Origins of new financial order

In March 1973, George Schultz — the then US Treasury Secretary — organised an informal meet amongst finance ministers of five major industrial democracies.

The meeting had been convened under circumstances that, in retrospect, can only be described as the bookend of one financial world order and the beginning of another. The parallels to the predicaments the global financial system faces today is striking.

In the years prior to that meet, the dollar had been pegged to gold at $35 per ounce and all global currencies were pegged to the dollar. This system of international arrangement, where the dollar played an anchor, had been in place since the late 1945 era.

From military might emerged the American ability to be the arbiter of global value — with the implicit understanding that the convertibility between the dollar-to-gold would be respected.

However, from early 1970 onwards the cumulative effects of the United States' massively expansionary expenditure programmes to finance the Vietnam war unravelled this system. The expenses were financed by ‘printing' more dollars, without a concomitant increase in its gold reserves.

The result of this was that other countries, who were pegged to the dollar, had two choices: either, print more domestic currencies to keep the exchange rate with dollar at the pegged value or, break away from the pegged exchange rate and let the exchange rate float.

The first would have resulted in increased domestic inflation (more money chasing same amount of goods); the second would have resulted in a world with freely floating exchange rates, interventionist central banks, rising exchange rate and volatility.

Predictably, the rest of the world chose not to subsidise American adventurism, military or otherwise; and the post-Second World War era ended with the dollar's substantive depreciation against major European currencies.

The meet that Schultz had organised, called the Library Group, was an effort to calibrate the functioning of exchange rates to macroeconomic sluggishness.

Brave new world

It was a brave new world of global finance. Central bankers had to relearn how to intervene in an economy marked by reduced economic output (due to the Opec oil action) and rising price and exchange rate volatility.

By 1987, this group had become the G7, by 1998 the G8 was born when Russia joined this group and by 1999, the first G20 meetings were held in Berlin.

The Asian/Russian economic crises was looming large in the background when the G20 met for the first time.

The heroes of the world economic order then, the American and European bureaucrats took it upon themselves to hector the emerging market on the need for fiscal prudence, regulatory oversight, sound monetary management and inflation targeting.