World leaders will gather in Washington, D.C., on Nov. 15 for what is being billed as Bretton Woods II, a sequel to the 1944 conference in New Hampshire where the postwar global financial architecture was first hashed out. At that time, it was thought some kind of monetary and financial order was needed to avoid the disruptive competitive devaluations of national currencies that had taken place in the 1930s. (Apparently New Zealand and Denmark, in a battle to promote butter exports, created some serious currency imbalances.)
Whatever the case, the result was a new global financial regime that saw the world’s currencies linked to the U.S. dollar, which was backed by vast gold reserves. The International Monetary Fund (IMF) and the World Bank were created to manage the system.
Since then, Bretton Woods has fallen by the wayside. By the early 1970s, the U.S. had dropped the gold exchange standard and most countries had adopted floating exchange rates, relegating the original agreement to the dustbin of history.
Amid the current economic crisis — the worst since the Great Depression — national leaders are again calling for some kind of global financial agreement to get us out of the muck. And currency issues are again at the table — though not yet in the way that they need to be, say critics.
Britain’s Gordon Brown and France’s Nicholas Sarkozy are pushing for improvements to ratings agencies and more transparency by banks. But the big question — the elephant in the room, as it were — is the massive currency imbalance between China and the U.S.
China, of course, has vigorously pursued an export-led growth strategy that has been helped along by the fact that its currency, the yuan, is effectively pegged to the U.S. dollar at an unnaturally low level. This attracts all kinds of investment to the low-cost manufacturing country. But according to policy analysts, it has also generated a massive wave of new money that has been recycled back into the international monetary system, typically into the United States through the purchase of U.S Treasury bonds by the Chinese monetary authorities. This “unholy alliance,” as it’s been called, has helped to keep U.S. interest rates artificially low, exacerbating the recent credit bubble. “China contributed to the credit crisis by setting its currency too low,” says Sebastian Mallaby, director of the Center for Geoeconomic Studies at the Council on Foreign Relations in Washington, D.C. “That is something we’ve learned from this crisis: that China has an effect.”
Is there any chance China will agree to unpeg the yuan and let it rise to a more natural level at the upcoming conference? Not this round, says Mallaby. He suggests there is a reson European leaders aren’t even talking about it: Any deal with China — which could use its US$2 trillion in foreign currency assets to recapitalize the western financial system — would see that country demand a vastly greater say in the IMF, and that would weaken Europe. But this is the deal that eventually needs to be struck, says Mallaby. Just as Bretton Woods I saw a waning British empire give way to a rising United States, we now need to see the West acknowledge China’s ascendancy.
Of course, China today is much different than the U.S. was 64 years ago. “China is much more inwardly focused than the U.S. was at Bretton Woods I,” says Mallaby. “It needs to preserve its own power at home, and it does that through nationalist appeals and the continuation of economic growth…and it still thinks of itself as a mid-level power.” Still, he adds, “China contributed to this crisis, and it has to understand that it has to be a responsible player on the world stage.”