THE AGE OF FINANCE
Twenty-five years ago, representatives of the 10 largest industrial nations met at the Smithsonian Institution in Washington to plan the rescue of their wobbly currencies and restore order to the international financial system. Their agreement was hailed as a great achievement, but within a few months, the Bretton Woods fixed-exchange-rate system, in effect since 1944, collapsed for good. Far from being the disaster many feared, though, the breakdown of Bretton Woods ushered in a whole new era of finance. Floating exchange rates eased cross-border investments, encouraged a proliferation of new products, and toppled capital controls and other financial regulations. Today, financial markets act as powerful agents of capital, seeking value where they can and wringing concessions from policymakers. The markets are hardly always rational--prices habitually ricochet, and the illogic of the markets' day-to-day behavior can be mystifying, if not terrifying. Currently, the dollar is strengthening, the Nikkei is again taking a drubbing, and Federal Reserve Board Chairman Alan Greenspan worries about possible "irrational exuberance" in the stock market. Just what has the Age of Finance wrought?
A great deal of good, as it turns out. It's difficult to remember or imagine, but when the post-World War II financial system first spun apart in the early 1970s, people were gripped by fear. The dollar would tumble into an abyss. Consumers and markets would become paralyzed by uncertainty. Governments would compete to depreciate their currencies and pursue other beggar-thy-neighbor policies such as those that sent the global economy deeper into depression in the 1930s. Trade would shrink, investment would dry up, growth would stall.
It never happened. Yes, there was stagflation in the 1970s. Debt crises erupted periodically in the Third World. Budget deficits grew. The U.S. stock market crashed in 1987. Repeatedly, monetary and fiscal crises threatened chaos and destruction, and just as repeatedly, government officials huddled and the financial markets retreated from the brink. Markets have been relatively unfettered, but central bankers and international authorities have not totally abdicated responsibility. Markets have been messy and unpredictable, but growth has continued.
Indeed, the unraveling of Bretton Woods has been a phenomenal boon for the world economy. Trade not only didn't implode, it exploded. Twenty-five years ago, the value of world trade was $300 billion in nominal terms. Last year, it reached $5 trillion--a staggering gain of more than 17 times. Investment held up well in most of the industrial world in the 1980s, took off in the developing world, and now, after a sluggish period, has risen in the U.S.
Equally important, the financial markets have done for economic policy what governments couldn't do themselves: impose a discipline that forces trade and budget imbalances to be corrected and closed economies to open up. Sometimes, the discipline is harsh, but usually that's because governments delay and delay--witness the renewed fall of the Nikkei as investors assess the effects of fiscal missteps and belated financial deregulation. But the markets can also reward good policies and good growth--as shown by the U.S. stock market's strong performance in 1996.
From time to time, gold bugs urge the return to a fixed-rate exchange system with currency values pegged to the price of gold bullion. Less zealous financial experts have pleaded for the adoption of a more stable system with guidelines for currency trading. And Europe is moving, albeit with some countries kicking and screaming, toward a new common currency in 1999. But history shows that the burden of proof is on the opponents of floating rates--and, by extension, the opponents of free financial markets. As the ad for the Volkswagen Beetle used to say: It's ugly, but it gets you there.