I should be at the INET conference in Bretton Woods this weekend but a scheduling conflict stopped me – plus all the hotels were booked (that’s the real reason I didn’t go). If I am invited next year, I will be sure to make proper arrangements early because it sounds like the event is generating very useful discussion. I have already flagged the talk at INET of expansionary fiscal contractions that popped up in an article on Larry Summers. I have seen this term used elsewhere now and think it’s a better way to explain austerity. I promise to come back to this issue later.
But now, I have come across another subject being discussed at INET, reserve currencies. Joseph Stiglitz is reviving the issue. I have talked a little about this in the past, in particular about the Triffin Dilemma and how the U.S.’s status as the world’s reserve currency makes current account imbalances endemic for the U.S..
The U.S. dollar is the world’s major reserve currency. Especially in the post-Bretton Woods world, this has meant capital account surpluses as foreigners accumulate U.S. dollar reserves. These capital account surpluses translate into current account deficits. So the "normal" situation, as Randy [Wray] put it, absent a depreciating dollar, is a U.S. current account deficit.
Read that post for more on this. I think the bottom line is twofold. Not only does the dollar’s status make a current account deficit the normal situation for the U.S., it also sets us up for trade tension in economic downturns. We saw this tension in the 1980s and 1990s with Japan and Germany and we are seeing it more now with China.
The solution pre-1971 was the gold standard. The purpose of gold is both to limit money creation and to simultaneously keep trade imbalances in check. But, as we saw leading up to the Great Depression, the trade balances persisted. There was a lot of talk last year about so-called gold hoarding, by France in particular, as a cause of the Depression due to a paper by Douglas Irwin called Did France Cause the Great Depression? on this issue. Trade surplus nations like France and the U.S. hoarded gold while trade deficit nations had a shortage of gold. So the trade balances persisted. And when the Great Depression came, protectionist sentiment driven by those same trade issues and the inflexibility of the Gold Standard insured a deflationary outcome that was catastrophic.
Then, the world’s powerful nations met in Bretton Woods to set up a new world order. John Maynard Keynes pushed an idea that ended the gold tether using a new reserve currency called the Bancor.
Here’s the Wikipedia description below:
Bancor was the name of the supranational currency that John Maynard Keynes conceptualised in the years 1940-42 and which the United Kingdom proposed to introduce after the Second World War. This newly created supranational currency would then be used in international trade as a unit of account within a multilateral barter clearing system – the International Clearing Union – which would also have to be founded. The Bancor was to be backed by barter and its value expressed in weight of gold. However, this British proposal of introducing a supranational currency could not prevail against the interests of the United States, which at the Bretton Woods conference established the U.S. dollar as world key currency.
Since the outbreak of the financial crisis in 2008 Keynes’s proposal has been revived: In a speech delivered in March 2009 entitled Reform the International Monetary System, Zhou Xiaochuan, the governor of the People’s Bank of China called Keynes’s bancor approach "farsighted" and proposed the adoption of IMF SDRs as a global reserve currency as a response to the financial crisis of 2007–2010. He argued that a national currency was unsuitable as a global reserve currency because of the Triffin dilemma – the difficulty faced by reserve currency issuers in trying to simultaneously achieve their domestic monetary policy goals and meet other countries’ demand for reserve currency. A similar analysis can be found in the Report of the United Nation’s "Experts on reforms of the international monetary and financial system" as well as in the IMF’s study published on April 13, 2010
According to an article on Bloomberg, Stiglitz has re-introduced this concept in order to stave off the trade imbalances which are the sticky wicket in the currency wars and in protectionist sentiment in the U.S., the major deficit nation. Obviously, this won’t solve the euro’s internal trade problems but it could have an effect on China – U.S tensions.
The world economy needs a new global reserve currency to help prevent trade imbalances that are reflected in the national debt of the U.S., said Nobel-prize winning economist Joseph Stiglitz.
A “global system” is needed to replace the dollar as a reserve currency and help avoid a weakening of U.S. credit quality, said Stiglitz, a professor at Columbia University in New York. The dollar fell to an almost 15-month low against the euro last week, and the U.S. trade deficit widened more than forecast in January to the highest level in seven months.
“By taking off the burden of any single country, we don’t have to have trade deficits,” Stiglitz said in an interview in Bretton Woods, New Hampshire. “Things would be much worse if it were not the case that Europe was having even more of a problem, but winning a negative beauty pageant is not the way to create a strong economy.”
The article goes on to discuss government budget deficits, which are not directly connected to this issue but that Stiglitz also mentions, saying:
Overseas holdings of dollar reserves rose to $3.14 trillion in the fourth quarter of last year, according to International Monetary Fund figures.
“Reserves are IOU’s,” Stiglitz said. “When IOU’s get big enough, people start saying maybe you’re not a good credit risk. Or at least, they would change in their sentiment about credit risk.”
This topic needs a lot more attention. And I think today’s so-called Bretton Woods II fiat system is unstable. Excess money creation and trade imbalances are secular problems that fiat currency has allowed to become destabilizing. If countries like the U.S. can create as much money as they want and run current account deficits as large as they want without any constraint, isn’t it likely that credit growth will always eventually outstrip nominal economic growth? Isn’t it equally likely that this will always lead to a destabilising financial crisis and the recrimination that global trade imbalances create? That’s my takeaway at least.
Despite Stiglitz’s efforts and the attention paid to this issue by economist Paul Davidson, I doubt we are going to get a voluntary departure from the existing monetary system. I say wait for the next crisis for reform of the monetary system. That is when the issue will be urgent and resonate more with policy makers.