The Influence of Political Philosophy on Postwar Monetary Policy
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Abstract

 

          In this paper, I will argue that states’ international monetary policies represent their underlying political philosophies and that discord between their philosophies breeds conflict between their economic policies.  The paper will begin by investigating the political foundations of the Bretton Woods financial order, and then will explain how states that embodied a divergent philosophy undermined that postwar regime.

  

Introduction

 

          We might think of an economy as the sum of the voluntary, or physically uncoerced, exchanges between the residents or citizens of a state.  A government cannot change this voluntary aspect of an economy; it can employ its monopoly on the legitimate use of coercion only to proscribe some exchanges or prescribe conditions for others.  Do its leaders view these voluntary exchanges as inviolable?  If so, they will not limit them, and a classical liberal economy will result.  Or do leaders have higher aims?  If so, they will encircle these voluntary exchanges with constraining or confiscatory devices that further the leaders’ aims; we might say that they will embed liberalism “within a larger social context of goals beyond those of economic efficiency.”[1]  Therefore the most fundamental question in political economy

is whether to politically embed the economy – whether the state may initiate coercion against individuals whose own exchanges are wholly voluntary – whether the individual belongs to himself or herself or to the collective.

  

Bretton Woods

 

          The Bretton Woods financial order represented an attempt to embed liberalism on an international scale.  This postwar economic regime consisted of two main components.  On the one hand, the “larger social context of goals” required each government to intervene in its domestic economy – in particular, “to expand and contract the national money supply in the quest for full employment and economic growth.”[2]

 

          On the other hand, these manipulations would alter domestic interest rates and create “differential rates of expected return in expected states,” which would prompt arbitrage in international currency markets, which in turn would destabilize the exchange rates of foreign currencies.  A government could restore preexisting exchange rates only by bringing monetary policy back in line with “international trends” – i.e., by sacrificing “the independent pursuit of monetary policies.”[3]  Yet postwar policymakers were unwilling to make this sacrifice.  Bretton Woods instead advanced the “restrictive economic practices” – namely, capital controls – that were “required to defend the policy autonomy of the new interventionist welfare state.”  These controls would prevent “speculative…international capital flows”[4] from taking advantage of “differential rates of expected return” to “generate foreign exchange market disequilibria.”[5]  Stable exchange rates would ensue, “encouraging international economic transactions.”[6]

 

          Both components of the Bretton Woods order conform to the same philosophical rationale for embedding an economy.  By manipulating “the national money supply in the quest for full employment,”[7] Keynesian macroeconomic policy redistributes “purchasing power,”[8] and the welfare state imposes a more direct tax on the wealthy.  Social aims of (a) economic equality and (b) general prosperity appear to override the goal of upholding individuals’ property rights, i.e., their freedom from coercion.  The collective makes a claim on the individual.

  

          The selection of capital controls over floating exchange rates reveals a similar principle.  Eric Helleiner argues that a key “explanation of the support for the restrictive Bretton Woods financial order was the widespread belief” in the incompability of “a liberal international financial order” and “a stable system of exchange rates and a liberal international trading order.”  But rather than liberalizing finance and trade, and letting exchange rates float, postwar leaders chose to “drive the usurious moneylenders from the temple of international finance” – to sacrifice individual freedom in the “financial sector.”  In return, states expected “a system of stable exchange rates and liberal trade,” which presumably would enhance general “prosperity”[9] in line with goal (b) above.

  

The Capital Mobility Hypothesis

 

          The Bretton Woods order grew impracticable as states “embrace[d] an open, liberal international financial order…beginning in the late 1950s.”[10]  David Andrews terms this the “capital mobility hypothesis”: “as capital mobility increases, the nature of [the] trade-off” between monetary autonomy and exchange rate stability “becomes more severe.”[11]  But if states had supported capital controls “in the early postwar years” to achieve certain political goals, then why would they narrow their political choices by repealing those controls?

  

          Andrews finds “at least three distinct types of underlying causes”: first, technological innovation has streamlined “private international capital transactions”; second, private actors have developed new financial instruments that similarly “facilitate[ed] the flow of capital across borders.”  Yet while these two trends may have hindered the enforcement of capital controls,[12] the state – as a monopoly on coercion – undoubtedly possessed tools to obstruct illegal capital flows.  Indeed, Helleiner writes that Western states made a decision not to “impos[e] more effective capital controls,” even though the creators of the Bretton Woods order had earlier proposed “specific mechanisms for overcoming [the difficulties]” of controlling capital.[13]

 

          Andrews provides a third reason for the abandonment of capital controls.  States now want to attract “capital-asset-holders” to their economies; “they are…effectively competing” with other states “for the right to regulate capital.  The general thrust of this new competitive dynamic has been for states to accommodate the preferences of market actors by liberalizing (or, in other words, lowering) their regulatory standards.”[14]  Yet this process was not inevitable: competitive pressures may undermine the “regulation of national financial markets,” but these pressures fail to account for the original liberalization “of capital movements between [markets].”  Andrews tries to explain the paradox by arguing that “[i]t is not clear that the…implications of capital control abolition were entirely understood by all the governments that undertook these reforms…[particularly] European governments.”[15]  However, Helleiner attributes more plausible motives to these states: they revoked capital controls not out of confusion, but rather to compete for capital in an earlier competitive spiral with the two states who first pushed for “a more open international financial order”: the United States and Britain.  These two states unilaterally gave “mobile financial traders a location in which to operate without regulation,” and both “supported [the] growth of the Euromarket in the 1960s and then liberalized and deregulated their financial markets in the 1970s and 1980s.”[16]  The source of increasing international capital mobility, in short, was states with relatively unembedded liberal economies.

  

Lessons

 

          Implicit in this historical account is the lesson that different political philosophies conflict – not only in theory, but also in their applications to international economic policy.  A state X whose leaders want to embed its economy and to stabilize its exchange rates requires capital controls.  Without these controls, X cannot augment (a) domestic economic equality with (b) the general prosperity gained by international trade.  But a state Y whose economy is unembedded and whose leaders unilaterally permit capital mobility will push X both to revoke its own capital controls and to deregulate its own markets, as outlined above.  Therefore X must accept increasing inequality at home, as it loses monetary policy autonomy – or it must accept increasing inequality with the rest of the world, if it chooses to maintain the capital controls and regulations that drive away market actors.  Either outcome is philosophically unacceptable to X.  And just as X’s leaders employ Keynesian macroeconomics or welfare policies to preclude such outcomes at home – as they use their monopoly on coercion in order to force state goals upon individuals who would frustrate those goals – so X will attain national aims by employing coercion against any states that would frustrate those aims.

  

          Here we return to the core philosophical principle: the collective is making a claim on the individual.  This principle wholly contradicts the belief that the individual belongs to himself or herself – a belief that underpins opposition to Keynesianism macroeconomic policy, to capital controls, and even to government-maintained exchange-rate stability.  And whether these opposing creeds are embodied by two individuals, two classes, or two nations, conflict will ensue.

  

Conclusions: Evidence from Politics and Academe

 

          Of course, Anglo-American international economic policies did not provoke war with the embedded liberal economies of the European continent.  European leaders likely do not assign economic equality such a high value relative to general prosperity.  In fact, the more they esteem overall prosperity, and the less heed they give considerations of equality or freedom, the more they will appear non-ideological or practical – and Kathleen McNamara indeed finds “that the governments of Europe followed a pragmatic, not ideologically purist, type of monetarism”[17] in response to economic crisis and capital mobility.

  

          On the other hand, individual scholars who can afford greater philosophical consistency take these beliefs to their logical conclusions in the form of policy prescriptions.  For example, in Mad Money Susan Strange considers central banks to be “ill-suited to the task” of resolving crises because they “have an innate tendency to prefer deflation to inflation, and to judge monetary stability more important than keeping people in jobs and troubled businesses from closing down”; unsurprisingly, she adopts a Keynesian perspective.  Equally unsurprising is her endorsement of the global policies that the aforementioned state X must follow if it is to embed its economy in a world it shares with state Y.  Jonathan Kirshner actually labels Strange’s approach as “global Keynesianism”;[18] she concludes with clear disappointment that neither individual states nor international economic institutions are “up to the job of managing mad international money” on a worldwide scale.[19]  And although this paper greatly diverges from Kirsher’s in tracing the economic implications of her political philosophy, we nevertheless might agree with his conclusions:

 

....That apparently technical debates are inescapably political.  And that those politics, more than the underlying economics, can best explain the shape of the monetary landscape.[20]

 
 


          [1] Kathleen McNamara, The Currency of Ideas: Monetary Politics in the European Union (Ithaca, NY: Cornell University Press, 1998), p. 54.

          [2] Ibid., pp. 54-55.

          [3] David M. Andrews, “Capital Mobility and State Autonomy: Toward a Structural Theory of International Monetary Relations,” International Studies Quarterly 38, no. 2 (June 1994), p. 195.

          [4] Eric Helleiner, States and Reemergence of Global Finance: From Bretton Woods to the 1990s (Ithaca, NY: Cornell University Press, 1994), p. 3.

          [5] Andrews, p. 195.

          [6] McNamara, p. 54.

          [7] Ibid., pp. 54-55.

          [8] Jonathan Kirshner, “The Study of Money,” World Politics 52 (April 2000), p. 427.

          [9] Helleiner, pp. 5-6.

          [10] Ibid., p. 12.

          [11] Andrews, p. 209.

          [12] Ibid., p. 198.

          [13] Helleiner, pp. 8-9.

          [14] Andrews, p. 199.

          [15] Ibid., p. 200.

          [16] Helleiner, pp. 12-14.

          [17] McNamara, p. 67.

          [18] Kirshner, pp. 418-419.

          [19] Ibid., p. 421.

          [20] Ibid., p. 436.


   

 
 
(c) 2008 Jacob Jaffe