Current debate and recommendation for a new Bretton Woods

Mohammed Sawkat Hossain Different schools of thought (or studies) commented on the introduction of a new international monetary system in the paltern of Bretten Woods (BW), for the course of the economic emergence of a fixed exchange rate periphery in the post-Asian crisis years. Under Bretten Woods-2 regions, the world appeared until 2007 to be back a at series of fixed exchange rates and therefore once again pegged to the US Dollar, particularly in peripheral Asian economies and some others in South America. Here the normal evolution of the international monetary system involves the emergence of a periphery for which the development strategy is export-led growth supported by undervalued exchange rates, capital controls and official capital outflows. The smoothness of the current system depends on the close co-operation between the major economies in the world. The success of this strategy in fostering economic growth allows the periphery to graduate to the centre. The fact is that the current international financial crisis has, however, put Bretton Woods 11 under considerable strains. By analyzing the Bretton Woods 11 system in the context of current international monetary system, it can be concluded that the current exchange rate regime between China and the U.S. can last for the near future. Other authors -- Eichengreen 2004; Goldstein and Lardy 2005; Palley 2008; Rogoff 2009; Glick and Hutchison 2009 and so on -- have also argued that the system will crash. However, the current account deficits and surpluses cannot be solved fundamentally. China tends to buy more assets from the U.S., either real or financial, which is an alternative route for channelling the capital flow back. Financial liberalization, in turn, requires floating exchange rates among the centre countries. But there is a line of countries waiting to follow the Europe of the 1950s60s and Asia today as being sufficient to keep the system intact for the foreseeable future. Therefore, from the latest existing literature, it can be figured out that the expectation and requirement for a "New Bretton Woods" has become one of the core issues for global debate and subjective argument. Martin Wolf, the leading financial journalist and columnist has reported that all financial crises since 1971 have been preceded by large capital inflows into affected regions. In fact, ever since the seventies there have been numerous calls from global justice movement for a revamped international system to tackle the problem of unfettered capital flows. But it wasn't until late 2008 that this idea began to receive substantial support from leading politicians and leaders. On September 26, 2008, Nicolas Sarkozy, French President and also the president of European Union (EU), had announced "We must rethink the financial system from scratch, as at Bretton Woods. "(Broda, Ghezzi and Levy-Yeyati, 2009). Mr. Gordon Brown, the former-British Prime Minister had later announced that world leaders must meet to agree to a new economic system and we must have a new Bretton Woods, building a new international financial architecture for the years ahead. However, Brown's approach is quite different to the original Bretton Woods System, basically emphasising the continuation of globalisation and free trade as opposed to a return to fixed exchange rates. It can be acknowledged that there have been tensions between Brown and Sarkozy who argue that the "Anglo-Saxon" model of unrestrained markets has failed. However, European leaders were united in calling for a "Bretton Woods 11" summit to redesign the world's financial architecture. As a matter of fact, President Bush was agreeable to the calls, and the resulting meeting was 2008 G-20 Washington summit. International agreement was achieved for the common adoption of the Keynesian fiscal stimulus, an area where the US and China were to emerge as the worlds leading actors. However, so far there was no substantial progress towards reforming the international financial system. Giulio Tremonti, Italian Economics Minister later said that Italy would use its G7 chairmanship to push for a "New Bretton Woods." He was critical of the U.S.'s response to the global financial crisis of 2008 and suggested that the dollar might be superseded as the base currency of the Bretton Woods system. Choike, a portal organisation representing southern hemisphere non-government organisations (NGOs), called for the establishment of "international permanent and binding mechanisms of control over capital flows" and as of March 2009 achieved over 550 signatories from civil society organizations. Gordon Brown, continuing to advocate for reform and the granting of extended powers to international financial institutions like the IMF at the April G20 summit in London, was reported to have got president Obama's support about introducing a monetary system. Dr. Zhou Xiaochuan, the governor of the People's Bank of China came out in favour of Keynes's idea of a centrally managed global reserve currency in a speech entitled Reform the International Monetary System on March, 2009. Dr Zhou argued that it was unfortunate that part of the reason for the Bretton Woods system breaking down was the failure to adopt Keynes's Bancor. Dr Zhou continued that national currencies were unsuitable for use as global reserve currencies as a result of the Triffin dilemma. He proposed a gradual move towards increased used of IMF Special Drawing Rights (SDRs) as a centrally managed global reserve currency. His proposal attracted much international attention. As a consequence of this, leaders meeting in April at the 2009 G-20 London summit agreed to allow $250 billion of SDRs to be created by the IMF and it would be distributed to all IMF members according to each country's voting rights. In the aftermath of the summit, Gordon Brown declared "the Washington Consensus is over". Last but not the least, President Sarkozy, in his opening address to the 2010 World Economic Forum in Davos, repeated his call for a new Bretton Woods. From the above discussions relating to developments unit recently, it can be stated that today's global financial system is a haphazard, suboptimal creation. The East Asian economies were strategically manipulating their exchange rates and the US policy-makers have rejected intervention on the grounds that markets know best and should be left alone. This asymmetry allowed East Asia to pursue neo-mercantilist policies that contributed to today's massive global financial imbalances (Aizenman and Glick, 2009). In fact, BW2 attracted considerable attention because it offered a relatively parsimonious explanation both for recent exchange rate policy in a number of Asian countries and for recent exchange rate and interest rate behaviour in the United States. However, the BW2 model is at variance with the Chinese reality at many important points that can be summed up: * It suggests that China should focus exclusively on undervaluing its exchange rate vis-á-vis the dollar, but more than half of China's exports go to markets other than the United States or to countries with currencies not pegged to the dollar. * The exchange rate that matters most for China's competitiveness and for employment in the export sector exhibited a nearly 30 per cent appreciation between 1994 and early 2002. That is not consistent with the view that keeping the real trade-weighted exchange rate undervalued has been an integral part of China's development strategy. * BW-2 implies that China's currency has been significantly undervalued for about a decade. In real judgment, significant undervaluation of the renminbi is a phenomenon that dates from early 2002. * One of the findings from the analysis is that without the capital stock argument, BW-2 is just another employment-oriented case for exchange rate undervaluation. * BW-2 underestimates the costs of sterilisation, particularly those associated with financial repression. Focusing on the low interest rate for central bank paper is misleading (Goldstein, 2004). * The argument has been that supra-normal profits generated by foreign firms exporting from China would provide them with both the incentive and the resources to lobby to maintain trade openness in the United States. It appeared to have misunderstood several dimensions of reality in China (Arslan, 2009). * Finally, BW-2 sets out a faulty development strategy for China over the coming decade. Rather than seeking to promote an enclave economy based on a significantly undervalued exchange rate and on domestic financial repression, China needs to accelerate the pace of financial reform, liberalize interest rates and reduce reliance on administrative controls and move toward greater flexibility in the exchange rate over the medium terms. This is what we have called a "two-stage currency reform" (Goldstein and Lardy, 2005). Regarding the implications of the Bretton Woods experience for future international monetary relations, all will agree that simply stabilizing exchange rates is not sufficient to automatically deliver the benefits provided by the proponents of such an initiative. It is crucial that national economic policies (budget deficits) and economic outcomes (inflation) converge to a certain extent before countries decide to fix exchange rates. However, a short term divergence of policies is not detrimental to the functioning of such a system. It is rather a credible commitment to fixed exchange rates that ensures its stability. It can be stated that ambitious international monetary reforms like the system of Bretton Woods can only work if they are integrated into wider economic and political convergence. With this fact in mind it is easy to understand how far the world, with its various countries, standards, policies and economies, is from a "new system of Bretton Woods". ....................................................... The writer is Lecturer Faculty of Business Studies, Department of Finance & Banking, Jahangirnagar University. Email: M. Hossain@wlv.ac.uk sawkat-031 @yahoo.com. Mohammed Sawkat Hossain is Lecturer, Department of Management Studies, Jahangirnagar University. Courtesy: 'Bangladesh at 40: Changes and Challenges,' a publication of Faculty of Business Studies, Jahangirnagar University (JU) to mark its holding of a three-day seminar on the afore-mentioned theme from December 09 to December 11, 2011 at the JU at Savar. The Financial Express is the media partner of the event