« If you have one International Money Clearing Unit, it’s worth so many dollars ».

Paul Davidson’s speech at the conference « The Financial Crisis, the US Economy, and International Security in the New Administration », New York, 14th November 2008.

par Paul Davidson
Langue : anglais - Traduction : Réformer la monnaie internationale

Let me quote the last two lines of a book I published in 2007 about John Maynard Keynes: « When, not if, the next Great Depression hits the global economy, then perhaps economists will rediscover Keynes’s analytical system that contributed the golden age of the post-World War II. For Keynes, however, it will be Pyrrhic victory ». I didn’t think the time would come that quickly. The question is, do you have to have a theory in order to know what policies should be implemented? And what do you think Keynes’s theory is about? Often people say, « it’s about sticky wages ». But Keynes didn’t say it was about sticky wages. « Oh, then it’s the liquidity trap ». But he said in the general theory that there is no such thing as a liquidity trap. Then they say, « Keynes didn’t say anything about international things in the general theory ». But there are actually 15 passages in the gene- ral theory which mention how the general theory will be modified if it’s an open economy. And of course we have all his work on Bretton Woods. And he wrote an essay called « Self-sufficiency », in which he said the law of comparative advantage is really irrelevant in trade patterns today. The only time comparative advantage works is if you have natural resources, or something that has to do with the climate. Obviously you don’t want to go to Iceland to do sunbathing. But for all the other things, as long as capital is mobile across national borders, it is the absolute advantage, not comparative advantage that determines trade patterns.

Suppose China built a factory in California that hired child labor, had no occupational safety regulations, polluted the atmos- phere and made people work 45 to 60 hours a week at a very low wage. The United States laws would say you are not allowed to trade with that factor. So why is it, if they put the factory in China, we allow the United States to buy? And why did we pass child labor laws in the first place? Because we believed it’s uncivilized to let children under 14 work - not because they didn’t want to work, or because their parents didn’t want them to work. In other words, there are some limits for people’s ability for self-regulation.

What was the Keynesian revolution about? It had to do with taxonomy. Keynes spent ten years trying to figure out what was wrong with the classical theory. He knew by the Treaty of Versailles there was something wrong, but he didn’t know what it was. What he did in essence was to change the definition of words that we use in economics. Remember, savings are defined as time preference in the classical theory. It just meant you bought something later rather than now, and since the manufacturer knew when you’re going to buy, he built more capital equipment to prepare for this extra demand later. Keynes said no, it’s the propensity to consume, when you save you have a liquidity preference; that is, you want to put your savings in liquid assets.

He also wrote a whole chapter about « Essential Properties of Interest and Money » in which he explains that every liquid asset has two essential properties: a) Anything that’s liquid cannot be produced in the private sector by the use of labor; b) According to the law of substitution, liquid asset will not be substituted. If its price goes up, you will not substitute products of industry. And what does it mean? It means that if you save, you buy things that couldn’t be produced in the private sector; and no matter how the price ran up you would never substitute producible goods for it. And that’s what caused unemployment.

The same goes for the financial markets in the international sphere: according to Keynes, these markets are liquidity preference markets. They were not « efficient ». That’s why he talked about « animal spirits » driving it, and not some strange idea of efficiency - what is an efficient market anyway? I hate when people keep talking about risk management: there is no such thing as risk management because you can’t predict the future. Keynes continually said, speaking about Tinbergen’s method(1), that the economic data are not homogeneous over time, which means that the economic behavior is non-ergotic (2). You can’t predict the future, and that’s precisely why liquidity is important. When a serious monetary theory will be written, the fact that contracts are made in the form of money will be the essential part of it. Think about the use of contracts in a global economy: when people in two different countries enter into a contract, what currency do you use? Very often they use a third currency, usually the dollar, especially when they trade commodities. If it’s a manufactured good, you usually use the currency of the producer. This creates all sorts of problems for the system. Keynes was very clear about that and suggested a plan at Bretton Woods to solve this problem.

I must confess that I feel today like a broken clock that tells the correct time twice a day every day. Since 1983, I have been warning that the international system is instable, that we have to transform it into something more like the Keynes plan. And every once in a while it turns out I’m right – as at the time of the Mexican crisis, during the default crisis 1998-99 or right now. At least four or five times during the day I’ve been right. It’s a long day, but it’s not the long run.

What did Keynes want to have in this Bretton Woods system?

First of all, he wanted a global monetary regime that operates without currency hegemony. He didn’t want to have the dollar at the heart of the system. He conceived of some supranational central bank with an international currency which only national central banks could deal with, not the public. I’ve been arguing that you don’t need a central bank; what you need is a clearing union.

Secondly, he wanted global trade relationships that support rather than retard domestic development. As soon as a country starts to develop it encounters the following problem: whenever it gets out of step with its trading partners, it runs immediately into balance of payment problems, must tighten its belt and try to succeed by controlling the currency, and therefore never has to worry about the balance of payments.

Third, Keynes wanted capital flow constraints, which is part of China’s strategy today, and this strategy seems to work.

Fourth point, a very important one: If there is a balance of payments problem, you want an international currency that puts the major onus on the creditor nation to solve the problem, not on the debtor nation. The problem with all convertible currency - whether with fixed or variable exchange rates, it doesn’t make any difference - is that the debtor nation is the one that’s required to tighten its belt; whereas the wherewithal for solving the problem is with the creditor nation. They have the money to solve it and Keynes suggested how this could be done: the creditor nation has to spend it excess reserves - it could spend it on buying products from other people, on foreign direct investment, but it has to get rid of those extra credits. If China doesn’t want to buy our products, it can invest in our light rail indus- tries, helping us to solve our transportation problem. We could sell municipal bonds to China to produce light rail, solving two problems at once and getting rid of their excess dollar reserves. Or, if they won’t do either of those two, there would be a 100 percent tax to take away these extra reserves. Instead of reserves, we would have something which I would call the Marshall Plan.

Let me remind you of what the Marshall Plan was about. At Bretton Woods, Keynes said that the European nations would need approximately $10 billion to rebuild. Harry Dexter White replied that the Congress would never give more than $3 billion, and Keynes’ plan was refused. The IMF and the World Bank were supposed to recycle private funds over the $3 billion that the Congress might allow. But then came 1947, a very bad year for agriculture. Western Europe loo- ked like it was failing; it might even turn Communist; so people eventually convinced General Marshall to do the Marshall Plan. In four years we gave $15 billion, not 10, to the Europeans. It was good for them, and it was good for the United States.

Why was it good for the United States? It was the first time in history that we didn’t have high unemployment after a major war. Think about it: 9 million men and women left the army and came back to the labor force. Where did they find a job? Some of them were absorbed into colleges under the education plan, but there were still a lot more of them. But thanks to the Marshall Plan, export indus- tries grew dramatically and that created jobs. So we gained, and they gained. And that was Keynes’s argument: the surplus country will gain from it as well.

The essence of the Keynesian system is that it is liquidity and financial markets that make a monetary entrepreneurial economy run; and that it’s a double-edged sword. If it runs as it should, it generates economic growth at a rate that you can’t have in a barter economy. If it doesn’t, as right now, you get a depressed economy. Keynes once said that in an economy where the real wealth is constant, and where peo- ple are handing around pieces of paper to each other, everybody feels better off if each day the price of the paper goes up. But if each day the price of the paper goes down, suddenly they feel worse off. The real economy hasn’t changed at all. But it will change if they feel worse off.

This is what we need in an international monetary system. We have to recognize a) that we cannot leave it to the market to solve these problems since capital markets are not efficient; b) that liqui- dity is the essence of the problem, and that we have to encourage peo- ple to spend. What amazes me is how everybody now picks on the poor American consumer because they spent more than they earned, and equity, and so on; we seem to forget that, since 1992, the global economy has been driven by U.S. consumers spending like crazy. As Allen Sinai pointed out, consumer spending went up from 67 percent to 71 percent of GNP in the United States, and of course this created not only the engine of growth for the United States, creating profit opportunities for our people, but also for the rest of the world. China’s growth lies in large part in America’s ability to buy Chinese goods.

What we need is thus a system based on these principles, an international, global system. The real problem is how we get there. Somebody asked me how this system would solve the Icelandic ban- kruptcy problem. The answer is that if somebody is in bankruptcy already, then it’s too late to solve it. That’s why we have bankruptcy laws. They get them out of it with the least penalty to themselves and to the lenders. So I can’t solve the Icelandic problem. But I can tell you that if we change the system along the lines indicates above, we will encourage every country to pursue full employment.

And why capital controls? If we had these capital controls, we could never pass off all these « toxic acid », so to speak, to Iceland, Germany, Northern Rock. All these things could have been prevented. Would they have been prevented? Well, this requires regulation and intelligence, and a regulator respecting the rule of meritocracy. Keynes always believed that our regulators, our civil servants, should follow the rule of a meritocracy. Otherwise, no policy will work. So let us have a meritocracy and let us understand the theory and the principles of what we need in this international system.

As John Eatwell pointed out, we should reform the IMF. Maybe that will solve our problems, but I doubt it very much. We need a new institution. Somebody said earlier that we could use old institutions to do new things. I don’t care whether you call it IMF or something else; I call it an international clearing union. This international clea- ring union clears between national central banks. The public never gets hold of the accounting - and hopefully central banks don’t do accounting fraud. Each country is permitted to set its exchange rate for one-way convertibility between the clearing union unit of account and its current account. It is permitted to do it, but it does not have to do it. All it has to do is say: « if you have one IMCU [International Money Clearing Unit], it’s worth so many dollars ». The advantage of this is that every central bank will be willing to hold IMCU’s because they know they can always have products at a fixed exchange rate.

Finally, does the exchange rate ever change in that system? Yes it does. It changes if the efficiency wage - that is, productivity less money wage - improves. Then there’s an advantage in changing the exchange rate. What I’m arguing is that you have relative real effi- ciency wages between countries that share productivity growth among every nation of the world. And we also have this onus on those countries that run up too big a balance in the clearing unit. They must get rid of their balance by buying something from others, which will allow the debtor nation to work their way out of debt. And that’s what we want people to do, work their way out of debt, not bail them out of debt.

(1) In reference to the so called Keynes-Tinbergen debate that took place in The Economic Journal in the 1930s, the first debate on econometric difficulties attached to the statistical testing of economic theory.

(2) A behavior that in certain respects remains incomprehensible through observation, and thus impossible to predict.

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