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The IMF’s Position in a Fragmented Global Economy

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Ten years ago Cambridge University Press published my book, The IMF and Global Financial crises: Phoenix Rising? I had written a series of journal papers on the IMF and used the format of a book to summarize what I had learned about the Fund. I also made some evaluations and projections about the IMF and its reputation; a decade later, how has the IMF done?

The book reviewed the history of the IMF from its founding at Bretton Woods through the global financial crisis. One of the theses of the book was that the IMF had paid a high price for its handling of the Asian financial crisis. The Fund had formulated programs for Indonesia, South Korea, and Thailand that proved to be controversial. Among the charges levied against the Fund was:

  • Condemnation for imposing harsh macro policies in the conditions of the programs;
  • Criticism for including inappropriate structural conditions;
  • Blame for indirectly precipitating the crisis through its support of capital decontrol.

In the aftermath of the Asian crisis as well as subsequent crises in Russia, Turkey and Argentina, the global economy entered a period of steady real growth and moderate inflation rates. The demand for the Fund’s assistance declined, and the IMF used the occurrence of relative stability to undertake post-mortem reviews and changes in its recommended policies. These included a retreat from its advocacy of full capital decontrol, and a reassessment of the purposes and scope of conditionality.

When the global financial crisis of 2008-09 occurred, it was an opportunity for the IMF to show that it had learned the lessons of the previous crisis and could adapt its playbook.  The IMF set up 17 Stand-By arrangements during the period of September 2008 through the following summer. The policy conditions attached to these programs were based on an understanding that the contractions in economic activity in the program countries were the result of falling international trade that followed the financial collapse in the advanced economies. Subsequent reviews of the programs found that credit was disbursed more quickly and in larger amounts than in past crises.

In addition to providing financial resources, the IMF called for a coordinated response to the crisis and the use of fiscal stimulus to offset its effects. The Fund’s economists completed its turnaround in its position on capital account regulation and acknowledged that capital controls could mitigate financial fragility. The IMF’s activist stance was acknowledged by the newly formed Group of 20, which approved an increase of the IMF’s financial resources, and called upon it to institute surveillance of their economies.

The IMF, therefore, came out of the global financial crisis with its reputation as a crisis manager restored. The whimsical subtitle of my book came from a line in Don Quixote that referred to a phoenix that rose from the ashes of a fure.  How the IMF used its reputation and handled new crises, however, could only be revealed with the passage of time.

The IMF does much more than serve as a crisis lender. The results of its surveillance of the global economy are published in reports such as the World Economic Outlook, and updates to its economic forecasts are widely reported. The IMF’s Managing Director, Kristalina Georgieva, has a high public profile, and speaks out a range of global issues. The research of its economists has grown to include work done on income inequality, gender and climate change.

The next major challenge the IMF faced was the Greek debt crisis, when it joined the “troika” of the European Central Bank and European governments in arranging a resolution. The loans extended to Greece were controversial because of the conditions the Greek government had to implment. As the crisis deepened, the IMF differed from its troika partners in advocating for debt relief. Greece eventually repaid its loans from the IMF two years earlier than planned, but in retrospect the IMF’s inclusion in the troika constrained its ability to set sustainable debt levels.

More recently, during the pandemic the IMF was active in providing financial assistance to its poorest members. Some of its funds were given through new facilities, such as the Rapid Credit Facility and the Rapid Financing Instrument, with (at most) minimal conditionality. Brad Setser of the Council of Foreign Relations pointed out that lending from the IMF and the World Bank to lower middle-income countries rose just as private credit flows fell. Setser observed:

“Such a surge made financial sense, and was a moral imperative as well. The Bank and the IMF, and thus President Malpass and Managing Director Kristalina Georgieva, deserve credit for making it a reality. The system, in a sense, worked. Low income countries had to struggle through the pandemic, but they didn’t lose access to new financing at the same time.”

But not all agree that such lending by the IMF is consistent with its core missions. Kenneth Rogoff of Harvard, who was chief economist at the IMF from 2002 to 2003, points out that the Fund, unlike the World Bank, is not an aid agency. It uses conditionality in part to ensure that it is repaid so that it can continue to lend.  He also argues that “forceful IMF conditionality is essential to establish financial stability and ensure that its resources do not end up financing capital flight, repayments to foreign creditors, or domestic corruption.”

More recently the IMF has become involved with a number of developing nations that can not meet their debt obligations, including Egypt, Sri Lanka and Pakistan. According to The Economist, this work is likely to escalate:

“Debt loads across poorer countries stand at the highest levels in decades. Squeezed by the high cost of food and energy, a slowing global economy and a sharp increase in interest rates around the world, emerging economies are entering an era of intense macroeconomic pain… All told, 53 countries look most vulnerable: they either are judged by the imf to have unsustainable debts (or to be at high risk of having them); have defaulted on some debts already; or have bonds trading at distressed levels.”                                                 The Economist, 7/20/2022

The Fund recently published a Staff Discussion Note on “Geoeconomic Fragmentation and the Future of Multilateralism.” The authors of the Note point out that the pace of globalization slowed notably after the global financial crisis, and geopolitical tensions have led to a reversal of economic integration. They examine the consequences of fragmentation on international trade, the diffusion of technology and the international monetary system.

Could the IMF be replaced? It is difficult to imagine how a new global organization could be organized. On the other hand, regional blocs may become more widespread. For example, the IMF’s Note on fragmentation notes that global liquidity has four sources: central bank reserves, bilateral swap agreements, regional financial arrangements, and the IMF. Bilateral swap lines and regional arrangements have grown rapidly, leaving  the Fund as the only provider of universal coverage. Further growth of regional arrangements based on geopolitical blocs would increase their coverage, but it would be uneven across blocks and could be inadequate to deal with large shocks.

I argued in my book that it is crucial to remember that the IMF is an agent for its 190 principals. Its ability to address global challenges depends on the willingness of the sovereign members to use the IMF to organize responses to the challenges. A world that is divided by U.S.-China frictions gives the IMF limited scope to play the role it seeks to have.

Has the Third Era of Globalization Ended?

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Behind the headlines forecasting a global economic recession there is another narrative about the end of globalization. This reflects political tensions over trade, the impact of the pandemic on global supply chains and the shutdown of economic ties with Russia. But dating the beginning and end of the most recent era of the integration of global markets poses challenges.

All chronological assignments for the purpose of establishing historical eras are arbitrary. Did World War II begin in 1939 when Germany and the Soviet Union invaded Poland? Or in 1937 when Japan invaded China? When was the First Industrial Revolution succeeded by the Second Revolution? Mid or late 19th century? And good luck finding agreement on when the golden age of rock and roll took place.

The dating of economic eras also involves assumptions. Did the First Era of Globalization begin in the early 1870s as usually stated, and if so, why? Germany’s adoption of the gold standard at that time is usually seen as a shift in monetary regimes that facilitated international capital flows, but trade and migration flows had expanded prior to the 1870s. Assigning a date to the end of the First Era is easier to do, as currency convertibility was suspended during World War I and borders were shut to migration.

The commencement of the Bretton Woods (BW) system marks the beginning of the Second Era of Globalization. The agreement was signed in 1944 and the IMF commenced operations in 1947, so 1945 can be seen as the beginning of the post-war era. But the system actually described in the agreement did not operate until 1958 when European currencies became fully convertible for current account transactions. Did the BW regime end in 1971, when President Richard Nixon ended the convertibility of foreign central bank holdings of dollars to gold? Or in 1973, when attempts to establish new fixed exchange rate values ended and the major currencies began to float? The IMF’s Articles of Agreement were not amended to reflect the new practices until 1976.

The Bretton Woods system ended in the 1970s, but globalization did not go into reverse. The post-World War II era can be extended to include the following decades, but that would overlook several important changes in how international economic affairs were conducted. The elections of Margaret Thatcher and Ronald Reagan in 1980 are widely seen as marking the beginning of what has been called the neoliberal era, which has been characterized as a shift to dependence on market outcomes. (Gary Gerstle of Cambridge University, however, shows that the term “neoliberal” encompasses a number of political agendas, not all of them consistent, in a compelling account in his book The Rise and Fall of the Neoliberal Order: America and the World in the Free Market Era.) The initial policy changes occurred domestically, but this was also the period when the IMF began to promote the removal of capital controls. On the other hand, the 1980s was a “lost decade” of growth for those countries, mainly in Latin America, that were embroiled in the debt crisis.

The year 1990 is another candidate for dating the start of a new era of globalization. Douglas Irwin of Dartmouth College has described the era of 1985-1995 as the period of “the greatest reduction in global trade barriers in world history.” China began to allow private enterprises to flourish at the end of the 1980s, while East European nations sought to integrate their economies with those of Western Europe and the rest of the global economy after the collapse of the Soviet Union in 1991. The North American Free Trade Agreement (NAFTA) signed in 1994 by Canada, Mexico, and the U. S. created a trilateral trade area amongst the three countries.  In 1995, the World Trade Organization was established, with a mission to facilitate international trade. The new international agency sought to promote new trade agreements while administering a mechanism to resolve trade disputes amongst its members. Economic inequality among nations narrowed during this period as many emerging markets enjoyed rapid growth, although inequality within nations rose as the benefits of global trade and financial flows were not equally shared.

But if the Third Era of Globalization is no longer operating, when did it cease? The global financial collapse of 2008-09 demonstrated the fragility of extended financial sectors even in the advanced economies, and lacerated confidence in the ability of regulators to anticipate sudden collapses of financial flows. The response of domestic governments and international agencies to the crisis led to a revival of economic activity but the recovery was slow, particularly for those who did not benefit from the rise in asset prices that low interest rates fostered. Foreign expansion by multinational firms continued but the pace of foreign direct investment slackened, while the IMF issued a reappraisal of its policy recommendations regarding capital flows to include capital controls as an acceptable macro policy tool.

The year 2016 has a strong claim for marking the end of this era of globalization. Donald Trump campaigned advocating the use of tariffs to end trade deficits and the erection of a wall along the border with Mexico to halt illegal immigration. He sought to implement those policies after his election, including the imposition of tariffs on Chinese goods. The votes in favor of Britain leaving the European Union (“Brexit”) in the same year demonstrated the distrust of many British citizens of multilateral governance as well as a fear of immigration. The result in that country has been a reduction in trade and migrant flows, with no evidence of a positive economic payoff.

Whatever momentum was left in international economic expansion was throttled by the pandemic and then the Russian-Ukraine war. The pandemic exposed the vulnerability of global supply chains to national shutdowns, and the dangers of dependence on single suppliers of strategic goods, such as medical equipment. In response to the invasion of Ukraine, the U.S. and European allies have sought to cut off trade and financial flows with Russia, which in turn seeks to use higher oil and gas prices to lower Western morale. The U.S. hopes to slow down Chinese technological advances by scrutinizing Chinese acquisition of U.S. firms while supporting U.S. firms in areas where they may fallen behind.

Whether or not the third era of globalization expired in 2016, 2020 or 2022, there is a strong sense that a new era has begun. But is it the end of globalization? Richard Baldwin of the Geneva Institute in his NBER paper, “Globotics and Macroeconomics: Globalisation and Automation of the Service Sector” and in a series of blog posts argues that changes in global economic activity have been misunderstood and misinterpreted. The drop of world trade/GDP since 2008 was largely a function of the decline in the value of commodities, particularly mining goods and fuels.

There has also been a slowdown in the transfer of manufacturing from advanced economies to a handful of emerging economies, as well as a reorganization of supply chains. But Baldwin shows that a new wave of globalization is taking place in the provision of intermediate service activities, which include accounting, financial analysis, legal analysis, and other activities. Advanced economies still account for the majority of service exports but emerging economies including China, India, Korea, Poland, the Philippines and Brazil have recorded rapid growth in these activities. The barriers to further expansion are technological, not regulatory, and those barriers are falling rapidly.

It is premature, therefore, to proclaim the end of globalization. Trade in manufactured goods may not be advancing at the same pace as it has in the past but that slowdown was inevitable. Trade in services, on the other hand, has grown continuously since 1990, although some deceleration in the current economic environment is inevitable. However, advances in artificial intelligence (AI) will alter the supply of both goods and services. Its impact on national economies and global markets is a matter of speculation, but the widespread use of AI may herald the start of the next era of glovalization.

When Safe Assets Are No Longer Safe

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The U.S. has long benefitted from its ability to issue “safe assets” to the rest of the world. These usually take the form of U.S. Treasury bonds, although there was a period before the 2008-09 global financial crisis when mortgage-backed securities with Triple A ratings were also used for this purpose. The inflow of foreign savings has offset the persistent current account deficits, and put downward pressure on interest rates. But what will happen if U.S. government bonds are no longer considered safe?

The word safe has been used to describe different aspects of financial securities. The U.S. government in the past was viewed as committed to meeting its debt obligations, although the political theater around Congressional passage of the federal debt limit has introduced a note of uncertainty. In an extreme case, the U.S., like other sovereign borrowers with their own currencies, has the ability to print dollars to make debt payments. However, there is also a constituency of U.S. bondholders who would vehemently object if they were paid in inflated dollars.

Safety has also been linked with liquidity. U.S. financial markets are deep and active. Moreover, there is little concern that the government will impose capital controls on these portfolio flows (although FDI is now being scrutinized to deny access to domestic technology). Therefore, foreign holders of U.S. Treasury bonds can be confident that they can sell their holdings without disrupting the bond markets and contributing to sudden declines in bond prices.

However, there has always been another implicit component of the safety feature of Treasury bonds. Bondholders expect that they can claim their assets whenever they need to use them. The decision by the U.S. and European governments to deny the Russian central bank access to its own reserves has shown that foreign holders of assets placed on deposit in the U.S. or the other G7 countries (Canada, France, Germany, Italy, France, United Kingdom) may not be able to use these assets at precisely the times when they are most needed. The Russian central bank had accumulated about $585 billion, but approximately half of that amount is no longer available. The central bank still has access to about $80 billion held in China and $29 billion at international institutions, as well as its holdings of gold. But the latter will be hard to convert to foreign currency if potential buyers are concerned about retaliatory sanctions.

The loss of access deprives the Russian central bank of foreign currency that could have helped the government deal with sanctions on its foreign trade. Moreover, the monetary authorities have not been able to use their reserves to halt the rapid decline in the ruble’s value. The other sanctions, therefore, will have a deep impact on the Russian economy. The Institute of International Finance has issued a forecast of a drop in its GDP of 15% in 2022 and another decline the following year.

The use of sanctions to cut off a central bank’s access to its own reserves raises questions concerning the structure of the international financial system. Other central banks will reassess their holdings and consider alternatives to how they are held. But what other country has safe and liquid capital markets that are not subject to capital controls and are not vulnerable to U.S. and European sanctions?  The Chinese currency is used by some central banks, but it is doubtful that there will be a wide-spread transition from dollars to the renminbi.

Another concern has arisen regarding the ability of the U.S. government to meet its obligations. In order to satisfy a continued demand for safe assets, the government will need to continue to run budget deficits. But increases in the debt/GDP ratio leads to concerns about the creditworthiness of the government. This problem has been called a “new Triffin dilemma,” similar to the problem that emerged during the Bretton Woods era when the U.S. was pledged to be ready to exchange the dollar holdings of foreign central banks for gold. Economist Robert Triffin pointed out that the ability of the government to meet this obligation was threatened once the dollar liabilities of the U.S. exceeded its gold holdings. The “gold window” was finally shut in the summer of 1971 by President Richard Nixon.

These long-term concerns are arising just as the market for U.S. Treasury bonds has entered a new phase. The combination of higher inflation and changes in the Federal Reserve’s policy stance have led to increases in the rate of return on U.S. Treasury bonds to about 2.5%. With an annual increase in the CPI minus food and energy of approximately 6%, that leaves the real rate at -3.5%. Several more increases in the Federal Funds Rate will be needed to raise the real rate to positive values.

A fall in the demand for U.S. Treasury bonds by foreign banks and private holders would contribute to lower bond prices and higher yields. All this could affect the Federal Reserve’s policy moves if the Fed thought that it needed to factor lower foreign demand for Treasury bonds into their projections. Moreover, a shift from U.S. bonds would affect the financial account of the U.S., and the ability to run current account deficits.  The exchange rate would also be affected by such a transition.

None of these possible changes will take place in the short-run. Central bankers have more pressing concerns, such as the impact of higher food and fuel prices on domestic inflation rates, and foreign central bankers will focus on the changes in the Fed’s policies, as well as those of the European Central Bank. But the sanctions on the use of foreign reserve assets will surely lead to changes over time in the amounts of reserves held by central banks as well as their composition. The imposition of these measures may one day be seen as part of a wider change in the international financial system that marks the end of globalization as we have known it.

The 2021 Globie: “Three Days at Camp David” and “The Global Currency Power of the US Dollar”

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Fall is the time of the year to announce the recipient of this year’s “Globie”, i.e., the Globalization Book of the Year. The prize is strictly honorific and does not come with a check. But the award gives me a chance to draw attention to a recent book—or books—that are particularly insightful about globalization. Previous winners are listed at the bottom of the column.

This year there are two winners, Jeff Garten for Three Days at Camp David and Anthony Elson for The Global Currency Power of the US Dollar. Each book deals with the financial hegemony of the U.S. dollar in the global financial system. Together they provide a fascinating account of how the dollar came to hold—and hold onto—this role.

Garten looks at the decision by President Richard Nixon in the summer of 1971 to end the link between the dollar and gold, a central foundation of the Bretton Woods system. Foreign central pegged their exchange rates to the dollar, which was convertible to gold by the U.S. government for $35 an ounce. This arrangement reflected the U.S. position at the end of World War II as the predominant economic power, able to use its influence at Bretton Woods to ensure a dollar-dominated system.

But the imbalance between the U.S. and the rest of the world shifted during the 1950s, particularly as Germany and Japan emerged as economic powers with growing trade surpluses. U.S. government spending resulted in growing foreign holdings of dollars. Yale Professor Robert Triffin pointed out that the ability of the U.S. to exchange its gold for dollars was deteriorating, and this incipient crisis became known as the “Triffin dilemma.” By 1971 this situation was no longer sustainable. Foreign central banks held about $40 billion in dollars while U.S. gold holdings had fallen to $10 billion. Speculators were taking positions on the response of the U.S. and other central banks in a global chicken game.

Garten describes the main players in the decision to end the link with the dollar. Nixon had appointed John Connolly as Treasury Secretary mainly because of Connolly’s political skills.  Connolly in turn depended on the expertise in international finance of Paul Volcker, then under secretary of the Treasury for international monetary affairs. George Schulz was known for his organizational expertise and served as the director of the Office of Management and Budget. Arthur Burns, Chair of the Federal Reserve, sought to serve Nixon while maintaining some semblance of institutional autonomy. Other participants in the decision included Paul McCracken of the Council of Economic Advisors and Peter Peterson of the White House Council on International Economic Policy.

These men (yes, all men) had different perspectives on the best way to handle the crisis. Volcker and Burns shared an appreciation of the existing framework, and wanted to consult with their counterparts in other countries on reforming the system. Schulz, influenced by his background at the University of Chicago, looked forward to a day when flexible exchange rates would replace pegged rates. Connolly, on the other hand, had no ideological agenda. He sought to promote American interests and Nixon’s re-election, and saw the two as entirely compatible.

Nixon, Garten makes clear, was concerned about the impact of the situation on his 1972 election campaign, and his response must be understood in that context. Nixon consulted with these advisors at Camp David on the weekend of August 13 – 15 on how best to meet the dollar crisis. After a broad discussion, the decision to end the link of the dollar with gold sales was made. The rest of the weekend was spent on deciding on how to present the issue to the American public and U.S. allies.

Nixon spoke that Sunday night, making the case on the need to achieve economic prosperity in the aftermath of the Vietnam war. Other measures he presented included a tax credit for investment, a freeze on wages and prices and the establishment of a Cost of Living Council to enact measures to control inflation, and a 10% temporary tariff on imports. He justified the latter on the “unfair edge” that competitors had gained while the U.S. promoted their post-World War II recovery.

The U.S. subsequently negotiated with the other leading advanced economies on establishing new fixed rates, but the effort was unsuccessful. By March 1973, almost all of the Western European economies and Japan had embraced flexible exchange rates. The Jamaica Accords of 1978 marked the official of the Bretton Woods exchange rate system. Central banks could continue to peg their currencies against the dollar, but there was no obligation on the U.S. to support the “non-system.”

Anthony Elson brings the story forward in time to explain the continuing dominant position of the dollar. It is doubtful that anyone in 1971 or 1978 would have predicted a key role for the dollar in the post-Bretton Woods era, and Elson shows that the dollar’s continued dominance reflects several factors. First, the dollar continues to be used for invoicing international trade, even for non-U.S. trade flows. The dollar is used for this purpose in order to minimize transaction costs, as well as its record of macro stability. Second, the continued dominance of financial markets in the U.S. draws foreign investors looking for safe and liquid markets. This in turn has encouraged the growth of dollar-based financing outside the U.S. Third, the dollar continues to the most commonly-used currency for the foreign exchange reserves of central banks. U.S. Treasury bonds are seen as a global “safe asset.”

All this, Elson points out, bring benefits for U.S. traders and investors, who can use the dollar to purchase foreign goods and assets. In addition, the government can finance a continuing current account deficit through its provision of U.S. Treasury bonds. The foreign demand  for these securities also lowers the cost of financing the fiscal deficits. On the political side, the government has learned how to use access to the dollar-based international clearing system as a tool of foreign policy, effectively “weaponzing the dollar.”

Can this system continue? The “new Triffin dilemma” has arisen as a result of the relative decline of the U.S. economy in terms of its share of world GDP at the same time as the demand for safe assets continues to grow. An increase in the issuance of U.S. securities to finance fiscal deficits coupled to the political posturing over the debt ceiling may threaten the confidence of foreign investors in the ability of the U.S. government to meet its obligations, much as the declining gold stock led to the 1971 crisis.

But what alternatives are there? The Eurozone and China have grown in size and importance and their currencies may serve as regional rivals for the dollar. But a multipolar reserve currency system may itself be unstable. The IMF’s Special Drawing Rights were designed to supplement the dollar, but their use has been limited, and it would take concerted intergovernmental action to encourage its use. Digital currencies may change how we view money, and central banks are actively investigating their use.

There is little history to provide a guide on the circumstances that lead to a change in the hegemonic currency. The dollar began to rival the British pound in usage in the 1920s as the U.S. economy rapidly grew. But the transition was finalized by the costs to Great Britain of fighting World War II. If a peaceful transition to a new reserve currency system is to take place, it will require more international cooperation than has been shown on other issues.

 

2020    Tim Lee, Jamie Lee and Kevin Coldiron, The Rise of Carry: the Dangerous Consequences of Volatility Suppression and the New Financial Order of Decaying Growth and Recurring Crisis

2019    Branko Milanovic, Capitalism Alone: the Future of the System That Rules the World

2018    Adam Tooze, Crashed: How a Decade of Financial Crises Changed the World

2017   Stephen D. King, Grave New World: The End of Globalization, the Return of History

2016    Branko Milanovic,  Global Inequality

2015   Benjamin J. Cohen,  Currency Power: Understanding Monetary Rivalry

The Return of Global Imbalances?

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The global economic contraction following the pandemic has led to a massive fiscal response. Governments have acknowledged the need to increase spending in order to offset the declines in consumption and investment. The decreases in public savings can lead to rising current account deficits that offset the capital inflows needed to cover the gap between savings and investment. But will these measures generate a return to the global imbalances that preceded the global financial crisis?

The IMF’s External Sector Report for 2020, subtitled Global Imbalances and the COVID-19 Crisis, appeared in August (see a summary here). The analysis was based on data from 2019, when the global current account imbalance (the absolute sum of all surpluses and deficits) fell by 0.2 of a percentage point to 2.9% of global GDP. But the report’s authors also considered the impact of the pandemic on countries’ balance of payments.

The IMF’s analysis suggested that about 40% of the 2019 current account positions were excessive. Larger than warranted surpluses were registered by Germany and the Netherlands, while deficits were larger than warranted in Canada, the U.K. and the U.S. China’s external position was in line with its fundamentals and policies.

In the report the IMF anticipated that in 2020 the U.S. would report a current account deficit equal to 0.5% of world GDP. Canada and the U.K.’s deficits were each projected to be equal in value to about 0.1% of global output. China was expected to register a surplus of about 0.2% of world GDP, as were Germany and Japan. These forecasts come with a large degree of uncertainty, and the report’s authors acknowledge that global financial stress could lead to more capital flow reversals and larger imbalances.

More recent data show clearly that the U.S. and China are running the largest current account imbalances in absolute terms. Brad Setser of the Council on Foreign Relations points out that Chinese firms have benefitted from the demand for electronic goods as workers stay at home, as well as the need for personal protective equipment. Moreover, the Chinese government has supported its firms that export, with less direct support for households. The U.S. has provided more direct support to households.

The fiscal responses of the two countries to the pandemic also differ. The Economist estimates that the 2020 U.S. budget balance will show a deficit equal to 15.3% of its GDP, while China’s deficit is estimated at 5.6% of GDP. Part of the U.S. fiscal deficit will be offset by household savings, which increased last spring to over 30% of disposable income. The savings rate has slowly come down since then, while households attempt to plan their spending in a world of uncertainty. If the recovery in the U.S. stalls and there is no additional fiscal stimulus, then households will be forced to dip into their savings.

The IMF’s current account forecasts are consistent with the analysis of  Matthew Klein and Michael Pettis in their recent book, Trade Wars Are Class Wars: How Rising Inequality Distorts the Global Economy and Threatens International Peace.  The authors claim that these imbalances reflect domestic policies that privilege the more affluent members of a country. The trade wars that divide nations reflect divisions within these countries between asset owners and workers.

Klein and Pettis attribute China’s surpluses, for example, to government decisions in the 1990s to foster development through investments and exports while suppressing Chinese consumption in order to generate savings. The government has since acknowledged this imbalance and sought to rebalance domestic spending, in part by promoting consumption expenditures while curbing shadow banking. But whenever economic growth has slowed, the government has responded by encouraging new investment, including housing, and total credit to the private sector has grown to 216% of GDP.

Similarly, Germany’s current account surpluses reflect its policies designed to encourage growth after the decade of the 1990s, when the costs of reunification weighed down the economy. There was a conscious decision to encourage savings, a shift that benefited capital owners at the expense of labor. Until this year the government took pride in its balanced budgets, despite a need for infrastructure spending. The high personal savings rate reflects in part a high degree of income inequality, with most gains going to those households more likely to save them. There was also an emphasis on the country’s external position, and wage increases were limited in order to hold down costs.

The increases in foreign savings were matched by capital flows to the U.S. These reflected the U.S. position as the financial hegemon, with the most liquid financial markets. Moreover, the U.S. provided something of great value: safe assets. U.S. Treasury bonds have been the preferred asset of central banks and European savers, although before the 2008-09 financial crisis mortgage backed securities with AAA ratings were seen as acceptable substitutes. The financial sector within the U.S. benefitted from the increase in domestic and foreign financial activity. But the capital inflows appreciated the dollar, which undermined the export sector. In the years leading up to the global financial crisis the Federal Reserve kept interest rates low in order to boost spending. A weak recovery after that crisis caused the Federal Reserve to continue its low interest rate policy.

The pandemic has brought a return to past conditions. Whether or not the most recent increase in the Chinese trade surplus is a transitory phenomenon, its current account is on track to record a surplus for the year (although at a much lower level than before the global financial crisis). Similarly, while Germany’s budget balance is forecast to show a deficit of 7.2% of its GDP for the year, its current account is expected to register a surplus equal in value to almost 6% of its GDP.  The U.S. current account deficit, which peaked at 6% of GDP in 2005, was equal in value to 3.5% of GDP in the second quarter of this year.

Klein and Pettis write that past global imbalances reflected a complementarity of interests between American financiers and Chinese and German industrialists, and reinforced inequality.  To change these patterns requires policy reorientations within these countries that will allow more income to be transferred to households. They admit that this is a difficult task, but point out that a new system was devised by the Allied nations at Bretton Woods in 1944 in order to guarantee living standards. The upheaval produced by the pandemic is global in nature and has the potential to bring about another policy transformation. The one necessary element that will be contested by those who profit from current arrangements is the political will.

Empires, Past and Present

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Economists rarely write about “empires,” unless they are referring to historical examples such as the Roman empire. But Thomas Hauner of the Federal Reserve Bank of Minneapolis,  Branko Milanovic of the Graduate Center of City University of New York and Suresh Naidu of Columbia University have presented a study of empires using criteria drawn from an economics classic, John Hobson’s Imperialism (1902). The same criteria can be used to examine whether any empires exist today.

Hobson was not a Marxist, but his work greatly influenced later Marxist writers who wrote about imperialism, including Vladimir Lenin, Rudolf Hilferding and Rosa Luxemburg. Hobson believed that there was chronic underconsumption in advanced capitalist countries due to unequal distributions of income. This lowered the return on domestic investment, and as a result the owners of financial capital turned to foreign markets where returns would be higher. These investors relied on their governments to guarantee the safety of their foreign holdings from seizure.

Hauner, Milanvic and Naidu demonstrate that there was a high degree of inequality within the advanced capitalist countries in the late 19th century. The foreign assets held by wealthy investors in Britain and France expanded greatly during this period, and these assets generated rates of return higher than those available from domestic investments. They also present evidence of a linkage between the accumulation of foreign assets and militarization that led to World War I. These results are consistent with Hobson’s work.

Hobson’s empires established positive net international investment positions (NIIP) and received income from these foreign investments. The payments appear in the current account of the balance of payments as “net primary income.” This component of the current account records the difference between payments received by domestic residents for providing productive resources, such as their labor, financial resources or land, to foreigners minus the payments made to foreigners for their productive resources made available to the domestic economy. For most countries, receipts and payments on financial assets are the largest component of their net primary income.

Great Britain was a financial center and the preeminent creditor nation during the zenith of its empire, and a net recipient of foreign income. It earned net income worth 5.4% of GDP in the period 1874-1890, and 6.8% from 1891 to 1913 (Matthews, Feinstein and Odling-Smee 1982). The surpluses were large enough to offset a trade deficit and allow the country to continue to invest abroad and expand their foreign holdings.

What are the largest creditor nations today? Are they also Hobsonian empires? Japan is the leading creditor nation, with a net international investment position of $2.8 trillion in 2015, which represented 67% of its GDP. It earned $165.88 billion in net primary income, worth 3.8% of its GDP. Germany is also a creditor nation, with a NIIP of about $1.5 trillion (45% of GDP) in 2015 and net income of $74.6 billion (2.2% of its GDP).

But Japan and Germany nations do not fulfill the other criteria to be called empires. They do not have the disparities in wealth that the U.S. and many developing countries possess. Their Gini coefficients are almost identical: 32.1 for Japan and 31.4 for Germany. These are similar in magnitude to those of other European countries, higher than those of the Scandinavian nations but below those of Portugal and Spain.

Moreover, the two nations are not militaristic powers. Japan’s constitution forbids the use of force, although the country does have Self-Defense Forces. Prime Minister Shinzo Abe is seeking to amend the country’s constitution in order to clarify the rules governing the disposition of these troops. Germany is part of NATO, but the foreign deployment of German forces is strictly supervised by Parliament.

The situation of other large countries is more anomalous. China is a leading creditor nation, with a NIIP in 2015 only slightly lower than Germany’s and equal to 194% of its GDP. But that country registered a deficit of net primary income of $41.8 billion. On the other hand, the country with the largest inflow of income in absolute terms was the U.S., a debtor nation with a NIIP of -$7.8 trillion in 2015, worth about 45% of GDP. Its net income inflow of $204.5 billion represented 1.1% of its GDP.

The explanation for these seemingly inconsistent results lies with the composition of the external assets and liabilities. The U.S. is “long equity, short debt,” with assets largely composed of foreign direct investments (FDI) and portfolio equity, and liabilities primarily in the form of debt (bonds, such as U.S. Treasury securities, or bank loans). In 2015, for example, 60% of its assets were held in the form of FDI or portfolio equity, which earn an equity premium because of their riskier nature. China, on the other hand, is “long debt and short equity,” where the debt includes the central bank’s foreign reserves held in the form of U.S. Treasury bonds. Debt assets and foreign reserves constituted 79% of China’s foreign assets in 2015, and the returns on these have been quite low in recent years. FDI and portfolio equity liabilities, on the other hand, accounted for 74% of the external liabilities.

The unusual nature of these income flows have attracted great attention. Yu Yongding of China’s Academy of Social Sciences, for example, has written about his country’s “irrational IIP structure.” He attributes this to an undervalued exchange rate that has allowed the country to have surpluses in both the current and capital accounts that were balanced by increases in foreign reserves, as well as government policies that favored FDI from abroad.

The positive return that the U.S. receives has been called an “exorbitant privilege” that is due to the status of the dollar as a reserve currency. In 1966 Emile Despres of Stanford University, Charles P. Kindleberger of MIT and Walter S. Salant of the Brookings Institution wrote that the configuration of the U.S. balance of payments was due to its status as the “world’s banker”, issuing short-term liabilities in exchange for long-term assets. More recently, Pierre-Olivier Gourinchas of UC-Berkeley and Hélène Rey of the London Business School updated this description of the U.S. to the “world venture capitalist.”

The global financial crisis might have ended this status of the U.S., but the influence of the U.S. economy and its monetary policies has not diminished. Changes in U.S. interest rates have widespread effects on capital flows and credit creation. Several recent studies, including one by Òscar Jordàof UC-Davis, Moritz Schularick of the University of Bonn and Alan Taylor of UC-Davis, have referred to the existence of a global financial cycle that is very responsive to U.S. monetary policy. Similarly, Matteo Iacoviello and Gaston Navarro  of the Federal Reserve Board have written about the spillover effects of U.S. interest rates on foreign economeis.

It may be time for a new definition of imperialism. If the U.S. possesses an empire, it is based on its ownership of foreign capital that it accumulates in return for the issuance of “safe assets.” It takes advantage of this position to invest in more lucrative equity. In addition, it hosts the largest and most liquid financial markets and networks. Moreover, the U.S. government has shown its willingness to use financial sanctions as a policy tool.

With respect to the other attributes of 19thcentury empires, we no longer send Marines to Central America to safeguard our foreign holdings. But our military spending greatly exceeds that of other nations. Wealth is heavily concentrated; the richest U.S. families—those in the top 1% of the distribution of wealth—own 40% of the wealth in this country. Those assets undoubtedly include direct and indirect ownership in foreign enterprises, which contribute to the returns they receive.

What could end this arrangement? The renminbi and the euro are rival currencies, but it is doubtful that they will attain the global status of the dollar. Under ordinary circumstances, one might expect the U.S. position to continue for the foreseeable future. But these are not ordinary times. The Trump administration seems ready to shred a wide range of international agreements, such as those that established the World Trade Organization and the North American Free Trade Association. Moreover, the tax legislation passed last year that lowered personal and corporate tax rates is pushing up the government’s budget deficit. The Congressional Budget Office’s projection for this fiscal year’s deficit has risen from $563 billion to $804 billion and is projected to reach $1 trillion by 2020. Will U.S. Treasury securities continue to be viewed as safe?

The record of transitions in international monetary regimes does not bode well for the future. The gold standard collapsed in the 1930s as governments sought to escape the world-wide contraction in global economic activity. The Bretton Woods regime began to disintegrate when the Nixon administration ended the conversion of the dollar reserves of foreign central banks into gold in 1971. None of these regime ends were planned and they led to further instability. The end of America’s hegemonic financial position has long been forecasted–and avoided. But the shockwaves of the global financial crisis are still taking place, and eventually may be even more disruptive than we ever imagined.

The People’s Verdict on Globalization

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The similarities in the electoral appeals of businessman Donald Trump and Senator Bernie Sanders have been widely noted (see, for example, here, here and here). Both men attract voters who feel trapped in their economic status, unable to make progress either for themselves or their children. Moreover, both men have assigned the blame for the loss of manufacturing jobs in the U.S. on international trade agreements. Regardless of who wins the election, globalization, which was seen as a irresistible force in the 1990s after the collapse of the Soviet Union and the entry of China into the world economy, is now being reexamined and found to be detrimental in the eyes of many.

Trump and Sanders have been particularly vociferous about the North American Trade Agreement, which they hold responsible for the migration of U.S. jobs to Mexico. But those who blame the foreign sector for a loss of jobs should also finger capital flows. The investment of U.S. firms in overseas facilities that then ship their products back to the U.S. represents outward foreign direct investment (FDI), and thus in this story is also responsible for the disappearance of manufacturing jobs. Moreover, Lawrence Summers of Harvard has pointed out that firms that have the option to relocate will be less inclined to invest in new capital in their home country, which leads to lower productivity and wages for their workers.

Whether technology or trade is more responsible for the shrinkage in manufacturing jobs has been the subject of much study (see, for example, here). In the past, most studies assigned the primary role for labor force disruption to technology. David Autor of MIT, Lawrence F. Katz of Harvard and Melissa S. Kearney of the University of Maryland, for example, drew attention to technology that accomplishes routine tasks without human intervention and leads to a polarization of the labor force, as middle-skill level jobs are eliminated, leaving only low-skill and high-skill jobs. In addition, information technology that allows firms to coordinate their facilities in different countries allows more outsourcing and reallocation of plants.

Those who seek to defend global trade flows cite rises in employment due to exports and also gains due to increases in efficiency and economics of scale that accompany specialization. In addition, lower prices due to imports raise real incomes. No one denies that increased imports can disrupt labor markets, but this has viewed as a transitional cost that could be absorbed.

But recent economic studies by widely respected economists (including MIT’s Autor) have found that imports—and in particular, imports from China—are responsible for some of the loss of U.S. manufacturing jobs. Autor, David Dorn at the University of Zurich and Gordon Hanson at the University of California—San Diego view China’s entry into world markets as an epochal shock. Standard economic analysis would have predicted a shift within U.S. industries as workers in firms that lost their markets to Chinese imports migrated to other sectors, with no change in aggregate employment. But in reality the shift to new jobs by those workers exposed to import competition has not taken place and employment has fallen in those labor markets. In another study with MIT’s Daron Acemoglu and Brendan Price, these authors estimate U.S. job losses from Chinese import competition in the range of 2 – 2.4 million.

The relative effects of technology and international trade/finance on employment will undoubtedly be investigated, analyzed and debated for many years to come. But Steven R. Weisman of the Peterson Institute for International Economics makes an important point in his new book on globalization, The Great Tradeoff: Confronting Moral Conflicts in the Era of Globalization:

Facts, by themselves, will never definitely resolve the arguments over the effects of trade and investment on inequality or economic justice in general. Globalization, and indeed the full array of political conflicts in the modern era, must be resolved by men and women, not idealized concepts and truths.

A honest debate over the benefits and costs of globalization is overdue. To date, the U.S. has managed to avoid hard choices, but that will not continue, Dani Rodrik of Harvard’s Kennedy School of Government has examined the policy challenge In his book, The Globalization Paradox: Democracy and the Future of the World Economy. He makes the case for the existence of a policy “trilemma,” by which he means that a nation can not simultaneously have democracy, national sovereignty and “hyperglobalization,” i.e., the removal of all domestic barriers to trade and finance.

Rodrik examines the three possible national positions under his trilemma. If a nation totally embraces the global economy, then it can not allow domestic politics to enact rules and regulations that are not in alignment with international standards. He cites the era of the Gold Standard as a period when nations could not exercise discretionary policies. On the other hand, democratically elected global institutions could devise global regulations for the global markets. This would require a sort of global federalism, i.e., the U.S. model on a wider scale. Rodrik cites the European Union as a possible move in this direction, but was skeptical when he wrote his book of the feasibility of the EU expanding its scope. Recent events have certainly diminished any confidence in that model.

That leaves the “Bretton Woods compromise,” which is the use of national regulations by nations to choose their degree of integration with international markets. The restrictions on capital flows under the Bretton Woods international monetary system allowed governments to use macroeconomic policies to attain full employment (see Ch. 2 here). Similarly, Japan, Korea, China and other East Asian economies implemented measures to promote exports to accelerate growth. The global economy benefitted those who engaged in it, but each nation chose the scale of its involvement.

Rodrik raised a concern that the embrace of the global economy has engendered democratic oversight. In the case of the U.S., this may have been mitigated by the role of the U.S. as a global hegemon that set the pace for hyperglobalization. The U.S. was an active proponent of the World Trade Organization (WTO), which replaced the General Agreement on Tariffs and Trade (GATT) in 1995 and has sought to further trade integration. Financial deregulation began in the U.S. in the 1980s with the removal of regulations on thrifts, and continued in the 1990s with the elimination of restrictions on interstate banking and the repeal of the Glass-Steagall Act that had separated commercial banking from other financial activities such as underwriting.

Both U.S. political parties embraced global economic integration. In the Republican party, the pro-business wing was allied with social conservatives and a group thaty advocated a strong military presence. The Democrats joined together unions with pro-business groups. But this year’s primaries are demonstrating that these coalitions are breaking down. Both Trump and Sanders are giving voice to those who feel that their support has been taken for granted and their concerns and interests ignored. There are projections of fundamental realignments on both sides of the political duopoly (see here and here), which may bring about a change in the U.S. position on globalization.

It is not clear what options are available. Despite the promises of Trump and other politicians, the jobs that have either been outmoded by technology or moved away will not be recreated. But it may be possible to devise stronger safety nets for those who do not share directly in the gains of more international trade and investment. President Obama went a long way in that direction through his achievement of expanded health care coverage. Rodrik believes that upper-income countries “…must address domestic concerns over inequality and distributive justice. This requires placing some sand in the wheels of globalization.” Summers has called for a shift in focus in negotiations from trade agreements to international harmonization agreements, that would include labor rights and environmental protection.

All this should be addressed, and quickly, since China’s impact on the global economy has not yet been fully felt. Arvind Subramanian and Martin Kessler of the Peterson Institute for International Economics claim that China’s effect on global trade makes it a “mega-trader.” A similar phenomenon may take place in the financial markets as China continues its relaxation of capital controls. The IMF has found that growth “surprises” in China already have a significant impact on equity markets in other economies. But the IMF expects that financial spillovers will become more significant in the future, particularly if Chinese residents are allowed to hold foreign equity and bonds. Martin Wolf points out that capital account liberalization may lead to a “large net capital outflow from China, a weaker exchange rate and a bigger current account surplus.” The international financial system is not robust enough to withstand another shock, which would only encourage more calls for nationalist measures. The costs of globalization must be explicitly addressed if we expect the public to ignore the siren song of politicians who would use protectionist measures to protect voters from the consequences of further globalization.

The BRICS and the Bretton Woods Twins

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The World Cup was not the only event of global significance to take place in Brazil this summer. The leaders of Brazil, Russia, India, China and South Africa met in the city of Fortaleza and announced the formation of two new financial institutions. One is the New Development Bank (NDB), which will finance “sustainable development” projects, with an eventual $100 billion in capital. The second is the Contingent Reserve Arrangement (CRA), which will make $100 billion available to lend to members in financial distress.

If these stated aims seem familiar, they should: they copy the missions of the Bretton Woods “Twins,” the World Bank and the IMF. Why, then, would we need another set of institutions with these mandates? A possible answer could be that these institutions will operate on a smaller scale, and therefore fill a gap between national organizations and international ones.  The principle of subsidiarity states that decisions should be made at the appropriate level, i.e., national policymakers address domestic needs, regional organizations deal with issues of regional relevance, and international institutions address global problems.  In this case, it might be argued that these middle-income nations are better able to make decisions on their level than in a larger forum.

However, economic efficiency is not what is driving this process. The new organizations are a response to the breakdown of quota reform at the IMF and the World Bank. A visitor to Beijing, as I recently was, will hear the complaints that the U.S. government, by not passing the measures needed to implement the reform measures, is frustrating the aspirations of the emerging market nations. Attempts to explain the inaction as the result of domestic politics are dismissed as self-serving justification.

It is difficult not to be sympathetic to these complaints. There is no reason why the long-overdue reallocation of quotas should not proceed. The governments of the emerging market economies have long been promised that an adjustment of their positions would be made, but there was always a procedural hurdle to be cleared. Now, when the world’s governments (including the Obama administration) agree on the particulars, a new reason for inaction appears.

Of course, there are details to be worked out for the new bodies. Who is eligible to borrow from the new development bank? Will it seek to compete with the World Bank by offering more money/fewer conditions? Will there be political “litmus tests” for would-be borrowers?

The new currency arrangement resembles the Chiang Mai Initiative Multilateralization (CMIM), an agreement on currency swaps within Asia, which has been viewed as a complement, and not a substitute, for the IMF. Moreover, as under the CMIM, a country that wants to borrow more than 30% of the maximum access allocated to it would also have to enter an arrangement with —  the IMF! The world, it seems, is not quite ready to cast off the Fund.

But it would be wrong to underestimate the significance of the establishment of these institutions. They are the result of the continuing clash between the G7 countries and the emerging market nations that see themselves as perpetually marginalized within the Bretton Woods institutions. While economic growth in China may be slowing and India continues to strive to accelerate its pace of development, the size of these and other countries in Asia, Africa and Latin America ensure that they will become more dominant over time. If they are frustrated within the traditional bodies of international economic governance, they have the capacity to establish their own forums.

However, economic and financial instability does not respect political camps. Their avoidance are international public goods, requiring cooperation from the full range of nations. A breakdown in global governance only leaves the international economy more vulnerable to volatility that can sweep across borders, as we learned in 2008-09. Perhaps the biggest question about the new organizations is whether they will strengthen the resiliency of the international financial system. It may take another crisis to learn the answer.

The Stars and Stripes Forever?

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Global imbalances are once again a focus of discussion. This time, however, it is Germany, not China, which is identified as the major surplus country and an obstacle to economic recovery.  The German surplus, it is alleged, makes adjustment harder in the Eurozone’s periphery countries.

Much less attention has been paid to the other side of the imbalances: the deficits in the U.S. current account. The U.S. balance of payments position reflects the dollar’s role as a global reserve currency. Andreas Steiner has shown in “Current Account Balance and the Dollar Standard: Exploring the Linkages” (Journal of International Money and Finance, in press) that the demand for reserves lowers the U.S. current account by one to two percentage points of GDP.

The demand for those reserves is not likely to diminish any time soon. Rakesh Mohan, Michael Debabrata Patra and Muneesh Kapur, in an IMF working paper, “The International Monetary System: Where Are We and Where Do We Need to Go?”, analyze the increase in reserves by major emerging market countries who may turn to reserve accumulation to expand their central bank balance sheets. They project the demand for foreign exchange reserves for seven emerging markets ((Brazil, Hong King, China, India, Korea, Russia, Saudi Arabia) under different scenarios for the mix of domestic and foreign assets, and estimate that their holdings of net foreign assets will increase from $6 trillion in 2011 to between $7.8 trillion and $14.9 trillion by 2017.  They caution that other emerging markets, such as oil exporters, are not included in their projections, and the demand for foreign assets may be higher.

The use of the dollar as an international currency appears in private markets as well. Mohan, Patra and Kapur present data that show the dollar with a 44 percent share of the global foreign exchange market. The dollar’s predominance in the foreign exchange market is matched by its use in international banking and bond markets.

Joseph Gagnon in “Global Imbalances and Foreign Asset Expansion by Developing-Economy Central Banks” has argued that the demand for dollar-denominated assets by central banks drives the balance of payments surpluses in many emerging markets.  If the dollar retains its status as a reserve currency, then there will always be a demand for dollars that feeds into the balance of payments. Until there is a credible alternative (or alternatives), global imbalances that include U.S. deficits will be an inherent feature of the international monetary system.

What could threaten the dollar’s special status? Emmanuel Farhi, Pierre-Olivier Gourinchas and Hélène Rey argue in their Reforming the International Monetary System that the “backing” of the dollar, which took the form of gold under the Bretton Woods system, now exists in U.S. Treasury securities. If there is a change in perception about the reliability of this backing, then the transition to a multipolar reserve currency system may be more abrupt than desired.

1944, 1976, 2013?

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When the financial crisis of 2007 was changing into the Great Recession of 2008-09, national leaders such as French President Nicolas Sarkozy and British Prime Minister Gordon Brown turned to the Bretton Woods conference of 1944 for inspiration. They invoked the spirit of the conference as they sought to resolve the crisis and devise regulations that would allow them to rein in the financial institutions that they held responsible for instigating the crisis. Indeed, Bretton Woods is often used as a model of international cooperation. (See, for example, here and here.)

But Bretton Woods is an odd choice for a prototype of international collaboration. Benn Steil in The Battle of Bretton Woods has shown how the conference proceedings were controlled by the U.S. delegation headed by Harry White, the U.S. Assistant Secretary of the Treasury. John Maynard Keynes, a member of the British delegation, was out-maneuvered by White, and the final agreement reflected the U.S. vision for the post-war international monetary regime more than anyone else’s. While the conference had a Quota Committee, for example, in reality the quotas assigned the members were chosen by the U.S. officials.

A more apt historical precedent may be the negotiations that took place during the early 1970s over the design of an international monetary system to replace Bretton Woods. Michelle Frasher has provided an account of these consultations in Transatlantic Politics and the Transformation of the International Monetary System. The U.S. had ended the conversion of gold for dollars by foreign central banks in August 1971. This act, according to Frasher, reflected the belief of U.S. President Richard Nixon and his Treasury Secretary John Connally that maintaining gold conversion limited their domestic and foreign policy options rather than any ideological view regarding Bretton Woods.

However, George Schultz, Connally’s successor as Treasury Secretary, came to favor floating exchange rates after the breakdown of the Smithsonian agreement in 1973. But while the U.S. had been able to dominate its Allies in 1944, it faced a different situation in the early 1970s.  It could not ignore the wishes of its major European allies, France, West Germany and Great Britain, which were concerned about unconstrained markets. The French in particular sought to place restraints on the ability of nations to maintain floating rates. In the end, the U.S. and French negotiators agreed to amend the IMF’s Article IV to include a commitment by the IMF’s members “to assure orderly exchange arrangements and to promote a stable system of exchange rates…” The IMF is still struggling to explain what this means in terms of which practices are permissible and which are not.

Over three decades later, many of the same tensions persist. Now, however, it is China and other Asian countries that express concerns about the U.S. Frasher (p. 135), for example, describes the source of the Europeans’ resentment in the 1970s:

…the US tendency to behave paternally and use its reserve status to disregard European opinions, act unilaterally on major policy initiatives, frame the relations in terms of US interests, and dictate the conditions of international monetary reform constantly frustrated European views about partnership. The economic and political differences within the transatlantic alliance made for an unconstructive, uneven, and often tense partnership.

Substitute “Asian” for “European” and “transpacific” for “transatlantic,” and we have a good summary of the Asians’ current views of the U.S. For example, Justin Yifu Lin, a former Chief Economist of the World Bank and the founding director of the China Center for Economic Research, wrote in Against the Consensus: Reflections on the Great Recession (p. 156)

One of the main flaws in the nonsystem that evolved in the post-Bretton-Woods period eventually led to the 2008-9 global crisis: the potential conflict of interest between US macroeconomic policy for domestic objectives and the dollar’s role as a global reserve currency…Inevitably, national economic concerns guided US fiscal and monetary policies, at times in ways that were detrimental to global stability.

Similarly, Xu Hongcai of the China Center for International Economic Exchanges in an article in the Global Summitry Journal co-authored with Yves Tiberghien wrote (p. 10):

Despite the status of the US as anchor for the global monetary system, the US central bank, the Federal Reserve is strictly mandated to set its monetary policy with consideration for US inflation, growth, and employment only. There is no channel for inputs from the rest of the world in managing the world’s currency. Thus, the major international reserve currency issuer continues to implement quantitative easing monetary policies in light of the needs of its own economy without considering the global spillover effect of such policies. These policies have caused inflationary pressures on emerging economies, and in turn increased the systemic risks of the global financial system.

After 1976, France gave up trying to devise a rule-based global system and turned to a regional system. What are China’s options? It has already shown a willingness to join with other Asian nations in a currency swap arrangement, the Chiang Mai initiative. It has the potential to do more, and could become a regional reserve currency. But to increase the use of the renminbi would require further financial decontrol, and until recently it did not appear that the government was ready to move in that direction. Most observers thought that a “fully global renminbi was a distant goal.”

The political battles over the debt ceiling, however, may push the Chinese government to rethink its long-run plans for the renminbi. Chinese officials expressed their frustration with the indifference of the U.S. to the global consequences of its domestic political discord. If Chinese policymakers now advance their timetable for expanding the renminbi’s use as a global currency, we may look back at 2013 as an inflection point.