The Next Bretton Woods

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The world is sinking into a major global slowdown, likely to be the worst in a quarter-century, perhaps since the Great Depression. This crisis was "made in America" in more than one sense.

The United States exported its toxic mortgages around the world in the form of asset-backed securities. It exported its deregulatory free-market philosophy, which even its high priest, former Federal Reserve chief Alan Greenspan, now admits was a mistake. It exported its culture of corporate irresponsibility, such as nontransparent stock options, which encourage the bad accounting that has played a role in this debacle. And, finally, the United States has exported its economic downturn.

The administration of President George W. Bush has finally come around to doing what every economist urged it to do: put more equity into the banks. But, as always, the devil is in the details, and Treasury Secretary Henry Paulson may have succeeded in subverting even this good idea. He seems to have figured out how to recapitalize the banks in such a way that it may not result in a resumption of lending, and this would bode poorly for the economy.

Most important, the terms that Paulson got for the capital provided to U.S. banks were far worse than those obtained by British Prime Minister Gordon Brown (not to mention those that U.S. investor Warren Buffett got for putting far less into the country's soundest investment bank, Goldman Sachs). Share prices show that investors believe that they got a really good deal.

One reason to be concerned about the bad deal that U.S. taxpayers are getting is the looming national debt. Even before this financial crisis, the U.S. national debt was scheduled to increase from $5.7 trillion in 2001 to more than $9 trillion in 2008. This year's deficit will approach a half-trillion dollars. Next year's will be even larger as the country's downturn steepens. The United States needs a big stimulus package. But Wall Street's fiscal conservatives -- yes, the same people who brought us this downturn -- will now be calling for deficit moderation. This is reminiscent of U.S. Treasury Secretary Andrew Mellon's policy during the Great Depression.

Now the crisis has spread, predictably, to emerging markets and less developed countries. Remarkable as it may seem, the United States, for all its problems, is still seen as the safest place to put one's money. No surprise, because despite everything, a U.S. government guarantee has more credibility than a guarantee from a Third World country.

As the United States sops up the world's savings to address its problems, as risk premiums soar, as global income, trade and commodity prices fall, developing countries will face hard times. Nations that have large trade deficits, national debts and close trade links to the United States are likely to suffer more than others. Those countries that did not fully liberalize their capital and financial markets, such as China, will be thankful that they did not follow the urging of Paulson and the U.S. Treasury to do so.

Many are already turning to the International Monetary Fund for help. The worry is that, at least in some cases, the IMF will go back to its old failed recipes: fiscal and monetary contraction, which would only increase global inequities. While developed countries engage in stabilizing countercyclical policies, developing countries would be forced into destabilizing policies. This will drive away capital when these countries need it most.

Ten years ago, at the time of Asia's financial crisis, there was much discussion of the need to reform the global financial architecture. Far too little was done. At the time, many thought that such lofty appeals were a deliberate attempt to forestall real reform. Those who had done well under the old system knew that the crisis would pass, and with it so too would the demand for reform. We cannot let that happen again.

We may be at a new Bretton Woods moment. The old institutions have recognized the need for reform, but they have been moving at glacial speed. They did nothing to prevent the current crisis, and there is concern about their effectiveness in responding to it now that it has hit.

It took the world 15 years and a world war to come together to address the weaknesses in the global financial system that contributed to the Great Depression. It is to be hoped that it will not take us that long this time. Given the level of global interdependence, the costs would simply be too high.

But, whereas the United States and Britain dominated the old Bretton Woods, today's global landscape is markedly different. Likewise, the old Bretton Woods institutions came to be defined by a set of economic doctrines that has now been shown to fail not only in developing countries but also in capitalism's heartland. The forthcoming global summit must face these new realities if it is to work effectively toward creating a more stable and equitable global financial system.

Joseph E. Stiglitz, professor of economics at Columbia University and recipient of the 2001 Nobel Prize in Economics, is coauthor of "The Three Trillion Dollar War: The True Costs of the Iraq Conflict." © Project Syndicate