A New World?

Monetary policy is in a serious quagmire and central banker policy discretion hasn't yielded great results. By hook or by crook, we're headed for a new world. The question is whether it will be a better or worse one than we have now. Remarks from Paul Volcker below:

Paul Volcker: Back to the Woods?

The world since the rule-based monetary system collapsed in the 1970s is not a pretty picture.

By Seth Lipsky

Former Federal Reserve Chairman Paul Volcker called last month in Washington for a new Bretton Woods, the 1944 conference of World War II Allies that set up an international gold-exchange regime. His remarks received little media attention.

This strikes me as an underplayed story, especially as Congress considers taking a serious look at the Federal Reserve. Some legislators in particular are concerned that the value of the dollar, while stronger than last year, is still worth less than a 1200th of an ounce of gold.

Mr. Volcker made his remarks at the annual meeting of the Bretton Woods Committee, a nonpartisan organization that has been getting together since 1983. He did not call for a return to the Bretton Woods gold-exchange regime per se and only mentioned "gold" twice. But the title of the speech was "A New Bretton Woods???" Let's take those three question marks to mean that Mr. Volcker wants to put this question out there emphatically.

Mr. Volcker reprised the history of the Bretton Woods system, which allowed foreign governments to redeem dollars in gold and established the dollar as the world's leading currency. The system collapsed under the weight of the Lyndon Johnson-Richard Nixon "guns and butter" strategy—paying for both the Vietnam War and expanded welfare benefits and doing so by deficit spending.

"Inevitable" was the word Mr. Volcker used to describe what has been called the "Nixon shock," a series of policies implemented in 1971 that included suspending the gold convertibility of the dollar. Mr. Volcker didn't say so directly, but he in effect vindicated Henry Hazlitt, the most prophetic critic of Bretton Woods when the system was first discussed in the 1940s. Hazlitt, then an editorial writer for the New York Times, believed Bretton Woods and the International Monetary Fund, which the agreements set up, were an inflation trap.

In his speech, Mr. Volcker also reprised the efforts to muddle through after Bretton Woods. The Plaza accord of 1985 devalued the dollar against the yen and the mark. The Louvre accord of 1987 sought to stem the dollar's slide. Or, as Mr. Volcker put it, "a lot of floating, some fixing, some 'do as you please.' "

"By now," Mr. Volcker said, "I think we can agree that the absence of an official, rules-based, cooperatively managed monetary system has not been a great success. In fact, international financial crises seem at least as frequent and more destructive in impeding economic stability and growth."

He spoke of the 1970s as "an unhappy decade of inflation ending in stagflation." He touched on the Latin American, Mexican and Asian crises that followed and the crisis of 2008 and the Great Recession in 2009. "Not a pretty picture," Mr. Volcker said, adding that he wanted to raise "a neglected question": "Has the absence of a well-functioning international monetary system been an enabling (or instigating) condition?"

Mr. Volcker made "a plea for attention to the need for developing an international monetary and financial system worthy of our time." He acknowledged what he styled the "forceful fiscal and monetary policies" of recent years, but clearly reckons them inadequate.

"The provision of ample liquidity by the key national central bankers is still taking place as we meet," he said. "But those measures don't really count as structural reforms." He said he could not answer the question of what approach to take, but tinkering with the International Monetary Fund was "not enough" and would mean "little without substantive agreement on the need for monetary reform and practical approaches toward that end."

Mr. Volcker added that he wanted to find "ways of encouraging—even insisting upon—needed balance of payments equilibrium" so that countries don't either suddenly run out of foreign exchange reserves or accumulate too many. "Nor," he said, "would I reject some reassessment of the use of a single national currency as the dominant international reserve and trading vehicle."

The ex-chairman noted that we are a long way from a new Bretton Woods conference, but said that "surely events have raised, whether we want to admit it or not, some fundamental questions that have been ignored for decades."

"It's easy to say what's wrong," Mr. Volcker told me over the weekend, "but sensible reforms are a pretty tough thing."

His remarks will still be music to the ears of many nursing the idea of monetary reform, even if he hasn't endorsed gold. A rules-based approach is certainly getting new attention, including at an important conference organized by economist John Taylor last month at the Hoover Institution.

Congress is starting to look at monetary reform. In July 2012 a bipartisan majority in the House voted 327 to 98 for a serious audit of the Federal Reserve. If the Republicans gain the Senate, the audit could end up as law. As could a bipartisan measure to mark the first century of the Federal Reserve by establishing a Centennial Monetary Commission to look to the Fed's second century.

That effort is coming from Congress's Joint Economic Committee, led by Rep. Kevin Brady (R., Texas). Sens. John Cornyn (R., Texas) and Rand Paul (R., Ky.) are nursing the measure in the upper chamber. It strikes me as a good moment to get Mr. Volcker in and see if he will back a centennial review of the Fed.

The idea, after all, is to see how the Fed could be improved for the next century. The measure has had tough sledding. But if a paragon like Mr. Volcker got behind the idea and supported a new, rules-based system, the effort might be able to get off the base-metal dime.