From Bretton Woods to Beggar-Thy-Neighbour: The unraveling of US-led economic systems
As the US revives protectionist policies reminiscent of the 1930s, the global monetary system faces its greatest stress test since Bretton Woods. Can the world avoid repeating the mistakes that deepened the Great Depression?
The changing global economic order in the form of tariff impositions and protectionist approaches or the changing global economic order is set to rewrite the allied 'International Monetary Order'. International trade payments are made, capital flows are adjusted, and exchange rates are determined within the framework of an International Monetary System. The changing situation reminds the 'Interwar Period' of the history of International Monetary Systems and the 'Beggar-thy-neighbour Policy' approaches of the economic superpowers during that period.
During the Interwar Period (the period between the First World War and the Second World War), gold convertibility was suspended mainly to finance military spending, and several global economies confronted high inflation, and there was exchange rate instability throughout the globe. Currencies were no longer backed by gold, and several central banks adopted independent monetary policies.
The 'Interwar Period' is particularly recognised as the period of trade protectionism, trade war, hyperinflation, exchange control, and trade promotion through forced devaluation. Global economies confronted the 'Great Depression' during the period with the associated economic instability, low inflation, and unemployment. Is the ongoing US-led approach and the associated responses taking us to those days of instability and uncertainty? What could be the possible cautious approach on the part of a developing country like Bangladesh?
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The interwar period saw a dramatic swing to protectionism. Tariffs were hiked to historic highs, and import quotas became commonplace. Major economies that had traditionally been open also turned protectionist. The US maintained high tariffs throughout. Several countries retaliated by raising their tariffs.
For developing countries, the collapse of world commodity prices and export revenues forced them into their protectionist responses. Many developing countries used tariffs as a revenue source and to protect budding industries. Several of these also resorted to import quotas and licensing as forms of protection. Protectionist policies had a profound impact on developing regions.
This is often cited as the spark that ignited a global trade war. The result was a swift contraction in international trade and economic shrinkage. Facing economic contraction, countries moved to 'beggar-thy-neighbour' – raising barriers to imports with the expectation of protecting domestic jobs and balances. In the developing world, Latin America, Africa, and parts of Asia were hit by discriminatory trade barriers in their key export markets.
Another form of protection was exchange control, which often went hand in hand with trade control. Exchange controls fragmented the world economy, resulting in harsh consequences for several export-orientated developing countries. By the mid-1930s, many countries had non-convertible currencies and required exporters to surrender foreign exchange to the central bank. The government would then allocate this foreign exchange to essential imports, thus controlling trade.
In effect, by 1935 the world economy split into trading blocs with limited convertibility between them: a GBP Bloc, a US Dollar Bloc, and a Controlled-clearing Bloc around Germany. Global trade became more bilateral and managed, a stark contrast to the multilateral free trading system of the Classical Gold Standard era. The net effect of interwar protectionism was to deepen the Great Depression and particularly to harm countries reliant on trade.
The World Economy faced the Great Depression (1929–1939) which triggered a massive collapse in global trade and unemployment. By the time the Second World War broke out, when the international monetary system was fragmented and unstable. The interwar monetary failures prompted greater interest in designing a more cooperative system after the Second World War, eventually leading to the Bretton Woods System (1944) and the creation of institutions like the IMF and World Bank.
It can easily be observed that in history, International Economic Orders and the associated International Monetary Systems were shaped under the leadership and wishes of mainly the US authority. Especially, the US played an active role in the installation of the Bretton Woods System, where the US Dollar was accepted as the reserve currency.
The early 1970s marked a turning point for the world economy when the USA ended the US Dollar's convertibility to gold and the world's major currencies were floating against each other, inaugurating a new era of flexible exchange rates. This shift coincided with a wave of economic globalisation and market liberalisation that accelerated in the 1980s and 1990s.
Under US leadership, many countries embraced freer trade, deregulation, and openness, setting the stage for unprecedented growth in international commerce. By the late 1970s, it was clear that the international economic order was transitioning – currencies floated, and a more integrated global market was emerging. The US played a pivotal role in shaping this rules-based global order, promoting institutions and agreements that advanced trade liberalisation and cross-border financial flows where the US Dollar remained the dominant international currency, giving the United States unique influence.
The 1980s ushered in a powerful wave of market liberalisation and globalisation across the world. Many developing countries followed suit by loosening trade restrictions and capital controls, often encouraged by US-influenced international institutions like the IMF and World Bank. This era saw pivotal shifts with China beginning its 'opening up'. By the end of the decade, the groundwork was laid for an even larger globalisation boom with the USA as chief advocate.
The 1990s were a decade of unprecedented globalisation, characterised by surging trade, cross-border investments, and new international frameworks. A series of historic milestones cemented an open global trading system, many driven or supported by US leadership. Crucial steps included the launch and completion of the Uruguay Round of GATT, which led to the creation of the World Trade Organisation (WTO) in 1995; the negotiation of the North American Free Trade Agreement (NAFTA); and the European Union's Single Market initiative and decision to form a monetary union (the euro).
These agreements exemplified the USA's commitment to liberalisation, opening markets for American goods and multinationals while also giving USA consumers access to cheaper imports. Globalisation continued into the 2000s, bringing new dynamics and some challenges as well.
Not different from earlier decades, the USA leadership is playing active roles in reshaping the global economic order; however, in the reverse direction! While economies remain deeply interconnected, a backlash against free trade emerged mainly after 2016, when the US adopted a more protectionist stance under President Trump's first term.
In recent times, the Trump administration implemented a series of significant protectionist measures aimed at reversing globalisation and promoting domestic manufacturing. The policy changes are expected to lead to inflation, slower economic growth, and even a global recession. This is expected to be responded to with reciprocal tariffs, protective measures, and greater exchange control. We are probably moving towards a chaotic 'International Monetary Order' that may be comparable to the situation of 'The Interwar Period'.
Growing protectionism and potential exchange control regimes will have implications for the trade payment methods. While globalisation once promoted free trade and economic integration, these developments have seen a reversal in the areas of geopolitical tensions, trade sanctions, and export controls, growing economic nationalism, and reshoring trends.
These developments may lead to greater mistrust among global trading partners, pushing companies and banks to revert to secure, traditional trade financing techniques like letters of credit (LC). Traditional documentary trade financing techniques are particularly suitable in a situation of currency inconvertibility, import/export restrictions, sudden tariffs, or sanctions. Traditional trade financing techniques like LC might get a particular boost in this period of uncertainty.
In the changing context, the influence and scope of work of international financial institutions and intergovernmental organisations would also change, which will compel developing countries to increase their reliance on internal resources and bring about strategic shifts.
Developing countries like Bangladesh, which have basically been followers of the US-led forward march, need to make efforts to refresh negotiations with the older trading partners (including the US) and to find new trading allies. Reduce import dependency as much as possible for essential and critical commodities.
Very importantly, it is the second very big signal that necessitates the country's effort to focus on our internal capacity enhancement for improving internal dependence. The global disruption caused by Covid-19, the biggest signal, exposed the vulnerabilities of over-reliance on international supply chains and imported goods. Countries faced shortages in essential items when borders were closed and exports were restricted.
This crisis emphasised the need for self-reliance in critical sectors like strengthening local agriculture and food processing to ensure consistent supply and mitigate global supply chain shocks, healthcare materials, and infrastructure.
In the process of strategising self-reliance, empowerment of rural and agri-entrepreneurs and small and micro enterprises would be crucial to fostering a more inclusive economy. It is crucial to recognise the value of improving domestic capacity for food production, medical and energy supply, and investing in infrastructure and technology that supports local production and distribution. Especially agriculture and small and microenterprises of the country deserve mighty policy, financial, infrastructure, technology, and marketing support for cementing a sustainable economic foundation and enhancing self-reliance.
Dr Shah Md Ahsan Habib is a Professor at Bangladesh Institute of Bank Management (BIBM).
Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions and views of The Business Standard.
