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Global monetary reform
The US dollar is the currency used for the majority of international trade and dollars make up around 70% of all the reserves held by the worlds central banks. When we said just now that dollars are created as a debt we meant that they appear when borrowers spend loan facilities they have been granted by financial institutions. Equally, the dollars involved are extinguished when those loans are repaid. This means that, for every dollar (or pound or yen or euro) in someones bank account anywhere in the world, someone else is a dollar (or pound, yen or euro) in debt. The dollars created through debt have no physical form. They are simply account entries. Only coins and actual dollar bills are spent rather than lent into circulation and these make up a small and declining part of the money Americans use.
Creating the majority of worlds money on the basis of debt has four serious defects. The first is that it is almost inevitable that some countries will find themselves with severe debt problems. The debt created when money is borrowed into existence has to be held by someone and it would be unreasonable to expect that a lot of it would not end up in economically-weak parts of the world. This is why, if Highly Indebted Poor Countries (HIPC) were to be forgiven their debts without the money system being changed, the debts would quickly recur.
But the debt feature of the worlds money system has been wonderful for the countries that issue the currencies used as global money. Collectively, these countries hold a controlling shareholding in the World Bank and have used that institution to impose structural adjustment policies on indebted nations. When a country that borrowed, say, to build a dam falls behind with its repayments, the Bank has typically required it to adjust by increasing its output of crops and minerals for export. This might be a reasonable demand for the Bank to make of one country, but its either stupid or grossly exploitative for it to insist that ten or twenty indebted countries all exporting much the same things increase their exports simultaneously. The competition that results just forces export prices down leaving the countries worse off than before. On the other hand, the lending nations and the rest of the OECD bloc are better off since the cost of their imports from some of the worlds poorest countries has fallen appreciably in terms of what they have to supply in exchange.
The second defect is that if a currency is debt-based, then interest has to be paid on that debt and, if the money supply is not to contract, the money required to pay the interest has to be borrowed too and interest paid on that loan as well. And then interest needs to be paid on the sum borrowed to pay interest. And so on and so on. A spiral of borrowing is set up and, unless the economy using the currency grows sufficiently rapidly or an inflation is allowed to occur, the debt burden increases in relation to national income until it eventually becomes insupportable and causes an economic and social breakdown.
The third defect of a debt-based money system is that it makes national economies and thus the world system - very unstable. If money only comes into existence when people borrow, severe problems arise whenever a lot of potential borrowers begin to think that the future looks so uncertain that it would be better if they didnt take out loans. A few months later there will be less money in circulation because more loans will have been repaid than fresh ones taken out. This causes the money supply to contract which in turn makes business conditions difficult so that the level of trading and profit declines. This makes it even more foolish to borrow. The caution of those who refused to borrow previously will prove to have been justified by a crisis they helped to create.
Japan is in exactly this trap at present. Until the Bank of Japan changed its policies in March 2001 and began pumping money into the economy by buying back government debt, the money supply had been contracting for four years. No one wanted to borrow despite the fact that some key interest rates had been 0.5% or less for over five years. There were two reasons for this. One was that Japans population is aging and increasing numbers of its people were reaching an age when they were more interested in clearing old debts and saving for retirement than taking on new ones. The second was that many firms were already carrying high levels of debt and, facing slack demand and falling prices, could find no opportunities appealing enough to warrant them borrowing even more.
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The compulsion to grow
The money creation systems defects one, two and three combine to create a growth compulsion. When an economy grows, demand, profits and optimism all rise. As a result, businesses, their profits up and their capacity under pressure, are happy to increase their borrowings. This creates a positive feedback. The additional borrowing puts more money into circulation. The extra spending power creates extra demand and hence a need for more loans to enable firms to increase their output to satisfy their customers. This virtuous circle can go round and round until, perhaps, labour or some other factor of production becomes scarce. This causes prices to rise and the central bank, fearing inflation, will step in to curb borrowing by putting interest rates up.
By contrast, if growth falters, firms are left with surplus stocks and idle productive capacity. They feel that it is time to be cautious. They postpone their investment plans and attempt to pay off outstanding loans. As a result, the money supply contracts, making it harder for everyone to do business. With less investment, less construction goes on and jobs begin to be lost. This causes consumers to lose confidence. They defer their borrowing for cars or new furniture, and this reduces the money supply too. A recession begins to set in.
Governments will do almost any thing to avoid a recession during their terms of office as if one happened it would make it unlikely they would be re-elected. They therefore work closely with the business sector to ensure that the economy (and the money supply) continues to grow. Indeed, they find themselves forced by the way money is put into circulation to pursue economic growth with little regard for the damage its creation might be doing to society or to the environment. And since economic growth is very closely linked with fossil energy use as the graph below shows, no government is going to be able to contemplate massive cuts in carbon dioxide emissions unless the money creation system is changed. This is why the solutions to economic instability and the climate problem need to be linked.
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How the United States gets a subsidy from the rest of the world
The fourth defect of the present system of money creation is the one that accounts for Americas military strength. When gold was the world currency, wealth was created wherever the gold was found. Today, wealth is created in the countries which issue the dollar, the euro, the pound, the Swiss franc and the yen the so-called reserve currencies - when their banks make more loans. The wealth created in this way is considerable. According to IMF figures, the dollar holdings of the worlds non-US central banks increased by approximately $145 billion in 1999 alone. But the dollars held by central banks are only part of the story since the US currency is 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. In early 2004, the US gain was increasing at at around $1.3 billion every day and the total stood at around $3,000 billion, a sum which the US had either lent or spent abroad since 1986, the year the country became a net debtor to the rest of the world. Americans had received goods and services in exchange for this $3 trillion of course, but they had not sent anything tangible back in exchange. In other words, they had created money out of nothing and used it to buy goods and services which had taken the global economy a lot of hard work and real resources to produce. They were and are - getting a massive subsidy the rest of the world, one which enables them to import half as much again as they export. It is this huge, cost-free seignorage gain that accounts for Americas power.
|Source: Bank of Montreal Economic Briefing.|
23 May, 2002
We say cost-free because although a high proportion of the $3bn. has been invested by the rest of the world in the United States and interest or dividends are being paid on those investments, the payments are being made in dollars created by bank bookkeeping operations and simply increases the total amount of dollars held by foreigners. A cost would only arise to America as a whole (as opposed to those who paid the interest or dividends) if the foreign recipients actually used the payments to buy goods or services from the US. However, no such cost has been incurred since the country went into a mild recession in 1991, the only year in the past twenty 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 ran a deficit on its import-export account and became increasingly indebted internationally. Its $3 trillion plus 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.
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The massive gains from seignorage
We can get a good idea of how big the $3,000bn subsidy has been by recalling that in 1998, the United Nations Development Programme estimated that 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. A handful of other countries benefit from seignorage too but to a much more limited extent. Britains balance of trade with the rest of the world has been negative in every year since 1985 with the result that the countrys net financial liabilities stood at £69.8 billion at the end of the third quarter of 2001. The government statistics office described4 this as a relatively large figure historically speaking although it was only 4% of what the US owed. On a per capita basis, each Briton owes about $2,000 to the rest of the world while each American owes $10,600.
The other countries in a position to benefit from seignorage have not done so. Japan, for example, has run a trade surplus for many years. So have Switzerland and the countries in the eurozone but the latter intend to change. One of the main reasons for the launch of the euro was the hope that the participating countries would be able to wrest a greater share of the annual global seignorage gain from the US. Why else did the European Central Bank print millions of 500-euro notes, a denomination which very few shoppers will ever use? To become the currency of choice for drugs dealers and arms merchants wishing to move large sums of money around the world in attaché cases, of course. The biggest dollar bill is only $100, so, in terms of value for volume, the European contender performs 4.4 times better and, once these notes are passed out by banks, very few will ever be lodged back again. Were not joking. Nor was Ken Rogoff, the chief economist at the IMF, when he wrote a serious paper5 on this topic.
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A true international currency
Rather than allowing a select group of countries to benefit by providing the world with its money, it would be better to have an international institution do so in order to share the seignorage gains among the currencys users. Remarkably, such a currency already exists. The press called it paper gold when it was first issued by the IMF in 1969. This was understandable 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 worlds money when account book entries could do just as well. Each SDRs 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 countrys 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 countrys 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 worlds 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%.
Essentially, SDRs are a version of the international currency, the bancor, (i.e., bank gold) proposed by John Maynard Keynes and the British delegation at the Bretton Woods Conference in 1944. Like SDRs, bancors were to be reserved for exchanges between central banks but, rather than their value being fixed in terms of a basket of other currencies, they were defined in terms of gold. The US also went to Bretton Woods with a plan for a world currency, the unitas, but as the Nobel-prize-winning economist Robert Mundell once put6 it academic internationalist idealism fell prey to economic national self-interest and the rival schemes were dropped. Instead, the US imposed a system under which the liquidity required for world trade was to be provided by gold and by dollars linked to gold at a fixed rate, $35 dollars an ounce. By so doing, America effectively made itself the worlds bank although as another institution with that name was set up under the Bretton Woods agreement, the public naturally became confused about what had gone on.
The link between the dollar and gold was broken unilaterally by the US in 1971 after it had spent many more dollars into circulation internationally to pay for the Vietnam war than it had gold in Fort Knox to back them. Fearing that the dollars value had become unsustainable, holders led by President de Gaulle of France rushed to convert them to gold before devaluation happened. A run on the bank began and the manager, President Nixon, responded by refusing to honour the promissory notes the US had issued every time more dollars had been lent into circulation. He defaulted by closing the gold window, thus ending any fixed relationship whatever between the dollar and gold. This destroyed the key feature of the Bretton Woods system that, looking back, seems to have served the world reasonably well. What emerged in its place was a totally unthought-through arrangement that allowed the defaulter, the worlds richest and most powerful country, to reap a massive benefit by creating the majority of the global money supply with no formal constraints at all.
The perversion of the international economic system caused by the US default needs to be corrected but replacing the dollar and the other reserve currencies with SDRs is not the best solution. This is because, while the gains from seignorage would be more widely spread, they would still go predominantly to the richer countries because of the way IMF quotas are calculated. Whats needed instead is an international currency that is given to each country on the basis of its population rather than its economic strength.
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Basing money on the scarcest resource
Moreover, reviving SDRs would be a missed opportunity. To deliver the maximum level of human welfare, every economic system should try to work out which scarce resource places the tightest constraint on its development and expansion. It should then adjust its systems and technologies so that they work within the limits imposed by that constraint. In line with this, an international currency should be linked to the availability of the scarcest global resource so that, since people always try to minimise their use of money, they automatically minimise their use of that scarce resource.
What global resource do we most need to much use less of at present? Labour and capital can be immediately ruled out. There is unemployment in most countries and, in comparison with a century ago, the physical capital stock is huge and under-utilised. By contrast, the natural environment is grossly overused especially as a sink for human pollutants. We believe that the scarcest resource is the planets ability to absorb greenhouse gases and that a new world currency should therefore be based on CO2 emissions rights.
How could that be done? Weve already seen that, under Contraction and Convergence, emissions permits would be issued to every adult in the world. Lets make an ironic bow to the IMF and call these permits Special Emission Rights or SERs. As we saw, these would essentially be ration coupons. They would be issued by an international Issuing Authority, distributed to individuals, bought up by dealers and sold on to fossil energy distributors such as electricity companies and oil and coal merchants. These companies would then pay over SERs in addition to normal money to fossil fuel producers whenever they bought fresh supplies. An international inspectorate would monitor the fuel producers to ensure that their sales did not exceed the number of SERs they received. This would be surprisingly easy to do as nearly 80 per cent of the fossil carbon that ends up as manmade carbon dioxide in the earth's atmosphere comes from only 122 producers of carbon-based fuels7. Once a producers sales had been checked, the inspectors would remove and destroy the SER coupons the producer had collected. Any not used would lapse at the end of a year.
Besides the SERs, the Issuing Authority would supply governments with a new international money called ebcus (emissions-backed currency unit) to be used for all international trade, not just for buying permits. Like SERs, ebcus would be issued to each country on the basis of its population but, unlike the SERs, they would be given to each countrys central bank rather than to individuals. The ebcu issue would be a once-off, to get the system started, and the Issuing Authority would announce that it would always be prepared to sell additional SERs at a specific ebcu price. This would fix the value of the ebcu in relation to a certain amount of greenhouse emissions. It would make holding the unit very attractive as rival monies such as the dollar have no fixed value and everyone would know that SERs would become scarcer year by year as fewer and fewer were going to be issued.
If a buyer actually used ebcus to buy additional SERs from the Issuing Authority in order to be able to burn more fossil energy, the number of ebcus in circulation internationally would not be increased to make up for the loss. The ebcus paid over would simply be cancelled and the world would have to manage with less of them in circulation. This would cut the amount of international trading it was possible to carry on and, as a result, world fossil energy consumption would fall. On the other hand, there would be no limit to the amount of trading that could go on within a country provided its fossil energy use was kept down. We recognise that selling these additional emissions permits would lead to the C&C emissions limit being exceeded in each year that sales took place. However, because a fixed amount of ebcus would be put into circulation at the start of the scheme and no more would ever be issued, the total excess over the years could never exceed the amount of SERs that the original sum of money could buy.
Essentially, the system is a version of the Bretton Woods arrangement that President Nixon destroyed except that the right to burn fossil energy replaces gold and ebcus play the role of the US dollar. Its introduction would ensure that the level of economic activity around the world was always consistent with the ability of the Earth to cope with it, at least as far as greenhouse emissions were concerned. It would re-link the money system to reality and the world.
The combined C&C/ebcu arrangement would not end economic growth but it would mean that growth could only proceed in countries that increased the economic value they extracted per tonne of CO2 emitted at a faster rate than they were having to cut their CO2 emissions back. There is no point in denying that this requirement would make global growth very difficult. Incomes in many countries would fall back although whether the quality of life would do so is another matter. However, some sectors of most national economies would grow very quickly those connected with saving energy and capturing power from renewable sources, for example and businesses ought to be able to get good returns on investments made in those sectors.
By encouraging people to borrow enough to maintain the money supply, these profit opportunities would reduce the risk of continuing to operate a national debt-based money systems during the period of emissions contraction. After that, however, the rate of change would become much slower and countries would be wise to gradually switch to using a money stock that was spent into circulation by the state. This type of money is described in James Robertson and Joseph Hubers NEF book, Creating New Money. Its advantage is that growth and continual borrowing are not required to keep an adequate amount of it in circulation. This helps to ensure a very stable economy because, if one sector goes into decline, there is still the same amount of purchasing power about and other sectors will expand to compensate.
The massive investment required to free the advanced countries from their reliance on fossil fuels should be the last act of the growth-reliant economic system. As roughly half of all energy gets used to achieve economic growth, it is absolutely imperative that richer countries adopt a money system that doesnt require them to keep growing to avoid an economic collapse. This is not only because they will have to buy fewer emissions permits if they cease to grow but also because they would free resources for use by much poorer countries.
In any case, economic growth in the richer countries is bringing negligible results in terms of increases to human welfare and happiness. The American economist Herman Daly thinks that growth has become uneconomic in a lot of rich countries because it is increasing costs more rapidly than benefits. In other words, it is proving damaging rather than beneficial. The Index of Sustainable Economic Welfare, which Daly developed, shows that this is the case in almost every country for which it has been calculated, even though the calculations ignored the damage potential of CO2 emissions. If estimates for this damage are factored in, the case for saying that rich country growth is seriously damaging becomes overwhelming.
But, as Daly pointed out in a speech to the World Bank in 2002,
The current policy of the IMF, the World Trade Organisation and the World Bank, however, is decidedly not for the rich to decrease their uneconomic growth to make room for the poor to increase their economic growth. The concept of uneconomic growth remains unrecognized. Rather the vision of globalization requires the rich to grow rapidly in order to provide markets in which the poor can sell their exports. It is thought that the only option poor countries have is to export to the rich, and to do that they have to accept foreign investment from corporations who know how to produce the high-quality stuff that the rich want. The resulting necessity of repaying these foreign loans reinforces the need to orient the economy towards exporting, and exposes the borrowing countries to the uncertainties of volatile international capital flows, exchange rate fluctuations, and unrepayable debts, as well as to the rigors of competing with powerful world-class firms.
The whole global economy must grow for this policy to work, because unless the rich countries grow rapidly they will not have the surplus to invest in poor countries, nor the extra income with which to buy the exports of the poor countries.
In other words, the present system makes it impossible for the poor to rise out of poverty. We are not merely playing a zero-sum game in which the gains of the winners equal the loss of the losers. We are playing a negative sum game in which even the people who think themselves winning are, in reality, losing out. Stopping damaging growth in the rich countries is not a cost but a gain.
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