Wanda Tseng：Reflections on the Bretton Woods System
Wanda Tseng: Former Deputy Director in the Asia and Pacific Department of IMF
The international monetary system has changed tremendously since the Bretton Woods Conference 70 years ago. Yet, the International Monetary Fund (IMF), an institution created at Bretton Woods, remains at the center of international monetary cooperation. This paper reflects on why the IMF has endured, how it has adapted to the changes in the world economy, and what reforms are needed in both the international monetary system and the IMF to realize the original vision of Bretton Woods—that is, international cooperation to achieve a more peaceful and prosperous world. Section I provides a brief historical background on the birth of the Bretton Woods system. Section II describes the historical contributions of the IMF. Section III covers the reforms undertaken in the international monetary system and by the IMF to address the global financial crisis. Section IV reflects on prospects for the IMF and the international monetary system.
I. Birth of the Bretton Woods System
Looking around the world, there are not many institutions or companies that stay around for 70 years. Most of them disappear for a variety of reasons: because they fail to adapt to changing trends and lose relevance, or because they fail to innovate and become outdated. So the fact that the IMF is still here can be viewed as an achievement, especially considering its birth during the uncertain times just before the end of World War II and when its success was, by no means, guaranteed.
The Bretton Woods institutions, the International Monetary Fund and its sister institution, the International Bank for Reconstruction and Development (more commonly known as the World Bank Group), were born in the summer of 1944. A month earlier, Allied forces had landed on the beaches of Normandy, ending the War in Europe, but more than another year would pass before Japan surrendered in September 1945 to end the War in the China Theater. In July 1944, 730 delegates from 45 countries gathered for the United Nations Monetary and Financial Conference at the Mount Washington Hotel in the cool mountains of Bretton Woods, New Hampshire. The objective of the conference was to set up a system for international monetary and financial cooperation that was hoped would create a more prosperous and peaceful world.
Harry Dexter White, a founding architect of the Bretton Woods System, said at the time:
The IMF is essential to winning and preserving peace, and that is why representatives of 44 nations here in Bretton Woods are taking steps to prevent a repetition of the currency chaos, which is usually followed in the wake of war.
On July 22, 1944, the participating nations signed the provisional Articles of Agreement for the IMF and the World Bank. John Maynard Keynes, the intellectual force behind the Bretton Woods System, said:
There has never been such a far-reaching proposal on so great a scale to provide employment in the present and increase productivity in the future…and I doubt if the world yet understands the bigger things we are bringing to birth.
China was an active participant at the Bretton Woods Conference. China was an original member of the Bretton Woods institutions. China had the third largest quota in the IMF until 1959, and thus was one of 5 countries entitled to appoint an Executive Director at IMF’s Executive Board (Boughton 2001). Koo Yee Chun (顾翊群), Vice Minister of the Nationalist Government at the time, was the first Chinese Executive Director; he served in that role during 1946-50, after which he had a distinguished career as IMF Treasurer. Mainland China assumed the representation of China in 1980, with Zhang Zicun as Executive Director. Since then, Executive Directors from China, including the recent Directors: Zhang Zhixiang, Wei Benhua, Wang Xiaoyi, Ge Huayong, He Jianxiong, have been an active voice on the Executive Board. They brought an unique perspective to the IMF Executive Board. Their insights about economic reforms, transition to a market economy, and economic growth and development were particularly relevant and valuable to the emerging and developing members of the IMF.
II. Historical Contributions of the IMF
During the past 70 years, the IMF has worked to achieve its purposes as set forth in the Articles of Agreement:
(i) To promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.
(ii) To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.
(iii) To promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.
(iv) To assist in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.
(v) To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.
(vi) In accordance with the above, to shorten the duration and lessen the degree of disequilibrium in the international balances of payments of members.
The vision of the IMF’s founding fathers—international cooperation to promote high levels of employment and real incomes, while fostering price and financial stability— is as pressing and relevant today as it was 70 years ago. Of course, the world has changed tremendously in the past 70 years, but the IMF remains central to the international monetary system today because it has adapted to changes in the world economy. Looking back, some of the milestones that have marked the history of the IMF include:
-1971 Collapse of the Gold Standard
-1973 Oil Shock
-1982 Mexican debt crisis
-1991 Collapse of Soviet Union
-1996 Launch of HIPC
-1997 Asian financial crisis
-2008 Global financial crisis
-2009 Euro zone crisis
While remaining true to its central mission, the IMF has adapted to the new challenges in the world economy. It has done so by innovating new tools, refreshing its views, learning from its mistakes, and developing new expertise. The following describes some examples of the IMF’s response to some of the major changes in the world economy.
(i)Collapse of the Gold Standard, 1971-73
The gold standard came under strain in the early 1960s owing to a deteriorating U.S. balance of payments and the corresponding loss of gold. With President Nixon’s official termination of gold convertibility of the U.S. dollar in 1971, it became apparent that a new monetary order was needed. A group of major industrial countries[ Group of Ten (G-10): Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States.]attempted a realignment of key-currency exchange rates, including a devaluation of the dollar under the Smithsonian Agreement in December 1971. But that agreement quickly came under strain, and finally, after two years of discussions, the goal of exchange rate stability was abandoned and the IMF instead was mandated to exercise "firm surveillance" over what was supposed to become a stable international monetary system through bilateral and multilateral oversight (Boughton 2012). That mandate was eventually enshrined in the Second Amendment of the IMF Articles of Agreement in 1978.
(ii)Oil-price shocks of the 1970s
Responding to the oil-price shock of 1973-74, the IMF introduced a new lending facility—the Oil Facility that borrowed from oil exporters and rich countries and lent these funds on low-conditionality terms to oil-importing countries, both industrial and developing.
(iii)Tumultuous 1990s: collapse of the Soviet Union and emerging market financial crisis
The 1990s brought a new set of challenges for the IMF. The IMF had to develop new expertise to assist the Soviet Union and the former Eastern bloc countries to make the difficult transition to market economies. Globalization quickened and large and volatile cross border capital flows surged. The increased financial integration and interdependence among economies meant that financial crisis is no longer confined within a country’s borders but spilled over to other countries and regions. Beginning with Mexico in 1994, a series of crippling financial crises spread across the globe and the Asian financial crisis erupted in 1997.
The IMF had to come to the aid of countries in financial crisis after the sudden stop of private capital flows. The IMF’s role during the Asian financial crisis was subjected to intense public scrutiny and criticism. Nevertheless, it should be recognized that the IMF rose to the occasion: it was there to help, when no one else was present; the IMF acted quickly and substantially; and the IMF involvement proved largely successful. In the case of Korea, the IMF was there to help after Japan and the United States turned down Korea’s request for bilateral loans and Korea was running out of foreign exchange reserves. The staff team worked closely with the authorities under great pressure, and a program was submitted for Executive Board approval within one week from the beginning of negotiations. The program proved largely successful: within a year, the economic downturn had begun to reverse and the financial situation stabilized. Within two years, real GDP exceeded the pre-crisis level. Within three years, the IMF-supported program had ended. And within four years, Korea repaid all outstanding IMF loans, well ahead of schedule. The reforms undertaken by Korea at the time made Korea what it is today, more transparent, resilient, and globally competitive.
In the aftermath of the emerging market crisis of the 1990s, the IMF moved to improve the functioning of the international monetary system. The IMF introduced the Financial Sector Assessment Program (FSAP) in 1999 to strengthen surveillance over a country’s financial sector; the FSAP examines in depth the potential risks and vulnerabilities of a country’s financial sector and offers recommendations for reforms. The IMF also adapted its surveillance to reflect the growing recognition that countries whose institutions are well regulated and transparent tend to demonstrate better economic performance and greater financial stability. So the IMF and the World Bank defined Standards and Codes in 12 policy areas (such as data dissemination, fiscal and monetary policy), which are benchmarks of good practices to help countries to strengthen their domestic economic and financial institutions.
The IMF also increased the transparency of its operations and outreach to civil society. From a largely secretive organization, the IMF now routinely publishes its Executive Board discussions and staff reports on country consultations. The IMF also increased engagement with civil groups—students, labor unions, NGOs—to expand the perspectives brought to its operational decisions.
(iv)Debt relief for low-income countries
The IMF and the World Bank launched the HIPC Initiative in 1996. For the first time in its history, the IMF wrote off some of its lending. This was because of the growing understanding that the heavy and unsustainable debt burdens can become a stranglehold on the growth and development of low-income countries. The HIPC Initiative aimed to ensure that no poor country faces a debt burden it cannot manage. Since then, the international financial community, including multilateral organizations and governments, have worked to reduce to sustainable levels the external debt burdens of the most heavily indebted poor countries provided they are implementing effective development strategies. To date, debt reduction packages under the HIPC Initiative have been approved for 36 countries, 30 of them in Africa, providing US$75 billion in debt-service relief over time.
(v) Global financial crisis and euro zone crisis
The first decade of the 21st century has been marked by financial crisis in the advanced countries. In 2008, a subprime crisis in the U.S. quickly engulfed the whole world, causing the most severe global recession since the Great Depression. This was followed by the euro crisis in 2009, and while the situation in the euro area is now stabilized, the full resolution of the crisis has not yet been achieved.
The IMF did not anticipate nor prevent the crisis in the advanced countries. It was a serious failure of surveillance. Indeed, leading up to the crisis, IMF had been in a lull, preoccupied with bureaucratic reorganization to downsize its staff because its lending activities had dropped sharply after the emerging market crisis of the 1990s.
III. Reforms to address the global financial crisis and strengthen the international monetary system
The global financial crisis led to renewed discussions about reforming the international monetary system. The deficiencies of the international monetary system—excessive risk-taking in financial markets, exchange rate misalignments and external imbalances, large and volatile capital flows—have resulted in repeated financial crisis with systemic spillovers.
Since 2008, the IMF has been implementing wide-ranging reforms to help improve the international monetary system. Some of these reforms are still ongoing. The key reforms include:
Creating a crisis firewall. To meet increasing financing needs of countries hit by the global financial crisis and help strengthen global financial stability, the IMF has greatly bolstered its lending capacity. It has done so both by obtaining commitments to double quota subscriptions of member countries[ On December 15, 2010, the IMF completed the 14th General Review of Quotas, which involved a package of far-reaching reforms of the Fund’s quotas and governance. The reform package involves an unprecedented 100 percent increase in total quotas (to SDR 477 billion from SDR 234 billion) and a major realignment of quota shares.—the IMF's main source of financing—to about $737 billion, and securing large temporary borrowing agreements from member countries, including recent pledges of $461 billion.
Stepping up crisis lending. The IMF has overhauled its lending frame framework to make it better suited to country needs and to give greater emphasis on crisis prevention. The IMF also streamlined conditions attached to loans. The new lending facilities include the Flexible Credit Line (FCL) and Precautionary and Liquidity Line (PLL).[ As of May 31, 2014, Columbia, Mexico, and Poland have arrangements under the FCL and Morocco has an arrangement under the PLL.] Since the start of the global financial crisis, it has committed well over $600 billion in loans to its member countries.
Strengthening regional and multilateral surveillance. The IMF has learned a great deal about the importance of surveillance over the financial sector, spillover effects, and regional and multilateral surveillance. The IMF revamped the FSAP in September 2009 to make its assessment more candid and transparent, and to improve its toolkit—by better identifying linkages between the broader economy and the financial sector and cross-country linkages. Since September 2010, the IMF made the Financial Sector Stability Assessment (FSSA, a major component of FSAP) mandatory for 25 systemically important jurisdictions.
The IMF also sharpened its analysis of spillover effects, giving emphasis to interconnectedness among countries and the external effects of a country’s economic policies. These analyses are published in its periodic Regional and World Economic Outlooks (REO and WEO), Global Financial Stability Reports (GFSR), supplemented by the introduction of an Early Warning Exercise, the Fiscal Monitor, the Spillover Report, the Pilot External Sector Report, and the G20 Mutual Assessment Process.
The IMF intensified efforts at crisis prevention. In bilateral surveillance with individual countries, one innovation is a more systematic assessment of risks so that potential problems can be identified and appropriate policy responses developed more effectively. Another innovation has been the incorporation of risk assessment matrices in many Article IV reports.
Rethinking capital controls. The IMF revised its thinking about capital controls. In 1997, consideration had been given to amend the IMF’s Articles of Agreement to make the liberalization of capital controls as part of the IMF’s mandate. However, in view of experience with the series of capital account crisis, the IMF issued an important paper in 2012, setting out its institutional view on a framework for managing capital flows (IMF 2013, IMF 2012). In addition to the traditional macroeconomic policies, the IMF considered that capital control measures, involving both certain macro prudential measures (MPMs) and capital flow management measures (CFMs), also have a role to play, and should be part of the toolkit for managing capital flows.
Helping low-income countries. The IMF undertook an unprecedented reform of its policies toward low-income countries and quadrupled resources devoted to concessional lending.
Reforming the IMF’s governance. In 2010, the IMF agreed on wide-ranging reforms so that its governance is more reflective of the increasing importance of emerging market countries. In addition to the doubling of quotas, the reforms will shift more than 6 percent of quota shares to dynamic emerging market and developing countries (mainly from advanced countries in Europe, which will also see a reduction in its seats at the IMF’s Executive Board) and make all BRIC countries be among the top 10 IMF shareholders. At the same time the voice of poorest countries will be maintained by preserving their voting shares. Unfortunately, IMF governance reforms suffered a major setback early this year as the U.S. Congress failed to approve these reform that had been agreed internationally four years ago.
IV. Future Prospects for the IMF and the International Monetary System
Despite all the efforts undertaken since the global financial crisis, reforming the international monetary system remains an unfinished agenda. There are three main gaps:
The first gap is the instability in an international monetary system anchored by the currency of a single country. The outbreak of the financial crisis in the United States—the world’s reserve currency country—and its spillover to the entire world revealed the vulnerabilities of this system. As Governor Zhou Xiaochuan of the People’s Bank of China pointed out, policy decisions taken in reserve currency countries might not be appropriate for the rest of the world, leading to systemic risks (Zhou 2009). Furthermore, the global financial crisis and increasing worries about the large and possibly unsustainable public debt burdens of the main reserve currencies raised questions about whether these currencies could maintain their store of value properties over the long term.
Since the global financial crisis, there has been renewed debate about alternatives to the present domination of the U.S. dollar, but progress has been elusive. A super sovereign reserve currency, such as the IMF’s Special Drawing Rights (SDR), is one possibility, but there seems to be little market demand for a substantial expansion in the use of the SDR. Governor Zhou has also proposed a stronger international role for the currencies of major emerging economies (such as the RMB) in the SDR basket. The IMF’s Executive Board is scheduled to review the SDR basket composition next year, in 2015.[ In October 2011, the IMF Executive Board concluded that the current criteria for SDR basket selection remained appropriate. For a currency to be included in the SDR, it should be “freely useable.” Indicators of “freely useable” include: the currency composition of official reserve holdings; the currency denomination of international banking liabilities; the currency denomination of international debt securities; and the volume of transactions in foreign exchange markets (IMF, 2011).
Another possibility is the emergence of additional reserve currencies. With emerging markets now accounting for half of the world’s GDP, emerging markets’ currencies (in particular, the RMB) could rise as additional global reserve currencies
Despite great progress, the RMB still has some distance to go before it can become a global reserve currency. China’s growing weight in global output and trade, together with policy measures taken by the Chinese authorities, have led to an increasing use of the RMB in international trade settlement. However, use of the RMB for international financial transactions remains very limited, notwithstanding the creation of rapid expansion of offshore RMB markets, The lack of sufficiently deep and liquid domestic financial markets, interest rate and other restrictions, remaining capital controls, and insufficient exchange rate flexibility hamper the international use of the RMB, especially as a reserve currency. Continued progress with these reforms will advance RMB internationalization and create market demand for its use as a reserve currency.
The second gap is the surveillance framework, in particular, the lack of mechanisms to compel countries, especially the systemically important ones, to take into account the external spillover effects of their domestic economic policies. The problems this gap create can be seen in the volatility shock that hit emerging markets in May 2103 after the U.S. Federal Reserve announced its intention to taper its quantitative easing. It has been suggested that the IMF’s Articles of Agreement be amended to incorporate an obligation for member countries to direct its economic policies toward global economic growth and financial stability, in addition to its own internal and external stability. However, this option is unlikely to materialize in the near future, as governments would see this as an infringement on their national sovereignty.
The third gap in reforms of the international monetary system is the urgent need for governance reforms. The world has changed greatly since the founding of the Bretton Woods institutions, yet its governance structure largely reflects the economic realities 70 years ago. This outdated governance structure undermines the legitimacy of the IMF as an international cooperative institution. Steven Pearlstein, a columnist in the Washington Post wrote:
Economic and political systems tend to be successful when there is widespread trust, a sense of mutual responsibility and an expectation that those in charge will not abuse their discretion just because it may be in their short-term interest to do so.
These words are applicable to the current impasse on IMF governance reforms and what is needed to make the IMF a more legitimate and effective institution. Decisions on which countries have a seat at the table have a major effect on what gets done and how successful outcomes can be. So completing IMF governance reforms is an urgent task.
In conclusion, an institution like the IMF is essential for the smooth functioning of the international monetary system. In the past 70 years, the IMF has been the central institution of international monetary cooperation. It has lasted because it has almost universal membership, with 188 countries, and because it is a learning institution, allowing it to adapt and reinvent itself as the world economy evolved. Hopefully, efforts to fill the gaps in international monetary system will be successful because, as President Franklin Roosevelt said nearly 70 years ago at Bretton Woods, the reform agenda is vital among “the arrangements which must be made between nations to ensure an orderly and harmonious world.”