The great call today is for a new international financial order to replace the Bretton Woods agreement of 1944. Politicians and peoples are panicking. Economists are offering lame excuses and wringing their hands.
This is a do-able thing.
The old order has broken down, and the choice is between no system and a new system.
- As panic in international markets and currency calamities across the world emphasize, no stable exchange rate system exists. The Bretton Woods I scheme was unilaterally abandoned in 1971 by Richard Nixon.
- A key institution of Bretton Woods I, the International Monetary Fund has long since abandoned its original mandate and morphed into an arm of Market Fundamentalism Inc. Past interventions by the IMF have been to benefit Western financial interests at the expense of developing economies.
- The dollar may be the only legitimate reserve currency standing at the moment, but that cannot last, since it is working for nobody except the U.S., and not very well for the U.S.
This realization, that the current system has not, is not and cannot work, is the only necessary motivation to fix things.
It is not as if the United States is benefiting from the existing scheme and all others are losing. Far from it. The free market fundamentalism that has devastated societies across the globe has also wrecked the American economy. The American industrial base has been eviscerated by the flow of jobs to low-wage nations.
In Russia, just as the average citizen was lifting his head, he is beaten down again by collapsing oil prices. In Brazil, enlightened macroeconomics are being wiped out by a run on its currency. In Eastern Europe, South Korea, the Baltics, financial turmoil has triggered yet another flight of capital and another destruction of currencies. Stock markets are being flattened. Ironically the major sponsor of global free market fundamentalism -- the IMF -- is being looked to for help. Fortunately the austerity measures they used to require as preconditions are barely murmured now. Those radical Right requirements were so far out of touch that they were barely whispered as possibilities for the United States. They used to be cardinal tenets of the IMF.
George W. Bush has called for an economic summit against a backdrop of panic and confusion and despair and increasing hostility. Behind this backdrop are the fundamental economic issues.
Three first three legs to a new economic order must be:
- A stable currency exchange regime.
- An end to the Washington Consensus' tenet of free-flowing capital.
- A functioning international institution that benefits all nations.
Nothing to it, you say?
Consider. This has to be the final straw for the floating exchange rate system, which has meant de facto dominance for the United States, since the dollar has become a so-called reserve currency, a note which everybody assumes will retain its value. At the same time, and in the same stroke, developing nations so recently the targets of investment capital are now beggared as capital flows away. In the free market the only way to influence the rate of exchange is by jumping in on the supply or demand side. Such efforts are futile in the face of the tens of trillions in so-called hot money that flow every month. Intervention in past crises has succeeded only in emptying central bank reserves.
This realization, that the current system has not, is not and cannot work, is the only necessary motivation to fix things.
A catalyst for this, and a good part of an eventual remedy, is the Tobin Tax. It would be a big first step to stability, but only a first step.
The Tobin Tax
Named for Nobel laureate James Tobin, an economic architect of the Kennedy and Johnson era, the Tobin Tax would levy a minute tax on financial transactions, including currency trades. As small as one-tenth of one percent, such a tax would be incidental to legitimate transactions in the real economy, but would slow down the hot money drastically.
Why?
Because this free-flowing capital is itself seeking tiny differences in return from one country to the rest. The "carry trade," borrowing in one country and lending in another, is an example. Unwinding the carry trade has unwound economic development.
Such a tiny tax, one tenth of one percent, would destroy the margins for money that is moved from one currency to another many times. One estimate I saw was twenty times per year. Since each transaction brings another imposition of the fee, twenty produces a two percent tax over the year.
Slowing down financial trading might make things more dull for computer screens from London to Singapore and Dubai to Wall Street, but it would only solidify real economies and trade in real goods and services.
As important for agreement to a Bretton Woods II.0, it would generate hundreds of billions of dollars in revenue. Even such a tiny tax multiplied by the immense financial markets would mean a huge source of stabilizing capital for use in all manner of productive pursuits. The tax would be paid by the financial sector, appropriately enough considering the hundreds of billions flowing in to rescue them. Plus, and as importantly, it would require an international cooperative arrangement of a breadth not seen before, but patently necessary -- as demonstrated by the fiasco we are currently witnessing.
Some short of structured exchange rate scheme is also essential. We must trade goods for goods through the medium of money. Trade which involved immense deficits by the United States and surpluses by the other nations of the world is upside down, to the detriment of all. The skilled manufacturing workforce of the U.S. was decimated by the cheap labor of nations whose governments insisted on surpluses. These foreign nations are now outraged by the collapse of their export market -- the American consumer -- and the simultaneous collapse of equities and currencies. The economic evisceration of the United States and the illusory wealth of the net exporters are now obvious as two sides of the same coin of debt.
Paul Volcker, former head of the Federal Reserve, mentions in a recent appearance at the Women's Economic Roundtable an exchange rate mechanism he worked on twenty-five years ago. As I understand it, adjustments to currencies would be triggered by certain levels of excess reserves.
To be clear, currencies must adjust the price of their exchange in order to equilibrate the trade of goods. It is the purpose of trade to move wheat to Asia and electronics to America, multiplied by the millions of products and hundreds of countries. This is trade. It is not trade to move Asian electronics to the U.S. and pictures of dead presidents on green paper to the vaults of Asian central banks. But the latter has been the experience on net of the world since about 1980.
And also to be clear, as devastating as the floating exchange rate regime has been to many of the world's economies, more devastating has been its brother, the free flow of capital. The movement of vast amounts of often highly leveraged capital in and out of nations has been a basic tenet of the free market fundamentalists, as epitomized by the IMF. This tenet has to be buried with the Washington Consensus.
Capital committed to a nation for projects or product development ought to be committed for more than overnight and in a form that does not morph in the middle of the project. But as we see with the current headlong rush out of developing nations, this is not so. Financial contracts treat capital as completely liquid. The currencies are decimated, plans are cut in half, and nations are left to pick up the pieces. The Tobin Tax is a dam against this wash of capital, but more stable structures ought also to be considered. The institution required to administer the tax is the perfect institution to consider and implement a more structured exchange rate regime.
So. A Tobin Tax:
- Slows the destabilizing free wash of capital (and to some degree the radical variances in exchange rates)
- Creates hundreds of billions in new revenues from an extremely broad base and an extremely low rate levied on financial actors.
- Necessitates a forum for international economic cooperation that will have new legitimacy and an independent budget.
Voila: Bretton Woods II.0