Why does the international monetary system matter?

Bretton Woods @ 70: Past, Present and Future

Panel discussion on the history of the Bretton Woods Conference

Johns Hopkins School of Advanced International Studies (SAIS), Washington, D.C. 9 October 2014

Ousmène Jacques Mandeng, Global Institutional Relations Group, Prudential Investment Management

Ladies and Gentlemen,

It is a great pleasure to be here at U.S. Korea Institute at SAIS. I'm most grateful to the organisers for the opportunity to moderate this outstanding panel. Before we start the discussion, I would like to offer some short introductory remarks focusing on what the Bretton Woods Conference was about, why it should matter to the public and why it offers critical insights for international investors.

The United Nations International Monetary and Financial Conference held at Bretton Woods, New Hampshire, in July 1944 aimed at restoring conditions adequate to a resumption of international trade and development at the end of World War II. It was about a new world economic order. It was truly visionary. It was broadly successful and remains probably the greatest achievement in multilateral economic policy cooperation to date.

The Bretton Woods Agreement established the International Monetary Fund (IMF) to promote international monetary cooperation based on an international monetary system of fixed but adjustable exchange rates tied to the dollar. The system was meant to prevent countries form resorting to competitive devaluations, exchange controls and other restrictions on international trade. Exchange rate stability was seen at the time as essential to facilitate international integration. It was a reaction to the inter-war period that saw considerable economic dislocation, rising protectionism and exchange instability (Figure). The system as designed lasted more or less until the early 1970s with the collapse of fixed exchange rates. It was subsequently modified but its purpose remained and many of its original features survived through today either as the euro, the Bretton Woods II system or the sustained high dependence of the international economy on the dollar.

The international monetary system is concerned with the rules and regulations that guide exchange rate regimes and international liquidity. Its principal actors are central banks and the IMF. It is the lubricant of the international economy. Its purpose is twofold: i) to provide a framework that facilitates the exchange of goods, services and capital among countries; and ii) to offer sufficient incentives for countries to conduct economic policies consistent with external balance –without incurring large and sustained external surpluses or deficits—and orderly balance of payments adjustments. The system had been successful on the first but far less successful on the second. Persistent large external imbalances and sharp exchange rate adjustments indicate that the system does not work as intended. The global financial and economic crisis was an outcome of the deficiencies of the system. The persistent high dependence of the international economy on the dollar and the lack of economic policy coordination are prone to persistent external imbalances and disruptive adjustments putting at risk the international economy as we know it.

Figure. Post war economic order

Cartoon The only bridge in sight

Franklin D. Roosevelt Library, Hyde Park, NY.

The international monetary system has been largely ignored by the public and other outsiders. It has remained an obscure matter to most. The lack of interest or understanding or both may have prevented considerations guiding the system to be more present in national economic policy debates. It may have lowered the pressure on policy makers to internalise measures necessary to maintain a policy stance consistent with a stable international monetary system. The lack of public interest may be the greatest obstacle to economic policy coordination.

Countries' national economies depend greatly on the international economy through international trade and investments. While the degree of countries' openness differs, even in relatively closed economies like the U.S. and Japan, exports and imports of goods and services represent about 30 percent of GDP; in open economies like Germany and Korea, it is more than 90 percent. The international economy is thus intimately related to employment, income and economic growth. Its proper functioning determines to a great extent actual prospects for prosperity. That is why Edward Bernstein of the U.S. Treasury Department, a key figure for drafting the Bretton Woods Agreement, in an address in December 1944 stressed: “[...] Our acceptance of the Bretton Woods Agreement now will ensure 135 million of us that we are taking one of the steps necessary to realise [...] [President Roosevelt’s] goal of 60 million productive jobs.”1

The international monetary system has never quite inspired public opinion. Ed Conway in his book The Summit about the Bretton Woods Conference reminded us that this was already the case when the Bretton Woods conference was held.2 He wrote as reported by the Office of War Information that at the time of the conference, “‘there is virtually no public opinion about the Bretton Woods Conference.’ ‘Not one in a thousand even knows there was a Bretton Woods Conference.’” Harold James in his book International Monetary Cooperation since Bretton Woods similarly highlighted that the obstacles to increased cooperation have been less technical but rather emotional or political. He wrote that the “the establishment of international linkages requires not just a willingness and an understanding on a high bureaucratic level, but also a society that is prepared to tolerate or even welcome the cooperation [...].”3

The international monetary system is under pressure to change. While the rise of private capital flows has undoubtedly transformed the system, its basic tenants have remained broadly intact. This contrasts with the significant changes in the international economy in particular the increase share of emerging markets including China in world output. Emerging markets are set to represent about 50 percent of world GDP at market prices over the next few years. Yet, emerging markets currencies continue to play no major role in the provision and management of international liquidity. This asymmetry between real economy and financial and monetary development is unlikely to be sustainable over the medium term. The integration of emerging markets currencies into the international monetary system represents one of the biggest challenges for the system. China is already positioning the renminbi as a new international currency.

International investors have also shown little interest in the international monetary system. Portfolio investments, for various reasons, continue to be highly concentred in a small number of countries. Emerging markets including China remain by any meaningful economic metric hugely underrepresented in international portfolios as approximated by the share of emerging markets in benchmark investment fixed income and equity indices. The integration of emerging markets currencies into the system will naturally be accompanied by the increasing integration of emerging markets assets. The increasing importance of emerging markets will eventually have major relative price implications also as emerging markets move increasingly from being price takers to becoming price setters. This will affect asset prices and exchange rates and should lead to a comprehensive recalibration of international investment portfolios. For international investors, changes in the system may constitute one of the greatest sources of innovation but also possibly of disruptions for international capital markets.

The case for reforming the international monetary system is a strong one. The international economy has changed significantly and yet the international monetary system changed very little. The system ought to instil greater incentives for external stability-oriented economic policies. The system’s reliance on the U.S. may have unduly diluted the notion, put forward during the 1960s of multilateralisation of responsibilities regarding the stability of the system among countries. While the system was meant to be multilateral in nature it has been mostly unilateral.

The international monetary system is unlikely to change on its own. The risk of a disorderly adjustment is therefore significant. It may require some vision, though unlikely to be as substantial as that prevailing at Bretton Woods but at least a framework to guide reforms. The international monetary system is not a market phenomenon and will unlikely become one. Policy makers need to think about establishing conditions sufficient to allow for an orderly transition into a new system. There may be few other economic policy issues that are likely to have a greater influence on employment and incomes over the medium term. The public and international investors be aware. After 70 years, it is time to take a fresh approach.

Excerpts presented during panel discussion with James Boughton, Ed Conway, Michael Dooley and Harold James.
1 Edward Bernstein, Monetary Stabilization: The United National Program, address to the Graduate School of Public Administration, Harvard University, 11 December 1944, Franklin D. Roosevelt Library, Hyde Park, NY.
2 Ed Conway (2014), The Summit, Little Brown, London.
3 Harold James (1996), International Monetary Cooperation since Bretton Woods, Oxford University Press, Oxford.