The view from Bretton Woods

From the back porch of the turn-of-the- (last) century Mt. Washington Hotel in Bretton Woods, New Hampshire, the view this past two days has been spectacular, with the sun glistening off the snow that still covers the mountain and runs in neat rivulets down the seams between them. The hotel is the fabled location of ...

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From the back porch of the turn-of-the- (last) century Mt. Washington Hotel in Bretton Woods, New Hampshire, the view this past two days has been spectacular, with the sun glistening off the snow that still covers the mountain and runs in neat rivulets down the seams between them.

The hotel is the fabled location of that fabled three weeks in the summer of 1944 when fabled characters like Great Britain's great economist John Maynard Keynes, U.S. Treasury Secretary Henry Morgenthau, his chief deputy Harry Dexter White, and the financial leaders of non-Axis wartime world concluded the agreements that established the fabled post war Bretton Woods financial system and its governing institutions, the International Monetary Fund (IMF) and the World Bank.

From the back porch of the turn-of-the- (last) century Mt. Washington Hotel in Bretton Woods, New Hampshire, the view this past two days has been spectacular, with the sun glistening off the snow that still covers the mountain and runs in neat rivulets down the seams between them.

The hotel is the fabled location of that fabled three weeks in the summer of 1944 when fabled characters like Great Britain’s great economist John Maynard Keynes, U.S. Treasury Secretary Henry Morgenthau, his chief deputy Harry Dexter White, and the financial leaders of non-Axis wartime world concluded the agreements that established the fabled post war Bretton Woods financial system and its governing institutions, the International Monetary Fund (IMF) and the World Bank.

Although it collapsed after less than a quarter century, the unprecedented increase in global prosperity during that period has caused it to be known ever afterward as the Golden Age and earned the Bretton Woods system a place in the pantheon of economic mythology.

It was in search of a rebirth of that kind of success that the George Soros funded Institute for New Economic Thinking (INET) brought 400 or the world’s leading economists, commentators, and policy makers back to Bretton Woods this weekend to develop, well, new thinking about how to foster future prosperity while avoiding crises. Ironically, however, the discussion so far has seemed to be more about old thinking than about new ideas.

For instance, here was last night’s dinner keynote speaker and long time advocate of financial deregulation Larry Summers invoking Hyman Minsky whose name in recent years had almost been erased from economic memory because of his belief that crises are an inherent part of financial markets which therefore must be strictly regulated. Even more uncharacteristically, Summers acknowledged to Financial Times economics columnist Martin Wolf that to some extent economists had recently managed to forget much of what they used to know.

Here too, was former Council of Economic Advisers and super-mathematical economist Ken Rogoff agreeing (a bit reluctantly it must be said) that there are things in economics that can’t be modeled. Even more telling were Rogoff’s references to the importance of the thinking of political economist and historian Charles Kindleberger whose books, once required reading, have vanished from the modern, mathematically oriented economics curriculum. In a significant aside, Rogoff noted that his students don’t consider Rogoff’s recent book on the history of recovery from economic crises to be a legitimate research effort because it is history rather than mathematics.

Perhaps more than any other, it has been the name Keynes that has been most frequently invoked, as he seems to loom over the halls and meeting rooms of the old hotel. In retrospect, today’s discussants seemed to think that his concerns about the crisis prone nature of markets, the need for government spending to offset deflation, the importance of regulating financial markets were more, and the need for a commodity backed global currency were more modern than the theories of rational expectations, perfectly efficient markets, and a dollar based floating currency system that were in vogue just prior to and that were a significant cause of the recent Great Recession.

Indeed, more than once, I have been reminded of New York Yankees catcher and everyman philosopher Yogi Berra’s famous dictum that "it was déjà vu all over again."

A few new things, or not well recognized old things, have stood out in the discussions so far. One has been the notion, voiced by Nomura Research top economist Richard Koo, that the recent economic crisis has been and is a balance sheet recession. In other words, households and corporations had accumulated  too much debt, and will now use cash flow to pay the debt down. This means that low interest rates and other inducements for consumption and investment won’t stimulate the economy because all extra money will be used by the private sector to pay down debt. In this situation, the only way to maintain even zero GDP growth is for the government to spend. Thus, the current U.S. fixation on reducing government debt is exactly wrong until such time as the household and corporate balance sheets are repaired.

A second point has been the New New Trade Theory. Old trade theory argued that trade flows are determined by resource endowment and specialization by countries on producing those things they do relatively better than other countries. The trouble with this was that by the 1980s this thinking could not explain the vast majority of trade flows. New Trade Theory noticed that while old trade theory assumed the absence of economies of scale, in fact, most trade involved industries in which economies of scale were very important. It then introduced economies of scale as another explanation for the location of production  and particularly for the fact of extensive trade in the same kinds of goods (autos e.g.) between developed countries.

New New Trade Theory notes that a very large portion of global trade is actually trade that takes place within the firm and that this trade involves outsourcing and offshoring in the context of a supply chain that slices production up into parcels of expertise. So for example, Volkswagen will make an auto engine in Germany, ship that to the Czech Republic for assembly into an auto that is then shipped back to Germany for sale. So Germany exports the engine and then reimports it in the car. These trade flows are determined by considerations of corporate organization rather than by strict economies of scale or resource endowment.

A third point has been the notion that because of shrinking populations in most of the world, immigration will become essential to maintaining economic growth. Thus, whereas there is presently resistance in many countries to immigration and particularly to immigration of unskilled workers, in the future, countries will compete aggressively to attract not only skilled immigrants, but the unskilled as well.

Finally, and most disturbingly, as a result of the Great Recession, the world’s major banks have become bigger and more powerful. Because they are now deemed "too big to fail", they have essentially taken the global economy hostage and are driving governments to continue to subsidize them at the expense of everyone else. This problem will not be solved without another bigger crisis than the one we have just been through.

So that is where "new thinking" has gotten us so far. But,hey, the old view is still great.

Clyde Prestowitz is the founder and president of the Economic Strategy Institute, a former counselor to the secretary of commerce in the Reagan administration, and the author of The World Turned Upside Down: America, China, and the Struggle for Global Leadership. Twitter: @clydeprestowitz

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