If triumphs in global economic co-operation were accorded the same importance as other diplomatic achievements—like peace treaties, say—then George Soros would not be sitting where he’s sitting right now.
Soros, the most influential hedge fund manager the world has ever known, is at the head of the table where a system of fixed exchange rates was signed into being near the end of the Second World War. That arrangement unravelled in 1971 thanks to Richard Nixon, it’s true, but the International Monetary Fund, the World Trade Organization, the G20 and the acceleration of globalization all flowed from those signatures. This chunk of rock maple is the epicentre of the economic system that has been in place for 67 years—albeit a bit shakily of late.
Lesser relics are protected from frivolous use by ropes and guards. But at the Mount Washington Hotel in Bretton Woods, New Hampshire, the site of the United Nations Monetary and Financial Conference in 1944—birthplace of the “Bretton Woods system”—the table sits out in the open. And talk about your frivolous activities: Soros is using the 14-place table to speak to a group of reporters! It’s like using Sir Winston Churchill’s desk from the Second World War to play a game of Battleship.
It’s not obvious that Soros knows the historical significance of his briefing location. But it’s clear he thinks the financial crisis has proven that the discipline of economics is bankrupt—a sentiment shared by more than a few people in economics itself. And he is very much aware of the historical significance of Bretton Woods. That’s why the New York-based Institute for New Economic Thinking (INET), which Soros seeded with $50 million (U.S.) to foment a revolution in the way economics is applied and taught, is holding its annual conference at the Mount Washington with the help of the Centre for International Governance Innovation, the think tank that Research In Motion co-chief executive Jim Balsillie established in 2002 to goose Canadians’ interest in international affairs.
Neither Soros nor Balsillie have a day-to-day role in their think tanks. But they certainly have a financial role, and on this weekend in April, their finances are being used to rustle up the ghosts of Bretton Woods to get the world economy back on track. There are no guests at the Mount Washington this weekend, only some 330 conferees, among them some of the biggest names in economics, both theoretical and applied: former Federal Reserve chairman Paul Volcker; former British prime minister Gordon Brown; Lawrence Summers, the Harvard professor who advised U.S. presidents Clinton and Obama; a handful of Nobel Prize recipients, including Joseph Stiglitz of Columbia University; and a couple of former IMF chief economists, including Kenneth Rogoff, the co-author of a landmark study on the history of sovereign debt defaults.
At the table with Soros is his handler, a slender, bearded man who, in a dark blue suit, pink shirt and a wool beanie, resembles U2 guitarist The Edge, dressed up for Sunday brunch at a fancy hotel. Soros, who wears hearing aids, sometimes strains to hear the questions. When this happens, The Edge repeats them: “WHAT LESSONS HAVE BANKERS LEARNED FROM THE FINANCIAL CRISIS?”
Soros gives a wry smile. “Not too many,” he says. “They would prefer to think of it as a nightmare that has passed.”
It’s a good line, both pithy and wise. But Soros’s swipe at the villains of the financial crisis hints at something else. As the finance industry’s nightmare fades, so too is the dream of those who had hoped that an economic calamity that rivalled the Great Depression in its destructive force could be used as impetus to bring order to the global economy. What the world needs is another Bretton Woods.
Persistently high unemployment and massive budget deficits are undermining the all-for-one-and-one-for-all spirit that characterized the initial response to the financial crisis. Gordon Brown, who led the Group of 20 summit in London in 2009 that pledged $1 trillion (U.S.) to fight the global recession, is now on the speaking circuit rather than at the helm of one of the world’s leading economies. Rahm Emanuel, who, as White House chief of staff, famously said that a crisis is a terrible thing to waste, is now mayor of Chicago, while his former boss struggles to recover from the “shellacking” the Democrats suffered in last November’s midterm elections.
French President Nicolas Sarkozy, the current head of the G20, started the year talking about overhauling the international monetary system, and even implied he was prepared to consider measures to replace the U.S. dollar as the world’s reserve currency. (That arrangement was Nixon’s gift to the world in 1971: By removing the discipline of the gold standard, he left the value of the currency at the centre of world trade to the whims of American policy makers.) Six months later, Sarkozy’s ambition has been severely clipped. Victory at the G20 summit this autumn in Cannes would now be getting agreement on adding the Chinese yuan to the basket of currencies used to set the value of the Special Drawing Right, the accounting unit used by the IMF and no one else.
Everyone knows the massive accumulation of foreign currency reserves in China and other Asian countries, combined with big budget deficits and low interest rates in the U.S. and Europe, are creating the conditions for further instability. Yet it took the G20 finance ministers 1 1/2 years to simply agree on the guidelines they will use to measure whether the world economy is drifting off track. No serious corrective action has been taken, and none is planned.
“It is incremental change in the face of massive system failure,” says attendee Simon Johnson, a professor at the Massachusetts Institute of Technology’s Sloan School of Management who was formerly chief economist at the IMF. “On a macro level, I don’t think there is anything you can do about it. The structure of the world economy is what it is.”
In the summer of 1992, George Soros brought the Bank of England to its knees, betting that the authorities would succumb to political pressure rather than protect the value of the pound by jacking up interest rates. He led a run on the pound, and won. Now he wants to break economic orthodoxy. INET is run by Robert Johnson, formerly of Soros Fund Management. The think tank’s goal is to blow up the econometric models that so dramatically failed to predict the financial crisis and recession, and replace them with approaches that recognize randomness is a fact of life, not an outlying variable. Change the way people think about economics and you change economic policy. Soros’s contribution to INET is funding anti-establishment research that seeks to show that economics is actually more about behaviour and history than math.
Paradigm shifts happen over decades, but Soros can’t wait that long. He retired from active investing in 2000, although he did return to portfolio management in 2007 and 2008, racking up about $4 billion (U.S.) in two difficult years. Soros’s Quantum Fund averaged returns of 31% between 1969 and his retirement three decades later. That easily earns him a place in the ranks of the world’s most successful investors. Now, in his eighth decade, Soros has evolved into one of the greatest forces in nature: a billionaire who is thinking about his legacy. As The Edge signals that it’s time to go, a Belgian reporter squeezes in one last question. He asks Soros whether he sees himself as a modern-day John Maynard Keynes, the British economist who revolutionized his profession and helped shape the Bretton Woods agreement.
“Yes, I do, actually,” Soros says. “There are not many people who know the market and care about the public interest. I have made enough money for myself. That is in fact my motivation.”
John Maynard Keynes died April 21, 1946, of a massive coronary thrombosis, at 62. The previous month, he had been in Savannah, Georgia, for the inauguration of the IMF as the overseer of the fixed-exchange rate system created at Bretton Woods.
The Savannah gathering was bittersweet for Keynes—probably more bitter than sweet. He quarrelled with the Americans, picking up where he had left off in Bretton Woods two years earlier. The original conference was taxing for Keynes, and not only because he already was in ill health. More than 700 delegates from 45 countries converged on the Mount Washington, but the talks were really between two men: Keynes, an adviser to the British Treasury, and Harry Dexter White, a senior official in the United States Treasury Department.
In 1942, both men had unveiled visions for a new global monetary order that would seek to put an end to the beggar-thy-neighbour policies that accompanied the Great Depression. Keynes was famous, his 1936 General Theory of Employment, Interest and Money an instant classic that would influence a generation of economists and policy makers. But as the lead negotiator for a suffering power, he was in tough against President Franklin D. Roosevelt’s men, who entered the talks representing the world’s only real economic force. Not even the world’s best economist could beat those odds.
Keynes wanted a global central bank that would oversee an international unit of exchange. What he was forced to accept was something closer to White’s proposal—a system of national currencies tethered to the U.S. dollar, which itself would be valued against the price of gold. The IMF would use contributions from member countries to disperse conditional loans at times of crisis. The Bretton Woods arrangements also included plans for the World Bank, which would fund development in poorer countries, and the General Agreement on Tariffs and Trade, a commitment to avoid the pernicious import duties of the 1930s that seeded the World Trade Organization.
Keynes wasn’t the only one disappointed in the final result. Louis Rasminsky, the future Bank of Canada governor who was Canada’s main negotiator at the conference, worried that the U.S. would dominate the system. Still, the agreement provided hope that the self-interested policies that preceded the Great Depression could be avoided in the future. Keynes saw scope for evolution, saying it was better to begin an era of co-operation in misery than to end one that way.
Things looked good at first. The Bretton Woods system fostered stability and confidence. By the early 1950s, the economies of Europe were growing quickly. Meanwhile Soros, a Hungarian Jew who spent the Second World War eluding the Nazis with his family, was in Britain at the London School of Economics. But he was an indifferent student who discovered that his grades were too low to achieve his ambition to become a philosophy teacher. So in 1953, he became an arbitrage trader. Three years later, Soros moved to New York to get away from the “stodginess” of London. The timing of his move was perfect. Wall Street had little idea of all the opportunities that existed in postwar Europe, and the multilingual Soros was happy to make the connection. He was on his way.
The monetary system created in Bretton Woods held up for the next two decades, but eventually, countries found it too difficult to maintain their currency pegs. As the centre of the system, the U.S. had a tacit responsibility to maintain sound fiscal policies that would keep the dollar’s value against gold stable. But in the 1960s, the Johnson administration started running big deficits to finance its domestic program and the Vietnam War. The spending generated inflation. Currency traders began testing the government’s resolve, taking advantage of the U.S.’s promise to redeem dollars for gold. The way to counter these pressures was to raise interest rates. But facing re-election in 1972, Richard Nixon was uninterested in making money more expensive. Instead, he ended the gold standard, declaring the U.S. would no longer exchange dollars for the metal.
The international monetary system has functioned without concrete rules ever since. As members of the IMF, countries pledge to adhere to sound fiscal policies and floating exchange rates, but the IMF has no power to enforce these protocols. Co-operation has always been an ad hoc thing.
Keynes’s global central bank would have promoted stability by taxing the accumulation of excessive reserves and limiting countries’ ability to run deficits. But without such an organizing principle, countries pursued their own agendas, however short-sighted. China began piling up foreign exchange reserves to keep its currency low against the dollar. The value of China’s reserves surpassed $3 trillion (U.S.) this year, a sum that even the head of the People’s Bank of China concedes is more than the country needs. The policy contributes to any number of distortions in global financial markets. The most important is the creation of cheap money in the United States. To keep its exchange rate low, the Chinese government buys U.S. Treasuries. This keeps interest rates low, which encourages borrowing.
Paul Volcker, who was the Treasury official in charge of monetary issues when Nixon decided to abandon the gold standard, is among those who see a connection between the financial crisis and the failure of leaders to create a system that would force China to invest more of its reserves and the U.S. to restrain its credit-fuelled consumption. “This monetary system we have has no discipline in it,” declares Volcker, slouching in a chair in front of delegates.
The legendary former Fed chairman is participating in a moderated discussion with Soros. Their exchange brings to mind Keynes and White: The biggest parallel between 1944 and 2011 is that the rising economic power today is no more interested in co-operating than the U.S. was back then.
Some believe a renewed commitment to co-operation could change this. China, by most accounts, is still finding its feet as a global power and has yet to fully engage. “This is a very bad environment for international co-operation,” says Soros.
But he thinks there is an opportunity to get China on board. Chinese officials have expressed interest in making greater use of the IMF’s in-house currency, the Special Drawing Right, or SDR. It’s an echo of Keynes’s original plan. Before the crisis, China’s central bank floated the idea of using the SDR as a unit of exchange for international trade, giving countries the opportunity to reduce their exposure to the U.S. dollar. “Closer co-operation is what is needed,” says Soros. “SDRs provide an opening to such a discussion.”
Volcker is having none of it. “Creating SDRs is going to do nothing,” he says. “It doesn’t do anything about the lack of discipline in the system.”
Soros has written nine books. Keynes’s Collected Writings span more than 12 volumes. But Soros isn’t trying to change economics by himself. That’s what INET is for. The group’s advisory board includes some of the world’s best economists. Among them is William White, who may be the greatest Canadian you’ve never heard of.
When he was head of the monetary and economic department at the Bank for International Settlements in Basel, Switzerland, from 1995 to 2008, White was in a position to assess how monetary policy was being applied in the world’s major economies. Unlike most of his brethren, White wasn’t seduced by the myth of Alan Greenspan, the Federal Reserve chairman who was dubbed the Oracle. White, who spent two decades at the Bank of Canada, criticized the Fed chairman’s contention that it was pointless for central banks to attempt to prick asset-price bubbles because they were too difficult to spot. According to Greenspan, the best thing for a central bank to do was to allow the bubble to burst and clean up the mess.
“If you have a policy that says, ‘I am never going to raise interest rates in the face of a bubble, but I’m going to reduce them drastically every time we do have a bust,’ it’s simple arithmetic to say you are going to ratchet your interest rates down to zero and eventually you are going to find yourself in a very bad place,” White tells me during the conference.
One would assume the financial crisis would have prompted a dramatic rethink of monetary policy. Not White. “I don’t think what we did made the slightest bit of difference,” he says. “And therein lies a really big tale about political economy and the governance of these systems—even if you can identify the problems, can you get people to moderate the downturn?”
White, who is now a part-time adviser at the Paris-based Organization for Economic Co-operation and Development, says the study of economics needs to be totally rethought. Economists have long been envious of physicists. Over the past three decades, practitioners of the dismal science created mathematical models to predict how different variables would affect economic behaviour. But these models are only as good as the assumptions that went into them—and none predicted how the collapse of the U.S. housing market would submerge the entire global financial system. White’s foresight that Greenspan’s approach to the U.S. credit bubble would lead to trouble wasn’t based on econometrics, but on an undergraduate textbook on the history of business cycles that he bought when he was in his 20s. The pertinent chapter concerned the period before the First World War.
The makings of the financial crisis were all there. Times are good, so people are willing to take on risks and banks are willing to extend them credit. The credit generates more spending, creating the impression that the economy is getting stronger, which feeds demand for yet more credit, which is backed by collateral generated by the debt rather than actual earnings. “Everything builds on itself until it collapses,” says White. “This is how it always has worked.”
These days, White is thinking about how to fix economics as much as he is thinking about how to fix central banking. He joined INET’s advisory board because he appreciates the group’s emphasis on history as a guide to policy. For White, the study of economics went wrong when its practitioners began to think of themselves as physicists. They embraced mathematics to prove theories that assumed economic agents behaved the same way, all the time. The financial crisis found the models wanting.
“Mechanical physics would say, ‘Big shock in, big shock out.’ This new way of looking at the world would say, ‘No,’” White says. There’s an illustration called the Sand Game. “You drop a piece of sand and another piece of sand. So it continues. At a certain point, you drop a piece and nothing happens. Then you drop a second piece and a little avalanche happens. And maybe you drop a fourth piece and the whole thing collapses. Underneath the surface of the pile of sand is all these fracture points having to do with friction and inertia. One grain of sand can be enough to trigger the whole thing.”
The point of the Sand Game is not to render the study of economics pointless, but to be humble about the limits of human knowledge. “Maybe we need a different framework, a biological framework that will evolve over time,” White says.
Soros says INET is already one of his most successful ventures. Less than two years after the group’s founding, some of the research it has sponsored is getting published in mainstream economics journals. The revolution has begun.
If he makes it to his 90s, Soros might see the return of a functional international monetary system. Many at the conference are persuaded by theories shared by Barry Eichengreen, an economic historian at the University of California, Berkeley, and Hélène Rey, an economics professor at the London Business School. They say it is only a matter of time before the euro and the yuan become viable options to the dollar. The U.S. is bringing this shift on itself by running massive budget deficits and setting its benchmark interest rates at 0, undermining confidence in the dollar. Investors are turning to the euro as the next best thing, and are likely to continue to do so. Meanwhile, Chinese authorities are steadily allowing more yuan to circulate outside of China, an acknowledgment that their economy has become too big to control from Beijing.
Says Eichengreen, “1944 was special. The Second World War was raging. The U.S. was the dominant power. Lots of countries, because they were in the enemy camp, were not even at the table. Now, when the G20, with its diverse interests, has to agree on anything and everything, the process is going to be a long, slow one.”
The long, slow road comes at a cost. Eichengreen previously attended a conference on the international monetary system at Bretton Woods in 1992, a fact he raises to illustrate that economists and officials have been grappling with these issues for a long time. Since that gathering, the world has endured the Asian financial crisis, the Latin American financial crisis, the Russian financial crisis, the U.S. technology bust, another U.S. recession in 2001 and the Great Recession. How many crises are the leaders of the world’s major economies willing to endure? If the future is clear, why not bring it forward? This is what Soros will be telling every politician he sees.
“Their role is to lead the markets,” Soros says. “That is what makes them statesmen. If they lead, the markets will follow.”