The G-7 and International Financial System Management and Reform

In selecting the reform of international economic institutions as the centerpiece subject for the Halifax summit, the leaders at Naples were returning to the central question that inspired the creation of the G-7 and that produced its first major success.[6] The demise and final death on August 15, 1971 of the Bretton Woods system of fixed, pegged but adjustable exchange rates, anchored in a U.S. dollar exchangeable into gold at U.S.$35 an ounce, had prompted U.S. Secretary of State Henry Kissinger to conceive of holding a multilateral summit of the major Western powers to define a new international monetary regime. French President Giscard D'Estaing, assuming office in mid-1974, took up the idea of holding a very private meeting among a very few people to address monetary and economic issues and related political questions confronting the capitalist countries.

Giscard was inspired by his experience in the Library Group, whose five members (the United States, France, Great Britain, Germany, and Japan), then representing 75 percent of the OECD's GNP and 45 percent of the IMF's quotas, met on the margins of international monetary negotiations and IMF meetings to seek a consensus that could move the more representative, slow, and bureaucratically encrusted multilateral organizations. Convinced that monetary stability was the key to economic recovery and expanded trade, and anxious to break the deadlock between a France that desired a rapid return to fixed exchange rates and a United States that preferred permanent floating, Giscard focused the first summit, which he hosted at Rambouillet France on November 15-17, 1975 on exchange rates. As the summit approached, he signaled a shift in the traditional French adherence to fixed exchange rates and gold, followed with a bilateral agreement with the United States at the start of the summit, and had this agreement discussed and endorsed by the six leaders at their Sunday morning summit session. Under the agreement, France accepted the legitimacy of floating exchange rates, while the United States promised to intervene in support of the dollar under particular conditions.[7]

The summit in Puerto Rico in 1976 reaffirmed this emphasis on appropriate domestic economic policy, accompanied by limited exchange market intervention, as the key to exchange rate stability. It also mobilized IMF-linked emergency financial support packages for Italy and Britain by agreeing that any special support should be offered on a multilateral basis, with the recipient undertaking supportive domestic policy adjustments. In regard to Italy, the "Berlin Dinner" four of the United States, France, Britain and Germany, meeting together for lunch just before the Summit, concluded that financial support should not be extended to Italy if communist ministers were allowed into the new government.

The 1977 London Summit encouraged Germany and Japan to let their currencies float upwards, in order to curtail their large trade surpluses and generate global growth. However as the 1978 Bonn Summit approached, a sharp drop in the dollar against the yen and the mark produced substantial monetary expansion in inflation-conscious Germany, and German calls for a stronger dollar through reduced U.S. budget deficits and oil imports. As a result of their concerns the Germans initiated the European Monetary System (EMS) of more closely aligned regional exchange rates, the British called for a "substitution account" to broaden the resources behind the world's reserve currency, the Japanese suggested target zones for exchange rates, and others recommended that the U.S. obtain large foreign loans for dollar support. However both the U.S. and Germany preferred to address the economic fundamentals underlying exchange rate movements, an attitude which bred the Bonn Summit's "package deal" of co-ordinated macroeconomic measures.

In the next two years monetary discussions dwindled at the Summit. The 1979 Tokyo Summit agreed that the G-7 would not respond to the second oil shock, as they had to the first, by allowing an inflationary pass through of the oil price increases. The Venice 1980 Summit reaffirmed this emphasis, despite Giscard's initial desire to use it to restore an more organized monetary system along the lines of Bretton Woods.

From 1981 to 1984, the strong and soaring U.S. dollar, interest rates, and fiscal deficit, and the advent of market-oriented President Reagan in the United States and socialist President Mitterrand in France brought exchange rate issues back to centre stage. The Americans resisted any intervention in currency markets, arguing that solutions to international problems lay in the pursuit of sound domestic policies at home, and that G-7 countries should independently converge around the U.S. formula of free markets, vibrant growth, low inflation, and, in principle, balanced government budgets. At the Ottawa Summit of 1981, high U.S. interest rates were criticized by Canada, France, Germany and Italy, defended by the U.S. and Britain, and left for time to solve. The recession-ridden Versailles Summit of 1982, however, slightly shifted the balance from policy convergence toward coordinated intervention. It authorized a study on the effectiveness of past interventions and mandated periodic meetings between the G5 Finance ministers and the Managing Director of the IMF to conduct mutual surveillance of G-7 economies in the interest of both economic policy convergence and exchange rate stability. At Williamsburg in 1983 the leaders endorsed their finance ministers' conclusion that internationally co-ordinated intervention could be an effective instrument against short term volatility, accepted their mutual surveillance guidelines, and approved their deputies work in responding to the third world debt crisis that had begun with the default of Mexico in 1982.[8] The 1984 London Summit reinforced these decisions.[9]

Following the 1985 Bonn Summit's endorsement of a more stable world monetary system, the G-7 moved swiftly to create and operate a new regime of managed floating.[10] At its heart were the Plaza and Louvre Accords of September 1985 and February 1987 respectively on currency intervention, and the 1986 Tokyo Summit's establishment of a new, stand-alone G-7 Finance Minister's forum to conduct policy surveillance. In the Plaza Accord the U.S. and its G5 partners, facing major international payments imbalances and resulting trade protectionism, reversed the policy of the first half of the 1980's and mounted a largely successful decline in the value of the U.S. dollar, through exchange rate intervention and co-ordinated interest rate changes (if not fiscal policy adjustment). The Louvre Accord created and sought, less successfully, to maintain references ranges for the values of the major currencies. The May 1986 Tokyo Summit created a Group of Seven Finance Ministers forum to meet at least once a year between Summits and use a set of economic indicators to evaluate the performance of G-7 members as a prelude to policy dialogue and adjustment.

Soon afterward, however, the emphasis of the G-7 turned from managed floating through mutual surveillance and appropriate macroeconomic changes to shock response and microeconomic reform. The October 1987 stock market crash saw the G-7 move swiftly and surely to restore market confidence through the co-ordinated injection of the required liquidity, reinforced by low U.S. interest rates and a falling U.S. dollar. The 1988 Toronto Summit marked the start of a new sustained and comprehensive Summit emphasis on microeconomic issues and liberalization, notably structural reforms in controls and regulations, competition, saving, investment and work incentives, tax reform, education and training, agricultural policy, and global financial markets (including securities).[11]

The start of the third seven-year cycle of Summits, at Paris in 1989, saw monetary and financial concerns give way to a preoccupation with newer issues such as the environment, and, above all, the participation in international economic institutions of, and provision of assistance to, the post-Communist societies of Central and Eastern Europe (CEE) and the former Soviet Union (FSU), in particular Russia and Ukraine. A letter from Mikhael Gorbachev to the G-7 leaders at the 1989 Summit, his post-Summit meeting with the G-7 at London in 1991, and a similar meeting between his Russian successor Boris Yeltsin and the G-7 from Munich 1992 onward reinforced this focus. It culminated in the assembly by the G-7 in the spring of 1993 of a $43 billion program of assistance to Russia, and the endorsement at the July 1994 Naples Summit and October 1994 Winnipeg Ministerial Conference of a similar program of up to $4 billion for Ukraine. Despite fears that this agenda would divert attention from the financial problems facing the developing world, the G-7 during this third cycle did introduce debt relief for the poorest of the poor, beginning with the 'Toronto Terms" of 1988.[12] However the recession of the early 1990's, the turning toward market and democratic systems in most communist countries, and the advent of emerging markets and powers in the developing world, catalyzed no fundamental review of the world's core financial institutions, until the Naples mandate of 1994.