international trade, finance and money essays in uneven development

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International trade, finance and money: Essays in uneven development Vasudevan, Ramaa

ProQuest Dissertations and Theses; 2006; ProQuest Central pg n/a

INTERNATIONAL TRADE, FINANCE AND MONEY Essays in Uneven Development

by

Ramaa Vasudevan

April 2006

Submitted to the New School for Social Research of the New School in partial fulfillment of the requirements for the degree of Doctor of Philosophy

Dissertation Committee Dr Duncan Foley

Dr Anwar Shaikh

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ABSTRACT

This dissertation argues that the ability of USA to sustain a growing extemal deficit depends on its role in the triangular pattern of recycling surpluses from creditor countries (Japan and China), to the emerging markets in the periphery (Latin America, South East Asia) The argument is made on the basis of historical comparison with Britain’s role as a lender of last resort during the gold standard The efficacy of this mechanism hinged on its ability to draw short term capital flows through its privileged role in the triangular patterns of settlements with the Empire Following the collapse of the Bretton Woods system, the euro currency markets played an analogous role recycling surpluses from OPEC countries to Latin America and paved the way for new triangular patterns, where creditor countries invested their surpluses in USA, while unregulated private capital flows to emerging markets precipitated financial crisis in the periphery

The dissertation elaborates the macroeconomic implications of financial intermediation

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ACKNOWLEDGEMENTS

It has been quite a long journey to this dissertation While the responsibility for such

research conventionally rests with the individual, it has been shaped and enriched by many interactions and associations, and I have incurred more debts in the process, than I could possibly

enumerate

The questions that motivate this dissertation arose in the course of years as an activist in India, during long and heated discussions on theories of imperialism with friends and comrades,

only some of whom are named below In many ways this research is the product of that period,

and the satisfaction of the final dissertation for me lies in having been able continue to focus on some of those concerns My deepest regret is that two persons who have been such an integral part of my activist and intellectual life, C.V Subba Rao and Sudesh Vaid, are both no longer alive to read, dissect and argue with my thesis

I owe a lot to my intellectual ‘upbringing’ from my years as a Masters student at Jawaharlal Nehru University, New Delhi, and an M.Phil student at the Center for Development Studies, Thiruvananthapuram, Before I embarked on a PhD at the New School I had been discussing this research project, in particular, with Prabhat Patnaik at Jawaharlal Nehru University and have been motivated by his analytical vision

A decisive role in my coming to New School was played by a fortuitous meeting in Delhi with Anwar Shaikh Despite all the pressures on his time, Anwar responded to a barrage of long emails filled with inchoate ideas with remarkable patience and thought Once at New School, he has continued to provide stimulus and inspiration to my research

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It was an incredible experience to have Duncan Foley as my thesis advisor, and my

intellectual debt to him will go far beyond this dissertation Through long conversations in person and over email he fostered the development of my ideas and forced me to rethink arguments and interrogate my analytical blind spots and biases It is quite a rare mentor who manages to both draw out your ideas, and teach you how to criticize them

Lance Taylor provided invaluable comments, encouragement and theoretical insights I am particularly grateful to him for keeping me honest and grounded in concrete developmental issues even as I grappled with more abstract theoretical questions

Apart from these three members of my dissertation committee, I would also like to thank Will Milberg, Gerard Dumenil and Suzanne de Brunhoff who took the time to discuss and

comment on different parts of my research project at various stages of its development

As a dissenting economist from a developing country, the economics department at New School with its rich and rigorous tradition of “informed, critical and passionate investigation of

the economic foundations of contemporary society” always had a special attraction for me I

feel privileged that I could pursue my PhD here Research at the New School would not have been possible without the award of various fellowships the Prize Fellowship, the Schwartz Center for Economic Policy Analysis Research Assistantship, the New School Teaching Fellowship, the Taraknath Das Foundation Fellowship and the Dissertation Fellowship Robert Kostrezewa, Tsuya Lee and Stephen Haggerty were wonderful in smoothing the path through the bumps of graduate life at the New School

The Heller School for Social Policy and Management at Brandeis University, in particular my colleagues and students at the Sustainable International Development Program provided me a congenial and supportive work environment after I moved from New York Id also like to acknowledge the library staff at Fogelman Library (The New School), Bobst library

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(New York University), Goldfarb Library (Brandeis University) and Dewey Library, (Massachussetts Institute of Technology), whose helpfulness aided the research

The companionship of fellow students, gives graduate life its unique flavor David (in his role as a student advisor but more importantly as a friend), Martin and Codrina shared the travails and joys of the research David also took the time to go through the final manuscript, despite being very busy

Anjali and Rathin generously allowed me to make their home in New York my own, and were unstinting in their friendship and support Vivek and Nivedita eased the transition to graduate student life in New York, and along with their daughter Ananya continue to make my visits there enjoyable Abha, Litu and other friends in Boston gave me the much needed sense of connectedness

Research can be quite a lonely process, especially when there is an entire life left behind Friends in Delhi, especially Harish, Kulbir, Pali, Areet, Archana, Joseph, Snehlata, Sharmila and Shahana continued to keep me in their lives without ever letting me feel like a deserter Without the affectionate support of my large extended family by birth and marriage, Vasu, Uma, Mala, Sanjay, Leela, Priyaranjan, Ruchika, Deepak, Aditya and Raghava, and my grandmother Marie, the dissertation would have been that much harder to complete Vandana, Christopher and Joya gave me the warmth and indulgence of family here in the US A special thanks to my parents, Vasu and Uma for encouraging my endeavors, even if they may not always agree with it!

My husband, Ashok, shared the journey both intellectually and emotionally, through all its rough patches and moments of discovery This journey has been the most rewarding part of the

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TABLE OF CONTENTS Acknowledgements iv Table of Contents vii List of Tables ix List of Figures X Chapter I INTRODUCTION 1 Chapter II BORROWER OF LAST RESORT: INTERNATIONAL MONEY IN HISTORICAL PERSPECTIVE 16 Introduction 16

1 The International Gold Standard and the dominance of Sterling 18

2 Bretton Woods and After: The Dollar Standard 37

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4 External Transactions 83

5 Accumulation of Financial Assets 85 6 Dependence of Asset Markets 87

7 Intermediation Accounting Preliminaries 89 8 Debtor Country Adjustments 92

9 Creditor Country Adjustments 96

10 Contrasting Dynamics of Debtor and Creditor 98 11 Conclusion 102

Chapter IV

TERMS OF TRADE, COMPETITIVE ADVANTAGE AND TRADE PATTERNS: A CIRCULATING CAPITAL MODEL _ 104

Introduction 104

1 The Basic Model 107

2 Trade with Profit Equalization 111

3 Trade with Capital Immobility and Unequal Profit Rates 115 4 Balanced Trade and the Question of Determinacy 118

5 The Trade Patterns with capital immobility: Different Closures 121 6 Absolute disadvantage and Scale 129

7 The Issue of Exchange Rates 132 8 Conclusion 134

Appendix: Exchange Rate and Choice of Technique 136

Bibliography 140

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LIST OF TABLES

1 Financial Crisis in the Core and Periphery 75

2 The Social Accounts Matrix for the ‘Closed System’ of Three Countries 82

3 Financial Balance Sheets for the Three Countries 83

4 Pattern of Specialization at different wage configurations 113 5 Trade Outcomes for Different Employment Ratios 124

6 Trade Outcomes With Different Savings Ratios 126 7 Trade Outcomes for different Initial Capital Ratios 128

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LIST OF FIGURES

1 US Current Account Deficit (% of GDP) 2 2 The Movement of US Exchange Rates 2

3 The Movement of the Real US Interest Rate 3 4 The Financing of the US Deficit (% of GDP) 5

5 Net Income Receipts in the US External Current Account Balance 6

6 Share of Private Sector in US International Investment Position 71 7 Private Long Term Capital Flows to Emerging Markets 74 8 Uses of External Resources 74

9 Trade and Debt as a share of GDP 77

10 Debt Service (as % of Exports of Goods and Services) 78 11 Interest Payments (as % of External Debt) 78

12 Share of Foreign Currency Debt/ Export Earnings GDP ratio 79 13 Net Acquisition of Foreign Assets (as % of GDP) 79

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Chapier I

INTRODUCTION

One of the defining characteristics of the global economy today is the mounting external debt of the USA, the dominant ‘hegemonic’ country With its deficit at 6.6 % of its GDP and a net external liability of nearly 26% of its GDP, the US is in effect sucking in savings and capital from the rest of the world In a curious inversion of the traditional formulations drawing on Lenin, imperial hegemony in today’s context would seem to be associated with net capital imports (rather than exports) by the dominant country

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FIGURE 1: US CURRENT ACCOUNT DEFICIT (% OF GDP) ~e, 2000 ở 1980 \ 1985 -1 \ 7 T x T + „ \ 1995 J NS NS 4e a of a \ \ I Current Account | oN \ Year

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FIGURE 3: THE MOVEMENT OF THE REAL US INTEREST RATE |——Reai Interest Rate | 1980 1 985 1 990 1 995 2000

Source: Bank of International Settlements (2005)

The sustainability of these global imbalances and the precise mechanisms of the adjustments that will be entailed, have been subject to debate One strand focuses on the loss of competitiveness of US due to the relative overvaluation of the dollar The imperative in this framework is to engineer currency realignments that would improve the current account balance of the US (Rogoff and Obstfeld 2004, 2005) The emphasis in a second strand is on the deficient savings in the US with a policy emphasis on attacking the fiscal deficit (Roubini and Sester

2004)’

Another set of explanations emphasize portfolio behavior affecting the capital account The US deficit is explicable in terms of the excessive demand for US financial assets by private international investors (Cooper 2004) or the official holdings of US bills in order to peg their currencies in support of export- led growth strategies of the China and the first tier newly

' The obverse argument is that of a savings glut in the rest of world with inadequate stimulus to investment demand in these countries (Bernanke 2005)

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industrialized economies of Asia (Dooley, Garber and Folkerts-Landau 2005) The Bank of International Settlements (2005) refers to two schools of thought depending on whether the stress is primarily on current account (real) or portfolio (financial) imbalances Analytically the real and financial imbalances are interdependent, with mutual feedback effects These real-financial linkages are also central in the stock-consistent frameworks of Godley and Izurieta (2002, 2004a, 2004b) and Grey (2004)

The unprecedented situation of a hegemonic debtor country and its relative immunity from destabilizing speculative attacks has been ascribed to the privileged position of the dollar internationally ‘the exorbitant privilege’ that the US is able to exercise The bulk of US debt is denominated in dollars and about 70% of US external assets are also denominated in dollars (US Department of Treasury 2005, p 11) A look at the financing of the US external deficit (Figure 4) suggests a pattern of intermediation where USA incurs Habilities largely in the form of private bonds and official holdings of dollar reserves and accrues assets through foreign investment outflows of both equity and foreign direct investment’ After 1984 (when 38% of investment was in equity) US investors have favored equities over debt securities with its share rising to as much as 70% in 2001 before dipping to 66% in 2003 (US Department of Treasury 2005, p 6)

* Note also how the direction of equity and FDI flows changes through the period After the 1982 debt crisis there is a period of net inflows into the US until 1990 The outflows of the nineties reverse after 1998, the period of the Asian Crises The period after 2002, once again sees investment outflows

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FIGURE 4: THE FINANCING OF THE US DEFICIT (% OF GDP) 10 r Dy soe | | Dollar Reserves &l Foreign Direct Investment A Equity 0 Private Bonds LA

Source: Bank of International Settlements, 2005

Tille (2003), Tille and Klitgaard (2005) and Gourinchas and Rey (2005) analyze the valuation effects in the external financial accounts and show that the US earned a substantial

premium on its gross assets relative to liabilities The higher returns the US reaps on its assets

have given rise to persistently positive net income receipts.’ Gourinchas and Rey reconstruct the external account balances to incorporate valuation effects for each category of assets and

3 The US earns about 4.5 % on its assets while paying out 3.2 % on foreign holdings of US assets (Tille and Klitgaard 2005)

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liabilities and suggest that this ‘return’ premium has been increasing since the collapse of the Bretton Woods and in fact became positive once the US became a net debtor (2005, p 5)

Arguing that there is "something misleading about calling a country that makes money on

its financial position the world's largest debtor", Hausmann and Sturzenegger (2005) have put forward the controversial thesis that the US is in fact a net creditor if one takes into account the capitalized values of the net income earnings from foreign assets The net income receipts represent the export of what has been christened ‘dark matter’ (Hausmann and Sturzenegger 2005) In 2004 for instance the US earned more on its assets than its liabilities to the tune of 30 billion on a net liability base of $ 2.3 trillion (Figure 5) This corresponds, on a 5% rate of return in perpetuity calculation, to a present value of $600 billion

FIGURE 5: NET INCOME RECEIPTS IN THE US EXTERNAL CURRENT ACCOUNT BALANCE ($ billions) 60 50 f\ 40 30 \ —a— Nei Income Receipts on Foreign Assets | oY £AA ey A 1980 1985 1880 18885 2000 2005

* Includes compensation paid to employees

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The dark matter thesis suggests that the US could in theory continue to accumulate liabilities to finance its current account deficits through the export of ‘dark matter’ (the difference between official current account estimates and Hausmann and Sturzenegger’s ‘imputed’ estimates) The sanguine prognosis for the future of dollar espoused in the dark matter thesis has been received with some skepticism It has been pointed out that empirically, the income accounts are approaching a tipping point and the positive return premium is likely to be eroded (Gourinchas and Rey 2005) Further, these net income receipts also fluctuate widely from year to year and would, even apart from any relation to the impact of tax avoidance practices on profit repatriation, constitute tenuous grounds for arguing a stable creditor position for the US (Figure

5)

The ‘return premium’ is implicitly conceived as an inherent property of the US asset base

and its existence is seen to signify a ‘real’ basis for USA’s ability to borrow globally.’ Thus, despite a loss of competitiveness in production, as manifested in its growing trade deficits, the return premium accrues to US capital because of its inherent ‘knowledge advantage, as insurance premium or its liquidity generating ability’ (Hausmann and Sturzenneger 2005) What gets obscured in this formulation that fetishizes valuation effects into an independent source of wealth creation is the fact that the US is drawing surpluses from an international division of labor, specifically from the expropriation of surpluses in the rest of the world This inversion of the real logic of capitalist relations is precisely what Marx critiqued in his analysis of valuation of public debt in terms of fictitious capital (Marx 1978, Part V) In the dark matter thesis we see the same inverted logic being applied to the privileged international position of the US in global financial

“In fact the idea in some ways is not new Writing in 1772 Dr Price writes “A state need never therefore be under any difficulties; for with the smallest savings it may in as little time as its interest rate can require pay off the largest debts.”” Quoted by Marx (1978, 520) as a ‘charming theoretical introduction to English national debt’ Marx goes on to critique the conception

Interest- bearing capital, however, displays the conception of capital fetish in its consummate form, the idea that ascribes to the accumulated product of labor, in the fixed form of money at that, the power of producing surplus-value in geometric progression by way of an inherent secret quality, so that this accumulated product of labor has long since discounted the whole world’s wealth ” Marx (1978, 523)

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markets One of the most significant impacts of the export of dark matter, in their revised estimates of global imbalances, is the transformation of USA and UK from a debtor to creditor status on one hand and China from a creditor to a debtor status

Rey and Gourinchas (2005) characterize USA’s international role after the collapse of the Bretton Woods in terms of its evolution from the world’s banker to the world’s venture capitalist Infact, the period of turnaround, 1977-1980, when the valuation component rose dramatically from - 3.6 % to 5.9% (Rey and Gourinchas 2005, 6) is also the period when the hegemony of finance was restored with the Volcker shock- the 1979 coup (Dumenil and Levy 2004) The period marks the coming of age of the ‘floating dollar standard’ with the concerted policy imperatives towards fostering integrated and liberalized financial markets globally

Marx had distinguished ‘national spheres of circulation’ where the state would establish

the standard of price from the international arena where bullion functioned as ‘world money’ Keynes while grappling with the problems international payments problems in the context of a

gold-exchange system advocated the establishment of a supranational authority to manage a credit-based international monetary standard But the actual evolution of the international financial system after the Second World War paved the way for a dollar standard

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that the international financial system based on a fiat-credit currency standard is able to

circumvent the external constraint to a greater extent

Financial intermediation by the hegemon does impart greater liquidity to the international monetary system The cost of provision of this ‘international public good’ is borne by the lender of last resort — the source of off setting countercyclical capital flows (Kindleberger 1986) One aspect of this cost might be the loss of international competitiveness, which would be reflected in the emergence of trade deficits The growing deficits however, need not precipitate deflationary adjustment in the hegemon, with consequent spiraling effects on other core countries The historical development of the international monetary system is such that the cost in terms of increasing financial fragility and debt-deflation is to a significant degree borne by the periphery, as the hegemon is transformed not simply to a ‘venture capitalist’, but is effect running a global Ponzi scheme,>

The asymmetric integration of countries in the periphery into the global financial system

provides a pivotal mechanism of adjustment Both the advocacy of free trade and the

liberalization of international capital markets have been instrumental in prying open developing country markets

In a survey of the literature on the declining commodity terms of trade faced by developing countries, Ocampo and Parra (2005) identify two major downward shifts one after the First World War and the second during the early eighties which reflected delayed responses to sharp slowdowns in the world economy Equally disconcerting is the empirical evidence of a ‘deteriorating trend for generic manufactures This would suggest that developing countries need to aggressively and strategically develop technological capabilities in order to compete

> Cline (2005) discusses the recent trajectory of USA, in terms of debt cycle theory, as that of a transition from a mature creditor (A positive net foreign asset position and a negative current account balance) to that of a young debtor (with both being negative) But there is an obvious difference in the relative position of USA and that of developing country ‘young debtors’

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effectively in the international markets These ideas of the dynamic technological advantages or the economies of scale that can be reaped through trade, what has been called the productivity

argument (Myint 1958, 1977; Ho, 1996), go back to the classical traditions and form, for instance, the lynchpin of Smith’s defense of the benefits of free trade

The advocacy of free trade however has come to be linked with the principle of comparative advantage® More recently, in the wake of the controversy around the loss of jobs and the continued deterioration of the US trade deficit as a result of outsourcing of white collar service jobs, recourse was taken to this doctrine of comparative advantage In the light of the path of a debt-fuelled consumption binge that the US is adopting, the espousal of free trade in the face of continued trade deficits might be linked to its potential impact in cheapening consumption goods.’ The analytical premises of the principle of comparative advantage are worth revisiting in this context, despite the considerable ink that has already been spilt on subject

De Brunhoff (2005) while discussing the contradictory process of the integration of the world capitalist system under a dollar standard suggests that that the complex relation between capitalism and imperialism should be subject to further scrutiny Harvey (2003) points to the instrumentality of debt in the imperialist project of ‘accumulation by dispossession’ in his study of the emergence of a ‘New Imperialism’ in the recent decades The underlying motivation for this dissertation project is the conception that a Marxist theory of imperialism needs to be linked to the theory of money and finance The research is a preliminary exploration of this research agenda

° Thus despite developing some of these themes of the ‘productivity argument’ in the new trade theory literature Krugman bemoans the dangerous obsession with competitiveness while arguing on the basis of the principle of comparative advantage that ‘the benefits of trade do not depend on a country having absolute advantage over its rivals’ (Krugman 1993) Free trade remains in this framework an appropriate good rule of thumb (Krugman 1987)

’ This point would be further underscored in the case of service outsourcing by connection between the structural break in the pattern of US growth-debt cycles in the 80’s, with the explosion of household service expenditure that ts traced in Taylor et al (2006)

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The core of my research argues that the ability of US to sustain a growing external deficit is its role in the triangular pattern of recycling surpluses from creditor countries (of Japan and China for instance) to the emerging markets (of Latin America or South East Asia) in the periphery

The thesis is put forward on the basis of historical comparison with Britain’s role during the gold standard in Chapter II Such historical analysis, with its particular focus on specific institutional mechanisms, yields interesting insights into manner in which international liquidity was generated, It has been argued that Britain in the period of the international gold standard and USA after the post war period in effect acting as the international lender of last resort, and

injected liquidity through their central role in international financial intermediation

(Kindleberger, 1985; 1996) However, the study argues that the mechanisms for liquidity creation and adjustment do not depend on the dominant country retaining a ‘creditor’ status Rather financial intermediation is made possible by the country’s ability to borrow from surplus countries on one hand and pass the burden of deflationary adjustment shocks to peripheral debtor countries on the other Historically specific institutional mechanisms, which relate both to imperial hegemony and international diplomacy, played a critical part in enabling the leading country to perform the role of financial intermediation by extending its short term monetary

liabilities

Liquidity in the Post-Bretton Woods dollar-standard derived from multilateral clearing mechanisms and financial intermediation analogous to that of the British Empire Critical to this mechanism of adjustments during the gold standard was Britain’s role in the triangular patterns of settlements Creditor countries like India and Japan placed sterling balances in London, while private capital flows to ‘emerging markets’ in Latin America and Australia bore the brunt of speculative attacks The monetary arrangements after the collapse of the Bretton Woods system, have allowed the US to draw on the surpluses of the OPEC Countries, Japan and more recently

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China (and Korea) while transmitting the burden of adjustment to the emerging markets in Latin America and South East Asia The offshore euro-currency market, thus, served as a parallel monetary mechanism, analogous to the market for sterling bills that financed triangular trade in the international gold standard period, while official holdings of US treasury bills by Central Banks in Asia are the counterpart to the sterling deposits of the International Gold Standard The existence of analogous mechanisms, however, should not obscure the important differences

between the two periods The specificities of financialization, the institutional mechanisms of

global integration and fashioning the international division of labor, the effective delinking of international liquidity from a commodity basis in gold, and the unprecedented debt position of the hegemon are distinctive features of present period

Chapter III elaborates an analytical macro-model that highlights certain implications of financial intermediation and triangular adjustment patterns that the historical account highlighted It presents a stylized, open economy, stock-flow consistent, social accounting matrix of the world economy as a closed system with no ‘black holes’ It is within the methodological tradition of Godley, (1999; 2005), Godley and Lavoie (2002, 2003, 2005), Izurieta (2003, 2005) Gray and Gray (1989), and Taylor (2004) The international economy is represented as three interdependent blocs: the US with its trade deficit; “trade account’ countries in the periphery (Japan, China) which have a current account surplus that intervene to preserve their dollar exchange rate by buying up US treasury bills; and debtor “capital account countries’ in the emerging markets in the periphery

The accounting framework integrates financial flows of funds with the sectoral balance sheets Changes in the financial position of any one sector affect other sectors and are intrinsically linked, and accounting consistency demands that accumulation of financial wealth generates stocks of wealth and debt that in turn regulate macroeconomic behavior The skeletal framework of social accounts imposes constraints on the macroeconomic structure of the open economy

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model The behavioral assumptions that animate this structure determine the precise mechanisms and channels of adjustment In particular the distinct, asymmetric position of the surplus creditor country and debtor country in relation to the ‘hegemonic debtor’ country are central to the

conclusion that the private capital markets in the debtor periphery play a critical role in the

international adjustment mechanism

The model it should be stressed is merely highlighting a channel of displacement of adjustment crisis Further development of macroeconomic model would need to integrate real investment and work out some of the real financial linkages that have been suppressed in the present model Even with the enormous simplifying assumptions of the set up of this model, which is focused on financial stocks and flows, this approach is a useful way to address the question The model shows how the imbalance in the debtor-hegemon’s external account translates into an excess demand for the emerging market financial assets leading to destabilizing adjustments in the periphery The open financial markets of developing countries could thus provide a line of defense for the dollar By precipitating a shift from assets denominated in domestic currency to those denominated in dollars, capital flight from these emerging markets acts like a safety valve for the core of the international monetary system hitched to the issue of dollar liabilities

The present international regime in the nineties has been referred to as ‘non-system’, with international liquidity being sustained increasingly by market channels (Kenen 1994a) The alternative interpretation of this system as a ‘floating dollar standard’ (Serrano 2002) may be more appropriate The tremendous growth in international liquidity® is being propelled by the ability of the US to ‘borrow’ internationally, to suck in capital from the rest of the world It is in effect acting like, a “borrower of last resort’ The creation of public debt and its growing

8 So much so that ‘international liquidity’ which was the subject of concern in the seventies is no longer considered an issue at the turn of the century.(Williamson 2002)

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financialization are integral to the international mechanism of monetary accumulation The direct

bearing that the political imperatives of the hegemonic state have on the international monetary system are also revealed in a starker form

The final part of this dissertation revisits the debate on comparative and absolute advantage, with a view to drawing out some implications of trade and competitive advantage on

uneven development Chapter IV is concerned with the competitive determination of the pattern

of trade, seen as a choice of technique problem within the framework of a two country two commodity classical circulating capital model While the chapter investigates the choice of technique problem for the case of capital mobility and capital immobility, the latter case is more interesting analytically since this is the premise on which the principle of comparative advantage has been put forward in the classical surplus based approach Trade balance emerges as a condition of quantity clearing and the system of price and quantity equations is indeterminate The validity of the principle of comparative advantage thus rests on the choice of boundary condition that determines relative scale of output in trading partners These conditions would be determined by the concrete conditions in the two trading partners

The model is elaborated in a trade-as-barter formulation, without explicitly considering the role of a distinct money commodity The absence of money in its wealth holding role would mean that quantity clearing with capital immobility also requires balanced trade While posing the problem in this manner does appear to address the patterns of trade in terms of ‘relative’ prices (in terms of the numeraire) it should be stressed that the starting point is not autarky relative prices but the competitive solution to the choice of technique problem In the context of the circulating capital model the real terms of trade are regulated by real production conditions alone, so that while monetary mechanisms would play a role in the realization of trade equilibrium the nominal exchange rate does not play a direct role in balancing trade in the trade equilibrium

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The analysis even at this level of abstraction (ie a real circulating capital model with balanced growth paths) does help clarify some implications of international competition for uneven development Feasible, competitive trade outcomes need not necessarily emerge for a technologically backward country Thus trade with the colonies would not be a natural competitive outcome of exposure to foreign markets However, a large country that has lost its technological advantage in both sectors can still end up trading in one of the goods and enjoy a higher than autarky rate of profit This result arises from the potential impact of the cheapening of the input or the wage good with trade

The approach adopted in the study uses the comparative dynamics of steady state as an analytical device In the context of developing countries, unbalanced growth and the dynamic productivity advantage would provide a more appropriate basis for espousing trade openness (Pasinetti 1981; Dosi et al 1990) Technological change and technological diffusion are integral aspects of international competition The framework of the circulating capital model with fixed technological inputs and a given commodity-sector configuration would not do justice to the complexities of international competition in an age of multinational corporations, global assembly lines and commodity chains and the constant flux of commodities, sectors and industries That task though critical to the comprehension of international capitalist competitions and imperialist dynamics is beyond the scope of this dissertation

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CHAPTER II

The Borrower of Last Resort: International Adjustment and Liquidity in Historical Perspective

Introduction

The present phase of ‘globalization’ is often compared to the decades around the turn of the nineteenth century that had also witnessed a significant degree of global integration The proliferation of trade flows that marked both periods was linked to, and engendered a parallel

burgeoning of international financial flows Global integration in both periods was premised on

the development of international monetary arrangements that could generate the necessary international liquidity The crux of these arrangements was the emergence of the monetary liabilities of a single country as the principal means of settlement of balance of payments, internationally

If the operation of gold standard from the last two decades of the nineteenth century, till the outbreak of the world war was in essence a sterling standard, the Bretton Woods system instituted after the Second World War in effect forged a dollar standard The pyramiding of official liabilities on a disproportionately small reserve base, and the parallel emergence of unregulated monetary mechanisms based on an explosion of private liabilities generated international liquidity in both periods It has been argued that Britain in the period of the international gold standard, and USA after the post war period, acted as the international lender of last resort, and injected liquidity through their central role in international financial intermediation In this paper, I argue that the efficacy of this mechanism hinges on the ability of the ‘leading’ country to draw short term capital flows and stem the efflux of capital in the face of growing trade deficits and dwindling reserves, in short to act as a “borrower of last resort’

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Critical to the institutional mechanisms that underpinned financial intermediation by the leading country in the two periods is the role of imperial hegemony

The following survey of the literature on the workings of the international monetary system in the two periods seeks to highlight the role of a “borrower of last resort’ in the mechanisms of adjustment and liquidity in the international monetary system The analytical argument draws on Marx’s discussion of the emergence of ‘world money’ and Keynes writings around the proposal for the International Clearing Union In particular, the paper explores the implications of the emerging dominance of the fiat money of a single country alongside a parallel proliferation of ‘credit money’ transactions, instead of bullion, in the settlement of international payments balances The privileged position of the currency of a single hegemonic country in the international monetary system imparts a degree of elasticity to adjustments in the developed core of the global economy The mechanisms of adjustment, however, generate greater instability outside this core

Section 1 reviews the literature on the actual workings of the gold standard period, to argue that the apparent stability and liquidity of the gold standard derived from the dominance of sterling in the web of international transactions Private capital flows and the specific role played by the British imperial system were pivotal in sustaining the dominance of the pound in the gold standard period Section 2 outlines the emergence of a dollar standard with the Bretton Woods system and compares the post-war dollar standard to the pre 1914 gold standard It argues that the euro-dollar markets that arose in the sixties played a role similar to that of the imperial network in the sterling standard period They were in fact instrumental in preserving the hegemony of the dollar through the crises ridden seventies, and were the harbinger of the post-Bretton Woods international monetary system in which the international role of the dollar came to be underpinned primarily by unregulated private capital flows Section 3 draws on this survey of the two international monetary regimes to make the central analytical argument about the role of the

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‘borrower of last resort’ in international liquidity and adjustment A pivotal role is played in these mechanisms by triangular patterns of intermediation and settlement between countries bearing a surplus and the debtor countries in the periphery

1 THE INTERNATIONAL GOLD STANDARD AND THE DOMINANCE OF STERLING

Conducting the International Orchestra

The pre-war ‘international gold standard’ emerged in the last two decades of the nineteenth century, when most countries had shifted from silver and bimetallic standards to a gold standard This international monetary regime can be seen to reflect the British domination of the international financial system as the largest capital market and trader’ The stability of the international monetary system, during this period, has been ascribed to the ‘management’ of the system by the Bank of England The Bank of England played the role of “the conductor of the international orchestra” and was able to calibrate international movements of gold, on the basis of relatively small gold reserves, by manipulating the bank rate (Eichengreen 1987; Sayers 1970,

1976)

A survey of the literature on the period, however, reveals that the ability of the Bank of England to ‘manage’ the system was by no means absolute’’ Until the 1870s the techniques of monetary control were rudimentary and marked by frequent changes in bank rate In the eighties the Bank of England often resorted to gold devices and interventions in the gold market rather than frequent discount rate fluctuations, to protect its gold reserves It was only at the turn of the century that bank rate policy actually became effective (Sayers 1970, 1976; Scamell 1985) Thus while the Barings crisis in 1890 was ‘managed’ without a significant raising of the bank rate; the

° The defeat of France and the eclipse of Paris money market after the Franco Prussian war concentrated liquidity in London Germany’s subsequent shift to a gold standard and its use of the war indemnity to acquire sterling claims (the Theirs Rentes), would have also been a defining element of this process '° Gallaroti (1999) stresses the absence of ‘active conscious hegemonic force’

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1907 crisis was contained through the deployment of the Bank rate, with a negligible intervention in the gold market (Sayers 1970, 1976)

The ‘management’ of the international system was far from automatic, and the role of the Bank of England was not exclusively predicated on the calibration of the discount rate but in deploying a variety of means to make the discount rate effective in the chaos of unregulated short term flows that constituted the money market The Bank of England was faced with the dual, often-contradictory pressures of protecting its profit and competitiveness on one hand and on the

other the need to maintain reserves (by running down its assets or increasing its liabilities) against

a possible drain on the exchequer'’ Further, large idle reserves, while increasing the cash basis of the Bank of England, also eroded the Bank’s ability to control the market (Pressnell 1968)

The efficacy of the instrument of the Bank rate was conditioned by institutional and historical developments, in particular the tremendous growth of private international capital flows - the ‘financial revolution’ that was taking place in England in this period The emergent source of dynamism in the English banking system derived from the growth of deposit banking Through the 1880’s and 1890's, with the rapid development of joint stock banks, merchant banks and discount houses (the heirs to bill brokers) as integral components of the British financial system, there emerged a parallel growth of monetary mechanisms Alongside the proliferation of international trade in the last quarter of the 19" century, the spread of sterling bills as a mechanism of finance that was independent of the Bank of England, had also gained prominence (de Cecco 1984) Deposits in the joint stock banks became an important source of the cash required by discount houses and bill brokers to discount the growing volume of bills of exchange

'' Gallaroti (1991) has an insightful analysis of the constraints imposed by what he calls the dual mandate of ‘profit and public interest’

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The concentration of Joint Stock Banks, with the wave of amalgamations witnessed in

this period accentuated the challenge to the power of the Bank of England’’ The joint-stock banks

were not subject to the austerity imposed by Peel’s Act, and they were under no obligation to

keep reserves with Bank of England’’ The intended curbs on ‘notes issue’ embedded in the

restrictions on the creation of banking liabilities were thus largely circumvented The

proliferation of deposit banking underscored the diminished influence of the Bank of England on

the money market, since this source of liquidity creation was untrammeled by reserve requirements Comprehension of the workings of the gold standard and the ability of the Bank of England to manage the system has to take into account the history of competition and contradiction between the Bank of England and the Joint stock banks

The involvement of the Bank of England on behalf of government was matched increasingly by its dealings in private sector assets, in particular, through active intervention in the bill business (Pressnell 1968, 180; de Cecco 1984, 99), Alongside the frantic pace of expansion in the eighties was a progressively worsening asset-reserves position.’ The Bank of England embarked, through this period, on a process of ‘conquest’ of the rediscount market and sought to bring bill brokers back into its fold The process of re-admitting the money market to its regular and rediscount facilities was signaled when the Bank began offering advances to bill brokers and discount houses on a regular basis, abandoning the 1858 rule’ In 1890 it began

'? Between 1881 and 1891 the capital of joint stock banks increased from 35 million pounds to 50 million Less than 2% of banks total deposits were kept with the Bank of England (de Cecco 1984, 95)

‘° The Bank Act of 1844 (Peel’s Act) split the Bank of England into the issue department and the banking department and set limits to the Bank’s interventions in the money market on the basis of reserve holdings The Joint Stock Banks however were not obliged to keep their reserves with the Bank of England

' The reserve ratio decreased from 52.5% to 47%, between 1886-90 (de Cecco 1984), The debt conversion of 1888 also fuelled a low interest, high liquidity regime that was a prelude to the Barings crisis

(Eichengreen 1997)

3 In 1858, in the aftermath of the banking crisis of the previous year, the Bank of England disbarred Joint Stock Banks from its discounting facilities

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rediscounting bills, directly, initially accepting bills with a currency of 15 days, and subsequently

accepting paper of longer maturity’

This competition for bill business, created potential pressures on Bank of England’s reserves and would have implications for the balance of payments through drains or reductions in inflows Interest rate manipulations could be used to regulate the demand for bills and the inflow of gold, and thus served as an alternative to maintaining large reserves But at the same time, the period was dogged by fears of declining reserves that put a damper on initiatives at monetary reform that sought to extend the Bank’s flexibility in fiduciary issue of notes'’ The banking system was caught in “blind alley of maximum reserves and minimum central banking” (Pressnell 1968) However, despite this ‘cautionary attitude’ and the constraints of acting within the 1844 (Peel’s Act) limits on notes issues, the banking system evolved to accommodate a growing volume of finance on the basis of a relatively ‘thin film of gold’

It has been argued that the small stock of gold reserves with the Bank of England betrayed tts essential vulnerability (Gallarott: 1999) The Bank displayed a manifest ‘reluctance to place British liquidity on the altar of international demand for money in restrictive periods’ (Gallarotti 1999, 139) and abated public panic ‘not by marshalling its own resources but by asking major British financiers and foreign central banks and governments for funds or special accommodations’ (Gallarotti 1999, 130)

'® In 1897 it began accepting bills with a currency of 3 months and in the first decade of the 20" century it admitted bills with a maturity period of four months and exceptionally six months However, the Bank would temporarily refuse to accept bills of longer maturity in order to stiffen the market (Sayers 1970; 1976)

'’ The abortive attempts at monetary reform after the Barings crisis are analyzed by Pressnel! (1968) He points to the prevailing notion that a gold hoard was necessary to face internal and external drains The external protection of sterling required international means of payment, but the internal problem was soluble by assurance of adequate supplies of legal tender Pressnell argues that the tangling of two distinct problems of international and domestic cash reserves before 1914 thwarted a more far reaching reform of the British monetary system (Pressnell 1968, 185)

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To illustrate, consider the 1907 crisis that was precipitated by a contraction in the US

economy following a speculative run on copper and the collapse of the Knickerbocker trust In response to the threat of a gold drain, the Bank of England raised the bank rate from 4.5 % to 7 % in response to the pressure placed by the demand for gold in the US to shore its financial system'Š Bank of France faced with a potential adverse spillover effect took it upon itself to discount British bills heavily The gold reserves of France, a creditor country, were thus made

available in the London gold market, pre-empting a further rise in the discount rate’” Gold flows

from the continent were then recycled to the US, which borrowed largely on bills on London.” It is true that through the period there was an incessant preoccupation with the British Treasury’s dwindling gold reserves and the declining ratio of reserves to liquid foreign liabilities”’ But the ‘thin film of gold’ that was sustaining international liquidity was in fact a reflection of the strength of the Bank of England bank rate policy Its efficacy hinged precisely on this ability to draw gold bullion from surplus countries and recycle liquidity in order to manage

crisis

Britain’s current account surplus, from earnings on its swelling foreign investment portfolio, and receipts on services and remittances account, offset its merchandise account deficits through much of the period But it is doubtful that Britain’s net short-term claims abroad exceeded corresponding liabilities and it is more plausible that her short-term payments position fluctuated from being a net creditor to a net debtor (Bloomfield 1964; Lindert 1967) In fact as we

I8 Through 1906-7 the Bank of England also curtailed loan and rediscount facilities allowed to the market (Sayers 1970)

'? In 1907, France made £ 3 millions worth of American eagles available to London by taking up sterling

bills (Sayers 1970, 110-113) The German Reichsbank also supplied liquidity by drawing in gold from the Russian State Bank (Eichengreen 1996, 35)

© USA engaged in direct negotiation with France in 1910 (Gallarotti 1999, 140)

*1 The gold holdings of the bank were around 2% of money supply through the period under consideration (Sayers 1976, 9-10) England’s gold reserves as ratio of imports was stable around 5% while France was above 50% for most of the period between 1895 and 1910 falling below 40% in 1913 The ratio of gold reserves to banking liabilities was around 5% (Bloomfield 1959, 21)

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argue, a short-term creditor position was not essential to the workings of the stabilization mechanism

More important was Britain’s ability to manipulate short-term capital flows Critical to this ability was the process by which the international financial system came increasingly to be

centered in England in this period The ability of the Bank of England to use an increase in the

discount rate to induce a net inflow of capital, hinged on the privileged international position of England enjoying as it did a large volume of short-term foreign claims, a currency of unquestioned convertibility and a zero exchange risk At the heart of this dominance was the rise of the Bill on London as a means of settlement of international payments - as a form of ‘world money’

With the emergence of the Bill on London as a means of international payments and settlements, private capital flows mediated through the financial center in London came to play a pivotal role in regulating and recycling liquidity These credit instruments imparted a high degree of elasticity to the supply of money while insulating gold stocks The concomitant growth of financial institutions and the extension of the discount market through joint stock houses enabled the creation of a credit pyramid on the basis of a relatively small gold edifice

The Bill on London and the Sterling-Standard

The bill of exchange had been growing as a means of financing trade, in particular, since

the mid nineteenth century” These bills were denominated in pounds but issued outside Britain

They provided the seller of goods with a financial instrument that could be discounted before its maturity, or reused as a means of payment after being endorsed Its wide acceptability as a means of payment depended on the presence of an organized market for discounting and negotiating bills

? In particular, this followed the international expansion of British financial institutions and improvements in communications consequent on the spread of the telegraph (Williams 1968)

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The last quarter of the nineteenth century saw the relative decline of the volume of inland bills with foreign bills becoming more dominant through the turn of the century”’ The immense growth of international trade and financial flows, in the nineteenth century, had fuelled the move to ‘monetary liabilities’ instead of bullion Foreign exchange claims that accumulated at an annual rate of about 10% outpaced the corresponding growth of gold reserves which grew at

about 6.3% over the decade, 1904-1913 (Lindert 1967, 26) Concentration of the pattern of

international settlement through the London markets, and the various measures deployed to economize on the use of bullion, also promoted the increasing recourse to sterling monetary liabilities, and the Bill on London, instead of actual bullion (Lindert 1969)

Britain typically paid for imports on a short-term basis while offering longer-term credit on exports (Marcuzzo and Rosselli 1991, 69) Exporters would draw bills on their shipments on London accepting houses or branches of foreign banks in London, and receive payments immediately Importers on the other hand were required to make their payments only when the bill matured British imports were financed by acceptance credits through London and accepting houses acquired a purely domestic claim on the British importers (or their banks) The actual financing of such transactions was provided by the purchasers of the foreign drawn sterling bills in the London market or by the foreign exporters (or their banks) if they held bills till maturity (Bioomfield 1963, 36-7) London houses also financed the bulk of trade between foreign countries through transactions in bills Such financing created short-term claims on importers

> Nishimura’s study shows that after a period of decline in the volume of bills through the seventies and eighties there was resurgence in the growth from the nineties However, this growth was predominantly that of foreign bills Inland bills reached a peak around 1873 (comprising about 83% of National Income in between 1861-71) and declined thereafter, Foreign bills, which had increased till 1873 also declined during the 1870-80s, but the recovery of foreign bills in the 1890’s outpaced that of inland bills The peak of this recovery was in the first decade of the 20" century (Nishimura 1971, 25, table 15)

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without necessarily creating a counterpart short-term foreign liability” Sterling bills, routed

through the London, for example, financed USA’s trade with Europe

With the acceptance of the bill as a medium of international transactions and for the financing of international trade, the role of the bill market in financial intermediation was extended internationally The London discount market became an integral part of the international monetary system This reflects not merely the greater use of bills to finance external trade, but more importantly, the greater deployment of bills as a mechanism of international borrowing Money market instruments came to be used for foreign investment of short-term funds and reflected the international movement of capital” These included imterest-arbitrage operations at

initiative of lenders who transferred liquid funds to London in order to profit from the difference in yields” For instance American bankers borrowed on finance bills in spring when the dollar was weak, and repaid debts later in the year when the dollar had strengthened, garnering huge profits in the process In this sense, the Bill on London had evolved from being a medium of

exchange representing an actual mercantile transaction, to become a financial instrument, a

‘means of payment’ mediating international relations of credit

Such ‘finance bills’ would be more sensitive to the interest rate rather than the volume of trade”’ The volume of finance bills decreased when the London discount rate was high, and the higher bank rate induced repatriation of funds employed abroad The boom of 1906-7, for instance, prompted speculators to draw bills on London where the rate of interest was higher In the slump of 1908-9, the reverse happened and fewer bills were drawn on London (Nishimura, 1971) Thus an increase in the discount rate (if not offset by corresponding increases elsewhere)

*4 Unless the exporter (or the exporter’s bank) held the bill till maturity or foreign investors purchased it on the London market (Bloomfield 1963, 37)

*° Bloomfield (1963, 38) Some 60% of bank acceptances outstanding in the London market in 1913 were estimated to comprise finance bills

*° Bloomfield (1963) Such transactions were perceived to display a negligible exchange risk

27 Nishimura (1971), 66 The predominance of ‘finance bills’ rather than commercial bills is revealed in the

correlation of the volume of bills to the interest rate

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could be used to induce capital inflows by ‘contracting the outstanding volume of London’s

acceptance and other short term claims on the rest of the world; by attracting liquid foreign balances seeking temporary investment in London; by stimulating arbitrage operations in securities quoted in London, by delaying flotation of securities in London; and through the transfer abroad of previous flotation’ (Bloomfield 1969) The short run impact of changes in Britain’s discount rate on the payments mechanism hinged almost exclusively on the capital movements it engendered

In no other country did the change in discount rate have such an immediate or profound impact This stemmed undoubtedly from London’s developed institutional money market, the confidence in the pound as a currency of unquestioned convertibility, and Britain’s dominant role in international trade and finance (Bloomfield 1969) The scale of acceptance financing by London markets was unrivalled” Through the gold standard period about 60% of world trade was financed through sterling bills and about £4000 million worth of long term securities were taken up from foreigners by this market, between 1860 and 1913 (Williams 1968, 268) The development of these internationalized capital and money markets depended on the growth of an mternational banking system centered on London

While the pattern of capital flows was, in general, conducive to adjustment, the period was not immune to “disequilibriating movements, destabilizing exchange rate speculation, capital flight, inadequacy of reserves and a high volume of international indebtedness” (Bloomfield 1969) What is remarkable is that while a predilection for destabilizing ‘hot money flows’ was present in this period, such episodes did not threaten the convertibility of the currency of the leading countries in the European center

8 France and Germany had also risen as reserve centers and also attracted liquid funds However, while the franc and mark outweighed the sterling on the continent, outside the continent the practice of keeping sterling reserves was prevalent and the sterling reserves outweighed reserves of marks and francs together The sterling was the leading currency for instance in Asia and Africa (Lindert 1969, 17-18, 25)

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The countries on the periphery, however, did not display a similar pattern of smooth adjustment and experienced perverse capital movements, convertibility crises, devaluations and

terms of trade fluctuations” A sudden rise in interest rate in London could attract short- term

funds from countries that had been in a balanced position, precipitating a drain of reserves Such

liquidity crises occurred for example in Argentina during the 1890 Barings crisis, Brazil in the

1890’s and again when Australian land company bubble burst in 1893 These crises were aggravated by the sudden withdrawal of British deposits (Bloomfield 1969; Fishlow 1985) The dollar too, was subject to speculative attacks in 1893-96 and in 1907

The hierarchical structure of international capital markets and credit relations, and the asymmetric nature of the Britain’s ability to manipulate short-term capital movements are critical to the explanation of the mechanism of adjustment under the ‘international gold standard’ The emergence of the Bill on London as a source of international liquidity cannot be understood without exploring the institutional structure of the credit relations underpinning Britain’s relation to its empire and to primary export producers in the ‘periphery’ The privileged position of the well-developed London markets at the center of the web of international transactions resulted in a pattern of settlements that was to a significant degree denominated in sterling, permitting the accumulation of sterling to meet debt obligations

The Imperial system and the gold exchange standard

The international gold standard can be seen as the product of the British Empire (De Cecco 1984) Heightened international competition and the erosion of Britain’s ability to penetrate the markets of Continental Europe and USA were compensated by increased exports to the countries in the Empire At the same time countries in the British Empire, in particular India,

*° Triffin (1964), Ford, (1956, 1960) Fishlow (1985) The different experience of the core and periphery has been explained in terms of absence of a credible commitment mechanism in these countries Bordo and Shwartz (1999)

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bore a surplus with Continental Europe The interconnecting network of multilateral trade, revolving around England, whereby it financed its deficits with USA and Continental Europe through the surpluses of the empire with these countries, became crucial to the stability of the system (Saul 1960)

Thus imperial relations allowed England to “look with equanimity at her loss of competitiveness on the world’s free markets for industrial goods as she kept control over the world’s raw material markets and the empire generated enough financial flows to serve as raw material for the City’s intermediation capacity ” (de Cecco 1984) The triangular pattern of international settlements played a pivotal role in preserving Britain’s domination of the international monetary system

On the one hand, countries bearing a trade surplus with Britain ran up sterling balances in London so that the adverse impact was offset by short-term capital flows Thus Britain’s deficits with Europe and North America were financed to a significant degree by the formal creation of sterling claims on London Britain’s surpluses on the other hand were with countries in its Empire where the banking system was largely British, and where the bulk of transactions of the empire were centralized in London Surpluses with its empire were financed by extending credit, but also by receiving gold on a large scale from the producing countries.*° Further as a consequence of the pattern of the empire’s transactions with the rest of the world, UK tended to increase its claims on the empire in the form of sterling balances.”

The international transactions of the British imperial system attracted non-empire business and countries outside the British Empire countries also began to settle debts between themselves in sterling Europe for instance held balances in London to clear deficits with

* Gold produced within the empire, was also sold in London for sterling, and then, in large part re-exported by the England (Williams 1968)

3! The surplus of countries in the empire with Continental Europe was held as sterling deposits in London Further a bulk of the trade between the Empire country and Continental Europe was financed through

sterling bills (Williams 1968, 285-6)

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countries of Empire and Latin America Thus, in this period the pattern of settlement of international debt of Empire centralized in London and bilateral clearing arrangements were transformed into a multilateral clearing mechanism (Williams 1968, 286)

Britain in the pursuit of its role in financial intermediation maintained the balance

between short-term indebtedness and long-term credit through these patterns of triangular trade

The system would function smoothly as long as short-term creditor countries had confidence in

sterling In practice such confidence was sustained by the fact that outside Western Europe and North America, British commercial banking was the dominant element in the financial systems internationally’ However, the banking system in North America also indirectly relied on the London money market to ease seasonal liquidity constraints

It has been shown that the practice of augmenting reserves with convertible foreign exchange was prevalent in the pre-war world and the gold standard was in fact a ‘gold exchange standard’.”’ India, Japan and Russia together held 60% global total of foreign exchange reserves (Lindert 1969, 13)

The origins of this system lie in the period of the depreciating silver currency As a result of this crisis, currencies that were tied to silver came to be stabilized in terms of sterling and gold at the turn of the century Sterling reserves, which were perceived to have zero risk, acted like a second line of defense that protected the gold reserves of countries that had vulnerable payments

°° With the extension of British banks into domestic banking business overseas, British banks controlled about one third of deposits in Brazil, and over a quarter in Argentina and Chile in 1914 Colonies and

dominions were even more heavily controlled (Williams, 1968; 271)

33 Lindert (1969, 18) Again, while sterling was the dominant currency, it was by no means unrivalled as a reserve currency especially in Europe Russia for instance held its reserves in marks or francs Russian government manipulated accounts between France and Germany, wielding the convertibility of their liquid funds as a financial weapon However in the both the Barings episode and the 1907 crises it was marshaled into serving the London market Bloomfield (1969, 13) also notes a sharp increase in the aggregate of official balances which increased from $60 million to $130 million between 1880-1899, further rising to about $ 1 billion in 1913 largely as a result of accumulation by these three countries