What will Bretton Woods 3.0 look like?

Nigel, a loyal MR reader, asks me:

Is it possible for the US to abuse the dollar’s privileged position, and do you expect a monetary conference to take place in the future that would alter the post-Bretton Woods arrangement in ways less favorable to the US?

A good question, but at current margins I don’t see many directions for movement.  I don’t know whether such a monetary conference will take place, but it is unlikely to be a decisive event for shaping actual outcomes.  I see these as the relevant questions:

1. Will China move to a true “free float”?  And if so, what is the collateral damage along the way?

2. Will some countries leave the eurozone? (and if they do, it is a big deal for them, but probably not a big deal for the global monetary order, unless it is Italy or France)

3. Will more countries attach to the euro (Iceland?) or to the U.S. dollar (additional parts of Latin America?)

4. How many additional countries will institute capital controls?

For the most part, those questions will be decided at the national level, although for potential euro leavers the nature of the proposed EU alternative (another bailout?) will be significant.

The most likely outcome is that more countries will institute partial capital controls, and in that regard we will move closer to some aspects of the initial Bretton Woods 1.0, in which capital controls were an integral feature.  Capital controls may come to keep a euro peg (already happened in Cyprus), to try to keep domestic jobs (ha, but recall Trump and Carrier), to prevent an imminent explosive capital outflow (China), to strengthen or preserve a banking system, to limit wild currency swings, or simply because governments will try all kinds of policies before admitting they have failed.  Other forms of “capital controls” may come through tax reforms and regulatory barriers designed to keep capital at home.

My best guess on China is that capital outflow pressures eventually will force a free float, but only briefly, and then they will return to capital controls in some form.

So my forecast for the future is much more in the way of capital controls, but without the hegemonic/cooperative international architecture that characterized Bretton Woods 1.0.


Worth considering what an international tax reform plan might look like for capital controls. You could imagine some reaction against "Panama Papers"-style tax havens, or an effort to put Piketty's Global Wealth Tax into action necessitating some alignment of global tax regimes that might only be workable in the real world as capital controls.

How come none of the Trumpsters mention disallowing foreign direct investment in USA?

That would be an interesting variant on Bretton Woods 3.0.

My expectation is that disallowing foreign direct investment (FDI) would decrease the trade deficit, and make us somewhat poorer, but we would have to do much of the production that happens overseas.

This also would remove many potential treasury bill buyers, and steer us towards a balanced budget. In short, it would achieve the majority of what Trump campaigned on. Of course congress republicans have had about 16 years to convince us that they don't really care about trade and budget deficits, so I am not holding my breath.

I am just sad that we are just barely better than Greece in fiscal discipline.


* (Why would disallowing FDI greatly reduce the trade deficit?)
Because FDI is the mechanism by which the USA domestic stock of money gets replenished following imbalance between imports and exports.




Anybody remotely interested can see from graphs above that around 1980, the US trade balance went very negative, and FDI started increasing. Is there some conspiracy about not ever mentioning this, in case Trump might hear it, and understand it would help reaching his stated goals?

'How come none of the Trumpsters mention disallowing foreign direct investment in USA?'

Because none of them, for all their manifold faults, are that incompetent?

'My expectation is that disallowing foreign direct investment (FDI) would decrease the trade deficit'


'and make us somewhat poorer'


'but we would have to do much of the production that happens overseas'

Ah, so you don't realize that when Toyota or Mercedes builds a plant in the U.S., that produces vehicles mainly for the North American market, this means that the production is in the U.S., and is not production occurring overseas. Maybe this link would be helpful to read - http://www.investopedia.com/terms/f/fdi.asp It has nothing to do with 'potential treasury bill buyers.'

I was wrong about the FDI definition, which is narrow, arbitrary and thus useless. If 9% ownership is not FDI, but 10% is, then the measure is quite flawed.

The big point is, is it to America's advantage with regulation that forces it to be more like Germany than like Greece?

Of course regulation that limits who can buy American items with yield is an example of capital controls, but much less repressive than the third world type designed to keep capital from fleeing following bad government decisions, rather this is regulation encouraging investment rather than consumption.

Where do you propose drawing the line?

Yeah, looks like you're confusing FDI with portfolio flows. And restricting portfolio flows is capital controls.

FDI finances current account imbalances, but by selling equity in US firms, not bonds. There are countries that restrict FDI, but that just means that anyone who wants to invest there has to do so with a local national that owns a certain percentage of the enterprise. Generally, that's a way of protecting the local crony capitalists from competition under the guise of keeping things local. Can't imagine why anyone would want to do that in the US.

This is a bit confusing. If using the economics definition of investment, then only creation of new capital would be an investment.

How would a restriction on who can own housing, factories, stocks and bonds protect crony capitalists? We would still be able to import products if the domestic producers price gauged, we would just have to be more selective about what to import.

What if all rental housing was owned by foreign residents, would the long term effect on GDP be good, bad or neutral?

We are a 241 year old country with sufficient domestic capital, if making a business analogy, should we compare yourself to GM, which does not need an IPO, or a small startup with a good idea?

Tangentially, I've always wondered: how can economists treat money as being mostly neutral while simultaneously discussing the effects of raising and lowering exchange rates on international trade?

And while I do hear of many economists treating money as being non-neutral, it's usually in the context of recessions and depressions. What if two nations with perfectly functioning economies at full employment take measures to modify their exchange rate? How would it have any effect?

Maybe importers and exporters are more price sensitive organizations?

Attach to every sentence of that kind "... in the long run" and you will have your answer.

Whenever I hear of a new Bretton Woods I think of those wacky Lyndon LaRouche people.

Define "abuse" (of the dollar's position). Seems like either a meaningless phrase, or something the US has been doing for some time now. Is there going to be "a monetary conference" that will "alter the post-Bretton Woods arrangement in ways less favorable to the US?" Yes there is, eventually. (Assuming the US share of the world economy continues to shrink, as it almost certainly will.) (Although, I can imagine some scenarios in which the US share increases, I don't find them likely - of course black swans aren't...) (On the other hand, perhaps the US'll go down the road to world (military) domination. There's still time - there always is. Of course, without a better birth rate, we'll probably need to hire a mostly mercenary military. Thank God for drones, a.i, and robots!)

Abuse = option b

Here is Cowen's Bloomberg colleague Noah Smith on foreign direct investment in the US: https://www.bloomberg.com/view/articles/2017-04-19/america-needs-more-foreign-investment The subject of capital flows reminds me of the metaphor that water seeks its own level. Capital seeks the highest rate of return. Here, there, and most everywhere. But I'm also reminded of the law of unintended consequences. For example, China's extraordinarily high savings rate deflates returns, inducing investors to make extraordinarily bad investments that promise impossible returns. https://www.nytimes.com/2017/04/19/business/china-minsheng-shadow-banking.html?ref=business Another example, the bull market in the US amplifies the returns of index funds, inducing otherwise very smart and sophisticated people to place all of their bets on index funds and the impossible promise of a perpetual bull market. https://www.nytimes.com/2017/04/19/business/dealbook/blackrock-earnings-rise-on-tide-of-etfs-and-index-funds.html?ref=business All of which highlights the human capacity to believe tomorrow will be just like today, only more so. No it won't. Cowen isn't the boy who cried wolf.

What is more likely are capital controls and requirements of having local partners which makes it difficult to leave or repatriate profits outside of the country.

It was mentioned on Bloomberg this morning that Breton Woods was never an international system. It was pretty much limited to the U.S. and western Europe. So the question is can you create a system like that to a larger scale?

Not if you don't let China and other rapidly growing countries get more of a say.

Which did not happen. And hence the system you suggest almost certainly not happen.

Was the original Bretten Woods all that favorable to the US? Didn't it deliberately set the dollar too high to aid European and Japanese recoveries as a key part of Cold War strategy?

You have to start with the given that money is neutral (long term and short) and that Baxter & Stockman showed in their 1989 paper that large swings in nominal variables in Fx markets have no real effect. Working backwards from that, it follows that a fixed exchange rate (a true Bretton Woods) anchored by a gold standard would not be the end of the world, indeed it might be a welcome change of pace from the extreme volatility of today.

In short, "Friedman was wrong about floating rates being a panacea".

Thanks for taking my question, Tyler!

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