When the heads of state of the world's 20 largest economies come together on short notice, as they just did in Washington DC, it is clear how serious the current global crisis is. They did not decide much, except to call for improved monitoring and regulation of financial flows. More importantly, they committed themselves to launching a lasting process to reform the world's financial system.
Of course, those who dreamed of a Bretton Woods II were disappointed. But the original Bretton Woods framework was not built in a day; indeed, the 1944 conference was preceded by two and a half years of preparatory negotiations, which is probably the minimum needed to decide such weighty issues. The recent G20 summit occurred with virtually no real preliminary work.
Three tasks must now be addressed. First, a floor must be put under the international financial system in order to stop its collapse. Second, new regulations are needed once the system revives, because if it remains the same way, it will only produce new crises. Finding the right mix will not be easy. For 25 years, the world has experienced a huge financial crisis every five years, each seemingly with its own cause.
The third task is to focus on real economic activity, end the recession, sustain growth, and, above all, reform the capitalist system to make it less dependent on finance. Long-term investments, not short-term profits, and productive work, rather than paper gains, need to be supported.
The first task is already being tackled. But, although the United States and some European countries have gone a long way toward restoring the lending capacity of banks, that may not be enough. After all, if the economy is to grow again, banks need borrowers, but the recession has led entrepreneurs to cut their investments.
The second task remains open. Disagreements about how to re-regulate the financial markets are deep, owing to countless taboos and the huge interests at stake. Moreover, there can be no comprehensive agreement that does not take into account the relationship between finance and the real economy.
The essential problem in addressing the third task is to find out precisely what is going on in the real economy. Some states (Iceland and Hungary) are clearly bankrupt. Some merely face a hazardous financial situation (Denmark, Spain, and others). Their financial crisis is the main reason for their weakness.
All of these problems are so difficult to resolve because they have been festering for so long. It is now increasingly evident that today's crisis has its roots in February 1971, when US President Richard Nixon decided to break the link between the dollar and gold.
Until that point, the US' pledge to maintain the gold standard was the basis for the global fixed-exchange-rate system, which was the heart of the Bretton Woods framework. During the 27 years that it lasted, huge growth in international trade, supported by non-volatile pricing, was the norm, and large financial crises were absent.
Since then, the international financial system has been highly volatile. The era of floating exchange rates that followed the end of the gold standard required the development of products that could protect international trade from price volatility. This opened the way to options, selling and buying on credit, and derivatives of all kinds.
These innovations were considered technical successes. Prices were (mostly) stabilized, but with a slow, if continuous, rising trend. The market for these financial products grew over 30 years to the point that they delivered huge opportunities for immediate gain, which provided a strong incentive for market participants to play with them more and more.
During this time, capitalism - smooth and successful between 1945-1975 (sustained high growth, low unemployment, and no financial crises) - weakened. Through pension funds, investment funds, and arbitrage (or hedge) funds, shareholders became well organized and seized power in developed countries' firms. Under their pressure, more and more processes were "outsourced".
In real terms, wages no longer rose (indeed, the average real wage has been stagnant for 25 years in the US), and a growing share of manpower (currently around 15 percent) was without steady employment. Everywhere, the share of wages and incomes began to fall as a proportion of GDP. As a result, consumption weakened, unsteady employment grew, and unemployment stopped declining.
Under such circumstances, the upper middle classes in developed countries increasingly came to look for capital gains instead of improving their living standards through productive work. This promoted inequality, and led to the under-regulated financial system's seizure of power over the entire economy, destabilizing the real economy by fatally weakening its capacity to react to external shocks.
Today's crisis marks the end of economic growth fueled only by credit. But untying the knot that an overweening financial sector has drawn around the economy will take time. Indeed, there is still no consensus that this needs to be done. Yet the G20 has opened the way to discussion of these fundamental issues. Today's recession will be a long one, but it will compel everybody to consider its root causes.
The author, By Michel Rocard,?is former prime minister of France, leader of the Socialist Party and a member of the European Parliament Project Syndicate.
(China Daily?December 3, 2008)
