When Will the Fed Realize It's Kind of Important?

When Will the Fed Realize It's Kind of Important?
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As World War II raged, tremendous thought was given to how the eventual victors would recreate order from chaos. Knowing full well the contributions of the Great Depression in causing the conflict, perhaps more attention was given to financial and economic matters than is commonly understood today. Paramount among most planners’ wishes was to craft a system, an international system, which would never end up in World War III.

An early proposal called for free trade, but mixed with capital controls and fixed exchange rates. And it would all be backed by gold, though not strictly in the manner in which the classical gold standard had once operated. Freed from it by World War I, there was very little appetite in political circles for going backward.

Most of all, there would have to be an international clearing union. A central mechanism was required which would dispel all the grave imbalances that led the world to 1929 (as it was commonly understood). Gold and fiat must not be carelessly shotgunned all over the world.

The purpose of one very early attempted clearing mechanism was plain enough. Individual bilateral currency exchanges could be brought under a single framework. A multi-lateral means would be set up for settling, and monitoring, conditions before everything got out of hand. 

One factor which almost everyone agreed which had been a significant contributor to the depth and scale of the Great Depression was current account imbalances. Under the quasi-fixed exchange of the interwar period, countries would often decide unilaterally to extricate themselves from balance of payments problems via harmful devaluations and/or protectionist trade policies (including capital controls).

It resulted in an inefficient, unpredictable cesspool of ruthlessly competing national interests. The central clearing union would instead, in theory, smooth operation and therefore foster the spirit of first economic and then political closeness. Eliminate the need for beggar-thy-neighbor policies in the first place.

Everyone wins.

The first international plan offered to achieve this goal wasn’t the result of the Bretton Woods conference in New Hampshire July 1944. It was instead proffered by Dr. Walther Funk four years earlier in July 1940. What he had in mind was less about cooperation, though, as it was then the other side envisioning the world after victory.

Funk was a senior German official, a Nazi in charge of the Reichsbank. What he envisioned as a first step to Großwirtschaftsraum, first a Continental and then a globalized economy centered upon Germany, was a European clearing union paving the way for eventual dominion. This would not take the form of a customs or even a currency union, simply a payment system centered upon Berlin.

In a letter to Hermann Göring, Funk wrote:

“I assume that the integration of the occupied territories into the Greater German economy and the construction of a European continental economy under German leadership will not happen with a single political act, by signing a treaty for customs or currency union for example, but that the objective has to be reached by means of a series of single measures which shall immediately be, and partly already have been, initiated.”

On July 30, 1940, the Reichsbank issued guidelines for establishing and upgrading the German payment system as it transitioned toward a multi-lateral European clearing mechanism. The Reichsmark was to be the central reserve currency, not the single one for all of Europe.

Not long after the Nazis had made a public spectacle of their grand monetary aims, in Britain then still under direct German threat Harold Nicolson, secretary for the UK’s Ministry of Information, championed John Maynard Keynes to write up a reply to Funk. It was a necessary propaganda response, he told a reluctant Keynes, in order to show that the British had such plans if not better ones.

Keynes, of course, did as he was asked. In private, however, he wrote to Nicholson telling him, “If Funk’s plan is taken at face value, it is excellent and just what we ourselves ought to be thinking of doing.”

The issue of global money is not inherently a political one. There is a teleological argument to be had about the nature of money in this realm. Carrying out exactly the same ideas, or nearly so, the results no doubt would’ve been absolutely different. A multi-lateral clearing system centered in Berlin wasn’t going to be anything like one created by Bretton Woods – even as they might’ve featured the same designs.  

What united the two ideas was purpose. International money in a globalizing economy is paramount. The first half of the 20th century had changed a great many things, but chief among them was how economies were no longer far distant islands connected only in trivial or superficial ways.

Seventy-five years ago this month, the global monetary conference in New Hampshire got underway. His critique of Walther Funk had gotten Keynes thinking about the subject long beforehand. In 1941, he would write, “Proposals for an International Currency Union” which was not really a proposal for a currency union, either.

The uniting would be done through a clearing union, a sort of global central bank operating on the same principles as any national central bank then in existence. Above all, Keynes wanted bancor – an international currency used strictly for balancing trade between nations.

By having a separate monetary system, a supranational central bank issuing bancor would be able to prevent the deflationary spirals which had precipitated and amplified the Great Depression. In the same way the Chicago Clearinghouse Association had kept that city’s banks out of the Panic of 1907 with the use of quasi-money clearinghouse certificates, Keynes’ World Bank would be able to issue emergency currency as necessary.

This would buy time for whichever country to deal with whatever had caused the imbalance in the first place. Perfect, or at least good enough, international monetary elasticity. That was the key.

Keynes, of course, didn’t get bancor in New Hampshire. Still, what came out of it was at least partway to recognizing global transformation. The fact that the postwar period was one of unparalleled prosperity should never be lost or forgotten even when critiquing and criticizing the agreements’ (many) flaws.

That Bretton Woods happened at all is itself an achievement. Unlike Walther Funk who had no wish for Nazi Germany to give small nations the same footing, Bretton Woods was truly a cooperative affair (though that’s not how many see it today). Nowhere was that more evident than during the conference’s Executive Plenary Session on July 20, 1944, held near its conclusion.

With many of the details complete or nearing completion, the Executive Committee presided over by US Treasury Secretary Henry Morgenthau gathered to argue the substance of the final documents. It was a critical moment in the proceedings. And though Keynes would only get the IMF, which in its initial design would function a lot like a global central bank only without its own currency to issue, he saw what was needed despite being perhaps far less than satisfied with the results.

One of the most contentious issues was the quotas; how much in the initial IMF would go to each individual nation. As you might surmise, there was tremendous pressure for each one to increase their own. The more your quota, the more your relative power in the new international order.

With IMF quotas being set by economic size relative to the overall whole, there was a legitimate argument about what constituted the most appropriate standard or measure.

As such, some of the sessions had been turned into raucous, often emotional airings of grievances. Should not the Chinese be given more considerations for the war privations forced upon their economy? The Russians would claim even more aggrieved status on the same basis, much of their economy laying directly in the path of the rampaging “Hitlerite” masses. What about Peru or Mexico, countries with historical ties to silver and its more volatile scheme?

In short, there were substantial “reservations” even as the final version of Bretton Woods neared its conclusion. The challenge before the Executive Committee on July 20 was whether or not any significant doubts should be included in the final form sent off to each and every participating government for approval.

Lord Keynes, as he was addressed, rose to make a motion that all such reservations of course be made public record but limited solely to being published in the various committee minutes. There wouldn’t be any reservations included in the official statements and documents because explicit national interests professed in them would jeopardize the whole, making it perhaps irretrievably weakened.

The Germans and Japanese (obviously absent and left out of New Hampshire) had further heightened the tensions by playing up what they characterized as a fractious and awkward atmosphere at Bretton Woods. The divisions between nations were too great, they would never hold it together. The attendees and delegates present knew the stakes.

And if they didn’t, Committee President Morgenthau told them on July 20, “I have been handed this morning the excerpts of broadcasts from Germany and Japan which have to do with this Conference and I can assure you that I don’t know any better answer to this propaganda than the statements by Dr. Kung and Mr. Mendès-France.”

Dr. Kung was the lead Chinese delegate while Mr. Mendès-France was representing the free French government at that time still in exile (the Allies had landed at Normandy only a little over a month before). Kung had first said:

“After listening to the excellent statement by Lord Keynes, and the eloquent speech of Judge Vinson—especially the touching sentiment which he expressed with reference to China—I am happy to state that the Chinese Delegation is ready to withdraw its reservation. After fighting seven years of war, I need not tell you that the needs of China are very great. We made the reservation because we are facing real difficulties but after the Chairman of the Quota Committee explained to us the problems they are facing we wired to our government explaining the difficulties confronting the Conference. China is ready to make further sacrifices and to cooperate with the friendly nations 100 percent in order to make this Conference a complete success.”

Mr. Mendès-France agreed:

“France has always been among the nations which have participated without reservation in matters of international solidarity. She will do so more than ever after this war which has proven once again the fundamental need of cooperation between all nations of good will. We believe firmly that the world would know a period of terrible disorder if the countries should not decide to collaborate closely toward the reconstruction of the world, social progress and maintenance of peace.

“This task inevitably requires that substantial concessions be made by all of the nations, and, I venture to say that each one will in the future respect to a larger extent than before the legitimate interests of other nations.”

He went on to argue, “Such revisions in international relations will, however, be adhered to only if all the peoples of the world are convinced that they are entering into organizations conceived in a fair manner.” And that if all the delegates were willing to set aside their considerable and worthy reservations, to have them published completely if separately in the minutes, the French delegation would gladly set aside its own.

Not everyone was happy with Bretton Woods. I’d dare say upon closer examination of the material, minutes, and documents that are available, that no one was happy with Bretton Woods. In my own writing, I’ve criticized the agreement mostly on the basis it lasted for a scant sixteen years (the end of the era wasn’t 1971, it was 1960 when the London Gold Pool had been formed).

None of this should dissuade anyone from the task. Despite the passage of seventy-five years, the issue remains anyway. The global monetary framework continues to be of the utmost importance to the health and stability not just of the global economy but also the world at large.

Only, like the sixties and seventies it is being neglected for the same challenges faced long ago. For one, there are those who claim nothing needs to be done at all. Several of the reservations expressed in 1944 alluded to the feeling, why are we doing this in the first place? As Mendès-France said in his concession, paraphrasing, there will inevitably be winners and losers which will come out of Bretton Woods.

What everyone hoped was that there would be far more of the former and not really many of the latter; the rising tide and all that. But no one could say for sure, it was a big leap into the unknown given a big push by the political and social climate of the day. Though many hadn’t realized it, the status quo had been obliterated a long time before.

There certainly isn’t anywhere near as much uncertainty in 2019 as there was in 1944, but that doesn’t diminish the requirement – especially since anything compared to 1944 is bound to seem downright tame given the extremes of that year.

The primary argument against any need for redesigning the global arrangement is how the economy, especially the US economy, is booming. Don’t touch the dollar because look what we’ve got going on over here! Captured by the unemployment rate though, the rate cuts that will start in just about three weeks say otherwise. Economic uncertainty, to put it mildly, even charitably, is rife.

And it is more so outside the US borders. Talk of de-dollarization is rampant. Most often China and Russia, the topic of global reserve currency is made political when it really isn’t. For decades, there was no objection to the dollar or even globalization. China and to a (much) lesser extent Russia embraced them. The Chinese system is itself dollarized inside and out.

So long as that system worked, that’s what kept everyone silent – no matter the grave differences in politics. The Chinese didn’t like it, but their modern, glittering cities and breathtaking economic transformation trumped any political objections. The very fact that there is so much demand for a global monetary alternative today doesn’t suddenly speak to those politics, it harkens back to the original purpose for an international clearing mechanism.

And what is that, currently?

The answer is hardly anyone really knows. For most people, even most central bankers, it’s as if everything was set in place in 1944 and like some mythological caterpillar Bretton Woods just evolved all on its own out of gold exchange and into some free-floating fiat butterfly. It’s just assumed that it works the way it works because it works, therefore no one really needs to describe how it works.

Talk of de-dollarization, not to mention so much economic devastation, including here in the US (the Great “Recession” wasn’t a recession), is a huge warning sign that it doesn’t work.

Even the Federal Reserve finally admitted that the dollar money system is a lot more complicated than they’ve ever let on before. With federal funds, of all things, falling further out of control, FRBNY’s Liberty Street Economics blog this week acknowledged:

“And so to answer our original question, changes in administered rates reach markets where the Fed does not intervene through the web of interconnected relationships between both onshore and offshore participants and through a host of short-term financial products.”

You see, John Maynard Keynes got his bancor after all, a truly international currency. The eurodollar is it. The key difference, something I’m positive Keynes would be apoplectic about, is that there is no central bank or anything behind the eurodollar system. There’s supposed to be at least the Federal Reserve there, as we’ve been told for decades, but it’s taken until 2019 for only one of its branches in only one blog post to recognize that it might be, maybe, kind of important.

The story of Bretton Woods is ultimately a good one, though not quite a great one. It teaches us that there can be a willing and cooperative atmosphere even under severe constraint and substantial competing political interests. Played out as it did against the backdrop of World War II, even the Nazi alternative attempting to remake the world into Großwirtschaftsraum, those interests can and most likely will be tamed under the realization that the those of the monetary system itself come first.

It’s not really a conflict or a race so much as it is who realizes the necessity. 

Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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