US Financial Crisis: Is It the Moment for Bretton Woods II?

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US Financial Crisis: Is It theMoment for Bretton Woods II?

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With Gramm-Leach-Bliley Act of 1999, peeling away part of the Glass-Steagall Act of 1933, finance industry got deregulated. Regular banks, mortgage houses, investment banks and other financial institutions gradually consolidated their functionalities. In this ambience, increasing financial innovation evolved.Consequently,with the aid fromcomputer-programmed high businessmathematics, so many complex derivatives and derivatives of derivatives like Collateral Debt Obligation (CDO) and Credit Default Swap (CDS) came up in the role of diversifying risk elements and promising alluring returns compared to low yields of treasury bills. No wonder the derivatives have formed about 80% of the global liquidity whilemoney and securitised debt together constituted amere 20% of the liquidity (Exhibit VI). Deregulatory regime - not insistent upon the capital adequacy norm - gave the banks a long leash to leverage their lending up to 30-40 times their base assets. Sensing the formation of a ‘bubble’ from past experience of the dotcom bubble in 2000, the Federal Reserve began raising interest rates progressively so as to prevent a sharp downturn in the housing market.

Between June 2004 and July 2006, little by little, interest rates got increased for 17 times and inched up from 1% to nearly 5% which inadvertently led tomounting defaultsmainly by subprime borrowers, sparking rising enclosures, falling home prices. Themutually negative influence of enclosures and home prices worsened the situation and induced intentional defaults even by the prime borrowers. The upshot was the burst of the housing bubble. This rendered the whole array of home mortgage derivatives and the derivatives of the derivatives toxic, resulting in a crisis of confidence and credit crunch, which led to the fall of famed Wall Street institutions and emergence of a financial ice age crying out for the thawing governmental bailout. For, the credit freeze has begun to affect the real sector by triggering the chain-contraction in consumption, investment, output and employment not only in the US but also in the rest of the integrated world.

Debate over the Revival of BrettonWoods

By facilitating lowinterest rates that fuelled the housing bubble, the post-BrettonWoods informal system - from behind the layers of proximate causes - is alleged to have contributed to the US financial crisis (2008), which quicklymorphed into a global crisis owing to both trade and financial linkages in the current era of rapid globalisation. The interest rates became low because the surplus dollars gained by trade surplus countries such as Japan and China and other Asian countries with respect to theUSwere not used to raise the standard of living of the trade surplus countries themselves but deposited in US treasury securities. As the famous economic journalist Martin Wolf writes, “China has about 800million poor people, yet the country now consumes less than half of GDP and exports capital to the rest of theworld”⁹ , mainly to the US. Hence, the growing need is to revive the BrettonWoods systemto prevent the repeat of a financial crisis having international ramifications.

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9]Judis John B., “Debt Man Walking: The US, China, Japan and the Foundations for a New Bretton Woods”, http:// www.japanfocus.org/_John_B__Judis-Debt_Man_Walking__The_US__China__Japan_and_the_Foundations_for_a_ New_Bretton_Woods/, November 20th 2008