Forty years ago this week, the greatest attempt at global economic co-ordination died.
On Aug. 15, 1971, Richard Nixon ended the U.S.’s commitment to convert dollars into gold. This destroyed the Bretton Woods agreement on fixed exchange rates, named after the New Hampshire resort where the outlines of the plan were completed in the summer of 1944.
The anniversary has brought scattered commentary, most of it expressing the hopelessness of ever returning to a system that so aggressively seeks to remove foreign-exchange volatility from the international economy.
The inability of the U.S. political system to stabilize its budget deficit without resorting to brinksmanship is the latest blow to the hope that the financial crisis might have added an outward perspective to local politics. Much of the current volatility in currency markets is the result of the decline of the U.S. dollar, which at least in part reflects the country’s widening budget deficit. The political showdown over the debt ceiling showed Congress cares little about supporting the world’s reserve currency with sound policies.
Some, including Nobel laureate Robert Mundell, argue for a return to fixed exchange rates. This is unlikely. Bretton Woods came about because the U.S. was the dominant political force and a system of fixed exchange rates aligned with its interests. The U.S. didn’t impose Bretton Woods, but it largely dictated the eventual architecture.
The world isn’t so aligned today. China might benefit from a financial system less reliant on the dollar. But it has little incentive to strike that bargain today when, in five or 10 years, its position in the world will only be stronger. At the same time, no country, nor group of countries, is strong enough to impose a new order on the United States.
“Calls for a new Bretton Woods agreement or a new international monetary order seem either utopian or simply a thinly veiled criticism of the U.S.,” Marc Chandler, global head of currency strategy at Brown Brothers Harriman, wrote in commentary this week.
So we’re stuck with the current system, a mish-mash of floating exchange rates, currency pegs (both official and unofficial), and the indiscriminate use of capital controls and interventions.
Some analysts argue that chaos need not reign.
In a book set for release in September, Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics and a former Federal Reserve economist, argues that the era of (mostly) floating exchange rates has worked better than many people think by giving central banks freer rein to smooth growth and inflation.
With some tweaks, Mr. Gagnon believes the current system could be made to work rather well. According to a summary provided by the Peterson Institute, Mr. Gagnon argues that the International Monetary Fund does a good job of determining countries’ equilibrium exchange rates. Therefore, Mr. Gagnon says, countries could agree to allow their currencies to float freely within a band tied to the fair rate set by the IMF. Countries that violate the band could be sanctioned.
Ideas such as that could show up in discussions this autumn among the Group of 20, which, under the French presidency, is studying whether the foreign-exchange regime needs to be overhauled.
A year ago, there was talk of replacing the dollar with a new international currency, perhaps the IMF’s special drawing right. But that talk has died off. Tweaks to the current order appear to be the best the G20 will achieve, and that could even prove a stretch.
The world economy has changed dramatically over the past four decades, but one thing has remained constant: national interests still trump the global good. Examples abound: the U.S. debt-ceiling crisis, China’s refusal to allow faster appreciation of the yuan and the efforts of Japan and Switzerald to curb the ascent of their currencies.
“It may not be polite to speak ill of the dead, but Bretton Woods has been romanticized,” Mr. Chandler said. “On the 40th anniversary of its death, the conditions do not exist for a new international economic order. The recent policy responses confirm that domestic considerations remain primary.”