"Beyond Bretton Woods 2". The Economist, Vol.397, No.8707. 6 November 2010.

 "Beyond Bretton Woods 2". The Economist, Vol. 397, No. 8707. 6 November 2010.

• Countries all blamed each other for currency problems at the 2010 G20 meeting in Seoul, with the USA blaming China for refusing to let the value of the yuan rise, while China blames the US Federal Reserve's 'ultra-loose' monetary policies, such as quantitative easing'. Developing countries all complain of their currency values being forced up by capital flows seeking higher returns. 
• The next head of the G20 for 2011, French President Nicolas Sarkozy, wants to put monetary reform at the top of that group's agenda.  
• No one is happy with the current global monetary regime. The complaints fall into three categories:
• The dominance of the US dollar in global trade and as in global reserves leaves many unhappy, as its importance in these fields is far in excess of America's 25% of global output and leaves other countries vulnerable to American monetary policy.
• Massive foreign exchange reserves have been accumulated, particularly in emerging economies, which hold ⅔ of global reserves. Reserve levels have risen from $1.3 trillion, or 5% of global output, in 1995 to $8.4 trillion, or 14% of global output, in 2010. This has created a perverse dynamic by which poorer countries loan money to richer countries, meaning poorer countries lack investment and richer countries, especially the USA, have their credit subsidized.
• Capital flows have increased in scale and volatility, triggering more frequent financial crises. This results in periods where foreign capital floods markets and periods where no capital is available after crises, as occurred in 1997 and 2008. These flows are driven by access to cheap capital in rich countries, encouraging investment in more lucrative, but less stable, emerging economies. 
• Any new global monetary regime will be limited by the Triffin trilemma of controlling domestic monetary policy, controlling exchange rates, and allowing free capital flows across borders. No system allows for all three options.
• The gold standard allowed for a controlled exchange rate pegged to gold and facilitated free flow of capital across borders, but governments did not have control over their domestic monetary policy,
• The Bretton Woods system pegged all exchange rates to the US dollar, which has convertible to gold, and allowed states to control their own domestic monetary policy, but achieved this by limiting international capital flows through capital controls.
• The Jamaica System that emerged after the end of Bretton Woods in 1971 allows for control over domestic monetary policy and has, since capital controls were largely lifted in the 1980s, allowed for free capital flows. Exchange rates are left to float according to market conditions, although states intervene through their central banks to try and keep these exchange rates level.
• The current monetary regime is characterized by large private capital flows, estimated to reach $340 billion in 2010 up from $81 billion in 2000; and large savings of reserves after the 1990s, as many countries responded to the debt crises of the late 1990s by building up larger foreign currency reserves.
• China alone makes up a large proportion of global reserves, which have also worked to keep the value of the yuan low. This strategy of a weak currency and massive currency reserves has been copied by other large Asian economies, who seek to retain export competitiveness, leading to the current situation, dubbed 'Bretton Woods 2', where many of the world's most dynamic economies are tied to the US dollar.
• The similarities between the Bretton Woods system and the current Bretton Woods 2 system mean that they are likely to also share many of the same problems. The main issue is the tension between the demand for US dollars in global reserves and the fear that the US dollar will lose its value, resulting in the main global reserve currency being exposed to massive indebtedness. 
• The current ratio of US dollars in reserves to American GDP is around 60%. At current rates of accumulation, this could rise to reserve values exceeding 200% of US GDP by 2020 and almost 700% of its value by 2035.
• The solution to this particular error, proposed by John Maynard Keynes in 1944 under the name 'Bancor' and again by John Triffin in 1947, is to create an alternative global reserve currency that could relieve the demand for US dollar liquidity. This system would allow the world to escape the Triffin trilemma. In 1969, the Special Drawing Right -- a basket of US dollar, British pound, Japanese yen, and, now, the euro -- was created by the IMF to fill this role, but its use has never taken off, as it constitutes less than 5% of global reserves and is not held in any private securities.
•  Zhou Xiaochuan 周小川, the governor of China's central bank, proposed in March 2009 that the Special Drawing Rights be turned into an actual global reserve asset to replace the US dollar. China is likely proposing this to enable it to shift its reserves from US dollars to Special Drawing Rights during such a time when the yuan value is allowed to appreciate against the dollar, which would reduce the value of those dollar reserves. 
• It is unlikely that Special Drawing Rights will replace the US dollar as the global reserve currency because it neither exists in sufficient numbers to serve global reserve needs nor it is a sufficiently liquid asset. One of the main appeals of the US dollar is that it has the world's largest capital markets, and thus is extremely liquid. Special Drawing Rights would have to have a large private market if they were to be this liquid, which in turn would require the IMF to issue them like a global central bank.
• The euro is the currency most likely to replace the US dollar in global reserves, although the yuan could also serve this role in the future if the Chinese government allowed that currency to be traded internationally. 
• The author believes that better solution to the current situation would be to reduce the demand for US dollars by working to ensure access to funds during financial crises, thus reducing the perceived need for currency reserves. This can be done by guaranteeing funds from the IMF and through the Federal Reserve institutionalizing swap agreements with the central banks of countries which large US dollar reserves.
• Demand for reserves could also be reduced by punishing those countries that accumulate excessive foreign currency reserves or run large trade surpluses. Such an idea was proposed by John Keynes at the Bretton Woods Conference, but was vetoed by the USA, the contemporary trade surplus economy; China would similarly veto any measure proposed today.
• "No global government; means no global central bank, which means no global currency. Full stop" (Barry Eichengreen).
• International economic sanctions for monetary policy have a bad track record, as seen in the EU's Stability and Growth Pact. The author thinks a better plan would be informal cooperation between G20 countries, similar to the 1985 Plaza Accords to reduce the US trade deficit. Peer pressure could be used to force China to allow the appreciation of the yuan.
• One proposed solution to large capital flows in emerging countries, adopted by South Korea, Brazil, and Thailand, has been to tax or restrict capital inflows. This is a good solution, although the Chilean experience demonstrates that it changes the composition of foreign investment more than its size, but will face challenges as capital markets become increasing integrated and capital flows grow.
• Other good solutions would be increasing regulation of domestic banking and finance, and tighter fiscal policy, which would limit the amount of credit available and thus prevent credit bubbles. 
• The current monetary system will survive for longer if China allows the yuan to appreciate against the dollar and also be used more internationally, as this would reduce the demand for reserves, supply another currency for those reserves, and reduce the debt obligations of the US to China through a depreciation of the value of the US dollar versus the yuan. If China decides to continue keeping a low exchange rate for the yuan and, with other countries, maintains its current demand for reserves, then the international monetary system is in serious trouble in the future.