Bretton Woods II
The second flawed monetary union is at the heart of the current international monetary system: the so-called Bretton Woods II arrangement, which is centred on China and the United States.
The current international monetary system is a hybrid of, on the one hand, mainly major advanced economies with floating exchange rates and liberalised capital flows and, on the other, a group of countries that actively manage their exchange rates. The result is a system that does not facilitate timely and symmetric adjustment to shocks or structural change. For example, despite its economic miracle, China’s real exchange rate did not appreciate in the two decades before the global financial crisis.
In the decade before the crisis erupted, China’s relentless accumulation of reserves contributed to low real interest rates and, for a time, subdued macroeconomic volatility.
Market participants increasingly assumed this stable macroeconomic environment would persist—prompting a search for yield, rising leverage and a dramatic underpricing of risks.
When combined with inadequate supervision of the financial system and ill-conceived deregulation of housing and financial markets, U.S. private non-financial debt quickly rose to levels last seen during the Great Depression.
With 20% of global output, the United States imported 60% of global capital (on a net basis) on the eve of the crisis. This would not have been a problem if this capital had been invested in expanding productive capacity. Unfortunately, not enough of it was.
Now, the debt cycle has decisively turned. Creditors demand repayment, and global growth will require global rebalancing.