Fred Bergsten calls for monetary reform

Fred Bergsten of the Peterson Institute is the “enfant terrible” of US international monetary and economic debate. Fending off the passing years, it is a role he has played with great panache for the best part of half a century. Always at the centre of things, always provocative, frequently infuriating, he has, as head of the Institute (the IIE) since its foundation, heroically kept the subject of international monetary reform alive when many economists and governments wanted to put a stake through its heart and bury it. For that he deserves and has received much credit.

His latest demarche is vintage Bergsten. “J’accuse!” he roars, like a latter-day Emile Zola protesting at French anti-semitism. What is the object of his denunciation? There are 22 countries on his hit list of “currency manipulators”, led by China and Japan, and including Korea, Malaysia, Singapore, Taiwan, Thailand, Norway, Russia, Denmark,  and Israel.  Little Switzerland is put in the stocks as “the world’s largest currency manipulator”. Reform of the entire monetary system is required, and if “we”, the US, don’t get it, we must retaliate.

He quotes with apparent approval the infamous statement with which the “xenophobic” treasury secretary John Connally concluded a meeting with his advisers in August 1971 (four days after bringing the curtains down on the Bretton Woods system);

“I appreciate the advice from you gentlemen and want to share my own philosophy with you before we break up: the foreigners are out to screw us and our job is to screw them first.”

“Our goal”, Bergsten says, “must be to start resolving these crucial problems by reforming the global system decisively before the arrival of the next John Connally.”

He is right to see the problem as a lack of symmetrical adjustment. The idea is to repair the design fault that goes back to Bretton Woods in 1944, when the United States successfully defeated Keynes’ plan for a symmetrical system that would force adjustment on persistent surplus countries as well as debtors. The US was of course then the world’s largest creditor and surplus country. After it became the world’s largest debtor – during the Reagan administration  in the 1980s – it has taken the same view as the UK did at Bretton Woods; surpus countries should also adjust. But whereas the UK was then on its knees, and could be ignored,  the US still accounts for more than 20% of world GDP. The alleged “currency manipulators’  account for about one-third of world output. So Bergsten posits a world war between countries accounting for more than half of world output. Moreover, if the US acts by pushing its devaluation of the dollar further,  the euro area will be forced to cap the rise in the euro in self-defence. Then many medium sized economies will be dragged into it, such as the UK. (Germany also is in the dock for “obviating the usual adjustment pressures even more than other surplus countries” ; even though it doesn’t have its own currency, according to Bergsten, it is cleverly hiding its undervaluation behind the facade of the euro). Very few countries are content to see their currencies appreciate. It is, as he points out, a situation similar to the 1930s.

 The US has been the source of major shocks

But Bergsten turns a blind eye to the main source of the major monetary shocks to the global economy – which has for the better part of 100 years been the US Federal Reserve. The fact that, as he points out, currency depreciation has not been the object of its policy is beside the point. The spillovers of its policies on the rest of the world  have been frequently destabilising. The US is the elephant in the room and as Otmar Emminger, former Bundesbank president, used to say, it is not comfortable being in bed with an elephant.

Deliberate currency depreciation has been the province of the US treasury. The one consistent aim of US monetary diplomacy for 70 years has been to secure a competitive exchange rate. It remains its aim, supported by the Peterson Institute. Bergsten does say the US should “put its house in order” but by that he means, mainly, long-term fiscal consolidation. On currency matters it should throw its weight  around. Indeed, he accuses the US treasury of “shamefully” failing to name and shame the “currency manipulators”, as if the US were an innocent party!

On the origins of the current crisis, Bergsten does admit that “the Chinese and other surplus countries of course did not force US banks to make stupid subprime loans”. Exactly! But he insists that they “created the environment” for the crisis including “lax regulation”. This follows Ben Bernanke and others in wrongly emphasising net flows when what matters for financing are gross flows. The US finances its deficit from international markets; surplus countries do NOT “finance” deficit countries. Insofar as the US subprime bubble was financed abroad, it was largely by European banks, not by China. Nor is there much evidence of a rise in global savings during the so-called “savings glut” years. He ignores the arguments of Claudio Borio and others that the origin of the crisis lay in monetary factors – an undisciplined global financial system fuelled by central banks that paid little heed to asset prices and held interest rates too low for too long – and not in “global imbalances”. See my earlier post on the so-called Asian surplus here. And we are repeating it all over again now.

Wrong diagnosis

Again, Bergsten is right to call for reform. He is right to locate the source of the trouble in the international monetary system, in asymmetrical adjustment – and right also to indict the reserve currency role of the dollar as being bad fo the US – and I would say, bad for the rest of the world as well.. Where he goes wrong – and, dangerously, harks back to the 1930s – is his prescription for policy. His aim sounds idealistic:

“We should in fact seek to move as quickly as possible to a multiple currency system with manipulation-free floating, rather than today’s dollar-based system with extensive competitive intervention, and specific changes will have to be adopted for that purpose.”

But the result would be nasty. His recommended measures hark back to John Connally: rasie trade barriers against persisent currency manipulators, tax their money in the US, retaliate by aggressively buying their currencies and organise an array of international sanctions. He says that reserve currency centres shoudl have a bigger say in the IMF – contrary to the trend towards multi-polarity. In other words, his measures are nationalist and protectionist and rely on intimidation – what he calls “breaking the crockery”. Their introduction by the US would start a wrestling match where those with the biggest muscle – the US, China and the euro – would win, It would be likely to split the world into warring blocs. Small countries would be forced into the protective arms of bigger groups. World output could collapse.

Fred Bergsten is right to draw a comparison with the 1930s. But he draws the wrong lessons. As the architects of Bretton Woods rightly saw, the experience of currency chaos and nationalism underscored  the need for exchange rate stability, an international monetary standard and mutual adjustment of imbalances through the discipline of a fixed exchange rate system. As the late, great Jacques Polak once said to me in an aside “it is very difficult to bring the collective international interest to bear in the absence of par value exchange rates”. Bergsten should have paid more attention to the arguments of advocates of exchange rate stability, such as his mentor Charles Kindleberger, and scholars such as Ron McKinnon and Robert Mundell.

It is the floating rate system itself that givs incentives to national governemtns to pursue inward-looking policies that undermine global monetary cooperation.

At a time when many observers expect a period of relative dollar strength, such calls for action to depreciate it go against the grain of market forces. Currency war rhetoric can only hot up further.

Let’s hope cool heads prevail.

China and other ‘new’ surplus countries must rapidly develop the confidence to lead a reform of the international monetary system. Bergsten does a service in keeping the debate about this alive. But let us hope that the rising powers insist on  the case for a system that will bring people together rather than separate them. This would be achieved by the re-establishment of a proper international monetary standard – the options are summarised in my book. Ideally, this would constrain equally the monetary policies of all member countries. Let us hope, finally, that  more Americans will understand that the best interests of the US lie in such a reform.