Bretton Woods is like the memory of an old flame: She seems to become more beautiful as time passes.
Searching for an elixir to a world suffering from a debilitated banking system, sinking economic growth and a credit crunch, economists and statesmen have turned to the post-World War II global monetary system fashioned at the Mount Washington Hotel in Bretton Woods, New Hampshire, in 1944.
``Perhaps what we need is to go back to the first Bretton Woods, to go back to discipline,'' European Central Bank President Jean-Claude Trichetsaid on Oct. 14. ``It's absolutely clear that financial markets need discipline: macroeconomic discipline, monetary discipline, market discipline.''
``The global financial system is too clouded with opacity, conflicts of interest, irresponsible risk-taking, and when problems occur countries have tended to look inwards and deal with them in isolation when it is clear that the only way forward is to look outwards and join in international cooperation,'' U.K. Prime Minister Gordon Brown said a day earlier. ``We must build a new Bretton Woods, a new financial architecture.''
Sorry, guys. While the global financial structure has undoubtedly been found wanting, the Bretton Woods system isn't the remedy. The arrangement eventually failed, precisely because its anchor currency was that of a country lacking discipline.
Before a doctor prescribes a specific course of medical treatment, he had better correctly diagnose the illness.
Gold Standard
The world could use more discipline. But, surely, Trichet isn't advocating a return to the rigidities of the gold standard, in which the vagaries of bullion output, mining costs and precious-metals discoveries influence monetary policy?
With gold futures prices fluctuating from $253 to $1,034 an ounce during the past nine years, pegging currencies to bullion ``would probably not produce the price stability that the advocates of the gold standard seek,''Frederic Mishkin, an economics professor at Columbia University's Graduate School of Business and a former Federal Reserve governor, wrote in ``The Economics of Money, Banking and Financial Markets.''
What's more, the challenges confronting the delegates at the conference in the Mount Washington Hotel were very different from those that today's leaders and senior monetary and finance officials face. Bretton Woods was all about rebuilding the world economy, especially Europe's, after World War II. It sought to foster international trade and avoid the ills of the prewar era, namely beggar-thy-neighbor strategies such as competitive currency devaluations, closed trading blocs and high tariffs.
Bubbles and Greed
By contrast, today's issues revolve around the bursting of a property bubble, banks' overly aggressive lending and investing, and regulators' inadequate supervision of financial institutions.
No doubt, the abundant liquidity created by asset- securitization, derivatives and Asian countries amassing huge reserves while pegging their currencies to the dollar fed both bubbles and greed. Yet these excesses could -- and should -- have been harnessed by alert central banks acting in concert.
At its heart, Bretton Woods was a fixed-exchange-rate regime in which the dollar was tied to gold at $35 an ounce, and other currencies were pegged to the dollar or bullion at agreed-upon parities. Countries had to keep their exchange rates within 1 percent of those parities by buying and selling foreign exchange.
Bretton Woods also gave birth to the World Bank and International Monetary Fund. The latter was charged with monitoring member nations' balance-of-payment positions and helping countries rectify imbalances. It did this by lending to those with big deficits and, if necessary, sanctioning devaluations of more than 10 percent. Where appropriate, the IMF also encouraged revaluations.
`Drastic Unemployment'
Deficit countries were ``spared the need to make adjustments by deflating themselves into drastic unemployment'' and lessening the need for import controls, Paul Samuelson, Nobel laureate and professor emeritus at the Massachusetts Institute of Technology, wrote in his ``Economics'' textbook.
The system collapsed in 1971 when President Richard Nixon suspended the convertibility of dollars into gold. The U.S. currency had become a victim of the high costs of the Vietnam War, accelerating inflation, ballooning trade and capital-account deficits, and the unwillingness of foreign governments and investors to hold dollar-denominated securities.
The deficit was partly financed by the U.S.'s shipping of gold to surplus countries. By 1973, official U.S. gold holdings had declined by more than 40 percent from their 1949 highs.
Bretton Woods isn't without its lessons, such as the need for cross-border cooperation and a global cop with muscle. The IMF, the would-be policeman, lacked the power to compel surplus nations to revalue their currencies or expand their economies. Such reluctance led to the dollar's becoming egregiously overvalued until the system finally collapsed.
Another lesson is the need to act quickly. Under Bretton Woods, by the time the IMF called for currency realignments, speculators had already begun to bet against weak currencies, exacerbating the misalignments.
Bottom line: If you want to keep banks on the straight and narrow, beef up the supervisor. You don't have to redesign the global monetary system.
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