Britannia Radio

This comes the day after the EU is cooking up ever more detailed and  
drastic regulations.  [see "A declaration of commercial war!"  
yesterday and postings to follow shortly] OK, so they are doing it as  
a power grab with little regard for economics but they’re in a  
regulatory mood - heaven help us all.

Conway here brings us sharply back to reality

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TELEGRAPH                    28.5.09

We must mend our ways, not make more rules

We are all ultimately to blame for economic crises, says Edmund Conway.

Earlier this week, a group of America's most intelligent and  

influential thinkers published a report heralded as the definitive  

solution to the financial crisis.

The Committee on Capital Markets Regulation's study is getting on for  
300 pages, so let me give you the gist: we must overhaul financial  
regulation, create a centralised market for the financial instruments  
behind so much of the trauma, find a more sensible way of dealing  
with collapsed investment banks and collect more information on hedge  
funds.

All this is worthy, correct and important – and completely misses the  
point. Like most of the analyses produced in the wake of the crisis,  
this report entirely fails to get to its heart.

Yes, we have had a horrible crunch, which is sapping any energy from  
the economy. Yes, there is plenty wrong with the way the banking  
system works. But trying to save the world economy with new  
regulations and codes of practice is like trying to cure a cancer  
patient with plastic surgery.

The financial disaster was the ultimate manifestation of a far deeper  
problem – a wholesale malfunction of the global economic system. The  
bankers and mortgage brokers may have been in the front line, but  
they were pushed there by forces far more powerful than any  
regulations. For decades, we in the Anglophone West borrowed too  
much, while the other half of the world saved too much. It was the  
tectonic collision of these imbalances which caused the crisis, which  
brought about the worst recession since the 1930s, and which could  
trigger another bust decades in the future.

Imbalances, of course, are nothing new. A country, or for that matter  
a town, will at any one time tend to import more than it exports, or  
vice versa. But being reliant on borrowing from abroad, which goes  
hand in hand with running a deficit, leaves you vulnerable. The  
history of economics over the past two centuries revolves around this  
quandary over international trade imbalances, and the series of  
crises they have caused.

We have wrestled with different schemes to try to even out the  
imbalances – to ensure that countries do not get too far into deficit  
or surplus. In the 19th century, we tried the gold standard, whereby  
countries' exchange rates were fixed against its price. Its breakdown  
after the First World War contributed towards the Great Depression,

Next, in 1944, came the Bretton Woods agreement, a bodged compromise  
between the opposing visions of John Maynard Keynes of Britain and  
Harry Dexter White of the US, which fixed nations' currencies against  
the dollar, and that in turn against gold. Again, this broke down a  
few decades later, leaving us with today's mutant monetary system:  
half of the world on floating exchange rates, and the other (China,  
the Middle East and others) pegging their currencies to the dollar.

Trace your finger back along almost any ledger of debts – whether in  
terms of the banking system or of government deficits – and you'll  
notice that the figures start rising pretty soon after Richard Nixon  
stuck the knife into the Bretton Woods system in 1971. So did the  
incidence of financial crises.

Without any kind of structure or balance, the world's monetary system  
has been barrelled around since the 1970s. Countries such as Britain  
and America borrowed more and exported less with impunity. Countries  
such as China and Germany have been allowed to build up massive  
current account surpluses. The result has been bigger booms, followed  
by nastier busts. A Bretton Woods-style system would have constrained  
both sides from generating these imbalances.

It would be nice to think that this economic crisis contains the  
seeds of its own solution: that following the trauma of recession, we  
will change our spendthrift (or insufficiently consumerist) ways. But  
in the absence of any kind of mechanism to right these imbalances,  
there is little to suggest that anything of the sort will happen once  
the current drama is over.

What most alarms me is that not only is nothing being done by those  
in power to re-engineer the global monetary system, but that few of  
the great and good in the City have faced up to the fact that it is  
the imbalances, not the regulations, that are really to blame for our  
current situation.

Remarkably, I strongly suspect that the ultimate solution will come  
not from Washington or London, but from Beijing. A couple of months  
ago, Zhou Xiaochuan, the governor of the People's Bank of China, put  
out a paper which alluded to precisely these problems. The detail  
most conspiracy theorists fixated on was the mention of a possible  
international reserve currency – was this part of a plan to dump the  
dollar and bring down the world's biggest economy?

No, it wasn't. His point was a far broader one: that we need a new  
international pact on how we manage the flow of goods and cash around  
the world, in which a world currency plays a merely functional role.  
In other words, a new Bretton Woods. We should be thankful that while  
the western elites are fiddling around with piddling regulation,  
someone sensible is starting to consider how we can actually make the  
world economy work.