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| | The global financial system vs the Bretton woods o (4th Jun 09 at 3:17pm UTC) | | The financial crisis has led many to doubt the current economic regime, and there has been an outcry by many for change. I have discussed the financial crisis in many previous shouts, and mentioned many ideas that different scholars and experts have floated, but the question I haven’t answered is; has it always been like this? The short answer is no.
The economic system was substantially different during the Bretton Woods regime, which was endorsed by forty-four nations at Bretton Woods in 1944. In fact, the Bretton Woods system is the complete opposite of the system we have today. The three major characteristics of the Bretton Woods system are fixed exchange rates (or adjustable pegs), Capital Controls, and Gold Dollar system.
The Bretton Woods system suggested that countries would have fixed exchange rate that was pegged to the Dollar. The architects behind the system sought to re-establish a world of international currency stability as floating exchange rates were associated with beggar-thy-neighbor competitive devaluations. However, the exchange rate was not completely static as with the gold standard, countries were allowed to adjust any imbalances by adjusting their currency’s value to the dollar with plus or minus ten percent. This allowed countries to enjoy the benefits of a stable exchange rate but also alleviate the domestic challenges with not being able to adjust your exchange rate according to domestic forces. The Dollar itself was linked to gold which limited payments imbalances between countries as the dollar gold link functioned as a somewhat automatic adjustment mechanism. It also limited the ability of the U.S. to finance a deficit by printing more dollars or Treasury bills, as the size of US gold stock would set a limited to the amount of Dollars the US could have in circulation. As a consequence, a country could only have a deficit or surplus for a limited amount of time until they would have to reverse their strategy. According to Wade, Rodrik, Wolf, and other commentators, the global imbalances are one of they key aspects behind the current financial crisis and thus extremely important to alleviate potential future financial crises. A stable exchange rate is also important in regards to trade or foreign direct investment as it impacts your competitive advantage. In other words, a low valued exchange rate facilitates for a company to produce goods and export it to a country with a high exchange rate for a cheaper price than the domestic company can. This is for example what China is doing in the United States. However, if the exchange rate is fluctuating it will be more difficult for companies to operate as they will never know at what value the exchange rate will be at a given point in the future as the rate of uncertainty correlates with the rate of fluctuation. A fluctuating exchange rate thus makes it increasingly more difficult to do business and might even discourage foreign companies to establish a presence in the country.
Another important aspect of the Bretton Woods system was that Capital Controls was legal and even encouraged. Capital Control is the ability of the government to control the inflow and outflow of capital to and from their country. Rapid in and outflow of capital in a country can have severe consequences on exchange rate, or if the exchange rate is fixed, have a massive impact on the domestic economy (like inflation). This was the case of Thailand in the East Asian crisis and was one of the main factors for the rapid capital outflow that intensified the crisis. Capital controls can limit or prevent rapid outflow of capital and can equip governments with the ‘tools’ to prevent economic crisis in the future. Some neoliberal commentators argue that capital controls would discourage investors from investing in the country, but empirical evidence suggests that this is not the case (Chang). In fact, Wade argues that after the extreme financial liberalization that took place in the 80s, the Global South have attracted a declining share of world Foreign Direct Investments (FDI). Prasad, the chief economist of the IMF at the time of publication wrote a report in 2003 stating “that there is no proof in the data that financial globalization has benefited growth”, supporting the arguments that free capital movements have done more bad than good.
The Bretton Woods system is an important aspect of the embedded liberalism that dominated the thinking from the end of World War II until the 1970s. Imbedded liberalism was the idea that "the state should focus on full employment, economic growth, and the welfare of its citizens and that state power should be freely deployed, alongside of or, if necessary, intervening in or even substituting for market processes to achieve these ends.” (Harvey). Many economists such as Chang argue that the characteristics and policy space associated with embedded liberalism are related with the economic prosperity experienced by both developing as well as developed economies from the 50s and onwards. Some commentators would argue that the policy space alongside with a stable financial system provided developing countries with right environment to pursue their own policies while minimizing the chance of being negatively influenced by external forces. | |
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