World Leaders discuss international finance but this is not Bretton Woods

Over this mid-November weekend, world leaders met in Washington to discuss a way out of the current financial crisis. There were no agreements of any substance or detail, but the leaders will be meeting again in April.  What will eventually emerge, whether any constructive agreements can be reached, is at this point, anyone’s guess.

President George W. Bush and other world leaders at the Summit on Financial Markets and the World Economy. (AP)

The current international financial system is largely based on the the system set up in meetings held in July 1944, at the Mount Washington Hotel in Bretton Woods, New Hampshire, where 44 Allied nations gathered to fashion a world monetary system from the remnants of the Great Depression and WWII.

One of the reasons Bretton Woods worked – that an agreement was fashioned - was that the U.S. was in a position to impose its will on all the others, including, a devastated Britain. Two world wars had destroyed the British economy.  Half of Britain’s food had to be imported.

Europe and Japan were in ruins.  China was undeveloped and in chaos.  India, South Korea and the rest of South East Asia, had not yet arrived as industrial powers with vigorous export industries. The Middle East, including Saudi Arabia, was not yet earning billions and billions of dollars annually on oil reserves. 

Although 44 nations were represented at Bretton Woods, only two had any chance for much input – the United States, through its sheer preeminent economic position, and Great Britain, through the sheer intellect wielded by the great British economist John Maynard Keynes, who fashioned a plan for the British Treasury’s position.

In the end it was largely the U.S. position that held sway - a world finance system based on semi-fixed foreign exchange rates with national curencies backed by the U.S. dollar, which in turn was backed by U.S. gold reserves.

In order for the system to work, the world needed dollars.  The United States obliged, by following policies to encourage the outflow of dollars.  For decades, through this day, it bought more goods from overseas than it sold, providing liquidity for the international economy. And early on, after WWII, it provided dollars through U.S. aid programs, including the Marshall plan under Harry S. Truman, which helped rebuild Europe. 

The system held up reasonably well through the 1950s and 60s.  But when the need for world liquidity began to outstrip the United States gold reserves, Richard Nixon took the dollar off of the gold standard on August 15, 1971.  Dollars, and currencies tied to the dollar, were no longer convertible into gold. 

Nonetheless, the dollar continued to be the world’s reserve currency, essentially backed by the productivity and strength of the U.S. economy, and the transparency of the U.S. financial system.  Only in recent times, has the dollar had any serious challenges as a reserve currency, from the Japanese yen and the euro.

Now it looks like the era of the absolute preeminence of the United States and the dollar may be coming to an end.  At the very least, the U.S. will no longer be able to dictate its economic will on the rest of the world.  It will need to listen and to persuade and perhaps be persuaded by others. And not only will the United States need to listen and to talk to Western Europe and Japan, but so will it need to include China, Brazil, India, and Saudi Arabia, and even Russia, in this dialogue.

The November 2008 meeting of world leaders in Washington made little progress in fashioning a new world financial regime.  But what could one have expected?  The Bush Administration is in lame-duck status.  And it is saddled with the stigma of an America that can be largely blamed for the current crises, since it is in America where national savings have been dreadfully low, where we have become adicted to living beyond our means, and where these new asset-backed securities and their derivatives that apparently led to this mess, were invented and exported.

Serious discussion on fashioning new international financial rules will need to await the Barrack Obama Administration.  Clearly, the United States will not be able to totally dominate the discussion as it did at Bretton Woods more than 60 years ago.