The Great Game On The Anniversary Of The End Of Bretton Woods

Aug. 14, 2021 10:00 AM ET20 Comments
Marc Chandler profile picture
Marc Chandler
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Summary

  • August 15 is the 50th anniversary of the end of Bretton Woods.
  • The Reagan-Thatcher era that followed it with a lag ended probably with the Great Financial Crisis.
  • Neither Europe nor China are ready to take the reins or supplant the dollar.
  • However, the key lies not in Berlin, Brussels, or Beijing, but with the US electorate in 2022 and 2024.

Wall street sign in New York with New York Stock Exchange background
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August 15 is the 50th anniversary of the end of Bretton Woods, when the US unilaterally ended the last formal linkages between the dollar and gold. Nixon ushered in the modern era, even if he did not intend to do so. The only thing that seemed pertinent at the time was that the US did not want to part with any more of its gold, and Nixon feared a recession that would undermine his chances for getting re-elected in 1972. The main demand for US gold was not coming from the Soviet Union or Communist China but from America's capitalist rivals and allies, primarily in Europe.

The period after the dollar devalued against gold (and other major currencies) might have been dubbed the first G-zero era. The US foreign policy in Vietnam undermined its international prestige. Germany's "ostpolitik" reflected a growing divergence between the US and Europe. Servan-Schreiber's international bestseller, The American Challenge (1968), accused US multinational companies of colonizing Europe.

However, it proved to be an interregnum. Then, less than a decade after Nixon's decision, a new era opened, characterized in many respects by turning Bretton Woods on its head. Currencies floated against the dollar. Capital was liberated, purposely freed from restrictions on its mobility in several dimensions. Resistance to new forms of protections, such as Voluntary Export Restrictions and Orderly Market Agreements, ultimately necessitated replacing the General Agreement on Trade and Tariffs (GATT) with the World Trade Organization.

The US trade balance, and more broadly, the current account balance, was deteriorating years before the capital markets were opened. This means that historically at least, the export of foreign savings to the US did not cause the external imbalances, even if later America's capital account surplus contributed to the yawning of the goods deficit. The capital offensive associated with Reagan-Thatcher came to an end. It may have ended with the tech bubble in 2001, but we would be inclined to mark the end with the Great Financial Crisis.

The anniversary of the end of Bretton Woods offers a timely opportunity to reflect on where we are in the great narrative of our times. One key element is that America's multilateralist elite was turned out of the presidency in 2016 and lost key parts of Congress. Trump delivered a more unilateralist foreign policy (what in an earlier era might have been dubbed "splendid isolationism" as the British did in the late 19th century to signify no permanent allies).

He reduced taxes and appointed conservative judges, fulfilling key elements of the Republican agenda. When he withdrew from the Trans-Pacific Partnership, he noted that both leading Democrat candidates (Clinton and Sanders) also opposed the treaty. Ironically, it seemed like the old Henry Cabot Lodge wing of the Republican Party, which defeated Wilson's League of Nations proposal after WWI, was resurrected.

Biden's election represents the "restoration" of the internationalist wing of the American elite. It requires more than one election to solidify its hold. To be sure, this is not a done deal. The Republicans are slightly better than 2:1 favorites on Predict.Org to capture the House of Representatives next year. On that site, the Democratic Party is a slight favorite to hold on to the White House in 2024.

The broad outlines of a possible new social contract are emerging. It includes greater progressivity in the taxes, rebuilding the infrastructure, broadly conceived, efforts to close the rural-urban divide, more sensitivity to environmental impact, and greater willingness to embrace social diversity. Nationalistic forces are strengthened. Raising the criteria for domestic content on government purchases and the USMCA is consistent with the Biden administration's pursuit of an import substitution strategy, from auto parts and medical supplies to semiconductor chips and solar panels, which arguably also began with Trump. Organized labor has been broadly supportive of such efforts.

Biden has used the specter of competition from China to push his domestic agenda. It also is a centerpiece to his attempt to offer a new iteration of Pax Americana. A common rival or threat makes for a more powerful, cohesive force for the fraying alliances. Biden's endorsement and modification of international tax reform that has been discussed at the OECD for at least a couple of years is another component. One element calls for a 15% minimum corporate tax, and another is that it allows a better alignment of sales and tax revenue distribution for the largest multinational companies.

Recommitting the US to the Paris Accord is one thing, but the Biden administration shows no inclination to re-join the TPP (renamed after the US withdrew to the Comprehensive and Progressive Agreement for Trans-Pacific Partnership), which the UK has recently sought formal ascension. Instead of the broad "parameter" defense of multilateral trade agreements, the Biden administration appears to be pursuing a "strong point" defense, seemingly focusing on a few key geostrategic and economic allies, which may better align economic and strategic interests. In addition, there is interest in the "next generation" of trade agreements to focus on expanding digital activity.

Biden has broadened tariffs and sanctions imposed by Trump on China and put them on a more secure legal footing. Although Biden has resolved the nearly two-decade dispute with Europe over Boeing-Airbus subsides and overcame the conflict over the Nord Stream II pipeline from Russia to Germany, it has not yet lifted the tariffs Trump imposed on steel and aluminum for national security reasons. Still, an agreement is possible before November, when the EU's waiver of an increase in the retaliation tariff ends.

In summary, at the risk of oversimplifying, the capital offensive of the Reagan-Thatcher era ended, and the traditional international US elite was shunned in 2016. It returned in 2020 with a "kinder gentler" domestic agenda that was more nationalistic than the previous incarnation. Its foreign policy reinforced its domestic policy. The 15% minimum corporate tax would help facilitate domestic tax reform. It argued that much of the infrastructure initiative was driven by the need to compete with China.

Biden claims that America is back and wants to reassert US leadership in a world where "bad actors" like China, Russia, Belarus, and Iran are key sources of instability. Before the euro was launched at the start of 1999, many argued that its economic and monetary union (EMU) could offer an alternative to American leadership. Yet, few push this line now. Monetary union is not complete. There is no banking union, and Europeans are still ambivalent about fiscal union. A common EU bond is one of the responses to the pandemic, but the battle over making it permanent is still to be had.

Brexit may have marked the beginning of a new era for the EU. Partly, as a result of the UK's efforts, and partly, the historical circumstances of the Soviet Union's demise, the EU has pursued a broadening strategy. One of the consequences, for example, has been the increase in qualified majority voting instead of unanimity. This diluted the UK's veto weakening the domestic coalition that the Tories previously led to enter the EU, which it had sought for many years. Meanwhile, Brussels' relations with eastern and central Europe members, most notably Poland and Hungary, are strained, to put it mildly.

When under the Soviet boot, the EU represented freedom, liberty, and modernity for many parts of central and eastern Europe. Now, to the conservative elites, the EU represents permissiveness, abortions, a breakdown of the nuclear family, and an assault on the binary gender distinction. Support for the EU appears to be stronger among the general population than the political elites, but on the current trajectory, that Hungary and/or Poland would leave the EU on a 3-5 year outlook, it does not seem so far-fetched.

With the UK out of the EU, one of the biggest obstacles to a European army has been removed. Yet, Europe seems reluctant to commit the resources to what is required to project its power, separate from NATO. Thirteen years after Russia invaded South Ossetia and seven years after Moscow annexed Crimea, Germany completed a gas pipeline with Russia. Even though the EU military spending exceeds Russian spending several times, central and eastern members are more reliant on NATO than the EU for defense. Moreover, reports suggest the EU is woefully unprepared for the emerging but significant battlefield of the 21st century - cyber warfare - the internet-centric non-contact capability to disrupt or paralyze an adversary. Yet, the single element of power that Europe lacks is will. As an aside, Biden could encourage Sweden, which plans on boosting military spending by a quarter by 2025, to join NATO.

Europe has good reason to be skeptical of the "America is back" meme. First, the US may be one election from leaving NATO, pulling out of the Paris Accord (again), and/or other multilateral agreements. Second, the Biden administration's multilateralism might not be all that it seems. First, America's NATO allies were reportedly blindsided by the US decision to pull out of Afghanistan. Second, as noted, more than half a year into Biden's presidency, steel and aluminum tariffs on national security grounds against Europe remains intact. Third, Washington's willingness to use access to the dollar payment system as a weapon to punish its enemies infringes on European sovereignty, and Brussels' quest for an alternative payment system continues.

Europe's economic and political weakness does not take anything away from its leadership on other fronts, including environmental and personal privacy issues. At the same time, Europe will continue to be dependent on US military might. Germany and the UK have been persuaded to demonstrate freedom of navigation in contested waters in the South China Sea. The UK has announced it will permanently deploy two naval patrol ships in Asia. Still, Germany and France resisted American efforts to use NATO to check China. The ill-advised EU investment agreement with China rushed to conclude the seven-year effort before Biden took office, lies in ruins.

The investment pact has not been ratified because the US managed to sabotage it but because of China's clumsiness on the world stage. The EU had joined other countries in sanctioning China over mass detentions of Muslim Uyghurs. Beijing retaliated with its own sanctions against think tanks and government officials, including five members of the European Parliament and its human rights subcommittee. As a result, the European Parliament has refused to take up the agreement.

As the Biden administration insists, the dualistic approach, dividing the world into democracies and authoritarian regimes, is too simplistic by far, and it gives an idealist thrust to its foreign policy. The American elite was able to have a modus vivendi with China after the Tiananmen Square Massacre in 1989. Both George W. Bush and Obama had established regular high-level meetings between the two countries. Certain traditional protocols regarding how Taiwan was treated were respected.

American leaders were not duped by China, as Trump insinuated. It appears difficult for many to grasp it, but the character of the communist regime changed. Arguably, Xi is to China what Trump was to the US. China, like the US, was on a path, and Xi, like Trump, signaled a change in direction. That Xi would not continue the trajectory of reforms was one thing, but the turning point was the suspension of terms limits. As a result, Xi will most likely lead China for years to come.

Xi's path is the new path for China, while Trump's path did not survive the first national electoral test in the US. Xi ended the dynamism within the Chinese Communist Party, where power alternated between the "princelings" whose fathers were important in the 1949 Revolution and the Communist Youth League, the "new men," the ambitious and talented people without blood ties. Deng Xiaoping handed power to the princeling Zemin, who was succeeded by the Communist Youth League's Hu. Xi, a princeling, followed Hu. Xi has solidified his power through anti-corruption campaigns, with rivals often targeted.

As China's Communist Party celebrated its 100th anniversary (July 1), Beijing found itself as isolated on the international stage as ever. It is the largest trading partner for three key US allies, Japan, Australia, and South Korea. Yet, its retaliatory actions against Canberra have been more irritating than substantial as the higher price of iron ore, for example, offsets declining volumes. Australia's exports to China rose by more than a third year-over-year and accounted for about half of the country's exports in June.

If China means to intimidate Australia, it is not working. If anything, it is seen as part of China's bullying tactics, which have been trained against Japan and South Korea in the past. Beijing escalated and persistently harasses Taiwan and is continuously probing others' territorial waters while jealously defending an interpretation of its territory that has been rejected by international authorities. These are the type of things that have alienated its neighbors and appear to be scaring Tokyo sufficiently that Japan's latest defense paper pledges to support Taiwan if it is attacked by China.

This was a stronger stance than the US has taken. Its famous "strategic ambiguity" policy really is meant to deter Taipei from declaring unilateral independence. There is no reason why Beijing should take America's declaratory policy at face value. Chinese officials must assume that the US would come to Taiwan's assistance if given a chance regardless of what the US says. China's military strategists are thought to be gaming for a "lightning strike," which requires overwhelming.

With the US, Europe, and Japanese overtures toward Taiwan, including the Biden administration's first weapons sale, Beijing has stepped up its display of force around the island. There is a vicious cycle at work, which breeds distrust and would seem to boost the risks of a misunderstanding. There has been heightened anxiety that China will move against Taiwan soon. We suggest a somewhat different scenario that would appear to be lower on the escalation ladder and that does not contain the risks associated with a direct assault on Taiwan. Beijing could instead take the Pratas Island off the southern tip of Taiwan and closer to Hong Kong than Taipei. It is an uninhabited atoll with a Taiwanese garrison. It could be a demonstration of force and will that gives a sense of inevitability.

At the same time, the US is in an awkward position of insisting that China respects the Law of the Sea when Washington has never ratified it. Securing the Senate's approval of the 1982 UN convention would further the thrust of the Biden Administration and put it on more solid footing. That said, a 2/3 majority needed to "approve a resolution of ratification" remains elusive. The fact that the US Senate has not given its consent does not prevent adherence by executive decisions. Still, it does mean that the US cannot formally participate in conflict resolution proceedings. Of course, China's acceptance of the convention does not prevent it from flaunting it, but in the Great Game violating the rules, as in basketball, are incorporated into the game itself.

While China's foreign policy is a cause of its isolation, it was becoming more integrated into the global capital markets. Its stocks and bonds were included in the most important indices used as benchmarks for active and passive asset managers. The US had blocked its federal employee pension funds from investing in China, but it did not seem to have a significant cooling effect. Yet, Beijing's recent campaign that started last November with the blocking of the Ant IPO and broadening to include anti-trust actions, handling of personal data, private-sector education, video games, and even the karaoke songs that are acceptable, may be more effective in cooling foreign interest than anything America has done.

It allows Washington to abide by the maxim often attributed to Napoleon of not stopping an adversary when they are harming themselves. The capricious nature of the Beijing actions and the attack on the private sector, which seem to be a critical source of China's innovations and economic prowess, is precisely the structural risk that scares international investors. Even before Beijing's apparent crackdown on its own bourgeoisie, the foreign share of Chinese stocks and bonds was proportionately less than many other emerging markets in the region. Moreover, while the low volatility of the managed yuan may have a certain desirable impact on portfolios for asset managers, the ESG ratings, which are becoming increasingly important, are another strike against it. A technological solution, like a digital yuan, cannot overcome investor reservations.

China is not ready for prime time. Its transformation since 1949 and since the late 1970s has been truly remarkable. But no matter how enviable many find its technological achievements, few want to live in China or model their country after it. Nor does Beijing have the institutional capacity to project its power globally. So besides some token gestures regarding Taiwan, Beijing faces the same challenge that the US does and the UK before it, turning economic power into political influence.

There are three areas in which Biden could work with China. The environment is the most recognized one. Sarwar Kashmeri (author and host of the Polaris Live podcast and blog) reminds us that with climate change and the search for new sources of raw materials, and national prestige, the Arctic has become contested terrain. However, rules of engagement and conflict resolution mechanisms can be established.

A third area is about establishing rules of engagement for the cyber warfare that is being waged. It would be like an arms control agreement. In this vein, the Biden administration should reverse President Trump's abandonment of efforts to align US policy with the 1997 international agreement that banned anti-personnel landmines. Here too, like the Law of the Seas, the US policy is nuanced. The US has not signed the treaty but adheres to the fundamental requirement of no use, production, or trade in land mines. Also, the US has provided more than any other country to clear landmines.

The Biden administration can also do better than the Build it Back Better World (B3W) that is meant to offer an alternative to China's Belt Road Initiative for infrastructure for mostly low and middle-income countries. In its rollout in June, it seemed to rely on the private sector and the normal credit issues. It was an unimaginative and milquetoast response. Much to the dismay of the partisans, it does little more than show that the late-2019 Trump administration efforts (with Japan and Australia) "Blue Dot Network" is scalable. BDN was launched to assess infrastructure projects in terms of impact on economic development, environmental sustainability, and financial transparency. The goal was to mobilize private sector investment. The US needs to think bigger and bolder.

The dollar was the numeraire under Bretton Woods. It retained a dominant place during the Reagan-Thatcher era. It is not just a reserve asset, more than all the other currencies combined. It is an invoicing currency as it is used by non-US parties to conduct trade. Many commodities, not the least being oil, is quoted and traded largely in dollars. The greenback is also a vehicle currency in that it is used as a middle step rather than bilaterally trade most currency pairs. There is no compelling alternative currency that has the US dollar's breadth, depth, and ubiquitousness.

The Great Financial Crisis stemmed from excesses that can be associated with the Reagan-Thatcher capital offensive. Populists and nationalists threatened to fill the vacuum. Instead, the international wing of the American elite recaptured the White House in 2020. Led by Biden, it is more inclusive and greener than it was previously and promoted an increase in government spending and taxes over the next decade. Internationally, it is trying to reassert American leadership by identifying a common threat (China, Russia, Iran), resolving some old conflicts, and throwing its weight beyond the older efforts at the OECD and G20 for corporate tax reform.

Europe is not ready to take the reins of leadership. Nor is China. But, they both have the heft to shape or blunt the reassertion of American leadership. Yet, ultimately, what will decide whether the US can succeed itself as it did after an interregnum period following the collapse of Bretton Woods is not to be found in Berlin, Brussels, or Beijing. While part of it rests with the US political elite and their ability to conjure a compelling vision of what American leadership can look like, the real power lies with American voters. Without their support, the international wing will be turned out again. It would show the fickleness of American leadership and make it more difficult to sell America is Back. The resulting polyarchy would likely be less stable and more prone to conflict.

This article was written by

Marc Chandler profile picture
15.34K Followers
Marc Chandler has been covering the global capital markets in one fashion or another for 25 years, working at economic consulting firms and global investment banks. A prolific writer and speaker he appears regularly on CNBC and has spoken for the Foreign Policy Association. In addition to being quoted in the financial press daily, Chandler has been published in the Financial Times, Foreign Affairs, and the Washington Post. In 2009 Chandler was named a Business Visionary by Forbes. Marc's commentary can be found at his blog (www.marctomarket.com) and twitter www.twitter.com/marcmakingsense

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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