Each state uses its own currency. These currencies have no inherent value but depend on people’s belief that they can be traded for future goods and services.
Gold and silver were once used as world currencies that had value in different countries. Today’s system is more abstract: national currencies are valued against each other through exchange rates.
The most important currencies-against which most other states’ currencies are compared-are the dollar, euro, and yen.
Inflation, most often resulting from the printing of currency faster than the creation of new goods and services, causes the value of a currency to fall relative to other currencies. Inflation rates vary widely but are generally much higher in the third world and former Soviet bloc than in the industrialized West.
States maintain reserves of hard currency and gold. These reserves back a national currency and cover short-term imbalances in international financial flows.
Fixed exchange rates can be used to set the relative value of currencies, but more often states use floating exchange rates driven by supply and demand on world currency markets.
Governments cooperate to manage the fluctuations of (floating) exchange rates but are limited in this effort by the fact that most money traded on world markets is privately owned.
Over the long term, the relative values of national currencies are determined by the underlying health of the national economies and by the monetary policies of governments (how much money they print).
Governments often prefer a low (weak) value for their own currency, as this promotes exports, discourages imports, and hence improves the state’s balance of trade. However, a sudden unilateral devaluation of the currency is a risky strategy because it undermines confidence in the currency.
To ensure discipline in printing money—and to avoid inflation—industrialized states turn monetary policy over to semiautonomous central banks such as the U.S. Federal Reserve. By adjusting interest rates on government money loaned to private banks, a central bank can control the supply of money in a national economy.
The World Bank and the International Monetary Fund (IMF) work with states’ central banks to maintain stable international monetary relations. From 1945 to 1971, this was done by pegging state currencies to the U.S. dollar and the dollar in turn to gold (backed by gold reserves held by the U.S. government). Since then the system has used Special Drawing Rights (SDRs)—a kind of world currency controlled by the IMF—in place of gold.
The IMF operates a system of national accounts to keep track of the flow of money into and out of states. The balance of trade (exports minus imports) must be balanced by capital flows (investments and loans) and changes in reserves.
International debt results from a protracted imbalance in capital flows—a state borrowing more than it lends—in order to cover a chronic trade deficit or government budget deficit. The result is that the net worth of the debtor state is reduced and wealth generated is diverted to pay interest (with the creditor state’s wealth increasing accordingly).
The U.S. financial position declined naturally from an extraordinary predominance immediately after World War II. The fall of the dollar-gold standard in 1971 reflects this decline.
In the 1980s, the U.S. position worsened dramatically. A chronic budget deficit and trade deficit expanded the country’s debt burden. Economic growth in the mid-1990s helped bring the budget deficit down temporarily, but it exploded again after 2001.
The positions of Russia and the other states of the former Soviet bloc have declined drastically in the past eight years as they have tried to make the difficult transition from communism to capitalism. Although out-of-control inflation in the early 1990s subsided in the late 1990s, the economies of the former Soviet republics are about half their former size. Western states have not extended massive economic assistance to Russia and Eastern Europe.
Multinational corporations (MNCs) do business in more than one state simultaneously. The largest are based in the leading industrialized states, and most are privately owned. MNCs are increasingly powerful in international economic affairs.
MNCs contribute to international interdependence in various ways. States depend on MNCs to create new wealth, and MNCs depend on states to maintain international stability conducive to doing business globally.
MNCs try to negotiate favorable terms and look for states with stable currencies and political environments in which to make direct investments. Governments seek such foreign investments on their territories so as to benefit from the future stream of income.
MNCs try to influence the international political policies of both their headquarters state and the other states in which they operate. Generally MNCs promote policies favorable to business—low taxes, light regulation, stable currencies, and free trade. They also support stable international security relations, because war generally disrupts business.
Increasingly, MNCs headquartered in different states are forming international alliances with each other. These inter-MNC alliances, even more than other MNC operations across national borders, are creating international interdependence and promoting liberal international cooperation.
MNCs sometimes promote economic nationalism over liberalism, however, especially in the case of state-owned MNCs or alliances of MNCs based in a single country.
