Prepare for Economic Life after the Demise of Bretton Woods II

Livemint     22nd September 2020     Save    

Context: The global currency regime is about to collapse, and India will have to reset its policies accordingly.

Evolution of the global currency regime:

  • Fixed Currency Regime till 1970: 
      • Disadvantageous for developing countries as they pegged their currencies to the US dollar, fixed exchange rates frequently led to surges in capital inflows, overheating the economies.
        • Spike in Inflation:  Inflation rates spiked from time to time despite the commitment to low inflation
        • Dependence on Financial institutions: Due to trade and current account deficits, emerging economies found themselves at the mercy of international financial institutions.
        • For, E.g. as seen in the Asian currency crisis of 1997-98. This cautions developed countries in maintaining a de jure peg to hard currencies and float their exchange rates.
  • Bretton Woods II- End of Fixed Currency regime in the 1970s: Developed nations moved away from the fixed current regime when after the abandoning of the Breton Woods system. 
      • America began to fret about the economic success of its former enemies—Japan and Germany
      • Tight monetary policy: In order to achieve competitiveness, it decided to follow an accommodative monetary policy and allow inflation to rise.
      • War effects: At the same time, its fiscal deficit began to widen due to the  Vietnam War.
      • Recession: American recession in the 1970s accelerated the decline of the dollar. 
      • Inflation: US attempt is to generate inflation and keep real interest rates as low as they were in the 70s
  • Impact of Bretton Woods II on developed nations: 
      • America's general government debt-to-GDP ratio declined from around 55% in 1961 to around 35% by the end of the 70s. 
      • In the UK, the net public debt-to-GDP ratio declined from 100% to 40% during the same period.
    • Impact on developing nations:
      • De-facto fixed exchange rate regime: Although the Bretton Woods system of fixed exchange rates was dismantled in the 70s, there has been a de facto fixed exchange rate regime, with the dollar as the anchor currency.
Conclusion:
  • The objective of developed countries: The unstated objective of developed countries (including America) for the 2020s is stealth inflation, thus inflating away the debt burden.
  • India's options: It includes matching that repression, pursuing a strong rupee, a re-imagined monetary policy regime, and capital controls. The status quo looks infeasible.