[EAI·JoongAng Sunday Joint Project] The 3 Major International Economic Systems Are Shaking, Resembling the Situation 100 Years Ago

Unemployed people line up in front of a soup kitchen set up in downtown Chicago, USA, in 1931 during the Great Depression.

This facility, advertised as offering 'free soup, coffee, and donuts for the unemployed,' was called a 'soup kitchen' and was established by mafia boss Al Capone.

An average of 2,200 people are said to have dined there daily. [Photo: U.S. National Archives and Records Administration]

The international community experienced how large-scale economic shocks and inadequate responses to them can lead to the ruin of the international order. This was during the interwar period (1919-1939), between World War I and World War II. The Great Depression, originating in the United States in 1929, collapsed the international economic system during the interwar period and led to the geopolitical conflict of World War II.

What collapsed during this interwar period were the three liberal systems: the gold standard monetary system, free capital movement, and the free trade system. Although the great powers of Europe sought to revive the prosperity of the pre-war era after World War I, these pillars collapsed one by one in the roughly twenty years between 1919 and 1939. The gold standard temporarily halted after European countries suspended gold convertibility to finance the war costs of World War I, and although attempts were made to restore it after the war, the restoration was not easy. For example, Britain restored the pound sterling to gold at its pre-war parity in 1925, but this was an excessive burden on the weakened British economy in the post-war period.

Distrust Fills the Void Left by the Demise of International Economic Cooperation

The Great Depression, triggered by the stock market crash on Wall Street in 1929, became a turning point that shattered the already fractured liberal international economic system. The impact of the Great Depression on the collapse of the international economic system can be broadly divided into three aspects. First, the collapse of the gold standard. The gold standard refers to a typical fixed exchange rate system where currencies such as the British pound, French franc, and U.S. dollar were pegged to the value of gold (1 ounce of gold was 4.25 pounds, and 1 pound was 25.22 francs), and it was a mechanism that promoted free trade through exchange rate stabilization. As deflation and banking crises due to the Great Depression overlapped, countries engaged in competitive currency devaluations to escape the economic crisis through export expansion. This famous 'beggar-thy-neighbor' policy was tantamount to the collapse of the gold standard, a fixed exchange rate system. Britain abandoned the gold standard in 1931, and the United States suspended gold convertibility in 1933. Gold bloc countries such as France, Belgium, the Netherlands, Switzerland, Italy, and Poland also followed suit by 1936. The gold standard collapsed due to competitive devaluations by each country.

Second, the strengthening of capital controls. As banking systems collapsed sequentially and capital rapidly sought safe assets, governments introduced foreign exchange controls and capital movement regulations to prevent capital outflow. Austria immediately implemented foreign exchange controls in the summer of 1931 following the bankruptcy of Creditanstalt. Germany introduced the Foreign Exchange Control Act in July 1931, strictly controlling the outflow of the mark and the purchase of foreign currency, effectively abandoning capital liberalization. Mussolini's regime in Italy intensified foreign exchange controls and restrictions on capital movement from 1935 onwards as part of its self-sufficient economy. While Britain and France did not adopt comprehensive capital control policies, they strengthened the management and limited control of capital movements.

Third, the rise of protectionism. In 1930, the United States enacted the Smoot-Hawley Tariff Act, imposing tariffs on 20,000 imported goods. The U.S. initially considered this tariff bill under the pretext of protecting farmers who were disadvantaged by the free trade system, but it ultimately led to a significant increase in import tariffs. After the implementation of this act, the average effective tariff rate in the U.S. rose from 40% to about 47-48%. In response, countries retaliated with tariffs, causing world trade volume to decline by more than one-third between 1929 and 1933. Britain established a pound bloc economy centered on its colonies and dominions through imperial preferential tariffs. The United States, France, Germany, and Japan also formed dollar, franc, mark, and yen blocs, respectively. The world economy was fragmented into several closed economic blocs.

These three trends created a vicious cycle, reinforcing each other. The collapse of the gold standard led to exchange rate instability, which justified capital controls, and exchange rate instability and capital controls fueled mercantilist protectionism. As a result, competition and distrust between blocs filled the void left by the absence of international economic cooperation, which ultimately became the backdrop for the geopolitical catastrophe of World War II.

The Bretton Woods monetary conference held in Bretton Woods, USA, in 1944. The Bretton Woods system, an international monetary order, was established at this conference,

pegging the U.S. dollar to gold, and determining the exchange rates of other currencies against the dollar. [Photo: World Bank]

The changes in the global economy since the 2008 U.S. financial crisis have been remarkably similar to the patterns of the interwar period. First, the fracturing of the dollar-centric reserve currency system. Even after the collapse of the Bretton Woods system, the dollar remained virtually the sole international reserve currency. However, as the credibility of the U.S. financial system was shaken by the 2008 crisis, emerging economies, including China, began to seriously move towards reducing their reliance on the dollar. The internationalization of the yuan, the expansion of intra-BRICS currency settlements, discussions on central bank digital currencies, and the recent strengthening of Russia-China's de-dollarization payment systems following sanctions against Russia are all part of the same trend. While there is no clear alternative to replace the dollar's position yet, confidence in the single reserve currency system has undoubtedly weakened compared to before.

Second, the revival of capital controls. Since the 2008 crisis, emerging economies have introduced various forms of macroprudential regulations and capital movement management tools to cope with rapid capital inflows and outflows. Even the International Monetary Fund has shifted its stance from the past to tolerate limited capital controls. Recently, new forms of capital and technology controls, justified by security concerns, are spreading, such as strengthened foreign investment screening in advanced industries, export controls, and restrictions on technology transfer. This is more complex than in the interwar period, as it evolves into controls that combine economy and security, going beyond simple capital movement regulations.

Third, the resurgence of protectionism. Since the 2008 crisis, countries have increasingly adopted measures to protect their domestic industries, while ostensibly advocating for free trade. The tariff war that began in earnest with the U.S.-China trade dispute from 2018 onwards, the competition for subsidies in strategic industries such as semiconductors, electric vehicles, and batteries, supply chain restructuring, friend-shoring, the Chip 4 alliance, the Indo-Pacific Economic Framework (IPEF), the discourse of de-risking, the expansion of BRICS, and the strengthening of the Shanghai Cooperation Organisation (SCO) demonstrate that the multilateral trading system centered on the World Trade Organization has become virtually defunct. This is a modern variation of exclusive economic bloc formation, where only allies share core resources and technologies. This is essentially similar to the bloc economy of the interwar period.

Intertwined Supply Chains Make Complete Decoupling Difficult

Will these similarities then lead to geopolitical conflict like World War II? Both opposing answers are possible. First, a pessimistic scenario. The path from economic system fragmentation to geopolitical conflict appears not much different from the interwar period. When distrust in the reserve currency system, self-centered capital and technology controls, and bloc formation by camp proceed simultaneously, countries prioritize security from self-reliance and camp cohesion over the economic benefits of interdependence. The current situation, where the U.S.-China strategic competition is spreading across trade, technology, and finance, and the war in Ukraine and instability in the Middle East are amplifying this, structurally overlaps with the process and dynamics where the interwar bloc economies and geopolitical tensions reinforced each other. This demonstrates how economic conflict can escalate into territorial wars and catastrophic disasters for the international order. The fact that the cost of armed conflict is perceived to be lower as economic interdependence weakens is a cause for concern.

However, an optimistic scenario is also plausible. This is because there are crucial conditions that differ from the interwar period. First, there are various multilateral international cooperation organizations related to finance, currency, trade, development, and security, as well as comprehensive, regular international policy consultation bodies like the G20 summits, which provide at least a channel for policy coordination in times of crisis. Such institutional mechanisms did not exist in the interwar period. Second, in the nuclear age, the concept of mutually assured destruction (MAD) is shared as a final red line among the leaders of major powers. Therefore, it deters the possibility of economic conflict immediately escalating into military conflict. Third, today's supply chains are far more intricately intertwined than the bloc economies of the interwar period, making the economic cost of complete decoupling immense. While the bloc economies of the past could achieve self-sufficiency within the bloc, it is virtually impossible for a single country or bloc to monopolize the entire value chain in modern advanced industries. Even if the U.S. and China call for decoupling, a complete severance of the entire distribution network of raw materials, components, and finished products could cause immediate economic shock to both sides.

The fundamental lesson from the interwar experience is that economic shocks become more destructive when combined with the vulnerabilities of the existing international economic system. In that the three pillars of the dollar system, capital movement, and free trade have been shaken again since the 2008 crisis, the current international economic system is clearly in a crisis phase similar to the interwar period. However, the next stage, whether this fragmentation will lead to geopolitical catastrophe like World War II, depends on the choices made by each country now. It is important to remember that the failure of the interwar period was not a predetermined fate but the cumulative result of policy choices.

Gold Standard Monetary System= A system that pegs the value of currency to a fixed amount of gold. Gold convertibility means that the currency authority's banknotes can be exchanged for gold at any time upon demand. While it stabilizes prices by limiting the money supply to the amount of gold reserves, it has the limitation of hindering flexible fiscal and monetary policies during economic crises.

Imperial Preference Tariffs= An exclusive protectionist trade system implemented by Britain in 1932, which lowered mutual tariffs within the British Empire while imposing high tariffs on countries outside the bloc. It led to the globalization of economic blocs and the division of spheres of influence, becoming a background to World War II.

Yongwook Lee is a professor in the Department of Political Science and International Relations at Korea University. He holds a Ph.D. in International Relations from the University of Southern California (USC) and previously served as an assistant professor at the University of Oklahoma and a fellow at Brown University. His research interests include the political economy of international finance and currency, East Asian financial cooperation, and financial diplomacy among Korea, China, and Japan. He is a co-author of books such as "Korea's Choices After the Crisis" and "The Transformation of Area Studies and the Understanding of World Politics."

[Source: JoongAng Ilbo, Reporter Ko Jeong-ae]https://www.joongang.co.kr/article/25445990