Bretton Woods: the Revenge

So there is to be an international summit to discuss the reform of international finance. Already comparisons are being made to the Bretton Woods Agreements. These are probably inaccurate. While anything could happen, as currently billed, the intention of the future summit is to address financial regulation, not trade or monetary policy. Nevertheless, it's a plausible excuse to assess the legacy of those agreements at the end of the war.

The US was in a position of considerable financial strength after defeat of Germany and Japan. Europe was in ruins and needed capital to rebuild. The US offered this capital in exchange for Europe accepting a movement from imperial trade blocs towards free international trade and a de facto currency peg to the US dollar (although this was initially by virtue of a peg to gold, for which the dollar was exchangeable). This allowed the US economy to gain access to new markets in which it compete on favourable terms. And although the dollar peg did not survive the massive deficits the US incurred during the Vietnam War, the US dollar remains (for now) the world's reserve currency. The other major legacy, the movement towards free trade, has gather steam to become the globalisation of today.

I don't want this to read as an anti-American spiel. The gold peg was a widely accepted mechanism of avoiding the tit-for-tat devaluations of the Depression, intended to gain a trade advantage. Free trade, when it has genuinely been a reciprocal opening up of markets, has on the whole been a force for good in the last fifty years.

However, both the dollar's status as a reserve currency and the increasingly integrated global economy have contributed to the present financial malaise. The dollar's status as reserve currency resulted in a flow of easy credit to American house-buyers and consumers from savers in the Far East. When that flow, and the resulting property bubble, broke down, the interconnection of the global economy made the contagion very difficult to contain.

So I would suggest that we need to move away from the need for a reserve currency, and away from view that globalisation is an unqualified. Clearly both carry risks.

One idea that it may be worth resurrecting, that first came about during the collapse of Bretton Woods, is the Tobin tax, a marginal levy on foreign exchange transactions. This would encourage developing economies to rely more on their monetary and fiscal policy to support their currency and less on maintaining large foreign currency reserves to fight of speculators. In turn, this would make imbalances of payments in the developed world more immediately apparent.

The problems with globalisation are harder to addess without straying into policies contrary to free trade - tariffs and subsidies. For now, I shall just frame the problem.

Globalisation allows different countries and companies to pursue their comparative advantage. This leads to greater efficiency and greater specialisation. But it removes redundancy and creates a tightly coupled global economy. This global economy is not immune to the market cycle and destructive exuberance of the markets, indeed by allowing these patterns a bigger field, it allows them to play out for longer and come apart more destructively than on a national scale. The globalised world economy is too specialised, too tightly coupled and it lacks firebreaks. When one element fails, it brings the rest crashing down with it.

We should be prepared to sacrifice some economic efficiency to create economic resilience. The global economy is in need of decoupling, and national economies in need of diversification. In particular, it seems desirable that national economies should to some extent try to match their production to their consumption. This is the old protectionist mantra of "self-sufficiency". How to realise this without veering into protectionism, maintaining most of the advantages of free trade, seems to me to be an economically and politically vexed question though.