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The War against Terrorism: Implications for the International Financial System

Brief Questions and Proposals regarding U.S. Measures
to improve National and International Economy


Pablo G. Arosemena G.

Arosemena & Asociados


1. Current responses to the September 11 attacks by the United States and other countries. Brief considerations.

A. Treasury Secretary Paul O´Neill appears to be committed to the "Strong Dollar

Policy" followed by the Clinton and Bush administrations, and might be expected to take whatever means are necessary to prevent anything other than a minimal devaluation of the dollar.

(a) Impact of the "Strong dollar policy" on U.S. economy.

Regarding the likely implications of this specific policy on the U.S. economy, several effects can be expected.

This measure, as part of the government's monetary policy to help improve national economy, can indeed help strengthen U.S. economic movement, by making it more stable, encouraging investment (also direct investment), consumerism, which is the main engine of this country's economy, helping take back confidence of foreign countries and private persons for the dollar and different securities, contributing in this way to have a better balance on their balance of payments, between their current and capital accounts, avoiding possible "deficits".

At this moment, I think this is a short-medium term policy that will continue to contribute to the reinforcement of the U.S. Securities in general, to the issuance of these assets, allowing the U.S. to receive immediate incomes through this assumption of debt. Devaluation also can be prevented by these means, increasing dollar holder's purchasing power.

The uncertainty left after the terrorist attacks, the fact that people is more concerned about risk, plus the fear among the population, all of them make it more difficult for the economy to go back where it was. That's why the U.S. is trying by any mean to make this downturn as short as possible.

In addition to this "strong dollar policy", other closely related economic measures that could be considered as part of this policy are been undertaken to revive the economy. For instance, the Federal Reserve has lately been pulling out all the stops to cut interest rates. With these several cuts during the past and current year, the FED is trying to stimulate the domestic market, by allowing consumers to have more access to capital, through loans, credit and other facilities, and encourage consumerism.

(b) Impact of the U.S "strong dollar policy" on the world economy.

Right after the September 11 attacks, the U.S. Federal Reserve Board announced that it and the European Central Bank had agreed on a swap agreement, specifically an exchange of 50 Billion of Euros for the same amount in dollars, in order to facilitate the functioning of financial markets and provide "liquidity" in dollars to several national central banks of the Euro system, so that they could meet their dollar liquidity needs within their U.S. operations. This measure is clearly an impact on world economy, headed to provide international community with necessary dollar supply and maintain the stability in world financial systems.

As stated before, this "strong dollar policy" seeks to maintain in a stable position the value of the US currency. Treasury Secretary Paul O´Neill appears to be committed to this policy, announcing that by any means they would prevent the weakening of the dollar.

Another of Mr. O´Neills commentaries indicated that they would just permit a minimal devaluation of the dollar. Its important to recognize that when a nation is considering a devaluation of its currency, specially in the case of a strong currency such as the dollar, this measure should be done in accordance to the purposes of the International Monetary Fund (IMF), which are to maintain and promote a stable system of exchange rates and assure orderly exchange arrangements.

Therefore, all member nations of the IMF have to comply with its Articles of Agreement before making exchange arrangements, specifically its article IV, which contains the general obligations for this matter. Thus, the IMF has the right to oversee that all countries, wanting to do some exchange arrangements, follow the essential purpose of the international monetary system, which is to provide a concrete framework that would facilitate the exchange of goods, services, and capital among countries, and that would sustain sound economic growth, promoting stability to the system of exchange rates. As said before, all actions undertaken, that is, policies and measures related to exchange arrangements, and also arrangements for intervention and the treatment of imbalances, should be done based on stable but adjustable par values. This notion is clearly stated under article IV, Section 4 (Par Values) of its Articles of Agreement. The IMF should survey each one of its 182 current members so that the actions they take to achieve adjustments in their balance of payments, and some other immediate actions such as devaluation of their currencies, don't affect and contradict the effective operation of the system of par values and the international monetary system. (as part of the world economy).

It's obvious that the strengthening of the dollar entails the strengthening of the U.S. economy. Because of the fact that the U.S. is considered as an engine of the world economy, any U.S. economic growth appears to influence growth in other countries significantly. This constitutes a positive impact on global economy, considering that the U.S. is a mayor-trading partner for many states all over the world, contributing to a rise in import demand, which is reflected directly in an increase in these countries exports. This commercial integration also includes financial linkages, which represent U.S. foreign direct investments (having control over the investment) and portfolio investments (which reflect purchases or general investments without control on them).

It's interesting to notice that all government chambers are taking actions to revive economy. For instance, some congress moves have been taken to promote investment in the U.S. the most relevant the recent Senate's approval of a U.S. - Jordan free trade area, which had been delayed for a year over environmental and labor disputes. This represents a clear change on U.S. foreign policy priorities, guided to increase the capital flow and economic movement within these two countries, helping domestic and foreign market.

With the strong dollar policy in mind... -->