Bretton Woods II Explained: Is the US Entering a New Global Monetary System? https://youtu.be/VJdP_aqOAT8
Is it possible that the whole system of global finance and trade, you know, the one that affects pretty much everything is actually running on a kind of hidden informal monetary system like a sequel nobody officially announced? Exactly. Something some economists call Britain Woods 2. Forget the treaties. This theory suggests it's a sort of quiet structure popped up after the old post-war system died. And maybe, just maybe, it's still defining how money and trade work even after massive shocks like the 2008 crisis. That's precisely what we're digging into today. This Bretton Woods two tath idea. It's a really fascinating way to look at the international money system that well arguably took shape in the late 20th century. Yeah. And it's crucial to get this. It's not some formal agreement you can find in a library. No signatures, no explicit rules agreed by governments, right? It's more like a description, a framework that certain economists proposed to explain how capital flows, trade, currencies, how it all seemed to function between specific groups of countries, you know, leading up to and even through the big financial crisis. And we've got some really solid material to help us unpack this. We're drawing on research papers, detailed analyses from economic institutions, uh, experts who've really spent time mapping out global monetary history, and this specific Brettonwood six phase. Think of this deep dive as us trying to pull out the key insights from those expert analyses. Yeah. Get right to the heart of what they found, what they argued. Our mission here is to cut through the usual finance jargon and complexity. We want to give you a clear picture, as clear as we can make it, of what this alleged system is, who the players are, how it supposedly works, and really importantly, how it held up under extreme stress like the 2008 meltdown. Did it break? Did it bend? We'll also look at what the sources hint might come next or maybe what won't come next. And this isn't just, you know, academic theory. Understanding these deep global financial currents can really shed light on things like trade wars, interest rates, things that affect all of us. Absolutely. So where do we start the core concept? Okay. Yeah. Let's unpack this Bretonwoods tok idea itself. What's the fundamental concept and who are the key players in this uh this supposed global game? All right. So diving into the core of the BWI thesis especially the version from Douly Fulkritz Landau and Garber often just called DFG right the DFG view they looked at the international monetary system that sort of emerged after the original Bretonwoods collapsed in the early '7s and they said hang on this isn't just chaos it wasn't just everyone floating currencies freely not exactly they saw it as a kind of revival maybe an evolution of a center periphery structure even though the fixed exchange rates were gone officially. They argue a new much more informal version took its place. Okay. And the defining feature of this new system, this BWI, the absolutely central pivotal role played by the United States. The US is the center country. Then what does that actually mean in this model? What's its defining job or characteristic? The crucial thing according to the theory is the US's ability and its willingness really to run a huge and persistent current account deficit. Okay, quick reminder. Current account deficit means importing way more than exporting. Plus, net income flows. Basically, yes. The US is buying much more stuff from the world than it's selling. And the income it gets from its investments abroad doesn't cover that gap. So, think of the US as the world's biggest customer, the buyer of last resort. It absorbs a massive amount of exports from everyone else. So, the US market is just enormous, acting like this giant sponge for products from the periphery countries. Precisely. But, and this is key, it's not just about buying goods. Tied directly to that role is the fact that the US also has the world's deepest, most flexible, and arguably safest financial system. And that provides something the periphery needs. Absolutely essential. It gives those exporting countries a place to put the massive amounts of money they earn. It offers them safe assets, mainly US dollar assets like Treasury bonds, to invest those export earnings in. This sounds like what you always hear described as a huge problem, right? The US deficit is this big unsustainable imbalance. Why would the US tolerate that? What did the BWI sources say? This is where the DFG perspective, drawing from our sources, really challenges that conventional wisdom. They argue the deficit isn't necessarily a problem or an imbalance that needs urgent fixing through say painful austerity. So it's not a bug, it's a feature kind of. Yeah. They see it more as a consequence, an inherent functional outcome of how this BWI system works. The US, they argue, seems willing to accept this deficit even if it means, say, a drag on manufacturing jobs or slower income growth in some areas. Why? What's the payoff for the US? The payoff is that the US has this unique, incredibly valuable advantage. It can create and supply the world with these safe, desirable, dollarenominated assets on a scale no one else can match because the dollar is the global currency and US markets are so deep. Exactly. The deficit in this DFG view is almost like the price the US pays or the service fee it earns for being the indispensable center of this global monetary system. It provides the safe assets the periphery needs to hold its wealth. Okay, that is a fascinating reframing. So the US is the center, the big buyer running the deficit, providing the safe assets. Who are the periphery countries in this setup? What's their part in the deal? The key players in the periphery as described in the sources are mainly in developing Asia. This group really solidified over the decades leading up to the 2008 crisis. We're talking China Korea. Yeah. China, Korea, Taiwan, Singapore, sometimes called the four Asian traders in older analyses. India is also discussed as maybe a later joiner, although its path has been maybe a bit different, less consistent than China's role. And the core economic strategy for these periphery countries, what are they trying to achieve? Their absolute focus is export-led growth. They build industries specifically to produce goods for export. Really leveraging their large labor forces. And a lot of those exports head straight for the US market. A huge chunk. Yeah. That large open US market is critical. This export engine fuels their domestic job creation and overall economic development. How do they make sure that strategy works so well? Keeps their exports competitive. A critical piece is their exchange rate policy. They maintain fixed or very closely managed exchange rates. Essentially pegging their currency or managing it tightly against the US dollar. Why the peg? Well, the main goal is to keep their exports priced competitively in global markets, especially the US market, which operates in dollars. It stops their own currencies from appreciating too quickly, which could make their goods too expensive for foreign buyers. And if you're exporting way more than you're importing, especially to the US, and you're keeping your currency from rising, Yeah. you end up piling up dollars. Exactly. The natural result is they accumulate these absolutely vast, ever growing stashes of foreign exchange reserves and overwhelmingly these reserves are US dollars. They earn dollars selling stuff and instead of selling those dollars on the open market, which would push their currency up, their central banks buy them and hold them as reserves, right? So they have mountains of dollars from exports. What do they do with all those dollars in this sort of symbiotic loop? Where does the money go? They invest it. They have to put those reserves somewhere. And where do they primarily put them? Right back into the US. Mostly into US securities, especially US Treasury bonds considered the safest liquid assets globally. Why? What are the reasons given in the sources? Just to earn interest. Well, initially earning some yield, some interest was probably part of the thinking. But you know later sources especially looking at the post208 period when US rates were near zero really question how important that financial return motive actually was compared to other factors. Okay, so if it's not primarily about chasing high returns, especially later on, why funnel trillions back into US assets? There are a few reasons suggested. One idea is that channeling these massive funds into the sophisticated US financial system, allows the US to potentially reinvest that capital more efficiently back into developing countries, maybe through private channels like FDI, better than those emerging markets could do themselves with their less developed financial systems, like a global capital recycling program with the US as the main hub. Sort of. Yeah. But maybe the most powerful reason, according to the DFG thesis, is tied directly to just how much dollar debt they hold. The sheer scale matters hugely because these periphery countries end up holding such enormous stocks of US dollar assets particularly US government debt. They develop a very strong vested interest in making sure the dollar stays stable and valuable and maintains its global role. Ah because if the dollar crashed their national wealth stored in those reserves would evaporate. Exactly. A big drop in the dollar's value would be a devastating loss for them. So their massive holdings effectively make them stakeholders giving them a powerful incentive to keep the system going to keep supporting the dollar. So holding reserves becomes a strategic imperative almost regardless of the immediate financial return. Now there's this connection the sources make between reserve accumulation and foreign direct investment FDI and it sounds well counterintuitive. Yes, this is probably one of the most surprising and central claims in the DFG thesis and it really flips standard economic thinking on its head. They argue that this buildup of official reserves by emerging market governments, the central bank holding foreign assets actually serves as a kind of deacto protection or collateral for foreign private investors. You know, the companies making FDI, building factories and those emerging markets. Wait, how does the government sending money out as reserves encourage private companies to bring money in as investment? That seems backwards. Unpack that for us. Okay, let's try. Yeah. Imagine you're a big US or European company thinking about building a plant in say China or Vietnam. You're putting a lot of your capital at risk in a different country, different legal system, different political environment. There was always some risk, political instability. Maybe the government could seize your assets or just act unfairly towards foreign firms. Right? The political risk factor. So the DFG argument goes like this. By holding huge amounts of dollar reserves safely parked abroad, say in US treasuries, the emerging market government is essentially creating a buffer. Or maybe more bluntly, it's creating a kind of hostage asset. A hostage asset. How so? Think about it. If a major geopolitical crisis erupted or if the emerging market government started treating foreign investors really badly, those massive dollar reserves sitting in New York or London would be an obvious easy target. The US or other Western governments could freeze or even seize those assets. Okay. So, by having this significant chunk of national wealth outside its direct physical control, the emerging market government is implicitly signaling that it has a lot to lose if it misbehaves towards foreign capital. The potential cost of losing access to those reserves makes drastic actions against foreign investors less likely. And that reassures the private foreign investors, makes them feel safer putting their money into the country. That's the idea. It acts as a form of implicit collateral, lowering the perceived risk for FDI. So paradoxically, the net capital outflow from the periphery country sending reserves out is crucial for enabling the gross capital inflow private FDI coming in that they want for development. Exactly. And this whole phenomenon, capital flowing uphill on a net basis for decades from poorer developing countries lending to the richer US is something the sources highlight as a major empirical fact. It contradicts the standard textbook models where capital is supposed to flow downhill from rich countries with lots of capital to poor countries where capital is scarce and should earn higher returns. Wow, that really does turn the conventional wisdom inside out. It makes lending vast sums to the rich US seem like a necessary strategic part of the periphery's development plan. And what about the effect back in the US? All this demand for US bonds from the periphery. What does that do to the US economy? Well, the massive ongoing demand for US securities, particularly safe assets like treasuries, from these surplus countries, pushes down long-term interest rates in the US. Rates are lower than they probably would be otherwise. Cheaper borrowing for the US government and maybe for businesses and consumers, too, right? And those lower borrowing costs can then fuel activity in the US. The sources specifically note how before the 2008 crisis, these low rates likely helped fuel the big runup in US private debt, especially mortgages and consumer debt. That borrowing helped US consumers buy all the imports coming from the periphery. And after 2008, after 2008 when the government stepped in with massive fiscal stimulus, those low rates helped make financing the resulting large increase in US public debt much more manageable. Okay, that gives us a really detailed picture of the Brentonwood cis theory, the players, the US deficit, the peripheries reserves, this strange uphill capital flow, the impact on interest rates. But systems like this don't just spring up fully formed. To really get BWI, we probably need to look back a bit, right, at the history of monetary systems in the 20th century. See how it compares, where it came from. Absolutely. Looking back gives crucial context. The 20th century saw these major attempts to create frameworks for international money and they had echoes of this center periphery structure like the gold standard way back when, right? The classical gold standard running roughly from about 1880 until it crumbled in the early 1930s. The key feature was fixed exchange rates. Each currency was pegged to a specific amount of gold and the British pound was the anchor then. De facto. Yes. Given the British Empire's dominance and London's financial clout, central banks were supposed to manage their interest rates to keep their currency convertible to gold at that fixed rate. Theoretically, gold flowing between countries would balance trade deficits and surpluses. Did it work for trade and investment? For a time, especially before World War I, it worked remarkably well. Stable exchange rates reduced risk, so trade and international investment flourished. There was a lot of confidence, but it didn't last. No, it was too rigid. It couldn't handle the shocks of World War I and then the Great Depression. Countries eventually abandoned gold to try and manage their own collapsing economies, leading to currency wars, protectionism, a real mess. It showed the tension between fixed rates, external stability, and domestic goals like fighting unemployment. And it left a scar, right? A fear of inflation. Definitely. The hyperinflation some countries saw in the 1920s left policy makers deeply wary of losing control over money that influenced later systems. Okay. Fast forward past World War II and we get the original Bretonwoods agreement. Exactly. Designed in 1944, fully operational later. This was a more managed fixed rate system. Currencies were pegged to the US dollar with some flexibility adjustable pegs. And crucially, the US dollar itself was pegged to gold at $35 an ounce. The dollar was the official anchor this time. Yes. The system aimed to rebuild trade, provide stability, avoid the chaos of the 1930s, and it presided over a period of strong growth, the post-war boom. But like the gold standard, it eventually collapsed, too. Why did Bretton Woods fall apart in the early '7s? A few things came together. Rising US inflation, partly from spending on the Vietnam War and social programs, made the dollar look less good as gold at that fixed price. Plus, the US started running trade deficits. Right? The famous Kriffin dilemma. The world needed US dollars for trade and reserves, but the US supplying them eventually undermined confidence in the dollar's gold backing. And crucially, capital markets were opening up, making it harder for governments to control money flows and defend their fixed exchange rates against speculation. and Germany played a key role in the final act. Yes, the sources highlight Germany. The German Bundes Bank was fiercely anti-inflation. As US inflation rose, keeping the Deutsch mark pegged to the inflating dollar became difficult and imported inflation into Germany. So, money started flowing into the mark massively. In early 1971, speculators bet the mark would have to revalue upwards. Germany, fearing the inflationary impact of printing marks to buy all those dollars, eventually let the mark float. And that was the beginning of the end. Pretty much other countries faced similar pressures. Then in August 71, the US under Nixon made the decisive move. Close the gold window. No more converting dollars to gold for central banks and slapped on an import searchcharge that effectively killed the Bretonsey system. So what happened immediately after the 70s and early 80s? Was that instantly BWI? No, not at all. That was a messy transitional period. Lots of attempts to create a new formal system failed. Mostly major currencies moved to floating rates, but regional blocks emerged too, seeking stability. The big one was the European monetary system, the EMS, centered around the German more. Yes, you could see the EMS as a kind of mini Breton Woods for Europe. It worked because Germany's Bundes Bank was so credibly committed to low inflation, providing a solid anchor for the other currencies pegged to it. countries basically imported Germany's anti-inflation discipline and Japan had an interesting maybe cautionary experience then too with the yen appreciating after BWI yeah McKinnon's analysis cited in the sources is really relevant here after the dollar link broke the yen appreciated strongly this put huge deflationary pressure on Japan's economy leading to this conflicted virtual idea right as the yen rose people expected it to rise further so they sold dollars the bank of Japan felt it had to intervene buying tons of dollars to slow the yen's rise and protect exporters. This meant piling up dollar reserves, a bit like the later BWI periphery, but it had consequences for Japan, big ones. McKinnon argues this intervention forced Japan into a situation where its domestic interest rates were effectively negative in real terms because everyone expected the yen to keep rising. He thinks this contributed to Japan's later struggles with deflation and the zero interest rate trap. Also, interestingly, Japan kept running trade surpluses despite the strong yen, suggesting exchange rates aren't the only factor driving trade. Okay, so we have these historical systems, gold standard, BWI, and the messy transition. How does the Brenton Woods theory specifically compare? What's similar? What's fundamentally new or different? Well, BWI, as described, definitely echoes some structures. You still have a dominant center country, the US, whose currency is the main global reserve currency, the dollar. That's like the pound and the gold standard or the dollar in BWI and the periphery pegs its currency. Many periphery countries in BWI use fixed or managed pegs to the dollar similar to the adjustable pegs in BWI or the EMS. So this idea of a hierarchy and an anchor currency keeps reappearing. But there are big differences that make BWI unique. Absolutely. The biggest one stressed in the sources is that BWI is informal. It's de facto. It's not based on any treaty, any conference, any signed agreement like Bretton Woods. I was it just emerged. It's described as emerging more organically from the converging interests and strategies of the US and especially those Asian export-led economies. This informality probably makes it different in terms of stability and how it adjusts compared to a rule-based system. And that specific dynamic we talked about the periphery piling up massive dollar reserves from exports and reinvesting them back in the US partly as this implicit collateral for FDI. That huge scale uphill capital flow is really a defining characteristic of BWI. It wasn't the same in earlier systems. In BWI, surplus countries accumulated dollars, sure, but not on this scale or with this specific strategic rationale of self- insurance and FDI collateral that the DFG thesis emphasizes for BWI. That informal nature feels key. Its survival depends on shared incentives staying aligned rather than legal rules. Okay, let's shift to the debates around BWI. A really common argument, especially in politics, is that the big US trade deficit, particularly with China, is basically China's fault currency manipulation, unfair advantage. How do the BWI sources tackle that narrative? This is where the DFG analysis really pushes back hard. The BWI theory fundamentally says the US deficit isn't just a bilateral issue with one country. It's a structural outcome of the whole system. the periphery's collective export-led strategy and reserve accumulation meeting the US's collective role as the consumer and safe asset provider. So it's not just China gaming the system in this view. According to this perspective, no blaming the entire US current account deficit solely on China misses the bigger global picture. The trade data in the sources back this up. Look at 2006 data for instance. What does it show? Sure, the US had big bilateral deficits with China and Korea, but it also had huge deficits with Japan, Mexico, Europe, many others. The overall US deficit was global. Okay. And here's a kicker. The sources point out that the four Asian traders block China, Korea, Taiwan, Singapore. When you look at their total trade balance with the whole world in 2006, they actually ran a small overall trade deficit, not a surplus. Really? How does that work? It means while they had a big surplus with the US, they must have run deficits with other regions, maybe importing commodities or components. So the financing they provided the world through reserves might have been offsetting US deficits with other places like Europe, not just funding their own surplus with the US. That definitely complicates the simple blame China story. What about the currency peg itself? Is it just a tool to keep the currency undervalued constantly like critics say? The sources suggest it's more complex than that, too. Yes, a managed rate helps competitiveness, but they note the real exchange rate between the US and China was surprisingly stable for like two decades leading up to the period study, meaning it wasn't constantly getting cheaper relative to the dollar in real terms, right? If the only goal was continuous mercantilist gain through further undervaluation, you might expect a clearer trend of real depreciation. its stability while maybe still leaving the currency undervalued overall suggests the peg wasn't solely about constantly tweaking for more advantage. Okay, so if it's not just about trade surpluses or constant undervaluation, why do emerging markets like China peg their currencies so tightly? What are the main reasons given? The sources point to a mix of factors, strategic, macroeconomic, even domestic development reasons. One big one highlighted by McKinnon is providing a nominal anchor for domestic prices. pegging to the relatively stable dollar help them control their own inflation. Imported stability makes sense. Second, pretty obviously for exporters, it eliminates currency risk. Predictability is huge if you're running an export business. Sure. Third, the sources argue the massive dollar reserve accumulation is partly just an unavoidable consequence. These Asian countries have incredibly high savings rates compared to the US. High savings tend to generate current account surpluses and those surpluses need investing somewhere. Exactly. And since the dollar is the main international currency, those surpluses naturally end up in dollars and get invested in dollar assets because that's the biggest most liquid market. And for China specifically, there was another dimension related to its internal development. Yes. The sources suggest China's exchange rate policy, keeping it arguably undervalued, also acted like a kind of control valve for managing its huge internal transformation. How so? By influencing the price of imports and the competitiveness of exports, the government could potentially manage the speed at which millions of people move from rural farms to urban factories, helping maintain social stability during that massive shift. Wow. So importing stability, managing export risk, dealing with high savings and maybe even domestic social engineering. A much richer picture than just currency manipulation, right? But this whole setup, US deficits, foreign debt, periphery holding, low yield reserves, it sounds inherently unstable long term. What were the big sustainability worries about BWI? Absolutely, lots of worries. On the US side, concerns focused on the rising pile of debt. First, the private debt boom before 2008, fueled by low rates. Then, after the crisis, the huge jump in public debt as the government spent to fight the recession, plus looming long-term liabilities like Social Security and Medicare. And just the fact the US became the world's biggest debtor, right? Going from creditor to the biggest net debtor by far with those deficits adding to the pile year after year. Figure two in the sources shows some of those debt trends. Was there an argument that it was sustainable? There was this argument which the sources call kind of pmic maybe more assertion than proof that the US deficit is sustainable precisely because Asian governments have to keep buying dollars. They need to protect their export model and the value of the reserves they already hold. It creates a sort of captive finance loop for the US. But the sources don't fully buy that mustold dollars idea. They bring up Nash equilibrium, right? They counter it using game theory concepts, specifically Nash equilibrium and the difference between collective and individual interests. They use the analogy of the gold pool from the 1960s. How does the gold pool illustrate the risk for BWI? Well, the gold pool was major central banks agreeing to sell gold together to keep the price fixed at $35. It was in their collective interest to maintain stability, but it collapsed. Why? Because individual countries had an incentive to cheat. Exactly. While collectively cooperating was rational, if any one bank thought the pool might fail, its best move was to stop selling its own gold or even start buying, letting others bear the cost. The fear that others might defect created a rush for the exits. It's a classic prisoner's dilemma leading to a bad outcome for everyone. A Nash equilibrium where no one can improve by changing strategy alone given what others are doing, but the result is collectively worse. and the analogy to BWI and dollar reserves. It's the same logic. It might be in the collective interest of all periphery countries to keep holding dollars to avoid a crash. But if any one country fears others might start diversifying out of dollars, its individual incentivist to quietly start selling first to protect itself. That very fear could trigger the run they all want to avoid. It makes the they must hold dollars forever argument look shaky. There's an inherent fragility. Yeah, it's much clearer. The fear of others defecting becomes self-fulfilling. And the fact BWI is informal, no written rules, does that add to the potential instability? The sources suggest it does. Without a formal treaty, clear rules, adjustment mechanisms, the system relies more on national interests staying aligned. If a major player changes course, there's no agreed process to manage the fallout. That could make it more vulnerable than a system with explicit commitments. Although, as we'll see, its performance in 2008 was quite surprising. Speaking of surprising, the sources mention this puzzle about the US external accounts. Despite being the world's biggest net debtor, the US historically earned positive net income on its investments. How is that even possible? A debtor should pay out more than it receives. It is really counterintuitive and a super important piece of the US position. Logically, yeah, you'd expect the US to pay out more interest in dividends than it receives. But for a long time, the opposite was true. The sources explained this puzzle with two main factors giving the US a unique edge. Okay, what's the first one? First, an income yield advantage. Basically, US assets held abroad, especially FDI, like US company's overseas operations historically earned a much higher rate of return than foreign assets held in the US, like foreign holdings of low yield treasury bonds or even FDI into the US. The stuff the US owned abroad was just more profitable on average. So higher quality investments abroad compared to what foreigners held in the US in terms of yield. Yes. Second, there are big valuation effects. These are changes in the dollar value of assets and liabilities due to shifts in exchange rates or asset prices. How do those help the US? Because US assets abroad are often in foreign currencies. While foreign assets in the US are mostly in dollars, currency swings have an asymmetric effect. If the dollar weakens, the dollar value of US foreign assets goes up. If the dollar strengthens, the value of US foreign assets might shawl in dollar terms, but the value of foreign dollar holdings in the US doesn't change much. Also, differences in asset types, stocks versus bonds, and their price movements matter. Historically, these effects often boosted the net value of US foreign holdings. So, even though the US owes more in total value, the assets it owns abroad earn more and tend to increase more in value than its debts cost it. like having smaller high-erforming assets outperform larger low-yielding debts. That's a good way to put it. This combined advantage, higher yield on assets abroad plus favorable valuation effects is often called the US's exorbitant privilege. A term from the BWI era, but some sources argue it actually got bigger after BWI collapsed as global finance grew. It's a huge economic benefit from the dollar's role and US financial structure. That exorbitant privilege certainly sounds like a strong reason for the US to stick with a system like this, deficits and all. And the sources talk about US revealed preference, suggesting the US implicitly accepted BWI. Yes, another core argument. If you look at the result, big deficits, shifts in the US economy away from manufacturing and assume these are partly consequences of BWI. The question is why did the US let it run for so long? The revealed preference argument looks at policy actions or lack thereof. What actions or lack of actions? They point to the fact that despite lots of complaining and political rhetoric, there was a relative lack of really harsh sustained protectionist measures against countries like China. Also, successive US administrations consistently chose not to officially label major trading partners as currency manipulators, which would trigger formal consequences even when exchange rates were hot issues. So, the lack of strong action suggests acceptance. That's the argument. It suggests that the policymakers, those calling the shots, implicitly accepted the BWI framework. Maybe the benefits like cheap imports for consumers, low financing costs for the government, benefits to the financial sector were seen as outweighing the costs to manufacturing jobs in their overall calculation. The US was willing in effect to let its labor market adjust to accommodate Asia's export-driven industrialization. So the argument is if it was fundamentally bad for the US overall from the policymakers view, we'd have seen much more drastic push back over the decades. The fact we didn't suggest the kind of tacid approval revealing their true preferences, it makes it a political economy story, not just pure economics. Exactly. It involves domestic trade-offs that US leadership navigated in a specific way. Okay. So this complex system, deficits, reserves, pegs, privileges, informal rules, underlying tensions, it sounds like it maybe balanced on a precarious edge leading up to the late 2000s. Lots of people predicted a crisis linked to these imbalances. How did BWI actually hold up during the ultimate stress test, the 2008 global financial crisis? Did it finally break like so many expected? This is where the DWI proponents argue their framework shared surprising strength before and during the early stages of the 2008 crisis. Yeah. The calming view is that this system of global imbalances, the US borrowing unsustainably from Asia was about to implode. The standard prediction involved a sudden stop of capital flowing into the US. What would that sudden stop have looked like? What was the predicted scenario? The fear was that foreign investors, especially those periphery governments holding trillions of dollars, would panic and stop buying US assets. maybe even dump what they had, cutting off the financing for the US deficit, right? That would kill demand for US treasuries and other bonds, forcing US interest rates, especially safe treasury yields, to spike upwards as the US government scrambled to find buyers and capital would flee the US. That was the prediction. Money would rush out of the risky US and into supposedly safer havens like the Euro zone, pushing interest rates down there. The dollar was expected to crash as demand evaporated and US asset prices expected to tumble while prices elsewhere might initially rise. This whole violent shift, spiking US rates, crashing dollar, capital flight was supposed to force a rapid, brutal correction of the US deficit, making imports unaffordable and forcing Americans to save drastically. Okay, so the prediction was basically a sudden chaotic dollar crisis forcing a painful rebalancing. What actually happened when the crisis hit full force in late 2008? According to these sources, this is the core point. The sources state that those predictions were largely wrong. What happened was in key ways the opposite of the predicted BWI collapse. Okay. First, no sudden stop of capital inflows. Foreigners did not flee US assets on mass. In fact, both private investors and foreign central banks kept buying US assets, especially treasuries, right through the panic. Why in the middle of a US- centered crisis? Because in a global meltdown, US treasuries were still seen as the ultimate safe haven. Investors scrambled for safety above all else, even accepting near zero returns. Okay, what else contradicted the predictions? Second, US interest rates, the risk-free Treasury yields didn't spike. They plummeted relative to the rest of the world. The flight to safety drove Treasury prices up and yields down. And the dollar, did it collapse? Third, nope. The dollar actually strengthened significantly against most other currencies once the crisis really bit after August 2007. The exception was the Japanese yen, another safe haven currency, but the predicted dollar collapse didn't happen. And asset prices fourth, yes, US house prices and stocks crashed. But the sources point out that other countries saw similar or even worse asset price collapses. It was a global contagion, not just a US imbalance story. So instead of a dollar crisis caused by imbalances, the sources say 2008 was fundamentally a failure of private finance, risk management, credit freezing up. Exactly. It was a catastrophic breakdown in the plumbing of the global financial system, a general panic and credit crunch. The BWI structure itself didn't cause this particular crisis. The crisis originated in the failures of private risktaking and intermediation. That's a major reinterpretation. So why then did the BWI system itself persist? Why didn't it collapse under that pressure? The argument is the crisis paradoxically didn't destroy BWI's foundations. Instead, it demonstrated the systems durability and crucially, it reinforced the underlying incentives, especially for the periphery countries. Reinforced the incentives. How? For emerging markets, seeing the global financial system freeze up and private capital vanish just made them more convinced that their strategy was right. Piling up huge foreign reserves felt like essential self- insurance against exactly this kind of global shock. The crisis proved in their eyes that relying on fickle private flows was dangerous. So the need for that reserve cushion became even more critical. Absolutely. It outweighed worries about low returns. And while the private financial plumbing broke temporarily, needing huge government bailouts, the basic structure of the international monetary system described by BWI held, the dollar remained the key reserve currency, even strengthening its safe haven status in the paddic. The euro zone structure also held despite its own internal stresses. Let's look at the data after the crisis. Did the imbalances fundamentally change? The sources show some adjustments, yes, but argue the core structure stayed. Global imbalances shrank overall during the recession, but the relative shares didn't change much. Figure six. The US still accounted for a similar proportion of global deficits. EM Asia for a similar proportion of surpluses, just at lower absolute levels for a while. And did the periphery stop accumulating reserves given the low returns in the crisis? Definitely not. Reserve growth slowed down from the crazy precrisis pace, but it continued. and in many cases picked up steam again after a pause. Figure 15. Figure 16 shows Asian economies actively rebuilding and often expanding their reserves well beyond 2008 levels in the following years. China especially China nearly doubled its reserves in the 5 years after 2008, hitting almost $4 trillion. And they did this even though US interest rates were near zero and their own currency started appreciating again after 2010. That must have been costly. Exactly. And this is critical evidence for the sourc's argument about motivation. They calculate the cost to China of holding those reserves near zero interest plus valuation losses as the ren minb rose against the dollar was huge over 6% per year by 2011. Why accept such cause? The sources say this proves financial return clearly wasn't the main driver. It powerfully supports the idea that strategic motives, self- insurance, export competitiveness, protecting the value of existing reserves were paramount. The crisis just made those strategic reasons seem even more compelling. So the crisis counterintuitively reinforced the BWI logic for the periphery. What about the US role post crisis? Well, the crisis caused a massive global demand shock and froze private credit. So governments, especially the US, had to step in with huge fiscal stimulus and central bank action like QE and zero rates. The government picked up the slack effectively. Yes. Government action replaced some of the collapsed private demand and financial intermediation. This in turn helped keep the periphery's export model viable providing demand. The US government through deficits and low rates essentially kept the cent's role functioning even after the private sector faltered. The core logic held periphery needs demand and safe assets. The US provided both enabled by policy. So far from breaking BWI, the crisis revealed its underlying drivers and maybe even strengthened the incentives, particularly the self- insurance motive, while government action kept the wheels turning. It survived because the core incentives persisted. That's the core argument for its durability presented in these sources. Powerful and maybe controversial, but it fits the postcrisis evidence they present. But no system lasts forever. Even if 2008 didn't kill BWI, what about the future? Could we finally be heading towards a Bretton Woods three? The sources are pretty cautious about predicting radical imminent change. The kind of sudden collapse predicted before 2008 didn't happen, and they don't seem to expect one now. Could the dollar lose its top spot? What about the euro? One source considers the euro as a potential challenger, but calls it quite improbable under current dynamics. Maybe if the global system became much more flexible or if major players like the UK joined the Euro zone which was floated as an idea back then boosting Euro asset markets. Did the Euro zone act like the BWI periphery post crisis? Not really in terms of actively managing the exchange rate down but the sources add a nuance. ECB policy aimed at the whole Euro zone arguably kept the euro undervalued for export powerhouse Germany while being too strong for southern Europe, worsening internal imbalances there. What about an Asian anchor? Could the yen or maybe eventually the yuan become the center of an Asian monetary union replacing the dollar regionally? The sources see that as unlikely anytime soon? They point to huge differences between Asian countries, politics, economics, development levels. It doesn't look like an optimal currency area. no strong regional leader like Germany was for the EMS, right? And probably not enough political will for the deep integration needed. So if DWI did somehow fall apart without a new global anchor, Asia might face a lot of disruptive currency volatility. So shifting the anchor seems hard. Regional alternatives face hurdles. What about this broader Britain woods 3 concept? A truly different system. It gets mentioned speculatively. One source title asks, BW2 is dead. Long live BW3. But the paper concludes BW2 wasn't dead. Another sees a post-dollar standard as possible, but way down the road. How might a BW3 emerge if not through a sudden crash? Maybe through slow, gradual evolution over decades. No big conference needed. Perhaps drawing on old ideas like Kane's banker, a global reserve asset managed internationally. What might it look like structurally? The contrast drawn is with BWI's export-led periphery deficit center dynamic. A potential BW3 might see major regions focusing more on domestic demand-led growth, less reliance on exports and managed currencies. Possibly exchange rates might need to adjust more freely to keep trade more balanced rather than having imbalances financed by these huge strategic capital flows. Internal balance would take priority over external imbalances being financed indefinitely. If China, the main periphery player, eventually shifts its model, does the theory predict a successor? Yes. The original DS thesis speculated that as China matured, absorbed its surplus labor and moved towards the center, another large country, probably India, could step into the periphery role using a similar export-led laborintensive strategy. That was the idea leveraging India's huge young population. How has India's story fit that prediction so far according to the sources? Well, India did show some similar signs before 2008. strong growth, rising reserves, but the crisis seemed to knock it off that track more than China. Growth slowed, reserve accumulation has been less consistent. So, India's role is less certain. It seems less straightforward. Yeah. Although the sources mentioned that the government elected around 2014 still seemed keen on an export-led strategy. So, the potential is there, but its integration into a BWI like role looks slower or more complex than China's was. And beyond money and currencies, any future system faces bigger challenges, right? Absolutely. The sources acknowledge that things like aging populations, climate change, resource constraints, these huge global issues will shape whatever economic system emerges far beyond just monetary arrangements. Okay, let's try and wrap this up. We've really dug into the anatomy of this proposed Bretton Woods 2 system. Yeah. Seeing it not as a formal treaty, but this description. US is the deficit center financed by Asia's export-driven surplus periphery, piling up reserves for strategic reasons. We looked at the history, the gold standard BWI, seeing the similarities, but also the key differences B II's informality, those massive uphill capital flows. We tackled the critiques, used the data to question simple narratives about the US deficit, and explored the complex reasons why emerging markets managed their currencies the way they did. Stability, risk, savings, even domestic development goals, plus that whole exorbitant privilege puzzle and the idea of US revealed preference. And the really striking part, how this system against many predictions weathered the 2008 storm, right? Instead of collapsing, the crisis seemed to highlight its resilience and even reinforce the core incentives, especially that need for self- insurance through reserves with governments stepping in to prop things up. We also looked ahead the difficulties of shifting the anchor currency, the speculative nature of a Bretonwoods 3 maybe evolving towards domestic demand and India's uncertain role as a potential successor periphery. So I guess the key takeaway from digging into these sources into this BWI framework is that the global money system isn't just numbers on a screen. Not at all. It's deeply tied into fundamental national strategies. How countries employ their people, manage savings. It reflects political priorities, stability versus adjustment. And it's this incredibly complex dance between governments, central banks, private capital, crossing borders in sometimes unexpected ways. The Bretton Woods IID idea, whether you like the name or not, really highlights this durable pattern driven by deep domestic and strategic forces. And its resilience through 2008 is pretty remarkable. It really makes you think about how quickly or slowly these fundamental global economic forces actually change. So the final thought for you, the listener, considering this resilience, what does it tell us about the pace of change in the deep structures of the global economy? and how do you navigate a world where these powerful often hidden dynamics keep shaping interest rates, trade, maybe even your job prospects? Definitely a lot to chew on there. Well, thanks for joining us on this deep dive into the intricate world of Bretton Woods. Second, its past, its surprising persistence. Thank you. We hope exploring these sources gave you a clearer view of this important, if complex, idea about how our global monetary system has arguably been working. We'll be back soon to dive into another stack of sources on a different topic. Until then, keep asking questions, keep exploring.