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Friday, December 05, 2003

The Bretton Woods revival that wasn´t

At a meeting of the G24 nations' finance ministers in Geneva in January 1999, Prof. Paul Davidson presented proposals that could have been considered as a starting point for an effort at reforming the international monetary system, but were abandoned as it became clear that muddling-through might once again be an option.

Davidson summarized his concept as follows:

"1. The unit of account and ultimate reserve asset for international liquidity is the International Money Clearing Unit (IMCU). All IMCU's are held only by central banks, not by the public.

2. Each nation'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. Ultimately, all major private international transactions clear between central banks' accounts in the books of the international clearing institution.

3. The exchange rate between the domestic currency and the IMCU is set initially by each nation -- just as it would be if one instituted an international gold standard.

4. Contracts between private individuals will continue to be denominated into what ever domestic currency permitted by local laws and agreed upon by the contracting parties.

5. An overdraft system to 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 clearing managers.

6. A trigger mechanism to encourage a 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.

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, even if a foreign government permits wage-price inflation to occur within its borders.

8. If a country is at full employment and still has a tendency towards 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. If it is a relatively rich country, then the deficit nation must alter its standard of living by reducing the relative terms of trade with major trading partners. If 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 interest charges, and/or [3] debt forgiveness.

It should be noted that proviso #2 permits capital controls. 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 #6, under any conventional system, whether it has fixed or flexible exchange rates and/or capital controls, there will 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.

Some think that my specific clearing union plan, like Keynes's bancor plan, a half century earlier, is Utopian. But if we start with the defeatist attitude that it is too difficult to change the awkward system in which we are trapped, then no progress will be made. Global depression does not have to happen again if our policy makers have sufficient vision to develop this approach. The health of the world's economic system will simply not permit us to muddle through."
(Further explanations are to be found on Prof. Davidson´s website)

The globalization process is in crisis. While the Bretton Woods arrangements enabled developing nations to grow faster than the industrialized countries - and both groups cumulatively to progress significantly faster than during the period of "Washington Consensus" globalization (roughly the last two decades), recent data from the FAO demonstrate that hunger is once again on the rise in the Third World. World Bank statistics show that foreign direct investment is decreasing. Trade negotiations have soured, and monetary policy has been reduced to an exercise in beggar-thy-neighbour practices.

What kind of catastrophe will it take for policymakers to reconsider viable solutions to problems created by ignorance and neglect?

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