60 Years of Bretton Woods

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Is the notion of Reinventing Bretton Woods conceivable? This simple question brings a multitude of thoughts about the bold objectives of the 45 nations whose representatives gathered at Bretton Woods, New Hampshire in the summer of 1944 to establish a new economic order; about the extent to which these ambitions have been fulfilled; about the many new challenges that have arisen in the world economy since Bretton Woods; and where, in view of these challenges, the international financial system is leading us. It is certainly true that the international monetary system has changed considerably since Bretton Woods – and in ways that were largely unforeseen in 1944. Instead of a system of fixed exchange rates among major currencies, we now have a floating rate system.
Where capital controls were once pervasive, we now have global financial markets. From the relatively small group of 35 countries that became the founding members of the IMF, Fund membership has expanded to include virtually every economy in the world. Indeed, all the complexities and uncertainties that the existing international monetary system presents, "Bretton Woods" seems to evoke a more orderly and cohesive world, raising the question of whether the international community should not strive toward a bib bang approach and revamping the international financial system for a new bretton woods.

In considering whether a "new" Bretton Woods is conceivable--or indeed desirable – I would like to evaluate in my presentation more specifically what we learned from the 1990’s with the international financial architecture debate. The last decade has seen a string of crises in emerging markets – in Mexico in 1995, Asia in 1997 and 1998, Russia in 1998, Brazil in 1998 and 2002, Argentina in 2001-02, and Turkey in 1999 and 2000-01. The turbulence –and its contagion –in financial markets has prompted a wide range of efforts in the 1990’s to improve the international financial system.

As policymakers, market participants, and academics around the world debated the next steps to address weaknesses in the system, they face a number of critical questions.

The world financial crisis demonstrates that the integration of emerging economies into the global financial system poses much larger policy challenges than had previously been anticipated. The early 1990’s will be remembered in the degree of euphoria that had emerged about the benefits of financial liberalization, private capital flows and emerging markets. Now that the risks and the costs have become more evident, a stronger foundation that would support these benefits with less risk may yet emerge.

Fears that capitalism had run amok and globalization would lead to poverty for most of the world galvanized Western leaders into promising swift reforms of the so-called "international financial architecture." The Mexican crisis led to the first global debate about the market-led international financial system in which governments are at the mercy of huge flows of private capital that spill across borders, playing havoc with currencies.

The debate took another dimension with the Asian crises -- which engulfed Thailand, Indonesia and Korea and then spilled over into Russia, New York financial markets and Brazil -- initially centered on who was to blame and what went wrong. Fingers were pointed at unscrupulous speculators, irresponsible bankers and cronyism.

But a plethora of proposals to scrap the existing framework and replace it with a "new" international financial architecture was sidelined by promises of "reform" of the international financial architecture.

The idea was to strengthen rather than tear down and rebuild the skeleton holding together the international financial system, which has no true global authority to enforce rules on sovereign governments. The phrase "reform of the international financial architecture" has been bandied about for years now, topping the agendas of international summits and countless meetings by institutions and policy-making bodies. The international financial architecture debate lost his momentum when it didn’t back the proposal from the IMF for a statutory approach for of a sovereign debt restructuring mechanism. Instead, the international community has decided at this stage to pursue a more marketdriven approach through the use of collective action clauses in bond documentation and possibly a code of good conduct clarifying the principles and responsibilities of issuers and creditors in the context of a debt restructuring. Nevertheless, the debate is not over, and the unfolding event with the current debt restructuring in Argentina is likely to have significant ramifications.

In September 1994, when the international financial community met in Madrid to celebrate the 50 th anniversary of the Bretton woods institutions, few observers will have predicted that the period will be followed by a series of financial crises and that the notion of capital flows, moral hazard, bail outs, collective action 
clauses, standards and code, will be the key words of the 1990’s.

Today, when we are today celebrating the 60 th anniversary of the Bretton woods conference, I would like to outline some key trends that will affect the role of the international monetary system.

1) The Exchange Rate Regime

• The Asian and Argentine crises as well as the Dubai G-7 communique have strengthened a movement within the international financial community to emphasize flexibility in exchange rate systems. Yet, many important countries continue to effectively peg their rates. What is an appropriate path toward flexibility for emerging market economies? How can the system as a whole improve its contribution to the adjustment of major, sustained balance of payment imbalances? Now that the Euro has become more established and Japan’s economy may finally be returning to health, are we likely to see countries diversify their reserves away from dollar assets? What would be the implications of a world of multiple reserve currencies?

• Today, there is little doubt that China’s exchange rate policy has emerged as a major global topic. China is perceived as an emerging global player because it has been enjoying export growth of 35% during recent months. As a result of booming foreign direct investment and the return of flight capital, China also has foreign exchange reserves of $355 billion or the second highest in the world after Japan. The U.S. is now able to finance its large fiscal deficits and current account deficits because of currency intervention by Asian central banks, especially Japan and China. The central banks of China and Hong Kong have purchased nearly $100 billion of U.S. government securities during the past eighteen months. The East Asian central banks now have 70% of the world’s foreign exchange reserves compared to only 30% in 1990 and 21% in 1970. They keep their $1.7 trillion of reserves 80-90% invested in U.S. government securities. Indeed, some observers have argued that we may

• be reentering “the old paradigm ”. Professor Michael Dooley (Mike Dooley, Peter Garber, David Folkerts Landau :Deutsche Bank Research, Reviving The Bretton Woods System. December 2003)
 and his colleagues argue recently in a recent paper that the system was never actually destroyed, just put into hibernation. Just as Europe and Japan benefited from fixed exchange rates in the 1950s and ’60s, the reasoning goes, so Asia is now profiting from the same. The success of China and India in exporting goods and services respectively is certainly built in part on undervalued currencies. Some Asian currencies are fixed, some have a managed float, but all of them are accumulating vast amounts of official reserves in US dollars. The insight of Dooley’s team is that this is an explicit contract, like Bretton Woods, not the operation of a free market. China has the potential to be a source of strength as well as vulnerability in reinforcing the precarious stability that has now returned to the international financial system, and in forwarding the recently interrupted move toward a genuinely global system of open finance. How it manages its multiple transformations will be of enormous importance for the international monetary system.

2) The Future Role of the International Monetary Fund

Many of the discussions on a new international financial architecture that were spawned by the Mexican crisis and continued through the Argentinian crisis raised questions about the future role of the International Monetary Fund (IMF). Four major areas merit attention: 1) the scope of Fund activities, 2) surveillance, 3) lending, and 4) governance. The IMF is still needed to help countries resolve payments problems in an internationally responsible way, to address liquidity crises, and to act as a crisis manager or convenor. Does this mean that crisis prevention should be at the core of the IMF’s work? Should it deepen its efforts to collect and disseminate information to investors and markets, further covering indicators of financial vulnerability as well as macroeconomic fundamentals? To what extent should its resources be expanded to enable it to provide liquidity, and under what circumstances should the Fund provide backstop financing for countries?
The large financing packages of recent years have according to observers increased the fund financial risks: Credit outstanding the largest three borrowers have reached an unprecedented share of total fund credit. This increased concentration in Fund exposure has been associated with a prolonged use of Fund resources by middle income countries with access to international capital markets. The current level of concentration has some precedent. But the importance difference is that previous episodes of high concentration reflected current account deficits of few large members which were offset by the current account surpluses of other members. What do these trends mean for the IMF and for the shareholders? In parallel what is the likely future evolution of the demand for Fund resources? For example the financial support provided by the IMF program with Mexico amounted to 18 billions dollars. This sum represented 6.3% of Mexico GDP. If China achieve levels of per capita income similar to Mexico and vulnerable to capital account crisis, the potential for demand for fund resources relative to future GDP could become very large That suggest that the cost of mitigating an emerging market style crisis in a country like China or India could well be of an order of magnitude that would dwarf present day level of fund resources. But other economic developments may temper this tendency as developing countries have increased their international reserves for self insurance and we are seeing a shift towards more flexible exchange rate regime that might temper the need of future demand for Fund resources.

Indeed, the environment in which the Fund operates has changed but the instruments at the Funds disposal have not. Can the IMF perform within its current governance structure or does it require a change in the governance reform. Does the Fund have the internal and governance and risk control mechanism to deal with capital account crises? If the preferred credit status should be reexamined in this new evolution, if we deal with fiscal policies difficulties and not balance of payment problems?

How can disparities in economic weight and financial contributions be reconciled with the need for more inclusive decision making in international institutions and arrangements. The question is not anymore if the G7 should be expanded but when, Maybe by September with the inclusion of China. More broadly, how can emerging economies be best represented in the international financial architecture recognizing that improving their development prospects is a principal aim of global financial governance? Will the G20 serve as a basis , perhaps in combination with regional forms of governance? With the emergence of the Euro, should we consider now the logical step for one EU single seat at the IMF?

Conclusion

These reflections bring me back to the question of Reinventing Bretton Woods. Despite the considerable changes that have occurred in the international economy since the Bretton Woods conference, I believe that the Bretton Woods goals are as valid today as they were half a century ago. In the next decade, the International Monetary Fund will be confronting with a series of potential new challenges: a need to adapt itself in a world with fewer currencies, also the possibility of a creation of a new regional machinery of international cooperation with the creation of a regional type of Bank for International Settlements or if you prefer an asian monetary fund a first step for an enhancement for an asian monetary cooperation akin to the European experience, an agreement among the EU countries for one EU single seat at the IMF, an the integration of China in the international monetary system.

If countries are to deal successfully with these potential challenges, they would need to re-establish the strong sense of international cooperation. As a forum for discussion, our forum hope to continue his mission in the years ahead.