Critics of neoliberal globalization have tended to focus on the role of the international institutions—imf, wto, World Bank—rather than on the world financial system itself. Yet in the post-Bretton Woods era, the functioning of the latter has been a major source of vulnerability for developing countries, exposing large swathes of their populations to sudden falls in real incomes and depressing national growth rates. It is, of course, difficult to disentangle the effects of the financial system from those of, say, the trade system, which also puts obstacles in the way of former ‘Third World’ countries rising up the value-chain into higher value-added activities. In combination, these systems have produced the slow rate of average income growth of most developing countries over the past quarter-century. Per capita international income distribution has become more unequal by several plausible measures, as has income distribution between the world’s households.

In what follows I attempt to show, first, the detrimental effects of the present liberalized world financial system on a majority of developing countries and, second, that the key features driving these effects result from the combination of the free movement of private capital and the ability of the us, as supplier of the main international currency, to run persistent current-account deficits—a combination that continuously raises the level of world liquidity. These features increase structural vulnerability by raising the volatility and destructive impact of key economic parameters: exchange rates, stock markets and interest rates. At the same time, they limit ‘real’ investment opportunities, including in developing countries, where one would expect them to be greatest. Finally, I argue that activists and ngos who have hitherto focused mainly on public-sector targets such as the imf and wto should be pressing governments to do more on the monitoring and regulation of flows of private capital.

From the mid 1940s to the early 1970s, the period of the Bretton Woods international financial system, the world economy operated with fixed exchange rates; an international medium of exchange and store of value—the us dollar—backed by gold; and restrictions on capital movements (closed capital accounts). This combination had three important effects. First, the backing of the main international currency by gold tended to check persistent trade imbalances, since the latter resulted in cross-border transfers of gold, or of dollars fully convertible into gold, and hence effected changes in national price levels which eventually restored trade balances. Second, private international capital flows were small. Public-sponsored international capital flows were much greater, including Cold War-justified military spending by the usa. Third, the main economic parameters—exchange rates, stock market indices, interest rates, price levels—were very steady. World growth rates were also high and stable compared with what was to come; and specifically, developing countries as a group enjoyed relatively fast growth.

When the Bretton Woods system collapsed in 1973 all this changed. Since then, the world financial system has been based on flexible exchange rates between the major currencies; non-convertibility of dollars into gold; the us ability to finance its debts to the rest of the world by issuing debt instruments denominated in its own currency (ious, in the form of, for example, Treasury bills); and free private capital movements (open capital accounts). The adjustment mechanisms that had kept trade imbalances in check under Bretton Woods no longer worked. Now that the us was not obliged to pay for its imports in gold, or in dollars backed by gold, and could instead pay with dollars or Treasury bills without supply-side limits, American deficits began to grow, as did the number of dollars in circulation worldwide. The corollary of the us current-account deficit, now standing at 6 per cent of the country’s gdp, was the swelling of other countries’ central bank reserves, most of which consist of dollars and dollar-denominated debt instruments.

The increase in central bank reserves provided the basis for rapid credit expansion. World liquidity surged, and the owners and managers of finance put pressure on governments to remove restrictions on cross-border capital flows. A few major oecd economies, notably the us and the uk, opened their capital accounts during the 1970s; other oecd economies followed through the 1980s, joined by growing numbers of developing countries in the next decades. At the same time there was a proliferation of private financial organizations, thanks to the removal of the constraints on finance imposed by the Bretton Woods regime. They include insurance companies, pension funds, stockbrokers, investment banks, mutual funds, venture capitalists, hedge funds and financial management companies. These bodies receive and invest revenue flows from sources such as insurance premiums and pension contributions, accumulating huge assets. Insurance companies of developed countries have assets of roughly $14 trillion. Pension funds of developed countries have roughly $13 trillion. By way of comparison, total World Bank lending over its entire existence is below $1 trillion.