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«Fix What Broke: Building an Orderly and Ethical International Monetary System Judy Shelton It has been more than six years since the global economy ...»

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Fix What Broke: Building an Orderly

and Ethical International

Monetary System

Judy Shelton

It has been more than six years since the global economy was put

through the financial wringer and left hung out to dry. According to

former Federal Reserve chairman Ben Bernanke, who presided over

the debacle: “September and October of 2008 was the worst financial crisis in global history, including the Great Depression” (da Costa

2014). Given that Bernanke is a scholar on the global economic collapse of the 1930s, his assessment is particularly sobering. After all, a horrifying world war followed in its aftermath.

Today’s situation might be less worrisome if we had any reason to believe that the fundamental problem of calibrating the global money supply to the needs of the global economy had been resolved.

But we don’t. Instead of establishing a sound money foundation that would permit free-market mechanisms to optimize capital flows and maximize long-term economic growth, we have empowered central banks to engage in central planning. Instead of building an international monetary system consistent with the values of democratic capitalism—free markets, free enterprise, and free trade—we have amplified the influence of government over the voluntary transactions of individuals operating in the private sector.

And what have we gained in terms of global financial stability?

Central bankers and government authorities are likely to prove less Cato Journal, Vol. 35, No. 2 (Spring/Summer 2015). Copyright © Cato Institute.

All rights reserved.

Judy Shelton is a Senior Fellow at the Atlas Network and Co-Director of the Sound Money Project.

Cato Journal than omniscient once more; the next worldwide financial meltdown may well be looming on the horizon.

Even more disabling would be our loss of leadership and perceived bankrupt principles. How can America promote the virtues of economic opportunity and honest competition in an open global marketplace while allowing currency disorder to distort the terms of trade? How can our nation stand for free people and free markets, and yet have nothing to say about the disrupting and destabilizing effects of capital flight and manipulative monetary practices?

Financial Disarmament The world has experienced more difficult and more dangerous conditions than our current setting. On July 1, 1944, delegates from 44 nations came together in Bretton Woods, New Hampshire, to work out arrangements for a new international monetary and financial order. Less than four weeks earlier, on June 6, 1944 (termed “D-Day”), more than 160,000 Allied troops had landed on the beaches of Normandy to battle against heavily entrenched Nazi forces. The outcome of the war was far from being assured.

In spite of the distractions of global hostilities—indeed, precisely because of such challenging circumstances—the assemblage was infused with a strong sense of purpose and resolve. The goal was to forge an agreement that would establish a stable international monetary system to serve the needs of a postwar world recovering from devastation. It was an endeavor both hopeful and fateful; if ravaged nations could not look forward to a more functional and productive global economy than the one that had sparked belligerence and confrontation, they might not be able to summon the necessary fortitude to prevail against totalitarianism.

Harry Dexter White, a monetary expert at the Treasury, sought to inspire struggling nations by providing a glimpse of an economic future that would grant them the opportunity to rebuild their economies through full participation in an open global trading system. In a draft memo that would be the precursor to the Bretton Woods agreement for international monetary cooperation, White (1942: 46) argued that prosperity should be built on a solid monetary

foundation of stable exchange rates:

The advantages of obtaining stable exchange rates are patent.

The maintenance of stable exchange rates means the International Monetary System elimination of exchange risk in international economic and financial transactions. The cost of conducting foreign trade is thereby reduced, and capital flows much more easily to the country where it yields the greatest return because both short-term and long-term investments are greatly hampered by the probability of loss from exchange depreciation. As the expectation of continued stability in foreign exchange rates is strengthened there is also more chance of avoiding the disrupting effects of flights of capital and of inflation.

The logic and clarity of the ideas pursued by White at Bretton Woods still have resonance today. They should not be tainted by the controversy that clouded his reputation. White was accused in 1948 of passing information to communists, a charge he denied before the House Committee on Un-American Activities; he died shortly after giving testimony (Shelton 1994).

What we should take from his economic writings and policy undertakings is the imperative of preventing “beggar-thy-neighbor” devaluations among currencies leading to retaliatory tariffs and a breakdown in international commerce and credit. As a bulwark against monetary disorder and economic depression, White proposed the creation of an international monetary fund comprising gold and national currencies. It would stabilize foreign-exchange rates, encourage the flow of productive capital among participating nations, help stabilize domestic price levels, promote sound credit practices, and reduce barriers to foreign trade.

All these tasks, as Treasury Secretary Henry Morgenthau Jr.

observed in 1943, were interrelated. “It is generally recognized that monetary stability and protection against discriminatory currency practices are essential bases for the revival of international commerce and finance” (in Horsefield 1969: 83).

The other key architect of the Bretton Woods agreement, John Maynard Keynes, brought his own perspective to the proceedings.

Keynes was primarily interested in channeling needed financial resources from wealthy countries to needy countries; he wanted to ensure that Britain, in particular, would continue to receive defense aid from the United States. Yet Keynes also understood that international monetary stability was the key to promoting increased trade and capital flows. He was intrigued with the idea of elaborating a truly international plan for global financial cooperation and he likewise saw an important monetary role for gold. Keynes recommended Cato Journal the creation of an international currency unit (he called it “bancor”) into which other currencies would be convertible. Keynes proposed that exchange rates be fixed in terms of bancor and that bancor be valued in gold.

Keynes (1942: par. 51) described the proposal for a gold-based international monetary union to facilitate world trade as nothing less than a call for global “financial disarmament.” White, for his part, believed that the vision of a better world offering nations a more prosperous existence in the future would inspire them to persevere in winning the war. People had to be assured that the United States would not desert them, but rather would help them through the difficult task of economic reconstruction. “To help them, not primarily for altruistic motives, but from recognition of the truth that prosperity, like peace, is indivisible” (White 1942: 38–39).

Golden Age It would be too pat to merely proclaim that the Bretton Woods agreement brought about a time of economic prosperity, high productivity, high average wages and high consumption. The International Monetary Fund (IMF) officially commenced operations on March 1, 1947, launching a gold exchange standard based on a U.S. dollar convertible into gold at the rate of $35 per ounce. The Marshall Plan would be implemented the following year, through which the United States would provide $17 billion (approximately $160 billion in 2014 dollars) in economic support to European countries.

Was it the existence of a reliable golden anchor for international monetary relations that was most responsible for delivering the period of high economic growth? Or should we attribute America’s foresight in channeling financial capital to Europe as a way to impose our own free market values and strengthen capitalism’s hold across the Atlantic? Improving the economic productivity of Western Europe not only served as a buffer against communism, it also created markets for American goods.

Still, the Marshall Plan was in operation for only four years whereas the Bretton Woods international monetary system continued to function until August 15, 1971, the day President Richard Nixon suspended convertibility of the dollar into gold.

Can it be coincidental that a fixed-exchange rate regime linked to gold accorded generally with the high-growth period from 1945 to International Monetary System 1975 referred to in France as the “Trente Glorieuses” or 30 glorious years? In his book Capital in the Twenty-First Century, French economist Thomas Piketty describes the postwar years in Europe as an exceptional time of economic “catch-up” as per capita output leapt ahead. “Western Europe experienced a golden age of growth between 1950 and 1970, only to see its growth rate diminish to onehalf or even one-third of its peak level during the decades that followed” (Piketty 2014: 97).

This more specific reference to the prosperous decades of the 1950s and 1960s, which marked the heyday of the Bretton Woods gold exchange regime, is echoed by economist Paul Krugman.

Writing in the New York Times, Krugman (2002) laments the increase in wealth inequality since the 1970s and concurrent decline of the middle class. “For the America I grew up in—the America of the 1950s and 1960s—was a middle-class society, both in reality and in feel.” For Krugman, the widening gap between the “very rich” and the rest is having profound effects in the economic, social, and political spheres; specifically, he asserts that the growing concentration of wealth since the early 1970s is at the root of “an extreme polarization of our politics.” Yet even as Krugman points out that income inequality was historically low during the era from World War II until the 1970s, he doesn’t make the association with the gold-linked monetary system that was in effect during the same period.

Fallacy of Floating Economists today accept the paradigm of freely floating exchange rates with the same conviction that an earlier generation of economists acknowledged the gold standard as the most rational and efficient approach to structuring international monetary relations. Those who propose alternative exchange-rate arrangements to the currency mishmash that exists in the world today are quickly branded heretics by fellow economists.

But has the system for determining exchange rates among currencies that came into being as the result of the void left by the collapse of Bretton Woods actually delivered results in keeping with the theoretical assumptions of a floating rate model? Has it delivered the results its proponents claimed it would achieve? Can we even refer to the current manner in which exchange rates are determined as any kind of system with regard to structure or orderliness?

Cato Journal In their book Manias, Panics and Crashes: A History of Financial Crisis, Charles Kindleberger and Robert Aliber (2011: 40–41) describe the reasoning of Milton Friedman in his assertion that destabilizing speculation would not take place under floating rates, or at least would be unlikely to persist: “The Friedman view is that since the destabilizing speculators would fail to survive, destabilizing speculation cannot occur.” Since the end of the Bretton Woods system, however, the behavior of exchange rates has not comported with Friedman’s expectations for a freely floating international monetary regime. Instead of providing a rational monetary approach to accommodate international trade and capital movements, fluctuating rates have engendered greater uncertainties and associated costs.

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