x Abu Dhabi, UAE Thursday 20 July 2017

Stuck in limbo on a well-trodden path

The global economy is in familiar territory, and with its G20 presidency, France has an opportunity to address the issues. But still, it seems, not enough has been learnt from the past.

Complaints about the inflationary effects of American monetary policy are rampant, despite there being barely a hint of inflation in the US. Rapidly growing catch-up economies are paddling furiously to avoid being dragged down by a torrent of capital inflows. Prominent policymakers, desperate for alternatives to the US's malfunctioning monetary system, have gone so far as to speak of a return to the gold standard.

I am not talking about this year, but about 1964. We have been here before.

In 1964, it was the rapidly growing economies of Europe, still catching up to the US, that were howling about the Federal Reserve. As a result of a recklessly expansionary American policy, they argued, they were being flooded with imported finance. The US was "exporting inflation".

American officials countered that the financial inflows reflected Europe's underdeveloped capital markets. Europe's inflation problem was a by-product of the reluctance of its central banks to tighten policy more aggressively, and the hesitancy of European countries to let their currencies rise, reflecting their long-standing commitment to export-led growth.

Plus ça change, as the French might say.

What the French under Gen Charles de Gaulle actually did say was that fiat monies should be jettisoned in favour of the gold standard. The US would then be subject to tighter policy discipline. But the French never explained exactly how restoration of the gold standard might be accomplished, or how it would translate into price and economic stability, given the volatility of gold markets and the disastrous consequences of the gold standard - not least in France - in the 1930s.

The debate, in other words, was as confused and confusing as it is today. Its one positive effect was to launch an effort to reform the international monetary system. So now that the French government - not them again! - has committed to making international monetary reform the centrepiece of its presidency this year of the Group of 20 leading and emerging economies, it is worth recalling the cautionary tale of the 1960s.

Back then, international monetary diplomacy focused on creating a new form of international reserves, what became the IMF's special drawing rights (SDR). The idea was that by issuing SDRs, the IMF would provide catch-up economies seeking to accumulate reserves with an alternative to piling up dollars. The US could no longer run balance-of-payments deficits "without tears". American policy could be curtailed without starving the global economy of liquidity.

The effort failed completely. SDRs never became an attractive alternative to the dollar, only modestly supplementing dollars and other national units in international use. Because they did not trust the IMF to assume the powers of a global central bank, the IMF's members established high hurdles to creating SDRs. Private markets in SDR-denominated instruments similarly failed to develop, in turn limiting their appeal to central banks.

The other focus of negotiations in the 1960s was an effort to enhance exchange-rate flexibility. Proposals to this effect - a response to the emergence of chronic surpluses in Germany and Italy, and chronic deficits in the US - attracted growing attention once the SDR negotiations sputtered to a close in 1968.

But with other countries having enjoyed two decades of export-led growth as a result of pegging their currencies to the dollar, there was a reluctance to mess with success. While the IMF, in a high-profile report on exchange rates in mid-1970, endorsed the principle of greater flexibility, it offered no new ideas for getting countries to move in this direction and proposed no new sanctions against countries that resisted. International imbalances continued to mount until the system came crashing down in 1971-1973.

The French government's recent hints about its reform agenda for this year suggest that, contrary to earlier speculation, an enhanced role for SDRs will not be at the centre of its efforts. Rather, the Sarkozy administration will seek to develop mechanisms for managing the transition to an international currency system in which the dollar, the euro, and the yuan all play consequential global roles.

This is a step forward, one that reflects real learning from history. But the French have not indicated that they will push for sanctions against chronic surplus countries that fail to adjust their currencies. The absence of such sanctions was a critical weakness of the original Bretton Woods system, and it remains a central weakness of our own - not coincidentally referred to as Bretton Woods 2.

Without sanctions to police global imbalances, the French step forward will take us halfway across a yawning chasm. In mid-air, with neither firm ground below nor enough momentum to make it to the other side, is not where the global economy should be.

 

Barry Eichengreen is a professor of economics and political science at the University of California, Berkeley, and the author of Exorbitant Privilege: The Rise and Fall of the Dollar and the Future of the International Monetary System, published this month.

* Project Syndicate