Prepare for Economic Life after the Demise of Bretton Woods II

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.

• 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.