Bringing the financial system into the 21st century

As a consequence of comments to my last article seeking my views on how a new Bretton Woods agreement would operate this article seeks to provide a framework for further discussion.

However before I do that I want to dispatch the fallacies coming from the Austrian School of Economics to the boundary (to use a cricket metaphor).

You would think that from their propaganda there were no recessions or depressions before the concept of Keynesian economics appeared, this is simply not correct. Recessions/depressions occurred in 1797, 1807, 1819, 1837, 1857, 1873, 1893 for instance all prior to the advent of Keynesian economics.

Keynesian economics sought to provide a system of stabilisation to reduce the consequences of the boom/bust cycle. It recognises that it is possible for price equilibrium between supply and demand to occur without ensuring all labour was being utilised.

Keynesian theory simply is that a new price equilibrium between supply and demand for goods could be created by altering levels of government expenditure, thus creating a price equilibrium that utilised all available labour.

The trick for governments is that creating debt to increase demand is only half the story. The activity that the government invests in has to increase economic capacity. Activities such as new dams, new roads, rail networks, ports etc that have the capacity to generate new economic activity or increase long term productivity, have traditionally been the activities undertaken during periods of Keynesian policy implementation. Employing persons to dig holes and fill in holes have not been a central part of Keynesian policies, but like all good propagandists the advocates of the Austrian School never let the truth get in the way of their story.

If we look at the recent financial crisis, its real root cause is that the private financial institutions have created a “blackmarket” fiat monetary system via the creation of derivatives notionally linked to the residential property market in the United States.

Looking at the damage done by the merchant bankers in this unregulated market it is unbelievable that the sales reps for the Austrian School believe that governments should abandon the regulation and control of the monetary system and hand it over to these same cowboys.

Framework for a new Bretton Woods Agreement

Rather than have one currency as the world’s reserve currency I propose the creation of an international four pillars framework. (Not to be confused with the four pillars underpinning the Australian Banking system.)

The four pillars would comprise of the United States dollar, the euro, the Japanese yen and the Chinese renminbi.

Each of these currencies would be fixed against a tri-metallic standard of gold, silver and platinum.

That is they would be fixed to a certain quantity of gold and for monetary conversion purposes silver and platinum would be fixed in value against gold.

The respective governments would guarantee full convertibility of their currency against one, two or three of the commodities.

That is gold, silver or platinum could be exchanged against any of the four reserve currencies.

The four currencies would be fixed in value against each other. The process for revaluation of reserve currencies will be explained later.

Each nation’s currency would be set against each of the reserve currencies with a tolerance of 3 per cent. Each nation’s monetary authority would be required to buy/sell their currency to maintain its value against all four reserve currencies within this prescribed range.

The process for revaluation of national currencies will be detailed later.

Currency re-evaluation process

To oversee the Bretton Woods institution there needs to be an economic security council consisting of 15 member nations with nine permanent members and six rotating members.

The nine permanent members would be the United States, the European Union, China, India, Japan, Brazil, Russia, United Kingdom and South Africa. The six rotating members would come from Asia (including Oceania) with two seats, Europe with two seats, Africa with one seat and the Americas with one seat.

For a change in either the value of one of the reserve currencies or the reserve commodities it would require an absolute majority of the council with seven of the nine permanent members concurring.

For a change in the value of any nation’s currencies only a simple majority would be required provided that nation could show a major disequilibrium in current account.

Reform of agricultural trade

Central to any new international finance system is the need to reform the corrupt trade arrangements in the agricultural sector.

The removal of all trade tariffs and quotas in agriculture would be a requirement of the new financial system.

The power to declare a list of agriculture commodities as essential goods would be provided to the economic security council. Changes to the prescribed list would require an absolute majority along with seven of the permanent members concurring.

The prescription of a commodity as essential goods would trigger in all nations regulations to limit speculative trading in those commodities. The primary purpose is to stop price distortion in commodities that are basic staples commodities in the developing world. In simple words stopping the suits getting rich by making the third world starve.

Summary

The Bretton Woods Agreement provided the framework for sustained economic growth, however as the world economy grew in size and diversity its central premise that the United States could become the “reserve” economy became unsustainable.

Rather than alter the framework to provide additional pillars to underpin the international financial system, the western capitalist world systematically unwound the institutions and frameworks of the Bretton Woods system through financial deregulation.

This has brought back uncertainty in international trade; companies involved in significant trading activities have to engage in hedging activity to minimise the risk in currency movements. This in itself can involve risks - one only has to look at Pasminco a resource company that disastrously hedged against currency movements and as a consequence went bust.

The need to divert financial resources to hedging activity removes financial resources from the “real” economy; it increases speculative activity in commodities, currencies and property. It leads to asset bubbles with asset inflation and when they burst asset deflation with dire consequences for the “real” economy.

That is why we need to put in place a new Bretton Woods Agreement.