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Climate and Currency: Proposals for Global Monetary Reform
Feasta believes that the present world financial and monetary system is so gravely dysfunctional that it makes the achievement of sustainability impossible. We have three main reasons for this belief:
a)The Earth is finite, and, as all economic growth requires some use of the Earth's resources, perpetual growth is not compatible with sustainability. Unfortunately, most of the money used around the world is created on the basis of debt and ceases to exist if that debt is repaid. This means that if the world economy is not to collapse because a lot of the money required to make trading possible has disappeared, it needs to grow continually by enough to ensure that investors can always find attractive opportunities and consequently always borrow more than they repay. In other words, as things stand, the money system is always in direct conflict with social and environmental limits and has to take precedence over them.
b)National and multinational currencies created by some of the wealthiest countries in the world are used as if they were world currencies. The countries issuing the pseudo-world currencies gain enormous power and advantages at the expense of the rest of the world.
c)Individual governments cannot afford to take account of whether the growth required to stop the global system from collapsing is socially or environmentally sustainable because current account and capital account money flows are lumped together when the market determines their currencies' exchange rates. This gives the owners of mobile capital an excessive amount of power over exchange rates and hence over governments. It also creates instability by allowing speculative financial flows to destabilise the 'real' economies of the countries concerned.
None of the proposals for reforming the world's financial architecture we have seen circulated so far in the run-up to the World Summit on Sustainable Development attempts to deal with the root causes of these problems as opposed to their symptoms. Accordingly, we present our proposals for changes at the Global, National and Sub-National levels in the hope that they will influence the debate. The proposals should be considered as a package. However, the three National and Sub-National level proposals could be adopted by countries in the absence of change at an international level. Our seven proposals are:
We'll look at these in turn.
1. A genuine world currency should be established.
The dollar, the pound sterling, the euro, the Swiss franc and the yen are all 'reserve currencies' - in other words, they are the currencies which the world's central banks keep in reserve against the day they might have to intervene in the markets to support the exchange rates of the national currencies for which they are responsible. When gold was the world currency, wealth was created wherever the gold was found. Today, wealth is created in the reserve currency countries when their banks approve loans. The amount of this wealth is considerable. According to IMF figures, the dollar holdings of the world's non-US central banks increased by approximately $145 billion in 1999. This means that the US either lent or spent these extra dollars in the rest of the world during that year, gaining either goods and services or interest payments for them, but that during the year it did not supply anything in return. By accepting the dollars without getting anything back, the rest of the world was giving the US a massive subsidy. In the eight years between 1992 and 2000, the world's central banks increased their dollar holdings by around $800 billion, effectively giving America a cost-free loan of the same amount.
We say cost-free rather than interest-free because most of this money was, in fact, deposited by the central banks with financial institutions in the United States and interest was paid on it. However, that interest was paid in dollars created by a book-keeping operation and added to the total amount of dollars held by the rest of the world. A cost to the US would only have arisen if the dollars paid in interest had actually been used to buy American goods or services but, in fact, no such cost has been paid since the country went into a mild recession in 1991, the only year in the past 20 in which the US supplied more goods and services to the rest of the world than it took in. In the other 19 years, the US has run a deficit on its import-export account and become increasingly indebted internationally. These debts will remain cost-free for as long as the US is able to continue to pay interest in dollars and increase the amount it owes.
A good idea of how big a subsidy this $800bn.is can be gained by recalling that in 1998, the UNDP estimated that half that sum, the expenditure of only $40bn a year for ten years, would enable everyone in the world to be given access to an adequate diet, safe water, basic health care, adequate sanitation and pre- and post- natal attention. But, huge though it is, the sum is just a small fraction of the advantage the US gains by having a reserve currency. In addition to central banks, dollars are also held by companies, institutions and millions of people around the world, either in notes in a wall safe, as deposits in a US bank account, or as some form of security - perhaps as a bond such as a Treasury bill or in shares traded on Wall Street.
The total gain from having a reserve currency (the technical term is seignorage) is the cumulative balance of payments deficit on the import-export account that the issuing country is able to run up. At present, the $2,500 bn. net debt owed by the US to the rest of the world would take the total income from its export sales for thirty months to pay off assuming America imported nothing at all. Looked at another way, seignorage currently enables America to import half as much again as it exports.
A handful of other countries benefit from seignorage too but to a much more limited extent. Britain does best amongst these runners-up. It gained goods and services worth £31 billion from the rest of the world between 1992 and 2000 thanks to the increase in central banks' holdings of sterling. This was just 5.7% of the US gain from the same source over the same period. Britain has also been able to run up a debt with the rest of the world - the UK balance of trade has been negative in every year since 1985 with the result that the country's net financial liabilities stood at £69.8 billion at the end of the third quarter of 2001. The government statistics office described this as 'a relatively large figure historically speaking' although it was only 4% of what the US owed i. Britain's present current account deficit is around 2.5% of its GDP.
The other beneficiaries from seignorage did not run up current account deficits and so failed to take advantage of their position. Japan, for example, which got 4.5% of the US gain between 1992 and 2000, has run a trade surplus for many years. The same applies to Switzerland (0.6% of the US gain) and the countries which now make up the eurozone (a miniscule 0.25%).
At present, countries without reserve currencies lack the freedom to refuse to earn increasing amounts of dollars, pounds, yen or euro only to lend them back to the countries which issue them. This is because while the volume of world trade is growing, they need to increase their reserve currency deposits with banks overseas for the same reasons that private individuals want more money in their personal bank accounts - to make investments and to pay for their increasing purchases. Accordingly, these countries' only choice is whether or not to reduce their holdings of one reserve currency - perhaps because they think that it's about to fall in value compared with the others - and to increase their balances of the others to compensate.
For as long as world trade continues to grow, the indebtedness (and thus the seignorage gains) of the reserve-currency issuing countries is likely to increase. But if world trade declines or a world currency is introduced, surplus reserve currencies would begin to return to their countries of issue in exchange for goods and services. On the basis of the figures above, only the US would be seriously affected by this. The value of the dollar would fall and American living standards would fall sharply as a higher proportion of everything being produced in the US would have to go abroad in exchange for the returning dollars. The cost of everything produced and consumed locally that could be exported would rise by the extent of the devaluation.
Some economists are concerned that such a collapse in US living standards might be imminent because they believe the US current account deficit is reaching unsustainable levels. In 1999, Catherine L. Mann, a professor at Vanderbilt University, investigated previous current account corrections in industrialised countries in the past twenty years ii. She concluded that a current account deficit of over 4.2% was unsustainable and that a correction in the US was likely in two or three years.
"The US cannot live beyond its long-term means forever, nor will US assets always be so favored by global investors" Mann wrote in an article 'Is the US Current Account Deficit Sustainable?' published by the IMF in March 2000 iii. "When a change in investor sentiment comes, it could be dramatic. What would happen if the dollar depreciated by a significant amount, say 25 percent?" she went on, only to answer her own question: "US consumers would shift from buying imported goods and services to buying those made domestically and US labor markets would tighten further. The combination of rising wages and a falling dollar likely would drive up prices." Then, she believes, the Federal Reserve would try to choke the developing inflation by raising interest rates, thus disrupting financial markets around the world.
Caroline Freund of the Federal Reserve researched the same ground as Mann and also found that the US deficit was unsustainable except that she reckoned that the markets normally bring these corrections about when the deficit rises above 5% of GDP rather than 4.2% iv. As the US deficit is expected to exceed 5% at the end of this year, Mann and Freund's work has led economists employed by stockbrokers and merchant banks to alert their clients to the dollar's potential fall. For example, Steven Roach, chief economist at Morgan Stanley, warned several times earlier this year of 'a US balance of payments crisis by 2003' and 'America's looming current-account adjustment' v while his colleague, Eric Chaney, talked of 'a massive devaluation'vi. Their predictions will certainly help bring the crisis they warn of about since they will be used by Morgan Stanley's 61,000 employees around the world to encourage clients to switch out of the dollar into sterling or the euro. In short, the present system of world money creation is both unfair and unstable.
A true world currency
Rather than allowing a select group of countries to provide the world with its money, it would be fairer to have an international institution do so in order to share the seignorage gains among the currency's users. Remarkably, such a currency already exists. The press called it 'paper gold' when it was first issued by the IMF in 1969 since its official name, Special Drawing Rights (SDRs), was somewhat boring.
SDRs came about because it did not make sense to mine gold and keep it in bank vaults to use as the basis of the world's money when account book entries could do just as well. Each SDR's value was based on a weighted average of the value of the currencies of the largest exporting IMF members and each issue was shared out among IMF members according to a quota based on the country's national income and the amount of international trade it did.
No SDRs have been issued since 1981 although a majority of the member countries of the IMF would have liked to see that happen. Each country's vote in the IMF is weighted according to its quota and 85% of the total weight of votes has to be in favour of a proposal before it is considered passed. As the US has 17% of the total voting weight, SDRs cannot therefore be issued without its approval. That will never be given because if the reserve currency system carries on as it is, the US can expect to be able to get an indefinite cost-free loan of perhaps 70% of the world's new money. If, on the other hand, SDRs are issued, the US share of the money given out internationally will be its quota, a measly 17%.
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