International Finance: Rules of Engagement

Between the two world wars, an Atlantic elite of economists, financiers and policy-makers, working in study groups at the Royal Institute of International Affairs, anticipated many of the themes and institutional mechanisms which contributed to international financial stability from 1950 to 1973. In the special atmosphere of Chatham House, ideas were freely expressed, exchanged and developed. Later events, especially the design of a new international financial system at Bretton Woods in 1944, were influenced by some of those ideas. The spirit and goals of the study groups, reflected in the hitherto unexamined documentary records, also have important lessons for the current debate on the international monetary system.

The World Today
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If one historical figure epitomises the increasing influence of economic analysis on public life, the emergence of the ‘economist as saviour’, it is John Maynard Keynes. As a young British Treasury official and Cambridge academic, in 1919 he made the economic dimension of the Paris peace negotiations the subject of heated public debate. Just over ten years later, he was to emerge as the scourge of gifted amateurism in policy-making, with his scathing and widely disseminated criticisms of the Governor of the Bank of England, Sir Montague Norman.

Ideas, money, power

Yet Keynes ultimately achieved more through his less visible contributions to a remarkable series of intellectual ventures. These brought together financiers, academics, officials involved in policy-making, and opinion formers in those critical years for international finance.

Chatham House was where they met. Throughout the 1930s and early 1940s, the Institute hosted a series of study groups on economic topics which reflected – and often anticipated – the major issues in international economic relations, from trade, to foreign investment, to international money.

Around the table with Keynes discussing the international gold problem, for instance, were, among others, Roy Harrod, Lionel Robbins, Dennis Robertson, Noel Hall, and Walter Layton. They were able to speak in a personal and unattributable capacity under the Chatham House Rule. The study groups required them to investigate facts thoroughly and explain options clearly, rather than to advocate a particular party line. Through free and constructive discussion, some of the main actors in the worlds of ideas, money, and power, were able to refine and develop their understanding of crucial aspects of the international economy.

The tide of world events was flowing too fast towards economic nationalism for those advances in knowledge to have any impact on the doomed World Economic Conference of 1933. But many of the ideas emerging from the discussions in St James’s Square were to influence the Bretton Woods negotiations, contributing to the design of the post-war international financial system.

The study of finance ignores history at its peril. The third quarter of the twentieth century was a time of financial parochialism, when slow change in the operation of financial intermediaries and markets was heavily controlled by national governments. Since then finance has evolved rapidly, eroding existing frameworks and bypassing barriers between national jurisdictions.

Just as in the inter-war period, this process of rapid financial change has been punctuated by episodes of crisis and perceived malfunction, which provided a powerful stimulus for debate: as Le Monde remarked in November 1973: Pour la plupart l’economie internationale est un peu comme les dents. On y pense quand on a mal (International economics are like teeth: one only thinks about them when they hurt).

Across time and space

Finance links firms, individuals and public bodies across time and space, by defining and managing debt and credit relationships between them. Despite their variety and ever increasing complexity, all financial linkages involve claims on resources and ownership rights.

Thus the flow of savings from families to the business sector allows firms to add more of current output to the country’s capital stock, in exchange for a share of the profits generated by the use of that new capital. By creating a structure of financial claims to match the stock of real assets of the economy, finance plays a central role in linking the past to the future.

Similarly, when a country can supplement its own savings by borrowing abroad, it can invest more and thus raise its living standards and level of economic development. On the other hand, the blossoming of Cyrillic welcome signs across the finest shopfronts of London, Milan and Paris, and in the bank branches of Nicosia and Zurich, proves that money does not always fly across space in the direction most needed.

Source of tension

Finance, therefore, stands at the intersection of two major trends of the twentieth century, whose future relationship to each other is in many ways the central issue of the study of the international economy. The first trend is the increased involvement of nation states in the economic sphere. This has been the subject of increased theoretical and ideological criticism since the 1970s, but has proved so far remarkably resilient to the many attempts to roll back the frontiers of the state.

The second trend is international economic integration: already the salient – if in many ways unexpected – feature of the Golden Age of economic growth, integration has picked up pace and reach since then. From the beginning of the 1990s it has been relabelled as globalisation.

The economic role of national governments has traditionally involved a significant degree of control over its citizens’ financial relationships, both in respect of one another and the state itself. Financial regulation, credit, monetary policy and taxation are some of the dimensions of the aspiration for ‘home-spun finance’ which was sovereignty and globalisation.

The concept of an international financial architecture reflects the ambition to resolve that tension. It aims to provide mechanisms of international economic activity capable of reconciling the perceived conflict between legitimate national economic objectives and the erosion of national economic sovereignty.

The urgency and the intensity of the debate reflect the seriousness of the conflict, and the disarray of the present rules of the game. It is therefore unsurprising that there should be parallels between two historical periods in which new rules were being discovered by trial and error. In the inter-war period, economists and policymakers were faced with the problem of how to reconcile the ‘automatic’ functioning of the gold standard with the new aspirations of national governments in the economic sphere.

They saw themselves as providers of jobs and homes fit for heroes, or as agents of industrialisation and re-armament. If many inter-war economists tried to protect the fruitful international interaction of enterprises and savers, the end of the twentieth century is at first sight dominated by the opposite question: how to preserve national economic and political sovereignty in the face of the market’s triumph of de-regulated, global financial linkages.

Running through today’s debate is a corrosive scepticism on the continuing need for the International Monetary Fund. Recalling that the Fund was established as the international lender to which countries would turn for balance of payments support within a fixed exchange rate system, its present critics contend that it has long been overwhelmed in this by the sheer scale of private capital flows, and is now redundant.

If correct, this argument would imply that the protagonists of the interwar discussions on the international economy saw its central financial institution as a very specific piece of machinery, narrowly designed to deal with the fixed exchange rate issue, and destined to be revolutionised out of existence by financial liberalisation.

Debt and poverty

Reality, as also witnessed by the call to ‘contribute… to the promotion and maintenance of high levels of employment and real income’ in Article 1 of the Fund’s Articles of Agreement, is very different. The documentary evidence from the inter-war study groups makes it clear that the Bretton Woods architecture emerged as an ambitious and creative response to the poor national and international economic governance of the inter-war period.

History, in our view, supports the recent evolution of the Fund’s philosophy and actions towards broader debt resolution strategies and poverty reduction. Not only is this evolution fully consistent with its original inspiration, it also reflects a timely recognition of the central economic issues in today’s international financial system. Open, non-partisan discourse on these themes is as necessary today as in the 1930s.