from Global Economy in Crisis

Previewing ’Bretton Woods Two’

CFR’s Peter Kenen discusses the current financial crisis and what will come of the upcoming international financial summit.

November 07, 2008

To help readers better understand the nuances of foreign policy, CFR staff writers and Consulting Editor Bernard Gwertzman conduct in-depth interviews with a wide range of international experts, as well as newsmakers.

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The November 14-15 summit in Washington of heads of top industrial and developing economies has been billed by some analysts as the successor to the 1944 Bretton Woods conference. At Bretton Woods, a group of countries agreed to create the International Monetary Fund and the World Bank. Peter B. Kenen, professor emeritus at Princeton University, says the comparison between the two meetings isn’t particularly accurate. Given the amount of planning that preceded the 1944 conference, and the fact that its delegates were leading economists and finance ministers, that meeting was much better placed to push through actual policy changes. He says the main point of this year’s summit will likely be to call for reforms, "without being terribly specific."

Can you give your general preview of the summit meeting and what sorts of policy you think will come of it?

I really doubt that the summit leaders are going to come out with a set of policy proposals. They’re more likely to come out with a declaration calling for some policy reforms without being very specific. After all, these are not economists or even finance ministers, although some of them have been. Their main message, I think, will be that reforms are needed, without being terribly specific. It’s not clear to me whether they plan to convene a so-called Bretton Woods Two to hammer out a set of reform proposals, or whether as they look at the situation they will discover that the reforms needed in one place are different from the reforms needed in others, and that a grand conference to try and negotiate common reforms, or create new institutions, is a bit unrealistic.

So perhaps some of the expectations that have been pinned on this are a little bit overblown at this point.

I think they are.

Given the abandon with which the phrase "Bretton Woods II" is being thrown around, could you give a little historical perspective on exactly what happened there, and how this might be different?

First of all, Bretton Woods was not a meeting of heads of state. It was a meeting of finance officials, and some central bankers, but mainly finance ministry people. And they had a fairly specific mandate, which was the creation of the International Monetary Fund [IMF], and as a sort of afterthought, the creation of the World Bank. There had been preparatory meetings going on between the United States and the UK. It was a considerable battle between the U.S. Treasury and the British as to how such an arrangement, such institutions, should be structured. The British were led by Lord [John Maynard] Keynes, the Americans by [economist and U.S. Treasury official] Harry White. Ultimately the weight of facts and economic power led to an IMF much more conservative in its powers than Keynes had wanted. The American view did prevail. And then, as I say, the charter of the World Bank was also drafted, but drafted rather quickly, as the membership recognized that postwar reconstruction and subsequent development were going to require public financing.

But the fund itself, as created, was simply a pool of national currencies, plus some gold, which could be used for short- to medium-term lending. Most of the early lending was to developed countries, but even that was restricted, since countries which were receiving Marshall Plan Aid in 1948 and thereafter were excluded from drawing on the IMF, at least temporarily. The IMF itself, of course, experienced a radical transformation in the years that followed as the ex-colonies became members, and as Latin America and Asia and Africa joined the fund, until it now has some 185 members. It was initially a pretty small body in terms of the number of members, but it did include all of the major countries except for Germany and Japan, with which we were still at war. They joined afterwards. The Russians at first indicated interest, but then pulled out and pulled a couple of their satellites out with them. But it was carefully structured-Keynes and White had been negotiating bilaterally for at least two years, probably longer, on the structure of the fund. And ultimately the U.S. view of the fund, as a pool of national currencies available for lending, prevailed. Here, if the summit comes up with at least a set of objectives for subsequent negotiation, I think it will achieve a remarkable purpose. But I’m not even sure at this stage that anyone quite knows what they are really aiming at achieving.

On a basic level, do you think the global financial system is best regulated by global institutions or by local institutions with increased global coordination?

I’m going to equivocate and say both. For example, a lot of the re-regulation that may be necessary is national and not global. If we decide to do something about the business model of the rating agencies, that’s going to be national, because the rating agencies of which we are concerned, though they do international business, are U.S. firms. There are certain to be some tighter regulations, perhaps even the prohibition of some kinds of financial instruments. But it is not going to be a massive reorganization of the monetary system, which is what the [International Monetary] Fund was concerned with. It’s going to be essentially an attempt to restructure regulation of the private financial sector. And there is, as I said, this disagreement lurking as to just how that should be done. But the distinction that I would draw is the fund was concerned with the monetary system, and this conference, if it focuses at all, will be concerned with financial markets. And those are not the same.

Do you think the IMF as it currently stands is adequate? Should there be new institutions, or simply modifications to the IMF?

I don’t know which way it’s likely to go. I’m not even quite sure how it should go, though I have skepticism about the extent to which the fund was presently equipped to do this job-my friends at the fund disagree, but that’s natural enough.

Let me put it this way. The ideal outcome would be a fairly short list of commonly needed regulatory changes: increases in bank capital; restructuring of the credit rating agencies; tightening and restructuring of the mortgage market, not only in the United States but in some other countries as well, to discourage the issuance of mortgages to people who are unlikely to pay; and perhaps also some arrangements for rescuing homeowners who have gotten in over their heads. I’m not quite clear in my own mind how far we might go toward what I think I would like-the trading of derivative instruments on organized exchanges. That would provide financial backup to some of those derivatives, and also some standardization. The trouble is the derivative instruments are tailor-made to the needs of individual clients, and therefore if you were to standardize the instruments, they would lose some of their value to the customer. But I still believe that exchange-traded derivative instruments would be more sensible than the terribly elaborate and unique instruments we have. And I would hope that the summit meeting, if it makes any specific recommendations, will look at the question of the origination and the trading of derivative instruments, particularly the credit-default swaps, as well as higher standards for mortgage lending. But again, the problem here is that [using the term] Bretton Woods raises the expectation that we will somehow derive a whole set of new rules for the system, and perhaps new institutions for the system, and you just can’t do that in a day. And what the follow-up will be is not clear.

Do you think you could do it granted a longer time frame? Or are there just existential problems here to any sort of global financial regulator?

There are obviously existential problems, and most countries are not going to want to delegate authority over their own financial markets to international supervisors. But in any case, it is a long and tough process because an awful lot of issues have to be covered. Even in respect to individual instruments, such as whether they should be exchange-traded or not, and what are the terms and conditions for these instruments? Some standardization is needed, and the role of individual investment banking firms in the tailor-making of these instruments has to be seriously reconsidered.