Download 1 THE KEYNES SOLUTION FOR PREVENTING GLOBAL

THE KEYNES SOLUTION FOR PREVENTING GLOBAL IMBALANCES
By PAUL DAVIDSON,
Editor Journal of Post Keynesian Economics
(Paper presented at conference on AFrom Crisis to Growth? The challenge of imbalances, debt
and limited resources@ Berlin , Germany, October 28, 2011BResearch Network
Macroeconomics and Macroeconomic Policies [FMM])
The mainstream economic solution for curing persistent global imbalances in international
payments is for the deficit nation(s) to become Amore competitive@ to increase exports and
reduce imports. Traditionally this has meant that the deficit nation should devalue its currency in
terms of exchange rates and/or reduce money wage rates and fringe benefit costs thereby
reducing production costs relative to the nation=s trading partners. This is still the orthodox
solution despite the experience of the Acompetitive@ exchange rate wars of the 1930s.These
exchange rate devaluations were seen as a way to becoming more competitive and therefore
Aexporting your unemployment@ to your trading partners. The result was to increase global
depressionary forces. As a sage once said: AThose who do not study history tend to repeat its
errors@. Most of today=s central bankers and politicians are on track to repeating historical
economic errors
When Greece=s international debt problem became obvious, many observers suggested
that if Greece was to resigned from the Euro and reinstate the drachma as the nation=s currency,
its problem could be solved by reducing the exchange rate of its drachma currency relative to
those of its trading partners. For example, the New York Times :@[Returning Greece to the
Drachma@; september12/ 2011 page B2] noted that Areturning Greece to the drachma, would
allow market forces to set the country=s wage levels.... Greece=s continuing current account
deficit....indicates that it remains deeply uncompetitive.... Greece may require living standards
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[i.e., wages] to decline by as much as 40 per cent to become competitive....the drachma=s value
would fall sharply....The equilibrium drachma would make Greek workers internationally
competitive. Greece also could achieve a trade surplus... [devaluation] would help push
unemployment down rapidly...Good behavior would result from self-discipline alone.@
Even today Central Bankers recommend this competitive solution to international
payment imbalances. For example, at the annual central bankers Jackson Hole August 2011
conference, the New York Times reported that the European Central Banker Jean-Claude Trichet
did not mention the European debt crisis, nor the ECU=s purchases of Italian and Spanish bonds
to contain runaway borrowing costs of European governments. The Times noted AInstead, Mr.
Trichet suggested that Europe=s problems are fundamentally a question of which governments
have taken steps to promote growth and become competitive and which have not.@ Trichet is
then quoted as saying
AGreece, Portugal and Ireland, in particular have progressively lost competitiveness visa-vis their main trading partners in Europe. Germany is now an example of how big
dividends of reform can be if structural adjustment is made a strategic priority and
implemented with sufficient patience@. [AIMF Chief Chastises Policy Makers@, The
New York Times, August 28, 2011, Italics added]
Germany=s positive trade balance must create negative trade balances with at least some
of its trading partners such as Greece, Portugal, and Ireland. Of course, if these latter nations
were to succeed in achieving a new level of competitiveness (as Mr. Trichet suggests), then they
will have reduced the production costs of labor relative to German workers and therefore the real
income of workers in Greece, Portugal, etc. If these nations successfully become more
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competitive and expand their exports, then their Euro trading partner nations such as Germany
must become relatively less competitive and lose export market share as well as shares in
domestic markets where the now newly more competitive nations can inundate.
In his September 2011 speech to Congress urging the passage of a jobs bill, President
Obama ultimately endorsed the same classical canard of solving jobs and payment problems via
competitive free trade. The long run solution of the US unemployment problem and thereby
restoring prosperity, President Obama indicated, will rely on
Aa series of trade agreements that would make it easier for American companies to sell
their products in Panama, Columbia, and South Korea B while helping the [American]
workers whose jobs have been affected by global competition. If Americans can buy
Kias and Hundais, I want the folks in South Korea driving Fords and Chevys and
Chryslers. I want more products sold around the world with three proud words >Made in
America=@.
As Keynes [ANational Self-Sufficiency@ (1933) reprinted in The Collected Writings of
John Maynard Keynes, vol. 21, p. 238] noted , however, AExperience accumulates to prove that
most modern production processes can be performed in most countries with equal efficiency@.
If, therefore, labor costs per man-hour in places like China and Korea are at no more than 10 per
cent of the American auto companies labor costs of producing the identical Fords, Chevys, etc in
the USA with the same technology, then American auto companies will produce cars at lower
costs in Asia for the Asian market rather than hiring workers in the USA. Only if American
wages can be pushed down by more than 90 percent so as to be competitive with those of Asian
workers, will American companies even consider selling cars that are really AMade in America@
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in foreign markets. In other words, the labor costs of America=s mass production industries
must become Acompetitive@ with production costs in cheap foreign labor markets before the
AMade in America@ label on autos, that President Obama endorses, will create employment in
the USA i .
Keynes [1936, pp. 382-383, Italics added] noted
Awhilst economists were accustomed to applaud the prevailing international system as
furnishing the fruits of the international division of labour and harmonizing at the same time the
interests of different nations, there lay concealed a less benign influence...if nations can learn to
provide themselves with full employment by their domestic policy, there need be no important
economic forces calculated to set the interests of one country against that of its neighbours...
There would still be room ...for international lending in the appropriate circumstances. But there
would no longer be a pressing motive why one country need force its wares on another or
repulse the offerings of its neighbour, not because this was necessary to enable it to pay for what
it wished to purchase, but with the express object of upsetting the equilibrium of payments so as
to develop a balance of trade in its favour. International trade would cease to be what it is,
namely, a desperate expedient to maintain employment at home by forcing sales on foreign
markets ...which, if successful will merely shift the problem of unemployment to the neighbour
which is worsted in the struggle.@
It is time to revive Keynes=s analysis of the perverse problems raised by the current
system of international trade and payments, of using bank credit to buy foreign assets, of
outsourcing, and of a blind desire for free trade at all costs. We must make central bankers and
government policy decision makers aware of the Keynes=s Solution for preventing international
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global payment imbalances while pursuing policies that assure global economic prosperity. For
if policy makers such as Chancellor Merkel, Banker Trichet and President Obama continue to
urge policies based on the classical theory=s long run solution, then as Keynes said AIn the long
run, we will all be dead@ and the long run will not be very far away.
We must instead pursue policies that bring producer and consumer of products and
services withing the same scope of national economic and financial institutions to assure full
employment. To do this we must reform the world=s monetary payment system to prevent
stimulus policies in any one nation creating import-export imbalance problems with its trading
partners as the domestic stimulus policy induces Amultiplier@ employment in the trading
partners. For if the latter occurs, then the only solution for the nation with a significant deficit
international payments problem will be Aausterity@ which by itself will be inadequate to
rebalance international payments among nations.
REFORMING THE WORLD=S MONEYB AN UPDATED KEYNES PLAN
The Bretton Woods Solution
Since the Second World War, the economies of the capitalist world have conducted experiments
with the different types of exchange rate systems. For almost a quarter of a century after the war
(1947-1971), nations operated under the 1944 international Bretton Woods Agreement that
provided 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
the 1970s, as many economists abandoned any support for Keynes=s policies and instead
accepted the classical theory of efficient markets as correct dogma, the conventional wisdom of
economists and politicians has been that nations should liberalize all financial markets to permit
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unfettered international capital flows to operate under a freely flexible exchange rate system.
As the second world war was winding down, the victorious Allied nations called a
conference at Bretton Woods in New Hampshire. The purpose of this Bretton Woods conference
was to design a post war international payment system that avoided creating conditions for
another Great Depression. Keynes was the chief representative of the United Kingdom
delegation at this Bretton Woods conference.
In contrast to the classical view of the desirability of free exchange rate markets,
Keynes=s position at Bretton Woods was that there is an incompatibility thesis in the classical
approach to international trade and finance. Keynes argued that permitting free trade, flexible
exchange rates and free capital mobility across international borders can be incompatible with
the economic goal of global full employment and rapid economic growth. Keynes offered an
alternative to the classical approach to the problem. This alternative was the AKeynes Plan@
solution, that would make international trade and financial flow arrangements to assure global
full employment and vigorous economic growth.
The United States delegation at the Bretton Woods conference was the most important
participant. It was clear that nothing could be done unless the United States delegation agreed to
any plan that was developed at the conference. The United States delegation, led by Harry
Dexter White, vetoed the Keynes Plan. Instead, the United States proposal set up the
International Monetary Fund (IMF) and what we now call the World Bank. The IMF and World
Bank institutions were supposed to deal with persistent international trade imbalances and any
potential international debt problems of nations. The evidence of persistent trade imbalances and
growing international indebtedness including the collapse of US mortgage backed security
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derivatives market and the possibility of Asovereign debt failures@among Euro nations indicates
that the IMF and World bank have failed in their mission. [Although, as noted in endnote 7, the
new IMF managing director, Christine Lagarde, has suggested a principle that is at the crux of
the AKeynes Plan@.]
Even though the Keynes Plan was rejected at Bretton Woods,, between 1947 and 1971
whenever imbalances in trade or international payments occurred, policy makers often
undertook actions that would have been normal under the Keynes Plan. For example, during the
period between the end of the second world war and 1971, whenever serious international
payment problems arose, many developed nations, including the United States, instituted capital
control policies. Capital control policies are designed to constrain the international flow of
capital funds across national boundaries B a policy that is directly contrary to the idea that free
markets means free movement of capital funds across national borders.
Despite such anti-free market government policies, this post war period until 1971 was an
era of sustained economic growth in both developed and developing countries. It was truly a
golden age of economic development for capitalist nations throughout the world. Moreover,
during this period, there was a much better overall record of price level stability associated with
these very high levels of employment compared to either the record since 1972 or the historical
record of the earlier gold standard era of fixed exchange rates (1879 - 1914).
The free world's economic performance in terms of both economic growth and price level
stability during this Bretton Woods period of fixed, but adjustable, exchange rates was
unprecedented. Economic growth rates during the earlier gold standard-fixed exchange rate
period, although worse than the Bretton Woods record, is better than the global experience since
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1972 when the movement towards liberalizing markets to achieve flexible exchange rates
became the conventional wisdom of economists and policy makers. The disappointing post-1972
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 income per capita) in some less developed countries and the global
financial crisis that began in 2007 contrasts sharply with the experience during the post war
period between 1946 and 1971.
The significantly superior performance of the capitalist world's economies during this
Bretton Woods pre 1972 period where exchange rates were fixed by governments compared to
the earlier gold standard fixed exchange rate period suggests that there must have been an
additional condition besides exchange rate fixity that contributed to the unprecedented growth
during that golden age of economic development. That additional condition, as Keynes explained
in developing his Keynes Plan for the Bretton Woods Conference, required that any creditor
nation that runs persistent surpluses in its trade balance must accept the major responsibility for
resolving and ultimately elimination of these trade imbalances. The post war Marshall Plan was
an instance where the creditor nation adopted the responsibility that Keynes had suggested. The
economic results of the Marshall Plan were excellent and unparalleled.
The Marshall Plan and the Trade Imbalance Problem following the Second World War
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 occur
among trading nations. This failure, Keynes [APost-War Currency Policy@ (1944) reprinted in
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The Collected Writings of John Maynard Keynes, vol. 25, 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.
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 payment
system requires transferring the major onus of adjustment from the debtor to the creditor nation.
This transfer of responsibility for ending persistent trade imbalances to those nations that
persistently experience exports that exceed their imports would, Keynes explained, substitute an
expansionist, in place of a contractionist, pressure on world trade. 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 Aenjoying@ a favorable balance of trade to
initiate most of the effort necessary to eliminate this trade imbalance, while Amaintaining
enough discipline in the debtor countries to prevent them from exploiting the new ease allowed
them@.
After World War II, the war-torn capitalist nations in Europe did not have sufficient
undamaged productive resources available to produce enough to feed their populations and
rebuild their economies. 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. After
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the second world war, the European nations had very little foreign reserves ii .
With insufficient foreign reserves to obtain the necessary imports from the United
States, the only alternative, under a free market laissez-faire system, would be for Europeans to
obtain an enormous volume of loans from the United States to finance the purchase of required
United States exports needed to feed the European population and rebuild their economies.
Private sector lenders in the United States, however, were mindful that German reparation
payments to the victorious Allied nations after World War I were primarily financed by
American. private investors lending to Germany (the so-called Dawes Plan). Germany never
repaid these Dawes plan 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 trade imbalance and international financial problems that was associated with the post-war
European nations need for United States imports. Keynes estimated that the European nations
might require imports in excess of $10 billion to rebuild their economies. The Keynes Plan had
an operational system that would have the United States provide funds to the Europeans to buy
these billions of dollars of US imports.
The United States representative to the Bretton Woods Conference, Harry Dexter White,
rejected the Keynes Plan. Dexter White argued that Congress would never provide the $10
billion Keynes said was required. Instead White stated Congress would be willing to provide, at
most, $3 billion as the United States contribution to solving this post war international financial
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problem.
The White Plan envisioned the International Monetary Fund (IMF) providing short-term
loans to nations running unfavorable balances of trade iii . These loans were suppose to give the
debtor nation time to get its economic house in order and stop importing more than it was
exporting. The White Plan had the United States. subscribing to a maximum of $3 billion as its
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 market. 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. [In
principle, a similar IMF arrangement exists with the European Financial Stability Facility for
solving the current sovereign debt problem of Euroland.]
Under the White Plan, international loans from the IMF or the World Bank were the only
available sources for financing the huge volume of imports from the United States that the wartorn nations would require immediately after the second world war. The IMF and World Bank
together did not have sufficient funds to make loans of the magnitude needed by the European
nations. Even if the IMF and the World Bank could have provided loans sufficient to meet the
needs of the war torn nations, the result would have been a huge international indebtedness of
these nations. Paying the resultant immense debt obligations by the European nations probably
would have led to political and social unrest in Europe.
If the debtor European nations could have accepted an Aausterity@ policy they would
have to Atighten their belts@. , i.e., to accept the main burden of adjustment. To tighten the
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nation=s belt is a euphemism to indicate that the debtor nations has to reduce dramatically their
need for imports and whatever domestic production that could be provided via policies that
deliberately reduce the real income of its citizens so they can buy less from both foreign and
domestic factories and farms. The ultimate result of any Aausterity@ belt tightening policies after
years of war would be a further significant decline in the standard of living in these countries
The result would have reduced the Europeans to a starvation level of income. Accordingly, any
conventional free market solution available to the European nations after World War II to obtain
United States imports for rebuilding their economy would so depress the standard of living as to
possibly inducing political revolutions in most of Western Europe. Not inconsequentially, the
tighten your belt policies also would have removed Europe as a possible large profitable market
for expanding American exports as the US nation=s armed forces were demobilized and able to
join the US labor force.
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 free
market 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 United States. 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 $153 billion in 2010 dollars.) The Marshall plan was essentially a
four year gift of $13 billion worth of American exports to the war devastated nations.
The Marshall plan gift gave the recipient nations a sufficient number of dollars to buy
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approximately 2 per cent of the total annual output (Gross Domestic Product) of the United
States for each of four years from 1947 to 1951. Yet no United States 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 during those years. The United States
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. American household income continued to grow throughout
the Marshall Plan period.
Immediately after the war ended, US government military spending was significantly
reduced, which by itself might have created for the United States some post-war unemployment
problems. Partially offsetting this reduction in government military spending was the Marshall
plan funds that the recipient nation=s were able to use to purchase American exports. This
Marshall Plan spending created significant increases in employment in United States export
industries just as several million men and women were discharged from the United States armed
forces and entered the United States labor force looking for jobs. For the first time in its history,
the United States did not suffer from a severe recession due to a lack of spending immediately
following the cessation of a major war. The United States 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 US
foreign aid give aways.
By 1958, although the United States still had an annual goods and services export surplus
of over $5 billion, United States governmental foreign and military aid exceeded $6 billion,
while there was a net private capital outflow of $1.6 billion. The post-war United States potential
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surplus on international payments balance was at an end as a total of $2.6 billion more funds
flowed out of the United States than were inflows due to foreigners=s spending on United States
exports.
As the United States international payments account swung into deficit in 1958 other
nations began to experience international payments surpluses. These credit surplus nations did
not spend their payments surpluses on additional imports of goods and services from the United
States. Instead the nations used a portion of their annual dollar surpluses to purchase
international liquid assets in the form of gold reserves from the United States. For example, in
1958, the United States sold over $2 billion in gold reserves to foreign central banks. These
trends accelerated in the 1960s, partly as a result of increased United States military and
financial aid responses to the construction of the 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 United
States export industries.
The Bretton Woods system had no way of automatically forcing the emerging creditor
nations experiencing a payment surplus to step in and accept the responsibility for resolving the
persistent payment imbalances B a creditor adjustment role that the United States had played
with the Marshall Plan. Instead during the 1960s the surplus nations continued to convert some
portion of their annual dollar surpluses into demands on United States 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.
In 1971, President Richard Nixon closed the gold window. In other words Nixon stated
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that the United States government would no longer sell gold to foreign nations who had earned
dollars and wanted to use these dollars to buy gold from the United States rather than buy
American produced goods and services. In essence, the United States withdrew from Bretton
Woods agreement. The last vestiges of Keynes's enlightened international monetary approach
where the creditor nation accepts a large responsibility for correcting persistent trade imbalances
was on its way to be forgotten.
Reforming the International Payments System
The post Second World War (1946-1971) global golden age of economic development required
international institutions and United States government foreign aid policies operating on principles
inherent in the Keynes Plan where the creditor nation accepting the major responsibility for solving
any international payments imbalance. Since 1971, the onus has been on nations with persistent
deficits iv in their international payments balances to solve their own deficit international payment
problems. The result has been that since 1971 the international payments system often impedes rapid
economic growth of many of the developed nations v of the world while severely constraining the
growth of many of the least developed countries. .
Using the ideas Keynes presented at Bretton Woods, it is possible to update the Keynes Plan
for a 21st century international monetary system that will promote global economic prosperity,
prevent persistent payment imbalances and still meet the political realities of today without bowing
one=s knee to efficient market advocates. For, as Keynes [APost War Currency Policy@ (1941)
reprinted in The Collected Writings of John Maynard Keynes, vol. 25, pp. 21-22] wrote:
Ato 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
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historical experience without having behind it the support of sound theory@
Since the Mexican peso crisis of 1994, some pragmatic policy makers have recognized
that free markets are not sufficient to prevent crisis in the international payments sector. Instead
they have advocated the creation of some sort of crisis manager to stop international financial
market liquidity hemorrhaging and to "bail-out" international investors. In 1994, United States
Treasury Secretary Robert Rubin encouraged President Clinton to use American funds to help
Mexico solve its peso crisis and thereby save the wealth of international buyers of Mexican
bonds. In 1997 Thailand, Malaysia, and other East Asian nations experienced an international
currency crisis that battered their economies. In 1998 the Russian debt default caused another
crisis that lead to the collapse of the Long Term Capital Management (LTCM) hedge fund
which, except for quick action by the New York Federal Reserve could have induced a
significant drop in American equity markets. (We should note that among the principals of
LTCM was Nobel Prize economics winner Myron Scholes, who won his Nobel Prize for
discovering the formula for Aproperly@ pricing risk in an efficient financial market environment.
Scholes formula, however, could not save LTCM from its investment blunders.)
At the time of the Russian debt default and the LTCM collapse, President Clinton called
for a Anew financial architecture@ for international financial market transactions. At the same
time, International Monetary Fund Director Stanley Fischer also recognized that the IMF did not
have sufficient funds to stem the crises that were occurring. Fisher suggested that the major
nations of the world, the so called G-7 nations, make a temporary arrangement where they would
provide additional financing to help provide funds to any nation suffering from deficits in its
international payments imbalances until such nations could get their economic house in order.
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Fisher's cry for a G7 temporary collaboration to provide funds to deficit nations is equivalent to
recruiting a volunteer fire department to douse the flames after someone has cried fire in a
crowded theater. Even if the fire is ultimately extinguished there will be a lot of innocent
casualties. Moreover, every new currency fire would require the G-7 voluntary fire department
to pour more liquidity into the market to put out the flames. Clearly a more desirable goal would
be to produce a permanent fire prevention system, and not to rely on organizing larger and
larger volunteer fire fighting organizations (e.g., the European Financial Stability Facility) with
each new currency crisis. Crisis prevention rather than crisis management should be the policy
goal.
President Clinton=s clarion call for a new international financial architecture implicitly
recognized this need for a permanent change and improvement in the existing international
payment system. Unfortunately, President Clinton=s call was not taken up as the international
community managed to muddle through the international debtor=s potential default experience
although some nations and its residents suffered severe economic pains.
By 2007 the global economy began experiencing signs of the collapse of the international
financial system. The US sub prime mortgage crisis created a contagious disease that caused
havoc with banking systems in many countries including Germany, the United Kingdom ,
France, Spain and others. The contagion caused the complete collapse of the Icelandic banking
system. For a while even the Swiss banking system, a system usually considered a paragon of
financial stability, appeared to be in severe economic trouble. With potential collapse of the Euro
and Euroland banks, the need for a permanent Anew international financial architecture@ is more
urgent than ever.
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.
In the 21st century interdependent global economy, a substantial degree of 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. Given
the recent Greek problem and sovereign debt problems of Italy, Portugal Spain and Ireland it is clear
that the supranational European Central Bank institution alone is not sufficient to resolve the euro
problem while promoting full employment prosperity in the Eurozone. This should suggest that a
supra national central bank per se could not solve a similar problem for the global economy. Thus
the Keynes Plan has to be modified to exist without any supranational central bank.
Accordingly, I have developed a more modest proposal than the Keynes Plan for a new
international financial architecture that (1)does not require a supranational central bank and (2) does
not require any nation to surrender control of its domestic monetary and fiscal policies. 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 (a) to solve the problems of
persistent trade and payments imbalances, and (b) to prevent international financial market
transactions that can be disruptive to the stability of any nation=s economy as well as a threat to the
global economy.
I have labeled the new international institution to be set up under this plan the International
Monetary Clearing Union (IMCU). The IMCU would require all international payments whether for
imports or financial funds crossing national borders to go through this International Monetary
Clearing Union. Each nation=s central bank will set up a deposit account with the IMCU. Then any
payments of a resident entity in nation A made to a resident entity in nation B would have to clear
through each nation=s central bank deposit at the IMCU. A payment from a resident in A to a
resident in B when cleared through the IMCU would appear as a credit for nation B=s central bank
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account at the IMCU and as debit to nation A=s central bank account at the IMCU. Although this
may seem to be a complicated process to the average layperson, it is merely an international version
of how checks are cleared when a residents of one state of the United States, say California, pays
other entities in another state, say New York. The checks clear through the clearing house
mechanism set us by the United States Federal Reserve.
This IMCU is a 21st century variant of the Keynes Plan. To operate it would require at least
eight technical provisions. For the purpose of our discussion, we need not delve into these technical
details vi . Instead we will elaborate on the principle involved in a Keynes Solution for an International
Monetary Clearing Union designed to end the possibility of persistent trade imbalances and
disruptive flows of financial funds across national borders..
The object of this International Monetary Clearing Union is to
(1) to prevent a lack of global effective market demand for the products of industry occurring
due to a liquidity problems whenever any nation(s) holds either excessive idle reserves by saving too
much of its internationally earned income. In other words this IMCU should encourage sufficient
spending globally to produce enough profit incentives in export industries to help assure global full
employment.
(2) to provide an automatic mechanism for placing a major burden of correcting international
trade imbalances on the nation running persistent export surpluses, and
(3) to provide each nation with the ability to monitor and, if desired, to control movements
out of the nation of (a) flight financial funds, as well as money moved across national borders in
order to avoid paying taxes on such funds, (b) of earnings from illegal activities leaving the nation as
well as 8) funds that cross borders to finance terrorist operations.
For our discussion the most important principle involved is that the IMCU system have a
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built-in mechanism that encourages any nation that runs persistent trade surpluses of exports over
imports to spend what is deemed (in advance) by agreement of the international community to be
"excessive" credit balances (savings) of foreign liquid reserve assets that have been deposited in the
nation=s deposit account at the IMCU. These accumulated credits (saving out of international earned
income) represent funds that the creditor nation could have used to buy the products of foreign
industries but instead used to increase its foreign reserves in terms of its deposit at the IMCU. This
first principle involves the recognition that when a nation holds excessive credits in its deposit
account at the IMCU, this means that these excess credits are creating unemployment problems and
the lack of profitable opportunities for business enterprises somewhere in the global economy.
The Keynes principle involved in this situation is to recognize that if the creditor nation
spends its excessive credits, this spending will increase profit opportunities and the hiring of workers
around the globe and thereby promote global full employment. The Keynes Solution would
encourage the creditor nation to spend these excessive credits in three possible way. These three
ways are:
(1) on the products of any other member of the IMCU,
(2) on new direct foreign investment projects in other IMCU member nations, and/or
(3) to provide foreign aid, similar to the Marshall Plan, to deficit IMCU members.
The credit nation is free to choose any combination of the above three ways to spend its excessive
credit at the IMCU.
Spending excessive credits via (1) encourages the surplus nation to reduce the trade
imbalance by purchasing additional goods from foreigners and therefore creating profits and jobs in
other nations. This means more income for people and businesses in the nations experiencing
unfavorable balances of trade and those that were borrowing from foreigners to buy their excess of
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imports over exports. In essence spending via (1) gives the deficit nations the opportunity to work
their way out of international debt by earning additional income by selling additional exports to their
creditors vii .
Direct foreign investment spending (2) requires the nation with excess credits in its account at
the IMCU to build plant and equipment in the deficit nation, thereby immediately increasing profits,
jobs and income in the construction industries in the deficit nation. If the nation receiving this direct
foreign investment is a less developed country, then this foreign direct investment spending will
help build the productive facilities to the 21st century standards.
Foreign aid spending (3) provides the deficit nation with a Agift@ that it can use to reduce its
debt obligations; or even buy additional products from foreign producers without going further into
debt.
These three spending alternatives encourage the surplus nation to accept major responsibility
for correcting trade and international payments imbalances. Nevertheless this provision gives the
trade surplus country considerable discretion in deciding how to accept the onus of adjustment in the
way it believes is in its best interests. It does not permit the surplus nation to shift the burden to the
deficit nation(s) by lending the deficit nation(s) more and therefore imposing on the deficit nation
additional contractual requirements for debt repayments 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 economic forces on
other nations and/or to build up of international debts so encumbering as to impoverish the global
economy of the 21st century.
In the event that the surplus nation does not spend or give away the credits that are deemed
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Aexcessive@ within a specified time, then the IMCU managers would confiscate (and redistribute to
debtor members) the portion of credits deemed excessive. This last resort is the equivalent of a 100%
taxes on a nation=s liquidity holdings that the international community has already agreed are
excessive. Since continual excessive liquidity holdings implies continuing and excessive
unemployment in one or more nations running trade deficits, if the surplus nation does not spend its
excessive surplus, then confiscating these excessive credits and providing them to debtor nations
will benefit the debtors. Of course the nation with excessive credits will recognize that these credits
are subject to a 100 per cent tax if not spent. It is therefore highly unlikely that this confiscatory tax
will ever have to be enforced.
Under either a fixed or a flexible rate system with each nation free to decide 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 saving
(hoarding) a portion of their foreign export earnings rather than spending it on the products of foreign
business firms. . By so doing, these oversavers are creating a lack of global market demand for the
products that global industries can produce.
Under this Keynes principle requiring creditor nations to spend excessive credits, deficit
countries would no longer have to engage in Aausterity@ to tighten their belt and reduce their citizens
income 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 products profitably abroad and thereby work their
way out of their otherwise deteriorating debtor position.
Currently, as the global financial crisis threatens to deepen because of the Euro sovereign
debt crisis, nations will be forced to realize that merely attempting to tinker with the existing system
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by perhaps upgrading the power of the IMF and the World Bank or encouraging the G-7 to again act
as a volunteer fire department (or Germany in the Eurozone) will not solve the developing
international trade and financial payments problems. For years now the international system has been
running into trouble while patches to the existing IMF and World Bank system were applied in a vain
attempt to end these global trade and payments problems. The world lost a great opportunity in 1944
when the United States vetoed the Keynes Plan at Bretton Woods. Let us hope we do not squander
this opportunity again.
When the 2009 Obama stimulus recovery plan began to take effect, whatever economic
recovery that the American economy experienced again placed the United States as the engine of
growth for the rest of the world. It also aggravates the United States international payments
imbalance problem as the United States increases its imports more than its exports especially to
cheap foreign labor countries such as China, Vietnam and India. The result, under the existing
payments system, may ultimately create an atmosphere where many fear the status of the dollar is no
longer the most liquid safe haven foreign reserve asset. Such fears can only roil global financial
markets and plunge the global economy into further recession. Hopefully, the leaders of the major
nations will recognize the need to adopt some form of the Keynes Plan such as the IMCU if the
global economy is ever to recover and reinstate prosperous times.
The Case For Capital Controls
Since the future is uncertain, at any moment of time some event (ephemeral or not) may occur
which can make residents of a nation feel more uncertain about the prospects of their economy.
Under a system of free exchange markets, residents of the nation that fear the future can remove
their savings from the domestic banking system and transfer them to another nation=s banking
system where they believe the latter is a safe harbor to store their savings. The funds used in any
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attempt to find a safe haven in another nation is called Aflight capital@. If enough people try at
the same time to move their funds from the domestic economy to this presumed safe harbor, the
effect on the domestic economy is similar to a run on a bank that causes the bank to collapse.
In the case of bank runs, a policy of insuring deposits is usually sufficient to stopping
bank runs. Unfortunately, a cascade of flight capital fund movements out of a nation to a safe
harbor in another nation can not be stopped by merely insuring the deposits at domestic banks.
Instead this flight of funds if large enough can bring about the collapse of the domestic economy,
as more and more people stop buying domestically produced goods to increase their holdings of
foreign liquid assets. This creates significant recessionary pressures on the domestic economy
thereby making it more difficult for the government to undertake economic policies to stabilize
the nation=s economy and prevent it from falling into recession or depression.
Under my IMCU proposal all movement of funds across borders would go through the
nation=s central bank deposit at the IMCU. Any nation can, if it desires, monitor and stop any
cross border financial fund movements by merely refusing to allow the cross border banking
transactions to be processed though the central bank=s deposit on the IMCU=s books. In other
words each nation can institute an effective policy to limit capital fund outflows from its country
if, for any reason, the government deems it in the best interest of the nation=s economy to
prevent such fund outflows.
The existence of less regulated financial markets abroad, has led the U.S. financial
services industry to successfully argue that if US financial firms were to be Acompetitive@ with
foreign financial service firms, then there would have to for less regulation of domestic financial
markets. From hindsight it is obvious that the result of all this financial market deregulation was
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the financial crisis of 2007-8 initiated by the development of tradable mortgage backed
derivative securities. If the IMCU system was in place, the Securities Exchange Commission
could have prohibited the creation of domestic derivative financial markets as dangerous.
without jeopardizing the domestic financial services firms with loss of customers to foreign
firms. Under the capital flow control provision of the IMCU, the American financial services
industries would not have to fear loss of profits to foreign financial services firms who did not
follow SEC rules that prohibited certain financial market activities by American financial
services firms. It could then be possible to create legislation for a 21st century version of the
Glass- Steagall Act which created an impenetrable divide between US commercial banks and
investment banks.
Finally, all movements of funds gained from illegal activities, or funds being moved from
the country to another nation in order to avoid the domestic country=s tax collector, or funds
raised in one country that is being funneled to other countries to finance international terrorist
activities must also flow through the nation=s central bank to the IMCU. Consequently, each
nation has the facility, if it wishes, to monitor and if necessary stop such cross border money
flow transactions from occurring. Clearly this is an important aspect of the IMCU plan for it
permits each nation to assure its citizens that others can not take advantage of the international
trading system to avoid paying one=s fair share of taxes, and to constrain the international
financing of terrorist organizations, as well as to permit the government to undermine the
profitability of any international illegal drug trade.
In sum, then my IMCU proposal would operate under the same economic principles laid
down by Keynes at Bretton Woods without requiring the establishment of a supranational central
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bank of the world. It requires an acceptable international agreement that does not require any nation
to surrender the nation=s control of either its domestic banking system or the operation of its
domestic monetary and fiscal policies to a supranational authority. Each nation will still be able to
determine the economic destiny that is best for its citizens as long as it does not detrimentally affect
employment and income earning opportunities in trading partner nations. The result will be to
provide an regime where persist international payment imbalances can be readily cured while
promoting global economic prosperity.
Notes
i. The pursuit of free trade agreements under the current international payments system presumes
the classical system of efficient markets prevails in a fully employed global real world.
ii.The foreign reserves are liquid assets that European war devastated nations could sell for
United States dollars that they could then use to buy imports from the only foreign nation that
had enough productivity capacity to produce for exports B the United States.
iii. The IMF loans were fundedvby initial contributions of the major nations such as the US.
iv. Except for the United States, where the dollar became the standard for international trade.
v. For example, the current payment imbalances in Euro countries threatens the Euro currency union
vi. For a discussion of these 8 provisions see Post Keynesian Macroeconomic Theory, Second
Edition by Paul Davidson (Elgar, Cheltenham, 2011) pp. 301-305.
vii.
Managing Director Lagarde of the IMF apparently is pushing for a similar policy outcome. In
an article entitled ARocking the Boat, Lagarde Seeks Common Vision@, The New York Times
reports [September 25, 2001, p. bu 7] That Lagarde Anoted that Germany was partly to blame for
the deepening divide in Europe. Germany became an economic powerhouse in part by exporting so
much to weaker countries..... But now [these weaker] economies ...were in trouble, she said,
Germany was refusing to buy imports. The solution , Ms. Lagarde insisted, was for Berlin to lift
domestic consumption [of imports].@
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