Theme II 1b Challenges in the Global Economy

Theme II 1b: Challenges in the Global Economy 1 The threat is nearly invisible in ordinary ways. It is a crisis of confidence, It is a crisis that strikes at the very heart and soil and spirit of our national will Jimmy Carter, Crisis of Confidence, 1979 1 Gas guzzled: OPEC’s 1973 oil embargo threw America into crisis and underlined the political power of energy. David Falconer/Wikimedia Commons

Criteria for Significance 1. Instability of Financial and Monetary System a. Unstable currency values and high debts 2. Illiberal trading order a. Decline in free trade and rise of new protectionism 3. Declining rates of economic growth and uneven development across the global economy Ai. Structural Issues and Consequences of the Golden Age of Capitalism 1. US-enabled growth eventually led to increasing convergence in developed economies as they endeavoured into similar industries and advanced to similar levels of industrial sophistication, increasing rivalry between developed countries a. From 1970s to 1986, US and Germany’s labour costs were twice of Japans but equalised. Similarly, US’s productivity decreased by thrice compared to Germany and 50 times compared to Japan. Increasingly similar factors of production led to less differences in factor endowments. To reap comparative advantages, the basis of trade decreased b. Trigger Price Mechanism was enacted in 1977 to impose tariffs on Japanese steel exports should they be sold lower than the trigger price. This was due to an advanced Japanese steel industry which outperformed the inefficient American one. US prioritised its own steel industry as both countries competed for steel dominance in the market. 2. Undud changes in the global economic structure that growth had depended on due to America’s unsustainable unilateral management removed the benchmark for currency values, destabilising the FMS and de-liberalising trade a. Maintaining the adjustable peg exchange rate depleted US gold supply. (1948-1959: 24 billion USD to 19.5 billion) . In 1971 Aii. US Abandonment of the Bretton-Woods System (1971) 1. Closing the gold window meant that the US dollar would be allowed to float against other currencies without a quality benchmark. A easily vacillating US currency increases volatility for other currencies pegged to it as well, thus inviting speculation and inflation, destabilising the FMS. a. MNCs, international banks and private investors, realising the profit to be made in the money market trade, indulged in extensive currency trading. Chiefly in the Euromarkets only, currency trade increased from less than 25 billion a day spiked to over 100 billion in 1973. Consequently, currency fluctuates at a faster rate, destabilising the FMS b. 1970s currency wars saw countries engaged in competitive devaluation to ensure that the prices of their goods, determined by transportation and exchange rates costs stay competitive. Not knowing the value of the currency promotes traders to hedge or buy insurance against future volatility, fuelling speculation which could lead to inflation. Consumer prices in Western economies doubled.

2. Collapse of the BWS meant that the external discipline provided by it was also removed, widening policy options for governments whom stimulated demands to offset recession by increasing wages which generated inflation a. UK’s Barber Boom was a product of extensive tax cuts and liberalisation of the banking system. It was possible as Britain did not have to grapple with defending the pound now without the BWS’s peg. Bank lending rose from 71 million to more than a billion and the monetary supply (M3) grown by 25%. The boom was short lived as inflation spiked to 24% 2and the country fell into a recession (2.4%) b. 1975 Without the need to defend the peso, the Argentinian government could enact populist policies without worrying about the fixed exchange rate. Rodrigazo saw a 150% devaluation of currency and 45% increase in wages. Consequently, purchasing power fell rapidly as prices doubled. 3Inflation went up to 450%4 3. Countries signed alternative agreements to stabilise their currencies against each other, reducing volatility and instability within the FMS by fixing exchange rates, regaining investors and trader’s confidence to engage in international finance. a. 1971 Smithsonian Agreement signed by the G10 agreed to create a new standard for the dollar, devaluing it from $35 to $38 an ounce of gold while other countries agreed to revalue their currencies. Probe: However, gold prices rose to 60 an ounce in 1972 and 90 an ounce by 1973. By 1973, the Smithsonian Agreement effectively collapsed as all major currencies were floating b. 1971 European Monetary System saw an adjustable exchange rate arrangement set up among European countries to stabilise exchange rates and stop inflation, facilitating inter-European trade. After 1983, exchange rate variability within the European Monetary System declined substantially. Aiii. Oil Crisis (1973 and 1978) 1. Sharp rise in oil prices raised the cost of production and brought about global recessions, delivering the most devastating blow to global economic growth and development to the point that they triggered the onset of the Crisis Decade. a. 1973 Oil Crisis quadrupled oil prices to $12 due to the OAPEC oil embargo that tightened oil prices (cut 1.2 million barrels of oil). Resulted in the first world recession (1974-1975) as consumer prices rose to an average of 10% compared to the 4% the earlier decades and unemployment grew to exceed 4%. b. Due to the Iranian revolution, oil supply from Iran dropped from 6 million a barrel to 500000 in 1979. Panic buying due to perceived shortage tripled the price to 38 dollars a barrel. Resulted in a second world recession in the 1980s as economic growth was uneven and averaged only 2.8% while inflation rate doubled to 14% in the 1980s. 2 https://www.ruffer.co.uk/en/thinking/articles/market-views/2022-09-barber-boom 3 https://en.wikipedia.org/wiki/Rodrigazo 4 Luis Ignacio Jácome. "Central Banking in Latin America: From the Gold Standard to the Golden Years", IMF Working Papers 2015, 060 (2015), accessed October 11, 2025, https://doi.org/10.5089/9781484303184.001

2. The oil crisis brought about improper financial recycling of petrodollars, generating the unstable financing conditions in the financial and monetary system that led to the debt crisis of the 1980s. a. Large volumes of Arab petrodollars were invested discreetly as sovereign wealth funds into major commercial banks of US and EU, contributing to the rapid growth of a less regulated Eurodollar.5 As it fell outside of many central bank’s regulatory purview, it was more volatile. Currency trading in the euromarket spiked to 100 billion a day in 1973. b. The 1973 oil crisis had created a vast shortage in developing countries whom still needed to finance their imports of oil and machinery. To prevent bankruptcy, they borrowed from oil-funded banks. Their economies had yet to reach a point of stability that would guarantee that they could eventually pay back. This ballooned debt, as it rose to 18% of GDP in 1977 3. The oil crisis 4. Various countries were able to adapt by diverting from oil intensive industries while others profited from the crisis as oil prices spiked, resulting in a relatively high economic growth rate as compared to the rest of the world. a. For oil producing states, the spike in oil prices increased. During the 1973 oil crisis, this revenue was estimated to be 70 billion while in 1979, it was estimated to 114 billion as compared to OECD’s average of <2% b. Japan shifted from oil-intensive industries to new ones like electronics while innovating in existing oil-intensive industries like automobile to create fuel- efficient cars. Japan also accelerated its nuclear plans and build more hydroelectric plants. Japanese GNP