Sat, Nov 15, 2008 - Page 9 News List

Bretton Woods II: a chance to remake the global financial system

Today, presidents and prime ministers from around the world meet in Washington to debate the future of the global financial system. Here is what they must do

By Will Hutton  /  THE OBSERVER , LONDON

The most important economic summit for a generation begins in Washington today. The leaders of the major industrialized countries — China, Russia, Brazil and India, along with the heads of the IMF, the UN, the World Bank and the EU — meet to discuss how to reform and then govern the international financial system. Summit aims do not get any more ambitious.

Fundamental questions are being raised about how capitalism is to be organized. It will be an achievement if, today, they get beyond agreeing on core principles and a commitment to talk more. But urgency is vital. The EU forced the pace by declaring on Friday last week that the summiteers should come up with answers within 100 days.

It is an ambitious deadline. It took nearly two years of discussion before there was sufficient agreement to attempt the 1944 Bretton Woods conference that established the postwar international financial system and to which this week’s summit is being compared. But shared awareness that the system is broken and that we risk a global depression is concentrating minds.

Where to start? The architects of Bretton Woods knew they had to avoid the beggar-thy-neighbor policies of the 1930s and that if the UK and the US could clinch a deal, then everybody else would have to follow. Even then it was a struggle. The question then, as now, was: How much are governments prepared to pool economic sovereignty and accept economic disciplines in order to produce the greater global public good? The US answer was not much. The US only agreed to the IMF managing a system of fixed exchange rates if the US in effect ran it. The dream of creating a system of global financial governance was passed up. Realpolitik had triumphed.


The system then only lasted as long as the US thought the benefits of running it outweighed the costs. When, in 1971, the Nixon administration was faced with the choice of increasing taxes to finance the Vietnam War or abandoning the Bretton Woods fixed-exchange-rate system that delivered predictability and less risk in international financial relationships, it had no hesitation. The markets would do the job instead and if other governments did not like the new risks, tough.

For a long time, it looked as though private markets could step into the breach — recycling first petrodollars in the 1970s and latterly Asian dollars back into the global system. Floating exchange rates were volatile, but instruments such as markets in future exchange rates emerged to manage new risks. There might be serious ruptures, like the Latin American debt crisis in the 1980s or the Asian financial crisis in the 1990s, but basically governments could step away from global economic management. The markets would do the job.

Now we know they cannot. The crises of trust and out-of-control speculation that wrecked Latin America and Asia have now attacked the system’s core in the US and Europe. The system proved unworkable. In good times, uncontrollable flows of private lending created massive asset price bubbles. In bad times, nearly US$3 trillion of loan losses have overwhelmed the capital of the Western banking system. Tsunamis of speculation in a US$360 trillion global financial derivatives market, allegedly hedging risk, mean that everything — currencies, interest rates, share and commodity prices — swings unstably, irrationally and incredibly quickly, beyond the capacity of actors in the real economy to react. The system is devouring itself.

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