Not Out of the Woods
The global financial system needs improvement, but not a radical reinvention.

Thursday, October 23, 2008

ROUGHLY 64 years ago, 730 delegates from 44 Allied nations met in Bretton Woods, N.H., to devise a post-World War II international monetary and financial order. The goals were to prevent a repeat of the Great Depression and to facilitate reconstruction in Europe. After three weeks, the delegates agreed to fixed, gold-backed exchange rates and outlined institutions such as the International Monetary Fund, the Bank for Reconstruction and Development (forerunner of the World Bank), and the General Agreement on Tariffs and Trade (forerunner of today's World Trade Organization). The Bretton Woods system has evolved -- major currencies float today -- but its basic structures remain recognizable. And it still rests on a presumption of U.S. political and economic primacy.

Now, with the global financial system in dangerous disarray, powerful voices in Europe are calling for a new Bretton Woods. Prime Minister Gordon Brown of England wants "very large and very radical changes" in the global economic order. Ditto French President Nicolas Sarkozy, Mr. Brown's rival for leadership in the European Union, who has said that "the 21st-century world cannot be governed with the institutions of the 20th century." Despite the European leaders' not-so-implicit assumption that U.S. free-market policy is at fault for the crisis, President Bush has consented to a Nov. 15 meeting in which leaders from the United States, Europe, Japan and emerging economic powers such as South Korea, China, India and Brazil will participate.

The global financial system does need reforms, and governments could achieve some of them on a coordinated basis over the coming months: agreement not to use insurance to compete for bank deposits; less reliance on ratings agencies to monitor financial risks; a commitment to rethink capital standards for global banks. After the collapse of the Doha round of tariff-reduction talks and the rise of protectionist sentiment that that failure both reflected and encouraged, a strong statement in favor of free trade and investment would also be welcome.

But there are limits to what the upcoming conference might accomplish, even if it were not taking place amid a U.S. presidential transition. The original Bretton Woods was a working meeting of technocrats, not a brief get-together among politicians. Also, Bretton Woods, though officially multilateral, was U.S.-dominated -- something that could not be repeated today. Even relatively small fixes will require country-by-country legal and policy changes, which will take time. For this reason, Mr. Brown's call for transnational curbs on executive compensation for bankers strikes us as more of a political posture than a workable proposal. So does his vision of the IMF as an "early warning system" for financial crises, an old idea with a basic flaw: Even if the warnings prove right, what could the IMF actually do to any country that neglected or refused to heed them?

The European leaders' call for radical reform is understandable, given their predicament and the widespread belief among European publics that the United States and its alleged free-market mania are to blame for that predicament. But the push for a new Bretton Woods overlooks two important points. First, existing Bretton Woods institutions are still useful: The long-dormant IMF, for example, has gone back into action negotiating bailouts for Iceland, Ukraine, Hungary and Pakistan. Unpopular as the IMF's lending conditions may be, they may prove preferable to the strings that Russia or China -- Iceland's and Pakistan's alternative sources of cash -- might attach. Second, the United States, for all its woes, is not quite finished as the world's preeminent economic power. American financial markets may be plunging, but European markets are doing just as badly, or worse, which is one reason that the dollar has just hit a two-year high against the euro. Until the euro proves able to replace the dollar as a global reserve currency, U.S. leadership -- the basic condition of Bretton Woods -- will, and should, remain unchanged.

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