Monday, June 11, 2018

North-South Divide: UN To Say "Let's Ditch the $"

It's times like this when you should be glad about my semi-fastidious approach to classic IPE problematiques. Today, we return to the never-ending issue of a North-South divide between industrialized and developing countries concerning reserve currencies. It is no secret that the US is resorting to all sorts of dollar molestation tactics to buoy its economy. The US government will print something on the order of $2 trillion in IOUs to pay for a $787 billion stimulus package and a plan to refinance foreclosed mortgages (many of which will foreclose again anyway). Plus, you have news that the Fed plans to add $300B or so more to its balance sheet by purchasing long-dated Treasuries to try and lower consumer borrowing costs. In effect, the US government is cranking the printing press not only to mint its IOUs but also to allow the Fed to buy up Treasuries that America herself issued. What a plan.

These actions have not endeared the US to LDCs, just as the US running chronic external deficits didn't at the turn of the 1970s culminating in the "Nixon Shock" demise of the dollar-gold standard. LDC unhappiness stems from the US being unconcerned as the value of the world's standard reserve currency, the dollar, sinks. In response to dollar molestation, necessary commodities become dear, swelling many LDCs' import bills--especially those of oil importers. Many have long been concerned about America's willingness to abuse this privilege of issuing dollars, including John Maynard Keynes who suggested the creation of the bancor. Postwar Britain not being the dominant power at the Bretton Woods conference, this idea was quickly shelved by the US, which naturally favored a multilateral system built on American hegemony.

Hence, special drawing rights (SDRs) established during the turn of the seventies did not really allay LDCs fears; it has never really fulfilled the role of an alternative reserve denomination as SDR holdings remain minuscule among various countries' reserve holdings. Given current global conditions, however, LDCs are once again clamoring for a genuine dollar alternative. From Reuters comes this potential bombshell:
A U.N. panel will next week recommend that the world ditch the dollar as its reserve currency in favor of a shared basket of currencies, a member of the panel said on Wednesday, adding to pressure on the dollar.

Currency specialist Avinash Persaud, a member of the panel of experts, told a Reuters Funds Summit in Luxembourg that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket. [He] said the recommendation would be one of a number delivered to the United Nations on March 25 by the U.N. Commission of Experts on International Financial Reform. "It is a good moment to move to a shared reserve currency," he said.

Central banks hold their reserves in a variety of currencies and gold, but the dollar has dominated as the most convincing store of value -- though its rate has wavered in recent years as the United States ran up huge twin budget and external deficits...

Persaud said that the United States was concerned that holding the reserve currency made it impossible to run policy, while the rest of world was also unhappy with the generally declining dollar. "There is a moment that can be grasped for change," he said. "Today the Americans complain that when the world wants to save, it means a deficit. A shared (reserve) would reduce the possibility of global imbalances."

Persaud said the panel had been looking at using something like an expanded Special Drawing Right, originally created by the International Monetary Fund in 1969 but now used mainly as an accounting unit within similar organizations.
So there you have it. After all this time, the question of an alternative reserve currency remains unresolved as old ideas are being resurrected. Actually, this proposal mirrors a more recent one by the historically LDC-friendly UN Conference for Trade and Development (UNCTAD) to reduce the asymmetries in the world economy where industrialized countries able to print reserve currencies can splurge while LDCs are forced to save [see my recent post on this point and also this UNCTAD summary]:
[UNCTAD Chief Macroeconomist Heiner Flassbeck] said it was essential to examine this problem from a broader perspective - namely that under the current system, some countries were not allowed to “print unlimited amounts of money” or run large budget deficits without causing their currency to “fall down a very deep hole.” This represented a fundamental asymmetry in the global economy that was in no one’s interest. In effect, countries who are the victims of currency speculation, or “carry-trade” (portfolio investments based on borrowing in low-yielding currencies and investing in high-yielding ones) are forced to take “pro-cyclical” measures (such as interest rate hikes or public budget cuts or freezes) that aggravate the crisis in the real economy in order to reassure international currency speculators. This perverse phenomenon underlined the importance of UNCTAD’s proposal to develop a multilateral framework for an automatic stabilization of real exchange rates that would defeat the purpose of any speculative attack on a currency. This would enable all countries to regain the policy space needed to act in the interest of the real economy and avoid “beggar-thy-neighbour” policies or “devaluation wars” reminiscent of the 1930s...

Such a global reserve currency was part of the original proposals of John Maynard Keynes at the 1944 United Nations Bretton Woods Conference (which he had termed the “bancor”), but it was resisted by the United States at the time. Instead, the IMF constitution enables it to issue an artificial liquidity called “Special Drawing Rights” (SDRs), but its emission has been blocked by the United States’ de facto veto at the IMF and suffers from a number of limitations compared to Keynes’ original proposal, including the IMF’s governance structure. Nobel Prize laureate Joseph Stiglitz, who also chairs the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, has repeatedly emphasized that the need for a new global reserve system which would be more stable than the US dollar has become more dire today: it is an idea “whose time may have finally come.”

In a nutshell, the system would work as follows: when a country faces a devaluation attack, the monetary authorities of the revaluing currency would automatically stave off the attack by a symmetrical intervention to stop the “undershooting” with its own currency, which is available in unlimited amounts: it can be printed. Nominal exchange rate changes would be readjusted periodically by governments, not markets - which contrary to neo-classical theory have empirically been proven not to be able to get “the price right.” These adjustments would be based on the objective criterion of changes in Purchasing Power Parity, or “inflation differentials.” Unlike the Post-World War II Bretton Woods system of fixed exchange rates (which was based on the US dollar and collapsed in 1970s), the value of each currency would be anchored to a new artificial global currency based on a basket of currency values, like the European “ECU” was used in Europe prior to Monetary Union.
One hopes this new proposal does not fall on deaf ears like both times before--at the Bretton Woods Conference and during the demise of the dollar-gold standard. Certainly, the US is much weaker at this point and cannot exercise as much hegemonic power as way back when. I, however, think the remedy to the US holding the rest of the world hostage to "quantitative easing" (dollar molestation) is for China to show solidarity with third world concerns and stop buoying the dollar. I wish the UN the best but do not pitch my hopes too high.

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