A Second Bretton Woods
With the world economy on fire, what are the two most important steps needed to get to safer shores?
October 13, 2008
In case you have been in a coma for the past six months, here is some stunning news: The world financial system has collapsed. Yes, it has collapsed.
The structural paradigms that have guided international finance and commerce for the past two decades lay in a heap of smoking rubble. No one — no central banker, no treasury secretary, no finance minister, no Oracle of Omaha — can put the pieces of the old system back together again.
Efforts to patch together ad hoc solutions aimed at restoring former structures are doomed to fail. Confidence is shattered to the point where money will continue to seek safe havens. Capital will continue to retreat from foreign adventures.
And relatively superficial technical issues such as sub-prime mortgages will continue to expand outward to other financial sectors and migrate to Main Street with increased ferocity, further undermining market-driven debt and equity structures. Government accounts will be called into question.
The age of Neocapitalism has come to an end. The perverse intellectual spawn of Milton Friedman and his acolytes at the University of Chicago, "Neocapitalism" was built on several pillars of common sense that have been twisted into a unique form of pretzel logic by unscrupulous politicians and naive political consumers around the world.
No, lowering taxes will not raise tax revenues — unless the tax rate is punitive. No, government deregulation does not breed market self-regulation. No, markets do not always make the right decisions and behave in a rational manner.
That these precepts had gained such unassailable currency in the global discussion is a function of both greed and ignorance — most likely willful ignorance driven by greed.
In the current crisis, "neocaps" have been stabbed in the back by their political soul-mates, the Neocons. As the "neocap" philosophy has come unhinged, a global backlash against it has been exacerbated by the unilateralism of America's neocons.
America has had few friends around the world through this crisis because of its recent neocon foreign policy. Accordingly, multilateral consensus on how to deal with the economic crisis has given way to an every-man-for-himself philosophy. "Let the Americans stew in their own juices!" And this attitude prevails at a time when solutions to the economic crisis demand multilateral consensus over and above all other factors.
To be sure, the Bush Administration has been a day late and a dollar short in dealing with this crisis every step of the way. It is Katrina writ large. But the Bush Administration is not solely to blame. Foreign economic stewards have taken insular and uncooperative positions, reinforcing Administration tendencies to go it alone.
Assigning blame is all well and good. It is important, however, only to the extent that one must understand one's mistakes in order to correct them. The only question on people's minds right now should be: How do we correct things?
I certainly don't have the solution. But I have some basic ideas that might provide a kernel of thought to policymakers. First, I don't think the existing systems can be put back together again. Second, I think we need to start designing the new system right away.
The new system must derive from clear multilateral consensus. Accordingly, as the essential first step, a meeting of the world's finance ministers, monetary officials and leading economists should be scheduled for early January. The location: Bretton Woods, New Hampshire.
At the meeting, the missions of the world's post-war financial institutions, the World Bank, the IMF and the WTO, need to be redefined and their powers expanded — or reduced — to cope with the drastically changed geo-economic environment of the 21st century. More importantly, two new multilateral bodies need to be established.
The first new body is a Global Wealth Fund. Such an entity needs to be vested with an enormous amount of capital — upwards of $3 trillion. This money needs to be derived from sovereign investors from around the world and augmented by private capital.
Everyone who expects to participate in the new global economy — the United States, the EU, Japan, China, the oil states of the Middle East, Russia and all the others need to pony up cash. Private investors, including pension funds, trusts and endowments, also need to contribute in order to preserve the value of the assets they currently hold.
Such a mega-fund would be empowered to invest in the global financial system on a for-profit basis. It needs to provide capital to financial institutions in exchange for common and preferred stock. It needs to assure global borrowers that short-term liquidity is available at reasonable rates of interest. And it needs to intervene in certain segments of the bond markets in much the same way a vulture fund would operate.
Such an entity, armed with enough capital and global will to cower any brazen market participant thinking of bucking its power, would have the immediate effect of restoring confidence in the markets and allow for a rational process of stabilization.
The second new body is a World Financial Regulatory Authority. This body must define the new rules of global finance that will apply to all financial entities that operate across borders. This entity must put an immediate end to the concept of competitive deregulation, a process whereby financial centers weaken their regulatory oversight to attract business from other financial centers.
Through this financial crisis, it has been convenient to simply blame Wall Street. But the bigger culprit has been the City of London. It is the city that has led in the proliferation of exotic instruments — and even more exotic derivatives.
It is not by accident that the world's financial institutions — banks from the United States, Germany, France, Japan and elsewhere — congregate in the city to run their global trading and derivatives books.
It is the most user-friendly regulatory environment in the world, and the freedoms allowed by the London regulators have put enormous pressure on regulators in other financial centers to remain competitive and keep pace.
Sarbanes Oxley is a clear case-in-point here. The United States enacted strict regulatory guidelines for public companies. As a result, U.S. companies started to list on the London Stock Exchange, whose Alternative Investment Market segment provides only perfunctory oversight.
Wall Street firms in turn went back to the U.S. Congress and demanded that Sarbanes Oxley be revised, lest New York lose ground in its financial center competition with London. This dynamic has been played out over and over again since the early 1980s — and it cannot continue.
A World Financial Regulatory Authority would govern only global financial institutions. And its statement to the markets would be simple: If you want to play in the global markets, you play by these global rules.
The enforcement mechanism would work in much the same way as the European Union promulgates its rules. The Regulatory Authority would issue directives, which would then be enacted into law by the member countries. Such a process would allow the global financial system to come under a uniform and consistent set of rules, even as individual countries maintain complete sovereignty over their domestic financial systems.
These steps would pave the way for the development of a financial system for the 21st century, one that is in tune with the vagaries of the global marketplace.
It took a World War for leaders to get together at the first Bretton Woods. Let's not wait for that to happen again.
Everyone who expects to participate in the new global economy needs to pony up cash to a Global Wealth Fund.
A World Financial Regulatory Authority must put an immediate end to the concept of competitive deregulation.
A World Financial Regulatory Authority's statement to the markets would be simple: To play in the global markets, you must play by global rules.
Through this financial crisis, it has been convenient to simply blame Wall Street. But the bigger culprit has been the City of London.
"Neocapitalism" was built on several pillars of common sense that have been twisted into a unique form of pretzel logic.