Money and Finance 195Even as the new international financial system, generally known as the
Euromarket, was gathering steam, the Bretton Woods monetary system was
beginning to weaken. In particular, it was becoming more and more difficult to
maintain the dollar’s price of thirty-five dollars an ounce. As pressure built on the
dollar and attempts at reform stagnated, the Richard Nixon administration finally
decided that the system was unsustainable. In August 1971, President Nixon “closed
the gold window,” ending the dollar’s free convertibility into gold. The dollar
was soon devalued, and by 1975, the gold-dollar standard had been replaced by
the current floating-rate system. In Reading 14, Barry Eichengreen evaluates the
ability of an international political explanation—the so-called theory of hegemonic
stability—to explain the evolution of international monetary relations across these
historical systems.
Under the current system of floating exchange rates, the value of most currencies
is set, more or less freely, by private traders in world currency markets. Thus, the
values of the dollar, the yen, the pound, and so on fluctuate on international currency
markets. This has led to frequent and rapid changes in the relative prices of major
currencies, as well as to frequent complaints about the unplanned nature of the
new system. Because of the central role of the U.S. dollar, even in today’s floating-
rate system, changes in American economic policy can drive the dollar up and
down dramatically, in ways that have important effects on the economy of the
United States and of the rest of the world.
The “unholy trinity” of a fixed exchange rate, capital mobility, and autonomous
monetary policy—and the necessary trade-offs engendered by the pursuit of these
three goals—is central to understanding the current floating-rate system and the
potential for cooperation among the world’s leading nations in international
monetary affairs. This problem is examined by Benjamin J.Cohen (Reading 15).
In Reading 16, Jeffry A.Frieden discusses the domestic societal implications of
the trade-offs involved, arguing that interest groups will vary in their views on the
desirability of one exchange-rate policy or another.
In the 1970s, as American inflation rates rose, the dollar’s value dropped
relative to other major currencies. From 1979 to 1985, American monetary policy
concentrated on fighting inflation while fiscal policy was expansionary, leading
to a dramatic rise in the dollar’s value. Although inflation was brought down,
the strong dollar wreaked havoc with the ability of many American industries to
compete internationally. In the mid-1980s the dollar dropped back down to its
lowest levels in nearly forty years, and in the 1990s it has gone up and down
continually.
Through all these fluctuations, there was dissatisfaction in many quarters about
the underlying uncertainty concerning international monetary and financial trends.
Today currencies fluctuate widely, many of the world’s major nations are
experiencing unprecedented trade surpluses or deficits, and capital flows across
borders in enormous quantities.
Monetary uncertainty has led some nations to seek security in a variety of
alternative institutions. Some countries and observers support the development of
a new international money, of which special drawing rights might be a precursor.
Others desire a return to the gold standard and the monetary discipline that this