Author: Tanya Rawat
The classical theorem of an ‘Invisible Hand’ is based on a very simplistic assumption that in the pursuit of maximising self-interest, individuals and/or entities, inevitably end up with outcomes that lead to a greater good of the society. With the current international financial system displaying hues of an asymptotic convergence to a pre-Bretton Woods era of fragmented ‘beggar thy neighbour’ philosophy with dire apathy to global welfare economics, Joseph Stiglitz’s stark reprove of the same bears resonance.
A world on a Gold standard post World War II felt the need to re evaluate the established system of an accepted currency regime. The planners at Bretton Woods had learnt harsh lessons from the Great Depression and World War I when creditor nations driven by self-interest demanded the repayment of Allied war debts and compensations leading to a breakdown of the international financial system and a worldwide economic depression. The goal was to avoid a recurrence of the closed markets and economic warfare that had characterized the 1930s. The Bretton Woods conference was an offshoot of a combined effort between the countries of the developed world towards economic prosperity and political stability in the post-war era. It led to the establishment of the IMF and the IBRD (now the World Bank); financial helplines for the world still in existence today. Additionally, whilst Keynes (in a joint study with E.F. Schumacher) suggested ‘Bancor’ as a world reserve currency and policies supporting economic growth, Harry Dexter White was propagating an amenable system of global financial liquidity via price stability across the world economies. Neo-mercantilist statesmanship preceded a global panacea and on the objection of the United States, the US Dollar was proclaimed the ‘reserve currency’. Thus, the US dollar took over the role that gold had played under the gold standard and backed by it, it was termed as ‘good as gold’ in the international financial system.
However, by the 1970s, heavy spending on the Vietnam War, Lyndon Johnson’s Great Society and the negative accrual of this system in light of the Triffin Dilemma were gaining traction. The Triffin Paradox is a theory that when a national currency also serves as an international reserve currency, there could be conflicts of interest between short-term domestic and long-term international economic objectives. In order to maintain enough liquidity in the world to fulfil world demand for this ‘reserve’ currency inevitably causes a permanent trade deficit for the originator currency. It drew conclusion that, if the United States failed to keep maintaining this, the world financial system would come to a halt. As a corollary, the sustained deficits eroded confidence in the currency as a reserve currency and created instability.
President Nixon subsequently suspended the convertibility of dollars in gold, ending the Bretton Woods system. Followed by the Smithsonian agreement in 1971, the US entered negotiations with its industrialised allies to appreciate their own currencies against the Dollar in response to the adjustment of the fixed exchange rate regime.
After the collapse of the Bretton Woods system in 1973, the IMF’s SDR was redefined from being equivalent to 0.888671 grams of fine gold (equivalent to one US dollar) to a basket of currencies consisting of the euro, Japanese yen, pound sterling, and US dollar. The basket composition reviewed every five years by the Executive Board, or earlier if the Fund finds changed circumstances warrant an earlier review ensures that it reflects the relative importance of currencies in the world’s trading and financial systems. Given China’s rise to prominence in the international trade and capital markets, it is only but natural that the next review in 2015 assesses the Kuai’s feasibility, as it inches towards full convertibility if we are to believe central bank adviser Li Daokui.
The financial crisis of 2007, Eurozone conundrum and the insistent currency wars bring a theme of sombre analogy to a pre-Bretton Woods era and stress a rethink of the global paragon of a reserve currency. Ideally, it should involve a gradual move away from the US dollar and any other singular currency alternative and towards exploring the status of International Monetary Fund’s (IMF) Special Drawing Rights (SDR) as a supranational currency. The SDR is neither a currency, nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Holders of SDRs can obtain these currencies in exchange for their SDRs in two ways: first, through the arrangement of voluntary exchanges between members; and second, by the IMF designating members with strong external positions to purchase SDRs from members with weak external positions. In addition to its role as a supplementary reserve asset, the SDR serves as the unit of account of the IMF and some other international organizations.
Nationally motivated imposed barriers and restrictions on international trade, Foreign Direct Investments (FDI) and often-autarkic protectionist policies are self-defeating and as history is precedent, now more than ever, we need statesmen and women to understand this watershed moment and collaborate as the world once did in 1944 to execute a Bretton Woods: Part Deux.
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