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REFORMING THE WORLD'S INTERNATIONAL MONEY
by Paul Davidson, Editor, Journal of Post Keynesian Economics, Visiting Scholar,
Schwartz Center For Economic Policy Analysis, The New School
Paper for conference "Financial Crisis, the US Economy, and International Security In
The New Administration". Nov. 14, 2008, The New School, New York, NY
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The last two lines of the original manuscript of my book JOHN MAYNARD KEYNES
(Palgrave, 2007) was written in July 2006. In those lines I noted that "when, not if, the
next Great Depression hits the global economy, then perhaps economists will rediscover
Keynes's ...analytical system that contributed the golden age of the post World War II.
For Keynes, however, it will be a pyrrhic victory".
The Winter of 2007-2008 will prove to be the winter of economic discontent and
the beginning of the end of the classical theory of the efficiency of global financial
markets. For more than three decades mainstream economists have preached, and
politicians accepted, the myth of the efficiency of markets, while burying any thoughts
of Keynes's analysis of domestic financial markets and their connection via the
international payments system.
Those who do not study the lessons of history are bound to repeat its errors.
Economists forgot the events of the world-wide Great Depression and the collapse of
unfettered financial markets that followed the "Roaring Twenties" prosperity. For
history has repeated itself with the growth of deregulated financial markets and the
prosperity of the 1990s and early 2ist century ending up in 2008 with the Greatest
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Financial Market Crisis since the Great Depression.
Within a few months, the so called U.S. sub prime mortgage problem that started
in 2007 developed from a small blip on the economic radar screen to a situation that has
caused the collapse of financial markets and threatened the viability of financial
institutions world wide as the contagion spread quickly via the existing international
payments system. If we are to prevent a global Great Depression, it is time to restore
Keynes's vision of how the international payments system should work to permit each
country to promote a national full employment policy without having to fear balance of
payments problems or financial events occurring in other countries from infecting the
domestic banking and financial system.
I. A LESSON FROM THE EARLY POST WORLD WAR II HISTORY
In The General Theory, Keynes argued that if an economy was operating at less than
full employment, then the nation's central bank, while maintaining the stability of
financial markets, should focus on providing all the liquidity that the economy can
absorb in order to reach full employment. For more than a quarter century after following
World War II, the major central banks around the world tried to meet the role that
Keynes had prescribed for them in his General Theory.
From the end of the war until the early 1970s most central banks tended to
provide increases in the money supply in response to any domestic or international
increase in demand for the nation's money , while maintaining interest rates at historic
lows for prosperous times. This endogenous increase in the money supply tended to
3
support expansion of aggregate demand that resulted in a golden age of economic growth
and development for both developed and less developed capitalist economies.
While exchange rates were fixed under the Bretton Woods Agreement, in the
early years after the second world war the United States avoided amassing surplus
international reserves by providing grants to the war torn nations, initially via the
Marshall Plan and then via other foreign aid programs. In essence, the United States
accepted the Keynes Plan suggestion that it is in the best interest of all nations if the
major creditor nation bear the major burden of reducing trade imbalances and
international payments adjustments. As a result of the Marshall Plan, for the first time in
modern history, a post war depression was avoided. The U.S. and its major trading
partners experienced unprecedented long run rates of real economic growth from the end
of the second World War until the early 1970s.
When, in 1973, the U.S. withdrew from the Bretton Woods Agreement, the last
vestiges of Keynes's enlightened monetary approach were lost, apparently without regret
or regard as to
[a] why the Bretton Woods system had been developed in the first place and
[b] how well it had helped the free world to recover from a devastating war which had
destroyed much of the productive stock of capital in Europe and Asia.
In the decades since the breakdown of Bretton Woods, the world's economic
performance has been unable to match what became almost routine economic success in
the quarter century since the end of World War II in terms of low rates of global inflation
accompanied by high rates of employment and real growth. Since 1973, however,
4
international economic problems have multiplied, while significantly high rates of
unemployment in many nations has again become the norm.
Under any traditional international free trade system, any nation that attempts to
improve its economic growth performance by pursuing Keynes's policies for increasing
domestic effective demand via easy monetary and fiscal policies will almost immediately
face an international payments problem. Expanding domestic aggregate demand will
increase the demand for imports relative to the value of exports. When a nation's
imports persistently exceed its exports, the nation typically requires foreign loans to
finance this import surplus that is encouraging increased economic growth in the trading
partners's export industries.
Since 1981 the United States has been the "engine of growth" for most of the rest
of the world, as U.S. ran an unfavorable trade balance as U.S. imports tended to grow
more rapidly than its exports In so doing, the United States has been saddled by
increasing international deficits almost every year for its laudatory efforts.
II. THE BRETTON WOODS EXPERIENCE AND THE MARSHALL PLAN
Too often economic discussions on the requirements for a good international payments
system that would eliminate persistent trade and international payment imbalances have
been limited to the question of the advantages and disadvantages of fixed vs. flexible
exchange rates. As suggested in Davidson [pp. 139-144, 2007] those who champion the
argument for flexible exchange rates most mainstream economists merely assume that
the price elasticities of the demand for imports and exports will meet the Marshall-Lerner
5
condition. Although the question of whether the Marshall-Lerner condition is important
in deciding whether a policy of permitting some flexibility in the exchange rate has
anything to recommend it, the facts of experience since the end of the Second World War
plus Keynes's revolutionary liquidity analysis indicates that more is required, if a
mechanism is to be designed to resolve persistent trade and international payments
imbalances, prevent contagion of financial markets globally, and simultaneously
promoting global full employment, rapid economic growth, and a long-run stable
international standard of value.
Since the second World War, the economies of the capitalist world has conducted
experiments with the different types of exchange rate systems. For more than a quarter
of a century (1947-1973) after the war, nations operated under the Bretton woods
Agreement for a fixed, but adjustable, exchange rate system where, when necessary,
nations could invoke widespread limitations on international financial movements (i.e.,
capital controls). Since 1973, the conventional wisdom of economists and politicians is
that nations should liberalize all financial markets to permit unfettered international
capital flows to operate under a freely flexible exchange rate system. The current
international financial market crisis is a result of permitting unconstrained international
financial flows.
In contrast to the classical view of the desirability of liberalized markets ,
Keynes's position at the 1944 Bretton Woods conference suggested an incompatibility
thesis. Keynes argued that free trade, flexible exchange rates and free capital mobility
across international borders can be incompatible with the economic goal of global full
6
employment and rapid economic growth.
Between 1947 and 1973 policy makers in their actions implicitly recognized
Keynes's incompatibility thesis. This period was, as already noted, an era of sustained
economic growth in both developed and developing countries. Moreover, during this
period, there was "a much better overall record of price level stability" with very high
levels of employment compared to either the post-1973 period or the earlier gold
standard era of fixed exchange rates (1879 - 1914) [McKinnon, 1990, p. 10].
The free world's economic performance in terms of both real growth and price
level stability during the Bretton Woods period of fixed, but adjustable, exchange rates
was unprecedented. Moreover, economic growth rates during the earlier gold standardfixed
exchange rate period, although worse than the Bretton Woods record, was better, on
average, than the global experience during the post 1973 period where liberalizing
exchange rate and financial markets to achieve more flexibility exchange rates has been
the conventional wisdom. The disappointing post-1973 experience of persistent high
rates of unemployment in many nations, bouts of inflationary pressure and slow growth
in many OECD countries, plus debt-burdened growth and/or stagnation (and even falling
real GNP per capita) in developing countries contrasts sharply with the experience during
the Bretton Woods period. Finally in the era of ease of electronic transmission of funds
globally, individual investors and institutions such as pension funds,, local governments,
banks, etc., looking for a slightly greater return on their money than they could obtain
from holding domestic safe investments , reached across national boundaries to purchase
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foreign assets that they did not understand ­ but which were represented as being "as
good as cash".
The significantly superior performance of the free world's economies during the
Bretton Woods fixed rate period compared to the earlier gold standard fixed rate period
suggests that there must have been an additional condition besides exchange rate fixity
that contributed to the unprecedented growth during the 1947-73 period. That additional
condition, as Keynes explained in developing his proposal for the Bretton Woods
Conference, required that any creditor nation that runs persistent favorable trade
payments must accept the major responsibility for resolving these trade imbalances. The
post war Marshall Plan (see infra) was an instance where the creditor nation adopted the
responsibility that Keynes had suggested was required.
III. KEYNES, FREE TRADE AND AN INTERNATIONAL PAYMENTS SYSTEM
To reduce entrepreneurial uncertainties and the possibility of massive currency
misalignments in any fixed exchange rate system, Keynes recommended the adoption of
a fixed, but adjustable, exchange rate system. More importantly, Keynes argued that the
"main cause of failure" of any traditional international payments system -- whether
based on fixed or flexible exchange rates-- was its inability to actively foster continuous
global economic expansion whenever persistent trade payment imbalances occurred
among trading partners. This failure, Keynes [1941, p. 27] wrote,
"can be traced to a single characteristic. I ask close attention to this, because I
shall argue that this provides a clue to the nature of any alternative which is to be
successful.
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It is characteristic of a freely convertible international standard that it throws the
main burden of adjustment on the country which is the debtor position on the
international balance of payments - that is, on the country which is (in this
context) by hypothesis the weaker and above all the smaller in comparison with
the other side of the scales which (for this purpose) is the rest of the world".
Keynes concluded that an essential improvement in designing any international
payments system requires transferring the onus of adjustment from the debtor to the
creditor position. This transfer would substitute an expansionist, in place of a
contractionist, pressure on world trade [Keynes, 1941, pp. 29-30]. To achieve a golden
era of economic development Keynes recommended combining a fixed, but adjustable,
exchange rate system with a mechanism for requiring the nation "enjoying" a favorable
balance of trade to initiate most of the effort necessary to eliminate this imbalance, while
"maintaining enough discipline in the debtor countries to prevent them from exploiting
the new ease allowed them" [Keynes, 1941, p. 30].
After World War II, the war-torn capitalist nations in Europe did not have
sufficient undamaged resources available to produce enough to feed its population and
rebuild its economy. Economic rebuilding would require the European nations to run
huge import surpluses with the United States in order to meet their economic needs for
recovery. During the war, the European nations had run down their foreign reserves to
extremely low levels. To obtain the necessary imports from the United States, under a
laissez-faire system, it would be necessary for the United States to provide enormous
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loans to finance the required U.S. export surplus to Europe. The resulting European
indebtedness would be so burdensome that it was unlikely that, even in the long run, the
European nations could ever service such debt obligations.
Private lenders in the United states were mindful that German reparation
payments to the victorious Allied nations after World War I were often financed by U.S.
investors lending to Germany (e.g., the Dawes Plan). Germany never repaid these loans.
Given this history and existing circumstances it was obvious that private lending
facilities could not be expected to provide the credits necessary for European recovery
after World War II.
The Keynes Plan, presented at the 1944 Bretton Woods conference, would require
the United States, as the obvious major creditor nation, to accept the major responsibility
for curing the international financial problems that would be associated with the post-war
European nations need for U.S. imports. Keynes estimated that the European nations
might require imports in excess of $10 billion to rebuild their economies. The U.S.
representative to the Bretton Woods Conference, Harry Dexter White, rejected the
Keynes Plan. Dexter White argued that Congress would be willing to provide, at most,
$3 billion as the U.S. contribution to solving this post war international financial
problem.
The White Plan created the International Monetary Fund (IMF) whose function it
would be to provide short-term loans to nations running unfavorable balances of trade.
These loans were suppose to give the debtor nation time to get its economic house in
order. The White Plan had the U.S. subscribing to a maximum of $3 billion as its
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contribution to the IMF lending facilities. White's plan also developed another lending
institution, now called the World Bank, that would borrow funds from the private sector.
These funds would then be used to provide long-term loans for rebuilding capital
facilities and making capital improvements initially in the war-torn nations and later in
the less developed countries. White's plan was basically the institutional arrangements
adopted at the Bretton Woods Conference.
Under the White Plan, international loans from the IMF or the World Bank were
the only available sources for financing the huge volume of U.S. imports that the wartorn
nations would require immediately after the war. This would result in a huge
international indebtedness of these nations. Even if the nations could obtain a sufficient
volume of loans to finance their import necessities for rebuilding, servicing the resultant
immense debt of these nations would require them o accept the main burden of
adjustment by "tightening their belt". To tighten the nation's belt is a catch phrase to
indicate that the debtor nations have to reduce dramatically their need for imports. The
ultimate result would be a significant decline in the standard of living in these countries
which probably would have led to political and social unrest in these nations..
Even if the debtor nations had abandoned the Bretton Woods fixed exchange rate
mechanism and opted for a depreciating currency under a flexible exchange rate system
to force the European residents to "tighten their belts", the result would have reduced the
Europeans to almost a starvation level of income. Accordingly, any conventional free
market solution available to the European nations after World War II to obtain U.S.
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imports for rebuilding their economy would so depressed the standard of living as to
possibly inducing political revolutions in most of Western Europe.
To avoid the possibility of many European nations facing a desperate electorate
that might opt for a communist system when faced with the dismal future that the
conventional Bretton Woods system offered, the United States produced the Marshall
Plan and other foreign grants and aid programs to assure that Communism did not spread
West from the Soviet Union. Despite White's argument that the U.S. would not be
willing to give more than $3 billion to solving this international payments problem, the
Marshall Plan provided $5 billion in foreign aid in 18 months and a total of $13 billion in
four years. (Adjusted for inflation, this sum is equivalent to approximately $135 billion
in 2007 dollars.) The Marshall plan was essentially a four year gift of $13 billion worth
of U.S. exports to the war devastated nations
The Marshall plan gift gave the recipient nations claim to approximately 2 per
cent of the total output (Gross Domestic Product) of the United States for four years from
1947 to 1951.. Yet no U.S. resident felt deprived of goods and services even as the
Marshall Plan recipients essentially siphoned off $2 out of every $100 worth of goods
produced in the United States. Real gross national income (GNP) per capita in the United
States (a measure of the U.S. standard of living) during the first year of the Marshall Plan
was still 25% larger than it had been in the last peacetime year of 1940. Per capita GNP
continued to grow throughout the 1950s.
Despite Americans giving away 2 per cent of their income per annum, there was
no real sacrifice for Americans associated with the Marshall Plan as the remaining
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income was significantly greater than pre-war levels. The resulting U.S. exports that
Marshall plan funds recipient nation's were able to purchase created significant
increases in employment in U.S. export industries just as the federal government severely
reduced its spending while several million men and women were discharged from the
U.S. armed forces and entered the U.S. labor force looking for jobs. For the first time in
its history, the United States did not suffer from a severe recession immediately after the
cessation of a major war. The U.S. and most of the rest of the world experienced an
economic "free lunch" as both the potential debtor nations and the creditor nation
experienced tremendous real economic gains resulting from the Marshall Plan and other
foreign aid give aways.
By 1958, however, although the U.S. still had an annual goods and services
export surplus of over $5 billion, U.S. governmental foreign and military aid exceeded $6
billion, while there was a net private capital outflow of $1.6 billion. The post-war U.S.
potential surplus on international payments balance was at an end.
As the U.S. current international payments account swung into deficit in 1958
other nations began to experience payments surpluses. These credit surplus nations did
not spend their entire payments surpluses. Instead they used a portion of their annual
dollar surpluses to purchase international liquid assets in the form of gold reserves from
the U.S. Federal Reserve System. For example, in 1958, the U.S. lost over $2 billion in
gold reserves to foreign central banks. These trends accelerated in the 1960s, partly as a
result of increased U.S. military and financial aid responses to the construction of the
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Berlin Wall in 1961 and later because of the U.S.'s increasing involvement in Vietnam.
At the same time, a rebuilt Europe and Japan became important producers of exports so
that the rest of the world became less dependent on the U.S. exports.
Still the United States maintained a positive merchandise trade balance until the
first oil price shock in 1973. More than offsetting this merchandise trade surplus during
most of the 1960s, however, were foreign and military aid plus net capital outflows from
the United States so that the United States experienced an annual unfavorable balance of
international payments. The Bretton Woods system had no way of automatically forcing
the emerging surplus nations to stop accumulating dollar surplus and instead step into the
creditor adjustment role that the U.S. had been playing since 1947. Instead the surplus
nations continued to converted some portion of their annual dollar surpluses into calls on
U.S. gold reserves. The seeds of the destruction of the Bretton Woods system and the
golden age of economic development were being sown as surplus nations drained gold
reserves from the United States.
When the U.S. closed the gold window and unilaterally withdrew from Bretton
Woods in 1971, the last vestige of Keynes's enlightened international monetary approach
was lost..
IV. CHANGING THE INTERNATIONAL PAYMENTS SYSTEM
The 1950-1973 global golden age of economic development required international
institutions and U.S. government foreign aid policies that operated on principles inherent in
the Keynes Plan with the creditor nation accepting the major responsibility for solving
international payments imbalance. The formal Breton Woods agreement, however, did not
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require creditor nations to take such actions. Since 1973, the international payments system
has been one where international payments considerations often impede any rapid
economic growth of many of the developed nations of the world while severely
constraining the growth of the least developed countries (LDCs).
Utilizing Keynes's general theory principles, it is possible to update Keynes's
original plan for a postwar international monetary scheme that will promote global
economic prosperity. For "to suppose [as the conventional wisdom does] that there exists
some smoothly functioning automatic [free market] mechanism of adjustment which
preserves equilibrium if only we trust to methods of laissez-faire is a doctrinaire delusion
which disregards the lessons of historical experience without having behind it the support
of sound theory" [Keynes, 1941, pp. 21-2]
In the 21 century interdependent global economy, a substantial degree ofst
economic cooperation among trading nations is essential. The original Keynes Plan for
reforming the international payments system called for the creation of a single
Supranational Central Bank. The clearing union institution suggested infra is a more
modest proposal than the Keynes Plan, although it operates under the same economic
principles laid down by Keynes. Our proposal is aimed at obtaining an acceptable
international agreement (given today's political climate in most nations) that does not
require surrendering national control of either local banking systems or domestic
monetary and fiscal policies. Each nation will still be able to determine the economic
destiny that is best for its citizens without fear of importing deflationary repercussions
and financial disruptions from their trading partners. Each nation, however, will not be
15
able to export any domestic inflationary forces to their international neighbors.
What is required is a closed, double-entry bookkeeping clearing institution to
keep the payments `score' among the various trading nations plus some mutually agreed
upon rules to create and reflux international liquidity while maintaining the purchasing
power of the created international currency of the international clearing union. The eight
provisions of the international clearing system suggested in this chapter meet the
following criteria. The rules of the proposed system are designed
[1] to prevent a lack of global effective demand either due to a liquidity problem1
arising whenever any nation(s) holds either excessive idle reserves or drain reserves from
the system, or a financial crisis occurring in any nation's banking and asset marketing
system spilling over to create liquidity and insolvency problems for residents and
financial institutions in other nations.
[2] to provide an automatic mechanism for placing a major burden of correcting
international payments imbalances on the surplus nations,
[3] to provide each nation with the ability to monitor and, if desired, to control
international movements of funds to prevent contagion from financial problems
occurring in other nations, tax evasion money movements, earnings from illegal
activities, and even funds that finance terrorist operations, and finally
[4] to expand the quantity of the liquid asset used in settling international
contracts (the asset of ultimate redemption) as global capacity warrants while protecting
the purchasing power of this asset.
There are eight major provisions in this clearing system proposal. They are:
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1. The unit of account and ultimate reserve asset for international liquidity is the
International Money Clearing Unit (IMCU). All IMCU's can be held only by the central
banks of nations that abide by the rules of the clearing union system. IMCUs are not
available to be held by the public.
2. Each nation's central bank or, in the case of a common currency (e.g., the
Euro) a currency union's central bank, is committed to guarantee one way convertibility
from IMCU deposits at the clearing union to its domestic money. Each central bank will
set its own rules regarding making available foreign monies (through IMCU clearing
transactions) to its own bankers and private sector residents.
Since Central Banks agree to sell their own liabilities (one-way convertibility)
against the IMCU only to other Central Bankers via the International Clearing Union
while they simultaneously hold only IMCUs as liquid reserve assets for international
financial transactions, there can be no draining of reserves from the international
payments system. Ultimately, all major private international transactions clear between
central banks' accounts in the books of the international clearing institution.
The guarantee of only one-way convertibility permits each nation to institute
controls and regulations on international capital fund flows if necessary. The primary
economic function of these international capital flow controls and regulations is to
prevent rapid changes in the bull-bear sentiment from overwhelming the market maker and
inducing dramatic changes in international financial market price trends that can have
devastating real consequences.
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There is a spectrum of different capital controls available. At one end of the
spectrum are controls that primarily impose administrative constraints either on a case-bycase
basis or an expenditure category basis. Such controls may include administrative
oversight and control of individual transactions for payments to foreign residents (or banks)
often via oversight of international transactions by banks or their customers. Other capital
controls might include the imposition of taxes (or other opportunity costs) on specific
international financial transactions, e.g., the 1960s United States Interest Equalization Tax.
Finally there can be many forms of monetary policy decisions undertaken to affect
net international financial flows, e.g., raising the interest rate to slow capital outflows,
raising bank reserve ratios, limiting the ability of banks to finance purchases of foreign
securities, and regulating interbank activity.
The IMF, as lender of last resort during the 1997 East Asian contagion crisis,
imposed the same conditions on all nations requiring loans for international liquidity
purposes. The resulting worsening of the situation should have taught us that in policy
prescriptions one size does not fit all situations. Accordingly, the type of capital regulation
a nation should choose from the spectrum of tools available at any time will differ
depending on the specific circumstances involved. It would be presumptuous to attempt to
catalog what capital regulations should be imposed for any nation under any given
circumstances. Nevertheless, it should be stressed that regulating capital movements may
be a necessary but not a sufficient condition for promoting global prosperity. Much more is
required.
If any government objects to the idea that the IMCU proviso #2 provides
governments with the ability to limit the free movement of "capital" funds, then this
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nation is free to join other nations of similar attitude in forming a regional currency union
and thereby assuring a free flow of funds among the residents of the currency union.
3. Contracts between private individuals in different nations will continue to be
denominated into whatever domestic currency permitted by local laws and agreed upon
by the contracting parties. Contracts to be settled in terms of a foreign currency will
therefore require some publically announced commitment from the central bank (through
private sector bankers) of the availability of foreign funds to meet such private
contractual obligations.
4. The exchange rate between the domestic currency and the IMCU is set initially
by each nation or currency union's central bank-- just as it would be if one instituted an
international gold standard. Since private enterprises that are already engaged in trade
have international contractual commitments that would span the changeover interval
from the current system, then, as a practical matter, one would expect, but not demand,
that the existing exchange rate structure (with perhaps minor modifications) would
provide the basis for initial rate setting.
Provisions #7 and #8 infra indicate when and how this nominal exchange rate
between the national currency and the IMCU would be changed in the future.
5. An overdraft system should be built into the clearing union rules. Overdrafts
should make available short-term unused creditor balances at the Clearing House to
finance the productive international transactions of others who need short-term credit.
The terms will be determined by the pro bono publico clearing union managers.
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6. A trigger mechanism to encourage any creditor nation to spend what is deemed
(in advance) by agreement of the international community to be "excessive" credit
balances accumulated by running current account surpluses. These excessive credits can
be spent in three ways: (1) on the products of any other member of the clearing union, (2)
on new direct foreign investment projects, and/or (3) to provide unilateral transfers
(foreign aid) to deficit members. Spending via (1) forces the surplus nation to make the
adjustment directly by way of the trade balance on goods and services. Spending by way
of (3) permits adjustment directly by the capital account balance, while (2) provides
adjustment by the capital accounts (without setting up a contractual debt that will require
reverse current account flows in the future).
These three spending alternatives force the surplus nation to accept a major
responsibility for correcting the payments imbalance. Nevertheless this provision gives
the surplus country considerable discretion in deciding how to accept the onus of
adjustment in the way it believes is in its residents best interests. It does not permit the
surplus nation to shift the burden to the deficit nation(s) via contractual requirements for
debt service charges independent of what the deficit nation can afford. The important
thing is to make sure that continual oversaving by the surplus nation in the form of
international liquid reserves are not permitted to unleash depressionary forces and/or a
building up of international debts so encumbering as to impoverish the global economy
of the 21 century.
In the unlikely event that the surplus nation does not spend or give away these
credits within a specified time, then the clearing agency would confiscate (and
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redistribute to debtor members) the portion of credits deemed excessive. This last resort
confiscatory action (a 100% taxes on excessive liquidity holdings) would make a
payments adjustment via unilateral transfer payments in the current accounts.
Under either a fixed or a flexible rate system with each nation free to decide on
how much it will import, some nations will, at times, experience persistent trade deficits
merely because their trading partners are not living up to their means -- that is because
other nations are continually hoarding a portion of their foreign export earnings (plus net
unilateral transfers). By so doing, these oversavers are creating a lack of global effective
demand. Under provision #6, deficit countries would no longer have to deflate their real
economy in an attempt to reduce imports and thereby reduce their payment imbalance
because others are excessively oversaving. Instead, the system would seek to remedy the
payment deficit by increasing opportunities for deficit nations to sell abroad and thereby
work their way out of their deteriorating debtor position.
7. A system to stabilize the long-term purchasing power of the IMCU (in terms
of each member nation's domestically produced market basket of goods) can be
developed. This requires a system of fixed exchange rates between the local currency and
the IMCU that changes only to reflect permanent increases in efficiency wages. This
assures each central bank that its holdings of IMCUs as the nation's foreign reserves will
never lose purchasing power in terms of foreign produced goods. If a foreign government
permits wage-price inflation to occur within its borders, then, the exchange rate between
the local currency and the IMCU will be devalued to reflect the inflation in the local
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money price of the domestic commodity basket. For example, if the rate of domestic
inflation was 5 cent, the exchange rate would change so that each unit of IMCU could
purchase 5 per cent more of the nation's currency.
If, on the other hand, increases in productivity lead to declining production costs
in terms of the domestic money, then the nation with this decline in efficiency wages [say
of 5 per cent] would have the option of choosing either [a] to permit the IMCU to buy [up
to 5 per cent] less units of domestic currency, thereby capturing all (or most of) the gains
from productivity for its residents while maintaining the purchasing power of the IMCU,
or [b] to keep the nominal exchange rate constant. In the latter case, the gain in
productivity is shared with all trading partners. In exchange, the export industries in this
productive nation will receive an increasing relative share of the world market.
By devaluing the exchange rate between local monies and the IMCU to offset the
rate of domestic inflation, the IMCU's purchasing power is stabilized. By restricting use
of IMCUs to Central Banks, private speculation regarding IMCUs as a hedge against
inflation is avoided. Each nation's rate of inflation of the goods and services it produces
is determined solely by (a) the local government's policy toward the level of domestic
money wages and profit margins vis-a-vis productivity gains, i.e., the nation's efficiency
wage. Each nation is therefore free to experiment with policies for stabilizing its
efficiency wage to prevent inflation as long as these policies do not lead to a lack of
global effective demand. Whether the nation is successful or not in preventing domestic
goods price inflation, the IMCU will never lose its international purchasing power in
terms of any domestic money. Moreover, the IMCU has the promise of gaining in
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purchasing power over time, if productivity grows more than money wages and each
nation is willing to share any reduction in real production costs with its trading partners.
Provision #7 produces a system designed to, at least, maintain the relative
efficiency wage parities amongst nations. In such a system, the adjustability of nominal
exchange rates will be primarily (but not always, see Provision #8) to offset changes in
efficiency wages among trading partners. A beneficial effect that follows from this
proviso is that it eliminates the possibility that a specific industry in any nation can be put
at a competitive disadvantage (or secure a competitive advantage) against foreign
producers solely because the nominal exchange rate changed independently of changes in
efficiency wages and the real costs of production in each nation.
Consequently, nominal exchange rate variability can no longer create the problem
of a loss of competitiveness due solely to the overvaluing of a currency as, for example,
experienced by the industries in the American "rust belt" during the period 1982-85.
Even if temporary, currency appreciation independent of changes in efficiency wages can
have significant permanent real costs as domestic industries abandon export markets and
lose domestic market business to foreign firms and the resultant existing excess plant and
equipment is cast aside as too costly to maintain.
Proviso #7 also prevents any nation from engaging in a beggar-thy-neighbor,
export-thy-unemployment policy by pursuing a real exchange rate devaluation that does
not reflect changes in efficiency wages. Once the initial exchange rates are chosen and
relative efficiency wages are locked in, reduction in real production costs which are
23
associated with a relative decline in efficiency wages is the main factor (with the
exception of provision #8) justifying an adjustment in the real exchange rate.
Although provision #6 prevents any country from piling up persistent excessive
surpluses, this does not mean that it is impossible for one or more nations to run
persistent deficits. Consequently proposal #8 infra provides a program for addressing the
problem of persistent international payment deficits in any one nation.
8. If a country is at full employment and still has a tendency toward persistent
international deficits on its current account, then this is prima facie evidence that it does
not possess the productive capacity to maintain its current standard of living. If the deficit
nation is a poor one, then surely there is a case for the richer nations who are in surplus to
transfer some of their excess credit balances to support the poor nation. (This is
equivalent t6o a negative income tax concept.) If the deficit nation is a relatively rich
country, then the deficit nation must alter its standard of living by reducing its relative
terms of trade with its major trading partners. Rules, agreed upon in advance, would
require the trade deficit rich nation to devalue its exchange rate by stipulated increments
per period until evidence becomes available to indicate that the export-import imbalance
is eliminated without unleashing significant recessionary forces.
If, on the other hand, the payment deficit persists despite a continuous positive
balance of trade in goods and services, then there is evidence that the deficit nation might
be carrying too heavy an international debt service obligation. The pro bono officials of
the clearing union should bring the debtor and creditors into negotiations to reduce
annual debt service payments by [1] lengthening the payments period, [2] reducing the
24
interest charges, and/or [3] debt forgiveness.
It should be noted that proviso #6 embodies Keynes's innovative idea that
whenever there is a persistent (and/or large) imbalance in current account flows, whether
due to capital flight or a persistent trade imbalance, there must be a built-in mechanism
that induces the surplus nation(s) to bear a major responsibility for eliminating the
imbalance. The surplus nation must accept this burden for it has the wherewithal to
resolve the problem.
In the absence of proviso #6, under any conventional system, whether it has fixed
or flexible exchange rates and/or capital controls, there can ultimately be an international
liquidity crisis (as any persistent current account deficit can deplete a nation's foreign
reserves) that unleashes global depressionary forces. Thus, proviso #6 is necessary to
assure that the international payments system will not have a built-in depressionary bias.
Ultimately then it is in the self-interest of the surplus nation to accept this responsibility,
for its actions will create conditions for global economic expansion some of which must
redound to its own residents. Failure to act, on the other hand, will promote global
depressionary forces which will have some negative impact on its own residents
.REFERENCE
Davidson, P. (2007) John Maynard Keynes (Palgrave, London and New York, 2007)
Keynes, J. M. (1936a) The General Theory of Employment Interest and Money
McKinnon, R.I. (1990) "Interest Rate Volatility and Exchange Rate Risk" Contemporary
Policy Studies, 8,pp. 79-91.
25
Keynes, J. M. (1941) "Post War Currency Policy" reprinted in The Collected Writings of
J. M. Keynes, 25 , (Macmillan, London 1980), edited by D. Moggridge. All page
references are to the 1980 reprint.
McKinnon, R. I. (1990) "Interest rate Volatility and Exchange Rate Risk: New Rules For
A common Monetary Standard" Contemporary Policy Studies, 8, pp. 79-91.