There should be three objectives for a well-functioning monetary system: i) internal balance, ii) allocative efficiency and iii) financial stability. The international financial and monetary system (IFMS) has functioned under a number of different regimes over the past 150 years and each has placed different weights on these three objectives. Overall, this recent Bank of England paper finds that today’s 'fiat' system has performed poorly against each of its three objectives, at least compared with the Bretton Woods System, with the key failure being the system’s inability to maintain financial stability and minimize the incidence of disruptive sudden changes in global capital flows. There is little consensus in the academic literature, or among policymakers, on what are the underlying problems in the global economy which allow excessive imbalances to build in today’s IMFS and/or which impede the IMFS from adjusting smoothly to counteract these imbalances. Critically though, while the fiat money system we are currently does indeed exhibit lower GDP growth volatility (by design), it has dramatically more incidents of banking and currency crises than under a Gold Standard.
The IMFS is the set of arrangements and institutions that facilitate international trade and the allocation of investment capital across nations. A well-functioning system should promote economic growth by channeling resources in an efficient manner across countries, over time, and in different states of the world. It should do this by creating the right conditions for international financial markets to operate in a smooth and sustainable fashion, discouraging the build-up of balance of payments problems, and facilitating access to finance in the face of disruptive shocks. These functions suggest that the ideal system should satisfy the following objectives:
- Internal balance — the IMFS should enable countries to use macroeconomic policies to achieve non-inflationary growth.
- Allocative efficiency — the IMFS should facilitate the efficient allocation of capital by allowing flows to respond to relative price signals.
- Financial stability — the IMFS should help to minimize the risks to financial stability.
While there are some complementarities between these objectives, there may also be conflicts.
The various IMFS regimes have involved different combinations of international and national frameworks. Members of the Gold Standard, for example, fixed their currencies to gold, allowed capital to flow freely across borders and tended not to use monetary policy actively. So they gave up on the internal balance objective to achieve allocative efficiency and financial stability. The Bretton Woods System (BWS) featured fixed but adjustable nominal exchange rates, constrained monetary policy independence and capital controls — effectively sacrificing the allocative efficiency objective to allow greater control over internal balance and financial stability.
In contrast, in today’s system there are almost no binding international rules; rather there exists a hybrid arrangement in which countries are free to choose whether to fix or float their exchange rate and whether to impose capital controls or not. While today’s IMFS affords countries the freedom to pursue policies to suit their domestic objectives, this flexibility has also created problems.
World GDP Growth
Similar average growth, less volatile under 'Fiat' via Keynesianism, much higher Inflation, much higher inflation volatilty...
World Crisis Incidence
dramatically lower incident of crises under Gold Standard; Double the average number of external defaults per year under current 'fiat' system
This paper attempts to provide a framework for thinking about these underlying problems, and thus a means for discriminating among the reform solutions.
In our words, it would appear that the current 'fiat' money system is akin to a prozac-loaded psychopath - all the time the prozac is there anger is dampened (but remains under the surface). If something happens to the pharmacist - some external shock that shuts them down - then the psychopath comes out bigger after his long suppression...
'Fiat' suppresses reality but the cumulative reality will always find a way to escape - in crisis
Full paper here: