EVOLUTION OF THE INTERNATIONAL AND REGIONAL MONETARY SYSTEMS

Robert Triffin

Evolution of the International and Regional Monetary Systems

Essays in Honour of Robert Triffin

Edited by

Alfred Steinherr and Daniel Weiserbs

Palgrave Macmillan

© Alfred Steinherr and Daniel Weiserbs 1991 Softcover reprint of the hardcover 1st edition 1991

All rights reserved. For information, write: Scholarly and Reference Division, St. Martin's Press, Inc., 175 Fifth Avenue, New York, NY 10010

First published in the United States of America in 1991

Library of Congress Cataloging-in-Publication Data Evolution of the international and regional monetary systems: essays

in honour of Robert Triffin I edited by Alfred Steinherr and Daniel Weiserbs.

p. em. Includes index.

1. Monetary policy. 2. International finance. I. Triffin, Robert. II. Steinherr, Alfred. III. Weiserbs, Daniel. HG230.3.E96 1991 332'.042-dc20 90-43256

CIP

ISBN 978-1-349-11063-6 ISBN 978-1-349-11061-2 (eBook)

ISBN 978-0-312-05302-4

ISBN 978-0-312-05302-4

DOI 10.1007/978-1-349-11061-2

Contents

Robert Triffin

List of Figures

List of Tables

Foreword

Frontispiece

Lord Jenkins of Billhead

Notes on the Contributors

Acknowledgements

Robert Triffin Alfred Steinherr

PART I INTERNATIONAL CO-ORDINATION OF ECONOMIC POLICIES: DIFFICULTIES AND PERSPECTIVES

1 The International Monetary System: Pluralism and

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ix

xi

XV

xvi

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Interdependence 3 James Tobin

2 Whither Macro-economic Policy Co-ordination? 10 John Williamson

3 Potential Gains from and Obstacles to International Policy Co-ordination 26 Robert Solomon

4 International Central Bank Co-operation: What It Can - and Cannot- Achieve 35 Alexandre Lamfalussy

5 Experience and Problems in International Monetary Policy Co-ordination 46 Wolfgang Rieke

v

vi Contents

PART II APPROACHES TO EXTERNAL DISEQUILIBRIA

6 Approaches to Managing External Equilibria: Where We Are, Where We Might Be Headed, and How We Might GetThere 59 Edwin M. Truman

7 The Exchange Rate and the Trade Balance: Insular Versus Open Economies 78 Ronald I. McKinnon

8 Exchange Rate Volatility and Misalignment: Evaluating some Proposals for Reform 99 Jacob A. Frenkel and Morris Goldstein

PART III INTERNATIONAL AND REGIONAL MONETARY PROBLEMS

9 Robert Triffin and the Reform of the International Monetary System Jacques de Larosiere

10 The Future of International Monetary Relations Michel Aglietta

11 Monetary Management in Latin America Victor L. Urquidi

12 A Proposal for Co-operative Relief of Debt in Africa (CORDA) Jacques Dreze, Albert Kervyn, Jean-Philippe Platteau and Paul Reding

PART IV EUROPEAN MONETARY INTEGRATION

13 European Monies and European Monetary Union Tommaso Padoa Schiappa

135

144

160

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201

Contents

14 Is the European Monetary System a DM-Zone? Paul De Grauwe

15 ECU Financial Markets: Recent Evolution and Perspectives Alfred Steinherr and Jacques Girard

VII

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228

List of Figures

7.1 Responses to an 'exogenous' rise in s in anticipation of future monetary expansion in an open economy 92

8.1 Major industrial countries: real effective exchange rates, 1980-88 107

12A.1 Relationship between secondary market price (COTE) and country risk (RATING) 196

14.1 French and German offshore 3-month interest rate and forward premium DM/FF 211

14.2 Italian and German offshore 3-month interest rate and forward premium DM/Lira 212

14.3 Differential offshore and domestic interest rate (3-month) France 213

14.4 Differential offshore and domestic interest rate (3-month) Italy 213

14.5 Domestic interest rate (3-month) and forward premium DM/FF 214

14.6 Domestic interest rate (3-month) and forward premium DM/Lira 215

15.1 ECU yields 237 15.2 Habitat: Belgian franc short-term nominal yield in

foreign currencies 246

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List of Tables

7.1 Insular economy with a pegged but adjustable exchange rate 85

7.2 Open economy with a forward looking (floating) exchange rate 91

8.1 Short-term variability of asset and/or auction prices, 1973-88 101

12A.1 ACP foreign debt (1986)- estimated market value 190 12A.2 Face value and the estimated market value of total

external debt 193 12A.3 Estimation of the secondary market price for the

debt of some developing countries 195 14.1 Unconditional and conditional standard deviations

of the monthly changes of the offshore and the domestic interest rates in the EMS 216

14.2 Estimation of equations (4) and (5); offshore interest rates 217

14.3 Estimation of equations (4) and (5); domestic interest rates (Treasury Bill rates) 218

14.4 Tests of causality (likelihood ratios), short-term interest rates 221

14.5 Tests of causality (likelihood ratios), long-term interest rates 221

14.6 Correlation matrix of contemporaneous changes in interest rates (3-month domestic interest rates) 222

14.7 Correlation matrix of contemporaneous changes in interest rates (Government Bond yield) 223

14A.1 Estimation of equations (4) and (5); offshore interest rates 225

14A.2 Estimation of equations (4) and (5); domestic interest rates 226

15.1 International ECU lending 239 15.2 Public bond issues denominated in ECUs since 1981 240 15.3 ECU issues by type of borrowers 240 15A.1 Composition of minimum variance foreign currency

portfolio 252 15A.2 Composition of minimum variance international

portfolio 252 15A.3 Incremental portfolio along the efficiency frontier 253

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15A.4

15A.5 15A.6

15A3.1 15A4.1

List of Tables

Composition of efficient international portfolio with same risk as habitat currency Composition of minimum variance portfolio Portfo~o composition for optimal exchange risk coverage Yen habitat: composition of MVP Composition of portfolios

253 254

255 259 260

Foreword Lord Jenkins of Hillhead

Since I left Brussels I have not been back a great deal. This has certainly not been due to any distaste - indeed I look back with nostalgia on the years from 1977 to 1981 -but rather to involvement with other things. The last time I came here was indeed as much as 15 months ago when I came to pay tribute to Emile Noel, the Secretary General of the Commission, on his retirement. I accepted with alacrity the opportunity to pay a similar tribute to Robert Triffin although not, I am happy to say, on retirement but for 50 years of international achievement.

Robert Triffin is one of the most quietly remarkable men that I have known. In at least two ways he spans two worlds. He has spent most of his life in the United States, a major figure in the life and teaching of Yale, a member of the Council of Economic Advisers, and much involved in Latin American monetary problems. But he was born, and remains, a Belgian, feeling in a fashion typical of the best traditions of this land which is almost more a meeting point than a country, a special responsibility for trying to make sense out of the clashing nationalism of Europe. Equally he has been a theoretician who has always been happiest when he was trying to advance practical solutions to pressing problems.

He was the principal architect of the European Payments Union in the late 1940s. He then made a unique contribution to freeing Western Europe from the shackles of a hobbling bilateralism. Thirty years later his knowledge and experience, together with his patient optimism, were essential ingredients in the setting up of the Euro­pean Monetary System.

As President of the Commission of the European Communities I tried to relaunch the idea of economic and monetary union in 1977. To begin with it fell on arid ground. But Robert Triffin was there with a watering can of intellectual refreshment. Within six months former Chancellor Schmidt and President Giscard d'Estaing began to see the need for at least a limited advance. A year later the EMS was in operation and it has now worked remarkably well (although, alas, without Britain) for almost 10 years. Adjustments have been neces­sary, but they have been carried through quietly and efficiently. And

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in a turbulent monetary sea, the Europe of the Community has been an island of relative exchange rate stability. Robert Triffin has helped to get us so far, and is constantly probing the possibility of necessary further advance.

The fertility of his ideas and the calm persuasiveness of his advocacy make it reasonable to compare him with Jean Monnet. But there is a difference. Monnet, with all his great gifts, saw things in black and white, with stark simplicity. Triffin comprehends all the complexity, but still sees the way forward.

His route, like mine, has been the monetary route, but that route has wide consequences. Anything to do with 'banking and currency', as our Oxford examination paper on this subject used to be called, has great political impact and this is particularly true of our European monetary arrangements.

The EMS began in 1978 by nearly toppling the Andreotti Govern­ment which was then in office in Italy, which was torn between what it saw as the economic risks and the political advantages of joining. But the effect over a ten-year span has been to hitch the Italian economy (or at least the northern and central parts of it) far more firmly on to the Franco-German core than would otherwise have been the case, and thus to avoid a two-speed Europe split, at any rate along a north/ south divide.

In France the political consequences came later, but were at least as momentous. In 1983 it faced the Mitterand Government with a clear choice. Either it could continue with its doctrinaire policies of the first two years, or it could remain a participant in the EMS and faithful to Europe and to the partnership with Germany. It could no longer do both. Perhaps with a sigh of relief it recoiled from doctrine, a semi-siege economy, and a defeat for the prestige of France, and opted firmly for the latter. No one can doubt that had they chosen otherwise the whole evolution of French politics over the past five years would have been utterly different.

Britain believed that the political complications of the EMS could be avoided by the simple device of staying out of the exchange rate mechanism. Within six months of each other, Mr Callaghan told me that. he had to stay out because otherwise too high a rate would prevent him dealing with unemployment, and Mrs Thatcher told me that she had to stay out because otherwise too low a rate would prevent her dealing with inflation. They did it in the same room to point the matter up; and Britain then proceeded for several years under both of them to enjoy a higher combination of unemployment

Lord Jenkins of Hillhead xm

and inflation than any participating member. But now the turbulent meeting of the new European spirit and Mrs

Thatcher's edict of Bruges ensures that the political tensions for Britain will be at least as great as they were for Italy or France. It is difficult to exaggerate the extent to which the European prospect has been transformed in the past two years or so. As recently as 1985 there was a widespread impression that the European Community with no significant achievement since the direction-pointing but limited one of the European Monetary System six years before, was bogged down in a sterile and apparently unending internal budgetary dispute, and had lost both its dynamism and its idealism. There was a fear that the enlargement to 12, with the impending entry of Spain and Portugal, would mean a further weakening of the decision­making power like that which occurred after the first enlargement from six to nine in 1973.

I never believed that there was a serious danger of the European Community breaking up. The sinews of economic interest had grown too strong for that. It was stagnation not disintegration which was the danger. But it seemed only too likely that the Community's institutions would continue in the trough of disregard to which the debilitating disputes and petty horizons of the early 1980s had condemned them.

This proved to be quite wrong. It underestimated the positive European commitment of the two Iberian countries, which far exceeded that shown by Britain and Denmark after 1973. It did not allow for the fact that the ratification of the Single European Act in 1986, by a return to some qualified majority voting pulled together the decision-making process more than the increase in the number of member states pulled it apart. And above all it ignored the extent to which the idea of 1992 could suddenly seize the imagination of business communities and governments. To some considerable extent this course of advance started with spontaneous grass roots irritation with the inconvenience of frontiers rather than with a response to political leadership.

However it has happened. This new capacity of the European idea to get up off its bed and walk may have been sufficient to take the Community past a critical point. Previously, ever since the great surge forward of the first years of the EEC came to a shuddering halt in 1966 with the quarrel between General de Gaulle and President of the Commission Walter Hallstein, the forces of inertia have been stronger in Europe than those of movement. It was sometimes possible to get things done, but it was hard going, struggling against

XIV Foreword

the grain. Now there has been a qualitative change, by which it has suddenly become possible to get enthusiastic support not merely for the next goal but for the one beyond that. Thus no sooner has the Single Market in 1992 begun to look possible than it is reasonably pointed out that this is not going to make much sense without stable internal exchange rates and a common monetary policy. As a result plans for a European Central Bank and even a common currency have come seriously over the horizon.

Too many people will see the clear consequences of a fourth refusal by Great Britain, which will be these:

(a) It will guarantee that leadership in Europe remains exclusively Franco-German. (b) It will make inevitable a two-speed Europe, with the only question being how many minor laggards Britain can keep in the rear column with her. (c) Standing out from central bank and common currency moves will endanger even the apparently impregnable financial pre­eminence of the City of London. (d) It may isolate British industry from the full benefits of the Single Market.

I do not think therefore that even with her great authority, Mrs Thatcher, inevitably towards the end of her long reign, will be allowed quickly to set Britain on a lone and rocky course for the late 1990s and beyond when she will not have to steer it. tt is very difficult for Mrs Thatcher to simulate a European feeling that she does not possess, or to respect European institutions largely run by foreigners who are not Americans. Out of these honest but stubborn prejudices will come much trouble for the future.

I do not however think that this will or should cause any weakening of drive so far as the remainder of the Community is concerned. Windows of opportunity open rarely. When they do they should be used to the fullest possible extent. This is such a moment, let us use it to the full.

Notes on Contributors

Michel Aglietta, Professor Paris X and Adviser at CEPII, Paris

Jacques de Larosiere, Governor, Banque de France, Paris

Paul De Grauwe, Professor, KUL, Leuven

Jacques Dreze, Professor, UCL, Louvain-la-Neuve

Jacob Frenkel, Economic Counsellor and Director of Research, IMF, Washington

Jacques Girard, Division Chief, EIB, Luxembourg

Morris Goldstein, Deputy Director, Research Department, IMF, Washington

Lord Jenkins of Hillhead, Chancellor, Oxford University

Albert Kervyn, Professor, UCL, Louvain-la-Neuve

Alexandre Lamfalussy, General Manager of the BIS, Bale

Ronald McKinnon, Professor, Stanford University

Tommaso Padoa-Schioppa, Deputy Director General, Banca d'ltalia, Rome

Jean-Philippe Platteau, Professor, FNDP, Namur

Paul Reding, FNDP, Namur

Wolfgang Rieke, Director, Deutsche Bundesbank, Frankfurt

Robert Solomon, Professor, Brookings Institution, Washington

Alfred Steinherr, Director of Financial Research, EIB and Professor, UCL, Louvain-la-Neuve

James Tobin, Professor, Yale University

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XVl Notes on contributors

Edwin M. Truman, Director, Federal Reserve System, Washington

Victor Urquidi, Professor, El Colegio de Mexico

John Williamson, Professor, Institute for International Economics, Washington

Acknowledgements

The conference in honour of Robert Triffin, held in Brussels on 8-9 December 1988, received financial support from CEDEL, the ECU Banking Association, the Bank for International Settlements, the Generale de Banque, the Kredietbank and the Commission of the European Communities.

Robert Triffin Alfred Steinherr

This volume comprises papers presented and discussed on the occasion of a conference in honour of Robert Triffin, held in Brussels on 8-9 December 1988. Why such a volume? To most people the answer will be obvious but most likely different from person to person. Some will have appreciated Robert's untiring creativity and enthusiasm, and some his consistent long-ranging and pioneering views; some may be readers of his stream of publications and will have admired his broad range, his global approach not neglecting human or political concerns in his economic analyses; and all of us sense all of that.

Over fifty years ago, in 1938, Robert obtained his Ph.D. at Harvard with a brilliant, Wells-prize honoured dissertation on 'General Equilibrium Theory and Monopolistic Competition'.

Newspapers and conferenciers frequently call Robert Triffin a great European economist. But is he really? As a presentation of his professional life makes it evidently clear, he is not. Although we Belgians and Europeans are proud of him, he does not exclusively belong to us. He, more than the great majority of us, is a true citizen of the world, and one could speculate about his life activity and role if he had not spent 40 years in the US. And clearly, he is more than an economist, and very successfully blends economic, institutional and political analysis. I mention his cosmopolitan experience and disposi­tion not only for the charm of it but because it has had far-reaching implications. It led him, first, to consecrate most of his activity to international problems. After a dissertation on monopolistic com­petition this was not at all obvious. What he retained from his dissertation was however the basic and important view that the competitive model is not the most useful one for the analysis of international problems, an insight that only recently has reassumed importance in international trade theory.

The second and crucial consequence was that his analysis never started out from a national view to englobe international relations in an appendix. In this respect he clearly surpasses the intellectual fathers of the Bretton Woods system. Harry White saw the system from an American perspective and it is not unfair to say that even

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Keynes' proposal was tainted by considerations of the future place of the United Kingdom in the system, and that he only appended inter­national relations to his theoretical framework of the General Theory.

To present a full account of his past and present activity would be a hopeless task in view of the extraordinary scope of this career of 50 years. And it is not necessary. On the occasion of the award of the 'San Paolo Prize for economics' a book was edited with the title 'Robert Triffin: San Paolo Prize for Economics' (1987) in which one can find a list of his publications and Robert's own account of his career. Let me now attempt to outline the basic, far-reaching views of Robert Triffin, developed during the 1940s and 1950s, refined and operationalised further subsequently. I shall argue that these views have a remarkable time consistency and are as valid today as at the time of their conception. The scope of Robert's basic thoughts is reflected in the contributions to this volume and I will follow this structure.

Bretton Woods was an attempt to set up an international financial system adapting the gold standard to the post-war economic and political reality. It was a system of rules leaving much more dis­cretionary policy choice to individual countries than the gold stan­dard. The task of the IMF was to monitor this discretion and assure international consistency.

Robert identified very quickly two problems which did not exist under the old gold standard. The first was the famous 'Triffin dilemma', a point on its own fatal to Bretton Woods. The second was to recognise that there was a major question of political power and hence of the distribution of adjustment of external accounts. Bretton Woods could be manipulated by the dominating actors, after the war by the US. This posed the problem of safeguarding the interests of other participants and mainly those of the weakest countries, namely the LDCs. As long as the US enjoyed unchallenged leadership the only issue was the one of seigniorage and of equity in the adjustment process, but the stability of the system was not put directly into question. However, from a long term point of view it was not at all convincing to assume that the US would be able to retain monopoly power in an otherwise atomised world. Once European countries and Japan recovered and LDCs gained in importance, economic and political power were to be diffused and the question arose how Bretton Woods would accommodate to this changing distribution of power? He was the first one to foresee, and to draw the conclusions from the transition of the period of dollar scarcity to dollar glut

Alfred Steinherr XIX

starting already in the 1950s: the dollar cannot remain the sole pillar of Bretton Woods and the redistribution of power required mechan­isms of coordination. I think it is fair to claim that Triffin was the first one to foresee the problem that retains much attention currently -without a definite solution on the horizon - namely, how to render national policies of the major players consistent and how to assure global efficiency.

Let me quote from his book Europe and the Money Muddle of 1957: 'The fundamental dilemma of international economic relations in the 20th century lies in the inadequacy of national sovereignty as a framework for policy decisions and their administrative implementa­tion in an interdependent world.' Today, how could one describe more appropriately the need for and difficulty of co-ordinating national economic policies?

As he made clear in his proposal for world monetary reform to the Joint Economic Committee of Congress in 1959, his first choice would have been a system reinforced through a world clearing house - sometimes misinterpreted as a Utopian proposal of a world central bank. But he was practical enough to realise that the time was not ripe for such a fundamental and dramatic institutional jump. There­fore, and following his general line of pursuing the ultimate objective step by step, he continued arguing in practical terms for a world accommodating several regional monetary systems replacing the world-wide integrated Bretton Woods systems. This led to one of his greatest achievements, the European Monetary System and the ECU. The practical precursor was of course the European Payment Union which he conceived and for which he acted as adviser. Also the personal relationships he developed at that time brought him into the group of European founding fathers for whom he should become a longstanding adviser and friend and some of whom - in particular Jean Monnet - had a lasting influence.

The idea was, of course, to develop several of such regional systems and this hope has failed so far, although political discussion and analysis of the scope and the means for regional monetary co­operation in Latin America, Africa and Asia have been pursued relying on Robert's visions and concrete advice.

The very heterogeneous group of LDCs has thus been left in a highly exposed situation of dependency. Robert combated therefore for inter­national rules safeguarding more generously the interests of LDCs. In this he failed as well and the work of the Group of Twenty in the early 1970s and its ultimate failure caused him grievance and regrets.

XX Robert Triffin

Therefore, in today's world, the large number of LDCs are rather dependent on the rules of the international monetary system and on the policies adopted in developed countries. In recent years, Robert has frequently pointed out and strongly criticised US policies which make the largest and richest economy a net debtor instead of providing resources to LDCs. Painful adjustment programmes and reduced growth in those countries most stricken by exchange scarcity are the regrettable outcome. He also did not spare the IMF of critique in this regard. Because he is not just a theorist but interprets very carefully empirical data, he has been able to pinpoint a substantial amount of official eye-washing.

If gold were evaluated close to market prices - about ten times the value at which the US evaluate their gold reserves -it would become clearly visible that international reserves have been mushrooming since the end of gold convertibility and Triffin documents the high correlation with worldwide inflation. On his statistical basis the share of synthetically created international liquidity in form of SDR hold­ings- conceived as a replacement of gold and of dollars- turns out to be insignificant and the failure of another element of reform becomes visible. Robert Triffin's statistical work also demonstrates that the share of LDCs in international reserves declined, rather than in­creased, as gold stocks are mainly held by developed countries.

Such an overview cannot do justice to Robert Triffin's contribu­tions during 50 years. But it emphasises that the major problems confronting policy-makers today are those which he identified and for which he has proposed solutions decades in advance. This volume in his honour further illustrates that Robert Triffin's work is not only an occasion to look reminiscently into the past, but forces policy-makers and scientists to reflect on today's problems and on what they imply for the future.

During the conference held in Brussels on 8-9 December 1988 the participants had an opportunity to share one of the great historical moments of Robert Triffin's career. In an interview with French television in 1972 which we were able to reproduce, an ever dynamic and perceptive Robert Triffin provided a synthesis of the Smithsonian agreement and an outlook that still commands our admiration today.

This volume allows us to say Robert Triffin: thank you for every­thing, your challenging visions, your patient teachings, your advice and your friendship. In the name of all the contributors: thank you, dear, admired, Robert Triffin.