PRINCETON: The chaotic and costly international response to the world’s current financial disorder has prompted French President Nicolas Sarkozy, British Prime Minister Gordon Brown, and German President Horst Köhler, a former head of the International Monetary Fund, to call for a new Bretton Woods Conference in order to design a new global financial system. But such a demand depends on a clear understanding of what a new agreement might provide.
It is easy to see the appeal of scrapping today’s global financial architecture, because there is obviously much that is broken. The existing institutions were looking increasingly irrelevant in normal times, and ineffective in times of crisis. Although the IMF delivered some gloomily accurate figures about the likely cost of the US housing fiasco, it played almost no role in addressing the current crisis. This was the first international financial crisis since the Bretton Woods Conference of 1944 in which the Fund stood on the sidelines.
The major international actor, instead, has been the G-7, a grouping dominated by medium-sized European states in which Asia’s dynamic emerging economies – the current source of global savings – have no representation.
The Bretton Woods conference succeeded not because it assembled every state, or because the participants engaged in an extensive powwow. John Maynard Keynes, an architect of Bretton Woods, believed that the true lesson of the failures of the Depression-era 1930s lay precisely in the character of the large and chaotic 1933 London World Economic Conference. Keynes concluded that a really workable plan could be devised only at the insistence of “a single power or like-minded group of powers.
Keynes was basically right, but he should have added that it helps when one power can negotiate with one other power. In the past, the most effective financial diplomacy occurred bilaterally, between two powerful states that stood for different approaches to the international economy.
This was true of the preparations for the Bretton Woods meeting. Although there were 44 participating countries, only two really mattered, the United Kingdom and, above all, the United States. The agreement was shaped by Anglo-American dialogue, with occasional mediation from France and Canada.
Bilateral talks subsequently remained the key to every major success of large-scale financial diplomacy. In the early 1970s, when the fixed exchange-rate regime came to an end, the IMF seemed to have outlived its function. Its Articles of Agreement were renegotiated by the US, which was looking for more flexibility, and France, which wanted something of the solidity and predictability of the old gold standard.
Later in the 1970s, European monetary relations were hopeless when France, Germany, and Britain tried to talk about them, but were straightened out when only France and Germany took part. In the mid-1980’s, when wild exchange-rate swings produced calls for new trade protection measures, the US and Japan found a solution that involved exchange-rate stabilization.
So, what form should such bilateralism take today?
In terms of countries, the obvious new pair comprises the US, the world’s largest debtor, and China, its greatest saver. In terms of themes, the conference would have to solve a new type of problem: how states should deal with the large flows of capital that over the past four decades have been mediated by the private sector.
Two alternative models seemed to work until 2008. On one side was the American model, with a variety of regulated banks, lightly regulated investment banks, and largely unregulated hedge funds managing the capital flows. On the other side was the Chinese solution, with increasingly costly reserve management giving way to activist sovereign wealth funds looking for strategic participation in investments abroad.
Both approaches were flawed – and liable to produce political controversy. The American model failed because banks proved to be highly vulnerable to panic once it became clear that sophisticated new financial instruments had formed a haystack spiked with sharp, dangerous, and indigestible losses. And, inevitably, today’s big bailouts have been followed by a politically fraught discussion of which banks were rescued, and whose political interests were served. Already, there is a ferocious debate about the influence of Goldman Sachs on the US Treasury. Likewise, the very large European bailouts (totaling as much as 20 percent of GDP in Germany) have produced controversies about the distribution of costs.
Meanwhile, the Chinese solution gave rise to nationalist fears that sovereign wealth funds might be abused to seize strategically vital businesses or whole sectors of an economy.
The original inspiration behind the creation of the IMF was that a largely automatic and rule-governed body would be a less politicized way of stabilizing markets and expectations. That remains true today: managing temporary stakes in banks in need of recapitalization, on behalf of large providers of capital (such as the Asian surplus countries), would put a neutral, depoliticized buffer between states and private-sector institutions.
The IMF was originally conceived in 1944 in a world without major private capital flows, one in which states undertook almost all international transactions. Extending its mission to include some private-sector rescues would recognize the preponderant role that markets now play. At the same time, the involvement of a rule-bound international agency would minimize the political poison associated with bank recapitalizations and currency interventions.
Harold Jamesis Professor of history and international affairs at the Woodrow Wilson School, Princeton University and professor of history at the European University Institute, Florence. This commentary is published by Daily News Egypt in collaboration with Project Syndicate, (www.project-syndicate.org).
