CHAPTER 14

A GLOBAL SYSTEM THAT WORKS

Managing Multilateralism

Perhaps the most formidable economic challenge today lies in the area outside the borders of any one nation or region. Present-day imbalances are global in nature and can no longer be resolved by any one power, or even by two or three. Indeed, there is enormous risk today of unilateral or bilateral actions (between the United States and the Eurozone, for example) being viewed by players left out of such actions as economically threatening or even hostile, leading to economic countermeasures, trade wars, or worse. The issue is compounded by the complexity of the relationship among and between developed nations on the one hand and emerging ones on the other. It is hard to imagine moving beyond a global economy that is just getting by, and therefore at material risk of new and deeper crisis, without a more open dialogue among the Group of 20 (G-20) nations and proactive steps toward mutual accommodation.

We are fortunate, I suppose, in one respect. All nations are put at risk by a slumping developed-world economy. Whether a country exports consumer products, steel, or natural resources, it is now coping with the downsides of global stagnation and overproduction. No one is immune. There is thus enormous commonality of interest if nations can find the right way to open a dialogue with one another.

Both surplus and debtor nations have understood that it is to no one’s benefit to attempt to aggressively advance their singular interests at the expense of their trading partners. We’re all in this together, our interests are intertwined in a flat world, and we’re dealing with more economic interdependence than ever before. And thus far, at least, we have more or less avoided the “beggar thy neighbor” strategies that went awry in previous slumps, either out of wisdom or the good fortune of their ineffectiveness. That said, we are a long way from a harmonious, cooperative global trading environment and I fear that the recent actions of the Bank of Japan to weaken the yen (despite the BOJ’s protestation that its monetary policy is not meant to target the value of the currency) is heading the global economy in a very challenging direction.

It is tempting, for simplicity’s sake, to view our problems in a more limited scope: the United States versus China; the core Eurozone nations versus the Eurozone periphery; Japan versus the rest of Asia. But we are well beyond that.

And if the complexity of the dilemma before us is not enough, there is another. Keynes’s greatest contribution to the study of macroeconomics may be one for which he is perhaps least remembered—the study and resolution of trade imbalances between nations. His views on how to resolve global trade imbalances in a world of fiat currencies were never fully implemented—and were often objected to. But they fully presaged the possibility of out-of-control imbalances of enormous size. But what he could never have realistically contemplated was the magnitude of the underlying cause of today’s imbalance: three billion people from emerging low-wage nations rapidly joining the global economy.

This Great Rejoining is far from over. Tens, if not hundreds, of millions of low-wage workers and trillions of dollars of new capital will flow into the global economy in the next decade. If the world doesn’t work together to find a better way to manage this change, we can count on new crises to come.

Three key multilateral issues need to be dealt with in order to achieve global stability:

The situation in the Eurozone will continue to plague the global economy until it either self-stabilizes or a solution is found. I do not believe that it will self-stabilize, so let’s discuss several proactive alternatives. A multilateral effort is going to require give-and-take across the board, and the European situation is at a stalemate. Other regions, I believe, would be willing to aid a European solution if it were part and parcel of moving the entire global economy forward. But no outside power is currently interested in assisting because the remedies that have been attempted to date have been decidedly lacking.

On a similar note, regionally, China is at a crossroads in terms of its internal rebalancing from an oversaving and overinvesting nation (with a national savings rate—not to be confused with the personal savings rate—in 2011 equal to a whopping 51 percent of GDP) to one in which consumption plays a greater role. The same is true, to a lesser extent, of the other ELOWASEENS. The table below contrasts the ELOWASEENS’ national savings rates with those of the major advanced regions:

ELOWASEENS

Qatar

54.47%

China

51.04%

Kuwait

48.70%

Singapore

44.37%

Saudi Arabia

43.04%

Libya

42.92%

Malaysia

33.67%

South Korea

32.42%

Thailand

30.00%

Russia

28.63%

Nigeria

28.35%

Venezuela

26.85%

ADVANCED NATIONS

Japan

21.93%

Canada

20.01%

Eurozone

19.80%

United Kingdom

12.92%

United States

12.88%

Source: International Monetary Fund (latest of 2011 or 2010 as available)

Finally, part of any G-20 grand bargain needs to include banking reform. At the beginning of the financial crisis, in 2007, Warren Buffett was widely quoted as observing, “It’s only when the tide goes out that you learn who’s been swimming naked.” As it turned out, the parade of nude bathers was quite long and included banks, investment banks, insurance companies, government-sponsored enterprises, and, in the case of the European periphery, entire countries.

Some were swept out to sea with the tide, but a sizable number have since obtained swimwear and are walking the boardwalk as though nothing ever happened. The fact is that many financial institutions today look pretty dismal under their cover-ups. Moreover, there is a substantial difference among regions of the developed world in terms of what constitutes a strong financial institution. Given the enormous interdependence of global financial institutions, having multiple standards means that the entire international financial system is as vulnerable as the weakest of those standards—which in the case of Eurozone banks is very weak indeed.

Resolving these interlocking problems, trade imbalances, ELOWASEEN underconsumption, the resolution of the Eurozone crisis, and the fortification of the global banking system will require a new level of global economic cooperation. And, to a certain extent, it is reasonable to assume that the emerging surplus and energy-exporting members of the G-20 will want to be assured that progress is being made across the board on stabilizing the economies and financial systems of the developed world (to assure both global stability and the strength of the emerging members’ principal markets) in order to make the concessions required of the surplus nations, particularly with regard to trade and internal consumption issues.

Since 1971, and growing massively with the enormous buildup of the ELOWASEEN trade surplus from the late 1990s forward, the U.S. dollar has acted as the global reserve currency. Today, some 62 percent of all foreign reserves are held in U.S. dollars. In the private sector, many of our most liquid commodities and the largest share of global financial and other assets are denominated and traded in dollars. Why is this a problem for the United States? Well, on the one hand, I suppose it’s not. The United States enjoys the many benefits of the “exorbitant privilege” of being the issuer of the world’s currency: enormous demand for both the currency itself (maintaining its global purchasing power) and for debt issued by the U.S. government and its agencies (keeping the cost of borrowing low, and today absurdly so).

But there is a dark side to all of this—the so-called Triffin dilemma, after the economist Robert Triffin—that posits that the issuer of the global reserve currency must, as a mathematical matter, be willing to run trade/current account deficits in order to supply the rest of the world with (in the present case) the dollars it wishes to hold. Thought of another way, if the global economic players were indifferent as to the issuer of the currency in which they held their reserves, they would take payment for those goods in any currency, there would be fewer dollars spent by Americans for foreign goods, less demand for the dollar, and correspondingly more balanced national trade accounts. The paradox to all of this is that, eventually, an economy that is running large and persistent trade deficits should become viewed as unstable and therefore should diminish the demand for and strength of the reserve currency.

But again, here’s where the magnitude issue comes into play. Global wage imbalances are so substantial between developed and emerging nations, and oversupply is so substantial relative to demand, that the emerging nations continue to seek U.S. demand, and correspondingly hold dollar reserves to avoid appreciation in their own currencies without worrying too much about long-term stability issues. In a very material sense, they have to. The principal goal of the emerging nations is to increase employment and the size of their middle classes as rapidly as possible. And given the numbers of people who have yet to be urbanized and/or are in poverty in the emerging world, they have a long way to go and cannot afford to lose any share of global demand. So the instability concern takes a backseat to the growth imperative.

Put another way, this crazy system—with all its obvious dangers—works just fine for China and other export powerhouses. They want the United States—the largest consumer market in the world—to keep buying more goods and borrowing more of their surplus cash.

But this cycle can’t go on forever. Growth inevitably must slow in an age of too much supply and too little demand. And the debt overhang in the developed nations slows growth even further. These phenomena, combined with the United States being the issuer of the global reserve currency, are deeply distorting the global picture. Because we see not only massive issuance of dollars to fulfill demand, but we also see enormous hoarding of dollars rather than the investment of dollars in the country of their issuance. In fact, what we see instead is huge demand to lend money to the U.S. government, which is not at all the same thing as investing in the U.S. real economy, encouraging U.S. government deficits (because it is so cheap to finance them, among other reasons) in addition to the trade deficits already mentioned.

In today’s world we see a condition that I refer to as “triple hoarding” of U.S. dollars in (i) the over $3.5 trillion held in foreign currency reserves; (ii) the nearly $2 trillion in excess domestic liquid assets held by nonfinancial U.S. corporations (together with perhaps another $3 trillion held in liquid form by U.S. business interests outside of the United States) and (iii) the trillions of dollars of uninvested household wealth, 75 percent of which is held by the top 10 percent of households. And I don’t blame any of the foregoing holders for not investing their money in new capacity. As discussed throughout this book, there is nothing very sensible for them to invest in, given the oversupply. Similar points can be raised with respect to the world’s secondary reserve currencies, the euro and the yen, but the numbers are of course far smaller.

This leaves the developed world with a dilemma even worse than Triffin’s. Either allow the pricing mechanism to clear the market of excess (which would mean further wage, price, and asset deflation in the developed world) or find some other way of getting excess reserves invested into their real economies. And that, of course, is what this entire book has been about!

Repairing all of the problems addressed here is an ambitious agenda, to say the least. It will require an overhaul of the global economic and financial system of no lesser scope than that of the 1944 Bretton Woods Agreement, which established a new such order for the post–World War II era, or the de facto Bretton Woods II understanding that has prevailed since the United States terminated the dollar’s gold convertibility in 1971 and most major world currencies became free-floating.

A Bretton Woods III plan, addressing all of the foregoing issues, is very much overdue, so in this chapter I lay out what I believe needs to be done in that regard.

Toward the end of World War II, in July 1944, the financial policy leaders of the soon-to-be victorious Allied Powers gathered together at the Mount Washington Hotel in Bretton Woods, New Hampshire. While what was then called the United Nations Monetary and Financial Conference took place in the nation that financially dominated the world, the Bretton Woods Conference (as the meeting was subsequently called) was actually dominated by a Briton, John Maynard Keynes.

Keynes may have been the greatest economic mind at Bretton Woods, but he was far from the most politically powerful one. He came to the conference with the most comprehensive plan ever seen (to this day) for the management of global currencies and trade in what was then a world as economically imbalanced as it has ever been (until the present age). What he left with was a package of half measures that acknowledged and stabilized existing problems but did little to reverse them or prevent their recurrence in the future.

Nevertheless, Bretton Woods saw many unprecedented developments, among them the delinking of other currencies from gold (chiefly because at that time the United States pretty much had all the gold in monetary circulation, or effectively owned it as a creditor of other nations) and, unsurprisingly, the linking of the dollar to gold and the rest of the world’s currencies to the dollar. The International Monetary Fund and the International Bank for Reconstruction and Development—the predecessor of The World Bank—sprang from the Bretton Woods Conference as well. Overall, a litany of multilateral economic issues that arose from fifteen years of depression and war were addressed and, to an extent, resolved.

But that was not Keynes’s plan going into the conference. Much has been written of the political machinations and details of the conference. No need to go into that here, other than to say that broader attempts at instituting global policy that would address the enormous economic imbalances that had arisen from the earliest glimmers of globalization—albeit one that excluded most of the globe—were watered down. Such efforts could have been of great use later, when the rest of the globe, following the collapse of international communism, joined the party in force.

No surprise again, the primary objector to broader economic integration was the world’s biggest (and basically only) creditor at the time, the United States.

The so-called Bretton Woods System was not fully implemented until 1958 and, as a practical matter existed in full flower for fewer than two decades. It ultimately collapsed when the burden borne by the United States in tying the dollar to gold (thus restricting credit growth) became too great to bear—thus, in 1971, ushering in the era of fully fiat global currencies and by 1980 the explosion of global credit that has been with us ever since.

What emerged from Bretton Woods was, at best, a temporary fix that seemed like the right thing to do as the war was coming to a close. Or, more accurately and by default, it represented the highest degree of coordination that global economic powers were capable of at the time.

But, again, it was not what Keynes put on the table—which, to a large extent, except among academic economists, has been long forgotten. In fact, what Keynes was most concerned about was resolving ongoing international account imbalances. He wanted not only to rebalance the post-depression and post-war imbalances that existed among a few of the developed nations of that day, but also to create an environment in which extraordinary external surpluses and deficits could be dealt with without economic conflict and crisis. That the world’s largest creditor/surplus nation at that time has today become the world’s most indebted/deficit nation should be testament to the wisdom of Keynes with regard to his proposals at Bretton Woods.

What Keynes suggested was an incredibly well-thought-out plan for the creation of a global central bank for central banks. But unlike the European Central Bank (arguably, the closest thing we have to a regional super-central bank), Keynes’s International Clearing Union (ICU) would have required a relatively continuous trueing up of large trade imbalances among fully sovereign independent currency-issuing nations.

Keynes’s proposal offers much guidance and insight with regard to today’s situation. So without getting too far into the plumbing, consider what Keynes suggested:

■ The creation of an inter-central-bank “currency” unit that all global currencies could be marked against and that transactions among central banks (i.e. trade) would clear through. Note that this is not a global currency in that it was not meant to be used within the nations of the ICU, only as a means of exchange among their central banks. But based on what Keynes had in mind for using the ICU currency unit (which he called the bancor)—to stabilize global trade and credit—it was more than a means of exchange at the central-bank level or merely a call on the credit of the constituent central banks. What Keynes was proposing was really more of a fully convertible reference unit, similar to the far more limited special drawing rights (SDR) maintained by the IMF (which itself grew from Keynes’s original plan).

■ In a nod to the gold standard, which could not possibly have been reinstituted at the time because the supply of global gold was so disproportionately concentrated in the United States, Keynes used the notion of a global reference currency as a means to ensure the global exchange-rate stability that is key to avoiding crises in trade. Anchoring the dollar to gold, and other currencies to the dollar, was a reasonable compromise until, of course, the pressures on the United States that resulted from having an overly strong currency and a growing balance of payments/trade deficit (as its products were too expensive for foreign buyers) became too much to endure and the United States took itself off gold. An elastic global reference currency, given the balance of what Keynes proposed, would not cause the same problems as those created by tying the global money supply, and therefore credit, to an always limited supply of the “barbarous relic.”

■ While the global reference currency unit—bancor—would itself constitute fiat money (as is any currency today issued by a central bank without a peg to anything else, as most are) Keynes proposed that member nations would subscribe to bancor in an amount necessary to handle their respective volumes of global trade (i.e., a bancor money supply sufficient to clear aggregate cross-border trade).

■ The relative value of each member state’s currency to every other one and, therefore, to bancor, would be based on relative purchasing price parity (PPP), the well-understood method of determining relative value based on the cost of a similar basket of goods and services in each nation. While PPP analysis is performed regularly today by international institutions such as the World Bank, there is some controversy in computational methods which, safe to say, were far less robust in Keynes’s time and may, as a practical matter, have been the best reason for having rejected his ICU at the time (putting aside political issues). Today, however, PPP modeling methods are far more powerful and are worthy of renewed attention by governments and academia.

■ Limiting bancor to a country’s current level of trade ignored the obvious fact that economies grow at different speeds by virtue of endogenous circumstances. Today, for example, China is growing at a rate far faster than that of advanced nations owing, in part, to the enormous number of people it adds to the nonfarming, urbanized labor force each year. As growth varies, so does the demand for money. So Keynes assumed that his ICU would need to extend credit—create bancor—much as central banks create money today in order to keep their respective domestic economies running smoothly. But to avoid the massive current account and trade imbalances we see today, Keynes’s ICU would have capped the amount of “overdraft” credit to a fixed percentage of each deficit nation’s aggregate cross-border trade. So nations could still choose to run modest deficits, but as no nation would be issuing the reserve currency (the bancor) and capital-to-finance deficits would be limited by the foregoing credit cap, wannabe deficit nations would eventually need to kick up internal production relative to demand, as opposed to filling that demand from abroad. I hope readers can by now intuitively understand what that would mean in terms of maintaining a respectable level of employment in nations (the United States being the present-day example) that would otherwise run enormous, destabilizing deficits.

•   •   •

As is certainly the case today, and as Keynes realized in the 1940s (and earlier), enormous trade imbalances are always accompanied by—if not caused by—currency-exchange rigidities, sometimes circumstantial, often intentional. As discussed throughout this book, other than protectionism, devaluation is the oldest trick in the book to help deficit nations to get their houses in order again. It is certainly more popular than deflation (or even dropping interest rates to nearly nothing in an attempt to fight off deflation). But as much as deficit nations might wish to devalue their currencies in order to regain economic vigor, surplus nations are seldom interested in seeing their currency appreciate—thus hurting exports and slowing their economies. So Keynes structured his ICU to include mandatory currency devaluation/appreciation formulas that would permit some leeway—after all, temporary surpluses and deficits occur all the time, and no country has a zero current account balance—but would crack down hard on countries that maintained vast surpluses. Why? Because Keynes believed that, de facto, such countries were engaging in mercantilism to the detriment of their trading partners.

Since no mercantilist nation would ever voluntarily permit its currency to appreciate merely to balance trade, Keynes’s ICU did it for them—requiring surplus/creditor nations that had accumulated an average annual surplus equal to 50 percent of “overdraft” credit to not only appreciate their currency but to pay an annual “fine” on that surplus (even at lower amounts than 50 percent) at a rate of up to 10 percent thereof per annum. This would essentially place a penalty on the hoarding inherent in running persistent surpluses or would, in other words, force hefty amounts of the savings being accumulated out of the pockets of those doing the hoarding. The opposite was prescribed in the case of nations running persistent deficits. They would have to depreciate their currencies if they hit the foregoing target of 50 percent and would, of course, pay interest to the ICU on the amount of the actual overdraft being carried. Nations failing to comply would be drummed out of the ICU and lose clearing privileges, thus damaging their ability to trade.

Some of the most cogent analysis of Keynes’s proposals at Bretton Woods can be found in an as-yet unpublished (at this writing) academic article by my Century Foundation cofellow and writing partner, Professor Robert Hockett of Cornell University, titled “Bretton Woods 1.0: A Constructive Retrieval.” In his article, Hockett sums up Keynes’s intentions well, as follows:

What Keynes hoped to accomplish with the Clearing Union plan, then, was to prevent global hoarding and the loss of domestic credit-money control that this tended to foment, and thereby to safeguard national control of domestic financial conditions and underwrite balanced, hence sustainable, growth worldwide. That would in turn give rise to a reciprocal reinforcement dynamic between liberal global trading arrangements on the one hand, and stable full-employment growth . . . within national economies on the other.

So why have I spent so much ink writing about a seventy-year-old proposal? Simply because the global financial crisis of 2007–2009 was nothing less than the first moment in modern history when international economic imbalances grew to a point comparable to the situation at the end of World War II—to the point at which the global economy literally began to shut itself down.

But this time, instead of rethinking the past couple of decades and coming up with solutions aimed at real underlying problems, the leaders of today’s largest economies (the G-20 nations) settled for making emergency monetary actions nearly permanent and took an every-man-for-himself approach to trade and currency issues. Had they been able to, any one of the major trading nations would have gladly beggared its neighbors by attempting to devalue its currency. But in the age of oversupply, with everyone attempting mercantilist currency devaluation at once, the result is that all go begging, so the G-20 nations made halfhearted pledges not to do what they couldn’t do anyway (although, in early 2013, Japan again went on a mission to talk the yen down). Moreover, in today’s environment, demands for surplus/creditor nations to allow their currencies to appreciate against the currencies of their deficit/debtor trading partners fall on deaf ears. In short, nothing changes.

And yet there can be no doubt that the Chinese, for example, would vastly prefer stronger trading partners and more robust demand. They and others with vast (or potential) capacity would gladly finance a “Marshall Plan” of employment-oriented infrastructure redevelopment for their best customers (with their trading partners’ own currencies, of course). Instead of hoarding gold today, surplus nations hoard dollars and euros, so there is plenty to invest.

Furthermore, the Chinese have expressed their view repeatedly that the U.S. dollar cannot be the world’s reserve currency forever. As Dr. Ken Courtis, the former vice chairman of Goldman Sachs Asia cited previously, noted to me: the Chinese are not inclined to allow their currency to be both freely exchangeable and freely floating in a world in which global monetary policy is dominated by decisions made in Washington from the standpoint of what is good for America.1 Some may criticize the foregoing view, given claims—mostly true—that the yuan is kept deliberately undervalued by the Chinese government for mercantilist reasons. But can we really expect that to change, or for the Chinese to move beyond mercantilism, until the world’s second-largest economy is offered a reasonable and stable currency exchange, a controlled market economy, and a balance-of-payments environment in which to compete on a truly level playing field?

Courtis has also pointed out that the Chinese would react well to a grand bargain that afforded them access—at market prices—to America’s new energy bounty, which I discussed in chapter 12.2 A grand bargain between the developed and emerging nations will doubtlessly involve a variety of economic and political concessions by both sides, and will be as complex as one might imagine; but the need for such an accord is unavoidable.

It can be said that the age of oversupply resulted from the absence of a cross-border monetary, currency, and balance-of-payments architecture commensurate with the massive explosion in global trade over the past two decades. In order to achieve the balanced and sustainable global growth to which Hockett refers above, we need to do what we should have done when we essentially stumbled haphazardly into the postsocialist era. How can bringing half the world’s population suddenly into competition with a developed world one-fifth its size in population call for anything less than the level of coordination required after the Great Depression and World War II?

We need to commit to such cooperation now—belatedly, but in earnest. A modernized ICU-type architecture would be a good place to start. In the long run, market forces will whittle down the imbalances discussed in this book. But as Keynes himself wrote in 1923, “The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

What we need today is a way of getting out of the present global slump that is based on both endogenous demand creation within countries—through reemployment-oriented investment policy in advanced nations—and more aggressive efforts to increase consumption by workers and businesses in emerging nations. That can happen only within a balanced system of global trade and a stable currency environment. The sooner we recognize this, the better. The faster we act, the more responsible our governments will be toward the populations of both emerging and advanced nations.

Just as I was completing this book, in March 2013, the former president of the European Central Bank, Jean-Claude Trichet, penned an op-ed for The New York Times in which he both acknowledged the global nature of the problems affecting the advanced economies and suggested, with respect to the Eurozone, that imbalances could be resolved only through the implementation of a system of monitoring macroeconomic imbalances and competitiveness within the zone, among other remedies.3 While I was heartened to see his reference to a global problem, I was dismayed that he thought “global” was chiefly a Euro-American measurement. Similarly, efforts to merely monitor imbalances in trade are relatively worthless without an agreed-upon method for resolving them.

Some may argue that the problems are too complex to be resolved and the best we can do is to wait them out. If we were able to do that, policy makers would be saved from having to make some very tough decisions. But economic, political, and social pressures arising during this age of oversupply are not likely to grant us that luxury. It is long past time to sit down and lay out a new economic playing field that is conducive to more evenly shared growth.