Bretton Woods II lives on, packing pain for western workers

LONDON (Reuters) - Pressure on western workers from the integration of China and other emerging giants into the world economy shows no sign of abating and that protracted shock will also keep borrowing rates subdued for years to come.

Employees work at a production line in a factory of the Chinese brand Gree, in Manaus June 24, 2014. Picture taken June 24, 2014. REUTERS/Jianan Yu

That’s the conclusion of three economists who a decade ago characterized the reshaped global economy of the new millennium as ‘Bretton Woods II’ - a monetary system aping the fixed exchange rate regime after World War Two.

In reviewing their oft-cited research from 2003, Deutsche Bank economists David Folkerts-Landau and Peter Garber and Cabezon Capital’s Michael Dooley last month reckoned that this mutually reinforcing regime of currency pegging and hard currency stockpiling had much further to run.

Still-powerful driving forces behind the system, they insist, are the industrialization of the remaining tens of millions of poor, under-productive agricultural workers in China and then another phase - perhaps just starting - when India adopts a similar model of mass employment in manufacturing and exports.

If they’re correct, the prospect of a ‘secular stagnation’ of the rich world over the next decade looms ever larger: workers’ incomes will continue to be clipped by the greater access of multi-national corporations to these new and cheaper pools of labor overseas.

While that’s likely to intensify simmering tension between western wage earners, capital and asset holders, it will also act as yet another lead weight on inflation. Combined with the recycling of emerging market savings sustaining the framework, long-term borrowing rates will remain depressed for far longer.

While the political stress may build, the economists reckon another wave of cheap industrial labor can just about be managed as China quickly graduates into a core rather than periphery world economy and helps balance a subsequent ‘India phase’.

“The 2008 financial crisis was the end neither of the international financial system known as Bretton Woods II, nor even of its China phase,” the authors concluded in their report.

“The old industrial center has seen its manufacturing and white collar clerical labor force displaced, and one might think it cannot stand yet another cheap labor giant like India pushing in,” they added. “But now that China will be in the center, the center’s capacity for absorption of another massive labor force will be a multiple larger.”

The election of Bharatiya Janata Party leader Narendra Modi as Indian Prime Minister in May on a platform of export-led development and labor-intensive industrial growth sets India on a similar path to China, they wrote, prolonging the life of the Bretton Woods II structure.


The sub par recovery of the rich world from the credit shock, ‘Great Recession’ and euro crisis of the past seven years has left households uncertain, unequal and unnerved.

For governments, central banks and investors, the headline rebound has barely masked the legacy of high unemployment, spare capacity and a persistent threat of deflation.

With high debts, slack demand, low inflation and near-zero interest rates, theories abound on everything from a ‘new normal’ or ‘secular stagnation’ for years to come. Looming pressures from ageing and retiring baby-boomers only add to the gloom.

Yet the attraction of the Bretton Woods II idea is that it straddles both pre- and post-credit crash periods and draws a link between the rise of China after the collapse of communism, growing western inequality and cheap credit, the seeds of the credit bust itself and a spluttering rebound.

The nub of the analysis from 2003 was that in deliberately pursuing an export-led growth strategy to bring 200 million poor subsistence farmers into modern industry and services, China fixed its exchange rate at an undervalued level.

This kept its exports cheap and competitive, boosted growth and attracted waves of foreign direct investment. Intermediating these inflows at a fixed exchange rate, the central bank then built vast hard currency reserves which it banked back in western government bonds - holding interest rates and yields on these bonds artificially low.

Even though western workers’ pay suffered from the surge in the global labor force, goods and credit remained cheap and multi-national companies benefited from offshoring staff and plants and lifted margins.

Many have suggested that the Bretton Woods II idea, after underscoring the destructive private sector credit binge and bust in the west, ended with the global recession of 2008/2009 as the huge surpluses and deficits that defined it halved and China turned toward consumption from exports.

But the authors insist it has endured the downturn and show that in dollar terms Chinese surpluses and savings are just as large as ever - even if lower as a percentage of its still booming economy. That much is clear from the continued climb in its foreign exchange reserves to almost $4 trillion in June this year - almost twice 2008 levels and 10 times that of 2003.

What’s more, they reckon that of the 200 million workers China needed to bring into the modern economy back in 2003, only 153 million had make the transition by 2013. This means Beijing will most likely keep its yuan and capital accounts under control for a few more years until these workers are absorbed.

At that point, it’s India’s turn to pick up the baton and China can help soften the pain. If China doesn’t, the trade friction and political backlash may well be severe.

Graphics by Fathom Consulting; Editing by Ruth Pitchford