------------ 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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