Monetary System Shifts: Oil, Inflation, and Capital Flows
Key Shifts in the Monetary System
a) Abandonment of fixed parities.
b) Definitive disappearance of gold as a monetary reference.
c) Fixing the value of each currency in accordance with the provision of reserves and special drawing rights (SDR) under the value of other currencies.
d) Evaluation of the SDR in accordance with the trading of major currencies, not the dollar as before. And signed the death certificate of Bretton Woods.
Consequences of these Changes
A. Different countries may settle on the deficit in their balance of payments with their own currency, which in practice means the possibility to prolong it.
B. The dollar remains the international currency but without reference to gold. The U.S. must ensure its stability. This involved a significant advantage: monetary policy was able to serve its own interests, leaving partners to adapt to changes. It was also feasible to finance military expenses or purchase equipment abroad with its own currency even if the trade balance was in deficit. The richest country in the world could live on credit at the expense of others.
C. The non-convertibility of gold has two additional implications: It penalizes the relative weakening of the U.S. economy compared to its competitors and its industry’s inability to endure longer the level of currency parities in force. It also facilitates the development of an international financial system with the dollar as its central support, which was only possible because no other Western country had a currency that could occupy this central position.
The Rise in Oil Prices and Inflation Trends
The new monetary system is characterized by high volatility and great flexibility in two main adjustment mechanisms: exchange rates of major Western currencies and movements in the balance of payments. This feature facilitated the absorption of the imbalance in international payments after the first oil shock of 1973, resulting from rising oil prices. This rise was a punitive operation by OPEC countries against the West for their assistance to Israel during the Yom Kippur War. Consumers reacted with provisions to save energy and use alternative sources like nuclear and renewables, in addition to promoting oil exploration outside of OPEC. However, oil demand in industrial countries remained high, leading to trade imbalances, an acceleration of inflation, and international monetary disorder. The oil crisis triggered an economic crisis. Although the situation improved between 1974 and 1978, the Iranian Revolution disrupted the market, and OPEC raised prices again in 1980. This second shock hit a weakened economy, and increased energy bills further complicated recovery. Instead of an initial deflationary phase like the one after 1929, there was a clear inflationary trend. In the next ten years to 1974, inflation averaged 10% in OECD countries. While the trigger was the rise in oil prices, other structural elements, such as the growth of the tertiary sector and the diminishing role of industry as an inflation buffer, should not be neglected. Controlling rising prices became a priority for government action.
Capital Movements
From 1980 onwards, there is a greater tendency towards financial globalization due to the free movement of capital. Financial globalization rests on a freer flow of capital, the abolition of intermediaries, and the integration of national financial systems. This fosters a global capital market. According to liberal theory, this has favored global growth by facilitating a more efficient allocation of savings, reducing intermediary costs, and obliging governments to be responsible in their economic policies. However, these statements must be qualified due to the emergence of new risks. The floating capital today represents a total volume of about 4 trillion, likely to move almost instantaneously from one financial center to another in search of better returns, sometimes based on mere rumors rather than economic fundamentals. The monetary and financial spheres are disconnected from the real economy.