Global Rebalancing & the Bancor
Last week my colleague Frances Coppola noted that “the present pattern of world trade is highly unbalanced: developing countries run large trade surpluses and most Western nations (with the notable exception of Germany) sizeable trade deficits. It could be argued that the developing nations have bootstrapped their growth from the willingness of people in Western nations to consume more than they produce and spend beyond their means, funding the difference with debt.”
One of the reasons underlying financial crises and international frictions is the imbalance of trade between nations. Countries running trade deficits fund the difference through debt acquisition, often through the mercantilist lending accrued money back to the debtor. As the balance of trade shifts the balance of debt, countries may experience magnified international frictions. Debtors broadly have an interest in devaluation — shrinking the burden of the nominal debt by inflating it away. Creditors broadly have an interest in price stability or even deflation, which increases the nominal purchasing power of the debt, tolerating only the amount of inflation that keeps the debt serviceable and the debtor purchasing produce.
In the longer run, enough currency devaluation by a debtor locked into an awkward creditor-debtor relationship will close the imbalance. But with policymakers locked into the dogma of endless trade deficits, creditors may retaliate with devaluation of their own, in order to boost their own export competitiveness and continue running deficits. This is the economic phenomenon known as currency wars popularised by James Rickards, and in the past currency wars and trade wars have had some very adverse consequences. If the trade deficit cannot be closed, debtors may lose financial independence, experience a destruction of domestic production capability or ultimately debtors may end up defaulting on the debt, further increasing international tensions. In extreme circumstances, this may result in war as the creditor comes to collect a pound of flesh. Or, the debtor — crushed by the burden of the debt — may end up going to war against the creditor to wipe the debt out. Unsurprisingly, those who pursue beggar thy neighbour policies often end up beggaring their neighbour or getting beggared themselves. Although there is sometimes a case for national industrial policy and a degree of protectionism to correct market failures, Frances Coppola is right that mercantilism and policies of endless trade surpluses are unsustainable and deleterious.
Robert Skidelsky has noted that imbalances of trade are an issue in the global economic system in the years leading up to the financial crisis: “a tenable view is that the accumulation of reserves by a handful of countries in East Asia and the Middle East played a key permissive role in the collapse. Between 2003 and 2009 (measurable) global reserves increased from $2.6 trillion to $6.8 trillion – an average annual rate of increase of about 15%, at a time when global GDP grew at an annual rate of 4.4%. This amounted to a big increase in deflationary pressure.”
John Maynard Keynes envisaged much of this back in the 1930s, and attempted to devise a long-term solution. In the 1940s, at the Bretton Woods Conference, Keynes alongside E.F. Schumacher tried to implement a global financial arrangement — the International Clearing Union— to minimise trade imbalances and the frictions that they can create. The International Clearing Union would be a global bank whose job would be the clearance of trade between nations. All international trade would be denominated in its own unit of account, the proposed bancor. The bancor was to have had a fixed exchange with sovereign national currencies, and would have been used as a unit of account to measure the trade balance between nations. Every good exported would add bancor to a country's account with the International Clearing Union, while every good imported would subtract bancor. To discourage imbalances, if a nation had a high trade surplus the ICU would take a percentage of its bancor balance and put it into the Clearing Union's reserve fund; this would encourage nations with surpluses to buy other nations' exports. Nations that imported more than they exported would have their currency depreciated against the bancor, thus encouraging other nations to buy their products, and making imports more expensive.
While we cannot be certain that Keynes’ system would have achieved its aims, it is extremely disappointing that it was never tried because it addresses some very serious problems. Keynes’ plan was vetoed by the US, which saw its trade surpluses as “hard-earned”. Instead the Bretton Woods Agreement of 1944 set up an International Monetary Fund to provide short-term financial assistance for countries in temporary balance of payments difficulties. Without an international clearing union there was no automatic stabiliser to prevent long run trade imbalances. As such, while the US once ran great trade surpluses, it is now the country running huge trade deficits. Since Bretton Woods, the United States has become the world’s consumer of last resort. In many ways, this has been a free lunch — dollars have been widely desired, and countries have been prepared to trade their production for green pieces of paper.
The extent to which this may destabilise and trouble the global economic system in the future is uncertain. Frances Coppola states that “the brutal trade rebalancing that is occurring in the Eurozone at the moment is a useful indicator of what may be to come on the global stage”, and it is possible she is right. Certainly China and the United States are locked in an awkward interdependent debtor-creditor relationship. Such relationships in the past have led to problems, including wars. In our case today it is possible interdependency will serve to pacify both parties — the United States appreciating having cheap imports, and China appreciating having a large market for its manufacturing output. In a successful rebalancing, China will have to accept some depreciation of its huge dollar and Treasury hoard, and accept that in the longer term it cannot rely on trade surpluses as a source of growth. In the longer term, the United States will have to come to accept the end of its reserve currency status, and the accompanying free lunch. Hopefully, an international reserve currency system in the mould of the bancor can be peacefully established to replace the dollar system, that can stabilise and balance trade. There are some positive signs on that front. In a speech delivered in March 2009 entitled Reform the International Monetary System, Zhou Xiaochuan, governor of the People’s Bank of China called Keynes's bancor "farsighted" and proposed the adoption of a global reserve currency.