In the light of the causes of the 2008 crisis as well as the ongoing deterioration of the UK economy under quantitative easing and the very high differentials in advantages gained from policy by different sections of the community, there is a need to understand how we have arrived at this point. This is not just a UK phenomenon, it is global. Therefore it is as well to try and identify the mix of sound or dubious practice and misleading statements made by national and international policy makers. In particular, with the call for a new Bretton Woods it would be useful to understand why this went wrong and how its promise misled most with regard to its likely impacts on the world economy.
Some associated facts of relevance
In 2014, the Bank of England published an interesting explanation of how banks credit accounts to create loans (debt), i.e. essentially out of thin air ( See, "Money creation in the modern economy" ).
However, for something like over 400 years similar process had been in place, very much unknown to the general public with such financial procedures being somewhat of a mystery. The general workings of banks tend to have remained outside the immediate concerns of the population or even companies whose primary interest has been to borrow money at a favourable rate of interest.
What was not taken into account was that such transitions as significant population rises in Commonwealth countries and the normal process of economic development was going to result in the British economy not being able to trade in sufficient volumes in relation to the national needs of its partners to avoid the problem of Commonwealth countries cashing in their pound sterling for gold. An underlying assumption on the part of the Bank of England was that Commonwealth members would not ask to convert their pound sterling holdings into gold.
United States bent of dominance
What could be interpreted as a fraudulent monetary scheme, by some, enabled Britain to live beyond its means for quite some time. With so much capital in circulation there was effective development of many technologies and many foreign entrepreneurs saw Britain as the place to convert their inventions into future income streams.
Having understood that much of the extraordinary growth of the British economy since the eighteenth century was driven by this system where the main financial costs were paper and mint operational costs (fractions of a penny per pound sterling) and the ink and time required for bank clerks to enter large loan values in pounds sterling in leather bound ledgers, one of the objectives of the USA was to get rid of the Imperial Preference and with the dollar-gold link as “the international reserve currency”, to undermine sterling and the prowess of the British economy. Later, this US strategy succeeded after some time with the rising UK trade deficits ending up with Commonwealth counties demanding gold in exchange for accumulating pound sterling.
It is necessary to place this British track record as a case study to understand the strategic objective of the USA in attempting to emulate this model to gain advantage for the country through the subsequent shaping of the Bretton Woods accord.
Bretton Woods was an attempt to reshape the economic development framework of the world economy following the war that ended in 1945. The USA essentially wished to apply the British Imperial Preference model as a new USA Preference model based on the dollar and extended to "collaborative nations". During the Bretton Woods negotiations there was an intense rivalry between the UK and the USA. However, much of the negotiation involved academic discussions on options for currencies when what should have been happening was for the British contingent to explain to other countries where this was going to end up. The problem is the general potential dangers were not fully taken on board and the USA, wining and dining delegates in an up market hotel where much business and arm twisting took place in bars and expensive restaurants.
The USA refused to accept John Maynard Keynes' far better proposal for the Bancor, a proposal for a more neutral international currency, less dominated by any particular national currency, which he had developed with Ernst Schumacher.
Therefore, amongst the strategic objectives of the USA were to use Bretton Woods to reduce the influence of Britain and pound sterling as a reserve currency on the international stage by undermining existing benefits of its remaining empire with GATT, as part of the Bretton Woods deal, undermining Imperial Preference and with the dollar-gold link becoming the central kingpin of the new international financial system and eventually replacing sterling.
This turned out to be successful with the persistent UK trade deficits ending up with Commonwealth counties demanding gold in exchange for accumulating pound sterling.
Robert Triffin (1911-1993), while not being able to make use of the demise of the British Imperial Preference as a case study, because it had not taken place at that stage, explained in 1959 that the dollar, as a national currency, was unsuitable as an international reserve currency because of the significant benefits bestowed on the country concerned as well as the practical difficulties of managing domestic needs with the needs for the reserve currency of other countries. He predicted that this setup would fail. Basically the size of the USA economy, in spite of its relatively large and expanding size, would be unable to embrace the potential growth needs of the world economy. For example, as the lead reserve currency, the entire world would need dollars to finance world trade.
What is somewhat amazing is that in these largely closed discussions, few appeared to appreciate the full extent of the benefits Bretton Woods was bestowing on the future power of the USA. In 1959 Triffin's opinions were ignored, the actual risks facing the USA were not fully understood.
For example, as the lead reserve currency, the entire world would need dollars to finance world trade. What is somewhat amazing is that in these largely closed discussions, few appeared to appreciate the full extent of the benefits Bretton Woods was bestowing on the future power of the USA. The best summation of this new Imperial Preference model but applied to the notion of the dollar as an international reserve currency was made by Barry Eichengreen who explained,
The rise of the American Empire
With the USA seeing unprecedented economic growth "on the cheap", based on the dollar international reserve currency status. By 1965 the USA was "consuming" 65% of global resources but this was not going to last long. Increasingly countries accumulated dollar reserves believing in the US commitment to convertibility into gold. This of course was the same benefit those Commonwealth countries had enjoyed with respect to the British pound.
The unstable craft in an increasingly choppy sea
However, by 1971, just 25 years following its creation, the Gold Standard was under pressure because increasing numbers of countries were cashing in their dollars for gold. To try and stop this drain on gold reserves, in 1971 delegations headed by U.S. Treasury Undersecretary Paul Volcker and Federal Reserve Board member Dewey Daane of the Richmond Federal Reserve Bank, did the rounds trying to dissuade European counties, such as The Netherlands, from cashing in their dollars for gold. In private conversations, while never admitting the USA did not want to honour its obligations, the offending bank governors, such as Jelle Zijlstra president of the Dutch central bank, was accused by Volcker of "rocking the boat". Zijlstra observed that,
However, Triffin's predictions proved to be correct because with global economic growth the USA was not able to settle the accounts between countries on the basis of a Gold Standard. As a result, when the USA faced this crisis in the run up to 1971, with several countries requesting settlement of dollars held in exchange for gold. As a result, the Gold Standard collapsed when Nixon removed this obligation. Up until 1971 the USA's competitive position meant the trade balance had remained in equilibrium but the implications of coming off the Gold Standard became serious as, coincidentally, increasing numbers of countries, such as Japan in several goods and in particular consumer electronics, were beginning to produce more competitive products than the USA so the trade balance of the USA rapidly became negative in the 1980s and the locking in of dollar and other currencies to a standard collapsed, the USA began to lose what had been a competitive advantages in some industries. Now with no benchmark in a sea of floating fiat currencies the USA and the UK rapidly lost their global "competitive positions" in industry and manufacturing.
From a national strategy to mutual suicide pact
In basic terms, the US strategy to undermine the power of Britain in a desire to become the world's dominant force backfired to become a pathetic mutual suicide pact under Bretton Woods. Both the UK and USA, in reality maintained some competitive industries so that when the slide began in 1971 the UK's balance of payment dived first to be followed a decade or so later by the USA.
By the mid 1980s in the middle of the slumpflation crisis Japan and several other countries were producing competitive products and UK and US corporations were causing declines in their national competitive positions by opting for offshore production, largely in South East Asia. As can be observed the USA decline was put off by the slumpflation crisis linked to the rapid rise in international petroleum prices creating the notion of "recycling fiat dollars" from the Middle East with the US being quick to introduce the quotation of international petroleum prices in dollars ("petrodollar") creating a multi-billion dollar trading activity benefiting specifically US traders (Nymex) and economy.
One of the slightly odd decisions made by the UK was to abandon the Commonwealth country interests in joining the European Community (EU) in 1973 largely on the basis that this would be the largest single global market.
The massive increases in the price of petroleum led to the decision to quote and trade petroleum in dollars. This was because the trade deficit was rising rapidly in the USA and switching to the petrodollar gave the US breathing space to circulate dollars based on an imported item of significance. This was to avoid the Triffin trap. However within a decade, the loss of position of USA economy turnover compared with that of global currency needs meant this tactic lost effect and US trade deficits rose sharply.
How the USA benefited from IMF and World Bank (WB) operations
The IMF and World Bank have been used by US administrations to the advantage of the USA with significant decisions being overseen and vetted by the State Department. Decisions on loans by both the IMF and the World Bank have imposed conditions to the benefit of US banks and industry or have seen preparatory work by dedicated World Bank staff being used to filter out opportunities for private US banks. The extraordinary size of WB loans has been used for many years to encourage politicians in low income countries to agree to WB conditions which invariably opened up business for US banks and corporations. The typical outsized WB loans combined in insufficient absorptive capacity of most low income countries led to waste and opportunities for corruption. Even the low income IDA provisions became a conduit to large infrastructural equipment supply contracts to US manufacturers. By the 1990s the performance of World Bank loans can under closer scrutiny and an internal report. This showed that something like 35% of loans were failing. Many loans were authorized to pay off outstanding loans. The stipulation of all loans needing to be subject to economic rates of return estimates was shown to have been abandoned with only around 20% of approved loans having had Cost-Benefit Analyses. In another report by the WB Evaluation Group, in spite of the "reorganization" that took place in the mid-1990s only confirmed in 2010 that the state of affairs remained the same.
States, in such countries as Brazil, were negotiating directly with the WB as a lever against their own federal government. Some State politicians were using specific projects linked to the environment as ways to extract funds for their election campaigns while elements in the WB justified "reductions" in project allocation to the Procurement Department staff while obscuring the fact that the actual work requirement had been drastically reduced, leaving even more funds for election campaigns.
A trail of WB hydroelectric projects has displaced millions of people worldwide without compensation and when the WB secured administration of the Global Environmental Facility (GEF) as a Trust Fund, a considerable proportion was used to fund the environmental appraisals of coal fired power stations.
The result of over 75 years of development under the Bretton Woods framework we find a world characterized by rising income disparity, declining production and consumption sustainability and an accelerating climate crisis.
The WB has published such reports and yet the flow of authorized projects without effective economic appraisals has continued to a grand total exceeding $400 billion over the last 10 years. The reason is that Senior Management are totally compromised in working closely with government and politicians from Member States most of whom do not want close audits on the efficacy of their pet projects, many of which are election fodder. As a result, senior management is aware of the fact staff are not completing economic rates of return analyses as required, but allow this to continue to make their own life easier with the political elements. In terms of WB regulations for clients it is do as I say not as I do leading to an unacceptable level of project design quality. The most advanced developments in project design procedures that trade off social, economic and environmental criteria, in the context of Sustainable Development Goal actions, is to be found in small private specialized groups and no longer in the WB.
The denial of reasonable expectations turns dreams into nightmares
An IMF Global Financial Stability Report (October 2014) pointed out that low interest rate policies under quantitative easing were exacerbating instability by creating a global imbalance with too much risk taking in asset positions as opposed to investment for growth according to José Viñals a financial counselor of the IMF in Washington. Risks to global stability were stated to no longer come from conventional but from the so-called shadow banking or grey financial market in which hedge funds, financial market funds and investment banks participate and who are not dependent upon savings deposited from the public.
The IMF had analyzed 300 large banks that hold something like 40% of total bank assets in developed economy all of which lacked adequate critical mass to provide credit for investment for recovery. In the Euro Zone this precariousness affected 70% of the banking system. There has been a massive rise in financial transactions within the grey financial markets where low interest rates are providing a direct incentive for investors taking higher risks in asset investments leading to significant liquidity risks on par with 2007 compromising the current state of global financial stability.
The IMF Report considered the prolonged period of very low interest rates to be building up a high risk status for the economy and the likelihood of a new financial crisis by encouraging excessive risk taking on global markets. The IMF Report went further in classifying the character of the growth in financial positions to be speculation.
It is now eleven years since the disastrous WB performance report and seven years since that IMF report and no substantive action has been taken. Quantitative easing has continued with a vengeance, promoting global income disparity, debt, falling sustainability an accelerating climate change.
The recent events in the USA serve to illustrate that a country that asks that the world to do as it "advises" rather than as it does, does not inspire the level of trust needed for such a country to consider itself fit for world leadership. Leadership is confused with power, economy or military expenditure but this is no substitute for leading through example. However, the society of such a country needs to be able to live out its life as a harmonious union and not as a gaggle of competing and sometimes uncivil and other times extremely violent groups. The trail of killing of unarmed individuals by poorly trained police continues setting no example to anyone.
The appeal to hope and dreams that soak the statements of US presidents and politicians, of creating " a more perfect union" pall at the widespread global violence dealt out in military ventures during the period of Bretton Woods with over 20 million people having perished in the wake of this violence.
Donald Trump served to uncover the more unacceptable aspects of US society by simply appealing to those who have been ignored for too long by all major political parties. Joe Biden is reinitiating a cycle of promoting dreams and union while people in the food bank queues wonder how? Just as the black Americans in small towns wonder when police might pick them up to spend time in local private jails as the corporate executives of the jail corporations concentrate on lowering their golf handicaps.
The price of gold
The switch from a gold-backed monetary system to a fiat system did raise questions on the likely rise in the price of gold as a safe asset as fiat currencies inflate and lose their purhasing power. Concern about this was reflected in a communication between the London Gold Pool and the Federal Reserve in the USA in 1974. This pointed to the ability of futures trading in gold to create "paper gold" where the price could be manipulated downwards and maintained so as to "stabilize" the gold price. This, in fact, is what has happened. The occasional regulatory cases against big banks for gold price manipulation result in minimimal fines, easily covered by the next period's gold price manipulations.
It is notable that since the creation of Bitcoin and the detereoriation in currency purchasing power, that Bitcoin's distributed characteristics and inability of central banks to control its price, has resulted in Bitcoin becoming the indicator of fiat currency values (see graph on left). However, larger institutions are now attempting to control the price of Bitcoin through large transactions. The Bank of England officials and the European Central Bank's Christine Lagarde have, of course, warned people about the risks involved in cryptocurrency investment while avoiding any discussions on the impact of central bank policies on the continued currency devaluation.
The Bretton Woods moment
The call for a new Bretton Woods to help global recovery after Covid-19 is a cynical appeal by people representing failed institutions. Institutions having been fashioned by the conditions of the past are no longer in tune with the conditions of the present. Too many people have lost faith in lofty institutions populated by very highly paid employees, including those of the Bretton Woods system. Any attempts at change will have to take place in a forum where no one will accept the notion of any particular country holding any advantages over others. With China overtaking the USA as the largest economy and manufacturer in the world and the proportion of the world's population to be found in BRICS approaching 50%, any realistic future "negotiations" will prove to be interesting.