How About a New Bretton Woods?
This weekend President Bush will host an economic summit of the G-20 nations. This summit has been compared to the conference at Bretton Woods, NH that convened in 1944 to rebuild the global financial system after WWII. Unfortunately, the most important reform to come out of that conference so long ago does not appear to be on the agenda of this latest version.
The original Bretton Woods conference was convened primarily to structure the monetary system that would prevail after the war. The desire for a stable monetary system grew out of the experience of the 1930s competitive devaluations and high trade tariffs. Many at the time rightly came to associate these devaluations and high tariffs with war. Freer trade and a stable monetary system were associated with peace.
The result of the first Bretton Woods conference was a system that pegged the US dollar to gold with the other major currencies pegged to the dollar. This system, while having many flaws, was a source of economic stability for 26 years. Other periods of fixed exchange rates (primarily fixed to gold) also produced more stable economic systems than floating rate regimes. This stability can be observed in the low volatility of commodity prices during the fixed periods. During the period of the pure gold standard from 1880-1913 (when the Federal Reserve was established) the standard deviation of commodity prices was roughly 4.5. During the free float period from 1914-1926 the standard deviation at least doubled (there are differences depending on which commodity index is used). During the Bretton Woods era from 1945 to 1971 commodity price volatility was reduced again to a standard deviation of about 8. Since 1971 volatility has again risen to about 15.
If the goal is more stability in the economic system, this new conference must begin to address the exchange rate system. Reducing the volatility of exchange rates and therefore commodity prices is essential to reducing the risk associated with international trade. Billions of dollars have been lost over the last few months alone by companies attempting, unsuccessfully, to hedge exchange rate and commodity price risk. UAL reported a $544 million loss from fuel hedges gone wrong. Citic Pacific Ltd. Lost $1.9 billion from hedging activities related to the Australian dollar. Northwest Airlines took a $410 million write down from losses on fuel hedges. Verasun lost $100 million from hedging the price of corn and ultimately filed bankruptcy. Sadia, Brazil’s second largest food company posted a $410 million loss from currency hedging activities and had their credit rating downgraded. While some of these losses were due to actions outside company hedging policies, they wouldn’t have happened if the need to hedge were eliminated or reduced.
Expectations for the conference are being downplayed and the goals minimized with the strengthening of the IMF seemingly the only concrete expectation. Most of the participant countries seem more interested in regulatory reform and that is certainly necessary and desirable. Even during the stable periods previously mentioned, there were banking crises here in the US. Even in a stable monetary environment, fractional reserve banking has the potential to destabilize. Based on recent experience with leverage, one would think that increasing bank capital requirements is one item that could be agreed upon. Other ideas, such as closer supervision of hedge funds and credit rating agencies, may not be necessary if monetary reform and banking reform are properly addressed.
The global imbalances much discussed over the last few years are exactly what the IMF was designed to address. When the IMF was founded along with the World Bank, the first Bretton Woods conference placed them in the context of a stable monetary system. Reforming the IMF without reforming the monetary system will not yield a more stable system. We would have to depend on the IMF not only to anticipate problems but also to act on them in a politically charged environment. The performance of the IMF since the fall of the first Bretton Woods agreement suggests that is too much to ask.
Monetary reform will not be easy. China and most of the emerging Asian economies will fight hard to maintain a currency advantage that they see as vital to the growth of exports that have fueled their past growth. The US will be reluctant to agree to a system that weakens the role of the dollar as the world’s reserve currency. The Europeans will press for a greater role for the Euro in international trade. These three currency blocs will all have their own agendas but the current global economic slowdown may be the perfect opportunity to address the issue of monetary reform. Global economic cooperation is no longer optional; this crisis has affected every region of the world.
Over the last 60 years we have witnessed a movement toward freer trade, freer markets and freer movement of capital that has raised living standards around the world. That movement accelerated over the last 30 years and the reduction in world wide poverty during that period is nothing short of astounding. It is critical that we construct a global monetary system that provides a stable structure within which we can extend this record and realize the full benefits of the free market.