With the world in the midst of the worst economic and financial crisis since
the Great Depression, there are calls for a new monetary order. These calls
essentially recommend reviving proposals formulated earlier by John Maynard
Keynes (1943), Robert Triffin (1959), Jacques Rueff (1932 and 1961), and
recently by Robert Mundell and a number of other leading economists.
These proposals consist of shielding the world economy from destabilizing
policies of an important economy or a group of important economies. At the
heart of these proposals are (1) the creation of a world central bank that is
independent of any government and free from fiscal pressures, and (2) the
issuance of
a single reserve currency that serves as a means of international payments and
as a reserve currency.
The prevailing financial order, more accurately financial disorder, has been in
large part driven by the disorderly monetary and fiscal policies of a dominant
reserve currency center, namely the United States. It is characterized by
heightened uncertainties, widely fluctuating exchange rates, fluctuating
commodity prices, and interest rates that are manipulated by two or three major
central banks. The present financial environment has become so unpredictable
that it is conducive only to speculation.
The financial crisis that broke out in August 2007 has been in large part
brought about by former Federal Reserve chairman Alan Greenspan's low interest
rate policy and aggravated by his successor Ben Bernanke's continued aggressive
monetary policy. As the issuer of a reserve currency, the US has financed its
monumental fiscal deficits and expansionary credit policy under the George W
Bush administration by running large external current account deficits,
extracting resources from the rest of world, sending commodities prices sky
high, resulting in food shortages for millions in poor countries, and a
depreciating dollar.
Now the administration of President Barack Obama is contemplating a stimulus
package on the order of US$1 trillion that will push the fiscal deficit to an
all-time record that could exceed $2 trillion. At the same time, Bernanke's Fed
is determined to keep interest rates at zero bound. The financing of the US
deficit will most likely be through seignorage, that is, printing money out of
thin air, depreciating the dollar further and sparking a period of rapid
inflation.
In view of ongoing competitive interest-rate cutting among major central banks,
drastic reductions of interest rates to zero or near zero bound, incredible
expansion of the balance sheet of the Fed, exponential money supply growth in
major industrial countries and exploding public sector deficits, world
financial instability will only intensify in the years ahead.
There is little hope for a return to monetary and fiscal discipline any time
soon. The outcome of these policies will be onerous for the countries
themselves and particularly for the global food and energy balance. The looming
fiscal deficits of major industrial countries will exact a huge tax on
developing countries, depress savings and investment, and can result in food
shortages in the coming years.
Rueff, in his book The Age of Inflation (1964), showed that US external
deficits are inflationary and could destabilize the world economy. He pointed
out that the US, as the issuer of the reserve currency, could run external
deficits indefinitely without facing any real payment constraints. He also
showed that holdings of US dollars by central banks entail a duplication of
money creation. Besides money creation in the creditor country, holdings of US
dollars are repatriated to the US for interest-bearing US securities by foreign
central banks. The repatriated dollars increase liquidity in the US and puts
downward pressure on interest rates. In the current crisis, this sequence of
events has fueled securitization of mortgage loans and contributed to the
housing bubble.
The only sure way to stabilize the world economy is to create a world central
bank and a return to a single reserve currency. Such a reserve currency was for
centuries gold, until the breakout of world war in 1914. Specie flowed from
deficit countries and provided a regulating mechanism for orderly and stable
world economy. Under such a system, no country could have an indefinite balance
of payments deficit without loosing all its gold reserves. With the collapse of
the gold standard, its replacement by the gold exchange standard (Genoa, 1922)
and then floating exchange-rate system, a reserve currency center can
permanently run an external deficit without loosing any real resources, as has
the US.
What are the advantages of a world central bank and a single reserve currency?
A world central bank would obviate the need for continuous surveillance of
macroeconomic policies around the world by neutralizing the effects of
expansionary policies of reserve currencies on world inflation, trade, and
exchange rates. Each reserve currency country would face the same constraint as
under the gold standard. While a reserve currency can exact seignorage on its
own economy, it cannot do so for the rest of the world countries. A single
reserve currency would eliminate duplication of money creation and would
therefore mitigate inflation.
The single reserve currency would circulate along with other currencies as a
mean of payments. The world central bank should have a strict and primary
obligation to follow a fixed rule and would not be allowed to adopt
discretionary policies. Its role would be only to provide a safe and stable
reserve currency, and not the achievement of full employment for the world
economy. Such a goal should be left to member countries. The new central bank
should not fix interest rates. It has to be a pure central bank, while the
single reserve currency could be pegged to a basket of commodities providing it
with a constant purchasing power.
Certainly, gathering political consensus for a common central bank and a single
reserve currency will be a long process and arduous. Nonetheless, a first
practical step could be for central banks to revert de facto to gold and
convert their holdings in paper currencies into bullion. Although bullion does
not earn interest income, indirect returns arising from monetary stability far
exceed interest income earned on securities. Gold neutralizes the effects of
expansionary fiscal and monetary policies in a reserve currency country on the
rest of the world economies. These economies would continue to grow in a stable
fashion without being taxed by reserve currency countries, and without
suffering permanent inflation and financial instability.
A conference on a world central bank and a single reserve currency should be
organized under United Nations sponsorship. Such a conference should set the
stage for the creation of a world central bank, and examine all technical and
legal issues pertaining to its foundation.
The world central bank could start with a minimum quorum of signatory
countries. While there is already wide support for such a central bank, the
most urgent priorities facing the world economy are to restore financial
stability and neutralize the very dangerous impact of destabilizing policies of
major reserve currency centers.
The United Nations should urge each member country to apply a strict ceiling on
monetary creation not exceeding 5% per year for an interim period, until
progress toward a world central bank is made. Monetary anarchy during 1920-1939
escalated into a world war; present monetary anarchy could cost the world many
years of instability, lost economic growth and massive food shortages.
Finally, we should note that the International Monetary Fund (IMF) is no
substitute for a world central bank. The evolving financial chaos has caused
the demise of the IMF. After suffering financial losses, the IMF has cut its
staff by over 500. Since 1995, the IMF has declared a war against poverty in
Africa, and has surrendered its role as the guardian of the international
financial system and international financial stability.
If you ask the IMF what is more important, preserving world financial stability
or reducing poverty in Africa, its response very well could be: reduce poverty
in Africa. This is a laudable objective. However, the IMF is not a poverty
reduction institution. Contrary to the World Bank which finances development
projects, IMF every six months puts a poverty loan into the government budget
which is immediately grabbed by the military, civil service, and politicians of
the recipient country. Such loans aggravate the fiscal deficit, and cannot be
repaid from taxes; it makes the country ever more dependent on the IMF for
financing salaries. Billions of dollars were squandered in the past decade.
If these resources were instead added to the African Development Bank, a
tangible progress would have been in reducing poverty. Had only $1 million been
invested in primary care and sanitation, more than 15,000 who died from cholera
in Zimbabwe could have been saved. Similarly, for Niger's famine in 2005, if
money had been used in agriculture instead of showered on the army.
Most importantly, the IMF has long abandoned its surveillance role to
coordinate macroeconomic policies for the greater good. It has become
politicized as an institution and has become subservient to the dictates of its
most important member countries, all along commending US monetary policy both
under Greenspan and Bernanke and forgetting to safeguard world monetary
stability.
It is time to establish a world central bank, free of political control, to
help get us out of this global financial quagmire that threatens the future of
us all.
Hossein Askari is professor of international business and international
affairs at George Washington University.
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