Besides moving from a single universal-money standard to a multi-currency regime, monetary fragmentation also occurs when there is a growing variety of exchange rate regimes being pursued by different governments, moving away from the spectral extremes of free floating and iron-clad peg towards the middle in the search for hybrid regimes promising the best of both worlds such as managed float or crawling peg. Yet another expression of monetary fragmentation, this one a post-crisis phenomenon, is the home-market bias of worried, crisis-stricken investors rushing back to their domestic base while seeking to reduce their foreign exposure for fear of greater losses, regulatory clamp-downs, and new risks beyond their control.
Finally, monetary fragmentation also occurs, once again as a more recent post-crisis phenomenon, in the implementation of re-regulation efforts which, even though conducted on a global scale under the auspices of the Bank for International Settlements and the G's Financial Stability Board, differ greatly between nations and regions in terms of scope, timetable, and application to give rise to temptations among banks for regulatory arbitrage.
These dual tendencies of financial concentration and monetary fragmentation live in constant tension with each other, and those tensions play themselves out within the institutional construct of the post-Bretton Woods multi-currency system. On the one hand those tensions produce centripetal forces driving towards a re-centering of the US dollar's dominance, as happened at key moments during the crisis triggering massive flights to safety into US Treasuries to the point of them ending up with negative interest rates even though the crisis emanated originally from the United States in the first place.
On the other hand, the same tensions can also translate into centrifugal forces away from the US dollar towards moving capital to other players, even entire regions EU, East Asia , and their currencies. The role of global finance is to mobilize and direct these simultaneous centripetal and centrifugal pressures towards a coherent growth pattern driving the world economy forward along its globalization path.
Centripetal forces in the global growth dynamic focus on the dominant role of the US dollar in the international monetary system, which directs a disproportionate share of global capital flows towards the US economy. The dual role of the US dollar as national currency of the US economy and the world's still-dominant international medium of exchange is a matter of great asymmetry. The US does not have to worry about its currency's exchange rate and is better shielded than anyone else from the vicissitudes of the world economy, but at the same time its actions and beliefs have disproportionately large impact on everybody else.
This is especially true with regards to the Fed's conduct of monetary policy, which can focus more exclusively on domestic concerns and less on international-economy considerations like the exchange rate than is the case for any other central bank in the world. But at the same time the Fed's decisions have a greater impact than anybody else on what is going on in the world economy. This asymmetry in impact is part of a broader seigniorage benefit accruing to the issuer of world money.
That issuer needs to run chronic balance-of-payments deficits, by which its currency gets moved out of domestic circulation and flows to the rest of the world using it as reserve or to pay each other. Since foreigners need to get their hands on dollars, they are willing to finance America's external deficits automatically, continuously, and, if needs be, even at zero or in any case very low interest rates. During the Bretton Woods years America's external deficit came about by means of massive capital exports, which had to exceed then-chronic US trade surpluses.
Those capital exports took the form of aid and assistance programs e. After dealing with the dramatic financial instability caused by the stagflation crisis of and its disinflationary denouement in the early s, the US began to run widening trade deficits amidst highly stimulative monetary and fiscal policies which it financed by importing lots of capital from the rest of the world.
But this large external debt is not like any other country's, because America borrows from the rest of the world in its own currency. So it does not have to earn foreign currency to service this debt. It can instead just create "print" its own money to service its foreign debt, usually just rolling it over upon maturity when repaying Treasuries coming due with new borrowings.
This is a huge advantage, an "exorbitant privilege" indeed. Its currency's world-money status has thus in effect freed the US from any external constraint, allowing that country unlimited funding of its private-sector S - I , budget T - G and foreign X - M deficits from the rest of the world. It thus could always pursue relatively more reflationary and stimulative macro-economic policies than other countries would be able to in the face of their respective external constraints, a policy bias enjoyed by both Republican e. Access to ample supplies of foreign capital has also allowed US financial markets to be deeper and proportionately bigger than elsewhere, a possible comparative advantage especially in the area of setting up new businesses or funding small- and medium-sized firms.
But the large-scale capital inflows ultimately had a more pernicious longer-term impact on the macro-behavior of the US economy, namely turning it into an economy prone to asset bubbles whose wealth effect would stimulate economic activity greatly until they burst. This propensity for asset bubbles was also anchored by major policy changes, especially in the wake of the "Reagan Revolution" of the early s which dramatically lowered the marginal tax rates for the top earners, reduced taxation of capital gains far below that of other income, set up tax-sheltered saving vehicles for retirement and other long-term projects e.
Since the Reagan Revolution of the early s the US has experienced three major consecutive asset bubbles supported by foreign capital imports. The first of these was a stock-market bubble fuelled by a group of daring investors known as "raiders" who used a new funding instrument, so-called high-yield or "junk" bonds, to attack undervalued US corporations with hostile take-over bids. Firms thus targeted either had to fend off attacks by paying the raiders handsomely or were taken over and dismembered to be sold off in pieces.
Soon investors went into speculative frenzy about which companies would be the raiders' next takeover target, seeking to buy into those to profit from any subsequent attack. In addition, such attacks triggered more far-reaching restructuring efforts in the sectors concerned. That stock-market bubble of the mids imposed shareholder value maximization as the new dictate of corporate governance while promoting the post-stagflation reorganization of US industry across a wide range of sectors. The bubble burst with a stock-market crash in October , linked to rising US interest rates pushed up by a concerted international effort under the so-called Louvre Agreement of February to establish target zones for the world's key currencies.
Ironically, a significant portion of the global capital flows towards the United States during that first bubble in the mids consisted of debt-servicing charges of less developed countries to US banks which allowed those to slow down the write-off losses from non-performing loans to LDCs.
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This arrangement resulted from the way a major global financial crisis, the so-called LDC debt crisis , was handled after August when Mexico, Argentina, and Brazil - the three largest Latin American economies to whom the nine largest US banks had lent percent of their bank capital - declared themselves in de-facto default.
These countries, like many other developing countries at the time, had reached the limits of their nationalist import-substitution phase of their development in the s when they experienced two oil-price shocks in a row. The massive surplus of oil producers after the first price hike in October was recycled through the Eurocurrency markets as loans to oil-importing nations.
This petro-dollar recycling was further enlarged after the second price-hike in March , but then rudely disrupted six months later when the Fed took on double-digit US inflation and a collapsing dollar by deregulating interest rates which subsequently tripled to levels above 20 percent in a matter of just three weeks. LDC debtors suddenly faced a double whammy of much higher debt servicing charges on their variable-rate Eurocurrency loans and declining export earnings as the world succumbed to recession in the wake of the Fed's spectacular tightening move.
And so about fifty or so LDCs found themselves in de-facto default at the height of the global recession in mid, necessitating hasty construction of an IMF-led international lender of last resort to avoid imposing potentially devastating losses on leading US and European banks. It is this debt-extension and -expansion strategy which led to the perverse situation of having impoverished debtors in the developing world provide during that period net outflows to the richest country in the world while themselves being pushed into deep-recession "adjustments" which took years to go through.
The IMF used its power as the creditors' police to impose on its assistance-seeking and hence pretty desperate clients a hard-line reform program of neo-liberal policy prescriptions, known as the Washington Consensus. This program comprised fiscal austerity, privatization, deregulation, and full insertion into the world economy through systematic dismantlement of barriers to unfettered market regulation implying a push for removal of trade barriers, capital and exchange controls, and currency-price manipulation. It is only in , when a majority of the largest LDC debtors had made sufficient progress with their policy adjustments and reforms while also having given US banks enough time to cope with the re-capitalization and loss-absorption challenges from non-performing LDC loans, that the crisis-manager troika of US Treasury, BIS, and IMF came up with a systemic solution to the debt-restructuring challenges facing dozens of debtor nations and their creditors, in the form of so-called Brady bonds.
It is perhaps at this moment, in , that LDCs become emerging-market economies EMEs as they get forcibly opened up and stabilized while pushing through irreversible structural reforms for fuller insertion into the world economy.
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In return they also regained access to international investors in the new EMB market. A good many of these countries took additional years of painful adjustments amidst hyperinflation and collapsed domestic production to achieve sustainable macro-economic stabilization, with Mexico's "Tequila crisis" or Brazil's new Plan Real marking as a crucial year for crisis resolution. That same year China, emerging from its post-Tiananmen Square turmoil, undertook significant tax, fiscal decentralization, and banking reforms while devaluing its currency in one swoop by 40 percent.
These measures put the wakening giant onto an export-led and investment-driven growth path for the next two decades. And the European Union, having chosen a ten-year transition towards a single currency with the Maastricht Treaty of , had survived more than a year of speculative attacks on its fixed-rate Exchange Rate Mechanism from July to September to start the necessary path towards convergence among its members at more realistic exchange rates which the currency markets had finally obtained in the resolution to that major currency crisis.
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These developments - the resolution of the LDC debt crisis, China's awakening, Europe's push for economic and monetary union - were part of an accumulation of centrifugal forces away from America's absolute dominance while broadening the reach of market-regulated capitalism. Underlying this trend was a larger transformation shaking the world in the early s when three billion people, half of the world's population, joined global capitalism all at once.
This demographic shock to the system did not just emanate from the collapse of the Soviet Union and its allies or China's dramatic insertion into the world economy, but also included such populous nations as India, Brazil, Indonesia, or Mexico all of whom exited their nationalist import-substitution phase of development with neo-liberal market-opening reforms and political change away from their traditional single-party states.
Global finance played a huge role in that transition, both by imposing its policy preferences on all those newly emerging market economies while at the same time regulating their share of access to the world's financial capital - both in terms of savings and money-creation capacity. Global finance, in particular the network of about universal banks comprising the inter-bank market at its center, had the unique capacity of mobilizing both the centripetal flows towards the United States in support of its deficits and the centrifugal flows engulfing half of the world onto a new development path at the same time.
Its two-way flow mobilization translated into a huge expansion of the capital accounts in the balance of payments of both the thirty or so advanced capitalist economies and the fifty to sixty EMEs. These bi-directional financial flows had to pass through the international monetary system, an institutional framework of agreements, rules, and conventions that provides for a range of internationally acceptable world-money forms, trans-national payments and settlement systems both public and private , the foreign-exchange market as the nerve center of the global economy, a range of possible exchange rate regimes from free float to currency board , all of this organized around hierarchically structured power relations between nation-states representing different factions of capital.
Think of the international monetary system as a sort of pyramid of monies and their issuers, with the US and its dollar at the top and barely convertible currencies of frontier economies from Albania to Zimbabwe at the bottom, with lots of movement between and within its six layers - the dollar layer, the challenger layer euro, yuan , the safe-haven layer yen, franc, pound , the resource-currencies layer real included , the convertibility-restoration layer most currencies of countries trying to find their place in the world economy , and the repressed-currency including dollarization or euroization layer of still mostly poor frontier economies.
Of course, what interests us here the most is what is happening in and with the resource-currencies layer as Brazil is right in the middle of it. First, however, we have to look at the origins of that resource-currencies layer and find it among the "Asian Tigers" along the Pacific Rim from Thailand via Vietnam up the coast to South Korea and extending to the island nations of Indonesia, Philippines, and Taiwan.
Their resource was and continues to be a young, eager, fairly well educated, multi-lingual labor force ready to do its part in the global supply chains of Western or Chinese multi-nationals. When those countries' hundreds of millions entered global capitalism, they did so - as in China - first as workers and only then as consumers.
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By the mids Eastern Asia's Pacific Rim had become a highly dynamic zone of rapid growth attracting investors from all over the world, with Hong Kong and Singapore the financial hubs distributing the billions flowing into the region among rapidly growing economies from Thailand to South Korea.
While the world was paying more attention to China's spectacular take-off, the so-called "Asian Tigers" racked up similarly high growth rates. In some instances the massive capital inflow set off asset bubbles. But even without that cyclical destabilizer the boom in Eastern Asia would not have lasted much longer, as its economies overheated, inflation rose, debt levels became unsustainable, and their current account balances deteriorated amidst a rising US dollar to which those currencies were for the most part pegged.
Add to this tremendous competitive pressure from China after its devaluation. By mid the situation had become precarious in the entire region as central bank after central bank used up rapidly shrinking foreign-exchange reserves to defend ultimately indefensible currency pegs. When that effort finally failed in one country, the botched devaluation of the Thai baht on July 2, , all hell broke loose.
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There was a huge explosion of capital flight and speculative attack hitting the region's currencies all at once, breaking their pegs and then rendering local debtors and banks insolvent when those had to match their dollar-denominated liabilities with suddenly sharply devalued local-currency assets. Truly unprecedented was the speed, scale, and contagion scope of this capital flight, the result of a fundamental change in the nature of global finance.
The investors were now for the most part mutual, pension, hedge funds, able to dump their securities at will. Commercial banks, on the other hand, do not have such an exit option, having to keep non-performing loans on their books and work out debt-restructuring deals with their impaired debtors over a good number of years see the LDC debt crisis of the s.
So this "Asian crisis" of was the first global crisis of "market finance" and as such had a violence all of its own.
It required rapid reaction, which consisted of huge bail-out packages by the IMF and swift enactment of stabilization measures whose initial extremism 65 percent interest rate in Indonesia! But while individual East Asian economies managed for the most part to stabilize their traumatized economies within a year or two, helped by booms in China and the United States, the crisis moved on.
First it knocked Russia into default in August , which in turn triggered the collapse of legendary hedge fund Long Term Capital Management and a bail-out by its Wall Street brethren. Then still-sceptical speculators tested the will and strength of Brazil with preventive assistance from the IMF in January Finally the speculators went after the dollar-peso currency board of Argentina which, hitherto considered more or less unbreakable, proved in December to be breakable after all. This crisis too coincided with a US bubble, just as the one in the s.
The bubble, which formed in early around the high-tech stock market known as Nasdaq, was caused by investor enthusiasm for the likely commercial impact of the internet. That euphoria grew into a folly during when the fear of the "Y2K bug" fueled huge corporate spending on new computer systems while internet entrepreneurs launched one spectacular initial public offer after another, turning them and their venture-capital supporters into multi-billionaires overnight.
It was in March , after the Y2K bug had proven a hoax, that the bubble collapsed. As is the case in many financial crises, this one too served the useful purpose of weeding out the mad and the weak to leave behind a battle-tested "hard" core on both sides of the ledger producer and financier learning from mistakes to make their engagements more resilient.
That is exactly what also happened to the "junk" bonds and the corporate raiders after the collapse of the first bubble a dozen years earlier. This second bubble pushing the internet was, however, less dependent on foreign capital inflows and more of a home-grown phenomenon even though US current account deficits reached a record It is at that moment, in , when the synchronized onset of sustainable recoveries in both the center US and the periphery emerging-market economies , together with the successful start of the eurozone, yielded a constellation of upswing forces that intertwined centripetal and centrifugal flows in particularly powerful forward motion.
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US multinationals and funds invested heavily overseas, especially in emerging-market economies eager to become part of the global supply chain that transformed multi-national enterprises into global production networks operating at a higher level of globalization. Out of this flow matrix was born the US housing bubble of which, by means of a massive loan-securitization machine of increasing complexity and scale, allowed a rapidly growing number of American homeowners to use their habitats like an automated teller machine at a bank to draw cash from whenever they liked.
This was a self-feeding bubble inasmuch as rising real-estate prices enabled Americans to refinance their mortgages with larger principals in line with the appreciation of their collateral or take out additional home-equity loans against their houses which they could spend on anything.