In July 1944, delegates from 44 countries gathered in the UN sponsored Conference in Bretton Woods, New Hampshire, to decide on a post-Second World War monetary and financial order. In his closing speech, then US Treasury Secretary Henry Morgenthau concluded that the Conference succeeded in addressing the twin “economic evils the competitive currency devaluation and destructive impediments to trade” that led to the War. To prevent competitive devaluation, the Bretton Woods Conference established the fixed but adjustable exchange rate system, based on the US dollar linked to gold and capital controls, with funding from a newly created World Bank and the International Monetary Fund (IMF).
The global free trade mechanism was negotiated first through the General Agreement on Trade and Tariffs (GATT), which later became the World Trade Organization (WTO). The Bretton Woods negotiations were led by the US chief delegate, Harry Dexter White (reputed later to be a Soviet spy) and the eminent British economist, John Maynard Keynes. Keynes argued unsuccessfully for the creation of a new international currency Bancor, whereas the US preferred its dollar. In 1944, the US was 50 per cent of world GDP, with the largest gold reserves, and major creditor to all economies suffering from war. No surprise that the Bretton Woods order was largely US-led and designed. This Bretton Woods structure lasted till 1971, when rising US fiscal and trade deficits forced the dollar to delink from the gold at the fixed price of $35 to one gold ounce.
After flexible exchange rates became the norm, the US continued to exploit its dollar exorbitant privilege – America is financed by the rest of the world because of the hegemonic position of the US dollar, protected by the might of the US military and strongest economy, including being the consumer of last resort. Eighty years later, the US share of world GDP is down to 25 per cent by current exchange rate (15 per cent by PPP terms), but the US dollar remains mightier than ever. Unfortunately, having the dollar as the global reserve country is both a blessing and curse.
The US is able to fund its fiscal and trade deficits easily, because the Rest of the World prefers to hold the dollar. But running forever deficits means that the US net liability to the rest of the world is now $21 trillion, or 20 per cent of world GDP, with gross sovereign debt of $35 trillion, one third of world GDP or 123 per cent of US GDP. Fiscal debt cost is rising as interest expense will rise from 3.4 per cent of GDP in fiscal year 2025 to 4.1 per cent by 2034. The fundamental difference between now and 80 years ago is that the US has moved from a giver of global public goods to a taker of global resources – 5 per cent of the world population that sanctions one third of the world’s nations and can seize or freeze any individual, firm or nation in using the US dollar, with no appeal mechanism in place.
The irony is that the largest debtor absorbs more and more of the world’s natural and financial capital that encourages global consumption to drive growth. Since consumption through debt ultimately generates more carbon emission, the current model is neither ecologically nor financially sustainable. To address these global imbalances, the UN has suggested that a “just transition” requires $2.4 trillion annually to fund clean energy and climate resilience. Where will this money come from? This is both a flow and stock problem. The annual shortfall (flow) can either be funded from an increase in taxation or a cut in expenditure. The stock issue is whether there is enough wealth to be taxed or used to fund climate action.
The French and Brazilians have intellectually accepted French economist Gabriel Zucman’s initiative, whereby a minimum wealth tax of 2 per cent on 3,000 wealthiest billionaires would raise $200-$250 billion per year globally from about 3,000 taxpayers. Current data suggest that ultrahigh-net worth individuals have an observed pre-tax rate of return to wealth of 7.5 per cent on average per year (net of inflation) over the last four decades, whereas their effective is roughly 0.3 per cent of their wealth. Alternatively, the Austrian Institute for Economic Research thinks that a global financial transactions tax of 0.1 per cent could yield between US$230-$418 billion per year.
Needless to say, the rich who control the electoral process in democratic countries will not allow such tax increases. There are two big ticket items in global fiscal spending which could be cut. The largest is the fiscal subsidies on fossil fuels, which were $7 trillion or 7.1 per cent of GDP in 2022 (IMF data). On top of that, global military expenditure was $2.4 trillion annually, with at least $100 billion funding by Nato for the Ukraine war alone. Probably the best way to increase global funding is to raise the capital of the global Multilateral Development Banks (MDBs), like the World Bank, Asia Development Bank etc. If the rich countries which control the Special Drawing Rights (or voting power) of the IMF can apply their recent $650 billion increase in 2021 to increase the MDB capital, at 8 times leverage, the MDBs can increase their lending by roughly $5 trillion (8 times $650 bn).
But to do so would require the rich countries agreeing that this is priority, which is unlikely given their current insecurity that leans towards protectionism and isolationism. In short, the 21st century requires multilateral cooperation in dealing with mutual existential challenges involving climate warming, social imbalances and serious polarization. If the Bretton Woods framework does not serve the Global South because the rich North is unwilling to reform it, do not be surprised if a BRICs-led set of institutions may rise to simply replace it.
(The writer, a former Central banker, comments on global affairs from an Asian perspective.)