Bretton Woods II This Is Not, but at Least It Is a Start

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Outlook

Anyone expecting something substantive from this weekend's meeting of the G20 in Washington is likely to be sadly disappointed. Comparisons with Bretton Woods are not so much misguided as completely ridiculous.

Bretton Woods, which gave birth to the international monetary framework that ruled after the ravages of the 1930s and the Second World War, took two years to negotiate and was agreed at a time when there was much more international consensus on how to govern the world economy than there is today.

By contrast, there doesn't even appear to be a fixed agenda for this weekend's "credit crisis summit" and, in any case, nothing beyond the anodyne is ever likely to be hammered out between different nations in just two days. For all governments, the immediate concern is not reform of the "global financial architecture", but collapsing demand and rising unemployment back home. For the time being, the solution to these problems lies not with international organisations but with national governments as they seek to address the crisis with reduced interest rates and reflationary policies.

Yet it is perhaps too cynical to dismiss the Washington meeting as just a grandiose talking shop whose primary purpose is that of shifting blame for what were fundamentally failures in national regulation and economic policymaking on to outdated international institutions.

That's not to say national governments and regulators are blameless. Undoubtedly, there is an element of buck passing going on here. The UK Government is still more inclined to blame fault lines in the international economy than its own policies for the mess we are in. The same goes for almost everywhere else too.

Nonetheless, the speed with which the financial and economic crisis has been transmitted from one country to another demonstrates a clear need for change. The immediate task is to apply the defibrillator to the stricken patient and only national governments can do that effectively. But it is also essential that steps be taken to prevent a repeat of the heart attack.

At the very least, the G20 machinations should start a process which in time should lead to worthwhile reform of the International Monetary Fund and a greater degree of co-operation between nations on financial and economic stability.

For those interested in the evolution of the international economy, there was an excellent history lesson on Bretton Woods together with an analysis of its contemporary relevance from the Governor of the Bank of England, Mervyn King, at this week's inflation report press conference. Central bankers have been accused of fuelling the credit bubble by keeping interest rates too low for too long. Mr King was having none of this.

Rather, the nub of the problem was that the international monetary system enabled a very low interest rate environment to rule, which in turn prompted a search for yield. It was this search for yield rather than low interest rates in themselves which tempted financial markets down the road of excessive leverage. How to reform the international monetary system to ensure this doesn't happen again goes to the heart of what needs to be discussed at this weekend's meeting.

With Bretton Woods, one of the major concerns about the fixed exchange rate system it established was that it placed few obligations on nations with big current account and capital surpluses, which in those days meant mainly the United States. The particular concern at the time was that if the US pursued inflationary policies, everyone else would be obliged to import America's inflation, and this would inevitably damage economic activity in the deficit nations.

Eventually, the fixed exchange rate system broke down, to be replaced by flexible exchange rates and domestic monetary and inflation targeting. For many years, this seemed to work well. …