Is the New Financial World Order in Making?
Indian Institute of Information Technology, Allahabad
The greatest, biggest, and oldest Investment-banks: Lehman Brothers, Bear & Stearns, Morgan Stanley, and Merill Lynch the symbol of American capitalism have perished and the rest are looking for shelter under the cover of Banking operation, global stock markets are down by more than 50%, commodities prices has collapsed, the hedge funds are out, the liquidity from the global market has evaporated, and the world is full of toxic debt. The world is going through the greatest financial depression ever comparable to Great Depression of 1929 and the received wisdom is that it has possibly not hit the nadir yet. The old international institutions looked incapable of coping with it. Yet it is hardly new: they could not cope even with the Asian financial crisis of 1997-99.
Several governments and regulators have been working overtime to bring back markets to normal functioning. In excess of a trillion dollar has been pumped into the global credit market by the US and European governments. And others like China, which recently announced financial stimulus package estimated around US $580 billion to boost the crumbling economy and Japan which is ready to offer US $100 billion support to IMF so that it can save world financial order.
Now, few natural questions arise out of this financial apocalypse:
- “Do we need a new Bretton Woods: to reshape the world financial order and to meet the challenges that have arisen in the world economy?”
- “And do the emerging economies like India, China, Russia, and Brazil would play greater role in shaping the world order or only the talk of re-shaping the world order will end on discussion as we have seen at the time of Asian Financial crisis in 1997-98.”
Before answering these questions, it is important for us to understand and analyze the view points of experts, who are divided into two groups: one who thinks that “The new financial world order (new Bretton Woods) is the need of hour with emerging BRIC economies playing far greater role than previously played along with old economic power houses like U.S.A, Europe, and Japan.” And, the other group, who thinks that “Central banks will become the new globocops and they will tighten the regulatory norms?” To find out how world would react to the current crisis, we have to look at the pros and cons of both the view points.
Bretton Woods II: The need of Hour
First of all let us look back at history of Bretton Woods agreement – named after the American hotel where it was agreed - was a historic deal signed in 1944 to shore up the global economy after the Second World War and out of Great Depression of 1929. Under the deal, exchange rates were fixed for almost thirty years and the value of the dollar was linked to gold, ensuring its status as a global currency.
This brought the global economy under control and stopped reckless economic activity. The agreement also established the International Monetary Fund (IMF), World Bank and other international bodies.
It is certainly true that the international monetary system has changed considerably since Bretton Woods-instead of a system of fixed exchange rates among major currencies, we now have a floating rate system and we now have global financial markets of hitherto unimaginable size and complexity.
There is no doubt that current system has failed in achieving the global equality, and achieving financial stability, however, still there is no denying that the expansion of world trade is one of the great success stories of the current system and is a major contributing factor in world economic growth. During the past quarter century, for example, world trade grew at an average rate of 5 1/2 percent per year, outstripping the 3 1/2 percent rate of growth in world GDP. The current system helped in orderly exchange rate and increasing capital mobility, which in turn, is one of the factors that have sparked one of the most striking developments in the world economy: international financial markets of unprecedented size, speed and agility.
The current financial crisis is not of the same magnitude as the Great Depression of 1929, which forced the world into the fire and mayhem of World War II, but in order to tackle the current financial crisis we need to promote international monetary cooperation, facilitate the expansion and balanced growth of international trade, and contribute thereby to the promotion and maintenance of high levels of employment and real income.
All, this could only be achievable if a new Bretton Wood is established where emerging economies like India, China, Brazil, Russia, and Mexico etc. have more egalitarian shareholding in the multilateral institutes like World Bank and IMF. The developing countries as a group now represent a much larger share of world trade than they did in the immediate post-war period.
And, if countries are to deal successfully with the many new challenges confronting the international monetary system--and we firmly believe that it is in all of their interests to do so--they must work for it. In this respect, to the extent that a "new" Bretton Woods is needed, it would be to re-establish the strong sense of purpose and determination that motivated the founders of the Bretton Woods system.
The Globocops: Central Banks
The Asian financial crisis of 1997-99, made everybody to agree that world needed a new financial architecture. Several meetings took place to discuss a new architecture, but before these could come to grips with the problem, it disappeared! Asia recovered smartly in 1999-2000. Russia and Latin America recovered as the prices of their commodities exports rose.
Now, the current financial crisis has almost engulfed the whole world due integration of world financial market and the liquidity from the market has evaporated so fast that even interbank lending have also vanished this is evident with the all time call money rates. And given the severity of the financial crisis set the central banks in damage control mode. This was evident by clearance of US $700 billion rescue plan for financial market by US Government and few days back US Federal Reserve opened swap lines of US $120 billion with four countries – Brazil, Mexico, Singapore, and South Korea – to keep international pipeline unclogged.
Similarly, European Central Bank entered into foreign currency swaps with Iceland and Switzerland, even though they are not part of the Eurozone. This all was done to ensure that “systemically” important to the US and European economies, do not suffer from a temporary shortage of dollars or euro’s.
Traditionally, this job should have gone to IMF and out of the mandate of Fed and ECB but IMF takes some time to design restructuring packages for distressed economies, while Fed and ECB are more concerned with overnight and short-term liquidity issues so that the confidence in the market returns and the market gets stable. Thereby, reflecting that multilateral institutions like IMF and World Bank do not have the wherewithal to tackle the scope of current financial crisis.
Also, the biggest difference - central banks can print money, while multilateral institute like IMF and World Bank has to depend on shareholders largesse and given the severity Fed and ECB are not leaving any to chance or to IMF’s time-consuming methods. A new multilateral regulatory, institutional structure where emerging economy has equal saying in world trade currently seems unlikely and all central will handle the situation by there on ways and would not like to be told what to do.
To tide the current waves of financial crisis, we think currently central banks would pass strict regulation to control the liquidity crunch and the point of creating Bretton Woods II depends on the vision of global leaders and their resolve for better co-operation among old industrial economies and new emerging economies.