28 May 2009
Earlier this week, a group of America’s most intelligent and influential thinkers published a report heralded as the definitive solution to the financial crisis.
The Committee on Capital Markets Regulation’s study is getting on for 300 pages, so let me give you the gist: we must overhaul financial regulation, create a centralised market for the financial instruments behind so much of the trauma, find a more sensible way of dealing with collapsed investment banks and collect more information on hedge funds.
All this is worthy, correct and important – and completely misses the point. Like most of the analyses produced in the wake of the crisis, this report entirely fails to get to its heart.
Yes, we have had a horrible crunch, which is sapping any energy from the economy. Yes, there is plenty wrong with the way the banking system works. But trying to save the world economy with new regulations and codes of practice is like trying to cure a cancer patient with plastic surgery.
The financial disaster was the ultimate manifestation of a far deeper problem – a wholesale malfunction of the global economic system. The bankers and mortgage brokers may have been in the front line, but they were pushed there by forces far more powerful than any regulations. For decades, we in the Anglophone West borrowed too much, while the other half of the world saved too much. It was the tectonic collision of these imbalances that caused the crisis, which brought about the worst recession since the 1930s, and which could trigger another bust, decades in the future.
Imbalances are nothing new. A country, or a town, will at any one time tend to import more than it exports, or vice versa. But being reliant on borrowing from abroad, which goes hand in hand with running a deficit, leaves you vulnerable. The history of economics over the past two centuries revolves around this quandary over international trade imbalances, and the series of crises they have caused.
We have wrestled with different schemes to try to even out the imbalances – to ensure that countries do not get too far into deficit or surplus. In the 19th century, we tried the gold standard, whereby countries’ exchange rates were fixed against its price. The system’s breakdown after the First World War contributed towards the Great Depression.
Next, in 1944, came the Bretton Woods agreement, a bodged compromise between the opposing visions of John Maynard Keynes of Britain and Harry Dexter White of the US, which fixed nations’ currencies against the dollar, and that in turn against gold. Again, this broke down a few decades later, leaving us with today’s mutant monetary system: half of the world on floating exchange rates, and the rest (China, the Middle East and others) pegging their currencies to the dollar.
Trace your finger back along almost any ledger of debts – whether in terms of the banking system or of government deficits – and you’ll notice that the figures start rising pretty soon after Richard Nixon stuck the knife into the Bretton Woods system in 1971. So did the incidence of financial crises.
Without any kind of structure or balance, the world’s monetary system has been barrelled around since the 1970s. Countries such as Britain and America borrowed more and exported less with impunity. Countries such as China and Germany have been allowed to build up massive current account surpluses. The result has been bigger booms, followed by nastier busts. A Bretton Woods-style system would have constrained both sides from generating these imbalances.
It would be nice to think that this economic crisis contains the seeds of its own solution: that following the trauma of recession, we will change our spendthrift (or insufficiently consumerist) ways. But in the absence of any kind of mechanism to right these imbalances, there is little to suggest that anything of the sort will happen once this drama is over.
What most alarms me is that not only is nothing being done by those in power to re-engineer the global monetary system, but that few of the great and good in the City have faced up to the fact that it is the imbalances, not the regulations, that are really to blame for our current situation.
Remarkably, I strongly suspect that the ultimate solution will come not from Washington or London, but from Beijing. A couple of months ago, Zhou Xiaochuan, the governor of the People’s Bank of China, put out a paper which alluded to precisely these problems. The detail most conspiracy theorists fixated on was the mention of a possible international reserve currency – was this part of a plan to dump the dollar and bring down the world’s biggest economy?
No, it wasn’t. His point was a far broader one: that we need a new international pact on how we manage the flow of goods and cash around the world, in which a world currency plays a merely functional role. In other words, a new Bretton Woods. We should be thankful that while the Western elites are fiddling around with piddling regulation, someone sensible is starting to consider how we can actually make the world economy work.