3 Nov 2010

Reforming Global Economic Governance — Towards Bretton Woods III

By Pierre Defraigne

World economic governance needs to move towards a Bretton Woods III involving effective supervision of all structural imbalances by the IMF, greater resources for the IMF along with fundamental reforms of that institution, and a shift from the dollar as dominant international reserve currency. This requires cooperation between the G3 – the US, China and the EU.

From ancient Rome to Britain until World War One, the world economic hegemon has always provided the currency for its sphere of influence. At the 1944 Bretton Woods Conference the torch was passed from the pound to the dollar despite Lord Keynes’ last-ditch efforts to switch to the Bancor, which would have been the first ever genuine international currency. Wasn’t America then the sole candidate for securing the liquidity the world was badly in need of? On the one hand, the dollar shortage exerted a deflationary pressure on the economies hit by the war and confronted with the heavy task of rebuilding their productive capacities. On the other, as the leader of the free world the USA considered the ‘dollar privilege’ as a sort of seigniorage right for a superpower in charge of the Western camp’s security.

As was to be expected, the USA eventually took advantage of that facility, inundating the world with dollars to the point that gold reserves were a mere fraction of the volume of dollars issued by the Federal Reserve. It is worth noting that the main dynamics at work were the successful attempts by Washington, through this massive oversupply of dollars, to dodge the ‘guns and butter dilemma’: the Vietnamese War and President Johnson’s Great Society social program were indeed the two pillars of US policy. Nixon broke the spell by decoupling the dollar from gold: Bretton Woods II was born with the responsibility of financing deficits transferred from the IMF to the market. But trust in American economic dynamism and strategic superiority was such that it made the financial markets very accommodating of a US profligacy which went unbridled through successive Presidential mandates until George W. Bush.

With the benefit of hindsight, it appears that the dollar’s ‘exorbitant privilege’, as President Giscard d’Estaing once qualified it, probably played an important role in the race between America and the Soviet Union, allowing the USA – through Washington’s unrestrained external indebtedness and exchange rate policy – to share the burden of defense, including the arms-race which culminated in ‘star wars’, with its Western allies. The USSR, plagued with systemic inefficiency, did not enjoy the same transfers of resources from its own impoverished camp.

Once the race was over, the extravaganza went on, nurturing world economic growth, this time thanks to the transfer of Asian savings to the USA to finance the trade deficit, mainly through the massive purchase of Treasury bonds. Japan was footing the bill for American security whilst China was buying access to the US manufactured goods market.

The financial crisis that broke out on September 15th 2008, has been shown to have as its underlying origin the Fed’s lax monetary policy, which allowed for an abundance of liquidity and low interest rates, enticing households to go into debt through excessive use of credit cards or mortgage credit and financial institutions to take on excessive leverage at an unprecedented scale. The end of the boom sent a shockwave throughout an over-indebted US economy and triggered the subprime crisis. But the ultimate cause was US monetary
policy and the fault line lay in the international monetary system.

Has the time of reckoning arrived? The self-interest of the USA may no longer lay in the continuation of the present system because it either makes its economy vulnerable to its Asian creditors or to a sea-change in the assessment of the robustness of the American economy by financial markets. Although it should remain for another generation the world’s leading economy, its relative weight is declining. For the EU, being subject to the vagaries of the dollar-based system constitutes the counterpart of the defence burden borne by the USA within the Atlantic Alliance. In this respect the EU behaves as a tributary ally of Washington and it will therefore not raise the issue of revamping the international monetary system. China takes an ambivalent view: On the one hand, as an emerging global economy and strategic power, it cannot satisfy itself with the present asymmetric system; on the other, as a large creditor, it must be careful about the real value of its dollar-denominated assets. For all players, the transition is critical and calls for a cautious step-by-step approach.

A Bretton Woods III must be conceived from now on, building up on the strengths and mending the weaknesses of the present system. This reform should cover a four-pronged agenda:

■Effective surveillance and gradual correction of all structural imbalances (including of the US and China) by the IMF;

■Giving more resources to the IMF so as to allow it to ease adjustment in poor and emerging economies;

■Rebalancing the governance of the IMF and the World Bank, by making more room for China and other emerging countries, and by substituting the EU for individual European Member States, and in particular the eurozone members;

Switching very gradually and cautiously from the dollar as a reserve currency to a basket of currencies including the renminbi. This implies a move to the latter’s full convertibility with the inherent risk of appreciation. This would ease the control of inflation and the move from an export-driven to a consumption-driven growth model in China. This would work towards smoother integration of China in the world economy and would contribute to the medium term recovery and rebalancing of the global economy.

Moving towards Bretton Woods III, calls for collective leadership which the G20 – extended to some poor countries – can provide. But the three largest economies, namely, the USA, China and the EU – a sort of G3 – have a key role to play in shaping the architecture of the system and piloting its implementation. If the EU means to become an effective player in the emerging multipolar world by assuming a growing role in the multilateral economic governance system, it must at the same time gain full autonomy with regard to its currency and more responsibility for its own defence since both issues are narrowly intertwined. This is what the future of the EU is about. A very long road ahead indeed.

This article is part of the book ‘After the crisis: towards a sustainable growth model‘, edited by Andrew Watt (ETUI) and Andreas Botsch (ETUI/ETUC) and published by the European Trade Union Institute (ETUI).

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