The Bretton Woods System

After the two world wars, world leaders sought to create a global economic system that would
ensure a longer-lasting global peace. They believed that one of the ways to achieve this goal was to set up
a network of global financial institutions that would promote economic interdependence and prosperity.
The Bretton Woods system was inaugurated in 1944 during the United Nations Monetary and Financial
Conference to prevent the catastrophes of the early decades of the century from reoccurring and affecting
international ties.

The Bretton Woods system was largely influenced by the ideas of British economist John
Maynard Keynes who believed that economic crises occur not when a country does not have enough
money, but when money is not being spent and, thereby, not moving. When economies slow down,
according to Keynes, governments have to reinvigorate markets with infusions of capital. This active role
of governments in managing spending served as the anchor for what would be called a system of global
Keynesianism -growth rates of global product (global GDP)
-the importance of public management, democratic politics, the mixed economy, global income
distribution, the management of global demand, investment and money

Delegates at Bretton Woods agreed to create two financial institutions. The first was the
International Bank for Reconstruction and Development (IBRD, or World Bank) to be responsible for
funding postwar reconstruction projects. It was a critical institution at a time when many of the world's
cities had been destroyed by the war. The second institution was the International Monetary Fund (IMF),
which was to be the global lender of last resort to prevent individual countries from spiraling into credit
crises. If economic growth in a country slowed down because there was not enough money to stimulate
the economy the IMF would step in. To this day, both institutions remain key players in economic
globalization.

Shortly after Bretton Woods, various countries also committed themselves to further global
economic integration through the General Agreement on Tariffs and Trade (GATT) in 1947. GATT's
main purpose was to reduce tariffs and other hindrances to free trade.

Neoliberalism and Its Discontents

The high point of global Keynesianism came in the mid- 1940s to the early 1970s. During this
period, governments poured money into their economies, allowing people to purchase more goods and, in
the process, increase demand for these products. As demand increased, so did the prices of these goods.
Western and some Asian economies like Japan accepted this rise in prices because it was accompanied by
general economic growth and reduced unemployment. The theory went that, as prices increased,
companies would earn more, and would have more money to hire workers. Keynesian economists
believed that all this was a necessary trade-off for economic development.
In the early 1970s, however, the prices of oil rose sharply as a result of the Organization of Arab
Petroleum Exporting Countries' (OAPEC, the Arab member-countries of the Organization of Petroleum
Exporting Countries or OPEC) imposition of an embargo in response to the decision of the United States
and other countries to resupply the Israeli military with the needed arms during the Yom Kippur War.
Arab countries also used the embargo to stabilize their economies and growth. The "oil embargo” affected
the Western economies that were reliant on oil, To make matters worse, the stock markets crashed in
1973 1974 after the United States stopped linking the dollar to gold, effectively ending the Bretton Woods
system. The result was a phenomenon that Keynesian economics could not have predicted-a phenomenon
called stagflation, in which a decline in economic growth and employment (stagnation) takes place
alongside a sharp increase in prices (inflation).
 Around this time, a new form of economic thinking was beginning to challenge the Keynesian
orthodoxy. Economists such as Friedrich Hayek and Milton Friedman argued that the governments
practice of pouring money into their economies had caused inflation by increasing demand for goods
without necessarily increasing supply. More profoundly, they argued that government intervention in
economies distort the proper functioning of the market.

Economists like Friedman used the economic turmoil to challenge the consensus around Keynes's
ideas. What emerged was a new form of economic thinking that critics labeled neoliberalism. From the
1980s onward, neoliberalism became the codified strategy of the United States Treasury Department, the
World Bank, the IMF, and eventually the World Trade Organization (WTO)-a new organization founded
in 1995 to continue the tariff reduction under the GATT. The policies they forwarded came to be called
the Washington Consensus.

The Washington Consensus dominated global economic policies from the 1980s until the early
2000s. Its advocates pushed for minimal government spending to reduce government debt. They also
called for the privatization of government-controlled services like water, power, communications, and
transport, believing that the free market can produce the best results. Finally, they pressured governments,
particularly in the developing world, to reduce tariffs and open up their economies, arguing that it is the
quickest way to progress. Advocates of the Washington Consensus conceded that, along the way, certain
industries would be affected and die, but they considered this "shock therapy necessary for long-term
economic growth.

The appeal of neoliberalism was in its simplicity. Its advocates like US President Ronald Reagan
and British Prime Minister Margaret Thatcher justified their reduction in government spending by
comparing national economies to households. Thatcher, in particular, promoted an image of herself as a
mother, who reined in overspending to reduce the national debt.

The problem with the household analogy is that governments are not households. For one,
governments can print money, while households cannot. Moreover, the constant taxation systems of
governments provide them a steady flow of income that allows them to pay and refinance debts steadily.

Despite the initial success of neoliberal politicians like Thatcher and Reagan, the defects of the
Washington Consensus became immediately palpable. A good early example is that of post-communist
Russia. After Communism had collapsed in the 1990s, the IMF called for the immediate privatization of
all government industries. The IMF assumed that such a move would free these industries from corrupt
bureaucrats and pass them on to the more dynamic and independent private investors. What happened,
however, was that only individuals and groups who had accumulated wealth under the previous
communist order had the money to purchase these industries. In some cases, the economic elites relied on
easy access to government funds to take over the industries. This practice has entrenched an oligarchy
that still dominates the Russian economy to this very day.
The Global Financial Crisis and the Challenge to Neoliberalism
Russia's case was just one example of how the “shock therapy" of neoliberalism did not lead to
the ideal outcomes predicted by economists who believed in perfectly free markets. The greatest recent
repudiation of this thinking was the recent global financial crisis of 2008-2009

Neoliberalism came under significant strain during the global financial crisis of 2007-2008 when
the world experienced the greatest economic downturn since the Great Depression the crisis can be traced
back to the 1980s when the United States systematically removed various banking and investment
restrictions.
The scaling back of regulations continued until the 2000s, paving the way for a brewing crisis. In
their attempt to promote the free market, government authorities failed to regulate bad investments
occurring in the US housing market. Taking advantage of "cheap housing loans," Americans began
building houses that were beyond their financial capacities.

To mitigate the risk of these loans, banks that were lending house owners' money pooled these
mortgage payments and sold them as “mortgage-backed securities” (MBSs). One MBS would be a
combination of multiple mortgages that they assumed would pay a steady rate.

Since there was so much surplus money circulating, the demand for MBSs increased as investors
clamored for more investment opportunities. In their haste to issue these loans, however, the banks
became less discriminating. They began extending loans to families and individuals with dubious credit
records-people who were unlikely to pay their loans back. These high-risk mortgages became known as
sub-prime mortgages.

Financial experts wrongly assumed that, even if many of the borrowers were individuals and
families who would struggle to pay, a majority would not default. Moreover, banks thought that since
there were so many mortgages in just one MBS, a few failures would not ruin the entirety of the
investment.

Banks also assumed that housing prices would continue to increase. Therefore, even if
homeowners defaulted on their loans, these banks could simply reacquire the homes and sell them at a
higher price, turning a profit.

Sometime in 2007, however, home prices stopped increasing as supply caught up with demand.
Moreover, it slowly became apparent that families could not pay off their loans. This realization triggered
the rapid reselling of MBSs, as banks and investors tried to get rid of their bad investments. This
dangerous cycle reached a tipping point in September 2008, when major investment banks like Lehman
Brothers collapsed, thereby depleting major investments.

The crisis spread beyond the United States since many investors were foreign governments,
corporations, and individuals. The loss of their money spread like wildfire back to their countries.

These series of interconnections allowed for a global multiplier effect that sent ripples across the
world. For example, Iceland's banks heavily depended on foreign capital, so when the crisis hit them, they
failed to refinance their loans. As a result of this credit crunch, three of Iceland's top commercial banks
defaulted. From 2007 to 2008, Iceland's debt increased more than seven-fold.

Until now, countries like Spain and Greece are heavily indebted (almost like Third World
countries), and debt relief has come at a high price. Greece, in particular, has been forced by Germany
and the IMF to cut back on its social and public spending. Affecting services like pensions, health care,
and various forms of social security, these cuts have been felt most acutely by the poor. Moreover, the
reduction in government spending has slowed down growth and ensured high levels of unemployment.

The United States recovered relatively quickly thanks to a large Keynesian-style stimulus
package that President Barack Obama pushed for in his first months in office. The same cannot be said
for many other countries. In Europe, the continuing economic crisis has sparked a political upheaval.
Recently, far- right parties like Marine Le Pen's Front National in France have risen to prominence by
unfairly blaming immigrants for their Woes, claiming that they steal jobs and leech off welfare. These
movements blend popular resentment with utter hatred and racism. We will discuss their rise further in
the final lesson.