The Borrower of Last Resort: International Adjustment and Liquidity in a Historical Perspective
Vasudevan, Ramaa, Journal of Economic Issues
If the operation of the gold standard from the last two decades of the nineteenth century, until the outbreak of the world war was in essence a sterling standard, the Bretton Woods system instituted after the Second World War in effect forged a dollar standard. The crux of these arrangements was the emergence of the monetary liabilities of a single country as the principal means of settlement of balance of payments between countries, internationally. It is argued that the stable functioning of the international monetary system depends on the dominant country acting as the international lender of last resort, injecting liquidity through their central role in international financial intermediation (Kindleberger 1982; 1985; 1996). In this paper, I have argued that the efficacy of this mechanism hinges on the ability of the "leading" country to draw short-term capital flows and stem the efflux of capital in the face of growing trade deficits and dwindling reserves, in short its ability to act as a "borrower of list resort."
The paper surveys the actual workings of the international gold standard before tracing the historical process by which the floating dollar standard was established after the collapse of the Bretton Woods system. The comparative historical analysis yielded interesting insights into the manner in which international liquidity was generated and the implications of the dominance of the monetary liabilities of a single country in the settlement of international payment balances. The privileged position of the currency of a single hegemonic country in the international monetary system imparts a degree of elasticity to adjustments in the developed core of the global economy. The mechanisms for liquidity creation and adjustment do not, however, depend on the dominant country retaining a "creditor" status. Rather, financial intermediation is made possible by the country's ability to continue to incur liabilities without undermining its privileged status. Historically specific, institutional mechanisms, which relate both to imperial hegemony and international diplomacy, played a critical part in enabling the leading country to perform the role of financial intermediation by extending its short term monetary liabilities. A pivotal role is played in these mechanisms by triangular patterns of adjustment with the periphery that allow the dominant country to borrow from surplus countries and pass the burden of deflationary adjustment shocks to peripheral debtor countries.
International liquidity in the post-Bretton Woods System is in effect based on triangular settlement mechanisms that parallel that of the international gold standard period. In comparing the emergence of the post-war dollar standard to the pre-1914 gold standard it is argued that the eurodollar markets that arose in the sixties played a role that was analogous to that of the markets for sterling finance bills and the imperial network in the sterling standard period. While recognizing that the specific institutional mechanisms were quite distinct in the two periods, the purpose of this analogy is to focus on the role of such parallel monetary mechanisms in preserving the dominance of the key currency.
The International Gold Standard
Conducting the International Orchestra
The prewar "international gold standard" emerged in the last two decades of the nineteenth century, when most countries had shifted from silver and bimetallic standards to a gold standard. This international monetary regime can be seen to reflect the British domination of the international financial system as the largest capital market and trader. (1) The stability of the international monetary system, during this period, is ascribed to the management of the system by the Bank of England. The Bank of England played the role of "the conductor of the international orchestra" and was able to calibrate international movements of gold, on the basis of relatively small gold reserves, by manipulating the bank rate (Sayers, 1970; Eichengreen 1987)
The ability of the Bank of England to manage the system was by no means absolute (Gallaroti 1995). …