John B. Judis: Economists know the fatal flaw in our system--but they can't agree how to fix it





For those Americans who are not daily readers of the Financial Times, the past few months have been a crash course in the abstract and obscure instruments and arrangements that have derailed the nation's economy. From mortgage-backed securities to credit default swaps, the financial health of the country has undergone a gory public dissection. And yet, as Barack Obama prepares to take office, one particularly frightening problem has escaped public notice; indeed, it may not even make the agenda of the global summit being held this weekend, dubbed "Bretton Woods II" after the postwar system of currency controls. The international monetary system is in big trouble.

For decades, the United States has relied on a tortuous financial arrangement that knits together its economy with those of China and Japan. This informal system has allowed Asian countries to run huge export surpluses with the United States, while allowing the United States to run huge budget deficits without having to raise interest rates or taxes, and to run huge trade deficits without abruptly depreciating its currency. I couldn't find a single instance of Obama discussing this issue, but it has been an obsession of bankers, international economists, and high officials like Federal Reserve Chairman Ben Bernanke. They think this informal system contributed to today's financial crisis. Worse, they fear that its breakdown could turn the looming downturn into something resembling the global depression of the 1930s.

The original Bretton Woods system dates from a conference at a New Hampshire resort hotel in July 1944. Leading British and American economists blamed the Great Depression and, to some extent, World War II on the breakup of the international monetary system in the early 1930s and were determined to create a more stable arrangement in which the dollar would replace the British pound as the accepted global currency. The new system, devised by economists Harry Dexter White and John Maynard Keynes, fixed the dollar's value at $35 for an ounce of gold. National governments, rather than speculators, were to set the value of their currencies in relation to the dollar and would have to disclose any changes in advance to the new International Monetary Fund (IMF).

The dollar became the accepted medium of international exchange and a universal reserve currency. If countries accumulated more dollars than they could possibly use, they could always exchange them with the United States for gold. But, with the United States consistently running a large trade surplus--meaning that countries always needed to have dollars on hand to buy American goods--there was initially little danger of a run on the U.S. gold depository....

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