II. Characteristics of the Trade and Financial Systems: Bretton Woods Revisited
A. From a common origin to different paths
In the course of the recent crisis, trade did not exacerbate the crisis by translating the shock of the stock market crash into a contagion fed by chain reactions throughout the global economy. Instead, countries heeded the call in the G-20 statement of November 2008 that all economies refrain from protectionist interventions in their markets.[1] Meanwhile, the capital markets ground to a halt as the credit markets froze when banks and other financial institutions were unwilling to lend to all but the most creditworthy borrowers. This leads to the questions: Why do these regulatory systems look so different? How did they evolve in such different directions? What were the aspects of the trading system that helped protect it from systemic failure? How do these characteristics compare to the financial system?
In considering this question, it is helpful to remind ourselves what a ‘political miracle’[2] the Bretton Woods system was.[3] The American Bankers Association claimed that the IMF would amount to ‘handing over to an international body the power to determine the destination, time, and use of our money... abandoning, without receiving anything in return, a vital part of American bargaining power’.[4] The National Foreign Trade Council, the National Association of Manufacturers and the US Chamber of Commerce were staunchly opposed to the proposed International Trade Organization (ITO) and helped to kill it in the US Congress. In the end, the vision of the founding fathers prevailed:
They conceived of a postwar economic system ruled by law. They wanted it to be a universal system... rather than a collection of trading blocs. They wanted permanent international institutions to promote cooperation on monetary, trade, and development problems. And they wanted somehow to reconcile the concept of maximum possible freedom in trade and payments at the international level with the domestic pursuit by governments ofprogressive economic and social policies.[5]
‘Monetary questions had to be dealt with before trade questions... because countries would not be willing to commit themselves to tariff reductions if the conditions of competition could be completely altered by large and unforeseen changes in exchange rates’.[6] A fixed exchange rate system based on gold and special drawing rights was adopted when the Keynes proposal for a Clearing Union with global overdraft facilities proved too ambitious and the founders anticipated that there would be a high degree of voluntary coordination of economic policy. From a systemic perspective, the critical issue that the Bretton Woods founders faced was how to reconcile an open international trading system with the free movement of capital. In the end, the importance of open trade took preeminence over capital movements. Finally, there was a fight over whether to authorize, encourage or prohibit capital controls that ultimately led to a compromise in which capital controls were allowed, even encouraged, but countries were not required to cooperate in their application.
For our purposes, the fight over capital controls was the most important because it pitted the New York bankers against the founders in a fight that led to the triumph of finance ministries over the New York bankers and their central bank allies[7] and prompted Henry Morgenthau to proclaim that one of the goals of Bretton Woods was to ‘drive the usurious moneylenders from the temple of international finance’.[8] In this respect, the founders backed away from a total commitment to an open, liberal international economic order and, instead, institutionalized the view that ‘a liberal financial order would not be compatible, at least in the short run, with a stable system of exchange rates and a liberal trading order’.[9] Underlying this position were complementary economic and strategic views. On the economic side, ‘capital controls were necessary to prevent the policy autonomy of the new interventionist welfare state from being undermined by speculative and disequilibrating international capital flows’.[10] On the strategic side, the US foreign policy establishment believed that a benevolent attitude toward the interventionist policies of Europe and Japan was the most effective means of promoting economic growth and sustaining the Cold War alliance.[9]
Ironically, the importance of international trade to the policymakers ran headlong into political reality. When the over ambitious ITO project was unable to overcome political opposition, the GATT was forced to survive on life support through most of its early years. Compared to its sister organizations, the IMF and the World Bank—which were busy through the decades of 1950s and 1960s building up a sizable staff, planting a dramatic bricks-and-mortar physical footprint in Washington, DC and spending their considerable resources—the GATT, or more accurately, the Interim Commission for an ITO, had to struggle in political obscurity until 1968 when the US Congress took the modest step of providing permanent authorization for contributions to the GATT Secretariat.[12] The GATT took on the challenge of proving itself as an effective international regulatory framework. Aided by the US willingness to lead with open markets and Marshall Plan assistance and some exceptional leadership within the organization from individuals like Eric Wyndham White, the GATT ultimately concluded eight major rounds of trade negotiations. ‘Pragmatic accommodation, good practical sense, and important leadership led a weak “birth defected” GATT to become an important part of the world’s international economic institutional landscape’.[13]
Europe was the critical partner throughout this period. European support for the GATT was affirmed politically and economically as the European Communities transposed the basic framework of the GATT into the core principles for their economic union and the very identity of Europeans became associated with economic integration through the elimination of internal barriers to trade among European countries and eventually the single European market.
The 1970s proved to be a watershed decade for both the trade and the international financial system. By the end of the decade, the USA had abandoned the dollar’s link to gold, imposed an import surcharge on Japan to force currency realignment, and launched the modern era of flexible exchange rates. Treasury officials decided to reverse their benevolent attitude toward capital controls and began to adopt policies encouraging the flow of capital, teaming up with the banks to use commercial leverage to affect the economic policies of other countries.[14] Meanwhile, the GATT concluded the Tokyo Round. It was the most ambitious trade negotiation round in history with agreements to lower tariffs, codes on such nontariff barriers as subsidies, government procurement, valuation and standards, and the elimination of some sacred cows (e.g. the American Selling Price system, Wine-Gallon Proof-Gallon valuation of imported spirits) that had been grandfathered in the GATT and were a longstanding source of tension with US trading partners. Approval of this liberalizing package by an overwhelming vote in Congress, even in the face of a recession, was made possible by a US fast-track legislative approval scheme that was nothing short of a revolution in the political economy of trade.[15] In short, the table was set for the globalization of the global economy driven by trade and capital movements that would be the dominant economic story of the following three decades.
Also important in the 1970s was the emergence of an alliance of right and left around the theme of regulatory efficiency. Contrary to the views of some that this was principally a conservative phenomenon, Eduardo Canedo has argued that the movement that became associated with deregulation had its roots in the convergence of views from the Chicago School of Economics (on the right), under the intellectual leadership of George Stigler, and from the left, under the intellectual and political instigation of Ralph Nader.[16] Both Stigler and Nader were highly skeptical of the role of government regulation, Stigler out of an innate faith in the market, Nader from the perspective that regulatory agencies were more likely to be captured by those they were intended to regulate. While these movements diverged over the issue of social regulation, they were extremely influential in the initiatives to deregulate a number of areas, from aviation and trucking to natural gas and power generation.
It was the resurgence of US competitiveness in the 1980s and the confidence that it gave to Americans that helped support the extreme monetary policies that Paul Volcker introduced in the early 1980s to break the grip of inflation on the US economy. The success of this policy in turn helped form the basis for the Washington Consensus, namely that the key to international development lay in the adoption of carefully managed monetary policies, open trade policies and liberalizing financial markets. The strong US economy buttressed the role of the US dollar and overwhelmed any efforts to replace it with the special drawing right or other currencies. It also gave US Treasury officials few incentives to consider new rules for global finance. New rules for the global world of finance were unnecessary because domestic policymakers could oversee the system, and all that was needed were loose confederations of regulators whose objective would be the exchange of ideas on collective problem-solving.
It is said that nothing succeeds like success, and this unfettered model of regulation marked an era of unprecedented growth in the financial sector and the proliferation of financial instruments. While global trade grew steadily over the past 50 years, exceeding GDP growth rates and reaching $14 trillion by 2007, financial assets saw explosive growth from being about equal to global GDP in 1980 to over three times GDP by the end of2005. By 2007, financial services accounted for over one third of corporate profits in the USA and an estimated 5.9 per cent of US GDP, up from 3.5 per cent of GDP in 1978 depending on how you calculate it.[17] This explosion in the markets for financial services was accompanied by the globalization of those markets and the combination of size, complexity, growth and global scope beyond the grasp, ifnot the reach, ofnational regulators set the stage for what some predicted would be a systemic crisis of global proportions.[18]
Somewhat ironically, the financial community was one of the most ardent supporters of the emerging rules of the international trading system, even as they resisted regulation as it would be applied to finance. Moreover, financial interests, through their associations, sought new rules in the context of the international trading system but their focus was on limiting restrictions that countries could use to constrain the operations of financial institutions across borders. These new rules were developed in what eventually became known as the General Agreement on Trade in Services (GATS), incorporated with the World Trade Organization (WTO) in 1995, and subject to further negotiations in the Doha Round.[19]
Meanwhile, as predicted, the floating exchange rate system did lead to crises, but these were successfully managed on an ad hoc basis with governmental and IMF bailouts that were seen as confirmation of the importance of implementing more rigorously the Washington Consensus, particularly in emerging markets. The importance of crisis management in preparing individuals and their mindset for the latest crisis is well described by Joshua Green in his profile of Timothy Geithner:
Geithner came of age in Washington just after the Cold War ended, when the country’s preoccupation with wealth and the long bull market made Treasury a nerve center of the government. It helps explain Geithner to think of him as someone whose formative experience was in figuring out how to contain the series of upheavals that swept the international financial community in the 1990s, from Japan to Mexico to Thailand to Indonesia to Russia, and threatened the boom. Toward the end of the Clinton administration, a view emerged that the government had more or less figured out how to manage the global financial system. Those at the helm won extraordinary renown. The era’s time- capsule-worthy artifact is a Time cover touting Alan Greenspan, the Federal Reserve chairman, Robert Rubin, the Treasury secretary, and Lawrence Summers, Rubin’s deputy, as ‘The Committee to Save the World’. Geithner was an aide de camp.[20]
It was roughly during this same period from 1980 to 1995 when the trading system made its most extraordinary evolution into a global systemic regulatory system. The great debate—whether the GATT should be a rule-based system with a juridical function or an essentially diplomatic facilitator where trade issues could be resolved through negotiations—was resolved in favor of converting soft law into hard law or hard-hard law. It is nothing short of revolutionary that the Uruguay Round was concluded with a single undertaking that every country in the world was required to take or leave and a dispute settlement understanding that gave any country the right to challenge the practices of any other country, no matter how big or small. Whether this system would work or not was unclear but the history since then is clear; the enforcement record of the institution is singular and the stress test of the Great Contraction has confirmed at least to date that the system is still holding.[21]
By the dawn of 2007, these two systems that started life from a common conception had evolved two very different regulatory and institutional structures. The WTO became a member-driven, rule-oriented, unitary, comprehensive and nearly universal system where the obligations run horizontally from members to other members, decisions are made by consensus, and obligations are interpreted and enforced through a dispute settlement mechanism with a highly developed juridical function having the power to determine violations and authorize sanctions. The international financial regulatory system became a fragmented, complex, multi-tiered, multi-dimensional, resource-oriented system[22] that accommodates the different domains and regulatory prerogatives of finance officials, central bankers, and bank regulators as well as the private financial community by creating a variety of different organizations from treaty-based to intergovernmental to cooperative arrangements among functional regulators.
- [1] Paragraph 48 of the Pittsburgh Summit Communique, 25 September 2009.
- [2] See Gardner, above n 2, at 28—32. Gardner points out the changes to the world order that haveoccurred since 1948, particularly: the ‘money bags’, the ‘brains’, the economic weight and the political influence are all moreevenly distributed today than they were.... Yet the old and difficult issues that confronted thefounding fathers of the Bretton-Woods system are still with us—how to reconcile freedom ofinternational trade and payments with full employment and social justice at home, how tobalance the need for effective international economic institutions with still-powerful demandsfor national economic sovereignty, and how to relate regional and bilateral economicarrangements to a global economic order.
- [3] Powerful political and intellectual currents on both sides of the Atlantic opposed the creation ofthese institutions. Ibid, at 28.
- [4] Ibid, at 31.
- [5] Ibid, at 32.
- [6] Ibid, at 36.
- [7] Eric Helleiner, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s(Ithaca and London: Cornell University Press, 1994) 45.
- [8] Cited in Gardner, above n 2, at 38.
- [9] Ibid, at 5.
- [10] Ibid, at 4.
- [11] Ibid, at 5.
- [12] See Gardner, above n 2, at 50—1.
- [13] John H. Jackson, Sovereignty, the WTO, and Changing Fundamentals of International Law (NewYork: Cambridge University Press, 2006) 261.
- [14] Helleiner, above n 21, 112—15.
- [15] For a detailed account of the political history of trade politics, see I.M. Destler, American TradePolitics (4th edn, Washington, DC: Institute for International Economics, 2005).
- [16] See Eduardo Canedo, ‘The Rise of the Deregulation Movement in Modern America 1957—1980’(2009 PhD dissertation on file at Columbia University, Department of History), at 97 (cited with thepermission of the author). See also Joshua Green, ‘Inside Man’, The Atlantic Monthly, April 2010(
- [17] Johnson, n 10, at 60—1.
- [18] See Alexander etal., above n 5, at 7: The recent history of capital market liberalization has coincided with a swing in the balanceof intellectual influence from a postwar theory of economic policy that urged nationalgovernments to limit international capital movements to the present-day theory thatencourages free capital movements and the abdication of national regulatory powers. Sofinancial stability is largely a matter of convention. Written in 2006, these authors make one of the most compelling predictions at page 9: ‘Recentcrises suggest the current international efforts to regulate financial systems lack coherence andlegitimacy and fail to effectively manage systemic risk’.
- [19] The Financial Service portion of the GATS deals narrowly with measures that limit the crossborder establishment and operation of financial institutions but the obligations are implemented noton a generalized basis but country by country and measure by measure, depending on the willingness ofcountries to incorporate the obligation into their schedule. The prudential exception [GeneralAgreement on Trade in Services, Annex on Financial Services, para 2(a)] could be a framework forincorporating rules on prudential supervision and this exception is subject to WTO dispute settlement,however, there has been little interest in this possibility to date. For the most part, countries havesimply incorporated into their schedules their existing framework of regulations.
- [20] Joshua Green, ‘Inside Man’, The Atlantic Monthly, April 2010,
- [21] See WTO Appellate Body, ‘Annual Report for 2009’, WT/AB/13, 17 February 2010.
- [22] There is an interesting view that the IMF started as a rule-based system while the GATT startedon a more flexible, ‘ideas-based’ system but they reversed their characters over time. See BarryEichengreen and Peter B. Kenen, ‘Managing the World Economy under the Bretton Woods System:An Overview’ in Peter B. Kenen (ed), Managing the World Economy: Fifty Years After Bretton Woods(Washington, DC: Institute for International Economics, 1994) 3—57, at 7: The International Monetary Fund was a formal structure intended to enforce an explicit setof rules; its Articles of Agreement contained a detailed list of international monetary do’sand don’ts and established enforcement capabilities. Some ofthe rules were not enforceable,however, and they failed to anticipate all the subsequent problems. The [GATT], bycontrast, was an ad hoc agreement intended mainly to provide a framework for pursuingnondiscriminatory, multilateral trade liberalization. Many observers would now concludethat the GATT was the more effective arrangement. The strength of a formal arrangement
