A new international Bretton Woods system?

The essential aim of Keynes’s international clearing union was to prevent the onset of competitive devaluations and to mitigate the deflationary tendencies caused by the reluctance of surplus countries to reflate and stimulate aggregate demand for the deficit countries. The pre-war system had imparted a contractionary bias which forced the deficit countries to adjust internally by imposing deflationary policies. Keynes had envisaged an international system which would reverse this deflationary bias and impart an expansionary impetus which would allow deficit countries to pursue full employment policies. This necessarily implied that the surplus countries would be obliged to incur more of the burden of adjustment.

The dilemma arose that the surplus countries could continue to accumulate foreign exchange reserves almost without limit, as long as the central bank could sterilise the inflationary effects. The deficit countries, on the other hand, would eventually run out of foreign exchange reserves and be exposed to speculative attacks on their currencies. In this sense, the burden of adjustment would be borne almost entirely by the deficit countries, which would be forced to enact contractionary policies and experience higher levels of unemployment. These asymmetrical shocks would ultimately depress international effective demand and have an adverse effect on the exports of the surplus countries themselves.

The Keynes plan had proposed that any country which experienced severe and prolonged balance of payments deficits (equivalent to half of its bancor overdraft), would be charged interest on its bancor account. It would also be obliged to devalue in order to prevent the outflow of capital. On the other hand, the surplus countries would be forced to reduce their balances of payments surpluses and revalue their respective exchange rates.

To prevent the deficit countries from incurring the entire burden of adjustment, Keynes proposed that the surplus countries, which had accumulated a bancor balance equivalent to more than half of their overdraft credits, would be charged interest at 10 per cent per annum. If their credit balance exceeded the total value of their permitted overdraft at the end of the financial year, the surplus would be confiscated. The overriding aim of these rules was to force surplus countries to clear their international balances and force them to incur some of the burden of adjustment.

Unfortunately, Keynes's Bancor plan was defeated by US opposition, led by their delegate H.D. White, at the Bretton Woods conference. The US dollar, tied to gold at a fixed price of 35 dollars per ounce, would instead perform the functions of reserve asset, unit of account and means of payments for the international monetary system based upon fixed but adjustable exchange rates (Skidelsky, John Maynard Keynes: Fighting for Freedom, Vol.3, 2000).

The Davidson Plan

The dollar/gold convertibility regime established by the Bretton Woods agreements had inherited a serious flaw, which became more evident as the US economy began to experience growing balance of payments deficits during the late 1960s.

Robert Triffin (Gold and the Dollar Crisis, 1961) was one of the first prominent economists to warn of the impending demise of the Bretton Woods system as a result of the role performed by the US dollar as an international means of payments and international reserve asset. The “Triffin dilemma” as it became known, essentially states that in order to supply the international economy with US dollars, the US itself would be obliged to run burgeoning balance of payments deficits to avoid a drain on international liquidity. But the very growth of these US deficits would ultimately undermine the role of the US dollar and hasten a series of crises. This contradiction would set in motion cycles of expansion and contraction of international liquidity and generate systemic instability.

After the demise of the Bretton Woods system in 1971-73, these destabilising flows of short-term speculative capital became more pervasive as countries abolished capital controls and deregulated their financial markets.

As the issuer of the global reserve currency, the US enjoyed the enormous benefits of dollar seigniorage. In other words, the US was no longer constrained by dollar/gold convertibility. Unlike the rest of the capitalist countries, the US could finance its burgeoning balance of payments deficits by the issuing of US dollar-denominated bonds and securities without the limits imposed by the accumulation of foreign exchange reserves. US policy makers could now pursue an unfettered strategy of restoring their international competitiveness by resorting to successive dollar devaluations. The dollar crisis therefore not only imparted an inflationary impulse, which forced other countries to impose quite severe deflationary policies, but successive dollar devaluations also threatened to erode the competitiveness of their capitalist rivals in Europe and Asia (Parboni, The Dollar and Its Rivals, 1981).

The problem of growing international payments imbalances has since emerged as a major source of financial instability. Indeed, the current crisis is quite unique because international “money” ceases to have a standard unit of value, analogous to the dollar/gold convertibility system or the 19th century gold standard regime under the aegis of Pax Britannica. In the absence of an objective standard of value, currencies only possess “fiat” values, which are governed by future expectations under the guise of hedging and speculative operations performed by the foreign exchange and derivatives markets. In the event of a credit crunch, the US dollar assumes its role as a safe haven and reserve asset.

Paradoxically, even though the international economy might experience an increase in the supply of US dollars as a result of the easing of US monetary policy, the velocity of circulation tends to fall as US dollars are hoarded. As long as deflationary forces remain quite robust, an increase in international liquidity is thwarted. It can be surmised that the existing system of deregulated financial markets and worsening payments imbalances cannot be sustained. Sooner or later, an irreversible dollar crisis will appear which will signify the end of the existing fiat money regime. At this moment, the political imperatives for international monetary reform will become irresistible.

In the tradition of the Keynes plan, Davidson (“Reforming the World’s Money”, Journal of Post Keynesian Economics, Vol.15, No.2, Winter) has devised a more simplified plan to reform the international financial and monetary architecture. Davidson proposes an International Money Clearing Union (IMCU), similar to the original Keynesian bancor system. Although a fixed exchange rate regime is proposed, countries would be allowed to adjust their respective parities to reflect permanent structural changes in unit labour costs and current account deficits at full employment equilibrium. At the same time, nation states would not surrender their control of the national banking system and would preserve their ability to pursue independent fiscal policies to maintain full employment.