Economy, explained.
The Mount Washington Hotel in Bretton Woods, New Hampshire, venue for the 1944 UN Monetary and Financial Conference. (Wikimedia)
What happens to the global economy when Washington no longer makes, and enforces, the rules-based order?
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A world without an economic hegemonA world without an economic hegemon
The United States is retreating from its role as security hegemon. But Donald Trump is also withdrawing America from its role as economic hegemon – supplier and enforcer of the much-vaunted “international rules-based economic order”. What happens if Washington no longer provides this role?
This issue is not new. Charles Kindleberger laid the blame for the severity of the 1930s Great Depression on the absence of an economic hegemon: the Great War took that role away from the United Kingdom, and America did not step into the vacuum. Abandoning the League of Nations was symptomatic, and Roosevelt missed his cue at the 1933 World Economic Conference.
As America recedes from its role as economic hegemon, the most likely future is one where much of the old order remains in place, although not working so well.
For Kindleberger, the main issue was exchange rates. He saw stable exchange rates as the essential element not just for international trade but, more importantly, international capital flows. Investors needed the assurance of long-term stability of exchange rates, which the gold standard provided.
The drawn-out demise of the gold standard was certainly traumatic. The lesson which Kindleberger (and others) took was that harmful competitive devaluations should be prevented by an economic hegemon. This view was reflected at Bretton Woods in 1944. The core agreement was to stabilise exchange rates.
International trade rules were also developed in this post-war world, though the General Agreement on Tariffs and Trade and then then World Trade Organization. Here the aim was to reduce trade barriers (tariffs and quotas) and prevent countries from doing trade deals which disadvantaged third countries through “most favoured nation” rules.
America dominated the rule-making (“they have the money”) and implementation through veto powers at the International Monetary Fund (IMF) and leadership of the World Bank.
The main change from the Kindleberger world is that since 1973, when America abandoned its gold-exchange commitment, exchange rates have been set in financial markets. The early years of floating currencies were rocky. But the system works well enough without much intervention on America’s part.
Despite bleating about “exorbitant privilege”, the global dollar is in the interests of all participants. Trump’s undermining of Federal Reserve independence is foolish and unfortunate, but not enough to unanchor the dollar.
Those who foresee China taking over America’s security hegemony may see China also taking over economic hegemony. This seems unlikely.
The global dollar is just one example of the United States providing a global public good – useful infrastructure which everyone can use. In the post Second World War period, a myriad of global public-good economic rules was developed, covering tax, intellectual property, use of the seas (UNCLOS), global communications, space, aviation and much more. The core principle was that such rules would be beneficial for all participants, and network effects increased the benefits of additional participation.
What change has Trump bought to these global public goods? His motivation is self-interest, his operational method is bilateral rather than multilateral, and he has misunderstood tariffs. Thus the international framework will not work as smoothly, and the benefits (particularly to the United States) will be reduced.
But Trump’s objective is not an isolated autarchy. He is still interested in the “art of the deal”, including on trade and capital flows. He sees tariffs as an instrument to skew the rules-based order in his favour rather than to abandon it. His power to do this is limited by the harm tariffs do to his own country, and the ability of other countries to build alternatives, such as the Comprehensive and Progressive Agreement for Trans Pacific Partnership (CPTPP). For the most part, the international order can work without American participation – as it does, for example, in UNCLOS.
Not all international order is driven by self-interest. There has been altruism too: the World Bank, United Nations and foreign aid, as well as agreements on refugees and human rights. Here Trump’s blinkered self-interest will be more damaging. Climate change presents a variant of this problem. Conferences and targets have a role in mobilising public opinion, but success depends on individual countries acting in the collective good. A motivated hegemon would be a huge advantage here, pressuring all countries to act. But we didn’t have this in the pre-Trump order, so we are no worse off now.
As America recedes from its role as economic hegemon, the most likely future is one where much of the old order remains in place, although not working so well, and with gaps where altruistic behaviour is lacking.
Those who foresee China taking over America’s security hegemony may see China also taking over economic hegemony. This seems unlikely. The renminbi is far from becoming a global currency. It may be used in some of China’s trade transactions, but it cannot provide a substitute for the dollar’s investment role, where America’s deep financial markets, backed by stable institutions and laws, will dominate China’s capital-controlled embryonic financial markets. Will China change the rules in institutions such as the IMF and World Bank? Tweaking is possible, to make China’s policy activism, subsidies and state ownership more acceptable. But the old order did nothing to constrain such departures from free-market norms. And if China stepped forward to lead the world in climate-change action, this would be applauded by many.
Much depends on how the United States and China use their weight to distort international rules in their favour through withholding monopolised supplies (China with rare earths, America with cutting-edge chips or international payments). But economies adapt. Push your power too much, and the victims find another way.
About the author
Stephen Grenville
Dr Grenville is a Nonresident Fellow at the Lowy Institute.
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