Tuesday, May 5, 2009

‘Bretton Woods II’: Key Features

In 2006 I wrote with Brad Setser a piece entitled: "How Much is Latin America Part of Bretton Woods II?". I will try to summarize the key features of that piece and I will also try to update the key conclusions of that piece.

The original Bretton Woods (1945-1971) system was a formal agreement led by the ‘center’ (United States) towards the ‘periphery’ (Europe and Japan). The IMF was then created to evaluate the periphery countries and eventually authorize devaluations. The periphery countries had their currencies formally pegged to the US dollar and the dollar reported its value in terms of gold. The system was designed to prevent ‘beggar thy neighborhood’ trade based on competitive devaluation such as those that afflicted the international economy during the Great Depression era. The dollar became the reference currency for Europe and Japan and formal provisions were created such that countries with structural trade deficits could devalue their currencies.

In 2001, the US dollar weakened against the Euro. As a way to preserve their high level of exports to the United States a group Asian countries and oil producing countries pegged their currencies to the dollar. In the same period, United States has posted high fiscal and current account deficits. In turn, the periphery peg has avoided a further depreciation of the US dollar and hence prevented the negative impacts that a depreciation of the dollar might have had in terms of inflation and interest rates. In turn, it is interesting to observe that the periphery nations (Asian and oil producing countries) have been financing the United States through their purchases of international reserves and US treasury securities. The movement is now led from the ‘periphery’ countries (Asia and oil countries) to the ‘center’ (United States). Such an arrangement was coined ‘Bretton Woods II’(BWII) and is used to explain the ongoing ‘stability’ and economic growth among the G7 countries, despite the high US current account deficit and fiscal deficit. Though some scholars argue that the system is not stable and hence its end may come unexpectedly spreading out a hard landing in the U.S. and Asia, others believe the BWII may last for a decade.

In brief BWII is an international monetary system where the periphery countries finances the center, and in turn, helps to keep low interest rates in the center. The United States is the center country and periphery is composed by Asian countries (notably China) and oil export countries.

The key features of this system are:
1. Heavy intervention on foreign exchange markets by the Asian and oil countries to avoid an appreciation of their currency against the US dollar;

2. In Asian countries, reserve accumulation is a by product of export-led growth strategy, which is needed to absorb the abundant labor force in traditional sectors, mostly in agriculture. Such strategy facilitates export growth by preventing or slowing currency appreciation.

3. A significant share of reserve accumulation by BWII countries has being invested in USD and (or) US securities. In turn, such mechanism has been financing the US trade deficit, preventing an increase in US interest rates and postponing (or avoiding) a further weakening in the US dollar.

4. Periphery countries have often large current account surplus.

5. Reserve accumulation in the periphery countries exceeds what is needed for precautionary reasons mostly because the ratio reserves to GDP is higher than needed to prevent a sudden stop episode.

2 comments:

  1. Hi Vitoria,

    I just came across your blog by chance and though I am not well-versed in economic matters, I do listen daily to a political/economic researcher called Alan Watt who has studied these matters heavily his whole life. Below, I'll post an excerpt from one of his shows where he spoke about BWII and reads/comments on some news articles back in October, 2008. If you are interested in hearing one of his shows, iTunes has the podcast, just look up Alan Watt or Cutting through the Matrix.

    Now it's time for me to see the rest of your blog ; )

    Regards

    Adam
    http://eyesonbrazil.com


    "Here’s an article from IPS news on Thursday, October the 30th."

    DEVELOPMENT: Bretton Woods II: New Lifeline for Ailing Giants

    Analysis by John Vandaele

    BRUSSELS, Oct 28 (IPS) - Europe, by way of the hyperactive French President Nicolas Sarkozy, demands a Bretton Woods II, that is, a major shake-up of the International Monetary Fund (IMF) and the World Bank. This is as much a rescue operation for two organisations that have lost muscle as a call for a new financial architecture. (Alan: Now, that’s not true. The World Bank and the IMF have been working with various companies, including Britain during Thatcher’s reign, to pull them out of the hole. Really, they’ve been sitting in the side lines for a while because they’ve been waiting for now to bring them to full power and authority. That’s why they set them up.)

    Up until mid-October 2008 the IMF, the world's most important financial institution, did not play a role in the unfolding credit crisis. The G7 (the seven industrialised nations, the United States, Canada, France, Britain, Germany, Italy and Japan) had given the task to make recommendations to the Financial Stability Forum dominated by the G7 countries, effectively bypassing the Fund.

    Also, the IMF proved powerless in prevention of the crisis. For years the Fund deplored the rising macro-economic imbalance between China and the U.S., which lies at the heart of the current crisis. The IMF had to do this because article 1 of its charter says one of the purposes of the IMF is "to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members." But the Fund simply has no real power over countries such as the U.S. or China. (Alan: Then it goes on and on and on with the usual kind of news but in the same newspaper, October the 30th, it says, )

    FINANCE: NGOs Call for Radical Reforms as IMF Offers New Loans
    By Jim Lobe

    WASHINGTON, Oct 29 (IPS) (Alan: Although this part was written October the 30th.) - Two weeks before U.S. President George W. Bush hosts an economic summit to address the six-week-old financial crisis that has wreaked havoc on the world's capital and stock markets, a coalition of nearly 600 non-governmental organisations (NGOs) from 88 countries is calling for a "fundamental and far-reaching transformation on the international financial and economic system." (Alan: So here you go again. Here’s anther side of the story. With it’s big meeting and calling for a new system, a Bretton Woods II. Now, does anyone that you know actually go to these meetings? No. Well here’s 600 non-governmental organizations from 88 countries going to it. Now, do you have any input into any of this or what it will come out with? No. Do you believe in democracy? Well what’s this then? A closed shop. The NGOs. See this is the new Soviet system I’ve been talking about for a while. That is what Soviet means… rule by councils, NGOs. Just like the Soviet Union, the people didn’t manage the NGOs or pick their leaders. They were picked by the Politburo. In the Western world, it’s the big foundations who put their men and women forward to lead these organizations.)

    In a statement released Wednesday, the groups demanded that the upcoming Group of 20 meeting Nov. 15 here to the way for a much broader and more inclusive reform effort in which all of the world's governments and international civil society should participate. (Alan: Oh, really? Give me a ticket.)

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  2. Dear Adam, Thanks so much for your comment and for the tip on Alan Watt, I didn´t know him at all. I am glad you found my blog!!

    Best
    Vitoria

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