by Soner Songul
A dissertation submitted to the faculty of
The University of Utah
in partial fulfillment of the requirements for the
degree of
Doctor of Philosophy
Department of Economics
The University of Utah
August 2002
Copyright Soner Songul 2002
All Rights Reserved
ABSTRACT
This dissertation is a descriptive analysis of three
selected world currency proposals: Keynes's Bancor
Proposal, International Monetary Fund Special Drawing
Rights, and Guttmann's Supranational Credit Money
Proposal. Specifically, the political economy aspect
of these proposals is evaluated. The deficiencies of
the current multicurrency arrangement, serving the
international monetary system, are the major theme of
these proposals. As a part of the investigation into
the suggested reforms, many difficulties and benefits
of achieving a monetary union are identified. The
conclusions of my study put emphasis on the overdraft
provisions of the proposals, issues of empowering the
central institution through design of enforceable
features, importance of maintaining political will of
the participant nations, and the desirability of
bringing symmetric adjustments to payment balance of
individual nations. My thesis is that the current
global economy requires an international nonmarket
agency for regulating the international monetary
system. Implemented, it would provide a multilateral
character to international lending and provision of a
truly international currency that would serve the
increasing integration of economic activities more
effectively.
ACKNOWLEDGMENTS
First, I would like to thank my adviser, Hans Ehrbar,
for his continued support and encouragement throughout
this work. His insightful comments always led to
additional thinking and rewriting for the better. I
believe he is a role model for demonstrating how a
sincere commitment to a line of thought would display
a consistent way of living. I would also like to thank
Lance Girton for his challenging questions and keen
comments on the material. I would like to extend my
gratitude to the other members of my dissertation
committee, Gunseli Berik, Al Campbell, Korkut Erturk,
and Nedim Alemdar, as well. They all contributed
significantly to the content reflecting their
extensive knowledge of the issues.
To my parents and my sister
TABLE OF CONTENTS
ABSTRACT ...............................................................iv
ACKNOWLEDGMENTS ......................................................viii
Chapter 1. INTRODUCTION ................................................ 1
2. CRITICISMS OF THE CURRENT
INTERNATIONAL MONETARY SYSTEM .................... 6
2.1 High Degree of Volatility and
the Periodic Misalignment of Exchange Rates .............. 8
2.2 Greater Capital Mobility and Globalization of Financial
Markets as a Threat to Systemic Stability .................... 9
2.3 Misallocation of Resources Arising from Uncertainties
Associated with Exchange Rate Flexibility ................. 11
2.4 Structure of Decision-making in the Monetary
System ....... 13
2.5 The Often Irrational Dynamic of Financial Markets
........... 14
2.6 Large Trade Imbalances Among the Major
Industrialized Countries ........................................ 14
2.7 Proposed Solutions ................................................. 15
3. SURVEY OF WORLD CURRENCY PROPOSALS .............. 18
3.1 Keynes's Bancor Proposal ......................................... 18
3.2 Special Drawing Rights ............................................ 28
3.3 Guttmann's SNCM Proposal ...................................... 34
4. COUNTERARGUMENTS AGAINST
WORLD CURRENCY PROPOSALS ............................ 40
5. POLITICAL ECONOMY ASPECTS
OF THE WORLD CURRENCY PROPOSALS ................. 47
5.1 Political Economy of International Monetary Relations ...... 48
5.2 Political Economy of Monetary Unions ......................... 54
5.2.1 Economic Benefits and Costs ............................... 57
5.2.2 Currency Domain in relation to
the Fiscal and Trade Domains ........................... 60
5.2.2.1 Does a single currency scheme require
fiscal federalism? ................................... 60
5.2.2.2 Is a single currency needed to support
fiscal federalism? ................................... 62
5.2.2.3 Interactions between currency regimes
and trade policies ................................... 65
5.2.3 The Transition to Monetary Union ......................... 65
5.3 Political Economy Aspects of
the World Currency Proposals ................................ 69
5.3.1 Keynes's Bancor Proposal ................................... 69
5.3.2 Special Drawing Rights ...................................... 74
5.3.3 Guttmann's SNCM Proposal ................................. 78
6. CONCLUSION ....................................................... 81
REFERENCES ............................................................... 96
CHAPTER 1
INTRODUCTION
Discussions of the international monetary arrangements
intensify every time a crisis hits the world economy.
Political power relations, using the dominant frame of
thinking, shape economic institutions that come about
after these discussions. Subsequent performance of the
world economy is intimately connected to the outcome
of these efforts. Most recently, the 1997-1998 Asian
crisis retriggered attempts to analyze global
connections between monetary measures and the real
side of the economy. After the Great Depression and
during the Second World War the Bretton Woods
Conference signified a collective effort to plan the
monetary scheme in attempt to avoid the recurrence of
the Great Depression. Keynes's Bancor proposal
represents the position of one of the two most
dominant negotiating nations, Britain. Despite being
shelved, it has a striking resemblance to some more
recent international system reform proposals (for
example, Davidson and Guttmann). This study
investigates the potential of world currency proposals
with an emphasis on the surrounding political economy
aspects.
Unfortunately, this is not a world where political
struggles have been replaced with conflict resolution
intended to benefit everyone. Even in situations where
cooperation would clearly enhance the outcome for all
involved parties, a joint solution may not be reached,
due to the negotiation process, priorities of
individual participant nations (for the sake of
coalition building), and repercussions on domestic
politics. It is understandable that policymakers are
responsible for protecting the welfare of their
constituents. What is missing appears to be
recognition of interconnectedness among nations and
the potential for betterment and progress, while
respecting similar rights of others.
Greater integration of world economic activity is a
characteristic of the postwar development of the world
economy. This market globalization was accompanied by
various disputes among the nations that remained the
political units of managing affairs. Despite
widespread impacts of individual nations' policies on
others, domestic policies have primarily been
motivated by domestic concerns. In the realm of
monetary policies, for the most part, national central
banks are doing a good job responding to the needs of
domestic economies. However, prospects of
international contagion usually present a real
challenge to national policymakers during crisis
times. This creates a need to look at the
institutional framework of international monetary
affairs.
Policymakers are challenged on several fronts in
connection with the globalization of economic
activity. Capital accumulation has a tendency to go
beyond national borders in all aspects: finance,
production and exchange. However, these aspects expand
at different paces and scope, causing concern about
coordination of the activities.
It should not come as a surprise to see that both Marx
and Keynes placed an analysis of money at the heart of
their own capitalism studies. Money represents a
social mechanism for the coordination of all
productive activities and social validation of output.
Viewing the current international monetary system,
there are multiple lines of inquiries observing
deficiencies of the whole structure. Several
deficiencies are observed while using multiple
national currencies for international roles. These
deficits include high degree of volatility and
periodic misalignment of exchange rates, globalization
of financial markets and capital mobility as possible
threats to systemic stability, misallocation of
resources arising from uncertainties associated with
exchange rate flexibility, concerns regarding the
structure of monetary system decision-making,
financial market dynamics (with its often irrational
outcomes), and persistence of large trade imbalances
among the major industrialized countries. Among
others, Schulmeister (2000) draws attention to the
double role of the key currencies as a major
contributor to the emergence of crisis situations.
Oftentimes the double role, in national and
international affairs, results in multiple conflicts
between the two roles being played. This position
establishes the starting point of world currency
proposals. More considerations in relation to the
current system will be discussed in the second
chapter.
One significant criticism against the world currency
proposals is their supposed irrelevance to the current
actual situation. This can be grounded in the belief
that the existing political forces will not allow a
truly international currency to replace the already
dominant currencies. It is true that the U.S. Treasury
is capable of blocking any increase in international
lending shares of the International Monetary Fund
(IMF) and World Bank therefore employing a definite
favoritism to big private lenders, instead of
international organizations. However, it would be
impossible to guess how soon the balance of power
might shift and preferences could be adjusted
accordingly by individual nations. Just watching the
European Monetary Union improving provides some clues
about rejecting the impossibility hypothesis, since
those countries are apparently willing to give up
their mostly credible national currencies in favor of
a joint currency created from scratch.
This dissertation will focus primarily on three of the
world currency initiatives. Those are Keynes's Bancor
plan, IMF's Special Drawing Rights (SDR) and
Guttmann's Supranational Credit Money proposal. In the
meantime, some consideration will also be given to
Davidson's plan. After introducing these world
currency proposals in Chapter 3, an examination of the
major criticisms against these three plans will follow
in Chapter 4, and the fifth chapter will investigate
the political economy aspects relating to these
proposals. The fifth chapter is particularly important
and constitutes the primary contribution of this
study.
Whenever a substantial change of the whole system is
introduced, the first line of criticism usually has
connections to the existent political structure. It is
no different in the case of world currency proposals.
As opposed to the usual approach for modifying the
system in an incremental fashion, all of these
propositions aim at restructuring the whole framework,
so that the functioning of the international monetary
system will be altogether altered. The ambition
supporting this lies in the goal of achieving a new
configuration so that (at least) some of the
disparities will be eliminated. The implications of
such a big change would naturally cause a stir in the
political side of the account.
Some common points of concern in relation to monetary
unification include loss of monetary autonomy,
distribution of seigniorage benefits, and symbolic
significance of national currencies. There are
numerous issues raised in connection with
relationships between the currency domain and fiscal
and trade domains. Further, there are additional
difficulties associated with transition from the
current system to a common currency. All of these many
aspects will be considered in Chapter 5; first in
relation to monetary unions (in general) and then in
relation to the studied plans.
Finally, crucial elements are identified from
conclusions of the considered proposals with special
emphasis given to central international institution
empowerment and overdraft provisions. These two
aspects deserve special attention. The latter
constitutes a main point of contention, relating to
the fundamental issue of how much creditors want to
try a new structure, essentially promising a more
stable system. In return they are likely to suffer a
loss in their power to decide who gets the funds. The
former issue is important for relating to possible
plan success/failure at implementation. The SDR
experience specifically indicates how the actual
functioning can be stalled in many different ways,
e.g., a veto power obtained by a country or a group of
countries, possible usage of unintelligible language
at the initial stage (defining the operation), or
connection to design of the governing board not
leading to promotion of IMF policies, even by
participant nations. Each of these characteristics is
crucial to deciding the outcome of the initiative.
The next chapter will provide an overview of the
criticisms of the current international monetary
system. Thereby a brief evaluation of the current
system's functioning will set the stage for the world
currency proposals that will be introduced in the
following chapter.
CHAPTER 2
CRITICISMS OF THE CURRENT INTERNATIONAL
MONETARY SYSTEM
International monetary relations have been a favorite
conference theme throughout history. Both political
and economic aspects are considered in these
thoughtful and challenging discussions. Not only are
they debatable at international meetings, but also
numerous academic studies attempt to build a better
understanding of monetary relationships among nations.
Any analysis should start with an assessment of the
current state of affairs, in order to establish
meaningful connections. In this study, before
investigating world currency proposals aiming to
improve performance of the world economy and
international monetary system, we will discuss
criticisms of the international monetary system that
indicate current concerns.
Today's world economy is characterized by increasing
internationalization of world markets. One of the
first questions tackled by many is the extent of
economic integration (Bryant 1990, p.16; Rodrik 1998,
p.4). Rodrik observes a `home bias' in asset
portfolios and concludes that asset markets are not
yet tightly integrated. Guttmann argues that the pace
and scope of integration process has yielded a
qualitatively different economic environment (1994,
p.324). While describing these qualitative attributes,
he notes an inherent tendency for capital accumulation
expansion beyond national borders in all aspects:
exchange, production and finance. However, a lack of
coordination in expansion of these activities is
observed.
In comparison to the national economies, global
economy has some unique structural features. Guttmann
(1994) identifies these as lacking a fully developed
state apparatus (also Bryant 1990, p.18), foreign
trade involving a second transaction (currency
conversion), and the need for a mechanism for
symmetric adjustments and even development. All three
aspects signify that any analysis of the world economy
should pay special attention to the nature of
interactions in between the existing political units.
Since a supranational structure to foresee the overall
picture is nonexistent, efforts for extended
cooperation need to overcome objections of individual
nations. Accordingly, challenges in the international
monetary sphere would need to address political issues
in consideration of implementation difficulties.
We could extend our investigation of the current state
of affairs by asking many other crucial questions,
such as: Does globalization aggravate inequality? How
significant are the benefits of globalization? How
much does globalization constrain national autonomy?
Each question is individually significant and demands
attention, but the focus of this dissertation relates
to monetary affairs so we will now turn to some
criticisms of the current international monetary
system.
In order to pave the way for expectations of the
international monetary system, it would be appropriate
to direct attention to criticisms of the current
system. Next, some common themes will be listed with
some brief explanations of relevant criticisms.
2.1 High Degree of Volatility and the Periodic
Misalignment of Exchange Rates
Lack of flexibility was seen as a critical deficiency
of the Bretton Woods system (DeGrauwe 1996, p.244). It
was hoped that with flexible exchange rates
depreciations and appreciations of the currency would
help smooth the correction of current account deficits
and surpluses. Flexible exchange rates were proposed
to achieve international trade balances through
adjustments in these exchange rates and to provide
national authorities with partial relief from the
maintenance efforts of fixed exchange rates. However,
the experience brought a high degree of instability to
the international monetary system, due to large
fluctuations in exchange rates. Looking at the time
series data of major industrialized countries the
current account imbalances increased ever since the
flexible exchange rates were adopted. In particular,
the dollar exchange rate is observed to fluctuate even
more than other reserve currencies (Schulmeister 2000,
p.365).
The oil shocks of the 1970s are cited among some of
the explanations for persistent current account
imbalances (DeGrauwe 1996, p.245). However, experience
in the 1980s has been ever-increasing current account
imbalances, well after the current account effects of
the oil shocks have diffused. Lack of coordination
among the countries' fiscal policies is suggested as a
second possible theory. It has been argued that the
presence of flexible exchange rates gives fiscal
policy authorities incentive to pursue more
independent policies that lead to divergent patterns
of national fiscal policies (DeGrauwe 1996, p.246).
Thirdly, the low price elasticity of trade volumes is
given as possible cause of increasing current account
imbalances just after exchange rate adjustments. The
existence of so-called `J curves' describes this lag
of volume response to price changes. When exchange
rate movements are perceived as transitory, the trade
flows are argued to be less responsive to exchange
rate variations (DeGrauwe 1996, p.247). As another
alternative, Schulmeister develops an analysis tying
developments in the postwar era to the double role of
the dollar, and inward oriented policies of the U.S.
(2000, p.366).
In contrast to flexible exchange rates, fixed exchange
arrangements are noted to have possible troubles based
on the following premises. Credible commitments by
national authorities for exchange rate targets are
seen as unlikely, since domestic objectives may
conflict with these commitments (DeGrauwe 1996, p.55).
Without political and institutional integration, a
joint monetary policy would be unworkable. European
integration presents a case attempting to introduce
such new institutional frameworks, including elements
of political integration.
Given the experiences from the 1970s to the 1990s,
flexible exchange rates bring a high degree of
volatility to the world monetary system (Cooper 1990,
p.289). The recurring misalignments forced significant
adjustments between the tradable and nontradable
sectors of many countries (DeGrauwe 1996, p.252).
2.2 Greater Capital Mobility and Globalization of
Financial
Markets as a Threat to Systemic Stability
`While exchange-rate volatility affects both
industrial and developing countries, mainly developing
countries suffer from capital-flow volatility' (Gunter
1996, p.115). In support of the exchange rate section
of this argument, DeGrauwe (1988) found that
exchange-rate variability explains 20 percent of the
slowdown in world trade growth since 1973. The growth
rate of world trade is not the only concern in
relation to exchange rate fluctuations, but it is
sufficient to demonstrate that impact is experienced
by all (for the most part). In consideration of
capital flows, we should note that the direction of
funds is, to a great extent, determined in financial
markets by fund managers and investors. Beliefs are
formed in these markets within informational
constraints on possible returns among alternatives.
Over time, these beliefs are subject to revisions with
new information and speculation shaping perceptions;
Capital markets are regarded as highly vulnerable. As
the Asian crisis exemplified most recently (Hahnel
1999), whenever a sharp reversal of funds occurs, the
developing countries are left with the detrimental
consequences of the financial crisis. Individual
countries' ability to sustain economic stability and
stability in world economy as a whole (to some extent)
depends on how successfully they deal with speculative
`hot money' that flows in and out of currencies.
Hence, one of the desired features for the monetary
system is finding structure that will discourage
speculation.
The principle of comparative advantage suggests an
international division of labor through a relatively
free movement of goods and services between countries.
This century-old trade theory accommodated capital
flows, expecting movements of capital to allocate
financial resources for real investments anywhere
(Roosa 1989, p.257). This physical capital formation
would nourish a more diversified worldwide growth by
means of highly integrated capital markets. In
contrast to this vision, the superstructure of
investments and currencies yielded a picture where a
dominant proportion of capital movements reflected
attempts of portfolio diversification (Guttmann 1989a,
p.17). Consequently, fluctuations in interest rates or
appraisals of exchange rates brought the impetus for
shifts of portfolio capital. Such structure of capital
movements translates into tendencies toward more
economic instability for individual countries and
transmission of troubles to other countries by means
of capital markets.
There are conflicting views regarding capital
controls. For example, IMF still sustains the view
that they are contrary to efficient resource
allocation. Only recently, IMF seemed to view capital
controls as transitory measures (IMF, 1995). Still,
there are views in support of protection by capital
controls, as they helped Chile and Colombia during the
1994 Mexican peso crisis (Gunter 1996, p.118).
Another proposal for reducing capital market
volatility is called Tobin tax. This is a tax on all
foreign-exchange transactions. Though it is argued to
be technically feasible (Arestis and Sawyer 1997),
political obstacles work against an introduction. And,
it is regarded as a second-best option by even Tobin
himself (Gunter 1996, p.119). Gunter argues for a
world central bank as the best solution. Until this
can be established, using Tobin tax, selective capital
controls and a set of regulatory and supervisory
responses seems appropriate. However, Cooper thinks
the impact of such a tax on short-term exchange rate
volatility is entirely unclear (1990, p.292).
2.3 Misallocation of Resources Arising From
Uncertainties
Associated with Exchange Rate Flexibility
Cooper presents the main features of this interaction
with the following list of possible ways exchange
rates influence the allocation of resources (Cooper,
1990, pp.286-288).
First, a high variability of exchange rates would
reduce investment in the sectors with intense
international competition. Not knowing how long
depreciation of currency will last would leave firms
hesitant to add productive capacity of tradables.
Second, major adjustments to external disturbances may
require changes in the overall price level of a
country. If the government takes a contrary action by
targeting the price level, adjustment via price level
to external disturbance would be obstructed. In due
course, the composition and level of the output would
be changed in response to pursued policies.
Third, imperfect competition would imply that fixed
market entry or market exit costs may avoid
adjustments in relation to exchange rate fluctuations.
No adjustment would take place until the exchange rate
fluctuation exceeds a certain threshold, making exit
or entry worthwhile for firms.
Fourth, since firms are unable to hedge future
production of investments against exchange rate
fluctuations, they may simply prefer to invest abroad
(across currency zones), even when producing at a
low-cost location could bring cost and scale
advantages.
Fifth, fluctuations in exchange rates may reflect onto
domestic firms as unfair competition from abroad and
they may seek protection from their government.
Resultantly, increasing trade barriers would alter mix
of output.
All the above connections suggest a misallocation of
resources in relation to exchange rate fluctuations
and uncertainty. Improving the current monetary
arrangements for a better environment to help
decisions of current and future production is
necessary.
2.4 Structure of Decision-making in the Monetary
System
Sustaining a satisfactory flow of capital to needy
countries and correction of the balance of payments
imbalances have been two of the issues addressed in
connection with how international flow of funds are
decided. The former aims at finding a way of reducing
the development gap through a better allocation of
funds. The latter issue is critical in maintaining
long-term sustainability of the whole system.
As noted above, currently the question of how
distribution of funds happens is answered in the
financial markets for the most part. In terms of
capital flowing through governments or some
international organizations, like IMF, World Bank and
so on, a two-way interaction with the markets is in
place.
There are doubts about how observed flow patterns in
the markets can be explained as rational decisions.
Further, the allocation of funds by IMF and World Bank
is also subject to some criticism. These institutions
are accused of excluding some countries for political
reasons, even when economic criteria would suggest the
opposite (The Economist, 1991, p.46).
Currently, the share of official institutions in
international lending remains very small in comparison
to private lenders. This fact is directly correlated
with U.S. polices favoring private bank involvement.
United States Treasury effectively blocks initiatives
to increase the IMF and World Bank's share of
international lending. However, the resultant private
bank lending is highly susceptible to the moral hazard
problem (Lance Girton, private conversations, May
2001). The prospect of being bailed out every time a
big failure occurs motivates big private lenders to
avoid smaller countries and projects, although funding
them would reduce risk through diversification.
Consequently, recurring crisis situations emerge at
the same time efficiency and equity are sacrificed.
Inability of the poorest countries to access
international funds suggests a better way of
distributing funds should be possible.
2.5 The Often Irrational Dynamic of Financial Markets
Social psychological dynamics of markets may cause
patterns of behavior that may not correspond to
economic basis. Following the trend may cause market
participants to pay less than adequate attention to
the underlying fundamentals (Cooper 1990, p.290).
Thus, process of forming expectations will likely add
to volatility in exchange rate markets. Consequently,
production and investment decisions are left with
higher uncertainty stemming from foreign-exchange
markets and international capital markets.
2.6 Large Trade Imbalances Among the Major
Industrialized Countries
As Cooper notes, `There is no special merit in
assuring balance in each country's current account
position'(1990, p.282) and `...we do not have a clear
operational definition of international equilibrium'
(1990, p.283). However, huge trade imbalances among
the major industrialized countries present the
possibility of exchange rate misalignments for
currencies being used as international money. The fact
that the U.S. runs trade deficits and finances these
trade deficits through capital inflows, creates a
potentially unstable situation because stability of
global economy is tied to foreign confidence in
dollar-denominated assets (Guttmann 1989b, p.219).
This was exactly the same scenario that led Triffin to
conclude that an international currency should be used
(1960).
As Guttmann argues, it would be reasonable for
less-developed countries to use foreign funds for
their real investments and experience payment deficits
as they catch up. The current picture significantly
exhibits the opposite in terms of payment balances,
not promising much development convergence among
countries.
2.7 Proposed Solutions
The above questions can be discussed in relation to
current international currency arrangements. Within
the current system, a few national currencies play
significant international roles and this fact leads to
connection inquiries. Schulmeister (2000) points out
that the double role of the dollar assigns substantial
importance to interest rates and exchange rates of the
dollar. As world currency, changes in dollar interest
rates and exchange rates reflect onto `...relative price
between commodities and manufactures in world trade,
the terms of trade between industrial and developing
countries, the speed of inflation and deflation in
world trade and the level of real interest rate on
international debts' (Schulmeister 2000, p.366).
Through an analysis of dollar exchange rate and
interest rate fluctuations, he demonstrates that
postwar development was shaped by the contradictory
relationship between the dollar's two roles as a
national currency and as a world currency.
There are several solutions proposed in response to
the above problems. Next, a brief overview of
suggested arrangements will be presented. The first of
these is the so-called Tobin tax, a transactions tax
on foreign exchange conversions, introduced above in
connection with high capital mobility of the current
system. As noted, it is regarded to be a second-best
option, and there are some concerns of diverting
attention from the need of more radical changes in the
exchange rate system, thus delaying implementation of
such changes (Gunter 1996, p.119).
Another proposal seeks stability in the foreign
exchange markets by setting target zones for major
currencies' exchange rates. Williamson's and Kenen's
names are associated with this proposal (Gunter 1996;
Cooper 1990). Possible problems with such a system are
technical difficulties in determining correct
fundamental exchange rates and an inability to avoid
short run volatility if target zones are not set quite
narrowly. As they did for the European Monetary
System, target zones might serve as a first step.
However, they must be brought together with increased
coordination surveillance and disclosure policies
(Gunter 1996, p.121).
Cooper proposes the initial institution of a single
currency by Japan, European Union, and the U.S.
(1990). The other countries would join later. He
emphasizes that disturbances to the real productive
side of national economies stem from nominal exchange
rate flexibility, to a significant extent.
Gunter argues that the current international monetary
system is not sustainable, primarily in connection
with exchange-rate volatility and speculative attacks
on currencies (1996). He believes that global
solutions are necessary. He addresses objections to
the World Central Bank idea and draws up a new
development vision that includes a World Central Bank.
Lietaer proposes a commodity-based global reference
currency (1996) with a demurrage charge. His
inferences from some historical examples and his
discussion of impact on business cycle, employment,
inflation, ecology and international business do not
seem very convincing.
The proposals to be examined in this study are
Keynes's Bancor proposal, Davidson's proposal, and
Guttmann's proposal, alongside the experience of SDR.
These proposals all concern attempts to institute an
international currency managed by an international
agency. What is striking about them is the
identification of problems in the current system at a
very fundamental level. They all attempt response to
the predicament of having few national currencies
serve the double role of national currency and world
currency, at the same time. Envisioning the
possibility of a truly international currency is
challenging; discovering what part of the current
problems are to be attributed to the system's daily
functioning, and what part belongs to design. Since
these proposals are usually dismissed for political
reasons, it is especially worthwhile to consider the
political economy aspects. In the next chapter, the
aforementioned proposals will be introduced, while an
investigation into their political economy aspects
will be pursued in the fifth chapter.
CHAPTER 3
SURVEY OF WORLD CURRENCY PROPOSALS
This chapter introduces the three world currency
proposals to be compared in this dissertation:
Keynes's Bancor proposal, SDR of IMF, and Guttmann's
Supranational Credit Money (SNCM) proposal. This order
also indicates the order of historical emergence.
Presenting them in this fashion allows for following
the development of features of the international
monetary system over the years.
3.1 Keynes's Bancor Proposal
Keynes's Bancor plan was brought to the table at the
Bretton Woods Conference. Discussions of this plan
took place (especially in Britain) during years
preceding the conference, and there is documentation
of those deliberations. More recent Post-Keynesian
proposals (Davidson 1992, 1998; Guttmann 1994)
resemble the Bancor plan to some degree. In this
chapter Keynes's Bancor plan will be introduced
alongside Davidson's proposal. Such a comparative
presentation should provide insights into basics of
the two and yield some indication of changing
concerns.
An initial description of the frame of mind behind
these proposals is worth mentioning, as one feature
common to both Keynes's and Davidson's presentation of
their own ideas. Paul Davidson presents his proposal
as `...a basis for the beginning of a sound analytical
discussion.' (1992) This attitude resembles the way
Keynes's Bancor proposal was brought to the table at
the Bretton Woods negotiations. It also embraced an
open-to-suggestions type of presentation. Although
both strongly believe in the virtues of their plans,
they prefer to open the doors of negotiation, without
being over-assertive. This appears to be the correct
attitude when proposing an ambitious plan for changing
many critical features of the system.
With intention to reform groundwork for the
international economic system, Keynes identifies a
list of conditions to prove a system long lasting:
(i)...[I]n the realm of internal policy the authority of
the governing board of the proposed institution should
be limited to recommendations, or at the most to
imposing conditions for the more extended enjoyment of
the facilities which the institution offers.
(ii) The technique of the plan must be capable of
application, irrespective of the type and principle of
government and economic policy existing in the
prospective member states.
(iii) ... management of the institution must be
genuinely international without preponderant power of
veto or enforcement to any country or group; and the
rights and the privileges of the smaller countries
must be safeguarded.
(iv) ... provision must be made for voiding the
obligation at due notice.
(v) [T]he plan must operate not only to the general
advantage but also to the individual advantage of each
of the participants and must not require a special
economic or financial sacrifice from certain
countries. No participant should be asked to do or
offer anything which is not to his own true long-term
interest. (Keynes 1943, p.56)
Through these conditions, Keynes introduces a short
list of essential features to be met before offering
the details of his plan. Since he served as a member
of the British delegation on different occasions, it
is no surprise to see such a presentation as it
demonstrates an awareness of themes likely to face any
such structural change. The above conditions address
some basic concerns for participant countries and
indicate acknowledgment of associated requirements.
Primacy of nations' internal politics in evaluating
this plan is the common theme in all above arguments.
For his plan, Keynes introduces an analogy with a
national banking system (Keynes 1943, p.66). A
national banking system provides means for utilizing
funds of depositors to finance business elsewhere, so
that balances are not left idle. Similarly, the
International Clearing Union (ICU) provides a
multilateral clearing system that provides a credit
mechanism in place of hoarding funds. As an
alternative to multilateral clearing, bilateral
arrangements (for providing international overdrafts)
would bring greater complexity and likely impacts of
extraneous political reasons (like those noted by
Viner (1929)). Keynes repeatedly stressed usefulness
of the `impersonal' lending attribute of proposed
facilities, particularly in transitional period after
war.
Wray argues that Keynes's banking analogy is flawed
(1998). Although Keynes indicates that existence of
ICU forms the basis for loaning money, Wray contends
the loans of Bancors create the Bancor reserves. He
attributes the plan's expansionary character to
reduction in exchange rate uncertainty. He suggests
the analogy be made with capitalist countries moving
from `mutual funds money' to `par money,' based on
gold reserves and later based on Central Bank
reserves. He argues that recent movement from gold
standard to flexible exchange rates in the
international sphere represents a backward step.
Wray's criticism is an effort to put developments in
perspective alongside a general query into the nature
of money. Wray's contention is noteworthy, since
probably the majority of who is interested in monetary
issues has a basic curiosity regarding these
questions. Hence, if the unit of account function of
money is the key to understanding its significance
then it would be this function to promote the
acceptability of a newly introduced currency. For
example, this would imply that it would be useful to
denominate all contracts in Euros as well as national
currencies during the last stage of transition into
common currency.
Returning to our discussion of Keynes's proposal, he
discusses properties sought for the system of
international currency as a means of setting the stage
for his plan objectives. He calls for:
(a) An international currency instrument to be
employed in transactions with other nations. A general
acceptability of this instrument among nations would
be a necessary condition.
(b) A method for determining relative exchange rates.
Rules must be agreed upon to prevent competitive
exchange rate devaluations through unilateral
decisions.
(c) A quantum of value, capable of responding to the
needs of world economy with deliberate expansionary
and contractionary states in response to the
deflationary and inflationary tendencies apparent in
world demand.
(d) A mechanism maintaining internal stability by
exercising pressure on any country to correct
departures from payments equilibrium in either
direction.
(e) A system capable of providing a stock of reserves
to every country after war to help during the
transition to peacetime conditions.
(f) A central institution to aid and cooperate in
planning and regulating the world economy. A purely
technical and nonpolitical character is expected to
hold true for this institution.
These conditions stand as a statement of concern for
stability of the system, and the appeal of a central
institution to watch currency needs and the general
economic state of the world.
Keynes's plan names Bancor, an international
bank-money, for settling international balances. The
value of a Bancor would be set in reference to gold.
Member state Central Banks would be entitled to settle
their exchange balances (in terms of Bancors) through
their accounts at ICU. Prevention of credit or debit
balances accumulating would be a prerequisite for
long-run system sustainability.
Keynes suggests that a governing board of ICU be
appointed by several member state governments. A
quota for each country would be determined for the
usage of the Union's credit facilities, as well as the
country's responsibility in managing the Union. As an
initial proposition, Keynes argues that quotas be
determined in relation to individual countries' trade
volume, while also possibly employing other factors.
Member states are allowed to overdraw Bancors up to
their quotas. A member state is required to pay 1
percent annually on its average balance of Bancors in
excess of one quarter of its total quota. This
payment increases to 2 percent for the average balance
in excess of half the allotted quota. Countries would
be allowed to avoid these contributions to the Reserve
Fund if they decide to help each other after governing
board consultations. Excessive use of interest-laden
borrowing arrangements would probably be restricted at
this consultation stage, because allowing for
extensive bilateral arrangements among the member
states would be rendering the enforcement mechanism
ineffective when faced with payment disequilibria.
Therefore, a limitation on bilateral cancellations
would be necessary for restraining international
payment disequilibria.
According to Keynes's plan, the following measures
suggest relief of debit balances: devaluation of
currency, control of outward capital transactions, and
outright surrender of gold or other liquid assets. In
case of credit balance, measures include expansion of
domestic credit and demand, appreciation of currency,
reduction of tariffs against imports, and
international development loans.
As the value of Bancor is defined and fixed in terms
of gold, member states are asked to not buy gold at a
higher price than the parity. Convertibility of gold
into Bancors is possible, while demanding gold for
Bancor balances is prohibited. This stipulation leaves
discretion of distributing excess gold balances to the
governing board, while ruling out possibility of a
rush for gold reserves of ICU. Wray adopts similar
reasoning to explain this one-way convertibility
arrangement (1998).
Nonmember state central banks are allowed to have
credit clearing accounts for their trade with member
states, but they would not have access to overdraft
facilities or any say in ICU management.
Keynes claims the following advantages for his plan:
- - an expansionist pressure on world trade,
- - overdraft facilities providing relief for some
countries without burdening others,
- - credit substituting for hoarding, to resemble the
national banking system,
- - multilateral character of international overdraft
arrangements,
- - provision of a mechanism to counter disequilibria,
- - setting adjustment responsibility on the creditor,
as well as debtor nations.
About five decades later, Davidson came out with his
proposal that primarily endorses Keynes's analysis
(1992). He recognizes more than simply choosing
between fixed and flexible exchange rate regimes is
required in effort to restructure the international
monetary system. He claims the targets as forming a
mechanism to resolve payment imbalances while
promoting full employment, economic growth, and a
stable international standard of value. Similar to
Keynes's plan, Davidson votes for a fixed (yet
adjustable) exchange rate system, combined with
requiring surplus trading nations to share the burden
of adjustment for payments imbalances. The concern is
persistent current account imbalances among trading
partners, leading to an inability to promote
continuous global economic expansion. This emphasis on
payment balance corrections fits exactly with the
Solomon (1996) and Triffin (1985) descriptions of
changing concerns in the 1970s.
Davidson's plan has provisions that appear to target
objectives similar to Keynes. He states that his plan
aims for: (1) prevention of lacking global effective
demand, (2) an automatic mechanism to place a major
burden of payment adjustments onto surplus nations,
(3) ability to monitor and control movements of flight
capital for each nation, (4) ability to expand
quantity of international currency, as global capacity
necessitates.
In terms of provisions, Davidson's plan shares
elements with Keynes's Bancor plan. It would introduce
an overdraft system, making short-term credit balances
available to finance productive international
transactions. Further, a trigger mechanism would be
instituted so that creditor nations are encouraged to
spend excessive credit balances. Davidson's
International Money Clearing Unit (IMCU) resembles
Bancor, given the role to facilitate transactions
through the International Clearing Union. IMCU
accounts will be held by central banks, while member
central banks will guarantee one-way convertibility
from IMCU deposits to their domestic currencies. This
provision avoids possible draining of national
currency reserves from the system. Davidson's plan has
this one-way convertibility arrangement in a similar
fashion but defined somewhat differently than what
Keynes argued for with gold-Bancor convertibility.
Davidson obliges national central banks for providing
their national currency when requested by ICU. Both of
these convertibility limitations aim at avoiding
unilateral actions of individual countries that might
leave ICU without gold reserves or domestic
currencies.
Exchange rates between IMCU and domestic currencies
will be fixed, yet subject to future modifications.
One cause for change in the exchange rate would occur
after a permanent increase in efficiency wages of a
country. Davidson's plan recognizes two basic options
for that nation in case of such productivity increase.
These are appreciation of domestic currency, or
keeping the nominal exchange rate as it is to attain
an increasing share of the world market for its export
industries. As for the opposite, if a rich country
experiences persistent current account deficits when
at full employment, rules of the plan require a
devaluation of its exchange rate over a period to
eliminate imbalance - without inducing significant
recessionary forces. If a poor nation has a current
account deficit, support through other nations' excess
credit balance transfers would be an option.
Davidson deems a supranational central bank infeasible
(in reference to the world politics) and his proposal
does not include it. However, in his proposal, an
international institution, sounding very similar to
Keynes' Clearing Union idea, still holds central
position.
Next, a brief discussion of some criticisms of these
plans will be introduced. First, will be Triffin's
concerns relating to Keynes's plan. Then Wray's
comments will provide a Post-Keynesian vision in
criticizing Keynes's and Davidson's plans.
Triffin (1957) offered three main criticisms of the
Keynes's plan regarding limitations on convertibility,
distribution of voting power, size and automaticity of
borrowing rights and lending commitments. All these
elements represent the principal themes of subsequent
disagreements.
The plan required commitment from each member to leave
the value of its currency in terms of Bancor unaltered
and not to acquire gold in excess of parity. With the
provision permitting all members to acquire another
currency through Bancor transfers, the plan would have
outlawed and made generalization of bilateral trade
and payment agreements impossible, which in fact
characterized the early postwar years. Hence,
convertibility limitations attracted some opposition
to the Bancor plan.
With disproportionate voting power of the sterling
area, another issue emerged. The initial proposition
of basing voting power in proportion to quotas would
take the countries' average trade turnover as base.
That would grant 30 percent of the total voting power
to the sterling area, opposed to 12 percent for the
United States. Keynes is noted to accommodate U.S.
opposition by agreeing in advance to substitute this
formula with `a special assessment,' as deemed
necessary.
The proposed size of borrowing quotas would be
adjusted over time, in accordance with average trade
turnover. This raised criticisms about the
inflationary bias of the formula. Triffin notes that
British proposals were designed for initial bargaining
positions. As for automaticity of lending, the
creditor nations were not as willing to accept a
system of `impersonal' lending. National lending had
been, and still is, an instrument of national power
and an adjunct to diplomacy.
Wray's criticisms have their roots in the
post-Keynesian view of money. Opposing the orthodox
view of money emphasizing the medium of exchange
function, post-Keynesian view highlights the origin of
money to lie with the unit of account function of
money (Wray 1998). According to Wray, times of
existential uncertainty and private property led to
the possibility of loan and emergence of money. The
endogenous money approach proposes that quantity of
money be determined in debt contracts, denominated in
money terms as a unit of account. This perspective
takes us to Wray's first criticism of Keynes's
presentation of the Bancor proposal. He sees efforts
to put the medium of exchange function at the
forefront a mistake. Essentially, he claims, designing
an International Monetary System, as if trade is
performed as `goods against goods,' is flawed. In any
capitalist economy, position taking in assets those
are expected to generate gross income (in monetary
terms) is a fundamental activity. Wray states that
Keynes's and Davidson's plans aim at eliminating the
speculative attacks on currencies arising from
flexible exchange rates. Such a change would remove
expected appreciation or depreciation component from
expectations of returns on foreign assets.
Consequently, that would be conducive to a more stable
International Monetary System. One can also propose
that fixing exchange rates would be more conducive to
speculative attacks. Therefore validity of either side
hinges upon an assessment of whether market forces
themselves are leading to attacks on currencies or are
efforts for maintaining fixed exchange rates leading
to credibility issues and possible attacks on
currencies. Wray's second criticism discusses Keynes's
banking analogy as confusion. This criticism was
introduced previously in connection with Keynes'
initial presentation of the plan.
3.2 Special Drawing Rights
When national currencies are used to meet global
liquidity needs, rapid growth of trade and investment
can be sustained only through payment deficits by the
key currency countries. Triffin emphasized that this
would inevitably raise doubts in regard to the quality
of those currencies (1960). Thereby, he argued for
inherent inadequacy of national currencies as world
money, which indicated need for a new liquidity
device. A decade after Triffin's initial proposal, in
1967 industrial nations agreed to the introduction of
Special Drawing Rights (SDR) to be issued by IMF. The
emergence of SDR represents the only historical world
currency experience and deserves a comprehensive
examination to discover the issues surrounding it.
Cumby (1983) provides a thorough overview of the
international monetary system and proposals for reform
prior to the Rio Agreement, which instituted SDR in
1967. Intellectual background supporting incubation of
the Rio Agreement include three major concerns:
reserve adequacy, asymmetries, and confidence problem.
Triffin introduced the notion of reserve adequacy as
the ratio of reserves to imports, assuming the reserve
demand grows with world trade (1947). He used this
measure to compare reserve adequacy over time and
across countries (1960). Based on this analysis,
Triffin predicted a prospective gold shortage.
However, claims of reserve inadequacy were challenged
in reference to possible controlling of liquidity
growth connected with price level increase concerns.
The measurement of reserve adequacy was refined to
include variability of export receipts and by
identifying it as a ratio to net external balance
rather than imports. On the other hand, it was noted
that a country's willingness to adjust external
balances by using exchange rates would reduce reserves
demand. Under such a managed floating exchange rate
arrangement, individual country reserve demands also
had this additional dimension. Cumby concluded (in
reference to Clower and Lipsey, 1968) `... measures of
adequacy based on trade data were insufficient and ...
making an assessment of adequacy under a policy regime
that encouraged speculation against the authorities
was impossible without an understanding of the
economics and psychology of speculative crises' (1983,
p.439). This statement appears more like a confession
of inability to specify the structural forces
determining the demand for reserves and pointing to
the connection of speculation.
Reserve adequacy was only one of the issues discussed.
The confidence problem was raised as an issue to
follow. Again, it is attributed to Triffin's (1960)
analysis of the gold-exchange standard's instability.
If the growth of reserve demand, in excess of
increases in gold supply, were to be satisfied through
increased official dollar claims, the confidence in
the fixed dollar price of gold would be challenged.
Cumby observes that prior to the Rio agreement,
gold-conversion decisions of central banks were
influenced by both political and portfolio
considerations (1983, p.440). In addition to the
military power of the United States, the common
interest in maintaining stability of the international
monetary system kept many countries away from
converting dollars into gold.
The existence of asymmetries in the system was another
issue addressed in the literature. The first asymmetry
relates to the United States facing no reserve
constraints while formulating its fiscal and monetary
policies. Triffin states, in retrospect, that in 1960
he placed too much emphasis on potential reserve
inadequacy, but insufficient emphasis on this
asymmetry (1978). Literature of the late 1960s
recognized the central role of the dollar primarily
indicated that U.S. policy determined the level of
world aggregate demand, while others argued it
manifested through determining the world interest
rates; leaving the other countries with a choice of
their interest differentials with the dollar to
influence capital flows (Cumby 1983, p.441). It is
possible to argue that the manifestation of this
asymmetry is possible through either monetary or
fiscal means.
A second asymmetry of the system involved assignment
of responsibility for correcting payment imbalances to
deficit countries. Deficit countries lacked the
ability to sterilize the impact on the monetary base
as they faced a loss of reserves. On the other hand,
surplus countries could insulate the monetary base (at
least in the short run) against the effects of payment
imbalances (Cumby 1983, p.442).
Despite pressures from developing countries,
proposals to create a link between reserve creation
and development finance were denied and SDRs were
distributed in proportion to IMF quotas. As Buira
indicates (1996, p.192), the main industrial countries
received the bulk of SDR allocations, as they command
the largest quotas. On the other hand, low-income
countries received only a small proportion even though
they have the greatest need to augment their reserves.
Williamson concurs with this observation and argues
strongly in favor of a new allocation of SDRs (1984).
His reasoning includes, but is not limited to, debt
relief for oil importing developing countries. Oil
exporting developing countries, the United States, and
the other industrialized countries would reap the
mostly indirect benefits by defusing the debt crisis.
He notes `(t)he purpose of inventing the SDR system
was ... exactly to allow countries to accumulate
reserves in the medium term without a net export of
real resources or foreign borrowing' (1984, p.26).
Providing reserves to hold, rather than to spend,
without generating inflationary pressures was the
original objective of the SDR system (1984, p.2).
Next, a few features of the SDR scheme will be listed
to characterize its operation at a basic level. IMF's
SDR department keeps record of each country's SDR
allocation and current holding. A country can use its
SDR balances by exchanging them for other currencies.
It can find another country to do the transaction, or
may ask IMF to find one. In response, IMF can provide
the currency from its own holdings, or can designate
another country to provide the currency requested.
Every country is obliged to accept SDR in exchange of
currencies, up to 300 percent of their net cumulative
allocations. Allocations of SDR are made in proportion
to the shares of individual countries' IMF quotas.
Value of an SDR is defined as equaling a basket of
five major currencies. The intention is to minimize
arbitrary variations, in real value of international
assets and liabilities, so that SDR would serve as a
useful unit of account.
Net receivers of SDRs over their allocation earn
interest to be paid by the net users. The rate to be
paid is determined in reference to the defined
instruments of the five major currencies, which
constitute the basket of valuation.
Since its introduction a total of 21.4 billion SDRs
were allocated over two three-year periods. Those
happened in 1970-1972 and in 1979-1981. As of March
2000, the share of SDRs within nongold reserves remain
at less than 1.3 percent (IMF, Annual Report, 2000).
SDR and the Development Finance Link
One main feature of Keynes's bancor proposal attracted
special attention because it reached another domain,
development. The grant of overdraft facilities
initially aimed at providing postwar relief,
rehabilitation, and reconstruction by allowing the
international body of ICU to help by distributing
unused funds. Williamson (1977) traces the origins of
discussion, instituting a link between SDR allocations
and development finance to Keynes's proposal. He
observed that there were subsequent proposals also
offering mechanisms for development borrowing. Most
proposals prior to 1970 suggested the link be
established in the form of project aid by the
Development Finance Institutions (DFI). The majority
of Less-Developed Countries (LDCs) clearly had
interest in a quota-based system of distribution with
special provisions for the least developed, since
borrowing from International Development Agencies
(IDA) was concentrated to a limited number of LDCs
(Williamson 1977). During the Committee of Twenty
negotiations of 1972-1974, LDCs exhibited a common
position, using a weighting factor that is greater
than one to determine the entitlement to SDR
allocations over quotas (Williamson 1977, p.83).
However, Williamson additionally commented that a
quota-based allocation would be less progressive than
distribution through IDA to the poorest countries,
because quotas are determined in proportion to
economic wealth of individual countries. After
identifying the United States and Germany as the only
two industrialized countries petitioning against the
link, Williamson finished his article on a rather
pessimistic note. He advised the developing countries
to find some means of exploiting the existent
nonsystem.
Kafka (1977) commented on Williamson's article. He
disagreed with Williamson on the potential of a link.
The link would be most useful for making aid
available, in spite of imperfect capital markets.
Kafka urges the LDCs to insist on a large quota
increase for all countries. He argues that even if aid
comes in the form of balance of payments finance
(rather than development), it would still feed into
and help development progress.
In conclusion, both the quantitative and qualitative
aspects of SDR leave it as supplemental to existing
forms of world money (Guttmann 1994, p.395). Solomon
points at the efforts of the U.S (during negotiations)
that propose not introducing the new reserve asset as
a new unit, therefore not appearing as a rival for the
dollar (1996).
Solomon also argues that the stress on international
liquidity during the 1960s was overdone. He claims
that the balance of payment adjustment process
deserves more attention than the international
liquidity issues. Fischer believes market developments
in connection with increasing capital mobility will
diminish the asymmetry involved in the status of
reserve centers (1983). Contrarily, Williamson points
to the reserve shortfall in many developing countries,
mostly consequential from troubles of inaccessibilty
to borrow under favorable terms. Furthermore, borrowed
reserves evaporate at times when most needed (as the
1982 debt crisis demonstrated (1984, p.24)). As a side
note, Williamson's position appears to have shifted to
being more optimistic about the potential of SDR from
1977 to 1984.
Fischer (1983) discusses the future of SDR in
relation to the possibility of the IMF changing into a
World Central Bank. He notes that the size of the
IMF's portfolio, and the process of negotiation that
must precede any SDR-stock increase, prevent IMF to
act as a lender of last resort. According to him,
stabilizing trade cycles is the second main function
of a central bank. He argues that it can be enhanced
by increasing use of SDRs as a reserve asset and also,
particularly, by increasing private institution SDR
use.
3.3 Guttmann's SNCM Proposal
Guttmann's (1994) proposal represents more of a recent
attempt considering an arrangement with an
International Monetary Authority (IMA) playing a
central role, and a SupraNational Credit Money (SNCM)
instituted in a multilateral regulation system.
In reference to the Bancor proposal, Guttmann notes
that Bancor would serve as an official means of debt
settlement (Guttmann 1994, p.428) and would have
required extensive controls on private cross-border
capital flows. As for the SDR and European Currency
Unit (ECU), he posits a similar argument. They have
been primarily used as official reserve and
debt-settlement devices. He contends (on the same
issue as Fischer) that their private use is extremely
limited and that impedes their ability to compete with
other forms of international money. Further, he adds
that the method of valuation for them as currency
baskets impairs their ability to function effectively;
either as an international measure of value, or anchor
for stable currency prices. Since Guttmann wrote these
lines, only one criticism has changed: the Euro was
introduced for widespread private use in January 2002.
The European Union presents three characteristics
favoring one-money form as being much more practical
in business. Those attributes are the volume of
intra-EC trade, emergence of a single regional market,
and unrestricted cross-movements of capital (Guttmann
1994, p.429). When considering the world, Guttmann
argues that the propensity for uneven development is
the precise reason for shaping the emerging global
accumulation regime through an institutional policy
framework that fosters integration and balance. Hence,
the development link occupies the central reasoning in
Guttmann's proposal.
Guttmann maintains that use of national credit money
as world money is an inherently unstable arrangement.
When used for international transactions, national
currencies fail to properly perform the medium of
payment and unit of account functions. Issuing
countries are allowed to meet their international
obligations by simply printing their own money,
thwarting the first of these two functions. Having
their values defined in reference to other currencies,
whose values are defined in reference to them,
indicates that the system is without a proper
valuation standard.
The inadequacies of this money form are observed to
feed chronic external imbalances, volatile exchange
rates, massive speculation, and an unstable global
banking network outside the reach of government
regulators. These institutional deficiencies
contributed to leaving countries at the periphery
without adequate access to capital and markets
(Guttmann 1994, p.428). Furthermore, choices of
trading partners are also influenced by the currency
used for payment. This fact favors nations with
currencies in widespread use. Therefore it limits
trading options, especially for less-developed
countries.
In early progression of his idea, Guttmann
differentiates between commodity money and credit
money (Guttmann 1994, p.29). He asserts that
exogeneity and neutrality hold only for a commodity
money. In reality, on the other hand, we use credit
money where monetary payments involve triangular
transactions including buyer, seller and bank. Money
creation is tied to bank lending, where they assume a
role greater than just being intermediaries.
As for institutional deficiencies of the
multicurrency system, Guttmann notes that it is
difficult to manage, because it leaves discretion
entirely on the policy-makers of the leading economic
powers. Coordination of their decisions is hard to
achieve, due mostly to conflicting national interests
(Guttmann 1994, p.428). In reference to the globally
integrated production networks and financial markets,
Guttmann argues that the time has come for a truly
international medium of exchange. That seems the next
logical step in historic evolution of the
international monetary system.
As for the SNCM, Guttmann seeks its proper
integration with national currencies as their
international extension, as it is supposed to serve as
money in all international transactions. This
arrangement covers all foreign transactions as
performed through the Central Bank accounts at IMA. He
points out that constituting an important aspect,
differentiating it from Bancor, SDR, and ECU. Those
are associated with a more limited role, only
functioning as an international means of payment to
settle net official debit balances. That is to say,
Guttmann suggests SNCM not only as a reserve asset,
but also as an international currency for all
international transactions.
IMA's clearing facilities are organized in a similar
fashion to Keynes's Bancor proposal, channeling the
surplus funds to deficit spending. As for the
advantages of such an arrangement, for surplus
countries there is a reduction of risk exposure by
lending to the IMA (rather than directly to deficit
countries), and for debtor nations it provides a more
reliable source of funds than the global banking
system or industrial nation governments. To make sure
that deficit countries will repay their debt, IMA
could link credit extension to adoption of specific
policies. Differences from current IMF practices would
be to have these policies introduced more gradually,
and regulation of adjustment on the basis of automatic
and nondiscriminatory rules. This arrangement is
promising symmetry in the adjustment process, and
institutionalizes the adjustment process under
supervision of a neutral nonmarket agency: IMA.
As noted above, the development link is a prime
motive for this SNCM proposal. This plan explicitly
favors developing countries, while rich nations are
thought to benefit rather indirectly through increased
export markets, reduced illegal immigration, and
greater supplies of cheap labor. This new picture
would correspond to a new international division of
labor. In the process of capital transfers to poorer
countries, IMA is described to combine the roles of
IMF and the World Bank on a much larger scale
(Guttmann 1994, p.441). These IMA loans are targeted
for financing infrastructure investments, to increase
the productive capacity and therefore be
self-liquidating. On the positive side, IMA would be
an agency freed from the private profit constraint of
banks. This should allow for flexible adjustment of
credit terms more to fit needs of the borrower. As for
the creditor nations, lending to IMA provides a more
secure arrangement than the current unregulated
offshore banking deposits. Additionally, having an
international scheme controlling the total borrowing
of each country would avoid overextension of credit
and possibly prevent following crisis situations. The
impact of IMA's investment banking activity is bound
to stimulate the world economy, as it adds to the
purchasing power of developing countries.
Exchange rates between national currencies and SNCM
are supposed to reflect the purchasing power
differences. These exchange rates are fixed, but
subject to future modifications like chronic deficits
leading to devaluation. As such, exchange rates are
needed to fit in a picture with individual countries'
trade accounts are essentially balanced while allowing
less developed countries to run deficits. So
Guttmann's proposal also includes a fixed exchange
rate regime with possible future modifications, as was
the case with the Keynes and Davidson plans
(introduced earlier in this chapter).
The presented plan is an intermediate stage toward a
world with a single currency for all (Guttmann 1994,
p.445). For that purpose it seeks: (i) abolishing
direct exchange of currencies, (ii) denationalizing
the creation of international liquidity, (iii) pushing
transnational banks into a payment system run by an
IMA, (iv) fostering gradual correction of
disequilibria while reconfiguring the distribution of
adjustment burdens among countries, (v) enforcing on
national governments greater coordination of macro
policies, (vi) assuring greater access to capital for
developing countries.
CHAPTER 4
COUNTERARGUMENTS AGAINST WORLD
CURRENCY PROPOSALS
Proposals for fundamentally reforming the
international monetary system attracted significant
opposition on varied grounds. Some counterarguments
address the economic features of the proposed changes,
while others make reference to political aspects.
One core issue raises significant concern over the
possibility of switching to a world money system. That
subject is the exchange rate regime that would be set
as an adjustable fixed-exchange-rate system, as
opposed to the (now dominant) managed floating. This
issue is at the core; one of the prime motives for
proposing a world currency lies in dissatisfaction
with widespread floating exchange rates and impact of
associated uncertainties. Fischer (1983) thinks that
relatively closed economies should maintain flexible
exchange rates with the rest of the world, under the
presumption price and wage stickiness exist within
each country or region. Nevertheless, the debate over
exchange rate regimes is far more elaborate than what
can be summarized in a short paragraph, and was
partially covered in the second chapter.
Most of the other criticisms on the economic analysis
side primarily focus on three issues: loss of
seigniorage to nations' accounts, ceasing the option
of using inflation tax, and taking away monetary
policy decisions from national authorities to grant
them unto an international agency.
By changing to a world currency system, income
generated from currency issuance would accrue to the
World Central Bank (WCB) at the first instance of
money creation. Fischer (1982) indicates that in some
years, various countries earned more than 5 percent of
their GNP from seigniorage. Accordingly, he concludes
that the basis for allocation of seigniorage would be
crucial for successful WCB creation. Another argument
on the same issue is brought up by Jefferson (1998) as
he calculates the seigniorage income to the United
States and indicates a trend: contribution of the
rest-of-the world has surpassed the domestic
contribution since the early 1990s. Sinn and Feist
(1997) analyze the case with the European Monetary
Union. According to the Maastricht treaty, each
country's share of seigniorage is designated
proportional to their equity shares of the European
Central Bank (ECB). Equity shares are, in turn,
derived from the population and GDP figures of
individual countries. Consequently, countries with
relatively low current monetary bases are emerging as
beneficiaries from the switch to the Euro. For the
possibility of a world currency, it is again apparent
that formula negotiations for seigniorage distribution
will include more than just population, GDP figures,
and preceding national monetary bases. Countries with
current key currencies would especially be seeking to
protect the advantage they have. However, the ultimate
purpose of these plans include the introduction of
rather symmetric features to the international
monetary system.
Another concern is the loss of inflation tax as an
independent instrument of national policy. Fischer
sees this as the main fiscal consequence of creating
WCB (1983, p.184). A switch to world currency would
remove this source of emergency revenue. One might
think the governments could use explicit taxation in
place of inflation tax. However, such a switch would
also possibly face political obstacles.
As a stylized fact, governments do not show
enthusiastic support for a world money idea, and their
reasoning includes the ability to run independent
monetary policy. Additionally, at the transitional
stage, due to commitment of maintaining convertibility
of fixed exchange rates, countries would be forced to
adjust their monetary policies - on the basis of their
world money reserves.
Smithin and Wolf (1999) point to two key issues
favoring independent national policy making. The first
one relates to democratic accountability that is
aligning responsibility for economic decision making
directly with political arrangements. Secondly, they
attribute a deflationary bias to practicing
international bureaucracies. Gunter (1996), on the
other hand, argues such independence of national
policies is already lost to a great extent. The
interconnectedness among countries in production,
trade, and other international affairs modify and
restrict available options. Smithin and Wolf also
discuss if monetary sovereignty is even feasible in
the contemporary global economy (1999, p.221). They
conclude that structural changes in world economy
necessitate a new set of principles for monetary
policy in the new environment.
The need for foreign exchange reserves of
individual countries already exists within the current
system. Despite the initial expectation that floating
exchange rates would eliminate the need for holding
reserves, national central banks do so partly in
recognition of possible speculative attacks targeting
exchange rates, alongside regular payment obligations.
Another concern is that a world money would make
control of capital movements more difficult (Fischer
1983). This might be true at the last stage of this
conversion, when public widespread world money usage
is established. However, as the currently studied
proposals stand, a much more centralized exchange of
funds would be the case. Therefore they propose what
appears to be a scheme; where it will be possible to
watch the flow of capital both at the overall and
individual transaction levels.
Even though exchange rate fluctuations will no longer
be a source of distress, other financial and trade
policy difficulties may get worse. Fischer thinks that
other weapons such as import restrictions, tariffs,
and commercial policy would likely develop as an
alternative means of adjustment. Opposing this, life
without exchange rate adjustments may trigger a more
extensive cooperation among countries. Competitive or
cooperative mood domination is a question of whether
countries demonstrate willingness to adjust their
policies. European countries have been trying to
accomplish this over time with their agricultural
policy disputes.
Another issue makes reference to the public good
nature of the basic benefit of such a new system. In
very broad terms, governments would have to give up
seigniorage and countercyclical monetary policy in
exchange for a smoother running international
financial and monetary system. This reward is
difficult to share - in a way that would make all
governments better off. This objection primarily
arises in reference to inability to quantify and
control benefit distribution in the new proposed
system. Meanwhile, qualitative assessments accompanied
with quantitative indicators are valid criteria to
judge the success or displeasure with a world currency
system. As Keynes noted, individual countries would
need the choice of leaving the scheme at due notice,
as they decide.
Fischer coined the phrase `world money exchange
standard,' describing when each country is obliged to
clear all balances against other countries through
their central bank accounts at the WCB. Against
Guttmann's claim, Fischer thinks such structure would
limit the world money's function to being only a
reserve asset. Guttmann argued that his SNCM would
achieve widespread use by including all transactions
of current and capital accounts, unlike the earlier
examples of SDR and Bancor. As a result, SNCM's role
(he thought) would reach beyond being just a reserve
asset. Rather than leaving the argument a claim,
Guttmann could have proposed policies to promote other
functions of money to be acquired by SNCM. The
proposal would have then held more of a real
application point of view.
In this world money exchange standard, if world money
is held privately, as well as by public sector, then
world money turns into a fiat asset whose value
derives purely from acceptability in exchange. Fischer
argues that the main difficulty with world money
exchange standard is the maintenance of parities.
Davidson's plan had a provision aiming at this issue.
He suggested a one-way convertibility arrangement,
leaving discretion to WCB for demanding national
currencies for world money. This would allow WCB to
obtain national currencies when trying to maintain
parities. If private agents are allowed to hold world
money, WCB could accomplish such a move by selling
securities in any national market where monetary
growth is observed as excessive. This would mean,
essentially, each government gives the WCB power to
undo national monetary policies during (at least) the
transitional stage to a single currency regime. In
connection to this point, Fischer thinks a world money
exchange system would be neither credible nor workable
as a fixed parity system.
Fischer argues that if the inflation rate of world
money happens to be high, it is likely to see private
currencies being issued. Those currences would be
convertible to world money, but pay a rate of return
indexed to a price level. Such possibility suggests
that it would be undesirable to outlaw private
currency for the possibility of issue, providing a
behavior check on the WCB (Fischer 1983, p.182).
One line of counterarguments reference the Optimum
Currency Areas literature. In the early 1960s, Mundell
(1961) and McKinnon (1963) introduced the concept of
Optimum Currency Areas (OCA). It was an attempt to
consider the economic costs and benefits of
establishing currency borders. Along these lines, it
was argued that diversity among countries, in terms of
their institutional features and economic situations,
would be an obstacle for having a single currency
serve them. It suggests that in the face of
differential national shocks, macroeconomic
instability will emerge due to limitations on exchange
rate adjustment (Minford 2000, p.69). Fischer (1983)
points to a weakness of the OCA analysis: its
treatment of factor mobility is exogeneous. He
counteracts, referring to the 1970s, when extent of
trade and factor mobility proved intimately linked
with the exchange rate arrangement.
Since their impact would reach many different domains
(challenging the status quo), it is no surprise to see
many arguments advanced against SNCM proposals. These
proposals address systemic features with intention to
changing them in major ways. An assessment of the
current problems would be the starting point for
deciding if a new system is needed, and if so what
features would bring a more satisfactory functioning
of the system.
If the choice emerges in favor of a common currency, a
primary question stands; how to form a monetary union
without having a political union. Is it possible to
convince countries for undertaking such a fundamental
cooperative endeavor given existing political
structures? The next chapter presents an analysis of
the political economy aspects of these proposals.
CHAPTER 5
POLITICAL ECONOMY ASPECTS OF THE
WORLD CURRENCY PROPOSALS
In this chapter, first a general introduction to the
political economy of international monetary relations
will be presented. Next, issues involved in political
economy of monetary unions will be discussed.
Following, Keynes's Bancor proposal, SDR, and
Guttmann's proposal will be examined in relation to
the political economy aspects.
Political economy is `...a vast terrain of research and
analysis into economic systems evolving through
historical time' (O'Hara 1999, p.867). It is different
from neoclassical economics, which takes a general
approach to the study of economy and society. The
neoclassical approach relies mainly on individualistic
explanations putting less emphasis on historical and
social explanations. Political economy `...is
characterized by the inclusion of historical and
social context as part of the fundamental factors
which shape and create economic activity' (Clark 1999,
p.868). Hence, a political economy perspective opens
the doors to a multitude of theories and approaches to
explaining economic phenomena.
Studying world money proposals with specific attention
for political economy aspects will help us discover
the social and historical context surrounding these
proposals.
5.1 Political Economy of International Monetary
Relations
A fundamental difference of the international monetary
system from the domestic monetary systems is the
presence of separate national currencies. There is no
existing formal world money, even though selected
national currencies play important international
roles. The right to create and manage money is seen as
a cohesive part of the state sovereignty (Cohen 1993)
since the nineteenth century. Recently, the connection
between money and nation-states has been subjected to
a variety of challenges. Many European countries seem
to be voluntarily abandoning their national currencies
in favor of a joint currency; almost all of the newly
formed states in Europe and Central Asia adopted their
own national currencies (Goodhart 1995, p.449).
Challenges include the growth of offshore banking
activities, currency substitution, emergence of local
currencies, and the possibility of private electronic
monies in the future (Gilbert and Helleiner 1999,
p.1).
The political economy of monetary relations is to be
understood within the interdisciplinary field of
international political economy. Two broad sets of
questions reflect the focus of the studies in
political economy of monetary relations. The first
group of studies addresses the motivations behind
government behavior in international monetary
relations. The second group focuses more on managing
consequences of monetary interdependence. An analysis
of the system's performance, in the face of policy
conflicts, is tackled by this latter group of studies
(Cohen 1993, p.xi). This grouping reflects the nature
of the question at hand, which requires a holistic
approach to include the desire for sovereignty and de
facto dependency among nations.
In line with that recognition, elements of both
cooperation and competition explain the monetary
relations between sovereign states. Promotion of the
highest level of technical efficiency and economic
welfare calls for improved cooperation. On the other
hand, the core of the competitive aspects is about the
distribution of economic welfare and political power.
At this point it is important to distinguish the terms
competition and cooperation as used in political
science and in economics. In economics, competition
may be a form of cooperation for organizing economic
activities. In political science, competition for
power is the opposite of using cooperation to achieve
common goals by sharing power.
Political power relations considerably affect the
conduct of monetary affairs between countries. Viner
(1929) provides a detailed account of the connection
between international loan transactions of European
governments and their balance-of-power diplomacy from
the 1880s into the First World War. There are striking
stories of using financial measures, in line with
shifting political alignments of creditor countries.
Similar stories are quite easy to find currently, as
well as throughout history. Political alliances, as
part of power struggles between nations, have shaped
monetary matters - as both conflicts and motive for
cooperation.
Cooper (1975) concurs that international monetary
relations can be understood as incorporating both
cooperative and competitive elements. Sources of
conflict in the international monetary regime are
important to investigate because of the resultant
actions that govern conduct of individual country
policies and economic outcomes.
Cooper lists five general reasons for monetary issue
controversy. Firstly, there would be diverging
preferences about distributional implications.
Secondly, conflicting preferences among policy
objectives would lead to conflicts. Thirdly, distinct
national economic circumstances would suggest
disagreements. Fourthly, conflicts over means-ends
relationships may emerge. Lastly, uncertainties about
reliability of other countries would lead to disputes.
Of these five, the first four make reference to mostly
economic concerns. Meanwhile, the fifth is a rather
political condition. Generally, most economic aspects
are displayed at the forefront, while politics are
often the key determinant on issues.
There are a multitude of dimensions when delegations
meet to discuss international monetary relations.
Therefore, compromises at the negotiation table can be
achieved only through a comprehensive evaluation
covering many aspects. Hence, when it comes to
reconciling differences between states there would be
no unique solution. Accordingly, a variety of
cooperation possibilities exist for both the top-level
decisions (with regard to the regime choices) and for
lower-level decisions (concerning daily activities).
Bryant (1995) provides a systematic presentation of
alternative arrangements regarding international
cooperation between nations. He develops a
classification involving several dimensions. The first
of these dimensions corresponds to the numbers and
strengths of international institutions and forums.
The second dimension is identified as the extent of
treaties, agreements, understandings and norms among
individual national governments. These two dimensions
locate a spectrum of regime choices, ranging from
`national sovereignty with little or no cooperation'
to `mutual governance through strong federal
supranational institutions' (1995, p.395). Next,
Bryant adds a third dimension: the amount of
information exchange, consultations and bargaining in
lower-level ongoing decision-making. Thereby, the
lower-level ongoing cooperation is introduced into the
classification to complement possibilities of
international regime environments. Bryant adds one
more dimension to this taxonomy, the degree of
activism in national operating regimes. This
presentation of possibilities allows for
distinguishing characteristics of international
cooperation among national governments, together with
choices of activism for national operating regimes.
The above categorization also helps to identify the
relevance of contributions from three major
perspectives in analysis of international cooperation.
These three perspectives are rule analysis, policy
optimization analysis, and institutionalist analysis.
These different points of view provide a diverse
outlook on international cooperation by their varying
emphasis of possibilities. Each of these perspectives
seems to enhance our understanding in different ways,
since the focus of each on Bryant's categorization
falls on somewhat distinct fields.
Some attempts to explain relatively more stable
periods in history make reference to the presence of a
stabilizing hegemonic power for the whole system.
Eichengreen (1989) considers the hegemonic stability
theories in connection with three different epochs of
the world's monetary history: classical gold standard,
interwar years, and Bretton-Woods system. He concurs
with Keohane's ``hegemonic cooperation'' notion:
`...cooperation is required for systemic stability
even in periods of hegemonic dominance, although the
presence of a hegemon may encourage cooperative
behavior' (Eichengreen, 1989, p.287). This conclusion
points at the overlap between various aspects
contributing to the explanation of stabilizing the
regime.
Eichengreen (1995) develops a general explanation
while studying shifts between exchange-rate regimes.
He advances six hypotheses to explain endogeneous
factors responsible for shifts between fixed and
flexible exchange-rate regimes: leadership,
cooperation, intellectual consensus, behavior of the
macroeconomy, fiscal and monetary rules, and
distributional politics. These hypotheses are neither
mutually exclusive nor incompatible, since there is
considerable overlap among them. Accordingly,
Eichengreen concludes that a discussion against the
evidence should include a blending of these
hypotheses. Furthermore, such an attempt can
incorporate an analysis of external pressures for
international cooperation alongside the primacy of
domestic politics. Understanding the shift to
alternative arrangements also requires an explanation
of change in balance of regime costs and benefits.
Endogeneous regime dynamics, together with the choice
of regime, would present a more complete description.
Progress of the European Economic and Monetary Union
(EMU) provides concrete examples of different
perspectives entertained by the participating and
nonparticipating countries. Conflicting visions exist
regarding the possibility of EMU success. Eichengreen
indicates that empirical evidence is inconclusive
regarding impact on economic welfare (1993, p.1353).
Wyplosz (1997) argues in favor, referring both to
political desire and economic benefits. Feldstein
(1997), on the contrary, disbelieves in the success of
this process. He argues that the political conflicts
will deepen, together with the detrimental economic
impacts of the EMU. Verdun (1999) contends that
European monetary integration is a gradual process and
represents the logical step forward.
Discussions of international monetary systems seem to
have accelerated with excitement of the European
experience. In addition to insights to be gained from
this experience, possible success would bring about
significant consequences for world politics. Possible
changes in hegemonic positions in the monetary realm
would most probably find parallels, with respect to
balance-of-power at the political scene of the world.
Hence, watching for developments with EMU will be
enlightening, not only for the possibility of an
international monetary reform, but also for likely
accompanying changes of power among countries.
Even though EMU is an attempt at regional level
monetary unification, troubles during implementation
and possible success will provide hindsight for
feasibility of global international money initiatives.
As for world currency proposals, an inquiry into their
political economy aspects would reveal political
concerns, relevant in consideration of proposal
viability.
When we question the nature of international monetary
arrangements, we delve into the realms of central
banking. The extent of ability to control money supply
by central banks is perceived differently by different
schools of thought. Neoclassical theory attributes
full control to central banks, while post-Keynesians
point to the endogeneous factors determining money
supply. Still, roles of central banks in monetary
policy decisions and domestic or international finance
undoubtedly place the utmost weight on institutional
characteristics of central banks. Therefore, central
banking is intrinsically political. When it comes to
world currency proposals within the current political
structure we need to ask: Is it possible to have a
World Central Bank without having a world government?
The concept of state sovereignty is seen directly
connected with the sole right to create and manage
money. Politics imply having each state with
individualized exchange rates, with its balance of
payments corresponding with policy priorities and
objectives. A rich research agenda is still awaiting
exploration, needed for understanding political
implications of world currency proposals with regard
to key political economy issues.
In the next section, we turn to the question of
political economy aspects of monetary unions, in
general. Following, we investigate world currency
proposals in these terms.
5.2 Political Economy of Monetary Unions
Optimum Currency Areas (OCA) theory led to
significant amounts of discussion on possible costs
and benefits of currency unions (Mundell 1997;
DeGrauwe 1996). However, when it comes to choices made
in the real world, there are severe doubts about the
predictive power of the OCA theory. It is observed
that political processes are key determinants of
answers for currency questions. The breakup of the
Soviet Union and the formation of the EMU are recent
examples of how political changes correspond to the
emergence of new currencies, as opposed to eradication
of independent national currencies in favor of joint
currency, primarily as a political choice (Goodhart
1995, p.449) .
Connections from currency issues to political concerns
are maintained through multiple channels. These
channels include economic benefits of monetary
autonomy, the role of seigniorage, and the symbolic
significance of national currencies as emblems of
sovereignty. They are the most commonly discussed
issues in this regard.
Loss of monetary policy as a national instrument for
demand management is seen as the primary cost of
changing to a common currency. Monetary policy can be
used for targeting interest rates or exchange rates.
However, by itself, monetary policy cannot achieve
differing objectives for both rates. Aiming at both
targets would call for another instrument, like
exchange controls to supplement monetary policy. The
Maastricht Treaty assigned monetary policy operations
to an independent European System of Central Banks
(ESCB), while assigning external exchange-rate
decisions to politicians (Goodhart 1995, p.457). This
issue raised considerable concern. Apart from the
question regarding the ability to control exchange
rates, or nominal interest rates, in a discretionary
fashion, politicians are especially suspected of
pursuing personal political choices over public
interest.
Independence for central banks from the executive
branch in a country is argued to be necessary if
politicians lose credibility to commitments against
inflation, resulting from attempts to engineer
short-term output increases. This notion assigns the
central bank with an overriding task of price
stability. In line with this contention, the
Maastricht Treaty adopted such a role for the European
Central Bank (ECB).
During transition to the monetary union in Europe,
the Exchange Rate Mechanism constrained the use of
monetary policies (over time) by member states. That
means that a large part of cost (from abandoning
monetary policy) was already experienced during that
transitional stage to full monetary union. These
issues of transition are examined further in
subsection 5.2.3.
Objections over loss of monetary autonomy can be seen
as a representative issue for general concern over
national interests. Monetary policy is discussed
mainly while it may be a more general worry regarding
protection for national interests what is raising
doubts about change to common currency.
Seigniorage from note issuing can be a significant
source of revenue for countries. It would matter most
in times of war and crises, when alternative sources
of funds are difficult or impossible to extend.
Security considerations form a significant reason for
maintaining a national currency. This national--defense
rationale indicates determination of the French and
Germans to finish their rivalry and the series of
European wars is a political key in the formation of
EC and moving to a single currency (Goodhart 1995,
p.455).
There is also an attempt to explain the reliance on
seigniorage through time inconsistency of civil
authorities. Time inconsistency reasoning suggests a
connection to political business cycles hypothesis,
and also argues that instability of the national
government would lead to using seigniorage
extensively.
Since currency is the most tangible and commonly used
claim to goods and services, substantial significance
is associated with its image and control (Goodhart
1995, p.454). Most of the time, a strong national
currency provides grounds for national satisfaction
while devaluation is seen as a sign of national
weakness. This association contributes to the
perception of national currency as a national symbol.
Monetary autonomy, seigniorage, and symbolic
significance of national currencies represent the
central themes of objections against monetary
unification. They each refer to considerations that
could easily spark political confrontations.
Meanwhile, economic benefits and costs are thrown to
the forefront in many analyses and discussions - more
so than political aspects. Next, we will look at
economic costs and benefits of monetary unification.
5.2.1 Economic Benefits and Costs
First, let us turn to the benefits to come out of
monetary unification in the long run, at the
steady-state after transition is complete. Goodhart
notes that most economic gains from monetary union
would come in increased microeconomic efficiency
(1995, p.458).
Benefits include a reduction in transactions costs.
Smaller countries and companies are likely to benefit
more from these savings in comparison to larger ones,
since larger companies and countries usually pay
comparatively smaller transactions costs. Secondly,
there would be reduced risk in realignment and
devaluation. Risk premia on national real interest
rates are thought to reflect expectations of business
leaders; on possibility of realignment in exchange
rates. Reduction in risk premium is estimated to bring
significant increases in community income for the
European Union (Goodhart 1995, p.459). Thirdly, there
would be efficiency gains to trade and capital
movements. The impact of decreasing exchange rate
uncertainty and greater price transparency are
difficult to quantify. Yet the scale of the markets
would be expected to expand as a result of reduction
in exchange rate variability and improved price
transparency. Fourthly, monetary unification is likely
to bring an internationally stronger currency.
Relative position of the union in international
negotiations would be enhanced, providing heightened
authority. Fifthly, monetary unification is thought to
lead to more stable prices. Goodhart (1995) casts
doubt on whether possible emergence of price stability
should be attributed to the independence of ECB or to
EMU (as a system). Abbott (2000) also challenges
independence arguments for central banks. She refers
to the strength of the economy leading to low
inflation rates rather than structure of central bank
governance. This is considering the countries
presented as examples of independence for central bank
yielding low inflation rates.
In addition to microeconomic gains, there are two
other main arguments favoring monetary unification. As
European integration suggests, it may be necessary to
have a single currency for single market success. It
may also be a prerequisite for further fiscal
federalism. These two issues will be further
elaborated on in the next subsection.
The main economic cost of joining a monetary union is
identified as the loss of domestic monetary policy as
an instrument of national demand management. Goodhart
argues the extent of this cost will depend on:
(1) Extent of likely asymmetric shocks to
participating nations and regions,
(2) Wage flexibility and possibility of migration of
factors of production to indicating the speed and
flexibility in relation to adjusting disequilibria,
(3) How far can the fiscal policy be used as an
alternative to monetary policy adjustments (1995,
p.461).
The first two of these three conditions resemble
initial criteria of the OCA theory, as introduced by
Mundell, McKinnon, and Kenen.
Considering the European Union, Goodhart indicates
that core countries are noted to have converged
sufficiently for monetary union feasibility. The
Commission of European Communities (1990) report
argues that asymmetric shocks are likely to fade when
trade barriers are eliminated. The peripheral
countries are thought to benefit more from EMU
advantages, reductions in transaction costs, risk
premia and improved price stability. Against this
argument (in reference to the American experience), it
is argued that local economies will become more
dissimilar; making themselves subject to asymmetric
shocks (Goodhart 1995, p.462).
There have been studies on nominal and real-wage
rigidities in European Community (EC) countries.
Generally, the findings are that EC countries
demonstrate considerable real-wage rigidities,
together with little nominal-wage rigidities, while
the United States is found to have more nominal-wage
rigidities alongside much less real-wage rigidities.
It is possible to use this result in both support of
or against EMU. Existence of real-wage rigidities
would imply that improving competitiveness through
nominal devaluations is not as possible, and EMU will
not show a big resultant loss for this aspect. On the
other hand, the same finding would indicate that labor
markets will probably have a harder time adjusting to
regional disequilibria. Nevertheless, there are
additional arguments (with regards to both) on the
existence of real exchange rate adjustments before
EMU, and likely changes in labor markets after EMU. It
is quite possible to attribute these differences in
labor markets as stemming from the strength of labor
movement at varying degrees, in different countries.
The resultant labor market structures also affect
fiscal expenditure patterns.
There is a serious trouble for empirical work in
questioning whether or not the monetary union will
bring convergence. Since most single currency domains
overlap with political and fiscal domains, any
observed convergence would be hard to attribute to the
role of the monetary union. We will consider
interactions between the currency, fiscal, and trade
domains in the next subsection.
5.2.2 Currency Domain in relation to Fiscal and Trade
Domains
There are many unanswered fundamental questions
regarding the case of a single currency with respect
to fiscal and trade domains. In this section, we will
investigate the answers in mostly general terms, but
still with references to European experience.
5.2.2.1 Does a single currency scheme require fiscal
federalism?
Fiscal measures would provide an alternative mechanism
of demand management when separate currencies are
abandoned, corresponding to individual state losses of
control on monetary policy. These fiscal measures
would aim at both stabilization and redistribution.
Stabilization efforts would be associated with
asymmetric shocks, while redistribution policies are
emphasized more in cases of regional divergence
(Goodhart 1995, p.466).
One argument in favor of shifting fiscal functions to
a federal center refers to fiscal constraints designed
against budgetary indiscipline. The European Union
Maastricht Treaty's requirements on national
governments' deficits and debts signify an attempt to
bring restraints on national authorities. Such limits
leave a relatively smaller scope for national
stabilization efforts. Instead, transferring fiscal
function to the federal level would provide room for
stabilization policies. An additional argument, in
favor of centralizing fiscal functions, makes note of
the overspills into neighboring areas. A country with
a high marginal propensity to import may pursue less
than desirable fiscal activities. Authorities of that
country might consider that benefits of an
expansionary fiscal policy would mainly accrue to
other countries. On the other hand, the impact of
excessive government deficits on national interest
rates would be partly reduced with an increase of the
general level of EC interest rates. When domestic
interest rates start to increase, a search for lower
interest rates outside of the country would increase
EC interest rates to some extent. A less disciplined
behavior may be observed as part of national fiscal
policymakers, in relation to overspills of national
fiscal policies.
Another argument in favor of centralizing fiscal
functions relates to increased factor mobility.
Movements of production factors, in response to
differential tax rates, make it difficult to
distinguish national benefits of said taxes. That is
to say, increased factor mobility would enforce a
convergence of tax rates.
Goodhart, in reference to the studies of existing
federal states, concludes both stabilization and
redistribution functions have been actively carried
out by those federal fiscal systems (1995, p.469).
However, he believes a transfer of unconditional
redistributive functions to Brussels is unlikely.
Some opposition to further transferring fiscal power
to Brussels is discussed on political grounds. It is
argued that the likelihood of substantial asymmetric
shocks and the benefits resulting from a federal
insurance scheme are both small. Furthermore, moral
hazard and situations when a nation is seen at fault
would present risks for the ability of a federal
insurance scheme to function.
One more argument in favor of federal stabilization
is again in political terms. Cyclical downturns would
be handled much more easily, helping defense of the
monetary union if temporarily disadvantaged countries
were to be helped through federal fiscal transfers.
5.2.2.2 Is a single currency needed to support fiscal
federalism?
Feldstein (1992) argues that successful functioning of
a monetary union would rely on interrelations of
monetary policy, and fiscal and trade policies.
Meanwhile, Goodhart asserts that it might be possible
to operate EMU while leaving most stabilization and
redistribution functions at a national level.
It is possible to argue for a causal connection
between comparatively fixed exchange rates and success
of a centralized fiscal domain. As an example, Common
Agricultural Policy agreements are able to function
only if intracommunity exchange rates remain stable
(Goodhart 1995, p.472). Hence, moving toward a single
market appears possible in connection with perceived
success of exchange rate stabilization arrangements.
There are reasons for doubt about the consistency of
a regime with periodic exchange-rate adjustments and
transfer of a considerable part of fiscal
responsibility to a federal center. Existence of
separate national currencies facilitates discussion of
EC fiscal policies on the basis of state
identification. In contrast, a single currency would
shift focus of debate to group identification with
respect to characteristics including age, job, and
income rather than geographic location. Discussion of
policy impacts on different groups would be likely.
Goodhart indicates discussion in national terms
represents a centrifugal force, while discussion in
terms of groups irrespective of location would serve
as a centripetal force (1995, p.474).
When fiscal expenditures are financed by taxes,
knowing some regions would benefit would make
achievement of agreement between regions difficult.
Martin (1993) argues that cohesion is maintained by
international organizations (like EC) by facilitating
stable linkages among issues. Keohane (1984) concurs,
saying that in world politics, international regimes
help to arrange linkage of issues, and thereby surface
side-payments. Cohen (1993) contends that success of
currency integration will depend on the existence of
`...either a local hegemon or a fabric of related ties
with sufficient influence to neutralize the risk of
time inconsistency' (quoted in Goodhart 1995, p.474).
In this regard, adoption of a single currency is seen
as a potential means of strengthening ties. Cohen
indicates that the process is mutually interactive
between formation of currency union and federalism in
the fiscal sphere, as well as encouraging ties in
other spheres.
There is some opposition against and fear of EMU; it
being an important step to federal Europe, where
identity and power of nation-states would be reduced.
For these opponents, the agenda of federalism is hard
to accept, rather than considerations of benefits to
and costs of a monetary union. Political sovereignty
is the focal point of these prejudices. Meanwhile,
other groups consider that in order to survive a
monetary union must be accompanied with greater fiscal
and political federalism. They worry that local
politicians would blame federal constraints for a
future national depression. The dispute between these
two groups focuses on whether a monetary union
requires fiscal and political powers to be transferred
to a federal center, or if a monetary union can
precede such large-scale transfer of power.
Respectively, Goodhart associates these two positions
with German coronation theorists and monetarists.
Opposing stands introduced (above) reflect divergent
opinions on the implementation of a transition.
Germans asserted the convergence of macroeconomic
policies and performances, and that transfer of power
to the center should precede the monetary union. The
French argued for immediate abolition of fluctuation
bands and transition to permanently fixed exchange
rates (Goodhart 1995, p.475). This conflict made the
Commission (1990) embrace the principle of
subsidiarity as a compromise. This principle asserts
that policies should be decided at the lowest
effective level of government. Such a statement takes
argument from general to particular. Goodhart states,
`For the time being, general questions about the
relation between monetary union and the appropriate
extent of federalism are purposefully masked as being
both too difficult and too potentially inflammatory to
attempt to answer directly.' (1995, p.476)
As the European experience exemplifies, when there is
political will compromises and deliberate efforts for
covering troubling issues to leave them for future
negotiations are applied.
5.2.2.3 Interactions between currency regimes and
trade policies
Goodhart points out that it is a threat to the success
of a single market if exchange rates could be shifted
independently from the desires and welfare of other
members (1995, p.478). Further pegged (but adjustable)
exchange rates are fragile in the face of political
unwillingness to promptly realign. The only way to
ensure success of the single market may be to move to
EMU quickly.
On the other hand, NAFTA operates with flexible
exchange rates. Goodhart points to the hegemon role of
the United States in NAFTA, while no such hegemon
exists in the EC. Another difference of NAFTA and EC
is the policies and rules adopted by monetary
authorities. Canadian and Mexican central banks are
observed to focus on price stability, rather than
watching over national competitiveness. European
authorities are noted to be relatively reluctant to
accept constraints for conduct of monetary policy
(1995, p.481).
5.2.3 The Transition to Monetary Union
Many of the studies and plans for EMU presumed a
series of stages in moving towards a monetary union.
Accordingly, for EMS, there was first the Exchange
Rate Mechanism (ERM) - with frequent realignments
(1979 to 1983) that progressed with occasional
realignments (1983 to 1987), and later with virtually
fixed rates (1987 to 1992). The system was then to
move (in 1994) to narrow bands for all EMS countries,
permanently fixing the parities by 1999, and
subsequently a single currency.
This phased plan presents a number of advantages. In
addition to making each step less radical, such a plan
enabled supporters to compare economic and political
advantages of monetary union to the ERM middle stage,
where most economic costs are already incurred with
few economic advantages (Goodhart 1995, p.482). Thus,
advocates of monetary union argue that the main cost
(loss of monetary sovereignty) has already been
experienced in early stages of ERM. Benefits to
peripheral countries would accrue at the final stage,
when inflation-risk premia on interest rates would end
and monetary policy would be set on an EMS-centered
(replacing German-centered) basis. Goodhart finds this
argument convincing within context of assumptions, but
indicates some weaknesses.
Firstly, none of the above arguments holds true for
Germany. Transfer of power to ESCB would mean a
potentially serious loss to Germany in terms of
monetary sovereignty. It is worth investigating the
German response to EMU. First, the Bundesbank is noted
to be a main center of Euroskepticism (Goodhart 1995,
p.482). Secondly, the bank, and most Germans insisted
that no serious losses would be imposed on Germany
through transfer of power to ESCB. This led to
drafting the constitution of ESCB similar to (and even
more rigid than) that of the Bundesbank. Independence,
priority on price stability, and the absence of
significant responsibility for banking system
stability are some aspects instituted for ESCB through
its constitution. Furthermore, they favored strict
criteria to be established so that other countries
could join ESCB only when their economic indicators
converge with Germany.
Benefits Germans see coming with EMU are also worth
noting. They are essentially political, and aim at
avoiding political and economic adversities in the
last two centuries by transferring economic and
political powers to a federal center (Goodhart 1995,
p.483). In addition to this, Germany is observed to
benefit from the single market, and its expansion
toward the east, more than other members. To the
extent that success of monetary union forms a
condition to the success of the single market, Germany
has stimulation for its EMU support.
As an alternative to the currently pursued phased
transition to a single currency, some plans argued for
achieving economic convergence, while floating
exchange rates are still in effect by granting
national central banks independence and coordination
to attain price stability during transition. A sudden
transition to a single currency is envisioned,
following convergence in economic indicators. The
major counterargument is the experience with flexible
exchange rates. Since 1973, exchange rates were not
exclusively, or even primarily, determined by economic
fundamentals and monetary policies. Hence, there is no
guarantee to reach relatively stable or properly
aligned exchange rates while maintaining flexible
exchange rates (Goodhart 1995, p.484). Any sudden move
to a monetary union could cause large capital gains
and losses to borrowers and lenders. These proposals
for keeping flexible exchange rates until the hour of
unification primarily attempt to avoid fragility of
exchange rates against speculative attacks during the
intermediate period (as the 1992 crisis exhibited).
Apart from the design of intermediate stages for
transition, transitional costs of changing from one
currency to another may be significant. These costs
include disturbances to information sets of the
public, establishing a new central bank, and printing
new notes.
Kenen (1992) identifies a list of six requirements to
be met before the introduction of a single currency:
having balance sheets of national central banks
denominated in European Currency Units (ECU), credit
institutions able to hold ECU balances with their
central banks, an ECB funds market allowing credit
institutions to lend to each other, government
endorsement of marketable obligations guaranteeing to
redeem in ECUs, a unified market for all securities
with ECU endorsements so that interest rates of
individual issues will be comparable, and that firms
and individuals hold and deal with securities in ECU
denominations.
Monticelli and Vinals (1993) point out some
conditions for achieving same-day payments and
settlements of ECU balances. Common technical
standards on operational reliability of central bank
practices would be a prerequisite. In addition, safety
measures would be required to reduce liquidity,
credit, and systemic risks (Goodhart 1995, p.493).
What considerations that normally make nations want to
have separate currencies may now induce EC countries
to voluntarily move toward a single currency? First is
the connection between autonomous currencies and
international constraints on the flows of goods,
capital and other production factors. A second
consideration is the form and nature of relations
between monetary and fiscal policies. Whether or not
it is sensible to push monetary union far ahead of
fiscal and political union stands as the most crucial
question.
5.3 Political Economy Aspects of the World Currency
Proposals
In this section we consider the three world currency
proposals that were introduced in Chapter 3. The focus
will be issues introduced in the previous section, and
the extent these three proposals addressed the
political economy.
5.3.1 Keynes's Bancor Proposal
Keynes's proposal, in general terms, is an attempt to
promote cooperation in spite of (then) acute
conflicts. The recent experience of the Great
Depression and the ongoing Second World War marked how
disorderly world economy and politics were. Even
though Keynes's plan essentially aimed at economic
life, particularly the monetary sphere, it may be
observed as a political agenda of a
cooperation-oriented new order. Conflicts of those
times most probably included all of Cooper's (1975)
categories. Yet Keynes's proposal, as well as the
Bretton Woods negotiations as a whole, represented an
effort to reverse the trend of conflicts.
If locating Keynes's proposal in Bryant's (1995)
cooperation possibilities, it would possibly
correspond to `strong activist coordination.' This
identification has two defining aspects. With regard
to the characteristics of interactions among national
governments and international institutions, extensive
joint decision-making is monitored and catalyzed by
strong international institutions. The second aspect
is the amount of information exchange, consultations
and bargaining in ongoing lower-level decision-making.
On this front, Keynes's proposal involves frequent
consultations with active searches for mutually
advantageous bargaining, which fit the `strong
activist coordination' identification.
As previously noted, political concerns seem to
address three issues as the primary worries for a
possible monetary union: economic benefits of monetary
autonomy, the role of seigniorage, and symbolic
significance of national currencies. Keynes's proposal
envisions a system maintaining present national
currencies. In part, this feature relieves strain of
symbolic significance (the last of the above issues).
In consideration of the other two issues, one
important attribute of the Bancor plan is the
establishment of fixed exchange rates. These rates are
thought to be subject to rare adjustments, as
conditions impose. However, this exchange rate
arrangement would raise questions relating to monetary
autonomy and seigniorage. Considering the period
preceding the Bretton Woods negotiations, the Great
Depression witnessed periods of unilateral action
leading to disorder and consequential limitations on
monetary autonomy. The Second World War again
presented limited monetary autonomy, but with an
extended role for seigniorage to support the war
effort in many countries. Hence, opposition
(especially to seigniorage) could be expected as
severe. This prospect is still correlated with the
vision of individual countries' willingness to accept
an arrangement that would systematically work against
the possible future war.
The primary economic cost of monetary unification is
seen to be the loss of monetary policy as a demand
management tool. The extent of this cost to national
economies would depend on the likelihood of asymmetric
shocks to participating regions, flexibility of
production factors adjusting to disequilibria, and
ability to use fiscal measures for adjustments.
Keynes's plan does not specifically address these
issues, but rather leaves the plan with a limited
scope. In fact, the plan intends to primarily
restructure the international monetary system. The
variety of issues involved at that level are more than
enough to cause a stir at the discussion table. All
that is included is a new way of handling
international monetary affairs without interfering
(much) with internal political structures of
participant countries. This attribute was listed as a
condition that Keynes thought necessary in order to
make an International Monetary System sustainable. He
noted that the technique of the plan should be
applicable to prospective member states, irrespective
of existing government and economic policy. These
objections, as well as likely benefits, would be
subject to investigation as part of individual country
assessments when it comes to joining the scheme.
Keynes discusses economic benefits of his plan almost
exclusively in the macroeconomic realm. These benefits
were introduced in Chapter 3, in reference to Keynes's
(1943) presentation to the British Parliament. He
listed the advantages of the plan in that document as
part of the plan promotion. These benefits included
expansionist pressure on world trade, overdraft
mechanism (providing a means of multilateral credit
facilities), and settling some rules to counter
balance of payments disequilibria while shifting part
of the responsibility to creditor nations. As
observed, Keynes's promotion includes benefits that
are all macroeconomic in nature.
When we discussed economic benefits of monetary
unification in the previous section, they were noted
to be mostly microeconomic efficiency gains. Namely
those are reduction in transactions costs, reducing
the risk of realigning exchange rates, efficiency
gains to trade and capital movements out of decreased
exchange rate uncertainty and greater price
transparency, more stable prices, and internationally
stronger currency. With Keynes's plan, even though
world money is not proposed to circulate freely in
hands of private agents, almost all above listed
microeconomic efficiency gains are still attainable.
The exchange rate arrangement is the key for achieving
efficiency gains to trade and capital movements,
reducing risk of realigning exchange rates. As Wray
(1999) pointed out, exchange rate stability is the
feature facilitating expansionist world economy in
Keynes's and Davidson's plans. Even though both Keynes
and Davidson put the emphasis on macroeconomic
aspects, at least some microeconomic benefits would
accrue - without seeking a complete monetary
unification.
The proposed structure of ICU indicates a bias
favoring smaller countries and Less Developed
Countries (LDCs). Special emphasis is put on partly
relieving the burden of balance of payments adjustment
from debtor to creditor countries. There exist
measures against continuing balance of payments
disequilibrium. These measures apply to all
participant countries on equal terms and promote
egalitarian treatment towards participant countries.
Furthermore, the proposal stipulates granting no veto
power to any country or group of countries in ICU
management. Additionally, overdraft facilities are
designed to help countries with limited access to
funds to initiate a recovery.
Another issue regarding the proposal is the
empowerment of ICU. For this purpose, the first step
is envisioned as establishing rules to apply
beforehand, and expecting national governments to
decide on joining or not joining, according to those
set terms. After that, the decision for participation
is tying and ICU has authority to apply the rules as
designed. While provisions are made to accommodate
special circumstances, application of the
agreed-upon-rules is not subject to any dispute
between ICU management and national governments.
Making requirements clear from the beginning while
leaving the door open for quitting the scheme
establishes ICU as an international body, with an
enforceable framework over participant states.
An additional component of empowerment for ICU is the
one-way convertibility. Keynes sought to put ICU in a
position where parity between Bancors and gold would
not be threatened by member country demands for gold.
Davidson included a similar feature in his plan,
ensuring ICU would acquire national currencies as need
be. Through these provisions, ICU is granted a status
and ability in this respect: to watch system stability
free from threat of unilateral actions by national
governments and private speculators.
A third aspect of Keynes's proposal demands attention.
He proposed the governing board of ICU be composed of
finance ministers of representative states. This would
be a wise choice for gaining political support of
national governments. The U.S. proposal, on the other
hand, insisted on employing lower-level technical
personnel on the board. The U.S. view claimed that
subject matter of international finance is more of a
technical exercise. The resultant structure, again,
favored the U.S. position and kept the board as a
group of technical experts. With Keynes's proposal,
IMF's role would acquire a more widespread impact. The
participants of the governing board (finance
ministers) would have the capacity to go to their
countries and defend decisions, against possible
domestic opposition.
5.3.2 Special Drawing Rights
Like Keynes's Bancor proposal, creation of SDR within
the IMF structure is an attempt at promoting
cooperation and addressing common problems in the
world's monetary system. As discussed in the third
chapter, the intellectual background leading to SDR
included three major concerns during the 1960s: the
possibility of insufficient global liquidity,
confidence in national currencies being used for
international purposes, and the existence of
asymmetries in world monetary arrangements. Despite
controversies surrounding these topics, political will
demonstrated common effort for resolving core issues.
In order to locate SDR within Bryant's (1995)
framework, we would need to distinguish between what
was initially aimed for and how things were shaped
later. Initial goals indicated a wish for introducing
a new asset with international character. However, as
years went by, the resultant picture did not resemble
the envisioned beginning.
The initial SDR proposal would correspond to `mutual
recognition in the context of an internationally
monitored preemptive rule game.' This identification
has two dimensions. In relation to international
regime environment dimension, it suggests
decentralized national decisions with weak monitoring
by international institutions. As for the second
dimension, there is information exchange,
consultations, and bargaining in lower-level
decision-making. At this front, we can describe the
original SDR proposal to be with active consultations
and exchanges of information (tentative efforts at
cooperative bargaining).
What has emerged as the SDR mechanism today? We can
locate it between `national autonomy' (extreme) and
`mutual recognition with infrequent consultations.' As
the international regime environment, this description
would correspond to decentralized national decisions
with minimal international cooperation. With regard to
the ongoing lower-level decision-making dimension, a
correct description would be very limited contact,
with almost no exchange of information or
consultations.
Unlike Keynes's (Bancor) and Gutmann's proposal
targets, SDR acquired a role that appeared
supplementary to the existent arrangements. Though it
was truly an effort to find a cooperative solution to
problems facing the entire world, it was left only a
minor component in the system. For this reason (with
national currencies in place), political economy
concerns of monetary unions (in general) do not apply
to SDR arrangements. Introduction of SDR and the
subsequent progress brought almost no questions, such
as SDRs affecting individual countries' monetary
autonomy or seigniorage revenues.
In an attempt to explain why SDR did not gain the
initially envisioned role, the changing monetary
structures are cited. One common argument is that new
conditions emerged with floating exchange rates and
increased capital flows, avoiding the need for
expanding reserves. Eichengreen and Frankel (1996)
refute both hypotheses. With regard to capital
mobility, they note there are models that assert (with
perfect capital mobility) the motive for holding
reserves would be removed, but this result is reached
under the assumption that countries can borrow at the
world interest rate. Eichengreen and Frankel point out
that this presumption is not true in reality, and
borrowing is hardest for countries when they need
reserves most (times of balance of payments crises)
(Eichengreen and Frankel 1996, p.340). Furthermore,
capital account itself can act as a possible source of
financial instability. For countries with floating
exchange rates, a high degree of capital mobility can
increase the exchange rate variability and such
countries would be more likely to hold reserves.
Similar arguments for holding reserves obsolescence
relate to movement towards floating exchange rates.
Expectations were that more frequent adjustments of
exchange rates through the markets would improve the
scope for adjustment through relative prices against
balance of payments imbalances. This mechanism was
thought to eliminate the need for reserves. Yet
following termination of the Bretton Woods system,
countries continued to manage their exchange rates.
Eichengreen and Frankel refer to the economic costs of
large exchange rate changes as the main reason for
government unwillingness to allow it happen
(Eichengreen and Frankel 1996, p.342). Depreciation of
domestic currency can lead to increased inflation
rates and depressed output level through higher prices
of imported inputs. It also can increase the burden of
debt in foreign currencies and endanger solvency of
domestic banks with liabilities denominated in foreign
currencies. Additionally, exchange rate volatility
itself would discourage international trade and
investment.
Eichengreen and Frankel (1996) suggest that the
changing features of SDR are its strength. According
to them, adaptability to new conditions is what kept
SDR useful over time. Among many pessimistic comments
regarding SDR's future, there are usually few lines
noting positive aspects. One aspect is having a
currency basket (like SDR) be a more stable unit of
account than individual national currencies. Also, the
financing provision for crisis management activities
of IMF would be another proposed role for SDR. A
development finance link is another proposal; this
link remains controversial among countries. Its
discussion is argued to be the most effective way of
abandoning a new allocation attempt.
There are valuable lessons to be learned from the SDR
experience. First is that a world money proposal has
so many repercussions; its creation and following
implementation over time requires commitment from all,
but especially the major players. If agendas of
participants do not match, there are secondary means
of stalling the functioning of the newly adopted
structure. Keynes noted that as a requirement for a
sustainable monetary arrangement, veto power cannot be
granted to any country or group of countries.
Secondly, while participation and decisions to leave
are left to individual nations' own discretion, there
is a prerequisite of intellectual consensus for
achieving a change of this magnitude. Eichengreen
(1995) notes this requirement in connection with
changes in the history exchange rate regimes. SDR
negotiations and subsequent implementation, despite
stemming from a rather common understanding of
problems facing the world's monetary system,
demonstrate how differently perspectives are attained
by different nations over time.
Thirdly, although there were provisions to empower IMF
for a lucrative functioning of the SDR mechanism, it
appears they did not suffice in order for SDR to
attain its stated goals.
Fourthly, the language of the Articles seems to have
caused confusion and provided room for avoiding
action. There is a need for providing straightforward
guidelines, instead of using phrases that may be
interpreted differently. Identifying the time of
additional allocations in vague terms, such as `when
the global liquidity needs happen,' is an example.
That did not provide a distinct criterion to step into
when the need occurred.
5.3.3 Guttmann's SNCM Proposal
We can observe issues reminiscent of the Bancor
proposal and of the SDR experiences occupying a
central place in Guttmann's proposal. He starts with
the idea of the need for an institutional policy
framework that will foster integration and balance, to
counter the propensity for uneven development of
current global accumulation regime. Therefore, the
development link is a primary concern and is
established from the beginning. Secondly, Guttmann
also recognizes the use of national currencies as
world money is an inherently unstable arrangement. He
specifically points to the deficiencies of national
currencies in relation to medium of payment and unit
of account functions, when serving international
transactions. He argues that a truly international
medium of exchange is the next logical step in the
historic evolution of the international monetary
system.
His reasoning for opposing the current multicurrency
system enables us to observe new features added into
Triffin's emphasis on reserve adequacy and confidence
issues. Guttmann makes references to more recent
observations, relating to the monetary system. These
include deficiencies of the current system feeding
into (chronic) external imbalances, volatile exchange
rates, massive speculation, and an unstable global
banking network outside the reach of government
regulators.
Guttmann's proposal has institutions, much like
Keynes's proposal. An International Monetary Authority
(IMA) is employed in both proposals for directing
surplus funds to deficit spending. Again, he notes the
mechanism's benefits in terms of providing a reliable
funding source for developing nations while reducing
risk exposure by surplus countries through lending to
the IMA, rather than deficit countries directly.
Further, it will allow observing borrowing totals of
individual countries, to avoid overextension of credit
and following crisis situations.
If we were to utilize Bryant's (1995) categorization
of international cooperation possibilities in the
monetary sphere, Guttmann's proposal would be
described as `strong activist coordination,' as was
Keynes's Bancor proposal. Again, this identification
corresponds to extensive joint decision making, with
regard to the international regime environment
dimension. In terms of lower-level ongoing
decision-making dimension, it suggests frequent
consultations with active searches for mutually
advantageous bargaining.
In comparison to the SDR and Keynes's (Bancor) plan,
Guttmann asserts his plan aimed at achieving
widespread use. For the previous two, he sees a
limited role as an official reserve and debt
settlement device, adversely affecting their ability
to compete with other forms of international money.
Hence, he is willing to introduce features that
promote private use as well.
CHAPTER 6
CONCLUSION
Keynes's, Davidson's, and Guttmann's proposals,
combined with the SDR initiative, all start with great
ambitions and aim at structural deficiencies of the
International Monetary System. They all represent
attempts to find a new means of organizing the
monetary affairs so that fundamental issues will be
addressed, as opposed to hoping the temporary crisis
management provisions will suffice.
Structural aspects addressed through these proposals
are centered around deficiencies of the multicurrency
system. The dual role of key currencies as both
national and international means of liquidity and
`numeraire' for flows and stocks yields problematic
results. Interest and exchange rates of these key
currencies are critical in determining prices of
standardized commodities such as crude oil, and value
of international debt and assets. Despite significant
international consequences, authorities of key
currency countries are noted to act primarily on
domestic concerns. Resultant policies are often
associated with objectionable neglect, and at times
overshooting adjustments. Many recent crisis
situations are possibly explained in these terms as
Schulmeister (2000) does specifically in relation to
the dollar.
It is true that changes on a substantial scale, like
those proposed by world currency schemes, are harder
to agree upon and are more intricate at
implementation. Consideration of ideas relating to key
questions is of utmost importance, so that a complete
perspective is obtained. However, as the common
attitude, many established relationships identifying
the system are treated as a given and remain
unquestioned. Particularly, supranational currency
proposals are often dismissed with regard to political
aspects raised as primary concerns. On the other hand,
there have been episodes in history (such as Bretton
Woods negotiations, emergence of SDR, and recent
European monetary integration) when political will
tended to converge on addressing issues, in order to
reshape the system substantially. Extending those
ideas, embodied in different perspectives, is a
fruitful exercise for better assessments of both
current arrangements and future possibilities.
Among the proposals studied here, Keynes's Bancor plan
is especially significant because of its context and
subsequent influence on following proposals. Even
though it did not prevail a winner at the Bretton
Woods negotiation table, its impact on future
theorists is noteworthy. Keynes introduced his plan in
a manner that left some details open to negotiation.
This demonstrates that a real bargaining situation
demands accommodation of other participants'
preferences. Despite being critical of existent
arrangements (in many key respects) and proposing
substantial institutional changes, presentation of the
case less strictly is absolutely appropriate and
necessary for opening avenues of dialogue on issues.
With regard to the Bretton Woods negotiations and the
Rio Agreement, the very act of convening to reshape
the monetary system signifies that troubles of the
monetary system can become so central that they will
provide impetus action. Often times, when a crisis
hits the world economy, the focus of policymakers
(unsurprisingly) tends to be crisis resolution, and an
analysis of the situation is postponed until clearer
assessment is possible. However, the experience of
troubling cases establishes the basis for modifying
the existent arrangement so that successful
functioning of the system can be attained.
Whether any cooperative attempts to reform the
international monetary system will exist anytime soon
is a matter of political perspectives entertained by
major players. The intellectual development leading to
changing perspectives would be formed in response to
failures and successes of the current system, and the
new structures instituted. In that respect, current
European monetary unification presents an invaluable
case for analyzing many ideas included in the world
currency proposals.
This study explored political economy questions
surrounding a limited subset of world currency
proposals. These schemes incorporate a political
agenda of new order, which is cooperation oriented.
Even though each of these proposals starts by pointing
at economic aspects and the proposed solutions are
essentially aimed at relevant economic features, the
connections to political issues are common. The
ultimate drive is fostering a collaborative climate,
both in economic and political affairs.
All of the considered proposals stipulated an exchange
rate arrangement of fixed exchange rates, with a
possibility of future adjustments. When comparing the
presented proposals, one feature is notable: they
offer different criteria for exchange rate
adjustments, when needed. Keynes's plan mentions it as
one option responding to persistent balance of
payments imbalances. Keynes stipulates a connection to
efficiency wages when determining relative exchange
rates of national currencies. Davidson's plan
includes a connection to changes in efficiency wages,
while Guttmann suggests a link to purchasing power
parity. This may be a difference in the theorist
perception for the critical determinant of exchange
rates, and appropriate adjustment time.
SDR's initial design also employed fixed exchange
rates. Later, as floating exchange rates prevailed as
the dominant choice, SDR's definition took the form of
a currency basket. Unlike Bancor, IMCU, SNCM
descriptions, or the initial intent for SDR, SDR
acquired a role supplementary to the existing monetary
structure. Meanwhile, with SDR's current role as a
basket of currencies, SDR presents a more stable unit
of account than individual currencies. In relation to
all studied plans, it is safe to claim that employing
structures to limit the scope for speculative actions
in exchange markets is desirable - given the
experience of recurring crisis situations in
relationship to sharp exchange rate fluctuations.
The value of international currency is tied to gold in
Keynes's plan. This may seem contradictory, knowing of
his opposition to the adoption of the gold standard in
Britain. Keynes points to the introduction of rigidity
if gold were to be used as a standard for the national
currency domain. He argues for the use of gold as an
international standard. In connection with its
psychological value, and also for lacking another
serviceable substitute, it would provide an
uncontroversial standard of value for international
purposes. How will national currencies be soft, if
fixed exchange rates are to be set in reference to
gold? He suggests that the ICU is expected to alter
external values of the national currencies, conforming
to internal values resulting from domestic policies.
Hence, primacy of domestic priorities is established
by assigning ICU to change external values of national
currencies in tandem with domestic values.
SDR, as initially envisioned, also maintained gold as
the international reference for valuation. However,
with its current definition as a currency basket,
SDR's value is tied to the monetary and fiscal
policies of major industrialized countries. Guttmann's
plan describes SNCM with emphasis on the unit of
account function. Thereby stress is placed on SNCM's
functioning as a numeriare, and the relative exchange
rates of national currencies (in terms of SNCM) create
a relevant question. Guttmann argues for settling
relative exchange rates of national currencies to
reflect purchasing power of currencies. Meanwhile,
SNCM is identified as an extension of national
currencies, serving as credit money for international
payments. Introduction of SNCM will not add to the
total purchasing power of the world economy, since its
utilization will correspond to equivalent reductions
of purchasing power from the paying country's national
economy. It would function like giving checkbooks to
central banks of nation states and then transferring
purchasing power from one nation to another whenever a
payment is made. In the meantime, domestic policies of
individual nations would be the basis for national
currency values, as their values (in terms of SNCM)
are connected to purchasing power differentials.
Still, in Guttmann's proposal, there are other
attributes that would be relevant to the valuation of
SNCM. He envisions a system where the central agency,
IMA, takes on a role combining both the World Bank and
the IMF of current structure. IMA includes both the
Monetary Department and the Financial Department, and
the policies pursued by those authorities would affect
the value maintenance of SNCM. For example, when IMA
deems an expansionary fiscal policy appropriate for
the world economy, extending additional credit lines
may be the proper policy. In connection with that, the
value of SNCM would be tied to the pursuit of
consistent policies for rendering the value of SNCM as
stable as possible.
Distribution of seigniorage is another relevant issue.
Keynes's plan does not stipulate any formula for
distribution of seigniorage among member states.
Nevertheless, the formula for determination of member
country quotas would be relevant for seigniorage
distribution as well. Usage of ICU's credit facilities
and associated payments (on excess credit and debit
balances) are tied to quotas of member countries. Any
allocation of Bancors would accrue seigniorage
revenues to member states in proportion to their
quotas, and would partly relieve their excess balance
payments to ICU. Guttmann's proposal also leaves the
question of distributing seigniorage, by and large,
not explicitly addressed. Stress on the unit of
account function for new currency renders it without
additional purchasing power for the world economy in
the proposed scheme. With SDR, since allocations are
made in proportion to IMF quotas of member countries,
distribution of seigniorage is also tied to IMF
quotas.
An important aspect observed by Gunter (1996) was the
effect of capital flows on developing nations. He
suggested an asymmetry relating to impact of capital
flow reversals. While both industrialized and
developing nations suffer from exchange rate
volatility, capital flow volatility is almost
exclusively detrimental to developing nations. Every
sudden reversal of funding flow leaves a wreckage of
devastated financial systems. In connection with that,
productive facilities are disabled by unexpected
failures of banks and other firms with overall
contraction of domestic economy. Structures watching
the overall borrowing of individual nations, and means
of monitoring the individual agents' actions are seen
as a solution.
With regard to capital controls, Keynes's plan lists
them among alternatives for eliminating balance of
payments imbalances. Further, the whole scheme of
channeling member state international payments through
ICU endows countries with the means of effectively
watching transactions individually and overall. Hence,
mechanisms for implementing capital controls are made
available, and thereby application of capital controls
would be an option deemed (at times) necessary.
Guttmann's plan includes elements of strict
convertibility restrictions. Capital controls would be
an integral part of this plan. National currencies are
restricted to circulate only within national
economies. There is need for implementing stringent
measures to avoid circulation of foreign currencies
into hands of private users. In the meantime, the
official channel for international payments through
IMA would (again) set the course of effective controls
on capital flows, as long as this channel is
effectively utilized. In relation to capital controls,
introduction of SDRs did not bring additional
arrangements other than what existed with the Bretton
Woods system and also (later on) during the period
with managed floating exchange rates. During the
Bretton Woods years, controlling capital flows can be
seen as a requirement for the maintenance of fixed
exchange rates, but addition of SDR did not establish
any additional constraints then or during the
following period with managed floating.
An overdraft mechanism is put forth in Keynes's,
Davidson's and Gutttmann's plans. In the case of SDR,
a link to development finance has been frequently
discussed. The former three plans are more favorable
for Less Developed Countries in comparison to the
current situation. There exists not only the overdraft
provisions, but also features promoting equal terms of
adjustment (between debtors and creditors) for balance
of payments disequilibria. However, significant
opposition is encountered for those provisions. In
response to these objections, arguments referring to
the overall picture are convincing. Overdraft
arrangement introduces a truly multilateral character
to international lending and borrowing. Keynes's
analogy to the national banking system is not without
merit. Both lenders and borrowers are likely to
benefit from the establishment, in addition to
introducing an expansionary bias to the world economy.
Yet it would eliminate most intricate political
choices of creditor nations used for determining
creditworthiness. This appears to be the ultimate
point of contention. Bringing multilateral features on
international lending would correspond only to equity
and efficiency improvements.
Another significant aspect of these plans is the
presence of special provisions, empowering the central
international institution as a neutral nonmarket
agency. These attributes include establishment of
rules clearly in the beginning, and one-way
convertibility conditions that give discretion to the
international organization on specific issues. When
the central agency is not equipped with adequate room
for discretion on matters, or if a country or group of
countries acquire veto power over decisions, the
majority of participant countries would have
insufficient ability to contribute on decisions. The
SDR experience exemplifies how overall success may be
tied to such additional specifications that would
leave space for international institution's actions on
implementation and consequent functioning.
Political will is the key component for success in any
initiative targeting of the monetary system structure.
Since many repercussions will follow such changes,
conflicts at the political realm are most likely to
take place. Nevertheless, compromises at the
negotiation table are often attainable provided the
political will is attendant. Meanwhile, if we question
how much yielding is possible, one notices that some
of the economic constraints brought onto the table do
not exist but are used as negotiation instruments. Or
it may truly be that understanding perspectives of
other participants will clarify the necessity of
compromise.
Political aspects of the studied proposals are the
most critical elements to determine likelihood of
possible adoption. This was true when the Bancor
proposal was negotiated, and also when SDR was agreed
upon. The same would hold true for Guttmann's
proposal. With regards to the Bancor proposal, it was
a time with intense political struggles among nations,
as was marked by the continuation of the Second World
War. Accordingly, negotiations at Bretton Woods and
the resultant arrangements were primarily shaped by
relative political and economic strength of
participant nations. The decision to implement SDR
also came primarily through political struggles.
Sustainability of the gold-exchange standard was
increasingly doubted in the face of U.S. manifested
policies. Still, political power of the U.S. combined
with concerns of avoiding crisis prohibited other
nations from acting against U.S. policies. However, in
1967, there emerged a common stand to implement a new
international currency. Nevertheless, the dominance of
the U.S. at the negotiations was again signified by
attributes adopted for SDR, and also through
subsequent functioning of SDR. More recent proposals,
like Guttmann's and Davidson's, would get a chance to
be negotiated among nations only when the dominant
nations favor such a scheme. The political aspects are
fundamental elements in deciding potential for
realization of all considered plans.
The proposals considered in this study specifically
have a common theme of the inadequacies of national
currencies serving an international role. Furthermore,
connections to development finance issues were made to
demonstrate the potential of a well-functioning
monetary system. It is this link to real economic
changes from the monetary sphere that makes these
proposals appealing since they attempt to introduce
analysis revealing key connections.
When we think about these proposals in the context of
increasing world economy globalization, they indicate
how certain primary concerns have changed over time,
yet common issues persist. The globalization context
corresponds to an environment where balance of
payments imbalances are expected to come, in
connection with the search of investment outlets for
more efficient production opportunities. Therefore, as
long as better productive structures are attained in
the world economy, balance of payments disequilibria
are considered inherent to the new context. Since more
efficient worldwide production activities are
desirable, the persistence of payment imbalances over
the years would still signal a warning to the
international monetary system, and the world economy
as a whole. First of all, the current direction of
imbalances does not fit the proposed new distribution
of investments among nations and across the globe.
Extensive flows of capital from developing nations, to
key currency countries, display movement in the
opposite direction. Persistent imbalances of key
currency countries are particularly dangerous for
satisfactory system functioning. Yes, there are
increases in foreign investment to developing nations,
but it is hard to conclude that this trend benefits
the majority of the world economy (Sachs, 2001).
Keynes's and Guttmann's proposals both started with
ideas of instituting a multilateral lending scheme
among nations. Such a scheme would increase efficiency
in investment flows, in line with globalization, and
fitting perfectly with current context. In Guttmann's
plan, balance of payments imbalances are accommodated
within the plan especially for developing nations.
Reduction in their development gap is one explicit
goal of the plan, as is the hypothesized consequences
of globalization. One main feature is the attempt to
commit the system to clearly-defined and symmetric
rules.
As a course for future studies, the connections from
the current monetary arrangements to features relating
directly to development gap between countries, trade
patterns, distribution of international investments,
and to pricing standardized commodities are promising.
These studies can focus on specific aspects of the
international monetary system, like exchange rate
arrangements and volatility, or capital flow
arrangements and volatility in relation to issues
similar to the ones listed above. The common attitude
of not questioning the system leaves plenty of
prospects for study by those who feel there should be
a better way of organizing the whole structure.
Several arguments have been developed throughout the
text. Reemphasizing some results of this dissertation
is worthwhile at this final stage. For that reason the
following subsection will provide a short repetition
of some associations derived in this study.
Reiteration of main findings. It has not been long
since the world economy faced troubles across the
globe after the 1997-1998 Asian Crisis. Other than the
multifaceted suffering of many people at different
corners of the world due to that catastrophe, its very
happening signified how the interconnected nature of
markets and production networks present real challenge
to policymakers. Many national governments found
themselves incapable of responding to international
contagion effects, in the face of ever expanding world
economy integration. Such detrimental consequences are
symptoms of lacking an institutional framework for
regulating the international monetary system.
Within the current structure, the intellectual
consensus mostly relies on temporary relief efforts
and modification of a few features along the same
lines as mainstream economic ideology. On the
contrary, some success stories are told in
glorification of countries that preferred to go
against mainstream policy prescriptions. Malaysia
applying capital controls after the Asian Crisis in
opposition to IMF conditionalities is an example of
possible better responses to situations as against to
standard prescriptions of neoliberal ideology.
This dissertation is an attempt to reveal some key
features of the international monetary system, through
a comparison of world currency proposals in reference
to their political economy aspects. The main proposals
considered in this study were Keynes's Bancor
Proposal, International Monetary Fund's Special
Drawing Rights, and Robert Guttmann's Supranational
Credit Money proposal. This selection corresponds to
distinct episodes in the history of monetary relations
among nations due to the times these proposals were
advanced. Comparing political economy aspects made a
particularly fruitful exercise, in order to assess the
features employed by each. Since conditions and
problems of the international monetary system evolve
over time, the changing attributes provide valuable
insights into changing perspectives.
The common starting point of the world currency
proposals is discontentment with the use of national
currencies for international roles. This
characteristic of the international monetary system
displays numerous conflicts between the two roles,
both being played by that specific group of national
currencies. Instilling faith in the decisions of key
currency country authorities has not been an enjoyable
situation for many countries. As such, the asymmetries
imposed on the system are worrisome for all.
The examined proposals are attempts to figure a new
way of addressing below par performance. They all try
to identify fundamental characteristics of the system
with motivation to considerably alter them. Both
Keynes's and Guttmann's proposals employ a neutral
nonmarket agency, forming the center of a new
institutional framework. From this structure, a
multilateral arrangement is sought to facilitate the
international transactions and lending among
countries. Such a multilateral character to
international lending is especially promising for more
efficient and egalitarian distribution of possible
funds. It would also bring symmetric features to the
balance of payments adjustments (as stressed by
Keynes) and help close the development gap between
nations (as emphasized by Guttmann). IMF's SDR has
also been discussed (in terms of possible uses) for
enhancing development chances of Third World
countries. However, those deliberations remained
inconclusive for establishing a link to SDR
allocations. It is argued that the most effective
means of abandoning a new SDR allocation would be to
bring this topic, a development link, to the
discussion table. This only signifies how
controversial this link has been among different
groups of countries.
One critical feature that emerges from comparing these
three proposals is the importance of initially
unanimous characteristics of the central institution.
If the central agency lacks enforcement capacity,
well-defined rules and procedures, the functioning may
not turn out as expected in the beginning. The real
experience of SDR exemplifies how the veto power of a
country or group of countries may leave the central
organization ineffective. Therefore identifying
guidelines clearly in the beginning and the provision
of enforcement mechanisms (leaving discretion to the
central agency on appropriate aspects) are attributes
needed for successful implementation.
Again, the SDR experience illustrates the importance
of political will by the participant nations. It is
the most important contributing factor determining the
feasibility of any change on this scale. Keynes's plan
introduces some characteristics at the initial design,
so that support of national authorities would be more
likely maintained. Having finance ministers serve at
the governing board of the ICU, instead of lower level
technical personnel, would be a step towards
sustaining cooperation of national authorities.
The current trend of increasing globalization in the
world markets and production networks has not been
complemented by an international institutional
framework for restructuring the monetary system. There
are times when cooperative efforts intensify to
resolve some conflicts, but the presence of
significant asymmetries and persistent inequalities in
the system point toward altogether rethinking the
international monetary system. The world currency
proposals represent a good starting point for analysis
of what we want and how to achieve it.
The current attempt for introducing a common currency
at the European Union is especially valuable for
predicting likely success of monetary unions.
Deliberations surrounding this undertaking are
informative for observing perspectives entertained by
different nations and groups within them. A better
assessment of monetary unions potential will be
possible, in relation to probable success or failure
at various manifestations. The overall success or
failure of the whole experiment will be consequential
in determining new distribution of economic and
political power in the world economy. Subsequent
changes of position by some currently dominant nations
would not be surprising - if this challenge is
perceived as real. Ruling out non-mainstream proposals
in reference to narrowly identified political features
is like avoiding understanding of the current system
and shunning possibilities down the road.
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