-- The World Beyond the Stock Market Crash of October 2008, 79 years on from 1929 --

The first meeting is likely to occur as early as November 15, 2008 in the US. Calls for a new Bretton Woods began surfacing in 2008 on September 26 when French, and current European Union President, Nicolas Sarkozy, said, "We must rethink the financial system from scratch, as at Bretton Woods." On October 13, British Prime Minister Gordon Brown said world leaders must meet to agree to a new economic system. "We must have a new Bretton Woods, building a new international financial architecture for the years ahead." Mr Sarkozy and US President George W Bush met on October 18 to discuss the possibility of a global financial summit. The meeting ended with an American offer to host a global summit after the US Presidential elections in early November modelled on the 1944 Bretton Woods accord. At the start of Bretton Woods in 1944, the then US President Franklin Delano Roosevelt said in his opening remarks, "The economic health of every country is a proper matter of concern to all its neighbours, near and far."

Bretton Woods -- The Historical Context

1. Bretton Woods is conceptually one of the most misunderstood frameworks in human history. The conventional wisdom is that Bretton Woods crafted the modern international economic architecture, coupling the trading and currency systems to the gold standard to achieve global stability. To some extent this is true. However, the form that Bretton Woods has taken in the popular consciousness is partially imagined. The real implications and meaning of Bretton Woods follow a different narrative altogether. The origin of Bretton Woods lies in the Great Depression of the 1930s, which succeeded the 1929 stock market crash. As economic output dropped during that subsequent period, governments worldwide adopted a wide spectrum of protectionist and populist policies -- including import tariffs -- that essentially reversed globalisation and international trade. In order to maintain domestic employment, governments and firms alike encouraged ongoing production of goods even though mutual tariff walls prevented the sale of those goods abroad. As a result, prices for those goods dropped and deflation set in. Soon firms found that the prices they could reasonably charge for their goods had dropped below the cost of production. The reduction in profitability led to historically unprecedented and massive layoffs, which reduced demand for products in general, further reducing prices. Firms went out of business en masse in the 1930s, workers in the millions lost their jobs, large-scale demand destruction took place, and prices continued to head south. A series of efforts designed originally to protect jobs resulted in a deep, self-reinforcing deflationary spiral, and the variety of measures adopted to combat this could not seem to right the accelerating systemic failure.

2. In an extremely tragic way, World War II provided relief from the economic devastation between 1929 and 1939. The military effort generated demand for goods and labour. Whilst the goods part is relatively straightforward, the labour issue is what really allowed the global economy to turn the corner. Obviously, the war effort required more workers to manufacture goods -- whether they were widgets or aeroplanes -- but "workers" were also called upon to serve as soldiers. As a result, the war removed tens of millions of men from the available labour force, shipping them out of the economy towards "unproductive" endeavours. Sustained demand for goods combined with labour shortages helped to raise prices, and as expectations for inflation rather than deflation set in across the world, consumers became more willing to spend their cash for fear it would lose value in the future. The deflationary spiral was finally broken and a result supply and demand came back into balance as a direct result of the second world war.

3. Whilst policymakers of the time were conscious that the prosecution of the war had suspended the depression, however, few were confident that the war had finally ended the underlying conditions that had made the depression possible. So between July 1 and July 22, 1944, 730 representatives from all 44 allied nations converged on a small ski village in New Hampshire at the Mount Washington Hotel, situated in Bretton Woods. Their task was to regulate the international monetary and financial order after the conclusion of World War II and to formulate jointly a system that would prevent subsequent depressions and -- should one occur -- come up with a means of ending it without having to engage in yet another world war. The USA was represented at the conference by Harry Dexter White and the UK was represented at the conference by Lord John Maynard Keynes. The delegates agreed to a system of exchangeable currencies and broadly open rules of trade. This system would be based on the gold standard to prevent currency fluctuations. The agreements signed set up the International Bank for Reconstruction and Development (IBRD) now part of the World Bank, the International Monetary Fund (IMF), and envisioned the General Agreement on Tariffs and Trade (GATT) now replaced by the World Trade Organisation (WTO). These institutions would now serve as guardians of the international system's financial, fiduciary and trade requirements.

4. The conventional wisdom is that Bretton Woods worked for a time, but that since the entire system was linked to gold, the limited availability of gold put an upper limit on what the new system could handle or realistically achieve. As post-war economic activity expanded -- but the supply of gold did not -- that problem became a paradox and the US had to abandon the gold standard in 1971. Most point to that period as the end of the original Bretton Woods system. We are, in fact, still using most of the Bretton Woods original framework with the US dollar acting as the anchor instead of gold!

5. In 1944, the European continental states -- and even the UK -- were not only economically depleted and hugely indebted but were also completely lacking the means of independent subsistence. This was very different from the end of World War I, where most of the fighting had occurred along a single series of trenches. This was blitz-krieg and saturation bombings, which left the Continent in ruins, and there was almost nothing left from which to rebuild. Simply avoiding mass starvation would be a challenge, and any rebuilding effort would be completely dependent upon US financing. The Europeans were willing to accept nearly whatever was on offer at Bretton Woods. For the US, the issue was one of seizing an historic opportunity. Historically, the US thought of the UK and France -- with their maritime traditions -- as more of a threat to US interests than the largely land-based Soviet Union and Germany. Even World War I did not fully dispel this concern. Japan, for its part, was always viewed as a hostile power. The US entered World War II late and the war did not occur on US soil. So -- uniquely among all the world's major powers of the day -- US infrastructure and industrial capacity emerge from the war far far larger than when it entered. With its traditional rivals either already greatly weakened or well on their way to being so, the US had the opportunity to set itself up as the core of the new world order under Bretton Woods.

6. The US faced the ultra-large-scale challenge of defending against the Soviet Union. The US could not occupy Western Europe as it expected the Soviets to occupy Eastern Europe because it lacked the troops and was on the wrong side of the ocean! The US had to have not just the participation of the Western Europeans in holding back the Soviet tidal flow, it needed the Europeans to defer to American political and military demands -- and to do so willingly. Considering the desperation and destitution of the Europeans, and the unprecedented and unparalleled US economic strength, economic incentives were the obvious way to go.

7. Bretton Woods was part of a broader American effort to extend the wartime alliance, without the Soviets and beyond Germany's eventual surrender. After all wars, there is the hope that alliances that have defeated a common enemy will continue to function to administer and to maintain the peace. This happened at the Congress of Vienna and Versailles as well. Bretton Woods was more than an attempt to shape the global economic system, it was an effort to grow a military alliance into a broader US-led and -dominated bloc to counter the Soviet threat.

8. The seminal idea behind the Bretton Woods was the notion of open markets. At Bretton Woods, the US made itself the core of the new system, agreeing to become the trading partner of first and last resort. The US would allow Europe near tariff-free access to its markets, and turn a blind eye to Europe's own tariffs so long as they did not become too egregious -- something that at least in part flew in the face of the Great Depression's lessons. The sale of European goods in the United States would help Europe develop economically, and, in exchange, the United States would receive deference on political and military matters. The North Atlantic Treaty Organisation (NATO) -- the principal hedge against Soviet invasion -- was born, post Bretton Woods.

9. The "free world" alliance did not consist of a concert of equal states. Instead, it consisted of the US at the centre with everyone else. The "everyone else" included shattered European economies, their impoverished colonies, independent successor states and so on. The truth was that Bretton Woods was less a compact of equals than a framework for economic relations within an unequal alliance against the Soviet Union. The foundation of Bretton Woods was American economic power -- and the American interest in strengthening the economies of the rest of the world to immunise them from communism and to build the containment of the Soviet Union simultaneously.

10. Almost immediately after the war, the US began acting in ways that indicated that Bretton Woods was not -- for itself at least -- an economic programme. When loans to fund Western Europe's redevelopment failed to stimulate growth, those loans became grants, ie, the Marshall Plan. Shortly thereafter, the US -- certainly to its economic loss -- almost absentmindedly extended the benefits of Bretton Woods to any state involved on the American side of the Cold War, with Japan, South Korea and Taiwan signing up as its most enthusiastic participants. And fast-forwarding to 1971, when the world went off the gold standard and the original Bretton Woods supposedly died, gold was actually replaced by the US dollar for all intent and purposes. Far from dying, the political-military understanding that underpinned Bretton Woods has only become more entrenched post 1971. Whereas before, the greatest limiter was on the availability of gold, now it became -- and remains -- the whim of the US government's monetary authorities.

Bretton Woods II -- The Future Agenda

For many of the G20 nation states that have been invited to attend the November summit in the US -- what some have already dubbed Bretton Woods II -- the fundamental issue is to do with the American centrality. The US is the key pillar of the world financial system. This epicentre of the global financial earthquake continues to produce shock waves. In some ways, it constitutes the core of the present systemic risk.

1. The fundamental principle of Bretton Woods was national sovereignty within a framework of interlocking relationships, ultimately guaranteed not just by American political power but by American economic power. Bretton Woods was not so much a system as a reality. American economic power dwarfed the rest of the non-communist world, and guaranteed the stability of the international financial system implicitly and explicitly.

2. What The Great Unwind financial crisis has shown is not that the basic financial system has changed, but what happens when the guarantor of the financial system itself undergoes a synchronised series of crises. When the economic bubble in Japan -- the world's second-largest economy -- burst in 1990-1991, it did not infect the rest of the world and cause contagion. Neither did the East Asian crisis in 1997, nor the Russian-Rouble crisis of 1998. A crisis in Germany, France or the UK would similarly remain a local one. But the series of ongoing crises in the US economy since July 2007 have become a global phenomenon with widespread contagion. The fundamental reality of Bretton Woods remains unchanged: the US economy remains the largest, and dysfunctions within it affect the world. The decoupling theory that the world can carry on functioning normally if the US goes down, just does not seem to hold true. That is the reality of the international system, and that is ultimately what the French call for a new Bretton Woods is all about.

3. There has been talk of a proposal at which the United States gives up its place as the world's reserve currency and primacy of the economic system. That is not what this meeting will be about, and certainly not what the French are after. The use of the dollar as world reserve currency is not based on government policy or fiat, but the reality perceived by the financial markets that the dollar alone has a global presence and trust. The euro, after all, is only a decade old, and is not backed either by sovereign taxing powers or by a central bank with vast authority. The European Central Bank (ECB) certainly steadies the European financial system, but it is the sovereign countries that define their economic policies. As we have seen in the recent crisis, the ECB actually lacks the authority to regulate Europe's banks. Relying on a currency that is not in the hands of a sovereign taxing power, but dependent on the political will of (so far) 15 countries with very different and differing interests, does not make for a reliable reserve currency in the future.

4. The Europeans are not looking to challenge the reality of American power, they are looking to increase the degree to which the rest of the world can influence the dynamics of the American economy, with an eye toward limiting the ability of the Americans to accidentally destabilise the international financial system yet again. The French in particular look at the current crisis as the result of a failure in the US regulatory system. And the Europeans certainly have a point. If fault is to be pinned, it is on the United States for letting the problem grow and grow until it triggered a liquidity crisis. The Bretton Woods institutions -- specifically the IMF, which is supposed to serve the role of financial lighthouse and crisis manager -- proved irrelevant to the problems the world is currently passing through. Indeed, all multinational institutions failed or, more precisely, have little to do with the financial system that was operating in the years leading up to 2008. The 64-year-old Bretton Woods agreement simply does not have anything to do with the current reality.

5. The Europeans would like to see a shift in focus in the world of international economic interactions from strengthening the international trading system to controlling the international financial system. In practical terms, they want an oversight body that can guarantee that there won't be a repeat of the current crisis. This would involve everything from regulations on accounting methods, to restrictions on what can and cannot be traded and by whom (offshore financial havens and hedge funds would definitely find their worlds circumscribed), to frameworks for global interventions. The net effect would be to create an international bureaucracy to oversee global financial markets. Fundamentally, the Europeans are not simply hoping to modernise Bretton Woods, but instead to Europeanise the American financial markets. This is ultimately not a financial question, but actually a political one. The French are trying to flip Bretton Woods from a system where the US is the buttress of the international system to a situation where the US remains the buttress but is more constrained by the broader international system. The European view is that this will help everybody. The American position is not yet framed and won't be until the new president is in office. But it will be a very tough sell. For one, at its core the American problem is "simply" a liquidity freeze and one that is already thawing. Europe's and East Asia's recessions are bound to be deeper and longer lasting. So the US is sure -- no matter who takes over in January -- to be less than keen about revamps of international processes in general. Far more important, any international system that oversees aspects of American finance would, by definition, not be under full American control, but under some sort of quasi-Brussels-like organisation. And no American president is going to engage gleefully on that sort of sovereignty-surrendering topic. Bretton Woods was ultimately about the US trading access to its economic might for political and military deference. The reality of American economic might remains. The question, then, is simply put: What will the Europeans bring to the table with which to bargain to create a new type of Bretton Woods?

6. What type of reform of the international financial system can take place? The present global financial crisis marks the end of the regime of deregulated finance. We need to move towards a new regulatory system along the lines proposed by the Bank for International Settlements in Basel, Switzerland. The hallmark of the new regulatory system will be its international uniformity to prevent financial institutions from exploiting gaps in regulation and its intensive coverage to include all financial institutions including non-banks. This would help to remove the possibility of regulatory arbitrage which is at the heart of the present financial crisis worldwide. This also highlights the irrelevance of the IMF in solving the current credit crisis and presents the need to reconsider the role and philosophy of institutions like the IMF and the IBRD. After the demise of Keynesian policies, the world economy has been dependent upon private expenditure for boosting aggregate demand. The consequent boom has caused deterioration in the conditions of people across many countries in the third world, while the crash also adversely affects them now. The present financial crisis also will have a similar impact on the masses of the third world. The proposal to turn the IMF into a proper lender-of-last-resort would vastly strengthen the IMF. Without a serious reform of its missions and its governance structure this is likely to make things even worse. The IMF has caused great damage to developing (and former socialist) economies that have come under its tutelage by insisting on deflationary macroeconomic policies and premature financial de-regulation and opening up. Without abandoning these policies, an expanded IMF will be even more capable of inflicting damages on its client countries. The IMF has been able to continue with these problematic policies because the suffering countries do not have much say in the running of the organisation. Therefore, the voting shares in the IMF (and in the World Bank) need to be re-distributed in favour of developing countries. This is partly to reflect the dramatic changes in international economic power balances since its foundation, but more importantly to increase the voice of the "customers" (mostly developing countries), when there is no competitor to whom dissatisfied customers may turn.

7. Bretton Woods II needs to address the system of currency relations which developed during the 2000s. As described by political economist Daniel Drezner, "Under this system, the US is running massive current account deficits to be the source of export-led growth for other countries. To fund this deficit, central banks, particularly those on the Pacific Rim, are buying up dollars and dollar-denominated assets." How to resolve this issue in the future is definitely on the minds of many of the invitees to the summit.

8. In light of the critical role that credit rating agencies play in today's financial system and the damages they have inflicted by blessing toxic assets, these agencies need to be much more heavily regulated or even replaced by an international government controlled body. Many invitees to the summit are genuinely concerned about the implications of handling credit rating agencies in the future.

9. There are likely to be other aspects of Bretton Woods II which will be raised by the G20 member states:

a. Carbon emissions trading and carbon taxation.

b. The introduction of a country bankruptcy code that will enable orderly sovereign debt restructuring.

c. Expanding the capital adequacy requirements, and also making them counter-cyclical, rather than pro-cyclical as they currently are.

d. More strict regulations of derivatives, hedge funds, tax havens and private equity funds, which have greatly contributed to increasing opacity in the financial markets.

10. At Bretton Woods II many will air concerns about achieving the Millennium Development Goals (MDGs) as soon as possible, but, unlike what its middle name suggests, the MDGs are mainly about providing basic needs -- health, education, and poverty reduction -- and little about development in the true sense of the world - expansion and upgrading of a country's productive capabilities. Whilst making individuals more productive through better health and education will increase a country's productive capabilities, but there is only so much that can be achieved through individual improvements. A lot of productive capabilities in modern economies need to be accumulated in the form of organisational routines and institutional memories in -- public, private, and cooperative -- productive enterprises through actual production experiences. To put it graphically, what really distinguishes the US or Germany, on the one hand, and the Philippines or Nigeria, on the other hand, are their Boeings and Volkswagens, and not their economists or medical doctors. The achievement of the MDGs is a noble goal in itself, but it is not the same as true development. There is a case to be made for increasing development in a Keynesian way if that money goes into innovation to raise productivity, long term investment and infrastructure projects which add to a nation's productivity for decades to come. Clean energy, sustainable technology, eco-friendly infrastructure, pure air and water projects, as well as micro-finance all have the power to unleash innovation to propel us "Towards The Golden Age: A Wisdom Based Global Economy" which ATCA published on 23rd May 2008 on mi2g.net.

[ENDS]

We acknowledge the research of the ATCA Research and Analysis Wing (RAW), the mi2g Intelligence Unit and Stratfor in compling this ATCA Briefing. We welcome your thoughts, observations and views. Thank you.

With love and warm wishes to you and family


DK with family

DK Matai

The Philanthropia, mi2g.net

DK's online community participation includes:

Open ATCA, IntentBlog, Holistic Quantum Relativity Group, LinkedIn, Facebook, Ecademy, Xing, Spock, A&B Blog and QDOS. [Profile in pdf]

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