Back to the Bubble?

By David Ignatius
Sunday, March 15, 2009

Leaders of the Group of 20 are talking about creating a new architecture for the imploding world economy. But there's a big risk that their crisis summit in London on April 2 will encourage a patched-up version of the instability that got us in trouble in the first place.

Fed Chairman Ben Bernanke teed up the problem in his speech last week to the Council on Foreign Relations. "It is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s," he said. "We collectively did not do enough to reduce those imbalances." And so the crisis came. The basic imbalance was that the United States consumed far more than it produced. America financed this excess consumption by borrowing money from China and the other rising nations of Asia whose export-led economies were generating huge savings. Both sides became addicted to the flows of trade and capital: America loved gorging on cheap foreign imports; the foreigners loved the rapid growth that came from shoveling goods into the insatiable U.S. market.

It was a global bubble: The tsunami of foreign capital to the United States helped keep interest rates low, fueling the housing boom. Investors took ever-greater risks in a globalized economy in which flows of billions of dollars were just so many dots on a computer screen. This system, congenial but inherently unstable, came to be known as Bretton Woods II.

The danger now, as economic activity slows around the globe, is that the G-20 leaders will seek recovery in a new version of the old, unbalanced system. That is, the nations of Europe and Asia will look to America, with its multitrillion-dollar stimulus and rescue programs, to rev up the world's sputtering engine. America, massively in debt, will go back to its role as import glutton, and the rest of the world will go back to selling us products. And then we're back to where we started.

As the G-20 meeting nears, Washington wisely has been pushing for a coordinated global stimulus to avoid the imbalances of the past. But the European nations are far less comfortable with deficit spending than Americans are. And the Chinese resist a stronger yuan that would make their exports more expensive. Last week, the grumpy finance minister of Luxembourg complained: "Recent American appeals insisting that the Europeans make an additional budgetary effort to combat the effects of the crisis were not to our liking." Oh, yeah? Well then, get ready for a replay of the old American-led boom-and-bust cycle.

As a G-20 prep exercise, let's recall some economic history. The modern financial structure was created in 1944 at a conference in Bretton Woods, N.H. It was a tightly disciplined framework: Countries would maintain fixed exchange rates; if they got into difficulty, the new International Monetary Fund would provide transitional financial help. Buttressing the system was the U.S. dollar, which could be converted into gold at a fixed rate.

The Bretton Woods system gradually lost its backbone. The United States dropped the gold standard in 1971 and allowed the value of the dollar to "float" in international currency markets. Other major economies gradually moved to flexible exchange rates, too. The IMF was still around for crisis lending, but the real action for emerging economies was in the massive flows of private investment.

Then came Bretton Woods II and its unstated formula for mutual financial dependency. America would provide the market; the rest of the world would sell the goods. We overspent; they oversaved. Countries that wanted to maintain artificially low exchange rates, such as China, were allowed to do so. The system couldn't last, and it didn't.

When the G-20 gathers, the leaders will discuss new financial regulation, which will make everyone feel better (although the problem now is getting bankers to take risks, rather than limit them). Perhaps the meeting will also endorse a new global clearinghouse for complex derivatives deals, so these financial killers don't pile up on the balance sheets of companies such as AIG.

But the G-20 will duck the real issue if its members don't address the financial imbalances that created this disaster. World prosperity in the future requires a coordinated global stimulus now -- not a lopsided effort by the United States.

The writer is co-host of PostGlobal, an online discussion of international issues. His e-mail address is

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