Do the International Monetary and Financial Systems Need More Than Short-Term Cosmetic Reforms?

Abstract:

The storm that has rocked our world has opened an interesting debate among economists and policymakers on the need for a new international monetary and financial architecture. In fact, the monetary and financial regime that has been in force since the collapse of Bretton Woods encourages the persistence of unsustainable dynamics that spawn increasingly serious crises, and are unable to impart an acceptable form of macroeconomic discipline to the world’s economy. It became apparent that the global role of a key currency along with the deregulation of financial markets (the neoliberal paradigm) have acted as underlying conditions for the U.S. financial crisis up to the present situation of global financial instability. In this article I point out the inadequacy of the institutional arrangements underlying the international monetary and financial regimes and I outline the relevance to the current debate of Keynes’s original plan, proposed with good reason over seventy years ago, but never came to fruition.

Keywords:

• international currency
• international financial architecture
• global imbalances
• Keynes plan

Notes

See Ocampo (2007–8) and the 2009 Report on Reforms of the International Monetary and Financial System by the Commission of Experts of the United Nations (United Nations 2009).

The following quotation may be useful for an understanding of Keynes’s project: “We need a quantum of international currency, which is neither determined in an unpredictable and irrelevant manner as, for example, by technical progress of the gold industry, nor subject to large variations depending on the gold reserve policies of individual countries; but is governed by the actual current requirements of world commerce and is also capable of deliberate expansion and contraction to offset deflationary and inflationary tendencies in effective world demand” (Keynes 1980a: 168–69).

If, for instance, a country A has a trade deficit to the benefit of country B amounting to x bancor worth, it may obtain a loan from the ICB to settle its position. The amount of bancor so created is, in turn, deposited by country B to the ICB: not a single bancor can leave the system. As regards loans make-deposits causality on which the endogenous money paradigm is based see Gnos (1998), quoted in Rossi (2007: 100).

“The principal object can be explained in a single sentence: to provide that money earned by selling goods to one country can be spent on purchasing the products of any other country. In jargon, a system of multilateral clearing. In English, a universal currency valid for trade transactions in all the world” (Keynes 1980a: 270).

As Keynes puts it (1980a: 211): “the problems of the debtors can only arise if creditors are not choosing to make use of the purchasing power they have obtained.”.

“If they are found acceptable they would be valuable and important inducements towards keeping a level balance, and a significant indication that the system looks on excessive credit balances with as critical an eye as on excessive debit balances, each being, indeed, the inevitable concomitant of the other” (Keynes 1980a: 173).

The role of the stabilization fund in fact is: to intervene in order to keep exchange rates stable, granting loans to countries with temporary deficits, above all in the balance of trade (capital movements playing a decidedly minor role at the time), and within the limits of the deposits, calculated on the basis of the economic clout each member country enjoyed in international trade. The gold-exchange standard system was not a currency union because all the currencies could be exchanged with the dollar and only the latter with the gold. Assessing these membership quotas meant determining not only the availability of credit obtainable but also the relative “weight” in voting.

“Since the proposed Stabilization Fund is to perform clearing functions for its members, it might seem, at first sight, to have a closer resemblance to the Clearing Union than it is the case. In fact the principles underlying it are fundamentally different. For it makes no attempt to use the banking principle and one-way gold convertibility and is in fact not much more than a version of gold standard, which simply aims at multiplying the effective volume of the gold base …. The scheme is only helpful to those countries which have a gold reserve already and is only helpful to them in proportion to the amount of such gold reserve” (Keynes 1973: 160).

He explained that if the global currency is a national currency, there is an irremediable contradiction between the issuing country’s internal domestic requirements and the external requirements of the world using it, that is: “what Triffin feared more than anything was the rarefaction of the global currency (shortage of dollars). What we might call Triffin’s ‘general dilemma’ can thus be expressed as follows: the stability requirements of the system as a whole are inconsistent with the pursuit of economic and monetary policy forged solely on the basis of domestic rationales in all monetary regimes devoid of some form of supra nationality. Almost 50 years ago, he shed light indeed on the flaws in that system based, as we have seen, on the dollar (i.e., gold exchange standard) and on fixed exchange rates” (Padoa-Schioppa, 2010: 13).

Serrano (2003: 95), in this regard, has pointed out that Triffin’s dilemma is linked to the hypothesis that the “velocity of circulation of gold” is indeed constant: Triffin assumed that there must be some proportionality between the quantity of gold and the quantity of dollars in short-term assets. But this is not the case since gross flows of international capital can make the “velocity of circulation” of gold increase without limit.

This is true even though the United States declined its relative economic weight in the world economy owing (cf. Eichengreeen 2011) to the so-called advantages of incumbency. Today, in fact, the dollar dominates international transactions since it is used in 85 percent of foreign exchange transactions and still accounts for 62.2 percent of the foreign currency reserves (COFER-IMF data, 2012) despite the fact that the United States represents only 20 percent of the world economy.

This privilege is contrasted by Kindleberger (1987) since, in his opinion, the United States behaved as the “commercial bank” of the world—it supplied a service creating international liquidity to the international economy and received a market remuneration for this.

As external positions of systematically important economies that reflect distortions or entail risks for the global economy, imbalances “may be outward signs of inner disequilibria located in one or more of the large national economies whose behavior is of systemic relevance” (De Cecco 2012: 30). .

Inflows were around two billion U.S. dollars every day during 2001-2007 (IMF 2007). At present the US fiscal debt is around 12,000 billion dollars.

Bernanke (2007), for example, emphasized “the global saving glut” hypothesis, which underlines that increased savings and current account surpluses in developing countries have to be counterbalanced with deficits somewhere else. This is because the total saving in the world must equal investment, and the sum of national current account balances must be zero. He then suggested that the real fault lies not with the American deficit but with excessive savings in Asia. By contrast, Palley (2011) and De Cecco (2012) correctly reject the saving glut hypothesis.

To understand the reserves injection process one can imagine that when, for example, Asian exporters receive the dollar balances, they need to sell their dollars for local currency in order to be able to spend the money domestically, such as to pay their workers, or make new investments. To avoid appreciation, which is not desirable, the local banking system and the central bank will usually buy the dollar inflows.

The U.S. dollar is, by far, the most important reserve currency in the world. Most of the current account surpluses and foreign exchange reserves are held by Asian countries that, prior to the crisis, held $3.4 trillion, or 59 percent of the world’s foreign reserves. China alone holds $1.3 trillion, or 22 percent of the world’s total reserves.

The academic debate has instead centered on the question of whether the U.S. trade deficit is sustainable or not, with emphasis on domestic factors. As stressed by Perelstein (2009), however, neither of these positions offers a sufficient explanation of the present situation since they do not account sufficiently for the global integration of capital markets. In this context, a more systematic view will be adopted to analyze the relationship between the U.S. imbalances and the global financial markets. “This will lead to the conclusion that the financial crisis in 2007–08 is transmitted to the rest of the world through the U.S. trade deficit; that there is a global financial dependence on the U.S. in addition to its political dominance; and that the U.S. macroeconomic imbalances cannot be resolved without affecting the rest of the world whose financial systems are dependent on dollars supplied by the U.S. through its current account deficit” (Perelstein 2009: 5).

Particularly the U.S. Treasury Bond (International Financial Outlook, 2005–8).

Roughly speaking, elasticity is defined as the degree to which monetary and financial regimes constrain the credit creation process and the availability of external funding. More generally: weak constraints imply great elasticity.

On this point, again, see the criticisms of Palley (2009) and De Cecco (2012).

During the writing of this article (July 14, 2015), the Chinese government devalued the yuan in response to quantitative easing policies (QE) adopted by the Federal Reserve, in the aftermath of the crisis, and, last but not least, by the European Central Bank and the Bank of Japan to avoid deflation. In the past, “currencies wars” were characterized by an accumulation of gold (during the gold standard period) to avoid negative future shocks, or by a “beggar thy neighbors” policies during the 1930s. Since QE policies have implicit effects on the devaluation of nominal and real exchange rate they are viewed with increasing suspicion by national policymakers.

See Sau (2003); Obstfeld et al. (2009) estimate that two-thirds of current reserve holdings are for insurance motives.

Supplemental reserve facility (SRF) and contingent credit lines (CCL).

In this regard Eichengreen (2009: 8) argued that: “the world for which we need to prepare is thus one in which several international currencies coexist.”.

This happened despite the fact that the IMF is committed by its Articles of Agreement to “making the Special Drawing Right the principal reserve asset in the international system.”.

Their appeal is so strong that in the very temple of national central banks, the Bank for International Settlements, the SDR has been adopted as unit of account.

As I pointed out in the first section, this was not the case of the bancor in the Keynes plan.

Today, many of the countries that do not accept free floating manage their currency with reference to a basket of other currencies that often reflect the composition of their trade. If SDRs were to become a genuine reserve asset, those countries would have an incentive to set or to manage their exchange rates with reference to a ready-made basket broadly representative of the composition of world trade.

Eichengreen (2009: 141) in this regard is rather pessimistic and trenchant: “this is not something that is going to happen overnight. No global government, which means no central bank, means no global currency. Full stop!”.

Very recently two important papers (Davidson 2015; Rossi 2015) have been published that are particularly intriguing and close to this debate. Nevertheless, here I have tried to show how the “dollar floating standard” is the main ingredient for U.S. and global financial instability and crisis, and why Keynes’s plan has to be considered as regards both the creation of a true international clearing union and the consideration of a true international currency closer to the characteristic of the bancor. The vast literature on the topic of the crisis and the reform of monetary and financial systems does not address the relevance of both aspects (see, e.g., the observations by Davidson [2015: 22] and Rossi [2015: 214]), and many contributions do not stress, up to present time, the “monetary” aspect of the current financial turmoil linking the analysis to the role of the dollar.

Recall the monetarist’s point of view and the new benign neglect on U.S. trade balance (Perelstein 2009).

Additional information

Notes on contributors

Lino Sau

Lino Sau is an Associate Professor in the Department of Economics and Statistics, University of Turin. E-mail: [email protected]. A first version of this paper was presented at the Conference on Political Economy and the Outlook for Capitalism, Centre Pierre Mendès, University Panthéon-Sorbonne, Paris, and at a seminar at CESMEP, University of Turin, fall 2013. The author gratefully acknowledges fruitful discussions with and advice from Santonu Basu, Fernando Cardim de Carvalho, Mario Cedrini, Carlos Alberto Lanzarini Casa, Roberto Marchionatti, Domenica Tropeano, Nina Eichacker, and all the participants in the session on Post-Keynesian Perspectives on Financial Crisis. This version has benefited from the comments and suggestions of two anonymous referees to whom the author is grateful. The author is, of course, responsible for any errors.