| Americans are no longer sole creditors to the world, and this may call for a new financial architecture
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| It is an unhappy characteristic of economic columnists that they fail to acknowledge any new unearthing by others. Having myself occasionally suffered from such behaviour, let me rectify the count by stating that, while Arvind Virmani was well ahead of others in highlighting the fact that China and India were growing faster than all other countries, Surjit Bhalla was the first to draw our attention to the fact that the Chinese Yuan was under-valued.
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| However Bhalla’s revelation does not validate the rest of his analysis. He supports the present American effort to persuade and pressurise the Chinese to revalue the Yuan; but it is hard to see why the Chinese should agree. The normal expectation is for a weaker currency to devalue, but not necessarily for a stronger currency to revalue.
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| However Bhalla takes the general view that it is not practicable to devalue the American dollar because other countries would automatically devalue with it since it is a Reserve currency and their exchange rate is fixed to it; as is the case with the Yuan.
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| It would be simpler he feels for the Yuan to be revalued than for the dollar to be devalued. However I doubt if any Chinese leader would have the political gumption to suggest that course of action, particularly when an under-valued Yuan seems to be doing so well for the Chinese economy.
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| But it is not the minutiae of exchange policy that I wish to pursue here. Rather it is the general outcome of these persistent trade surpluses from Asian economies as it now affects the general financial architecture devised under the Bretton Woods Agreement and supervised by the IMF.
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| The essential problem is that these reserves held in dollars and euros affect the economic policies of these currencies to a disturbing degree. For example the monetary authorities are being compelled to lower their interest rates to accommodate Asian Reserves and being pushed into an expansionist policy which they may not want.
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| Further, just as Indians are uncomfortable with fiscal deficits, some Americans (perhaps many Americans) must be being made to feel uneasy by the foreign purchases of their national debt. It is said that China and Hong Kong have purchased $ 280 billion of US treasury securities as a of way parking their trade surpluses.
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| This outcome is a consequence of the system created and accepted at Bretton Woods, namely the setting up of an international Stabilisation Fund as proposed by the Americans and the rejection of the alternative more ambitious Clearing Union system proposed by the British.
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| The IMF is simply an evolution of the Stabilisation Fund which was designed by America when the Americans were almost the only surplus country. Its purpose was to ensure that credits were given cautiously so that American interests were not frittered away. But the world has now changed and Americans are no longer the creditors.
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| Other countries like Japan, Korea and China have built up surpluses while the Americans have accumulated debt. This burden is causing as much anxiety to Americans as the Government of India’s fiscal deficit causes to Indians.
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| The alternative system proposed by Keynes was the creation of an International credit and debit system accounted for in a unit known as Bancor which would be administered by the Fund. The par value of every national currency was to be fixed against Bancor and would be automatically altered both upwards and downwards if debits or credits exceeded a certain percentage.
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| If this Clearing Union system were now in operation, the Chinese with their surpluses would be forced to revalue their exchange rate against Bancor while the Americans would in effect be devaluing the dollar against Bancor.
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| Further, since under the Bancor scheme, creditors would be paid interest and debtors charged interest, no creditor would feel compelled to invest surpluses in US treasuries. Thus any purchase of Treasury Bills by surplus countries would only be done under general investment principles, and creditors would expect to take the same risk as any other investor.
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| However, the outstanding merit of the Clearing Union System was that it provided a closed system, and one which was entirely self regulating. For it relied on the crucial principle that one country’s debit was another country’s credit.
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| And, since the net credits and debits would accrue in a closed system, the overall monetary system would always be unaffected. Thus any debit made by a payer within the Clearing Union would automatically be credited to the Clearing Union balance of whoever received it. This system ensured that the Clearing Union as a whole could never run short of resources.
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| To understand the principle, consider how it would be under the ordinary national banking system if payments and receipts could only be made by a banker’s draft issued by the Central Bank. Such a system could never go bust even if a particular bank were too generous to its clients.
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| So long as the payments were made by debits and credits at the Central Bank, the system would continue to be robust. Further, the volume of funds within the system would not become depleted as every debit would have a corresponding credit in the system.
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| Keynes proposed applying this principle internationally. He saw it as easily monitored by the Fund by means of some rules that punished both persistent debtors and creditors by requiring changes in the exchange rates to reduce the imbalance and payment of interest, not only for deficits but even for excessive credits.
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| The purpose of the scheme was to prevent excessive hoarding by surplus countries while penalising deficit countries. The logical structure that Keynes proposed was rejected by the Americans. Now more than half a century later it could re-emerge as the classically simple scheme needed to operate the international system.
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| The plan was rejected by the Americans because they feared that the expansionist policies underlying the Clearing Union would have to be paid for by them as creditors. They were not enthusiastic about debt accumulation on the part of Europeans for in the past these debts had to be written off.
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| Nowadays the Chinese and other surplus Asian countries have no such apprehension about America’s accumulated debt, and it is the Americans who are perturbed by these excessive movements.
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| In reconsidering the Bancor scheme, ( which is extensively described in Keynes’s Collected Works, Volume XXV), certain economic principles should be borne in mind.
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| First there is need for a unit of value that does not change with the whims of fortune. In an earlier age that unit of value was thought to be gold or silver. It would no longer be fashionable to revive that as a monetary tool.
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| However this does not prevent an artificially created Bancor being established, and initially each country could arrange its exchange rate against the Bancor arbitrarily.
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| Every national currency should be able to devalue its exchange rate against Bancor if it so desired, but if as a consequence it were to build up a substantial surplus, the Governors of the Fund should be able to require that currency to be revalued against the Bancor.
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| The scheme proposed here is not exactly the same as the one suggested by the authors of the Clearing Union. In this paper it is proposed that under the new system, exchange rates should be allowed to vary extensively, while the old system preferred fixed exchange rates with small variations.
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| However, the merits of the two schemes are similar and such that they deserve the attention of the financial and economic world.
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| sjmulji@aol.com
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