R.I.P. Bretton Woods

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Originally posted at MarctoMarket.com

On this day in 1971, US President Nixon broke the last formal links between the dollar and gold and ushered in the modern era of floating exchange rates. What was a necessity has become a virtue, and letting markets determine exchange rates, anathema in earlier times, has become the best practice urged by the G7 and G20.

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Although the common refrain is about the liberal world order ushered in by Bretton Woods, the truth is less pristine. Trade barriers were high. Capital flows limited. Exchange rates were rigid. It took years of crises and negotiations for what we call the liberal world to emerge and, ironically, the collapse of Bretton Woods made it possible.

The Great Financial Crisis spurred talk of the need to reform the global financial markets, and there have been some efforts on the Basel level. However, the broad outlines remain largely the same. China's call in 2009 for sweeping reforms, including supplanting the dollar with Special Drawing Rights (SDRs) has not amounted to very much. Chinese officials recognize that it is not ready to replace the dollar, but it offers a steady critique of the current order, seemingly keeping the US on the defensive.

Others talk about the need for a new Bretton Woods. This does not seem realistic. In some ways, there may be an interesting parallel with US healthcare and Brexit. Recognizing that the status quo is not acceptable is one thing, but reaching an agreement on an alternative is magnitudes more difficult.

Moreover, power relations are in flux. Consider what the world will look like in a decade. India's economy will likely be around twice as big (~7% growth for a decade). China's economy will be more than 50% larger. A new Bretton Woods risks freezing institutional arrangement based on current power configurations. That was a congenital problem of Bretton Woods: It institutionalized the unsustainable power relationship that existed in the immediate aftermath of WWII. By the time that the Bretton Woods agreement was implemented, it was the late 1950s, and Europe and Japan were already rebuilding, and there was near constant pressure, for example, on the German mark and Japanese yen to appreciate.

Bretton Woods was also partly predicated on inter-capitalist rivalries being submerged under the necessities of the Cold War. The ideological competition between Communism and Capitalism is over. The rise of nationalism, after the Great Financial Crisis, similar but more constrained than after the Great Depression, also serves to make a new Bretton Woods agreement unlikely. We argue that US President Trump has little time for the traditional ideological conflict and puts a clear emphasis on the economic rivalry, as reflected by the tariffs on steel and aluminum that are applied to Canada, Europe, and Japan on national security grounds.

The US appears more willing than in the past, perhaps since 9/11, to view access to US markets, both for goods and access to the dollar funding as policy levers. It seems quicker to impose sanctions and limits on access to the dollar. This also seems to argue against a new Bretton Woods, where the dollar was more a public good/utility. The US stance makes other chafe and will likely continue to look for alternatives and/or workarounds.

A fixed exchange regime or even bands will prove too rigid for our era of heightened capital mobility. Also, taken for granted now, countries cannot simultaneously fix their currency, have free capital mobility, and an independent monetary policy. The first is the easiest to avoid.

Bretton Woods. R.I.P.

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