NEW! CalculatedRisk Newsletter on Real Estate (Ad Free) Read it here.

Monday, October 11, 2010

Duy: The Final End of Bretton Woods 2?

by Calculated Risk on 10/11/2010 09:25:00 PM

Tim Duy is deeply concerned: The Final End of Bretton Woods 2?

The inability of global leaders to address global current account imbalances now truly threatens global financial stability. Perhaps this was inevitable - the dollar has not depreciated to a degree commensurate with the financial crisis. Moreover, as the global economy stabilized the old imbalances made a comeback, sucking stimulus from the US economy and leaving US labor markets crippled. The latter prompts the US Federal Reserve to initiate a policy stance that will undoubtedly resonate throughout the globe. As a result we could now be standing witness to the final end of Bretton Woods 2. And a bloody end it may be.
...
Put simply, the Federal Reserve is positioned to declare war on Bretton Woods 2. November 3, 2010. Mark it on your calendars.
...
Consider the enormity of the situation at hand. The Federal Reserve is poised to crank up the printing press for the sake of satisfying their domestic mandate. One mechanism, perhaps the only mechanism, by which we can expect meaningful, sustained reversal from the current set of imbalances is via a significant depreciation of the dollar. The rest of the world appears prepared to fight the Fed because they know no other path.
...
Bottom Line: The time may finally be at hand when the imbalances created by Bretton Woods 2 now tear the system asunder. The collapse is coming via an unexpected channel; rather than originating from abroad, the shock that sets it in motion comes from the inside, a blast of stimulus from the US Federal Reserve. And at the moment, the collapse looks likely to turn disorderly quickly. If the Federal Reserve is committed to quantitative easing, there is no way for the rest of the world to stop to flow of dollars that is already emanating from the US. Yet much of the world does not want to accept the inevitable, and there appears to be no agreement on what comes next. Call me pessimistic, but right now I don't see how this situation gets anything but more ugly
There is much more in the piece.

Back in 2005, I discussed Bretton Woods 2 with Brad Setser (Duy excerpts from one of Brad's pieces). I suggested that the housing bubble would collapse, reducing the U.S. demand for overseas goods and that would bring an end to Bretton Woods 2 - and that led me to predict that the trade deficit would decline in 2007 (a very lonely position!). However I didn't expect the imbalances to return so quickly, and that is very concerning. And I hope Tim Duy is wrong about how it ends.