Twenty years after the fall of the Berlin Wall and the collapse of communism, the world is facing another stark choice between two fundamentally different forms of organization: international capitalism and state capitalism. The former, represented by the US, has broken down, and the latter, represented by China, is on the rise. Following the path of least resistance will lead to the gradual disintegration of the international financial system. A new multilateral system based on sounder principles must be invented.
While international cooperation on regulatory reform is difficult to achieve on a piecemeal basis, it may be attainable in a grand bargain that rearranges the entire financial order. A new Bretton Woods conference, like the one that established the post-World War II international financial architecture, is needed to establish new international rules, including treatment of financial institutions that are too big to fail and the role of capital controls. It would also have to reconstitute the IMF to reflect better the prevailing pecking order among states and to revise its methods of operation.
In addition, a new Bretton Woods would have to reform the currency system. The post-war order, which made the US more equal than others, produced dangerous imbalances. The dollar no longer enjoys the trust and confidence that it once did, yet no other currency can take its place.
The US ought not to shy away from wider use of IMF Special Drawing Rights (SDR). Because SDRs are denominated in several national currencies, no single currency would enjoy an unfair advantage.
The range of currencies included in the SDRs would have to be widened and some of the newly added currencies, including the yuan, may not be fully convertible. This would, however, allow the international community to press China to abandon its exchange-rate peg to the dollar and would be the best way to reduce international imbalances. And the dollar could still remain the preferred reserve currency, provided it is prudently managed.
One great advantage of SDRs is that they permit the international creation of money, which is particularly useful at times like the present. The money could be directed to where it is most needed, unlike what is happening currently. A mechanism that allows rich countries that don’t need additional reserves to transfer their allocations to those that do is readily available, using the IMF’s gold reserves.
Reorganizing the world order will need to extend beyond the financial system and involve the UN, especially membership of the Security Council. That process needs to be initiated by the US, but China and other developing countries ought to participate as equals. They are reluctant members of the Bretton Woods institutions, which are dominated by countries that are no longer dominant. The rising powers must be present at the creation of this new system in order to ensure that they will be active supporters.
The system cannot survive in its present form and the US has more to lose by not being in the forefront of reforming it. The US is still in a position to lead the world, but, without far-sighted leadership, its relative position is likely to continue to erode. It can no longer impose its will on others, as former US president George W. Bush’s administration sought to do, but it could lead a cooperative effort to involve both the developed and the developing world, thereby reestablishing US leadership in an acceptable form.
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