Understanding International Finance in Forex
The selections included in this book up to this point have been concerned with the theoretical aspects and policy issues involved in the use of monetary and fiscal policy in an environment from which problems of foreign trade and the balance of international payments have been excluded. In other words, in the jargon of the economist, we have been discussing a "closed economy."
In reality, of course, the U.S. economy is closely linked to that of the rest of the world. In 1972, for example, our exports of goods and services amounted to $74 billion, while our imports came to $78 billion.
Although each of these totals amounted to less than 7 percent of U.S. GNP, imported consumer goods are a significant element in our high standard of living, while both imported raw materials and export markets for our products are of major importance to some of our industries. Moreover, since most of our trading partners are less self-sufficient and more dependent on foreign trade than we are, our trade is more important to the rest of the world than it is to us.
In addition to our trade relations, our financial markets are closely linked to the financial markets of other countries through a complex network of international borrowing and lending activities.
As a result of these trade and financial ties, our prosperity is affected by economic developments occurring in other countries and by policies followed by other governments. And the converse is true, perhaps in even greater degree: since trade with the United States is of major importance to many other countries, economic developments here and the policies we follow will often have a major impact on the prosperity of the rest of the world.
The way in which economic impulses are transmitted from one country to another and the nature of the resulting interdependence that exists among countries depends to a considerable extent on the structure of the international monetary system-that is, the complex web of rules and arrangements governing financial relations among countries. From early 1947 until the beginning of 1973, world trade was based on a financial system which had its origins in the Bretton
Woods Conference of 1944, at which the International Monetary Fund (IMF) was established. This system bore some resemblance to the so-called gold ex change standard that was developed in the 1920s, under which participating countries held their reserves partly in gold and partly in national currencies such as the dollar and sterling-which were themselves freely convertible into gold.
The gold exchange standard proved to be unstable, and under pressures of the Great Depression in the early 1930s, it broke down completely as a result of speculative movements of funds induced by fears of currency devaluation. The result was nearly a decade of international monetary chaos which helped to spread depression throughout the world and brought a drastic decline in world trade.
The Bretton Woods system contained features designed to pre vent a repetition of the international financial disaster of the 1930s, and the strength of the system is most clearly reflected in the vigorous growth and prosperity of the world economy and the rapid expansion of international trade that occurred during the quarter century following its establishment.
But with the passage of time certain problems with the system became increasingly apparent, and its future is in doubt as of this writing since the convertibility of dollars into gold which was a fundamental part of the system was suspended by the United States in 1971 in response to massive short-term capital outflows; and in February, 1973, eight of the European participants decided to let their currencies float jointly against the dollar, while maintaining fixed rates among themselves.