In this chapter we survey the history of international finance spanning a century and a half. We start by characterizing capital flows in the long run, organizing our discussion around six facts relating to the volume and volatility of capital flows, measured in both net and gross terms. We then connect up the discussion with exchange rates and monetary policies. The organizing framework for this section is the macroeconomic trilemma. We describe where countries situated themselves relative to the trilemma over time and consider the political economy of their choices. Finally, we study the connections between international finance and economic and financial stability. We present consistent measures of growth and debt crises over the century and a half covered in this chapter and discuss how their incidence is related to those institutional and political circumstances, and, more generally, to the nature of the international monetary and financial regime.

Based on a thorough analysis of the BIS Annual Reports from the early 1970s to the late 2010s, this chapter traces the evolution of the BIS’s thinking on the international monetary and financial system. It demonstrates how – as a result of the growth of the Eurocurrency markets in the 1970s and of the sovereign debt crisis of the 1980s – the BIS’s traditional focus on exchange rates and their potential impact on monetary stability gradually shifted to global capital flows and to the risks posed by an increasingly complex and interconnected banking system. The 1995 Mexico crisis and 1997–8 Asian crisis reinforced this shift and led to an overriding concern with the procyclicality of the financial system as a potential threat to financial stability. While recognising that the focus of the BIS on a macro-financial stability framework has contributed a lot to advancing the work of the Basel-based committees and standard-setting bodies, the chapter also concludes that not much progress has been made in coordinating monetary policies or in addressing the fundamental problem of excessive elasticity of the financial system.

Becoming a professor was easier than becoming an economist. Growing up in Berkeley I was surrounded by professors; they dominated my parents’ dinner parties, though my mother and father themselves were not academics. The conversation touched on book projects, sabbatical plans, and foreign travel. There was the security of a regular paycheck but, so it seemed, no one resembling a boss.

Growing up in Berkeley had its distinctive aspects. An outing for the socially conscious among my high school classmates was going down to the university and getting tear-gassed. At about this time the high school curriculum compelled one to choose between the natural sciences, social sciences, and humanities tracks. Social sciences were irresistible for someone growing up in this political petri dish. The natural sciences track, in contrast, would have meant more math. Early decisions have long-term consequences.

The University of California, Santa Cruz, where I was an undergraduate, was another child of the 1960s. Intended as an alternative to factory schools like Berkeley, it had no grades, few major and breadth requirements, and little intellectual structure. Students were encouraged to design their own majors. This encouraged healthy disrespect for conventional academic boundaries, something that comes in handy for an economic historian. Santa Cruz also sent me for my junior year to the University of St. Andrews. St. Andrews students met periodically with a tutor to discuss assignments and read papers. My tutor was the Spanish economic historian Geoffrey Parker. In my senior year back at Santa Cruz, the department hired as a visitor a brilliant graduate student from Stanford, Flora Gill, to teach a course in economic history.

Introduction

An important part of western Europe's post-Second World War success story was its rapid integration into the world economy as well as its rapid integration with itself. The Great Depression, protectionism, and the war had reduced foreign trade to the levels recorded just before the First World War. In 1947–8, for instance, the volume of western European exports was barely above what it had been in 1913 (Svennilson 1954). As for capital movements, they had virtually come to a standstill, in a world riddled with inconvertible currencies and rigid controls on foreign exchange flows. Sixty years later, the volume of exports had been multiplied by fifty, free trade prevailed in both western and eastern Europe, and the degree of openness had reached unprecedented levels, as had the extent of intra-European trade, while capital movements were almost completely free. Indeed, a significant number of countries had gone as far as doing away with their domestic monies in favor of a new common currency – the euro.

The rising importance of foreign trade over the period is documented in Figure 11.1, which shows the share of exports in GDP for western Europe in constant prices. The series, after dipping in the interwar years, rises very sharply after 1950 to levels that by 1973 had already overtaken those achieved during the last phase of globalization at the beginning of the twentieth century. The rise in the trade share is even more spectacular in the last few decades.