On the Agenda for Bretton Woods II
One may regard it as a mistake to convene a conference that is widely described as Bretton Woods II without the two years plus of preparation that preceded Bretton Woods I in 1944. But the die has now been cast, and the leaders of the G-20 countries are going to convene shortly in the first stage of what is widely described as Bretton Woods II. That being so, it behooves those of us interested in the topic to suggest the agenda that they should pursue.
It is doubtlessly inevitable that a conference convened in the midst of a world economic crisis will devote much of its attention to measures to address the crisis. I happen to think that the relevant set of measures (with the possible exception of a fiscal stimulus) have already been adopted, and that the best contribution the leaders could make would be to respect the adage: "Don't just do something, stand there." I doubt that they will see things the same way.
But irrespective of what they do to try to resolve the crisis, they will surely also want to begin to address the topic of reconstructing the international financial system so that it is less prone to crisis in the future. It is this subject that I wish to discuss.
The first topic that they will have to address is who to put in charge of the reconstructed international financial system. The options seem to be: a G-something; the Financial Stability Forum (FSF), which was invented after the Asian crisis; the International Monetary Fund (IMF) that was invented at Bretton Woods I; and some completely new organization. I am provisionally in favor of giving this responsibility to the IMF. All the G's exclude any influence of the smaller countries, which deserve to have a say in the future international financial system. The FSF is basically a transatlantic group of countries, plus the international organizations, with a minimal role for the Asians, whereas the need of the day is to give the Asians a weight that reflects their current role in the world economy. Creating a new organization would confront the same problems of power politics as reconstructing the IMF and would deprive the world of the services of its highly competent staff as a secretariat. Ergo, I prefer a reformed IMF.
The proviso is that the IMF is indeed reconstructed to reflect current realities. This means allowing the position of the Managing Director to be open to those of any nationality rather than restricted to those coming from a particular geographical region; ensuring political direction of the Fund by finally creating the Council; and altering the balance of power in favor of Asia at the expense of Europe. The minimal reform agreed earlier this year does not begin to address the need to make potential borrowing countries feel that this is now their organization and that it can therefore be expected to address their problems sympathetically.
Having decided who is to be in charge of the international financial system, and reformed its governance to make it a fit instrument for the role to be assigned to it, the next task will be to decide the nature of the reforms that are to be legislated. These are essentially financial reforms; no one has been criticizing capitalism in general. I am among those who would like to see a reform of things like the exchange rate mechanism and the rules for the provision of international liquidity, but it is not widely agreed that weaknesses in these areas caused the current crisis. The leaders will surely want primarily to prevent a recurrence. There are two views about the extent to which the crisis is a result of macro excesses versus weaknesses in financial regulation and supervision, but no one doubts that the latter contributed and are not at present internationally managed, so one would expect the leaders to focus on these.
Note that it was not so much deregulation as the failure to regulate new instruments that was the weakness we need to remedy. For example, derivatives traded on an exchange at least have the potential of being regulated, while the over-the-counter derivatives that have proliferated are completely unregulated. The leaders might wish to indicate their desire to see the vast bulk of derivatives traded on exchanges.
The objective should be to turn the IMF into a body where national authorities agree on the outlines of what each of them will legislate. In particular, one envisages that an international agreement made in the IMF will lay down minimum standards that all countries will ensure. The actual tasks of regulation and supervision will remain national responsibilities.
There are several other features that the leaders might agree to specify as terms-of-reference for their officials. For example, they could specify that they wished to see a system of regulation that builds in countercyclical features (in place of the procyclicality of Basel). Another possibility would be to relieve companies of mark-to-market accounting when, but only when, they can show that the assets are financed by long-term liabilities. They might wish to ensure that initiating financial institutions retain a proportion of the securities created from the loans they originate on their balance sheets, to limit moral hazard. Less relevant to the current crisis but of major long-term importance in securing adequate tax revenues, they might wish to outlaw tax havens. Technical solutions are known that could meet all these requirements, but the political will to legislate them has been lacking in the past. The leaders might also remit one or two challenges to the deputies, such as restricting compensation of executives to rules that would give them incentives to behave in socially-responsible ways.
There is not a lot of time before the start of the conference to develop proposals. The leaders will therefore have to stay fairly general. This does not mean that the conference need be a waste of time, provided that the conferees do not imagine that they are facing the end of capitalism or battling a repeat of the Great Depression. There are ideas on which much work has already been done, and there were prophets of doom—Ned Gramlich on housing finance, Paul Woolley on financial sector rewards, Warren Buffet on derivatives—from whom we can learn. The challenge will be to identify a coherent set of proposals regarding the financial sector and focus the leaders on those issues, rather than run the risk of their addressing everything and agreeing on nothing or, worse still, agreeing on the infeasible and thereby contributing to a new collapse of confidence.