Strategy Environment and Markets “What the global banking and trading system needs is a new Bretton Woods” A critical discussion by Simon Weihofen If you enjoy this essay or receive any value from it, then I would be greatly appreciated if you leave a review on Amazon. Thanks in advance, your Simon. Click here to post your review on Amazon! Introduction In context of the latest global financial crisis, more and more leading decision-makers call for a second Bretton Woods Conference to achieve a sustainable solution to the problems occurring with the crisis. Hence, French Prime Minister Nicolas Sarkozy was quoted on the speech at the annual meeting of the World Economic Forum: “That’s exactly what we need today; we need a new Bretton Woods” (Sarcozy, 2010). However, also critical opinions enter the discussion. In their point of view, a second Bretton Woods Conference is likely to fail and is not presenting an adequate solution (Tett, 2010). This essay picks up this discussion by analysing the historical background of the Bretton Woods Conference and its outcomes. In addition, the developments of the three main international institutions resulting from this conference get addressed. Furthermore, the current global political situation and the developments of the global financial crisis get analysed in order to indicate the obstacles of a second Bretton Woods Conference. The essay finally closes with the conclusion of whether or not a second Bretton Woods Conference is likely to provide a solution to the global financial crisis. The UN Monetary and Financial Conference at Bretton Woods Nearly one year before the end of the Second World War and before the official foundation of the United Nations, a conference of 44 state officials was held in July 1944 at Bretton Woods, New Hampshire, USA (James, 2011). The “UN Monetary and Financial Conference” which is mainly known as the Bretton Woods Conference had the goal to create a new economic order from the scratch (Harper, 1998). The Situation before the Bretton Woods Conference It was obvious that Europe and parts of Asia will be destroyed by the Second World War but not only was the industry and infrastructure destroyed but also whole economies were ruined. In addition, a major concern was to learn the lessons from the period between the two World Wars in which unemployment and economic insecurity helped fascists to gain power (Heywood, 2011). The possibility of another dictatorship in Europe after WWII should therefore be avoided. However, the Great Depression in the 1930s also implied other damaging side effects such as the welfare dilemma. The welfare dilemma describes the situation if one state’s economic increase concludes an economic decrease by another state (Heywood, 2011). This could happen during the 1930s since every country had full sovereignty over its trade and monetary policies. Hence, countries raised tariff barriers by imposing taxes on imports or by devaluating their currencies to achieve cheaper and thus more competitive exports (Harper, 1998). These measurements also known as ‘beggar-thy-neighbour’ policies prevented international collaboration and thus resulted in a low level of global trade. Process of the Bretton Woods Conference The Great Depression obviously revealed major weaknesses of the global economic system. Hence, US Assistant Treasury Secretary Harry Dexter White and British economist John Maynard Keynes initiated the Bretton Woods Conference to produce a solution for the upcoming decades (Scaliger, 2008). A crucial part within the Conference was the USA given its economic and military power and thus represented the leading force in the negotiations. The national agenda of the US aimed to maintain economic growth rates past the end of the Second World War. Given the own productivity and the expected demand after the war, a globally open and stable economic system was needed. In addition, the expansion of Soviet Union should be stopped by supporting a counter-part to communism in form of a liberal economy. (Heywood, 2011) The Soviet Union, at this time the world-leader in gold production, was another heavy weight in the round of 44 nations at the Bretton Woods Conference (Scaliger, 2008). However, besides contrary positions in details, all delegates agreed on the necessity to implement international institutions that should govern global economy (Harper, 1998). Consequently, the World Bank, the International Monetary Fund (IMF) and the International Trade Organisation (ITO) were founded to encourage global economic reconstruction and stability. 2.1 The resulting institutions of the Bretton Woods Conference The World Bank When founded at the Bretton Woods Conference, the World Bank also called the International Bank for Reconstruction and Development (IBRD) had the major goal to act as a financial intermediary to provide loans for reconstruction the European economies in the post-WW2 phase. Hence, the first loan over $ 250 million was provided to France in 1947. (Heywood, 2011) The Articles of Agreement underlying the World Bank’s business describe its purpose and goals which are amongst others: Reconstruction and development of destroyed or under-developed economies Promotion of private foreign investments by providing guarantees and loans Promotion of long-term balance of payments and trade as well as long-term growth (Phillips, 2009) The World Bank’s president is nominated by the US Treasury Secretary and the decision-making process is by weighted voting according to the member nation’s financial contribution to the World Bank (Heywood, 2011). The International Monetary Fund While the World Bank was founded in form of a legal bank, the IMF was founded like a club. Member nations have to pay an annual subscription fee and also have to agree to the IMF code of conduct (Harper, 1998). The main goal of the IMF was to govern the international monetary system. During the Bretton Woods Conference, the delegations agreed to uniformly return to the gold standard. This means, every currency was able to be converted to the US dollar which again could be converted in to gold. The exchange rate was pegged at $ 35 per ounce of gold. (Heywood, 2011) Besides the introduction of the gold standard, the IMF code of conduct also noted that the IMF has to be asked for permission in case a member nation aimed to devaluate its currency (Harper, 1998). Besides promoting currency stability, the underlying assumption was that member nations could easily finance themselves in times of short-term deficits and borrow money to other members in times of surplus (Harper, 1998). In conclusion, the member states faced a second opportunity to finance short-term deficits besides devaluating their currencies. The International Trade Organisation The underlying assumption behind the foundation of the ITO was that increased international trade would accelerate economic growth because products and materials would be available cheaper and faster due to a reduction of trade barriers (Griesgraber and Gunter, 1997). Hence, economic growth would lead to a decrease of unemployment which in turn would increase productivity, trade and further economic growth. By the end of the Bretton Woods Conference, the ITO was not yet founded due to ongoing negotiations. These negotiations were finished on 24 March 1948 during the UN Conference of Trade and Employment. However, 23 countries agreed on the General Agreement on Tariffs and Trade (GATT) on the Geneva Trade Conference in October 1947. The GATT which was originally intended as an interim agreement till the negotiations on the ITO have finished, got effective on 1 January 1948. (Griesgraber and Gunter, 1997) However, the GATT succeeded since the US Congress abandoned the ITO in 1950 (Harper, 1998). Developments of the Bretton Woods institutions With the quick reconstruction of European economies resulting in the economic boom period of the 1960s, the Bretton Woods Conference clearly achieved its primary goal. In addition, the underlying idea to set aside protectionism in form of ‘beggar-thy-neighbour’ policies and instead to promote economic collaboration has led to avoidance of another World War and the establishment of the European Union. However, to evaluate the contribution of the Bretton Woods Conference to today’s global economic and political situation, it is necessary to highlight the developments of the World Bank, the IMF and the GATT. Development of the World Bank Soon after the foundation of the IBRD, it became obvious that the bank lacked financial resources, clear organisational structures and staff to adequately meet the demand from Europe. In the meantime, Secretary of State George C. Marshall represented the European Recovery Programme (also known as the Marshall Plan) in June 1947 outlining the American contribution for restructuring European economies. After the adoption of the Marshall Plan the World Bank found itself only a minor player regarding the European reconstruction. (Marshall, 2008) As a consequence the IBRD shifted its focus and concentrated on the development, mainly of South American states. Hence, the first development a loan was transferred to Chile ($ 16 million) in March 1948 with additional loans for Mexico and Brazil in 1949. (Marshall, 2008) While providing loans for development countries, the World Bank built a good reputation as a financial intermediary resulting in a ‘triple A’ rating constantly held since 1959. This outstanding reputation is crucial for the business model of the World Bank. The institute buys funds on the private market to lend to development countries subsidised through the contribution of the 185 World Bank member states. While mainly focusing on infrastructure projects in the early years, also education projects were financed since 1963 through development loans. (Marshall, 2008) Today, the World Bank Group consists out of five institutes: International Bank for Reconstruction and Development (IBRD) International Development Association (IDA) International Finance Corporation (IFC) International Centre for Settlement of Investment Disputes (ICSID) Multilateral Investment Guarantee Agency (MIGA) (World Bank, 2011) In addition, the IBRD runs four multilateral development banks sharing the goal of financing and developing transitional economies: Inter-American Development Bank African Development Bank Asian Development Bank European Bank for Reconstruction and Development (Phillips, 2009) In the 1980s, the World Bank was criticised for its Structural Adjustment Programmes which provide development loans only when adjusting national policies. Criticism mainly focused on the lack of success of these adjustment measures. The World Bank reacted by shifting away from macro-economic development towards structural and human aspects of development with the introduction of the Comprehensive Development Framework. (Phillips, 2009) Development of the International Monetary Fund After its foundation at the Bretton Woods Conference, the IMF functioned as international monitoring institutions of its members’ currency values. The par rate system described the convertibility of all currencies to the US dollar which in turn was pegged to gold. Furthermore, the IMF developed the quota system which defines the levels of available funds of each country in relation to the country’s deposited reserves. As with the World Bank, the voting system within the IMF is weighted according to the quotas of the members. (Harper, 1998) During the economic boom-time of the 1960s, the IMF developed the Special Drawing Right (SDR) in response to the increasing demand for capital and due to the fact that global gold reserves could likely not back up the amount of circulating US dollars anymore. In addition, member countries were not able to control inflation rates due to a lack of sovereign control over their monetary policies. These circumstances in combination with the large deficit of the US household made former US President Richard Nixon suspend the gold-dollar standard on 15 August 1971. (Mundell, 2009) With the suspension of the gold-dollar standard, currencies were allowed to float resulting in a free movement of the relative values of currencies towards each other. Hence, the IMF had lost its major task which was the maintenance of world monetary system stability. In conclusion, the IMF shifted its focus towards rescue-lending for states being in financial trouble. (Feldstein, 1998) During the late 1970s, it turned out that this role of the IMF was demanded since states increasingly faced difficulties in serving their commercial debts which mainly originated from the fast-growing private financial market. The IMF provided medium-term resources to states in trouble so that these states were able to restructure its internal financial business to able to serve its debts in future again. (Harper, 1998) Today, the IMF counts 186 member states and is actively involved in providing funds for states which got into trouble through the recent global financial crisis (Heywood, 2011). The latest example can be found in the attempts to rescue Greece in cooperation with the European Union. (Matsaganis, 2011) Development of the GATT In contrast to the originally planned ITO, the GATT lacked jurisdiction and only represented a vague framework for trade negotiations (Griesgraber and Gunter, 1997). Hence, there have been seven negotiation rounds from its foundation in 1948 till 1986 with the aim to decrease trade restrictions among countries (Feenstra and Taylor, 2008). The Uruguay Round of trade negotiations which took place from 1986 till 1994 resulted in the establishment of the World Trade Organisation (WTO). The WTO became effective on 1 January 1995 and represented an expanded version of GATT with the goal to further reduce trade barriers. Thus, a key principle of the WTO is the so-called ‘most-favoured nation’ clause in its first article describing that tariffs applied to one nation must be applied to all other member nations of the WTO. (Feenstra and Taylor, 2008) Today, the WTO is headquartered in Geneva Switzerland and counts 153 member states. Besides periodically trade negotiations, the WTO represents a forum to settle trade disputes amongst member states. Furthermore, the decision-making process at WTO is made by consensus. (Heywood, 2011) The latest round of trade negotiations started in 2001 with the so-called ‘Doha Round’. The negotiations get heavily criticised due to its slow process and ongoing disputed concerning agricultural subsidies in developed countries. (Steger, 2010) Current global political landscape and financial crisis Global power distribution Short before the end of the Second World War, the political landscape was rather simple with the USA on one side and the Soviet Union on the other side (Dicken, 2011). However, with the collapse of the Soviet Union, the increasing collaboration and growth of the European Union, the political power relations got more complex (Dicken, 2011). Today, there are still a few developed countries having dominant economies which are most prominently represented by the G7 (Smith, 2011). However, transitional economies in form of emerging countries such as BRICS (Brazil, Russia, India, China and South Africa) and the Next Eleven (Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, Philippines, South Korea, Turkey and Vietnam) will make the future global political map look even more complex (Wilson and Stupnytska, 2007). An example for the increased political power of those nations can be found in the increasing importance of the G20 summits (Smith, 2011). The global financial crisis The global financial crisis is a result of an increasing complex financial market and an increasing global interdependence. What started as a US mortgage crisis in August 2007 developed to a banking crisis with the collapse of the fourth biggest investment bank Lehman Brothers and the leading insurance company AIG in September 2008 (Mishkin, 2011). After the collapse of these two important financial institutes, the members of the banking sector lacked trust amongst each other leading to increased finance costs which in turn made it more difficult also for countries to borrow new loans on the private capital market (BMF, 2011). As a result, the European debt crisis as it is apparent today, reflects the current interdependence of the global financial markets. Conclusions The Bretton Woods Conference of 1944 can be seen as successful since 44 nations agreed on a new global economic order from the scratch. In the following period, the prevention of the threat of war by increased economic collaboration can be seen as a historically outstanding achievement. In addition, the accelerated international trade and monetary stability led to the economic boom of the 1960s with growth, welfare and prosperity. In the context of the current financial crisis, several leading politicians call for a second Bretton Woods Conference reflecting a desire for achieving stability which enables future growth. However, it is important to analyse what the Bretton Woods Conference still contributes to the financial crisis of today. Although the World Bank as changed its originally intended focus early after its foundation, it today provides a valuable tool for financing development projects. Its future success depends on the World Bank’s ability to learn from former mistakes and to adjust future project financing. The latest WTO negotiations are stuck since the 2001 Doha round. Ten years of negotiations without agreement or significant process is called by many officials a farce. In conclusion, the WTO proves to be successful in reducing trade barriers only as long as this is beneficial to developed countries. Hence, reform of the international trade system is necessary to set aside the current imbalance between developed and developing countries. Although the IMF lost its originally intended monetary surveillance function with the abandonment of the gold-dollar standard in 1971, it still proves to play an important role as global non-market lending organisation within the financial crisis. Thus, the IMF can be seen as stabilising element. If the IMF would not be available to provide loans to countries suffering from the European debt crisis, the Euro would already have collapsed with unpredictable consequences for the global interdependent financial markets. To prevent a second financial crisis, strict regulations of today unregulated financial markets could be a solution with the IMF as the global surveillance organisation. Another barrier towards a second Bretton Woods Conference is today’s complexity of political power distribution. In 1944, there were roughly two powerful nations being the USA and the Soviet Union. The achievements of the Conference can also be explained in the win-win situation for both nations. While the USA had stable conditions for exports, the Soviet Union as major producer of gold benefited from the introduction of the gold-dollar standard. A new Bretton Woods Conference, however, would require agreement of at least the G20 which will likely to conclude a minimum consensus. This minimum consensus, in turn, would not imply groundbreaking changes to the current global financial and trading system. References BMF (2011): “Entwicklung der Finanzmarktkrise: Von der US-Subprime-Krise zum Bad Bank Gesetz”, published by Bundesministerium für Finanzen, retrieved via http://www.bundesfinanzministerium.de/nn_97140/DE/Buergerinnen__und__Buerger/Gesellschaft__und__Zukunft/finanzkrise/076__Entwicklung__Finanzmarktkrise.html?__nnn=true on 7 December 2011 Dicken, P. 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