Just before the Washington G20 summit in November last year, David and I co-wrote a paper entitled A Bretton Woods 2 Worth of the Name. As the title implied, we were politely sceptical of some of the political rhetoric then flying around, comparing the G20’s discussions about bank capitalisation with the rather more far-reaching discussions held at the Mount Washington Hotel in 1944.
Now, though, things are getting more interesting. Two days ago, Zhou Xiaochuan – the governor of China’s central bank – quietly published a paper on the People’s Bank of China website, entitled Reform the International Monetary System. It opened like this:
The outbreak of the current crisis and its spillover in the world have confronted us with a long-existing but still unanswered question, i.e., what kind of international reserve currency do we need to secure global financial stability and facilitate world economic growth, which was one of the purposes for establishing the IMF?
Later, Zhou continues that:
The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.
Now this line of thinking really does take us straight back to Bretton Woods – and in particular to Keynes’s proposal for a new global currency called the bancor, and a new global institution called the International Clearing Union (ICU).
What Keynes proposed was for the ICU to be a kind of global bank, designed to regulate trade between nations, and in particular to prevent the build-up of dangerous trade imbalances in the global economy (sound familiar?). Under his plan, all international trade would be denominated using bancors as the currency – the value of which would be fixed against a range of other commodities, including gold. Exports would add bancors to a country’s account at the ICU, while imports would do the opposite.
Crucially, incentives would then be applied to encourage countries to keep their ICU balance as close to zero as possible: run too high a surplus, and the ICU would take a cut of your money and put it into a reserve fund – giving you an incentive to spend your surplus on other countries’ exports, bringing the system back towards balance. As author Michael Rowbotham observes,
The efforts of debtor nations to promote exports was intended to coincide with the efforts of creditor nations to expend their otherwise worthless Bancor surplus. These charges were intended not so much as a deterrent or punishment, but as a benign ‘feedback’ mechanism, ensuring that, over time, trade remained in balance.
In the event, Keynes’s proposal was overruled by Harry Dexter White, the head of the US delegation at Bretton Woods – one of the key moments in the global power-shift from the UK to the US. Instead of an ICU, the world got an IMF; and it was the dollar, not the bancor, that became the de facto reserve currency. Many countries fixed their exchange rates to the US dollar; and the US, for its part, fixed the dollar to gold at $35 an ounce – a system that remained in place until 1971, when Nixon removed the dollar from the gold standard.
Zhou Xiaochuan’s essay is well aware of all this, and indeed explicitly regrets that Keynes’s approach did not carry the day at Bretton Woods:
Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date. Back in the 1940s, Keynes had already proposed to introduce an international currency unit named “Bancor”, based on the value of 30 representative commodities. Unfortunately, the proposal was not accepted. The collapse of the Bretton Woods system, which was based on the White approach, indicates that the Keynesian approach may have been more farsighted.
Most media coverage of Zhou’s essay starts from the perception that China is worried about the safety of its enormous stash of dollar holdings, particularly given the risk that US recovery plans may lead to significant inflation – and hence erosion in the value of its dollars. As the Wall Street Journal put it,
Chinese officials are frustrated at their financial dependence on the U.S., with Premier Wen Jiabao this month publicly expressing “worries” over China’s significant holdings of U.S. government bonds. The size of those holdings means the value of the national rainy-day fund is mainly driven by factors China has little control over, such as fluctuations in the value of the dollar and changes in U.S. economic policies.
But in the background, there’s also the issue that the by issuing the world’s reserve currency, the US occupies a highly advantageous position – being, in effect, subsidised by everyone else. With fundamental commodities like oil denominated in dollars, other nations must export products to the US in order to gather the dollars they need to buy oil: a windfall for the US economy, which can cheerfully issue debt and manage ever larger trade and fiscal imbalances, while simultaneously maintaining the dollar’s purchasing power.
If, on the other hand, the world moved over to a multilateral reserve currency – based, perhaps, around a reformed version of Special Drawing Rights (as Zhou suggests) – then the US would forfeit this privilege. So if Bretton Woods 1 was in some ways a negotiation on the transfer of power from UK to US, then an end to the dollar’s status as global reserve currency would certainly represent a transfer of power away from the US and towards the multilateral level. (Time magazine’s Justin Fox argues that this ending the current set-up would be in the US’s long term interests anyway: as he observes, “running big deficits and spending more than you earn aren’t really great long-term economic strategies”.)
In practice, as Zhou recognises, this is a very long term agenda – certainly much further off than the London Summit. Nonetheless, it does mark a significant evolution in the debate. Until now, China has been notably reluctant to talk turkey about what it really wants from multilateralism, preferring instead to stick to the comfortable but largely content-free language of its a ‘peaceful rise’. Zhou’s essay, on the other hand, moves a significant step closer to talking turkey on new rules for the global economy.