Why a Second Bretton Woods Won't Work_ the World Economy's Dire Situation Can't Be Fixed With an International Agreement

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WhyasecondBrettonWoodswon'twork:theworldeconomy'sdiresituationcan'tbefixedwithaninternationalagreement.

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DoestheworldneedanewBrettonWoodsmeeting,asDavidSmicksuggestedinthepreviousissueofTheInternationalEconomy?DespitetheDavoshyperoptimism,theworldisinadirestateandcertainlyneedssomething.ButanewglobalmonetarysystemrunbygovernmentsnotthatthiswaswhatSmickwasadvocating)or,heavenforbid,NGOsandcabalsofbusinessmenandbankers,mightbethelastthingitneeds.

The"nonsystem"thathasbeeninplaceforthepastfourdecadeshashadamixedrecord.The1970swereprettyawful.Buttheywereawfulbecauseoffailuresofpolicy,notfailuresofthe"nonsystem."Theossificationofmanydevelopedeconomiesviagovernmentregulation,control,andintervention,substantialunionpower,hightaxes,capitalcontrols,andarigidfinancialandindustrialtechnostructureproducedadeclineintrendproductivity.Preservingemploymentwouldhaverequiredrealwageslowerthanotherwise.AndloosemonetaryandfiscalpoliciesinthefinaldaysoftheBrettonWoodssystem,especiallyintheUnitedStates,sparkedacommoditypriceboomthatintensifiedthedownwardpressureifemploymentweretobepreservedonrealwages.Butunionsandgovernmentsattemptedtoresistthatdownwardpressureandmanycentralbanksvalidatedthatresistance.NAIRUsrosesharplyalmosteverywhereandtherewaswidespread,prolonged,andsubstantialstagflation.ThatsomecountriesnotablyGermanyandSwitzerlandperformedbetterthanothersinthisperiodwaslargelybecausetheyranmonetarypoliciesdifferentfromtheinternationalconsensus.InGermany'scase,itwasnotuntilthemisconceived"coordination"ofpoliciesintheBremenandBonnsummitsof1978thatthecountrywassuckedintothekindofmessalreadysufferedbymanyothers.Itisveryhardtosee,giventheintellectualclimateofthetimeandthewidespreadeconomicmisconceptionsandthemisdirectedpoliticalpressure,howsomesortofglobaleconomicandmonetary"system"wouldnothavemadethingsevenworse.(Ataregionallevel,the"system"representedbytheEuropean"snake"simplycouldnotholdtogetherinthoseintellectual,economic,andpoliticalcircumstances).

Inthe1980sand1990s,the"nonsystem"workedverywell.Thedramaticchangesineconomicstructurebroughtaboutbythetremendous,ifnotuntarnished,effortsofReaganandThatcher(notforgetting,ofcourse,thepioneeringRogerDouglasinNewZealand)hadworldwidedemonstrationeffects.And,justasimportant,theheroicworkofMichaelMilkensmashedthetechnostructure,facilitatingtheproductivityrevolutionoftheearly1990s.Globalizationandfinancialliberalizationspread

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capitalismtovirtuallyallpartsoftheworld,liftinghundredsofmillionsoutofpoverty.True,therewerefinancialcrisesinthisperiod,mostoftheminemergingmarketsandsomeofthemveryserious.ButnonederailedthemarchtogreaterprosperityexceptinJapan.Thatcountrysufferedfromitsacceptanceofinternational"coordination"intheinfamousLouvreAgreement(acertainJeanClaudeTrichetwasacrucialplayer),whichnotonlyledverydirectlytotheWallStreetcrashof1987butalso,muchmoredamagingly,gaveadditionalimpetustothefinalstagesoftheJapanesebubble.And,ofcourse,theExchangeRateMechanismcreatedinstabilityandsignificanteconomicdamageinEurope.

Thiswasnotanidealworld,evenasidefromtheLouvreAgreementandtheERM.Butatagloballevel,itwasprobablybetterthananythingelsethemodernworldhasseen.(Whataboutthefinalthirdofthenineteenthcentury?I'llcomebacktothat.)

Whydidthingsgosobadlywrongfromthemid1990s?Therewerethreemainproblemareasandaunifyingintellectualmistake.First,U.S.FederalReserveChairmanAlanGreenspantotallymisreadthepolicyimplicationsoftheproductivitysurgeintheUnitedStates.Second,themonetaryunioninEuropemagnifiedthefaultsoftheERMdramatically,withimplicationsnotonlyforitsunfortunatemembersbutalsoforeconomiessuchasBritain'swithstrongtradelinkswiththeunion.Third,China'sintegrationintotheworldeconomy,constrainedbytheweightofhistoryandinitialpovertytookplaceinconditionsthatmadeitsdevelopmentalmostinevitably"unstable,unbalanced,uncoordinatedandunsustainable,"asPremierWenJiabaofamouslyputitin2007(showing,onemightnote,muchmorerealismthanwesternleadersatthattime).

Thethreadrunningthroughalltheseepisodeswasadistortionofthekeyrelationshipsinacapitalisteconomy:betweentheanticipatedrateofreturnoninvestment,theexantereallong(ish)rateofinterest,andthesubjectiverateofhouseholds'timepreference.And,asIarguedintheFall2008issueofTIE,amajorsourceofthesedistortionswasthetriumphofaBundesbankstylemodelofcentralbankingemphasizingpricestability.Thattriumphproducedsubstantialincomeinequality(justasDennisRobertsonhadworriedinthe1920sthattheFed,in"goingalloutforpricestability,"asheputit,mightberobbingworkers).ItalsomadebubblesandPonzigamesinevitable.ThemechanismemphasizedintherecentInternationalMonetaryFundpaperon"Inequality,LeverageandCrises"(KumhofandRanciere,2010)describesaneffectofthesedevelopmentsratherthanacause.Butitisaverydangerouseffect,andonepointedtobynoneotherthanKarlMarx.(IsChinaperhapsthecountrynowmostatriskofunrestofthekindprophesiedbyMarx?)

Theimmediatequestionnowiswhethertheworldcanrecreateabubblethatwilllastaslongasthe200307bubble.Ifitcan,theworldwillsimplyfinditselfbackinthetotallyunsustainablesituationitwasin2007,butprobablywithasignificantlyweakerdollarthannowandashiftinatleastpartoftheburdenofunsustainabilityawayfromtheUnitedStatestosomeoneelsetobenamedlater.Thefinancialcrisisthatwillbringthisrecreatedbubbletoanendmightoriginate,thistime,somewhereotherthantheUnitedStates.Butanotherfinancialcrisiswouldbeanunavoidableresultoftheprocess.Andaccommodatingcommoditypriceincreasesincommodityimportingcountries(ratherthanattemptingtooffsetthemthroughlowernominalwagesanattemptwhichwouldbringhigherunemployment)wouldmeananeventighterandlongersqueezeonrealwagesandpotentiallyevengreaterperhapsuncontrollablepoliticalstrains.

Butthealternativeisthatworryaboutcommoditypriceinflationineitheremergingmarketsorinmatureeconomies,oraninvestmentcrashinChina,abortsthebubblemuchsoonerthistimearound.Riskassetmarketswouldcorrectdownwardsandhopesofasustainedglobalrecoverywouldbescuppered.Another"Austrian"liquidationcrisiswouldbeuponus.Thepoliticalconsequencesofthat,too,mightbeuncontrollable.

Theworldthusremainsinadirestate.Butitishardtoseehowanyfeasibleagreementamonggovernmentsaboutaninternational"system"couldreallyhelpimprovethings.Certainly,areturntoanykindofcommoditystandardwouldbefraughtwithdanger.Thefinalthirdofthenineteenthcentury,theheydayofthe"classical"goldstandard,isoftenheldasaparagonofsystemicvirtue.ButthatperiodsawaveryrapidretreatfromfreetradeeverywhereexceptBritainanditscolonies.Thatretreat,alongwithcolonialistexploitationbyallthemajorpowers,reflectedadesiretomaintainratesofreturninthemorematureeconomiesatlevelselevatedenoughforhighglobalrealratesofinterest,inducedbyhighratesofreturninthe"emergingmarkets"oftheday,nottodestroyemployment.Incomedistributionstrugglesbecamevirulentandincipientlyviolent.OnedoesnothavetobeaMarxisttoseethestrainscreatedbyarigidglobalmonetarysysteminthefaceofdynamicallychanginggeographicalpatternsofcomparativeadvantageandratesofreturnasbeingamajorcontributoryfactorintheslideintotheFirstWorldWar.Similarrigiditiestodaywouldprobablydestroynotonlycapitalismbutpeace.



Onecanseethesedangersalltooclearlyintheeconomic,financial,social,andpoliticaldisasterthatisEuropeanmonetaryunion.Intheworldmorebroadly,thelessonoftheexperiencebothof"systems"andofthe"nonsystem"isthatinaglobalized,dynamiceconomy,macroeconomicpoliciesinindividualcountriesmustbetailoredtosuittheirindividualcircumstances.Thealternativemustinvolveeitherdevastatingboombustsor"coordination,"notjustofmonetarypolicyandmacroeconomicpolicy,butcoordinationofallpoliciesinallareasthatmightimpacttherateofreturn:industrialpolicy,trade,educational,labormarketandincomes,social,demographic,cultural,religiouseverythingyoucanthinkof."Coordination"isanexcuseforprotoMarxists,oratleaststatists,corporatists,andmarketphobes,toimposeacentrallyplannedeconomyandanantidemocraticpolity.ThisnightmareisnowveryvisiblyplayingoutinEurope,coordinatedbythetwoarchmarketphobes,theFrenchandGermangovernments.Thishasbeenaverypredictabledevelopment(indeedIpredicteditfifteenyearsagoinmybook,TheRottenHeartofEurope)butitisnolessalarmingforthat.

Buteventotalcentral"coordination,"horrendousasitwouldbe,couldnotsolvetheexistingproblemscreatednotbythe"nonsystem"orevenjustbyEMU,butbyafailureofmonetarypolicyunderstanding,mostcruciallyinthesecondhalfofthe1990s,whichhasmadetheworldasawholeanenormousPonzigame.Theacademicmacroeconomicsindustrymustbearaheavyburdenofsharedresponsibilityforthistrahisondesclercs,ortreasonoftheintellectuals.Atallevents,theworldnowfacesadilemma.Onerouteinvolvesabandoningloosemonetarypoliciesandtriggeringacollapseandgoodnessknowswhatelse.Theotherinvolvescontinuingthosepoliciesandhaving,soonerorlaterandprobablysooner,eveninrichcountriestofacethepoliticalandsocialconsequencesoffurthershiftsinthedistributionofwealth.Inequalitywillincreasebetweenfinancialmarketboomsononesideand,ontheother,realwagesreducedbycommoditypriceboomstogetherwithrealreturnstosavingsreducedbyaseculardownwardtrendinrealratesofreturn,realinterestrates,anddelusionofdelusionsriskpremiums.

Again,"coordination"candonothingtoresolvethisdilemma,which,forwantofabetterterm,onecanperhapschristen"AustroRobertsonian."Acounterexamplearguablycanbefound:theG20latein2008mayhavehelpedsteermanycountriestowardsprovidingfiscalsupportinconditionsofaglobalcollapsebothin"animalspirits"andintheavailabilityofprivatesectorfinance.ButitisonlyinextremelyraregloballyKeynesianconditionsasprevailedforsixmonthsorsoaftertheLehmanbankruptcythatcoordinationcanpotentiallybehelpful.Inallotherconditions,"coordination"means,inpractice,doingsomethingwhichisdamagingintheaggregateinonecountrybuthelpfulforaparticularinterestgroupinanothercountryifthatothercountryagreesinreturntodosomethingequallydamagingforitintheaggregatebuthelpfultoaninterestgroupinthefirstcountry.

Ofcourse,genuineinternationalimbalancesexist.ThemostimmediatelydamagingisthatbetweenGermanyandtheperipheralcountriesofEMU.Itisbeyonddoubtthatthebestwaythough,giventheunfortunatepresentexistenceofEMU,stillhighlydisruptivetoresolvethatimbalancewouldbethroughareturntoa"nonsystem"ofexchangeratesinEurope.ThebilateralissuebetweentheUnitedStatesandChinahassimilarities.IfChinaisnotgoingtoacceptaneedtomakehugeunrequitedtransferstotheUnitedStateseveryyear,itmustchoosebetweenmuchmoreflexibilityintherenminbiandeventualmassiveU.S.default.

Butwhilearesolutionofsomebilateralproblemscouldhelptheworldatthemargin,therecanbelittleoptimismthatinternationalmeetings,"coordination,"ortheerectionofnewinternationalmonetarysystemscouldhelp.Andthebiggerproblemisthatthe"nonsystem"required,foritsbenefitstobereaped,thatmonetarypolicyinallthemajoreconomiesmustbepursuedappropriately.Infact,ithasbeenpursuedinappropriately,eversincethesecondhalfofthe1990s,intheUnitedStates,theeuroarea,andChina(asInotedabove,itwaspursuedhighlyinappropriatelyinJapaninthelate1980spreciselybecauseoftheattemptoftheLouvreAgreementtoestablishelementsofa"system")and,inconsequence,virtuallyeverywhereelse.Nosetofmacroeconomicpoliciesgoingforwardcanavoidthedreadfuldilemmabetweenpotentialcollapseandcertainincomedistributioncalamities.Anythingthatmightbeimplementedattheinternationallevelwouldsimplybe,inlargemeasure,shufflingproblemsaroundbetweencountries,atundoubtedlyenormouscostintermsoftheestablishmentofnewinternationalbureaucratic,unaccountable,andantidemocraticinstitutionalstructuresaglobalnomenklatura,infact.

Whatisinsteadneededissomewayofallowingrealinterestratestorise,bringingthemintocloseralignmentwithsubjectiveratesoftimepreference,withoutproducingaterrifying"liquidationist"collapse.Theonlywaytodothatistocreateaworldwideriseintherateofreturn,suchthatfutureincomeand(nonbubble)demandprospectsvalidateexpost,sotospeak,thevolumeofrealfixedassets,atpresentreflectingexpectationsoffuturebubbleconditionsdemandcurrentlyinplace.Thatrequirescompetitionincuttingtaxrates,inreducinggovernmentinterferenceandcontrol,instimulatinginitiative,infosteringglobalization,andinrestoringthespiritoffreeenterprise.Inotherwords,itrequireseverythingthat



currentmovesinEuropearedesignedtoavoidoratleasttodistort.Acapitalistsystemcannotworkwithoutcapitalism.Andattemptstocreateaglobalmonetaryandeconomic"system"aretheenemyofcapitalismandofdemocracy,freedom,andpoliticalstability.

HowThingsGotSoBad

Whydidthingsgosobadlywrongfromthemid1990s?Therewerethreemainproblemareasandaunifyingintellectualmistake.First,U.S.FederalReserveChairmanAlanGreenspantotallymisreadthepolicyimplicationsoftheproductivitysurgeintheUnitedStates.Second,themonetaryunioninEuropemagnifiedthefaultsoftheERMdramatically,withimplicationsnotonlyforitsunfortunatemembersbutalsoforeconomiessuchasBritain'swithstrongtradelinkswiththeunion.Third,China'sintegrationintotheworldeconomy,constrainedbytheweightofhistoryandinitialpovertytookplaceinconditionsthatmadeitsdevelopmentalmostinevitably"unstable,unbalanced,uncoordinatedandunsustainable,"asPremierWenJiabaofamouslyputitin2007(showing,onemightnote,muchmorerealismthanwesternleadersatthattime).

[ILLUSTRATIONOMITTED]

B.Connolly

BernardConnollyisManagingDirectorofConnollyGlobalMacroAdvisers.

COPYRIGHT2011InternationalEconomyPublications,Inc.Noportionofthisarticlecanbereproducedwithouttheexpresswrittenpermissionfromthecopyrightholder.Copyright2011Gale,CengageLearning.Allrightsreserved.

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Why a Second Bretton Woods Won't Work_ the World Economy's Dire Situation Can't Be Fixed With an International Agreement