Resolving the Global Financial Imbalances: An Evaluation of

Policies and RegulationsAlex Kondonassis

Mary MalliarisTassos Malliaris

The 10th Biennial Athenian Policy Forum Conference

at the Duetsche Bundesbank,Frankfurt, July 28-31, 2010

Focus of the Paper

• Trace the Evolution of the Global Monetary System

• Emphasize the Persistence of Global Financial Imbalances

• Evaluate Economic Policies

Evolution of Global Monetary System

• Bretton Woods I

• Bretton Woods II

• Bretton Woods III ?

Bretton Woods I

• Why Was Bretton Woods Developed?

• Keynes’ Incompatibility Thesis: Cannot achieve Free Trade, Flexible Exchange Rates, Free Capital Mobility and Global Full Employment

The Gold Standard Period

“It is characteristic of a freely convertible international standard that it throws themain burden of adjustment on the country which is the debtor position on theinternational balance of payments.”

Keynes, Post War Currency Policy, 1941, pp. 29-30

“An essential improvement in designing any international payments system requires transferring the onus of adjustment from the debtor to the creditor position. This transfer would substitute an expansionist, in place of acontractionist, pressure on world trade “

Keynes, Post War Currency Policy, 1941, pp. 29-30

1944 Bretton Woods Conference

• U.S. Major Creditor• Europe and Japan Are Devastated• Need to Grow Global Economy• Presence of Economic Imbalances• Keynes’ Estimate of $10 billion needed• Dexter White proposes $3 billion• Marshall Plan Over 4 Years: $13 billion

Bretton Woods 1947-1973

• Stabilized Global Economy

• Promoted Growth

• Created New Global Imbalances

• Core or Center (U.S.) vs. the Periphery (European and Asian Countries)

Collapse of Bretton Woods I

• Global Imbalances

• French Conversion of Imbalances into Gold

• U.S. Inflationary Monetary and Fiscal Policies

The Modern History of Gold

New York Gold Price Per Ounce

$0.00

$200.00

$400.00

$600.00

$800.00

$1,000.00

$1,200.00

1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

Year

$/oz

*Non-Inflation adjusted prices

The Global Monetary System After 1973

• More Flexible Exchange Rates• Exchange Rate Volatility and Uncertainty• Accelerated Global Capital Mobility• Independent Monetary Policy• Several Currency Crises, leading to Banking

Crises and often to Real GDP Declines

The Dollar-coaster

Three Major Developments

• 1989: Japanese Stock Market Crash and Japan’s Lost Decade

• Formation of the EU and EMU: Creation of the Euro

• Emergence of China

Collapse of U.S. Trade Balances

Bretton Woods II

• 2003: Dooley, Folkerts-Laundau and Garber• Bretton Woods Revived• Core: U.S. Dollar is Used as a Global Currency;

Balance of Payments Deficits.• Periphery: Export-led Growth Driven by an

Undervalued Exchange Rate; Massive Accumulation of Reserves

• System Can Be Maintained in the Long-run

U.S. Current Account Decline

China’s Dollar Holdings

An Evaluation

• Argument for Bretton Woods II is Supported by Reality

• There Are also Several Differences Between BWI and BWII

• Periphery: Numerous and Heterogeneous• Existence of the Euro• Free Capital Mobility• Liberalization of Financial Markets

The Global Financial Crisis of 2007-09

• Started in September 2007 as a Subprime Mortgage Crisis with a $300 billion potential loss

• Developed into a Major Financial Crisis • The Role of Easy Domestic Monetary Policies• The Bernanke/Taylor Debate of Global Savings

Glut

Global Dimension of the Crisis

The Crisis of the Euro

• While the U.S. is Assessing the Impact of Global Imbalances in Its Financial Crisis

• The EMU, viewed as a Bretton Woods System of a Smaller Scale, Experiences a Global Imbalances Crisis of its Own

Current Policies and Regulations

• The emergence of the G20 as the Global Governance Group

• The Designation of the Global Economy Meeting as the Bi-Monthly Central Banks Monitoring Group

• The reform and Expansion of the Financial Stability Board

Future Possible Scenarios

• Bretton Woods III: Public Sector U.S. Growth• An Asian Monetary Union? • Continued Depreciation of the U.S. Dollar?• Domestic Consumption Led Growth vs. Export-

Oriented Growth?• Recycling of Accumulated Reserves as Foreign

Aid to Developing Nations? • Are There Reasons for Optimism?