That's why the future of the world economy is balanced in a knife edge.
It could go either way – towards “sauve qui peut” nationalism, withdrawal from international cooperation, a turning away from globalisation; or towards a remaking of the international system and regulatory apparatus in an effort to harness the benefits of globalisation for citizens.
It could depend on chance events. The downing of a civilian aircraft over Ukraine, a mistake during China’s massive military exercises now under way (involving apparently a simulated “invasion” of mainland China by hostile forces) , an act of terrorism in protest against Israeli hostilities and civilian casualties in Gaza, or merely a sudden upsurge of rage against unemployment in Europe.
Or it could be triggered by a renewed financial crisis involving possibly a withdrawal of market funding from one or several megabanks – a good old-fashioned run.
What would governments do in response? The initiative by the BRICS in establishing a mini-IMF shows that leading emerging market governments are moving beyond the stage of making speeches about the need to reform the monetary system and actually doing something abut it (though it turns out that their new creature will be closely tied in to the existing power structure).
Another response would probably be to impose capital flows on movements of capital – controls that were allowed under Bretton Woods (though policed by the IMF), in accordance with Keynes’s original aim to stabilise exchange rates.
Should free international capital flows be permitted across currency boundaries, or should each nation seek to insulate its domestic financial system–by exchange controls on capital account if necessary–from international influences?
As described in The Money Trap, and in Ronald McKinnon’s recent book on the Unloved Dollar Standard, for free international financial flows to work tolerably well requires a stable international monetary standard with well-defined “Rules of the Game” to which the principal players adhere. At its best the gold standard was just this, with the Bank of England playing a leading role. This proved that, given a strong standard, instead of being “hot” money, private international financial flows can be stabilising.
Equally, the dollar standard played also a stabilising role in the two and half decades after World War II, which saw extremely rapid growth in all the industrial countries save Britain. The UK continually rebelled against the rule of the game which required that British monetary and fiscal policy had to be subordinated to keeping its dollar exchange rate stable. Instead, the British tried to target unemployment or growth with numerous sterling crises, stop-go policies, resulting in slow growth.
Then came the Nixon devaluation and break up of Bretton Woods in August 1971, which led to increasingly erratic US monetary polices—leading to global monetary instability. This abuse of the system has reached its apogee now with zero interest rates inducing hot money flows into emerging markets, chaotic conditions in the world’s money markets, and incipient, if undeclared, currency wars.
I differ from Ron in the kind of standard we need – I would go for a more ambitious, democratic overhaul of the system rather than just a rehabilitation of the dollar standard (which will be vulnerable to American exploitation and strongly disliked by surplus countries). The options are reviewed in Chapter 12 of The Money Trap. But we agree on the need for a standard and belief that, after a transition period ,countries would see it as being in their own interests to adhere to it (this would NOT be a “large euro”). Nothing that has happened since has made me change my mind: either we adopt some such system, with well-known rules of the game, or we face a disintegration not only of the economic but also of the political order that is bound up with it.
Now that they have dipped their toes in the warm waters of reform, with their BRICS bank, perhaps the BRICS will flex their monetary muscles again by more insistently pushing for such a reform.
If they do, it will be up to the established powers led by the US to respond creatively.
Like Germany, Russia and the US in the early 20th century, the BRICs are the rising powers challenging the established powers. It was the refusal of the top dog of the time, Great Britain, to accommodate German and Russian ambitions that created the conditions for the wars of the 20th century.
Let us hope that when the US is challenged, it will have the wisdom that Britain lacked then, when myopia led to its downfall as a “Great” power and the end of civilisation as the Europeans defined it.
What is clear is that the great powes have not learn the lesson of the financial crisis, which is that it was the inevitable result of financial globalisation running ahead of the structure of rules needed to channel its energies for the good of the global society. As Ian Goldin has put it:
“The crisis should have served as a wake-up call, spurring the financial sector, policymakers, and multilateral organizations to take action to enhance systemic stability. But, despite employing tens of thousands of highly educated economists whose primary job is to determine how best to protect the financial system from globalization’s destabilizing effects, these institutions seem to be even less willing to act now than they were before the crisis.”