The System Worked_How the World Stopped Another Great Depression
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Fearing domestic-asset bubbles from an inward rush of capital, many of these countries complained loudly and publicly about the prospect of QE2. In September 2010, Brazilian finance minister Guido Mantega labeled the phenomenon an “international currency war.” A week later, IMF managing director Dominique Strauss-Kahn seemed to endorse this concern, warning in a Financial Times interview against using currency depreciation as a “policy weapon.”5 Analysts quickly adopted “currency wars” as a term of art; within a month it had made the cover of The Economist magazine. Despite this rhetoric, the Federal Reserve went ahead with its QE2 program, angering most of the other G20 members. Officials from Germany, Brazil, and China blasted Federal Reserve chairman Benjamin Bernanke in a private G20 meeting in South Korea in October 2010; those critiques went public a month later.6 By the end of 2010, Brazil, South Korea, Taiwan, Thailand, Indonesia, and Chile had all imposed capital controls to slow down hot money inflows.7 These few months of public skirmishing strongly fed perceptions that the G20’s influence was fading and that exchange rates were gyrating wildly.8 Foreign policy analysts joined the chorus of concern, warning about the global implications of a currency war.9
FIGURE 3.1 J. P. Morgan G7 Volatility Index, 2000–2012
Source: Hood 2012, chart 3
Lost in all the hype was the simple fact that neither markets nor experts were terribly perturbed about the possibility of excessive exchange-rate volatility or an actual currency war. After fall 2008, exchange-rate volatility receded to close to pre-crisis levels, as figure 3.1 demonstrates. Even including the acute phase of the crisis, exchange-rate volatility did not reach the levels that immediately preceded the collapses of the Bretton Woods system and the gold standard.10 Assessing the performance of the international monetary system during the worst of the crisis, Uri Dadush and Vera Eidelman at the Carnegie Endowment for International Peace concluded: “Over the worst days of the crisis, from September 2008 to June 2009, the international monetary system remained orderly and flexible currencies provided a safety valve. Exchange rates adjusted quite smoothly and, while month-to-month volatility increased in 2009, changes in real exchange rates were modest. Those changes that did occur appeared justified by economic fundamentals … today’s international monetary system is remarkably resilient.”11
The gap between perceptions and reality about the currency wars continued to diverge as time passed. As figure 3.2 demonstrates, J. P. Morgan’s G7 Volatility Index did spike briefly in fall 2010 but never came close to approaching its 2008 peak. By the end of the calendar year, the index had fallen back to pre-2008 levels—continuing a downward secular trend in exchange-rate volatility toward levels below the pre-crisis average.12 Surveys of international business executives and financial analysts in the Bloomberg Global Poll conducted in September 2010 revealed minimal concerns about exchange rate volatility and relative comfort with US monetary policy.13 By January 2011, investors were far more interested in taking risk in overseas investments, indicating muted fears about currency volatility.14 Indeed, in its issue on currency wars, the Economist’s lead editorial concluded that “these skirmishes fall far short of a real currency war … The capital-inflow controls are modest. … Nor is there much risk of an imminent descent into trade retaliation.”15 This matched the assessment of market analysts and economists as well.16 By spring 2011, fears of exchange-rate volatility had died down in the popular press as well.
Despite the failure of a currency war to actually emerge, the meme never died out. A Google Trends analysis shows that “currency wars” repeatedly triggered elevated search levels despite continued declines in currency volatility.17 The meme peaked again in December 2012—and this time the gap between perception and reality was even more pronounced. By that fall, the United States was engaged in a third round of quantitative easing, and the European Central Bank had also reversed course, moving from raising interest rates to making more aggressive purchases of eurozone sovereign debt. The Japanese central bank acted aggressively to lower interest rates on the yen. This triggered rumblings from other Pacific Rim central bankers about the need to prevent “negative spillover effects” and the creation of a “regional core currency.”18 Again, the use of the term “currency war” spiked. Bundesbank president Jens Weidmann gave a speech in which he cautioned against the “increased politicization of exchange rates” and a potential “devaluation competition.” Other G20 central bank officials publicly warned that a currency war was brewing yet again.19 So did notables such as Pimco’s Mohammed El-Erian and Microsoft’s Bill Gates.20
Again, both the hard data and expert analyses refuted the bubble of concern about a currency war. As figure 3.2 demonstrates, J. P. Morgan’s G7 Volatility Index only increased modestly. Indeed, it failed to come close to its 2012 high, much less the 2010 levels. Neither the Bloomberg Global Poll of investors nor the Financial Times/Economist poll of executives showed any elevated concern about currency volatility. Numerous experts pointed out that during this episode, as during the 2010 period, central banks were simply trying to stimulate their domestic economies through expansionary monetary policy. Former central banker Philipp Hildebrand explained in the Financial Times, “Central banks are simply doing what they are meant to do and what they have always done. They set monetary policy consistent with their domestic mandates.”21 Indeed, this sentiment was reflected in the G20 communiqué issued by finance ministers in February 2013: “Monetary policy should be directed toward domestic price stability and continuing to support economic recovery according to the respective mandates. We commit to monitor and minimize the negative spillovers on other countries of policies implemented for domestic purposes.”22
By summer 2013, an interesting policy turnabout had taken place between the United States and the developing country members of the G20. The Federal Reserve had announced forward guidance suggesting a slow tapering of quantitative easing as the US economy picked up steam. In anticipation of higher interest rates, capital rushed out of the developing world and toward the United States. The movement in capital markets negatively affected India, Brazil, and other emerging markets. In response, the same countries that had accused the United States of launching a currency war three years earlier reversed their policy position. They complained that the United States was going to do exactly what these countries had advocated three years earlier—but now it was a bad thing.23
The gap between the rhetoric and the reality about currency wars remains wide. Barry Eichengreen noted, “‘Currency war’ is a meme that will not go away.”24 Why? One reason is that the term “currency wars” was catchy enough for even noneconomists to understand and repeat. Goldman Sachs’s Jim O’Neill went so far as to blame social media for the idea catching on, labeling it as “another sign of the ‘Facebook Times.’”25 Business Insider’s Joe Weisenthal concurred, noting that “basically, ‘currency wars’ is a silly phrase with huge viral potential.”26 The currency wars meme demonstrates that when other perceptual biases cause observers to believe that global economic governance is faltering, those perceptions are hard to reverse.
Days of Global Economic Governance Past
The presumption in much of the commentary on the current global political economy is that past eras of hegemonic leadership or governance structures were better and stronger. For example, adroit management of the gold standard facilitated nineteenth-century globalization, boosting trade flows between 30 percent and 70 percent.27 When commentators talk about reviving the gold standard, they reference this period as an example of why such a policy would succeed today.28
An even greater number of post-crisis analysts look back on the late 1940s as a halcyon time when global economic governance “worked” in any plain-sense definition of the word. That postwar era witnessed a major burst of growth in global governance structures. The creation of the Bretton Woods institutions, backstopped by the United States, ushered in a new era of global governance.29 In 2012, former US national security advisor Brent Scowcr
oft encapsulated the post-crisis conventional wisdom on this subject.30
The [2008] crisis demonstrated that we had a single worldwide financial system in which a crisis in one area could quickly spread throughout the world. But the world clearly had no single global way to deal with that crisis. This was far different even from the end of World War II. … The postwar leaders set up the International Monetary Fund, the World Bank, and the General Agreements on Tariffs and Trade to develop rules of the road. The new G20 is but a pale reflection of that once-brilliant institution building.
This narrative elides two inconvenient facts. The first is that past efforts at global economic governance have had more than their fair share of futility. For example, American hegemonic leadership did indeed achieve its acme in the late 1940s. According to the traditional narrative, this was a period of peak performance in global economic governance as well. Even during this peak, however, the United States failed to ratify the Havana Charter, which would have created an international trade organization far wider in scope than the current WTO. With the Marshall Plan, the US decided to act outside the purview of the Bretton Woods institutions, permanently weakening their influence.31 The United States created the Coordinating Committee for Multilateral Export Controls (CoCom) to restrict trade with the Soviet bloc but encountered severe difficulties in getting its allies to expand the strategic embargo. After the late 1940s, American leadership and global financial governance experienced as many misses as hits. The logic of the Bretton Woods system rested on the economic contradiction that the United States continue to export dollars but also be able to redeem those dollars into gold—a paradox that became known as the Triffin dilemma. Extravagant macroeconomic policies in the United States, combined with the growing reluctance to accommodate the US position, eroded that global financial order. As the logical contradictions of the Bretton Woods regime became more evident, existing policy coordination mechanisms failed to correct the problem. The IMF found itself incapable of pressuring countries running surpluses.32 By 1971, when the United States unilaterally decided to close the gold window, all the major economies had chosen to prioritize domestic interests over coordinating action at the global level.33 In ending Bretton Woods, the United States also undercut the IMF’s original reason for existence.
Post–Bretton Woods global economic governance was equally haphazard. While tariffs continued to fall, the developed world embraced a plethora of nontariff barriers designed to restrict imports. An increase in antidumping cases, countervailing duties, and quantitative restrictions on imports weakened the rules of the global trading system over the next two decades. Neither the United States nor any international institution was able to prevent the Organization of Petroleum Exporting Countries (OPEC) from raising energy prices from 1973 to 1986.34 Exchange rates and macroeconomic policy coordination devolved from the IMF to the G7. A predictable cycle emerged: other G7 countries would pressure the United States to scale back its fiscal deficits. In turn, the United States would pressure Japan and West Germany to expand their domestic consumption in order to act as locomotives of growth. Not surprisingly, the most common outcome on the macroeconomic front was a stalemate.35
There is a second problem with the nostalgia for past eras of global governance: it understates the considerable policy errors that occurred when there actually was agreement. The history of efforts at exchange-rate and macroeconomic policy coordination illuminate this problem, as even perceived successes had perverse policy outcomes. The era of the classical gold standard, for example, was the heyday of international exchange-rate coordination. This period was also unusual for other reasons, however. The limited extent of the democratic franchise, combined with the low degree of political organization among the working classes, made it easier for governments to make the painful domestic adjustments necessary to keep the gold standard functioning. Economic historian Barry Eichengreen has observed that the pressure that twentieth- and twenty-first-century governments experienced to subordinate currency stability to other policy objectives was not a feature of the nineteenth-century world.36 Adherence to the gold standard during periods when gold discoveries were small contributed to crushing depressions and deflations across Europe—often forcing countries to abandon the gold standard. Only after 1895, when a burst of gold discoveries allowed global liquidity to increase, did the domestic costs of adhering to the gold standard temporarily ease.37
Similarly, the “successes” in postwar macroeconomic policy coordination yielded mixed results at best. The most notable success was the aggressive US macroeconomic response to the Asian Financial Crisis in 1998. By cutting interest rates rapidly in order to serve as a market for distressed goods, the United States expedited the regional recovery. Yet, policy coordination during other eras was more problematic. The G7 economies were successfully managing the depreciation of the US dollar—and the US current account deficit—via the 1985 Plaza Accord and 1987 Louvre Accord. But while successful, these agreements allowed the value of the yen to skyrocket and triggered the beginning of an unsustainable asset bubble in Japan. In Europe, the creation of the euro in 1999 seemed to count as an example of successful monetary policy coordination. The European Union’s Growth and Stability Pact that was attached to the creation of the common European currency, however, was less successful. Within a year of the euro’s birth, five of the eleven member countries were not compliant; by 2005, the three largest countries in the eurozone were ignoring the pact.38 Since the start of the 2008 financial crisis, the inherent flaws of the eurozone arrangement have become manifestly clear.
Regardless of the distribution of power or the robustness of international institutions, macroeconomic policy coordination does not have a distinguished history.39 In comparison, the three years of successful macroeconomic policy coordination between mid-2007 and mid-2010 were downright remarkable. None of this is to deny that global economic governance was useful and stabilizing at various points after 1945. Rather, it is to observe that even during the heyday of American hegemony, the ability of global economic governance to solve ongoing global economic problems was limited.40 The original point of Kindleberger’s analysis of the Great Depression was to discuss what needed to be done during a global economic crisis. By that standard, the post-2008 performance of key institutions has been far better than extant commentary suggests.
Where You Stand on Global Economic Governance Depends on Where You Live
An old axiom of bureaucratic politics is that “where you stand depends on where you sit.” The point of the aphorism is that one’s attitudes toward a policy problem depend crucially on where one is located in the government bureaucracy. An official at the Federal Reserve, for example, might approve of the centralization of bank oversight if it were placed under the Fed—but not if it were placed under the Securities and Exchange Commission (SEC). It is possible to apply the same logic to attitudes about global economic governance. Relative optimism or pessimism could depend crucially on where one is situated. And what is interesting about the post-2008 global economy is the distribution of the rebound.
Two trends have marked most post-1945 global business cycles: economies recover as quickly as they drop, and the advanced industrialized states suffer less than the economic periphery. Neither of these trends has held during the Great Recession. As previously noted, recovery from a financial crisis is longer and slower than from a standard business-cycle recession.41 But the deviation from the second trend is particularly pronounced. The core economies—the advanced industrialized democracies—did not rebound as vigorously as they did in prior recessions. According to the Economist Intelligence Unit, the OECD economies averaged annual gross domestic product (GDP) growth of 0.5 percent between 2008 and 2012. The non-OECD economies averaged 5.2 percent during the same period. The US economy did better than both the European Union’s and Japan’s, but as figure 3.2 shows, the Great Recession led to deeper and longer job losses than the United States experienced in any other postwar reces
sion.
FIGURE 3.2 Percent Job Losses in Post–WWII Recessions, Aligned at Maximum Job Losses
Source: Bill McBride, “Comments on the Disappointing Employment Report,” Calculated Risk blog, January 10, 2014, http://www.calculatedriskblog.com/2014/01/comments-on-disappointing-employment.html
The distribution of growth matters because it does not mirror the distribution of commentary about global economic governance. The overwhelming bulk of analysis about the global political economy in general—and global economic governance in particular—emanates from the advanced industrialized democracies. A quick survey of the top international relations and international political economy journals makes this clear. Since the start of 2009, the top five journals have published a combined total of more than a hundred articles on global economic governance. Authors based in the United States and Europe were responsible for approximately 93 percent of those articles.42 The United Nations–sponsored journal Global Governance is ostensibly supposed to counteract this trend and offer up “a wide range of multidisciplinary and multicultural perspectives” in its pages, according to its own website. Yet, in the four years after the 2008 financial crisis, Western scholars and practitioners authored 88 percent of the articles published there. Similar biases would be found in the distribution of authors among prominent policy journals as well. The same story can be told in the distribution of analyses of the 2008 financial crisis and the Great Recession—they mostly emanated from the advanced industrialized states.43 In other words, the overwhelming majority of subjective assessments about the state of the post-crisis global economy and global economic governance are based in the parts of the globe that did not rebound robustly.