What G20 Leaders Must Do To Stabilise our Economy and Fix ... - Vox

A New Bretton Woods system should curbboom and bustVijay Joshi and David VinesOxford University; Oxford University and CEPRToday's crisis has roots in a risky international monetary system as well as a risky financialsystem. Current international monetary arrangements encourage boom and bust cycles. G20leaders should aim to build a system that induces nations to manage their macroeconomiesin ways that produce neither financial bubbles nor large external imbalances and inappropriateexchange rates.While some G20 leaders hope the November 15th Summit will lay the foundationsfor a 'New Bretton Woods', many are sceptical and we share this view. The 1944Bretton Woods Conference was preceded by three years of difficult discussions amongthe US, UK, and other nations.The G20 leaders should start a process that will eventually produce agreement afterthe present crisis has subsided. At this meeting, they should lay out the essential elementsof a new system. We argue that better financial regulation is only one of theseelements.The rollercoaster ride that the world economy has been on this decade has revealeda scandalously risky financial system. It has also revealed a risky international monetarysystem that encouraged boom and bust cycles. If the G20 leaders aim to build a'New Bretton Woods' system, they will have to address more than financial regulation.Since current international monetary arrangements tend to fuel instability, thenew system must also address monetary arrangements.A boom-and-bust international monetary systemAn important feature of the rollercoaster ride was excess savings, especially in EastAsia. For example, in Indonesia, Korea and Thailand, investment fell by 10% of GDPafter the Asian financial crisis, and has stayed down. China's savings outstripped itsalready very high investments. The excess savings were translated into currentaccount surpluses since sterilized foreign exchange intervention kept exchange ratesundervalued. All this made sense for the individual nations. It allowed them to accumulatereserves as insurance against a 1997-style crisis and it fostered export-ledindustrialisation.Asian excess savings were greeted by American cheap-money policies. US interestrates were cut from 6% to 1¾% in 2001, then cut further to 1% and remained exceptionallylow for three years. The result was colossal housing and asset price bubbles,and very large current account imbalances, with the dollar's reserve-currency statusaiding and abetting America's ability to run massive trade deficits. All this made sensefor the US. The US interest rate policy was an understandable, even necessary,response to prevent Asian excess savings and current account surpluses from causinga recession in the US and the rest of the world.57