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[home] THE INFORMATION HIGHWAY OUT OF BRETTON WOODS Directions for a
successful trip out of Bretton Woods . . . take the
information highway. by Dean
LeBaron February
26, 1995 Only fate could have determined that the G-7 would
sponsor two seemingly-unrelated conferences on the weekend of February
25-26, 1995. In Halifax, Nova Scotia, representatives of finance ministers
discussed, with added urgency, preparation for new institutional measures
to update the 1944 Bretton Woods Accord. In Brussels, an unusual blend of
Eurocrats and technology leaders discussed the implications of the
information superhighway. Halifax dealt with
international arrangements for currency alignment and development-finance
in the modern economic world under conditions unimaginable only a decade
ago. The agenda for this conference had a series of failures before it,
the finance ministers having been powerless to stop currency crashes in
Britain, Italy, and, the most serious recent case, Mexico. Brussels dealt
with the opposite issue—whether to establish institutions to manage the
success of global, instantaneous, cost-less, and volume-insensitive
information transfer. On the surface it seems only a coincidence that these
two meetings were simultaneous. Except for CNN, I doubt if the
participants of one knew what the others were doing. But they related in a
miraculously simple way and offered the solution being sought in Halifax. Bretton Woods recently celebrated its 50th
anniversary. Amid statesmanlike speeches by world leaders in 1944, calls
for study and moderate reform were sounded. The original Accord, modified
in several ways as recently as nine years ago, converted the gold standard
to a dollar standard, and governments were encouraged to maintain,
wherever possible, fixed rates (lately, “fixed” implied a +/- 2.5%
range) around the stated peg, the dollar. More importantly, governments
and their central banks pledged a coordinated action to defend weakening
currencies through information exchange and support mechanisms . . . they
were not to be destructively competitive but cooperatively collaborative.
And, finally, two huge and powerful institutions were created, the World
Bank and the International Monetary Fund, with the ability to accept
government deposits and issue drawing rights (SDR) according to a set of
rules. Gradually these institutions, especially the World Bank and its
subsidiary, International Finance Corporation, assumed the major role in
channeling development capital to emerging economies. In the two generations since the original agreement,
unplanned factors have become mighty forces. First, foreign currency alignments no longer follow
trade but lead it. Purchasing power parity can be way out of line with
exchange rates for long periods of time. Exact figures are impossible to
determine, but it is estimated by some that 98% of currency flows are
speculative, unrelated to trade settlements. Currency levels bear some
relation to underlying economic policies but far more to the perceptions
of traders of those policies . . . and even to the perceptions of traders
about the perceptions held by other traders. Trillions of dollars trade
each day on the 24-hour, instantaneous, global-currency lottery. If
earlier it was possible to “red-dog” a large stock on a single day,
now an entire economy may take only a week. No institution or collection
of institutions can stop it with tens of billion-dollar bailouts.
Central-bank intervention is rather like sending a kiddy car onto a
no-speed-limit autobahn . . . dangerous even if the kiddy car is driven by
an adult. Second, markets for foreign exchange are accessible
for high levels of borrowing. Through the use of derivatives, leverage of
a hundred times base capital is available. Thus the amounts at risk are
huge and grow as the velocity of trading increases. Third, the entire system is almost instantaneous.
There is no time for quiet, reserved, confidential deliberations by
central bankers. Waiting to act may be weaker than consciously doing
nothing, but the luxury of observing markets slowly adjusting to new
equilibria is inconsistent with the evidence of non-linear,
non-equilibrium, almost chaotic processes. No procedures have been devised
to deal with the speed and magnitude of the outcomes. The closest parallel
might be computer programs at the US Department of Defense that analyze
and prepare responses to nuclear threats. But even there, if the math
worked, the armaments of defense are inadequate to the onslaught of
traders with the smell of currency blood in their computer models. Finally, currency trading has become a major profit
center for large international banks. The tyranny of performance
measurement of individual traders—the asymmetric payoff where they win
big bonuses if they win by taking risks, and only lose their job if they
lose money—presents an important element of incentive to play the game
high. It is not in the lexicon of free markets to erect
trading barriers. To the contrary, G-7 nations have espoused free trade
and full convertibility to all (while the U.S. tempers the advice by
calling for “managed trade”). The siren song was that the sober,
dedicated-to-stability central bankers would take care of the system. All
the developing economies had to do was pursue sound policies. Some would
occasionally question whether the United States met the standards for
borrowing from the World Bank, but the necessities of the day caused such
embarrassing questions to fade. There is much about foreign exchange trading that we
do not know. No tick-by-tick database exists (the closest is the arduously
compiled ten-year database of Olsen & Associates in Zurich). There are
no volume figures, only reports of interest rate quotes that combine real
interest rates, expectations of inflation or deflation, and any separate
currency expectations. This is a fast, continuous market about which we
only have anecdotal information. And we can’t stop it. Nor should we. Foreign exchange markets lack only one thing, and it
is the only thing that is large enough and fast enough to correct
imbalances. Information. And now we come back to the two meetings of the
weekend. The only institution that should be established is a
common information gateway through which all currency transactions must
pass. Trade information is recorded, protected for security of the
parties, and disseminated to the world, continuously. Markets could then
respond in whatever way they wished to the observed currency flow. Market
analyses would flourish, with the usual mixture of insights and junk. All
market participants would have equal access to factual information on
trading flows, regardless of size. Governments would be relieved of the
responsibility of maintaining a fixed exchange rate because there would no
longer be a “dollar” standard. It is worth recalling the dramatic
decline of the dollar against the mark and the yen . . . undesirable
behavior for a reserve currency. There would be no reserve currency.
Everything would float because it does anyway. To pretend there is a fixed
mechanism is a fiction of markets long past. The gateway capture is
comparatively simple to a world that devised the Internet without really
planning to do so. Markets would be stabilized by market participants,
properly informed. And what of the international institutions founded
fifty years ago? I am reminded of an old story about central bankers in
the gold standard days. It was decided to put the world’s reserves of
gold on an isolated island with one central banker to represent each
country who would move the gold on the island from one country bin to
another according to cabled instructions. The bankers, the world’s gold
reserves and a one-year supply of champagne were sent to the island and
left to await a resupply of champagne in a year. Cables went daily to the
island instructing the bankers to realign the gold according to the
settlement requirements. Everything was fine and stable on the world
economies for the first year and the new system was heralded a success.
However, the first resupply mission that arrived at the island with the
champagne found the bankers dead of a tropical disease, and it was
estimated they died shortly after arrival. News that the gold had not been
moved for a year brought the world’s economies to their knees. Chaos. The moral? In a free market, disclosure or
“sunshine” is the prescription. The next G-7 meeting on Bretton Woods
reform should combine with the G-7 meeting on information technology.
Something might happen. ---------------------------
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