A New Bretton Woods to Restructure the International Financial System?

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by: Jeffrey Frankel

The first thing to say about the calls for a “new Bretton Woods” is that they overreach, in the sense that it is very unlikely that any changes in the structure of the international monetary or financial system will or should, at this point in history, come out of multilateral discussions that are big enough to merit comparison with the first Bretton Woods. Certainly we are not talking about fixing exchange rates, as the 1944 meeting did.

Detour for an anecdote. In mid-1998, when the crisis that originated in Southeast Asia had reached its one-year anniversary without abating, President Bill Clinton decided to give two important speeches. He wanted to call for a new Bretton Woods. His economic advisers (including both at Treasury and in the White House) advised him against this, on the grounds that one should not call for something as portentous as a new Bretton Woods when one was not likely to have proposals substantive enough to merit the name.

Soon after the (successful) speeches, British PM Tony Blair called for a new Bretton Woods. Clinton asked his advisers, “How come Blair got to call for a new Bretton Woods when you wouldn’t let me do it?” Our answer was along the lines, “Blair’s Treasury Secretary, Gordon Brown, does not necessarily have his interests aligned with his boss, in the way that Bob Rubin does. So Brown had less incentive to stop Blair from saying something foolish.” The big irony of the story is that Brown today is himself leading the move for a “new Bretton Woods.”

Nevertheless, it is worth taking the opportunity to consider what changes – whether more ambitious or less — might be made at the multilateral level to improve the functioning of the system.

Changes in government policy at the national level have already been radical in many countries, compared to anything that would have been imagined a short time ago:

  • Central banks’ extension of credit to institutions and under terms not contemplated in the past,
  • Governments’ buying up bad assets and taking over troubled banks and financial institutions (or engineering their transformation),
  • Agencies guaranteeing deposits (without limit) and money market funds, and so on.

Some of these steps can be done at the purely domestic level (US takeover of Fannie Mae and Freddie Mac); others require cooperation between a small number of countries (rescue of Fortis by Benelux countries); but others arguably require multilateral agreement, and thus are candidates for a modest “Bretton Woods.”

The International Monetary Fund has been given the task of outlining what a new Bretton Woods would look like – appropriate since the IMF is one of the original Bretton Woods institutions (along with the World Bank).

  • An Early Warning system is almost certain to be high on its list. But it already developed early warning indicators, after the East Asia crisis of 1997-98, and they haven’t been much help.
    • This time around, however, the Fund has more competition (including from the ECB, the Gulf countries, China, and Sovereign Wealth Funds), and partly for that reason will probably demand less conditionality from the borrowing countries.
    • Bill Rhodes has proposed that the Fund facilitate expansion of currency swap arrangements, to allow emerging markets to have the same access that has been made available to developing countries; and that it should try to resurrect a lending facility known as Contingent Credit Lines.
    • The Fund would have to turn to newly-wealthy countries like China to help finance such new facilities and programs.
    • Michael Bordo and Harold James have suggested that the Fund could manage reserve assets of the new surplus countries; but it is not clear why the latter should want it to.
  • There has been a loose one-year campaign to suggest guidelines for the operations of Sovereign Wealth Funds themselves. But benefits of the SWFs may be more widely appreciated now, in the context of the current crisis than previously.
  • The IMF, just as all the multilateral economic institutions, has moved far too slowly to give added representation to the newly important developing countries such as China, Brazil, Korea, India and Mexico – representation at least in proportion to their economic role, to say nothing of population.
    • A big part of the problem is that larger quotas and voting shares for these countries would have to come to a substantial extent out of Europe’s share.
    • In a fair world, Europe would also give up its stranglehold on the Managing Directorship (especially after the performance of the last two incumbents); and the same goes for the U.S and the World Bank presidency.

The G-8 has been increasingly handicapped in recent years by virtue of its obsolete membership.

  • How can they discuss global current account imbalances or the need for exchange rate adjustments without China and Saudi Arabia at the table? It looked like the G-20 would supplant the G-7.
  • The G-7 still retains some relevance, in its role as self-appointed steering committee for world governance. After all, this financial crisis did not start in the developing countries, as it did those of 1982, 1997 and 2001.
  • But they will still have to start inviting China, Saudi Arabia, and any other country that they expect to help finance any of its plans.

The most probable substantive outcome from talk of the need for a bold new multilateral initiative is that there could be a “Basel III” to replace the “Basel II” agreement.

  • It would make capital requirements on banks countercyclical, rather than what has turned out to be procyclical, i.e., destabilizing, under Basel II. (Ironically economists at the BIS in Basel probably deserve credit for being the observers, in addition to Charles Goodhart, who most accurately warned of the procyclicality before the crisis.)
  • A Basel III could also replace the option of self-regulation of banks (under which they could choose their own Value At Risk models) with external regulation.
  • International guidelines for guaranteeing deposits (possibly reinstating a ceiling, such as $100,000, after the crisis has passed) should perhaps be coordinated, to avoid flight of the sort that Ireland’s European partners experienced.

Other possibilities:

  • A more ambitious reform would be to try to agree on guidelines to extend prudential regulation from international banks to non-bank financial institutions, since the latter were such a serious part of the problem in 2008 that many either failed or were bailed out, against all expectations.
  • More radically, regulation of this sort not just agreed multilaterally but carried out multilaterally, rather than at the national level, by the BIS (which now includes major emerging market countries) or a new agency.
  • The IMF, Financial Stability Forum, and other institutions will vie to lead the effort.
  • Other radical proposals:
    • A securities transactions tax, harmonized internationally, to raise revenue in a way that satisfies the public’s understandable feeling that the financial sector, which created this financial crisis, should not benefit from the solution.
    • Regulation of certain derivatives, such as Credit Default Swaps.
    • But there is a danger that derivatives regulation could do more harm than good, e.g., a ban on futures markets or short-selling.
  • At the other end of the spectrum, one should consider the possibility that doing nothing might in the end be better than undertaking fundamental reforms in the international financial system.