Leanne Ussher
Part of a Triple Crisis series leading up to the Nov. 11-12 G-20 meetings.
At the recent G20 meeting of finance ministers in Seoul, Timothy Geithner was right to put forward a proposal that asks countries to cap their current account surplus, but the manner in which he suggested such goals be achieved offered little incentive for surplus countries to commit to such restrictions. This is why solutions for global imbalances put forth by luminaries such as John Maynard Keynes and Nicholas Kaldor were grand plans to change the system.
Both economists were skeptical of the powers of flexible exchange rates to equilibrate imbalances. In particular, Kaldor [1] found empirically that appreciations of the Japanese and German exchange rates, and even rising labor costs relative to their trading partners, did little to change their increasing share of world trade in the 1960s and 1970s, at the expense of the US and UK. Looking at the history of currency realignments, the success of devaluations in reducing surpluses is variable at best.
Kaldor’s insight was to focus on the terms of trade between manufactured goods and commodities – the raw materials essential to industry. Ordinarily, devaluation will raise a country’s cost of raw materials (if primarily imported), create inflation and possibly lead to rising wages. This would increase the cost of manufactured exports and lower competitiveness. Kaldor found that the appreciation of the Japanese and German currency, in the 1960s and 1970s, compensated for rising prices of food, industrial materials and oil. This, along with Verdoorn’s law (increasing returns in production and the positive feedback in market share and labor productivity) allowed these countries’ trade surpluses to grow, despite their appreciation.
Today, if China was alone in maintaining a low exchange rate relative to the US dollar, they would necessarily be lowering the price of their own manufactured goods (i.e. the price of the ‘value added’ by its processing activities) in terms of basic inputs (food and raw materials). However this trade-off between competitiveness and terms of trade is not occurring because there are many other emerging market nations that are also devaluing their currencies, including those that primarily sell commodities. All are hoping to create a competitive edge and develop their manufacturing base through export-led growth.
One has to design a trading system that would balance the manufacturing trade between the highly industrialized nations and prevent the industrially dominant market leaders from growing through unrequited exports, at the expense of other industrial countries – effectively stopping them from exploiting their own growth potential and ability to pursue policies of full employment. Kaldor felt that only with appropriate cost pressures from raw materials (and/or a limited supply of labor, though this was rarely binding due to immigration) would an export-led country have an incentive to raise its exchange rate enough to counter its competitive advantage in manufactured exports.
Kaldor’s preferred solution was the institution of a new reserve currency, backed by a basket of commodities. He called this commodity reserve currency (CRC) his ‘gadget’ and once instituted he believed that it would be an apolitical, automatic stabilizer that would resolve global imbalances, promote even growth and effective demand throughout the world. (Kaldor initially took this idea from Benjamin Graham and worked on it with Albert Hart at Columbia University in the 1960s and 1970s.)
A CRC would create a bufferstock of storable raw materials and allow for the stabilization of their price index over the cycle. The stockpiling of these goods (located at regional futures exchanges and trading centers) would be paid for by the issuance of the reserve currency (redeemable inventory receipts for the basket). The targeting of a commodity price index with open market operations would increase the supply of CRC when demand and pressure on commodity prices were low, and contract when economic growth was high. This new currency offered a standard of value, a liquid asset that can grow with world trade, and most importantly a source of stable income to the developing world allowing it to be the driver of world growth.
Unlike the SDR this currency could be internationally traded by public or private participants and would not require liquidity or mass acceptance to make it valuable. It would be independent of national currencies, hence exempt from the Triffin paradox, and its supply would be endogenous to rising world demand. This new reserve would exist alongside individual sovereign currencies which could peg or float to the international reserve. Importantly, each nation would be free to choose its monetary, fiscal, exchange rate and trade policy with its own citizens’ priorities in mind.
In 1977 Kaldor thought his commodity reserve currency proposal was at least 20 years ahead of its time. But even today this idea remains politically unfeasible and futuristic. Yet we desperately need bold solutions that will create enough renewable resources to both sustain the industrialization of the developing world and act as a stable generator of world effective demand. Trying to tweak a system that is structured as a prisoner’s dilemma only tempts coordination failure. We must change the system such that there are trade-offs and equilibration. Radical and bold approaches are required.
[1] Kaldor, N. (1978) “The effect of devaluation on trade in manufactures.” Further Essays in Applied Economics. N. Kaldor. London, Duckworth: 99-116.
Leanne Ussher is assistant professor of economics at Queens College, City University of New York.