An International Role

Now we come to dealing directly with the international LOLR concept. Unless the International Monetary Fund (IMF) or some other body can issue any currency it wishes on demand and without limit, it cannot act as international LOLR. Many of the advocates of this scheme come close to recognizing this, and urge that the IMF should be given more reserves to enable it to lend more freely. The trouble with that, apart from its ignoring the fundamental point that an international LOLR has not yet been justified, is that the more resources it has, the more it will need. Only when it has enough to be able to replace on demand the entire money stock of an economy with US dollars (assuming that to be the money demanded) will it have enough.

But why should there be such a body in any event? A domestic one is needed because banks cannot suddenly declare that (for example) dollar deposits are no longer redeemable in dollars, but only in a currency of the bank's own issuing which floats against the dollar. That option is always available to a country; a country can always float its exchange rate.

Can there be such a thing as an international lender of last resort? Certainly it has often been asserted that there can be, with some talk of the IMF or some such body behaving in this fashion. When the Bank for International Settlements was established in 1929, hopes were expressed by some that it would go on to become a central bank. Or, for example, there has been the view that the Bank of England was the effective LOLR to the world in the classical gold standard years, 1880-1914. Rockoff (1986) even goes further in saying that any national bank that acted as an LOLR was forced by the gold standard to act as an international LOLR.

But the dominant view of the operation of the gold standard is that if there is a shortage of funds in one participating country, funds will be drawn in from other countries and in this particular case from the Bank of England, the 'conductor of the orchestra', in one smooth and continuous process of arbitrage. The process would have been encouraged by adherence to the 'rules of the game'. We do not dissent from that. Our argument is that a financial crisis is different. It is more than the normal ebb and flow of funds. A financial crisis requires prompt injection of liquidity. We place principal emphasis on the fact that the LOLR is the ultimate source of the means of payment. The only currency the Bank of England supplied was sterling. Thus if there were a financial crisis in, say, the United States, interest rates would rise there and that might have the effect of drawing cash from England and from other countries. But the Bank of England was not able to supply dollars in quantities in excess of the base money of the system. And indeed all the evidence is that the US suffered repeated banking panics and financial crises while England was relatively free of them. That was one of the reasons why the US set up the Federal Reserve.

Furthermore, the gold standard was the long-run rule that provides long-term price stability. The LOLR is in some respects the antithesis of this. Hawtrey was one of the few writers who seems to have been clear on this and made it explicit: 'An international central bank can only help so long as an international medium is required; it cannot supersede the ultimate remedy of an emergency issue, which remains a matter of national not international jurisdiction' (1962, p. 274). Kindleberger has argued that there has been a need for an international LOLR. He argued first (and correctly) that financial crises could be, and often were, internationally transmitted. He then produces a non sequitur: 'It follows from the international propagation of financial crises . . . that a case can be made for an international lender of last resort' (1978, p. 201). We reject that for the reasons given above.

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