In search of a new global financial system

AN international summit meeting on the economy is scheduled to be held in Washington on November 15 with the objective of devising new rules for the global financial system. Although a detailed agenda has not yet been drawn up, it is almost certain that the role of the US dollar in international trade will occupy an important position in it.
The entire international economic architecture established at the Bretton Woods conference by USA and its allies has become, if not obsolete, but to a large extent ineffective. It is noteworthy that it has not been able to save even the economy of its chief architect USA, from the current disastrous situation.
Sixty odd years after the Bretton Woods accord, America's financial system is broken and its economy is sliding into the worst recession since the 70s. Economic activity is falling and unemployment is rising. Domestic consumption has fallen and the future for US exports is bleak because of the slow global economy. All this has led many economists to think that US economy is heading towards a deep depression.
At the heart of America's troubles, is its addiction to debts. Debt created the housing bubble, the stock market bubble, the meltdown and finally the credit crunch. The US, as a nation is suffering from the effects of a prolonged period of double deficits -- the budget deficit and the current account deficit. (The budget deficit for the current year alone will be at least $700 billion and the current account deficit will rise over 5.5% of the GDP. The US national debt now stands at over $10 trillion.) The truth is American households, banks, corporations and government have already spent a significant portion of their future earnings.
In fact, it has been "perhaps the greatest wealth transfer since the Bolshevik Revolution in Russia in 1917." As Michael Mandelbaum writes in Democracy's Good Name: "It is not a wealth transfer from rich to poor that the Bush administration will be remembered for. It is a wealth transfer from the future to the present."
Now this is fair to ask: Who is financing America's debts and why? If America's economic situation is so bad why has the US dollar been appreciating against most major currencies since August this year? At this time of global crisis, why are the investors taking refuge in the currency of the country where it began?
The answers to these questions are tied to the role played by the US dollar in international financial transactions for the last sixty years. At the Bretton Woods Conference, the US dollar emerged as the world's major currency for international trade and investment. The dollar was made exchangeable into gold at a fixed rate of exchange. The other currencies of the world were made exchangeable into the dollar. The rest of the world had no other option but to trust the US that it would only issue as many dollars as they were backed by gold. Actually for a number of years, the US Treasury maintained a scrupulous watch on the ratio of dollars issued to its gold reserves.
Unfortunately, the Vietnam War changed all that. In order to meet the ever-rising war expenditure, US started emitting a disproportionate volume of dollars, which was not backed by gold. For a time, this phenomenon went unnoticed by America's creditors.
But at a later stage, they became suspicious and started exchanging dollars for gold quietly. Unable to sustain the situation, on August 15, 1971, Nixon abolished the gold standard system. Thus gold-based dollar was brought to an end-giving rise to a faith-based dollar.
Most probably, never in the field of international trade has a country occupied such a privileged position than that of US. Year after year "it has consumed much more than it has produced, and it has managed to discharge its debts with the money that it alone could lawfully print."
Yet until now the world has had so much faith in America's future that its creditors have sent back those dollars to the United States to buy American stocks, government bonds etc. Actually, the world has considered the US dollar as good as gold; hence the phenomenon of stashing away trillions of US dollars in global central bank vaults as reserves, especially in Asia's large trading nations.
One of the reasons given for the rise of dollar is that even though the outlook for the American economy is bad, that for the rest of the world is deteriorating rapidly. The fact remains that with its nearly $14 trillion GDP, the US is by far the world's largest economy. From an economic point of view, the dollar is the ultimate symbol of America's long-term creditworthiness and from a political point of view it reflects world's faith in the long-term stability of its political system. But how long will America's creditors have faith in the integrity of American finance? How long will they be able to maintain their trust in the dollar as a store of value? Is the world financial system ready to cope with a situation created by a hypothetical decision to sell these dollars in a rush? What will happen to the global economy when the next dollar-based bubble bursts?
The summit of November 15 must try to address these issues and devise a global financial system, which will not be wholly dependent on the US dollar, but based on a basket of the world's major currencies. Some economists have even suggested that it is time to go back to the gold standard, which will give greater stability to the global financial system and impose some discipline on America's profligate spending habits.
It is also time to reform World Bank, IMF and World Trade Organisation, which until now have primarily served the interests of America and its Western allies. They have consistently applied double standards in enforcing the rules of financial discipline -- one for the industrialised Western countries and the other for the so-called emerging nations.
Because of globalisation and the rise of new economic powers, it is imperative for the convenors of the summit to have a more inclusive agenda and invite representatives from Asian, African and South American countries to attend the meeting so that they can also contribute to the establishment of a new architecture for the international financial system.

Chaklader Mahboob-ul Alam is a Daily Star columnist.