Sunday, November 2, 2008

Lost in the Bretton Woods

New Bretton Woods

NBW: New Bretton Woods or No Bretton Woods? – A number of articles are written on this idea launched in Europe and signed onto by Mr Bush in the aftermath of the financial chaos of having a New Bretton Woods meeting. But after reading any number of articles I am no closer to understanding what it is that world leaders are going to meet to discuss that when I had read none. The first Bretton Woods was a Post-war meeting set to try to restart international trading under a system of rules that would establish what is fair and what is not. A fixed exchange rate system was adopted with the dollar tied to gold (@$32/oz) and other currencies pegged to the dollar. It lasted until the early 1970s.

Post Bretton Woods: After that the collapse of Bretton Woods, a new system (often called a non-system) of fluctuating exchange rates was adopted. It functioned well enough for a while and has been flexible enough to deal with many economic shocks. But it has been marked by any number of exchange rate crises involving both developed and developing nation currencies.

Pending issues, building problems: Perhaps the biggest failing of the current system is that, under it’s auspices, a constellation of balance-of-payments excesses has emerged that has proved to be quite entrenched or resilient. Exchange rates as it turns out do NOT move to eradicate these imbalances. Large and growing imbalances simply persist in this system. This mixed system with some currencies fluctuating (with occasional official interventions in exchange markets) and others pegged (such as the yuan) has created a new set of tensions. The rapid movements in exchange rates have also exacerbated other problems at time as commodities are priced in dollars and their prices have been destabilized.

Then Vs Now: Until the current financial crisis, it has been in vogue to not worry about such festering problems. Faith has been – had been - that markets will deal with these issues in time. Well, Alan Greenspan applied that faith to the housing market by ignoring excesses that were brought to his attention and look what has happened. Not surprisingly some may think it is time to take a look at the world financial system and see what is going wrong and how it might be put back on track before gets too far out of hand.

There has been blood - We have in recent years seen an Asian debt crisis (1998), a hedge fund ‘unwind’ (2000) threaten the financial system, a stock market bubble collapse (2000) and a housing bubble that inflated and is now still deflating and still creating explosions in the financial markets as it has revealed other excesses (in judgment leverage and market practice) that had remained hidden. That bubble has exposed a number of financial practices that are/were ill conceived. And all the banks of all major trading countries as well as many banking groups from smaller countries have been caught in the net with the result that governments and central banks around the world are intervening in markets in various ways to prop up banks and stabilize markets. Through it all Canada has been named as having the safest banking system in the world.

Fix what? So now as a New Bretton Woods is being discussed different participants see different problems. They have differing objectives, just as they did in the post war period. But do they have enough in common to strike an agreement? That goal is not as clear as it was when the first Bretton Woods meeting was held. And that is the problem for anyone with high hopes.

What Europe wants - Europeans seem most upset that institutions such the credit rating agencies discharged their responsibilities so poorly. There is also a sense that US regulators were asleep at the switch or even purposely glued the switch open on the belief that markets know best. Europeans are looking for a uniform system of institutional of oversight, US authorities mostly feel that is unworkable.

What is the POINT? Fixing this sort of regulatory lapse that occurred is important. But Bretton Woods was about the trading/currency system. It was about exchange rate regimes and certainly the system now in place shows all the signs of building new and threatening excesses due to the lack of adjustment mechanisms in the monetary system that is in use. Foreign exchange reserves pile up in China, in Japan and elsewhere. Accumulating these reserves undermines the rule of the game that surplus countries should let their currency rise to choke off the surplus. It also keeps the deficit country currency from falling and thereby from restoring the balance to trade. It leaves a system far more interlinked by capital flows that it becomes structurally dependent upon. That must be viewed as an Achilles Heel of this system; an accident waiting to happen. But is there a will to find a remedy? We must conclude that the answer is ‘no.’ Like the earlier Betton Woods meeting that occurred when competitive devaluations that were the problem, chronically undervalued exchange rates are a similar modern counterpart. One additional interesting aspect today is that countries like China with MASSIVE reserves are shuttling them over into sovereign wealth funds so the ‘reserves’ can accumulate a broader class of assets. This may raise questions of fairness since the reserves were accumulated by eschewing the usual rules of the game and seemed to have accumulated with the idea they would reinvest in monetary assets.

The IMF and the China Conundrum - The IMF is the usual arbiter of FX rules and their ‘enforcement’… But as an enforcing agency it is pretty toothless. Moreover China is a bit of a special case since developing countries long have been allowed to peg their currency to one of their choice. Still, China is special case because it is huge, its development has been tremendous and even so its underdevelopment remains colossal. China is a conundrum. But there were other ‘surplus’ hogs before China overtook them to steal the limelight for itself. It may seem odd to brand China and other Asian countries as countries that consume too little and save too much. But if they did not do these things their surpluses would be much more manageable and would not push excesses off on their trading partners as they do now. China, a country that needs economic development needs to spend more, to consumer more. Faced with tremendous poverty and under development it is accumulating reserves instead of spending them on development.

And China does not want to make any of these changes.

Room to Horse Trade? But China may be wiling to trade its current policy tilt for a larger say-so in world organizations. It has already made a call for a new synthetic world currency but again who knows that that means? A global currency hardly seems viable at the moment.

Many have called the dollar dead but one thing is clear and that is in this crisis period while many things are coming unglued the dollar is NOT ONE OF THEM. The dollar has risen in value and has been sought out above nearly all other currencies and competing ‘stores of value’ (yen-excepted) including gold, silver and other precious metals.

Mixed incentives and conflicts - China is in the WTO but the US has not used WTO claims against China (as an unfair trader using as the basis for a claim its pegging its FX rate to the dollar at too low a level). That is probably because China and the US have a complex relationship. US multinational corporations (MNCs) located there benefit from the current arrangement although the US balance of payments suffers. These MNCs have been opposed to any anti-trade action by the US Vs China. From the standpoint of the US giving up more authority to China in world organizations, it may not be as costly as it seems since the US itself confronts mixed interests due to the spread of the US multinational corporation. But this issue may be evolving and the US may come to see its interests as more aligned with its balance of payments than with its MNCs’ overseas operations given time. Right now the US BOP deficit and the US is where the dangers seem to be looming the largest.

Bretton Woods Bartering: This is the sort of to and fro bartering that is talked about in connection with the New Bretton Woods. But none of this has been talk aimed at a new financial architecture. Is there any plan? Are the authorities ready to endorse some rules regarding fluctuating exchange rates- including rules about allowing ‘developing countries’ to peg their currencies? Are they willing to adopt some interim ranges to LIMIT FX movements? What are they willing to do? Is there a New Bretton Woods being planned or are we being led into the woods with the intent of being abandoned?

G—20: Progress unlikely

On balance I am a skeptical about progress. It’s hard to get agreement on such abstract topics. The financial crisis should be a motivator, but I still don’t think its enough. The reason is that the Fed’s actions have already been meted out and its assistance provided without any quid pro quo. Thus the US cannot use that assistance as leverage. For now there is too much on the table and too-poor a record of cooperation among these varied participants. Regions are not simply seeking different things from the current system but are aiming at different areas of reform altogether. This is not like the first Bretton Woods where world trade was seizing up and countries were looking for a way to reignite trade - a solution for a definable problem. This time around, some are looking for more and better regulation, some are looking for a global regulator, some are looking for some sort of currency reform, some are focused on their own development and some simply have an anti-America agenda. There is no consensus going into the meeting on WHAT THE CONFERENCE IS REALLY ABOUT let alone what the problem is that needs to be solved or what the solution might be. The financial crisis has been a motivator but it has not helped to focus attention on any one issue. Instead, it has opened a grab bag of competing wish lists that almost guarantees there will be no resolution.

1 comment:


Bretton woods marked the end of sound money.