When, in a few years from now, political analysts will look back on November 2010, they will likely see it as the moment when the debate over a new multipolar world monetary system became really serious. On Nov. 2, President Obama and Democratic Party suffered severe losses in the US mid-term elections – mainly due to the protracted economic malaise in America. On Nov. 3, the Federal Reserve decided to buy US treasury bonds (and state and municipal bonds) worth $600 billion (a lot more will likely follow). The international answer was unprecedented – in the negative. Then, on Nov. 8, Robert Zoellick, the head of the World Bank and a key figure of the US establishment, suddenly proposed the creation of a “new monetary system”.
By Michael Liebig
QE 2.0: Causes and Consequences
With its decision on Nov. 3, the Fed is launching a second round of “quantitative easing” (QE) – in simple words increasing the money supply. Supposedly, QE 2 would “stimulate” the real economy, but the first round of QE in 2009 had no such effect. In 2010, official unemployment is close to 10% and enterprises (awash with cash) don’t invest. The reason is structural: the average American household is suffocated by debt. Often, the mortgage on the family home is higher its (market) value. And, job insecurity comes on top of accumulated consumer debt. For the past decades, debt-financed domestic consumption had been driving the American economy, but since the 2007-08 financial crisis the American consumer has become quite restrained.
Except for the IT and defense sectors, American manufacturing is not really competitive in technological terms. Therefore, there is no short-term prospect that the USA might expand domestic investment and employment via significantly expanded exports – except slashing labor costs and depreciating the US dollar, thus making American products cheaper on international markets.
Moreover, the American state is buried under an “Himalaya” of public debt. Some 40% of US public debt is held by foreigners – China being the biggest creditor. Had America’s giant public debt gone into education, science, technology and infrastructures, the problem would likely be manageable. But the debt was mostly spent for foreign wars, an absurdly bloated defense/security complex, tax cuts for the super rich and the like.
In this setting, the Fed’s QE policy seems to make “sense”. Over the next few years, QE in the USA will:
- drive up US inflation due to the widening gap between money in circulation and real economic output
- depreciate the dollar exchange rate, which has a double effect: making US exports cheaper and reducing the value of US assets held by foreigners
- create an “American carry trade”: ultra-cheap and abundant US liquidity will flow into “emerging” economies (driving up exchange rates and overheating financial markets)
- fuel commodity speculation (energy, minerals, agricultural products, etc.) – and consequently fuel inflation internationally
Of course, Fed chairman Bernanke is and US Treasury Secretary Geithner are vehemently denying these rather obvious consequences of QE 2.0. On Nov. 7, Bernanke at a conference in Jekyll Island, Georgia, where his predecessor Alan Greenspan was also present, proclaimed: “I have rejected any notion that we are going to raise inflation to a super-normal level in order to have effects on the economy… Our purpose is to provide additional stimulus to help the economy recover and to avoid potentially additional disinflation which I think we all agree would be a worse outcome.” And even more so would Bernanke deny that there is a “hidden agenda” behind the QE 2.0: “debt relief” by “controlled” inflation and active currency devaluation.
Fixed debt titles with fixed interest are “eaten up” by inflation and the value atrophy of debt titles held by foreigners is reinforced by depreciating the currency in which the debt is denominated. [LINK: http://www.solon-line.de/controlled-inflation-as-exit-strategy.html] Bernanke, Geithner and Obama know perfectly well that the giant over-indebtedness is the central problem of the United States. And, they seem to think that they have found a “clever” way of dealing with this problem: debt relief by actively pursuing a policy of inflation and dollar depreciation.
The public rhetoric sounds differently. Every other day, US Treasury Secretary Geithner proclaims that the U.S. government remains committed to a “strong dollar” and “will never use our currency as a tool to gain competitive advantage.” There is a reason why the US authorities don’t want to admit what they actually are up to. Such an admission would not only collide with the ideological axioms of free-market capitalism, which American leaders have been preaching to the rest of the world for decades. Such an admission would be incompatible with the role of the US dollar as the world reserve currency. As Jacques Rueff put it: The United States have the “strange privilege to increase demand abroad without a corresponding reduction of demand at home”.
When the USA are in trouble, the American authorities usually blame others. Over the past months, we have seen a new round of “China bashing”. China is accused of “actively manipulating” its currency exchange rate – swamping the world with “artificially cheap” exports. Over the past decades, we have seen many episodes of China bashing – usually followed by spates of Sino-American “rapprochements”. Remember, in 2009, the silly talk of a “G-2” – an alleged US-China condominium. No doubt, the Chinese government does not allow the yuan to float freely. The reason for controlling the yuan exchange rate is simple: Most Chinese products are not yet technologically advanced enough to be competitive on international markets if the yuan exchange rate would rapidly and significantly appreciate. In contrast, most German export products remain competitive (due to their technological quality) even when the Euro is appreciating significantly. What also seems to be overlooked is the fact that China is not only export-dependent, but import-dependent. In 2009, according to WTO data, China’s exports were $1.2 trillion, its imports $1 trillion. Essentially, China’s export surplus is generated through its bilateral trade with the USA.
The latest political and media campaign against China has a simple purpose: Creating a diversionary smokescreen behind which the USA would “actively manipulate” its currency exchange rate – not just to “artificially cheapen” its exports, but for an unilateral “debt relief”.
It seems, the real American agenda was not missed by the rest of the world as demonstrated by the international reaction to the Fed’s QE announcement:
- China: In the newsletter of the People’s Bank of China, the economist Xia Bin wrote: “Unbridled printing of dollars is the biggest risk to the global economy… China must set up a firewall via currency policy and capital controls to cushion itself from external shocks… The last but the most important point is that in the long run the considerable depreciation of the dollar will help America to transfer its debts to others.” The official China Daily noted: “China faces the risk of its dollar-denominated assets depreciating and the risk of increasing inflows of international speculative money.”
- Germany: Finance Minister Wolfgang Schäuble: “They have already pumped an endless amount of money into the economy via taking on extremely high public debt and through a Fed policy that has already pumped a lot of money into the economy. The results are horrendous.” On the currency dispute with China, Schäuble accused Washington of “pursuing the same goal with different instruments”. The American fiscal and QE policies “will create more problems for the world”.
- Brazil: Finance Minister Guido Mantega: “it doesn’t work to throw money from a helicopter because this won’t make growth flourish.” The head of the central bank, Henrique Meirelles, added that the Fed’s move has “negative consequences for other countries, which is the case for Brazil,”
- South Africa: Finance Minister Privin Gordhan: “Developing countries, including South Africa, would bear the brunt of the US decision to open its flood gates without due consideration of the consequences for other nations… US policy undermines the spirit of multilateral cooperation that G20 leaders have fought so hard to maintain during the current crisis.”
- South Korea: A senior official of the South Korean Finance Ministry said: “Our country will actively consider implementing capital control measures,” in response to the American QE measure.
Towards a “Multipolar Curreny World”
In his Nov. 1 “Commentary” [Link: http://fbc.binghamton.edu/commentr.htm], Immanuel Wallerstein, the American social scientist and economist, noted that its current monetary, fiscal and financial policies will not salvage America’s international monetary-financial position. As the exchange rate of the dollar has been steadily slipping, the “surpluses invested in U.S. treasury bonds are worth less as time goes by. There comes a point at which the advantages of such investment (the principal advantage being that it sustains the ability of U.S. enterprises and individual consumers to pay for imports) will eventually be less than the loss of real value of the investments in the treasury bonds. The two curves move in opposite directions. The problem is one which is posed in any market situation. If the value of a stock is falling, owners will want to divest before it becomes too low. But rapid divestment by a large stockholder can impel a rush to divest by others, thus causing even greater losses. The game is always to find the elusive moment to divest that is neither too late nor too soon, or not too slowly but not too fast. This requires perfect timing, and the search for perfect timing is the kind of judgment that quite frequently goes awry. I see this as the basic picture of what is happening and will happen with the U.S. dollar. It cannot continue to maintain the degree of world confidence that it once enjoyed. Sooner or later, economic reality will catch up with it. This may happen in a five-minute shock or in a much slower process.”
The net result of this development will be the end of the US dollar’s role as world reserve currency. “We shall be in a multipolar currency world,” concludes Wallerstein.
As a caveat, Wallerstein adds that this might create situation, in which “no one feels comfortable.” Indeed, that might be so. But the status quo in world monetary affairs is unsustainable. Sooner or later, a new, multipolar world monetary system will have to be established.
It seems, even in the USA itself some are thinking in this direction, albeit as a way to preempt others from taking the initiative. Why would Robert Zoellick, the current head of the World Bank and a key figure of the US establishment, suddenly propose the a creation of a “new monetary system”? In a Nov. 8 column in the Financial Times, Zoellick wrote “This new system is likely to need to involve the dollar, the euro, the yen, the pound and a renminbi [yuan] that moves towards internationalization. The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values.”
My preliminary hypothesis would be that Zoellick and a significant faction of the US establishment know that the rest of world is not buying the Bernanke-Geithner-Obama policy: The USA will get isolated internationally as other actors will pursue an alternative set of monetary-financial policies based on the economic growth dynamic among BRIC countries and relatively favorable (when compared to America) economic conditions in Europe. It seem to me that Zoellick’s basic idea is: If you can’t stop the train that’s already in motion – jump on it.
Given America’s status as No. 1 debtor nation and an abysmal condition of the economy, what – besides political clout and military power – does the USA have as a lever in international monetary affairs? Answer: 8.133 tons of monetary gold. In comparison, Germany has 3.408t, France and Italy 2.400t each, China 1.035t, Switzerland 1.040t, Russia and Japan roughly 750t each, and Brazil 35t.
It’s an historical irony that 39 years after the Nixon administration unilaterally decoupled the US dollar from gold – an thus terminated the Bretton Woods world monetary system – a leading figure of the US establishment calls for a new world monetary system with gold as an “international reference point” for currency values. Zoellick’s initiative is also a (late) response to the March 2009 Chinese initiative on world monetary reform. [Link: http://www.solon-line.de/china-for-new-monetary-system.html]
It seems obvious to me that gold will play a role in the emerging multipolar world monetary system. How important that role will be, is another question. Zoellick’s focus on gold seems more like a tactical maneuver to reinforce the American position in the inescapable debate over reforming the world monetary system.
From Option to Necessity
One does not have to be monetary expert to know that – beyond the technicalities – international monetary systems are rather simple constructions. They all start from a rather straightforward recognition of the correlation of (real) economic forces among states and state alliances. The purpose of international monetary systems is to facilitate regional and international trade and economic cooperation which are the necessary offspring of an ever more differentiated division of labor within national and regional economies and the world economy as whole.
Possibly, the European Monetary System (EMS), created in 1979 on the initiative of German Chancellor Helmut Schmidt and French President Valery Giscard d’ Estaing, might serve a model for the emerging multipolar world monetary system. The EMS was created – in the aftermath of the collapse of the Bretton Woods system – with the prime purpose to contain (by no more than 2.25%) the fluctuations among the currencies of the then-European Economic Community. As a common reference, a synthetic unit of account – the ECU – was established which was based on a basket of EEC currencies relative to the respective economic strength and gold. De facto, the deutschemark was the anchor of the EMS.
I think it is realistic to assume that regional monetary systems will emerge in Asia (probably not just one, but two or three), in Latin America, Russia-Central Asia, and Africa. Europe has already the Euro single currency (however quite distinct from the EMS). Each regional monetary system will have an anchor currency. And of course, there is the US dollar – for the continental United States. Regional monetary systems will have to assure monetary, trade and financial stability within the respective region.
Following the same principles underlying regional monetary systems, the multipolar world monetary system could operate – incorporating half a dozen (or so) regional monetary systems. Such a reformed world monetary system could contain wild currency fluctuations among the regional monetary systems and eventually create a globally accepted (synthetic) unit of account.
On Nov. 11-12, the G20 Summit will convene in Seoul, Korea, where France will take over the G20 chair. It’s quite unlikely that any decisions on world monetary reform will be made. But, the events of November 2010 have demonstrated that a new multipolar world monetary system is no longer a (desirable) option, but a urgent necessity which has entered the realm of realpolitik.