Beware: Don't go back to the bubble that burst
Leaders of the Group of 20 are talking about creating a new architecture for the imploding world economy. But there's a big risk that their crisis summit in London three weeks from now will encourage a patched-up version of the instability that got us in trouble in the first place.
Fed Chairman Ben Bernanke teed up the problem in last week's speech to the Council on Foreign Relations, noting we collectively didn't do enough to reduce the global imbalances in trade and capital flows beginning in the 1990s.
The basic imbalance was that the United States consumed far more than it produced, financing this excess consumption by borrowing money from China and other rising nations of Asia whose export-led economies were generating huge savings. Both sides became addicted: America loved gorging on cheap imports; the foreigners loved the rapid growth from shoveling goods to the insatiable U.S. market.
It was a global bubble: The tsunami of foreign capital to the U.S. helped keep interest rates low, fueling the housing boom. Investors took ever-greater risks in a globalized economy in which billions of dollars were just so many dots on a computer screen. This system, congenial but inherently unstable, came to be known as Bretton Woods II.
The danger now, as economic activity slows around the globe, is that the G-20 leaders will seek recovery in a new version of the old, unbalanced system. That is, the nations of Europe and Asia will look to America, with its massive multitrillion-dollar stimulus and rescue programs, to rev up the world's sputtering engine. America, massively in debt, will go back to import glutton, and the world will go back to selling us products. And then we're back to where we started.
As the G-20 meeting nears, Washington wisely has pushed for a coordinated global stimulus to avoid the imbalances of the past. But the European nations are far less comfortable with deficit spending. And the Chinese resist a stronger yuan making their exports more expensive. Get ready for a replay of the old American-led boom-and-bust cycle.
Let's recall some economic history. The modern financial structure was created in 1944 at a conference in Bretton Woods, New Hampshire. It was a tightly disciplined framework: Countries would maintain fixed exchange rates; if they got into difficulty, the new International Monetary Fund would provide transitional financial help. Buttressing the system was the U.S. dollar, which could be converted into gold at a fixed rate.
The Bretton Woods system gradually lost its backbone. The U.S. dropped the gold standard in 1971, allowing the dollar to "float" in international currency markets as other major economies gradually moved to flexible exchange rates, too. The real action for emerging economies was in the massive flows of private investment. Then came Bretton Woods II and its unstated formula for mutual financial dependency. America would provide the market; the rest of the world, the goods. We overspent; they oversaved. Countries that wanted to maintain artificially low exchange rates, such as China, were allowed to do so. The system couldn't last, and it didn't.
When the G-20 gathers on April 2, the leaders will discuss new financial regulation, which will make everyone feel better. Perhaps they'll also endorse a new global clearinghouse for complex derivatives deals, so these financial killers don't pile up on the balance sheets of companies such as AIG.
But the G-20 will duck the real issue if its members don't address the financial imbalances that created this disaster. World prosperity in the future requires a coordinated global stimulus now - not a lopsided effort by the United States.
© 2009, Washington Post Writers Group