------------ EH.NET BOOK REVIEW --------------
Published by EH.NET (March 2007)

Barry J. Eichengreen, _Global Imbalances and the Lessons of Bretton 
Woods_. Cambridge, MA: MIT Press, 2006. xix +187 pp. $26 (cloth), 
ISBN: 0-262-05084-6.

Reviewed for EH.NET by Anna J. Schwartz, National Bureau of Economic Research.


Barry Eichengreen has committed to print four lectures he delivered 
in Buenos Aires, Argentina. He starts out in the first lecture by 
challenging the view that Michael Dooley, David Folkerts-Landau and 
Peter Garber presented in a series of articles to the effect that 
there are similarities between the Bretton Woods System of 1958 to 
1973 and the present international monetary system. The center 
country in the Bretton Woods system, as well as since its demise has 
been the United States. Its balance of payments was in deficit 
earlier as well as currently; it was a source of foreign reserves to 
countries in surplus on the periphery both earlier and currently; it 
was open to exports from countries around the world earlier as well 
as currently; finally, surplus countries then and now have resisted 
revaluation of their under-valued currencies for fear of negative 
consequences for export-led economic growth, and for capital losses 
on their reserves stock.
Eichengreen's reponse to this list of similarities is a list of 
differences between then and now.

1. The possibility of reserve allocation did not exist in the Bretton 
Woods era. Then, the U.S. trade and current account balances were in 
substantial surplus, mitigating concerns about the stability of the 
dollar. The U.S. was saving more then than it was investing at home. 
It was investing abroad on net. Its accumulation of foreign assets on 
which it earned income betokened that the U.S. balance of payments 
would improve over time, but markets were not reassured that the 
system would endure, since the current account surplus began a 
decline in the second half of the 1960s.

2. Asian countries now constitute the periphery, whereas then, 
European countries dominated the periphery. Commonality of purpose 
and mutual trust are less advanced in the former than they were in 
the latter. Now China would prefer regional integration, but Japan 
favors bilateral agreements. Collective action sustained Bretton 
Woods from 1958 to 1971. Limited possibilities for collective action 
currently dim the forecast of the number of years the present system 
will survive.

3. One example of successful financial cooperation by the Asian 
periphery is the Asian Bond Market Initiative to encourage investment 
of reserves in local currency bonds, an avenue for reserve 
reallocation likely to grow over time. In the 1960s there was no 
comparable means of reallocating reserves.

4. Under Bretton Woods, the U.S. relied on regulations and controls 
to keep private investors from shifting dollar-denominated assets to 
foreign ones and short-selling dollars. Now there is less regulation, 
so private investors will have the option in the future if asset 
prices change to forsake dollar assets for other more attractive ones.

5. Domestic financial market structures differ from those that 
existed forty years ago. Then forced savings could be channeled 
through regulation into capital formation in the traded goods sector. 
Japan did so, as did European countries also. Thus then the 
distortions of undervalued exchange rates, repressed consumption and 
forced savings in the periphery offset other distortions that would 
have resulted in too little investment in the highly productive 
traded goods sector. Since then, in the 1990s, with persisting 
undervalued exchange rates, in a more deregulated financial 
environment, low interest rates and ample credit were available for 
the non-traded goods sector and the property market. Some Asian 
countries experienced property market booms that weakened their 
financial institutions. Currently, the same policies have led to real 
estate booms in coastal China. Asian authorities are aware that the 
export benefits of their exchange rate policy are offset by 
heightened financial risks.

Eichengreen predicts that Asian authorities will let their exchange 
rates rise, and will emphasize expansion of domestic demand, not of 
exports, that they recognize that traded goods are not the sole 
center of productivity and growth externalities. They will therefore 
promote balanced investment in both non-traded and traded goods.

To allow real exchange rates to rise, the cartel of Asian countries 
that have maintained the dollar's rate will need to cut back on 
intervention in the foreign exchange market, allocating part of their 
reserve portfolios, preferably to assets denominated in regional 
denominated currencies. This will cause the dollar to decline and may 
force the Fed to raise interest rates, curbing domestic absorption. 
The euro may rise against the dollar, harming European exports.

Eichengreen's final thought is that the end of the present 
international monetary regime is not far off.

Eichengreen asks whether more monetary and fiscal restraint by the 
U.S. would have lengthened the life of Bretton Woods, and whether a 
dollar devaluation against gold and foreign currencies would have 
countered a secular decline in the current account surplus.

Had the U.S. raised taxes and the Fed raised interest rates, domestic 
demand would have been curbed, and export competitiveness enhanced, 
strengthening the current account, but other countries' exports might 
have fallen, owing to the decline in U.S. domestic demand. Lower U.S. 
inflation might have stimulated capital inflows, and the drain on 
U.S. gold reserves slowed. In 1969, Germany might not have revalued 
the mark and delayed the end of the dollar standard.

Eichengreen believes that by raising the price of gold, expectations 
would have arisen that the step would be repeated, increasing the 
likelihood of a run on the U.S. gold reserve. A better course would 
have been floating the price of gold, but the authorities resisted 
severing the dollar-gold link until there was no other alternative. 
Also, had the U.S. raised the $35 per ounce price of gold, other 
governments might well have followed suit

In the present situation, Asian central banks foil the U.S. desire by 
buying dollars to prevent appreciation of their currencies, using the 
dollar accumulation as a hedge should the dollar decline against the 
euro.

In short, Eichengreen doubts that changed U.S. policies could have 
significantly prolonged the life of Bretton Woods. Countries would 
have needed additional reserves as the world economy grew, and gold 
and liquid claims on the U.S. were the available ones. As changed 
U.S. policies weakened their current accounts and increased capital 
outflows to the U.S., these countries might have responded by also 
tightening monetary and fiscal policies. World economic growth would 
have slowed and also demand for international reserves. But this 
would not have solved the Triffin dilemma that for other countries to 
acquire dollars, the U.S. had to run deficits that diminished 
confidence in the dollar. Bretton Woods would last only a little 
longer.

In the second lecture, Eichengreen reviews the reasons for the 
collapse of the Gold Pool. It was based on the idea that collective 
action by a cartel of countries would support the $35 price of gold. 
Divergent views of its members destroyed the Pool after six years. He 
sees a parallel in the cartel of Asian countries that by collective 
action seek to prevent appreciation of their currencies. Members' 
views are beginning to diverge, so cooperation becomes problematic, 
although the timing of the collapse of this cartel may differ from 
that of the Gold Pool.

In the third lecture, Eichengreen offers the example of how at the 
end of Bretton Woods Japan, which for two decades had pegged the yen 
at 360 to the dollar, on 28 August 1971 loosened the peg, as a 
precedent for China to follow in decisively allowing the exchange 
rate of the yuan greater flexibility.

The title of the fourth lecture, "Sterling's Past, Dollar's Future," 
succinctly describes the content. Eichengreen notes that the holdings 
by foreign central banks of U.S. liquid liabilities which are large 
relative to holdings of foreign liquid liabilities by the Fed and 
U.S. government are not a threat to the reserve currency status of 
the dollar. Similarly, before 1914, Britain borrowed short and lent 
long, and liquid claims of foreign official creditors exceeded 
British liquid assets, yet Britain ran current account surpluses. 
However, what makes the U.S. case currently a worry is that it occurs 
when the banker to the world has been running large ongoing current 
account deficits. Importing short-term capital and exporting 
long-term capital, Eichengreen argues, do not require a current 
account deficit. The deficits and U.S. growing net foreign debt 
threaten the U.S. hegemony.

With no change in U.S. policy, but a rise in inflation because of a 
falling dollar, foreigners will decline to add dollar-denominated 
securities to their portfolios. Once the dollar exchange rate falls 
in response, a flight from dollars may result. In Eichengreen's view, 
only if the Fed can raise interest rates just enough to contain 
inflation without producing a severe recession, will a financial 
crisis be avoided and correction of the current account deficit ensue.

Sterling's loss of international preeminence followed repeated 
inflation episodes and devaluations against the dollar. Given good 
economic management, the dollar need not lose its reserve currency 
status but it will share it by 2020 or 2040 with the euro, assuming 
the health of the European economy improves. Eichengreen believes it 
is premature to consider the yuan as a possible new reserve currency.

There is much to learn from these lectures about the past and current 
international monetary arrangements. I disagree with Eichengreen's 
reference to the twin deficits as an important factor that explains 
the current account deficit. The relationship has sometimes been 
observed, and at other times not. This is true for the U.S. as well 
as other countries. I also do not share his view that the persistent 
current account deficit is a U.S. problem that only the U.S. can 
solve. The current account deficit is a global problem that other 
countries as well as the U.S. must cooperate to manage. The leading 
capital exporters to the U.S. (Japan, China, Germany, Russia) with 
current account surpluses are required to reduce their own and the 
U.S. imbalances. What the U.S. can contribute is a program to raise 
national savings.


Anna J. Schwartz is writing a monograph on the history of U.S. 
official intervention in the foreign exchange market (with Owen 
Humpage and Michael Bordo).

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