Published by EH.NET (March 2007)
Barry J. Eichengreen, Global Imbalances and the Lessons of Bretton Woods. Cambridge, MA: MIT Press, 2006. xix +187 pp. $26 (cloth), ISBN: 0-262-05084-6.
Reviewed for EH.NET by Anna J. Schwartz, National Bureau of Economic Research.
Barry Eichengreen has committed to print four lectures he delivered in Buenos Aires, Argentina. He starts out in the first lecture by challenging the view that Michael Dooley, David Folkerts-Landau and Peter Garber presented in a series of articles to the effect that there are similarities between the Bretton Woods System of 1958 to 1973 and the present international monetary system. The center country in the Bretton Woods system, as well as since its demise has been the United States. Its balance of payments was in deficit earlier as well as currently; it was a source of foreign reserves to countries in surplus on the periphery both earlier and currently; it was open to exports from countries around the world earlier as well as currently; finally, surplus countries then and now have resisted revaluation of their under-valued currencies for fear of negative consequences for export-led economic growth, and for capital losses on their reserves stock. Eichengreen’s reponse to this list of similarities is a list of differences between then and now.
1. The possibility of reserve allocation did not exist in the Bretton Woods era. Then, the U.S. trade and current account balances were in substantial surplus, mitigating concerns about the stability of the dollar. The U.S. was saving more then than it was investing at home. It was investing abroad on net. Its accumulation of foreign assets on which it earned income betokened that the U.S. balance of payments would improve over time, but markets were not reassured that the system would endure, since the current account surplus began a decline in the second half of the 1960s.
2. Asian countries now constitute the periphery, whereas then, European countries dominated the periphery. Commonality of purpose and mutual trust are less advanced in the former than they were in the latter. Now China would prefer regional integration, but Japan favors bilateral agreements. Collective action sustained Bretton Woods from 1958 to 1971. Limited possibilities for collective action currently dim the forecast of the number of years the present system will survive.
3. One example of successful financial cooperation by the Asian periphery is the Asian Bond Market Initiative to encourage investment of reserves in local currency bonds, an avenue for reserve reallocation likely to grow over time. In the 1960s there was no comparable means of reallocating reserves.
4. Under Bretton Woods, the U.S. relied on regulations and controls to keep private investors from shifting dollar-denominated assets to foreign ones and short-selling dollars. Now there is less regulation, so private investors will have the option in the future if asset prices change to forsake dollar assets for other more attractive ones.
5. Domestic financial market structures differ from those that existed forty years ago. Then forced savings could be channeled through regulation into capital formation in the traded goods sector. Japan did so, as did European countries also. Thus then the distortions of undervalued exchange rates, repressed consumption and forced savings in the periphery offset other distortions that would have resulted in too little investment in the highly productive traded goods sector. Since then, in the 1990s, with persisting undervalued exchange rates, in a more deregulated financial environment, low interest rates and ample credit were available for the non-traded goods sector and the property market. Some Asian countries experienced property market booms that weakened their financial institutions. Currently, the same policies have led to real estate booms in coastal China. Asian authorities are aware that the export benefits of their exchange rate policy are offset by heightened financial risks.
Eichengreen predicts that Asian authorities will let their exchange rates rise, and will emphasize expansion of domestic demand, not of exports, that they recognize that traded goods are not the sole center of productivity and growth externalities. They will therefore promote balanced investment in both non-traded and traded goods.
To allow real exchange rates to rise, the cartel of Asian countries that have maintained the dollar’s rate will need to cut back on intervention in the foreign exchange market, allocating part of their reserve portfolios, preferably to assets denominated in regional denominated currencies. This will cause the dollar to decline and may force the Fed to raise interest rates, curbing domestic absorption. The euro may rise against the dollar, harming European exports.
Eichengreen’s final thought is that the end of the present international monetary regime is not far off.
Eichengreen asks whether more monetary and fiscal restraint by the U.S. would have lengthened the life of Bretton Woods, and whether a dollar devaluation against gold and foreign currencies would have countered a secular decline in the current account surplus.
Had the U.S. raised taxes and the Fed raised interest rates, domestic demand would have been curbed, and export competitiveness enhanced, strengthening the current account, but other countries’ exports might have fallen, owing to the decline in U.S. domestic demand. Lower U.S. inflation might have stimulated capital inflows, and the drain on U.S. gold reserves slowed. In 1969, Germany might not have revalued the mark and delayed the end of the dollar standard.
Eichengreen believes that by raising the price of gold, expectations would have arisen that the step would be repeated, increasing the likelihood of a run on the U.S. gold reserve. A better course would have been floating the price of gold, but the authorities resisted severing the dollar-gold link until there was no other alternative. Also, had the U.S. raised the $35 per ounce price of gold, other governments might well have followed suit
In the present situation, Asian central banks foil the U.S. desire by buying dollars to prevent appreciation of their currencies, using the dollar accumulation as a hedge should the dollar decline against the euro.
In short, Eichengreen doubts that changed U.S. policies could have significantly prolonged the life of Bretton Woods. Countries would have needed additional reserves as the world economy grew, and gold and liquid claims on the U.S. were the available ones. As changed U.S. policies weakened their current accounts and increased capital outflows to the U.S., these countries might have responded by also tightening monetary and fiscal policies. World economic growth would have slowed and also demand for international reserves. But this would not have solved the Triffin dilemma that for other countries to acquire dollars, the U.S. had to run deficits that diminished confidence in the dollar. Bretton Woods would last only a little longer.
In the second lecture, Eichengreen reviews the reasons for the collapse of the Gold Pool. It was based on the idea that collective action by a cartel of countries would support the $35 price of gold. Divergent views of its members destroyed the Pool after six years. He sees a parallel in the cartel of Asian countries that by collective action seek to prevent appreciation of their currencies. Members’ views are beginning to diverge, so cooperation becomes problematic, although the timing of the collapse of this cartel may differ from that of the Gold Pool.
In the third lecture, Eichengreen offers the example of how at the end of Bretton Woods Japan, which for two decades had pegged the yen at 360 to the dollar, on 28 August 1971 loosened the peg, as a precedent for China to follow in decisively allowing the exchange rate of the yuan greater flexibility.
The title of the fourth lecture, “Sterling’s Past, Dollar’s Future,” succinctly describes the content. Eichengreen notes that the holdings by foreign central banks of U.S. liquid liabilities which are large relative to holdings of foreign liquid liabilities by the Fed and U.S. government are not a threat to the reserve currency status of the dollar. Similarly, before 1914, Britain borrowed short and lent long, and liquid claims of foreign official creditors exceeded British liquid assets, yet Britain ran current account surpluses. However, what makes the U.S. case currently a worry is that it occurs when the banker to the world has been running large ongoing current account deficits. Importing short-term capital and exporting long-term capital, Eichengreen argues, do not require a current account deficit. The deficits and U.S. growing net foreign debt threaten the U.S. hegemony.
With no change in U.S. policy, but a rise in inflation because of a falling dollar, foreigners will decline to add dollar-denominated securities to their portfolios. Once the dollar exchange rate falls in response, a flight from dollars may result. In Eichengreen’s view, only if the Fed can raise interest rates just enough to contain inflation without producing a severe recession, will a financial crisis be avoided and correction of the current account deficit ensue.
Sterling’s loss of international preeminence followed repeated inflation episodes and devaluations against the dollar. Given good economic management, the dollar need not lose its reserve currency status but it will share it by 2020 or 2040 with the euro, assuming the health of the European economy improves. Eichengreen believes it is premature to consider the yuan as a possible new reserve currency.
There is much to learn from these lectures about the past and current international monetary arrangements. I disagree with Eichengreen’s reference to the twin deficits as an important factor that explains the current account deficit. The relationship has sometimes been observed, and at other times not. This is true for the U.S. as well as other countries. I also do not share his view that the persistent current account deficit is a U.S. problem that only the U.S. can solve. The current account deficit is a global problem that other countries as well as the U.S. must cooperate to manage. The leading capital exporters to the U.S. (Japan, China, Germany, Russia) with current account surpluses are required to reduce their own and the U.S. imbalances. What the U.S. can contribute is a program to raise national savings.
Anna J. Schwartz is writing a monograph on the history of U.S. official intervention in the foreign exchange market (with Owen Humpage and Michael Bordo).