoming crisis and restoring growth and market access.
World Economic History
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Senior Bureaucrats and Author
V.Srinivas is an IAS officer of 1989 batch, presently posted as Chairman Board of Revenue for Rajasthan
He had previously served in the Ministry of Finance and as Advisor to Executive Director (India) IMF, Washington DC. Also worked as Planning and Finance Secretary of Rajasthan.
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