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A
Good afternoon, or good evening, I should say. My name is Matthias Kuniga Kibuji. I'm from the lse. And it is a pleasure today to introduce a lecture by Professor Curren within this Ralph Miliband series on the future of global capitalism. Of course, interest in global finance probably goes through waves, and these waves are often triggered by financial crisis. And when these waves in a reach their top, it is often the case that many people present themselves as experts of financial policy, financial governance. You have a flurry of books coming out expressing various viewpoints on how the global financial system should be reformed, what was wrong, and so on. So it is an especial pleasure this evening to introduce a scholar who has been working on global finance for over 40 years, I must say, and has produced and contributed, made pivotal contribution to the study of global governance. Professor Cohen is Louis G. Lancaster professor of International Political Economy at the University of California in Santa Barbara. He is the recipient of a Distinguished Scholar award awarded by the International Studies association in the year 2 and 20,000. And he's author of a long list of books, too many to mention here. I just would like to mention some that had a particularly deep impact in the understanding of today's global finance, and in particular on monetary relations, which are the Geography of Money, published by Cornell University Press in 1998, the future of Money, published by Princeton University Press Press in 2004, Global Monetary Governance, published in 2008, and the latest book, International Political Economy An Intellectual History, published by Princeton University in 2008. And Professor Cohen this evening will talk to us about the coming global monetary order or disorder, I hope. Order. But we will hear about it very soon. Thank you.
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Okay, thank you very much, Matthias. I very much appreciate the warm introduction and your very generous comments. I'm just sorry that my parents couldn't have been here to hear them. My father would have enjoyed them. My mother probably would have gladly. I have been in this business a long time, and in fact, I started my teaching career actually 46 years ago. And as someone who chose to specialize in the area of international money and finance, it was reasonably true that virtually every year for 46 years, I could walk into the classroom and say, this is a really interesting time to be talking about international money and finance. And because there's always something going on, there's always a crisis of some kind. But this is a really interesting time talking about international money and finance. I want to express my appreciation for the invitation to be here tonight. I recognize the honor in being invited to be part of this lecture series. I appreciate everyone's attendance. I know that I'm up against a fair amount of competition this evening. With the debate coming up later this evening. I hope I can make it somewhat interesting for you. You may have noticed that we turned off our microphones while we were talking. I had an object lesson yesterday on what happens with a live mic. Now, just to be sure. No, I thought that we had. Oh, here we go. There we go. Okay. Principle number one, press the right button. Okay. So I suggested the title Coming Global Monetary Disorder because I wanted to, with the disposal in parenthesis, not because I wanted to dis the audience, but because I wanted to imply that there is some question whether what is coming in the future in international monetary relations in the global monetary system is in fact likely to be better or worse than what we've experienced in recent years. We've been living now for almost three years with a major crisis. No question about that. This has been the biggest economic challenge, Starting with the crash of the American housing market in the middle of 2007, spreading through financial markets, spreading to the real economy, with declines in GDP in virtually every country in the world, in some cases, double digit falls of gdp, gross domestic product. This has been the most serious economic challenge since the 1930s. It's difficult to exaggerate how close we came to a really major collapse of the world economy. And I think that we should all be grateful that that was avoided. The question that we face is, in the aftermath of this great crisis, can monetary order be restored? Global monetary order? Can we establish some kind of stability? It's a question that clearly is on everyone's mind. The International Monetary Fund just had its spring meeting just last weekend, preceded by meetings of the various groups, the group of seven and the group of 20 and others, and then finally the meeting of the International Monetary and Finance Committee of the imf. And it's clear that governments are preoccupied with the subject of the coming global monetary order or disorder. Can we do something? Can we restore order? Can we improve the international monetary system? Can reform occur? And will that reform be successful? Answers obviously differ and range from, as I put out here, yes to no and any shade of gray in between. Some say this is a Bretton woods moment. This is the time when we should try to do again what the allied nations did at Bretton woods in the summer of 1944 and build a new international monetary order from the foundations up. Others suggest, more pessimistically that the answer is likely to be more negative, that we will as soon as the crisis has passed. We will move back to more or less business as usual with relatively little change, and possibly things worse rather than better. And as I suggest here, my own answer is closer to no than yes, but with some nuance, which I hope you will appreciate as we, as I go forward. First, a few words about what we mean by the global monetary system, just to be sure that we're all on the same page, or in this case, the same slide. Global monetary system can be understood to operate at two levels. At one level, at the level of markets, it consists of all the institutions and institutional arrangements for the transfer of purchasing power between countries, between currencies. This, in other words, involves the foreign exchange market and the vast array of international financial markets that exist around the world. It is a functioning market system, if you will. But then there's also the global monetary system, the meaning at the official level, where what we mean by the monetary system is more akin to, shall we say, a constitutional order within which a political system evolves. It is the set of mechanisms, arrangements, institutions that involve the formulation and implementation of the rules of the game. The point is important here. The point is important because while we have a sense that there is such a thing as a global monetary system, it's clear that we don't have a global monetary government, we don't have a world central bank or anything like it. The International Monetary Fund is the most well known institution at the international level, that is delegated authority in the area of international money and finance. But it is a very weak form of governance. What we are talking about here is informal terms in formal terms of political science. Anarchy, absence of formal authority. That's anarchy, absence of formal authority. But of course it's not anarchic. Somehow the system seems to have rules, and to some extent those rules are observed. What we have is what is often called in political science and political economy literature, governance, governance, implementation, formulation, implementation, enforcement of rules, governance without government. That's inevitable in the kind of world in which we live, a world where politically we are organized into sovereign states, sometimes called the Westphalian system, going back to the Peace of Westphalia of 1648. A system of sovereign states, by definition, sovereignty means there is no formal authority above the individual territorial state. But what that means then is that if there is going to be any governance at all of relations between sovereign states, it must rely on the cooperation of those sovereign governments. There must be some form of formal or informal institutionalized or not cooperation among sovereign governments. It's necessarily imperfect. It's unrealistic to Think that sovereign states would be prepared to completely pool their sovereignty in some world monetary authority? I would insist on that as an axiom, though some of you may disagree. The consequence is that inevitably what we're talking about is some approximation of governance, but hardly a perfect form of governance. Now, when we talk about global monetary governance, we talk about this thing, governance of world monetary and financial relations. We're basically talking about four. And I always have to be sure to look at my hand to be sure. I have been known to say we have four stick up three fingers. So I always have to make sure four. We have four critical elements. Adjustment, liquidity, confidence and leadership. Governance involves all of these. If there's going to be governance of the global monetary system, we must address all of them. We cannot rely on just one or two. First is adjustment. After all, what is the monetary system thinking in terms of states? The monetary system consists of the payments relationships between states. The balance of payments is a country's not balance sheet. It's the equivalent of its income statement measure of flows of revenue in and out of the country. Every country has a balance of payments. Those balance of payments. Those payments balances can be in surplus or deficit. Critical to the element of governance, to the idea of governance, monetary relations is the notion that when these deficits and surpluses occur, that there must be some agreed set of rules for how they will be dealt with. How countries will be expected to adjust their economies to restore some form of balance in their payments relations. Central to this is the system of exchange rates. Because the system of exchange rates, the rate of exchange between and among currencies. The role of exchange rates essentially is to dictate or determine what range of policies are available to governments to deal with their payments balances. Or more properly, to deal with their payments imbalances. If we have. I always teach my students that countries basically have three instruments at their disposal to deal with balance of payments problems. Deficits or surpluses. Specifically deficits. They have the three Ds. Three Ds, devaluation, deflation, which means reducing spending in the economy and hence spending on imports or direct controls, trade controls, capital controls and the like. Devaluation, reducing the exchange rate of the currency. Deflation, squeezing spending out of the economy through fiscal and monetary policy or direct controls. If you have a fixed exchange rate, you have deprived yourself of one of those three Ds, and that therefore dictates a different mix of policy than if the exchange rate itself can be used as part of the adjustment process. You're all familiar with what's going on in Greece today. And we know that part of the problem that Greece faces in the sovereign debt crisis is that the Greeks cannot devalue to get their way out of their problems. They cannot devalue because they're part of the Eurozone. Nor can they use direct controls because they're part of the European Union. They can't apply capital controls, they can't apply trade controls. They only have one D left. Deflation, austerity. And you can be sure that between them, Mr. Strauss, Kahn and Frau Merkel will make sure that the Greeks institute policies of severe austerity. The exchange rate. Management of exchange rates is critical here. Liquidity, to the extent that balance of payments deficits cannot be eliminated immediately, imbalances cannot be eliminated quickly. They must be financed. We have to have a sufficient supply of financing for balance of payments deficits pending their adjustment. Thirdly, we need confidence. If there's going to be liquidity, there's going to be financing, then we have to have confidence in the instruments that we use, the instruments of liquidity that we use. And finally, there has to be leadership. Because it's not easy to have a global monetary system that is based entirely on the decentralized decision making of individual countries. It's rare that we governments left to themselves, will reach an optimal outcome. The invisible hand may work well in private markets. It doesn't work very well in relations between governments. So four elements. Now, if we think about the Bretton woods system, the Bretton woods system addressed all of these implicitly, if not explicitly. What's striking about the Bretton woods system, that set of rules of the game that were negotiated and agreed at the conference in 1944 at the Mount Washington Hotel in Bretton Woods, New Hampshire. If any of you ever have a chance to visit the United States and you're in New England, it's worth a special trip. It's a three star in the guide Michelin. It's a three star place. Well worth the visit. Beautiful location. Historic site. These governments, during the six weeks that they met there, came up with a design that was very state centric in the sense that governments were expected to participate collectively in the governance of the world monetary system. For example, on the issue of adjustment, they agreed on something called the par value system. Every government would establish a par value or parity for its currency, currency and it would assure that that exchange rate would remain in effect on a permanent basis, or at least for a long period of time. The idea here was therefore that governments determined what the exchange rate would be and governments would manage those exchange rates through interventions or adjustments on liquidity. They created the International Monetary Fund. That was what the conference was all about. They created the International Monetary Fund to provide liquidity financing to governments in time of need. Since the IMF was itself a creature of the governments that created was run by collective. It was to be run by collective decision making. Hence, once again, governments were to be in charge of determining access to liquidity. And of course you had the system of quotas for individual countries and allowance for conditionality to be attached to the loans by the IMF and so on. But all of this was to be done through the collective decision making of the governments that were the managers of the imf. As far as confidence was concerned, there didn't seem to be any issue at the time. The dollar was considered as good as gold. In fact, in the first years after World War II, it was often thought the other way around, that gold is just as good as the dollar. Things have changed, obviously. And finally leadership behind it all was in fact the fact that there was an acknowledged leader and that leader. Unlike what happened after World War I, the United States was prepared to accept the responsibilities and obligations of leadership at this time. One can debate its motivations, but that's another story. As the post war period went on, of course the United States came to share some of that leadership burden with first the group of five, which was then expanded to six and then expanded to seven starting in the 1970s, so that by the 1980s leadership was understood to be exercised through the Group of Seven, not just the United States alone. Now compare that with where we are today because over time things really changed, fundamentally changed. Over time the system became increasingly, as you see here on the slide, privatized as a result, and I'll explain that in a moment. As a result, the rules have become increasingly opaque. There's greater uncertainty in the system. There's greater potential for instability. What do I mean by privatized? Consider the matter of adjustment. Central to adjustment, as I said, is the exchange rate system. The exchange rate system that had been agreed at Bretton woods in the 1970s was completely overturned. The key article of the Articles of agreement of the IMF is Article 4. Article 4 In 1944, the original Article 4 said that each country was to establish a par value defined in terms of the US dollar of weight and fineness of July 1, 1944, which is to say it defined in terms of the of gold weight and fineness of the dollar of July 1, 1944 was 1 35th of an ounce of gold of a certain fineness. The new Article 4 said governments are free to do anything they want with their exchange rate except except establish its par value in terms of gold. In other words, the one thing that had previously been required of everybody was the one thing that was now prohibited. The result is that choice was widened. Many countries chose to allow much more flexibility of their exchange rate in some case, absolutely clean floating. And what that means basically is that the determination in management exchange rates was now to be left to markets. Market actors now became the key decision makers on exchange rates rather than government. Same thing with liquidity. Where the IMF was created after World War II to be the central source of financing for countries in trouble. Increasingly, for any country that had creditworthiness, financial markets developed starting in the 1960s with the Euro currency market and growing onward from that. Countries that had creditworthiness more and more found that it was more to their taste to apply to the markets to sell bonds in the markets or borrow from banks rather than go to the imf. Even though it might be a little bit more expensive. The great value of it was there was no conditionality. Banks bond markets could not impose conditions on governments the way the IMF could. And so more and more governments found it convenient to go to the markets to market actors. So once again, market actors, private market actors, came to be the decisive managers of access to international liquidity. In many ways an attractive system because the markets could be very flexible in terms of their financing. But as we well know, markets tend to be. The financial markets tend by their nature. The fact that they are trading in assets where everybody is worried about their future value and not just their present cost. These markets are prone to volatility, prone to herd behavior, prone to crisis. And with the result that we have much greater uncertainty now about access to liquidity. We often find that access to liquidity is pro cyclical. That is to say, when there's a lot of expansion in the world economy, too much is provided. When there is. When there are problems in the economy, then not enough is provided. And Greece, of course, again is a good example of that. On the confidence issue, it's clear that confidence in the dollar is on the decline. The United States has become in my lifetime has gone from being the greatest creditor nation in history to the greatest debtor nation in history. Historically high level of foreign debt. And so doubts about the dollar have accumulated. The problem, of course, is that there's no clear alternative for the dollar. So once again, a great Deal more uncertainty and finally leadership. One of the historic historians are going to look back on the crisis we've been living through the last two and a half to three years. The Ghana looked back and said that one of the most interesting developments in this crisis was the way in which leadership slipped very quietly from the G7 to the G20. The G20 was established after the Asian financial crisis in the late 90s and was really at the time considered a kind of gesture to emerging market economies that there would be a place where they would have an opportunity to talk with the big guys with the traditional G7. It was to be somewhat symbolic, but not necessarily a governance mechanism. And then somehow, as this crisis broke, and obviously it has a lot to do with the success of China and other emerging market economies in the period in the last decade, the G20 simply took over. But we're not really sure who runs the G20. We're not really sure how decisions are made in the G20, if they make any serious decisions at all. And so once again there is a question, once again, a great deal of uncertainty. So we're faced today with a variety of challenges reflecting this increased privatization of the global monetary system, reflecting the increased uncertainty, the proneness to crisis and instability and volatility. We have a number of problems that we have to ask ourselves about under all four headings or all four of these elements of governance, adjustment, liquidity, confidence and leadership. On adjustment, the question is whether management of the of payments, balances and imbalances of exchange rates can be improved. Basically, that translates into the question you see on the slide, can surveillance be strengthened? What we have is a decentralized system in which governments can have virtually any kind of exchange rate system they want. And therefore the choices for adjustment are very varied. The only real way of managing this is through surveillance of some kind. And so the question is whether surveillance can be strengthened on liquidity. If the problem is that markets have, for many countries, taken over as the principal source of financing for balance payments deficits, and markets themselves are prone to instability and often crisis, then the question is whether market crises can be prevented or to the extent they occur, better managed than they have been recently. Thirdly, on confidence question really boils down to what comes after the dollar. And on leadership question has to do with the G20, whether in fact the G20 can be expected to operate effectively having replaced the G7. So what I would like to do is then take a few minutes on each of these. On adjustment, the issue of surveillance, it was understood at the time that the Article 4 of the IMF's Articles of Agreement at the time that this was rewritten back in 1976, it was understood that to just tell governments that they could do anything they wanted with their exchange rate was a prescription for, at the minimum, uncertainty, if not instability. And so part of the revised wording of the Article 4 was that the IMF would exercise, quote, unquote, firm surveillance, firm surveillance over the exchange rate policies of members. Have you all seen how firm the surveillance has been of the International Monetary Fund? Clearly there's been something short of firm surveillance in the years since. In 1977, the IMF issued its so called decision in which it identified a number of indicators that it would use to suggest when a country might be behaving in a way that needed some correction. Wording said that these indicators would trigger a discussion or an ad hoc consultation. One of these indicators, for example, would be protracted. This is quote, protracted large scale intervention in one direction in the exchange markets. If anyone is thinking China, that would obviously be an example of quote, unquote, protracted large scale intervention in one direction in the exchange market. But any surveillance of Chinese exchange rate policy has been most conspicuous by its absence. In 2007, a decision was made to supplement the existing list of indicators with a new indicator, an indicator labeled external stability, which was defined as a balance of payments position that was unlikely to generate disruptive exchange rate movements. This was passed over the protest of the Chinese government because it was clearly understood that this would open the door to criticism of China's exchange rate policy. But once again, what we note is that the IMF on the issue of China has been notably silent. Even with the addition of this new indicator, external stability, three years ago, the IMF has yet to actually speak publicly in criticism of the Chinese government. Now, what's going on here? What's going on here clearly is that countries that are big enough to be a problem are also big enough to exercise some influence over the imf. Or to put it differently, the IMF does not feel free to quote, unquote, name and shame governments that are not acting in the common interest. The IMF Secretariat, the IMF Managing Director are after all, ultimately under the their authority is entirely delegated. They are agents of their principals who are the governments. And if they want to maintain good relations with the governments who are the governors of the imf, they feel reluctant, the IMF feels reluctant to antagonize particularly the larger members. To become more effective, the IMF clearly has to be in a position to publicly name and shame governments that it feels are not abiding by the rules. But the question remains of whether the larger members would let the IMF do that. And I would submit to you that until now there's no evidence that they would. Instead, what they have done actually is to in the G20, they have spoken of an alternative to IMF surveillance. They've spoken of peer pressure. That is to say, they've spoken of establishing a quote, unquote framework for strong, sustainable and balanced growth. I like that. Reminds me of the Stability and Growth pact of the European Union with equal authority, the framework for strong, sustainable and balanced growth. The idea is that they would establish a peer review process, a mutual assessment process in principle, committing them to work together to assure that governments threaten monetary stability. Is this realistic? Is it likely to evolve into any more effective form of governance of the adjustment process? Clearly, by now you can feel that I'm exhibiting a certain degree of skepticism on this. I would refer you to the most recent meeting last week. If you were to name today the two most prominent issues of adjustment in the global economy, I think it would be fair that most of you would vote for Greece and China. Greece is clearly a challenge right now and could lead to a great deal of difficulties, as I'll come back to in a few moments. And China's exchange rate policy clearly has contributed to difficulties because its insistence on maintaining a fixed rate to the dollar has enabled it to avoid appreciation, has led to major surpluses with corresponding deficits elsewhere, not just in the United States. If you actually look at what happened last week, you will find that these two topics, Greece and China, were not even discussed. They were very carefully avoided. Nobody had a word to say, not just in the final communique, but at the meeting itself. The two most important problems. Again, the two most important problems in the monetary system today, and they weren't even discussed by the group that is trying to establish a, quote, framework for strong, sustainable and balanced growth. Well, I leave it to you to decide whether this is likely to change. On liquidity. Basically this comes down to, as I said, management of the financial markets to minimize the risk of crisis or to better contain and manage crises when and if they occur. And of course, as you well know, many ideas have been proposed. In the IMF's most recent report on global financial stability, there is a quotation says there's agreement that, quote, there's a need for some combination of ex ante preventive measures as well as improved ex post resolution mechanisms, crisis prevention, crisis management, and these ideas have been floated over the last two and a half years. Include financial transactions tax. Your present Prime Minister has associated himself with that proposal, which is a variation on the old Tobin tax proposal. Tougher capital requirements, better management of liquidity, various forms of macroprudential regulation, which is to say prudential supervision or regulation which would take account of systemic risk and not just the risk to individual institutions. Many ideas, but so far relatively little action. As again, I'm sure you're aware, there have been some new initiatives at the national level in some countries. In my country, the United States, the House of Representatives has passed a bill sponsored by Representative Barney Frank. The Senate, on the other hand, just last week, I guess it was Monday. This week the Republican Party held firm and prevented even the beginning of discussion of the corresponding Senate bill sponsored by Professor Senator Chris Dodd of Connecticut. The reality is that very little has actually been accomplished at the national level. Some governments are opposed to any significant change in the rules. The Canadian government, for instance, has said, hey, our banks didn't get into trouble, so we don't see any need for new arrangements. The G20 does seem to be focusing on a small number of possible reforms. One would be a tax on non deposit liabilities of banks. It's not a bad idea, but by itself is unlikely to solve major problems. Second would be a tightening of capital requirements, a Basel III to follow the original Basel Accord that was designed in the 1980s and the Basel II that was finalized in the early 21st century. But again, there doesn't seem to be any momentum for anything more significant than this. As the IMF's global financial stability Report says said we are still living with regulatory uncertainty. I think that's an understatement. And of course what's looming over this is the new problem of sovereign debt, symbolized of course by Greece. Most of all. Many people take the view that, well, this is an isolated case. It's not necessarily going to create global problems. I'm reminded when I read these comments about Greece today, I'm reminded of a cartoon by David Lowe. Remember David Lowe, who did cartoons? Some of you with hair that's whiter than mine might remember David Lowe from the interwar period did political cartoons for the what was then the Manchester Guardian. There was this wonderful cartoon he did in 1931 when the great financial crisis broke, starting with Credit Darnstalt bank in Vienna. And there was this cartoon of a boat in a storm, a little dinghy rowboat in a storm. And one end of the boat was High in the water with little figures labeled us, uk, France, and then at the lower end of the boat bailing furiously were countries labeled Austria, Hungary. And one of the figures at the upper end of the boat was saying, thank goodness the leak is at their end of the boat. I'm reminded of that when people talk about the possibility of containing the situation to Greece alone, it's very unlikely that it will be limited to Greece alone. French banks own something like $80 billion worth of Greek public debt. German banks about 45 billion of Greek public debt. I think that the risk of a default, or what is more politely called a restructuring of Greek debt is extremely high and these banks will have to declare losses. And that is exactly the kind of pattern that led from the failure of the Credit Unstaal bank in Vienna ultimately to Britain leaving the gold standard. This kind of domino effect. And then you add Portugal, which has been downgraded, you add Spain, which has been downgraded, and you're talking about the risk of a really serious crisis. What's of course distressing is the way in which responsible governments have been scurrying around and not in fact showing much ability to come to an effective collective decision. We know, for example, that Germany, because of an upcoming election in North Rhine Westphalian, the German government has been very reluctant to commit itself, has been insistent on measures of austerity in Greece that many would regard as unrealistic. We know that the system is very vulnerable at the moment. On the issue of confidence beyond the dollar, what do we look for? Well, ask yourself. If the dollar is declining, if confidence in the dollar is eroding, if the status of the dollar is declining, what would replace it? When sterling went into its long term decline after World War I, there was an obvious alternative, the US dollar. Today it's not so clear what could conceivably replace the dollar, the euro. I've written extensively about the problems of the euro and the reasons why. I personally do not see much prospect that the Euro could surpass or even come close to the role of the dollar as an international currency. For a variety of reasons, but most importantly because of the ineffectiveness and ambiguous ambiguities of its governance structure. And nothing has illustrated that more than the difficulties that the Eurozone countries have had in getting their act together in the last two years, I would argue that the Euro at best will remain a regional currency. In fact, the numbers, the statistics are really quite strong in this respect. After a rapid start in its first five years, when the euro in various roles increased its prominence since roughly 2003, 2004, its use has stabilized, has been limited primarily to the European region, and in no way seems to be on the road to surpassing the dollar as a global currency. How about the Japanese yen? A couple of decades ago, people thought the yen was destined to replace the dollar. After two decades of stagnation in Japan since the bursting of the bubble economy, I would argue personally that the yen has to be regarded as yesterday's currency, the yuan, otherwise known as the renminbi, or people's currency. Certainly, if trends continue, current trends continue, the yuan could indeed become a major challenge to the dollar, but it'll take a long time. I would say that it's tomorrow's currency, but not today's. What about a new global currency? A lot of voices have been heard recently advocating either an expansion of the role of the SDR or a new global currency that would somehow be based on the sdr. We've had the governor of the People's bank of China calling for this. We've had the Russian government calling for this. The United Nations Conference on Trade and Development, a UN commission chaired by Joe Stiglitz of Columbia University. A lot of voices for this. But if you accept that there are some problems with the governance mechanism of the euro, try multiplying that to 192 countries, the current membership of the IMF. Just imagine the difficulties of trying to manage a genuine global currency. Who would control it? That's a critical issue. Who would control world monetary policy? Would the markets accept it? Not at all clear. If the markets are skeptical about the euro, just think how much more skeptical they would be about a currency dependent on the collective consensus of 192 countries. My own view is that it's highly implausible. My conclusion is that we are heading toward a leaderless currency system. Title of a recent paper of mine, A leaderless currency system. One in which the dollar will still be prima center Paris but by no means as dominant as it has been in the past. There'll be more competition between three or four currencies in individual regions around the world, but there will be no dominant currency. And so, once again, uncertainty and instability. Finally, the issue of leadership. If there is to be leadership in this realm of governance without government, leadership requires two critical factors. One is that there be consensus on basic principles. And the other, that there be a sufficient concentration of power so that the leader or leaders can use the instruments of power to bring others along. By instruments of power, I mean persuasion, coercion or bribery. Basically, at the time of Bretton Woods. These were conditions, these were factors that clearly were operable. You had at Bretton Woods a basic consensus on principles. In fact, a book called International Currency Experience summarized that was published in 1944 by the League of Nations, summarized that consensus. And by the time they got to Bretton woods, after two and a half years discussion between the British treasury and the US treasury, between John Maynard Keynes and Harry Dexter White, they had reached a consensus on virtually everything, and there was relatively little left to negotiate. At Bretton woods, there was a consensus. Likewise, there was a concentration of power, as we all know, and the result was that they could build a new system. Didn't last forever, but it did last for several decades. Today, those two factors are most conspicuous by their absence. We don't have consensus on basic principles. We're all over the place. It's not at all clear whether we could achieve any kind of consensus. Different countries have espoused very different views on what needs to be done. And likewise, what we've had is not a concentration of power, but a diffusion of power. Worse, this diffusion of power that has occurred has basically made it more difficult to achieve any kind of agreement. In the relevant scholarly literature, we have a recognition that there are two dimensions to power, autonomy and influence. Autonomy is the ability to do your own thing without somebody else controlling you. Influence is getting others to do what you want. One way to define influence is letting others have your way. One way to define autonomy is others letting you have your way. Now, what's happened is that a number of countries have accumulated enough power in the world to enjoy more autonomy than they once did. Think of China, think of Brazil, the brics. A number of countries have gained autonomy, but haven't yet reached the stage where they can actually effectively exercise influence. The result is that we have circumstances where decision making can be stopped, can be eroded, because there are more countries out there of significance, of systemic importance, with the capability of saying no. And, you know, just think of what happened in Copenhagen with the environmental conference where China was able to simply say no. China exercised autonomy. It didn't have the influence to be able to set its own agenda, but it had the ability to say no. And we have that in the monetary area as well. If there is to be leadership in this kind of setting, we need to find some way of achieving common ground on key issues, and we need to achieve a winning coalition of powerful states. But those two things are obviously much easier said than done. And for that reason, I come to the conclusion that I do that fundamental reform basically is unlikely. This is not going to be another Bretton woods moment. This is going to be a situation in which we may have some tinkering around the edges. We may have some attempt to pretend that we have better surveillance, maybe some new taxes on banks or new macroprudential regulations, maybe an attempt to build up to some extent the role of the sdr. But basically, what we will be doing, to use a phrase that is familiar to students of British history, we will continue to muddle through. And so that's the reason why, in terms of my initial question, I said my position is closer to no than yes. Now, some of you might regard this as really quite pessimistic. Others might think it's optimistic. After all, my conclusion is not that the system is about to crash. I'm not saying that you should all rush out and build a bomb shelter, that the monetary system is about to fall apart. By that standard, my conclusion is somewhat optimistic. On the other hand, if you were coming here hoping to hear a formula for the optimal redesign of the international monetary system, then this sounds pessimistic. I'll leave it to you to make your own judgment as to whether the views I've expressed are optimistic or pessimistic. I'll just end by reminding you of the distinction between the two. Optimism. Pessimism. Optimism is Dr. Pangloss in Voltaire's Candide, who goes around smiling and says, this is the best of all possible worlds. And the pessimist is the person who nods sadly and mutters, I'm afraid I agree with you. On that note, I will conclude. I look forward to your questions and your comments. Thank you very much for your attention.
- [51:51]
A
So I would take a number of questions, perhaps two or three to start with. Yes, I see a hand over there. I see a hand over there. And I think on the back. So would you like to start perhaps?
- [52:03]
B
Yeah.
- [52:06]
C
Hello.
- [52:06]
B
Okay, thanks.
- [52:08]
C
Thanks for this very Luxit presentation. First, I want to clarify. I'm not from China. Before proposing that first question, you mentioned that China is one of the greatest challenges for the international monetary system. But. But I kept on thinking one thing. The major. The resistance, for the resistance to appreciation for its currency not only come from the concern about their relative competitiveness in the international trading, but also come from concern over the potential devaluation of a huge amount of American government debt they are currently holding. So sometimes I was wondering, is there possible arrangement for disconnecting, dissociating the two factors? For instance, could that be for the American government to propose a Plan say, okay China, you try to lose your exchange rate control and appreciate your currency and I will give some compensation for your loss by holding American debt.
- [53:19]
A
Is that possible?
- [53:21]
C
That's just my first question. And second question is. Sorry, second question is that after the financial crisis, the liquidity of the international monetary system was restored to a large extent by the endorsement from various nation government which inevitably but unfortunately came from new debt.
- [53:46]
B
Could that be?
- [53:47]
C
I was sometimes wondering, is that this really solution into the current situation or that just a painkiller that will actually postpone and in some way deteriorate the outlook of our economy? That's the second question. Thanks.
- [54:07]
A
Thank you. Yes, this gentleman, can you perhaps very briefly introduce yourself at the beginning?
- [54:14]
D
Okay. I'm a fellow also from China. I'm in the LSE ideas fellow. I've got to touch upon two things. The first thing is about Copenhagen conference because I was totally involved in all the process of the negotiation in Copenhagen. I think I have the responsibility to say some words on that. It's not China. The problem is that the United States could not accept a Kyoto Protocol responsibility there because they are not signictories to that Kyoto Protocol and they couldn't recognize the model of Kyoto Protocol. And this is what the European Union want from the United States. And for China, China shouldered the responsibility beyond the UN Convention on Climate Change. I think that's the point. And also luckily we have a Copenhagen Accord. In my view, according to this accord, the BRIC countries shoulders more responsibility beyond the UN Convention than the developed ones or advanced or industrialized countries under Kyoto Protocol. The other thing is about the topic that you taught today. Well, I was wondering, are we really going to wait for the total failure or the fall of the current disorder or current non system or current system that we establish a new one? Is there any kind of possibility for G20 to organize their members representing the majority of the major economies of the world to reach cold exchange rate like floating zone with a gap and bottom and with the binding obligations and sanction measures like what the G10 did in last century. Thank you.
- [56:35]
A
Yes, this gentleman over there.
- [56:37]
B
Yes, thanks very much.
- [56:39]
C
Norman Baildon, one of the many people currently trying to understand the dynamics of our current crises. Thank you very much for a really engaging lecture. And one of the perplexed. Can I say why just in terms of one component of what we're currently witnessing every day, right. The crisis in Greece, the causes for it many and very involved. The crisis is now moving. We gather from today's papers to Portugal and now To Spain. A key actor in this moving feast are the ratings agencies. And I am perplexed as to why the rating agencies are so influential in determining a whole nation's economic future. When we know in Washington right now, you know, Senate investigation committees are raising big questions about the methodologies used by the rating agencies. And in today's FT and yesterday's ft, similarly in London, there are questions about the methodologies used by the ratings agencies. So reading one's way through all of this, I don't understand why the ratings agencies have so much power and influence over a nation. Greece now, Spain, Portugal and the economic future and well being of millions of people.
- [58:11]
B
Thank you, thank you, thank you all three of you for very challenging, interesting questions. The first person asked two questions. First, about China's resistance to appreciation and its relationship to the issue of the value of the dollars dollar denominated assets that are held by the Chinese government. For those of you who are not familiar with this, the reserves of China are approaching $2.5 trillion. Chinese government does not release data on currency composition of its reserves, but it's thought that about 70% or so is held in the form of dollar denominated assets. Overwhelmingly that would be U.S. government debt or quasi public debt such as obligations of Fannie Mae and Freddie Mac and the like. And it's clear that if China were to allow appreciation of its currency, it did after all, from 2005 to 2008, a modest appreciation that cumulatively added up to about 20% appreciation of the exchange rate of the Yuan automatically means that in Yuan terms, the the value of those dollar assets is lower than before. And China clearly has in a sense painted itself into a corner by accumulating such a large amount of dollars because that stock of reserves is equal to about 50% of GDP. That's a number that is unbelievable. Historically, it's hard to think of another country that has ever accumulated reserves to that extent. 50% of GDP. It used to be thought that 10 to 20% of GDP would be a large number. So in effect, China has painted itself into a corner now where having accumulated all these dollars, it now is at great risk. A 10% devaluation of the dollar or appreciation of the yen is the equivalent of 5% loss of GDP. That's a lot of money. One might ask, of course, why China has accumulated all of this. And we all well know that it has something to do with the preservation of competitiveness of exports in order to preserve jobs in the Chinese economy and so on. It's an old story. The question you ask is, is there some way that China can be protected against the loss of value on its holdings? Well, first of all, we have to acknowledge that if anything is done for China, it has to be done for somebody else as well. And there are a lot more dollars around the world. I'm reminded of the conversation between Valerie Giscard d' Estaing at the time of the when the US ended the convertibility of the dollar into gold. And there were these negotiations going on on whether Europe should revalue or the dollar should be devalued prior to the Smithsonian agreement in December of 1971. And Valerie Giscard d' Estaing was talking with John Connolly, the US Treasury Secretary, and he was trying to explain that, well, you know, the French government holds all these dollars. We have lots of dollars. And Connally's reply was, well, Gskar, we have a hell of a lot of dollars too. You can make that what you want. The fact is that. You could imagine forms of compensation to protect dollar holders against a loss of value. You could imagine an exchange guarantee to be extended by the US government. We did that back in the 1960s by issuing bonds denominated in foreign currency. And one could imagine the US Government doing that again. Alternatively, there is the proposal for a substitution account at the IMF where a country like China could take some of its dollar denominated assets and go to the IMF and get SDRs in place. But there's always the question then of who bears the exchange risk if the dollar then subsequently depreciates. In the case of an exchange guarantee through foreign currency bonds by the US Government, the US Government would be bearing the cost. In the case of an IMF substitution account, presumably it would be the IMF that would bear the cost. There are unavoidable costs to somebody and for that reason, and it's a zero sum game, there's going to be somebody is going to gain and somebody is going to lose by any arrangement that is worked out. And for that reason it's difficult to imagine a negotiation being successful. The US Government enjoys being in the position where it could effectively write down the value of some of its liabilities by simply allowing the dollar to depreciate. It's a the US has little motivation, little direct motivation to agree to some form of compensation if the alternative benefits the United States directly. So I see relatively little hope of this. Now on the issue of public debt, I take the view strongly that governments had no choice in the context of the financial meltdown in 2007, 2008 into 2009, governments had no choice but to institute the kind of Keynesian fiscal stimulus that so many governments did, including the Chinese government, the US Government, European government. There's no question that this was necessary. Basically what we had was a balance sheet crisis. And the only way to get the balance sheet of the private sector under any kind of control was to allow for an increase of public debt. Basically this whole crisis has been one of converting private debt to public debt. I personally think that governments had no choice, but it has created a problem where a number of governments now find themselves with fiscal policies that are unsustainable. And that's the reason why we have a Greece, why we have a Portugal, and so on. The governments have no choice but to get their fiscal policy positions under control. But it's a delicate road walk because you don't want to do it too soon. We still are in a serious risk of a double dip recession. There is absolutely no reason to think that we're out of the woods, that the recession is behind us. The recovery is going to be long, it's going to be weak, it's going to be at least in more advanced, mature economies. And an exit strategy implemented too rapidly would be highly dangerous. So we have. But on the other hand, if we don't, if governments don't develop credible exit strategies, then clearly there will be more Greeces and more portugues. And so governments have to develop credible exit strategies, strategies in which they make clear that there will be circumstances in which they will more or less automatically move back toward some degree of fiscal sustainability. Not an easy process, but unavoidable. With respect to the second set of questions on Copenhagen, maybe you and I should talk about Copenhagen afterwards because this is, after all, about a different subject. I probably shouldn't have even brought it up. But it is true that there was an agreement. It is true that at the last minute there was an agreement, but it was a very informal agreement. It's not binding on anybody. And the brics did make some pledges. But whether the brics come through is another matter. We have too much evidence of governments making commitments that they don't follow through on. Now, it is true that the US did not ratify Kyoto Protocol and did not accept the Kyoto Protocol under the previous administration. I think it's fair to say that the present administration was completely committed to implementation of Kyoto or a successor to Kyoto. I think it's a little misleading to suggest that the US was unprepared to accept its share of the responsibility. But we could talk about that afterwards. Is there any possibility of the G20 organizing itself to reach an accord on, for example, exchange rates? I suggested at the end of my talk that in principle, we know what we have to do. We have to develop a consensus and a winning coalition of states. We know what we have to do. But clearly there are very strongly held views and very divergent material interests, as suggested, for example, by my answer to the previous question about the value of the dollars held by China. When you have this kind of a situation, it's very difficult to reach those critical elements of consensus and a winning coalition of states. There will not be this. I can state very firmly, There will not be anything like an agreement on exchange rates. Governments will not accept exchange any kind of a commitment to an exchange rate regime which would obligate them to adjust their domestic economy in order to maintain some set of exchange rate relationships. That's simply not in the picture. What we have in the history of the international monetary system is a tendency for cooperation to occur, but to occur episodically in moments of crisis when governments feel that they have to do something. And this has happened repeatedly, There have been a number of such instances. But as soon as the sense of crisis ebbs, governments go back to prioritizing their own domestic interests. And that's very understandable. And the result is cooperation breaks down very quickly. We are not likely to see anything like a commitment to some form of stabilization of exchange rates. Finally, on the rating agencies, people have recognized that the rating agencies have had an undue influence for a long time. There is a scholar at the University of Warwick named Tim Sinclair, who's been writing about this for over a decade. I upset him one time when after about a decade of this, he presented yet another paper on the rating agencies. I said, come on, Tim, you got to get a life, write about something else. The fact is that he forgave me. The fact is that rating agencies have an inordinate influence. You have situations where governments get elected on a platform, and then if the rating agencies drop their rating, their credit worthy, credit worthiness rating, the government, government does policies to please the rating agency, which is to say, please the market rather than the people who elected them. We had many such episodes. Why? Well, it's really related to the fact that it's very expensive to gather all the information to make your own judgment. Rating agencies exist precisely because of the cost of accumulating the information that you would need to be able to make an independent judgment of the Creditworthiness of a borrower, any borrower, is beyond that of most investors. And so we rely on the credit rating agencies to do the job for us because it's simply too difficult for individual investors or portfolio managers to do all that research themselves. So the rating agencies have a genuine function to perform. Problem, as we well know, is that sometimes they really get it wrong, as they did in the case of the derivatives, the mortgage backed derivatives in the United States. And there is a risk in the current situation which many people recognize, that the credit rating agencies today, in the context of sovereign debt difficulties of countries like Greece and Portugal, are overreacting. They're trying to prove that this time they're going to get it right. And they may in fact be provoking the very problems that we're trying to avoid. But we don't have an alternative. Just imagine how politicized it might become if we had governments doing the credit rating. The notion that individual governments or groups of governments would rate other government on the creditworthiness of their public debt, you know, just you can imagine how difficult that would be, how politicized that could become. And so it's difficult to imagine any alternative to private rating agencies, and given the cost of the information research that's involved, difficult to imagine any alternative to rating agencies of some kind. Thanks. Yes, one question here and one question here is. Yes, I'm Bob Talbot Stern from the Wharton Business School in Philadelphia. This is, I hope, is a very simple question. It's very basic. You stated that, yes, we were in a real crisis, crisis of the ages. And in fact you backed it up in one of your answers to one of the prior questions. Could you tell us if there had not been the so called bailout, if we had not done the Keynesian transferring of debt to the public side, what would have happened in very explicit terms? Because this is a non political question with massive political implications because there are many parties, especially in the U.S. now that the crisis is so called past that they're criticizing the bailout and they want us to balance our books as soon as possible. But would your salary have been paid? Would Social Security payments have been made? Would people have gotten pensions? Could I have used my credit card? Exactly what would have happened if we had stood on our hands? Thank you.
- [73:57]
C
Alok Basux, lse, you talk rather forlornly about the absence of any substitute for the dollar should the dollar go down at some stage in the future. There is of course one currency which is even older than man and that is gold, which you've referred to from time to time in your lecture. Could you see potentially a role for gold in the future in the absence of anything else? Especially given that the last 40 years or so since Bretton woods have been largely an aberration and most human societies have used gold as a basis. Thank you.
- [74:34]
A
Would you like to reply to this?
- [74:35]
B
Sure. Okay. On the first question, this is sort of historical counterfactual question. What would have happened in the absence. My favorite story on this was back in the 1920s when there was a contest in Germany, Weimar Germany, for the most improbable newspaper headline. And the winning improbable newspaper headline was Archduke Ferdinand found Alive. Great War Fought by mistake. What would have happened? I'm absolutely convinced what would have happened is that the credit markets, which had already, the interbank market, had already frozen up. Without the bailouts, credit markets generally would have frozen up completely. No one would have been able to borrow any money. No one would have had access to credit. And that in turn would have simply frozen up the wheels of commerce. I think we would have seen a real second Great Depression. I'm personally convinced of that. And the reason I'm convinced of it is not because this was a classic. This was a classic balance sheet recession. And we had reached levels of debt in relation to GDP that were astronomical and unprecedented at the time. In 1931, when we had the Great Crisis, the level of debt to GDP in Britain was half of what it was in the current situation and comparable proportions elsewhere. Without the action by governments, not just fiscal stimulus, but the, the TARP program and all the rest in the United States and so on, we would have been in. It would have been a serious recession. You ask, maybe jokingly, would my salary have been paid? Well, I had to take an 8% pay cut this year because of the crisis that we had. The state of California can't balance its budget. I teach at the University of California. The budget is provided by the state legislature. State legislature cut our budget by the equivalent of three campuses. And the result is that I had to take an 8% pay cut. I think I would have taken a much larger pay cut if the situation had been worse. And who knows, maybe even the Wharton School might have suffered some. Now, on the role of gold, is there any role for gold in the future? Simple answer, no. I'm firmly convinced that John Maynard Keynes had it right when he described it as a barbarous relic. I don't think that we can go back to an era in which we allow our economies to be ruled by the accidents of discovery or the unavailability of gold. Variations in the demand at the private level. It's not a way to run a corner grocery store, let alone to run a world economy. We have long since moved to a world in which we take for granted and should that societies are capable of more intelligent management than leaving it to the arbitrariness of the supply and demand for a particularly glittery mineral. And I just don't think that we can anticipate anything like that. I've actually debated Ron Paul on the subject, if you know who Ron Paul is. But we're talking about something that whose era is long gone. It's a commodity and it's a store of value that can be attractive in moments of uncertainty about paper currency. But then there are a lot of other assets that people can invest in as well. There's nothing particularly special about gold as a basis for a monetary system. Thank you. Yes, one question here. My name is Jenny Conway. Another one of those irritating what if questions. Lehman Brothers, had it be rescued, had it been rescued in the way that AIG and the other banks were rescued.
- [79:10]
D
Would the global financial situation have been much less severe?
- [79:19]
A
Are there any other questions? Then maybe I could slide question of my own end. It seems that the distinction between optimism and pessimism doesn't quite capture your view. Maybe another distinction is better suited, the distinction between satisfiers and maximizers. Maximizers try to get the best possible system, while satisfiers just are content if they get a good enough system and think there should not be further reform. Do you actually think that trying to create, to implement those ideas that you summarized could actually be dangerous? It seems that you are basically a satisfier. Do you think that trying to implement or some particular states or powers to force through a change could actually destabilize the system further? Either because it would create conflicts or unintended consequences of some kind.
- [80:17]
B
Okay, first, Jenny Conway. Okay. If Lehman Brothers had been rescued, would the crisis have been less severe? I think that it would have been less severe for the first few days after that weekend when it was allowed to fail. Whether it would have been less severe over a longer period of time measured in weeks or months, is very doubtful. You had the credit markets in full flight at that point. And if it hadn't been Lehman Brothers, it would have been something else. It was a situation where the system was in free fall and things would. How do I want to say this? If it hadn't appeared with Lehman Brothers, then it would have been aig, it would have been Freddie Mac and Fannie Mae, it would have been someone else, some other institution. It was just everything was so interlocking that the. Crisis would have manifested itself over period, measured in weeks or months. Regrettably, we had built up a structure which was unsustainable. We had a market for assets that had no value. And even today the IMF is estimating that in the end we're talking about a write down of about $2.3 trillion worth of assets. That's a lot of money. And it would have happened whether Lehman Brothers had been rescued in the short term or not. Matthias, question There is an expression never let the perfect be the enemy of the good. And yes, I am a satisfier and a satisfieser in that sense. I'm not saying that you have to have a perfect solution or it's not worth doing anything. Quite the contrary. I am an incrementalist. I believe that to be realistic in political terms, to believe that at most what we can hope for are incremental changes rather than a wholesale new Bretton woods as called for by, among others, Nicholas Sarkozy. Could that make the situation worse rather than better? That's a good question. It is entirely possible that putting a patch in one place can result in a greater problem somewhere else. And I acknowledge that the Greek situation is a good example of the way in which crises can manifest themselves differently. But they're still crises. I mean, in the old days before the Eurozone, it would have manifested itself as a crash of the drachma, because the crash of the drachma was no longer possible. Since there was no longer a drachma, it manifested itself differently as a sovereign debt crisis. You push in on one place in the balloon and it pops out somewhere else. Ultimately, what you're talking about are the underlying compatibilities of national policies and incremental reforms. The effect of those incremental reforms on the underlying compatibility or consistency of policy is the real issue. There's no way of saying a priori whether a given incremental reform, whether it be an agreement on new rules of surveillance, or whether it be a substitution account at the IMF, or whether it be non deposit liability tax of banks. Whatever the incremental reform, there's no way of saying a priori what its effect is likely to be on the underlying consistency of national policies. And so I hesitate to generalize. In response to your question, I wrote a book that was published about 35 years ago called Organizing the World's Money. And I suggested at that time that there are two desiderata in any international monetary system. Or put it differently, every international monetary system can be understood in terms of two objectives. One is efficiency. You want to have arrangements that to the extent possible, enhance the efficiency of international market operations. The other objective is consistency. You must have consistency of underlying national policies. If you don't have that, then no reform, no policy reform, the no institutional arrangement is going to help. What you have to have is the willingness of governments to undertake modifications of policy in the common interest, otherwise known as cooperation. Cooperation in the international political economy literature is simply defined as a mutual adjustment of policies. It may be coerced, preferably it's by mutual agreement. But ultimately you have to have an ability to modify policies in ways that minimize the negative externalities of one country's policies on others. That's what the market stability criterion that the IMF adopted a couple of years ago was all about in 2007. The idea is that you need to in some way create incentive structures that will get governments to recognize the need to, as we say, internalize the externalities. Basically, what we're dealing with in the international monetary system is a situation in which what one country does inevitably has repercussions on others. Because international monetary relations are by definition mutual and reciprocal. What the US does affects others. What China does affects others. If you're Nicaragua, you can probably get away with things. But if you're in the United States or Eurozone or Japan or China or Britain, what you do has consequences for others. And those consequences in turn are going to generate responses which could have effects, adverse effects on you. That's what we mean by externalities, by negative externalities. Cooperation internalizes the externalities. Cooperation through mutual adjustment of policies eliminates those repercussions and feedbacks that create crisis. It's not the detail of reform, but the extent to which reforms do or do not assure some movement toward institutionalization of cooperation among nations. That's the problem that we face. That's the problem that we have not yet been able to resolve. And until we do, we're going to live with the kind of uncertainty and volatility that I've been describing. And it's 8 o'. Clock. Okay.
- [87:37]
A
Please join me in thanking Professor Cohen for his lecture.
- [87:41]
B
Thank you all.