Atlantic Community:Open Think Tank Article "Bretton Woods Revisited, Again"

November 17, 2008 | 5 comments | Print | E-Mail Your Opinion

Bretton Woods Revisited, Again

Luke A. Nichter: With this weekend’s G-20 meeting in Washington, calls for the return to a Bretton Woods-like system can be heard around the world. However, before getting caught up in the momentum of “reform,” the incoming administration of President-elect Obama should carefully heed the lessons of history.

On the occasion of this weekend's G-20 meeting in Washington, the global economic crisis seems more entrenched than ever. Calls for the return to a Bretton Woods-like system can be heard around the world. The Washington Post has said that a new Bretton Woods "could reform the IMF" (October 20). The Times of London has reported Prime Minister Brown's call for a new international financial architecture (November 14). Le Monde has printed favorable coverage for a "Bretton Woods acte II" (November 14). Before getting caught up in the momentum of "reform," the incoming administration of President-elect Obama should carefully heed the lessons of history.

The Bretton Woods system was set up in July 1944 by 44 nations in New Hampshire. The system allowed the recovering economies of Europe to accumulate U.S. dollars--including postwar American aid such as the Marshall Plan--which could be converted to gold at the rate of 35 dollars an ounce, guaranteed by the U.S. Treasury's gold reserves. The American guarantee was maintained in exchange for other countries' obligations to ensure monetary discipline at home.

The United States did not have this same discipline imposed upon it, so American debts could be paid by issuing new currency. During the late 1950s and 1960s this occurred with greater frequency as a result of ballooning American foreign aid programs, Lyndon Johnson's "Great Society" initiatives, and the funding of growing American involvement in Southeast Asia. After 1958, the total number of dollars in circulation had eclipsed the gold held in reserve, a violation of a key tenet of the Bretton Woods system. This ultimately set in motion a series of monetary crises throughout the 1960s.

After a gold crisis in 1960, the Eisenhower administration worried that the entire Atlantic alliance might collapse. The Kennedy administration once mused that payments deficits worried the president more than nuclear weapons, and President Lyndon Johnson was concerned that he might be blamed for a global economic depression. This system was also painful for American consumers. Expansionary monetary policies without a devaluation of the dollar attracted imports, causing inflation, increased prices, and reduced exports. Thus, even in its purest form, the Bretton Woods system had a certain amount of instability built into it from the beginning.

Knowing that American gold reserves could not withstand a mass conversion of dollars into gold, throughout the 1960s American policymakers created a series of political inducements to compel Europeans (and later, Japanese) to hold onto their dollars rather than exchange them for gold. Beginning in 1961, the U.S. negotiated "offset" agreements with West Germany. In 1963, the Group of Ten leading industrial nations began discussions to develop a new monetary system, without success. Then, in 1968, Special Drawing Rights were created in an attempt to meet shortages in liquidity.

This was the system that Richard Nixon inherited in 1969. Nixon ignored the advice of Milton Friedman and Paul Volcker that the change in administration was an ideal time to overhaul Bretton Woods. Friedman argued that the dollar must be set free from the burden it carried as the pivot to the system. Ignoring advice to act in 1969, Nixon announced his New Economic Policy on August 15, 1971. Considered to be the mortal blow to Bretton Woods, Nixon suspended the conversion of dollars into gold, and included a host of other domestic initiatives (e.g. wage and price controls) and international programs (e.g. import taxes) that were in the spirit neither of Bretton Woods nor Nixon's conservative beliefs.

The lesson here for the Obama administration is that references to a "new Bretton Woods" must be understood carefully. Many calls for such a system appear with little context, and do not take into account the fact that the system depended on perennial manipulation, or that it was solvent for less than half of its existence. In 2009, there are too many unanswered questions. What would the currency pivot and reserve asset be? What will the responsibilities of membership be? What will the mechanism of enforcement be? What will the penalty for not playing by the rules be? Calls for reform are simple, but answering these questions are much more difficult. The system was unable to meet the liquidity demands of the 1960s, and it appears dramatically more out of step today.

Luke Nichter is an assistant professor of History at Tarleton State University-Central Texas.

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November 17, 2008

Marek Swierczynski, journalist at TVN24, Diamond Contributor (1100)

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If re-designing of the world's financial institutions is the main short term task on both sides of the Atlantic, one has to admit that the European side has a larger homework to do. Both the European Commission and the European Central Bank failed to protect the citizens of the EU as a whole and the bearers of the euro notes from what was predictable for a long time. Both institutions should be held accountable for their failures and the EU voters should make use of the next year's European Parliament elections to give a strong red card to the "fat cats" in Brussels, Luxembourg and Frankurt. More generally, a debate should start now on how to avoid being tied to speculation with one's pension and life savings. A return to grassroots economics is much needed, greed must be tamed, real value of markets reestablished.

November 17, 2008

Donald Stadler, Self-employed, Diamond Contributor (1052)

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I'm not entirely sure I agree with Marek, because I think the US has to redesign the way it's economy works or risk serious decline. The US must retool itself to get off the drug of easy credit from China and other exporters. The recession will help in this goal, but once the recover starts we must find a way to avoid the easy solution of borrowing to finance consumption we cannot afford.

November 18, 2008

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Nice article.
A few extra points of interest if I may.
Toward the end of each world war American farmers were asked to increase crop output so we could feed Europe countries until they had rebuilt their farms and could feed themselves. American farmers borrowed money from the banks to buy more land, and crow more crops for Europe. Initially this was going well and they were paying off the new debt. Europe recuperated in about 3 to 4 years, which was faster than expected. The USA then had a surplus of crops, the prices dropped and the farmers could not pay their bills. Neither the US or Europe governments would help these farmers, so the banks foreclosed and took not only the new land that was purchased, but also the original farmland owned by these farmers. The farms were sold cheap to big business.

The President Nixon price controls were a complete disaster. Example: Cattle farmers refused to sell at the low prices and decided to hold out for the price to go up. Of course the shortage of beef caused the price to increase. Then all the holdout farmers sent their beef to the market at the same time which caused an immediate decrease in price as there was now a surplus. Dairy farmers had a tough time also, as some people would not sell and actually set up road blocks to stop other farmers from delivering any milk. The USA inflation tends to average about 3 to 5 percent. After the release of these price controls the 1970’s gave us a few years of between 9 and 11 percent inflation.

President Bush Economics for the last 8 years.
French Laissez-faire (hands off, let alone, let it be) economics. An economic ideology which advocates minimal state intervention in the economy. Meaning private initiative and production are best. So what happened with 8 years of hands off? Regulations were removed from banking and loaning practices which made room for some creativity in making more money. Example: I write a clause in the loan that says “If you make a late payment the bank can double your interest”. Now since there are no regulations I can say “If you make a second late payment the bank can triple your interest” or whatever, you get the point.
Here is the really bad part. Say the bank increases your interest. Your house payment goes from $1,000 a month to 2,000 per month (some payments went as high as 2,500 per month once extra interest was added). Since this is made legal (and still is) if you fail to pay up, the bank can foreclose on your house and put it up for auction. Honey we have visitors. The US Marshalls and the Sherriff are here not to protect us from criminals but to help criminals steal our house. Then the Federal Government steps in and says you owe a tax penalty and must pay up now.
Laissez-faire may work when used by honest business people, yet clearly it has not worked to the benefit American middle class homeowner and bread basket consumers for the world economy.

November 19, 2008

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Keynesian Economics and the last 8 years in the USA
British style Keynesian economics: The government can in fact stimulate economic growth and improve stability in the private sector through a variety of methods simultaneously. By lowering interest rates, taxation, and starting public projects. These methods were used successfully in Britain 1920’s and the USA 1930’s.
Factors:
1. Government Projects. Large scale projects started, managed and paid for by the government hire unemployed workers to build, roads, railways, bridges, schools etc. This puts money into lower and middle class immediately and they naturally spend that money on basic needs.
2. Government lowers tax and interest rates for businesses. Companies are to use this extra savings to hire researchers to develop new products, which are sold at a later date. These new employees then have money to spend.

So did we even try this plan? If yes then why did it fail?
President Bush did start with some efforts to improve education by at least attempting to increase school funding by 40% (I am not sure what amount was actually approved). This was to support a new economy where the USA leadership would create next level technology jobs for American workers. The government did support NASA exploration missions to maintain existing high-tech jobs and even created some more for Hubble repairs, planetary probes etc. Also added were some new research jobs to develop hydrogen fuel cell automobiles and a refueling network.

So the next question is; Were these enough projects and if not why not?
Well, obviously looking at the current situation this year losing 60,000 or more jobs per month, over 2 million home foreclosures, we see very clearly, there were not enough government projects started and maintained. I believe this was due to so many tax cuts; the US government was not able to pay for such large industrial strength projects. Also every person that lost a job was one less tax payer.

Corporations: Did they recruit more researchers to develop innovative products since they were now saving big money in interest and taxes? A few did, however many actually laid off people with experience and PhDs because those employees cost more than inexperienced employees. They forced lower paid employees to try and develop the other skills and do multiple jobs at once. This caused many projects to fail again and again. The Management solution to this was Re-org Itis. Claim they needed to re-organize the team. This is normal for new projects like retooling for a new model of computer or automobile. It becomes a problem when every three to six months the corporation completely re-organizes who reports to whom (new manager) where you work and who you work for with no apparent reason.

How did the US Government try to make up for this lack of new research?
College Grants for Research: Universities were provided grants (money for specific projects) to try and get the college students to do the research the corporations failed to do. The problem here is that the students are in school to learn basic, intermediate and advanced concepts and do not have the experience of a PhD or experienced researcher that has been working in that field or specialty for decades. So did the students succeed? No! Now they did have lots of fun using the skills they were learning with lots of practical projects like building solar powered mini-autos. So for the students the classes were more fun and inspiring.

The fundamental problem with the corporation ideology in America is Instant Gratification, Instant Wealth. They cannot seem to get that the biggest technology gains are made long term. Can we develop everything instantly? No! We probably never will.
We are kind of chasing our own tail in this regard. We as Customers demand absolutely perfect products very quickly and very cheaply. Then we as producers must work harder with less help, less experience to create a higher quality product.

Conclusion:
1. Government projects are definitely a requirement. People would rather have a job and be able to pay taxes.
2. Corporations that accept the Tax savings should be held accountable for recruiting researchers and developers.
3. College students need to study and learn new things, not do the job for corporations.

November 22, 2008

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I would like to return to the initial topic, the international call for a "new Bretton Woods". In my opinion, Mr. Nichter is totally right saying that there are too many unanswered questions to create a new monetary system.

I would even go one step further: in today's globalized, multipolar world, there cannot be a second Bretton Woods, because a global lead currency does not exist. A global monetary system is thoroughly built on trust and stabilty. Inargueably, the US is still the world's economic leader.

But there are two other realities which speak against the US as a guarant of global economic order: In the first place, the dollar has already failed in its role as key currency in the late 1960s/early 1970s. In these times of economic uncertainty, US leaders changed from a stabilization-oriented to an employment-oriented economic policy and had had to boost the volume of money in order to finance the Vietnam war. Calling for a new Bretton Woods, we should keep in mind, that the old one did not work. Secondly, the current crisis is originated in the US, more precisely in the US' housing sector. Curing the world economy with the currency of the "crisis' host country" will not make the monetary system a trustworthy one.

Another option for a new system's pivot money could only be the Euro - considering the yen's weakness and the ongoing instabilty of emerging countries such as China and India. As to its financial institutions, I disagree with Mr. Swierczinsky that Europe has larger homework to do than the US (besides, I ask myself how, in the 2009 European parliamentary elections, Europeans can give a "strong red card" to the Commission and the Central Bank which are not directly elected and have nothing to do with the 2009 parliamentary elections?!). However, Europe is still far from having converged economies and its endebted economies are as well fighting recession.

I think that precisely in the time of a global crisis, we should and can not institutionalize the domination of one single currency. At the same time, cooperation and coordination are indispensable and the G20 summit is the right first step to find collective solutions.