Zhou's International Reform Proposal - We Can't Afford to Ignore It

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Includes: UDN, UUP
by: Howard Richman

Unlike the incompetent economists who make American economic policy, the head of the People's Bank of China, Zhou Xiaochuan, understands the cause of the current recession and what the world needs to do to get out of it. Nevertheless, American economists simply ignore his advice, as when he suggested in December:

Before the global crisis, the international community was calling on China to increase consumption and the U.S. to increase savings. Now, the U.S., in order to get through the crisis, is issuing policies to boost consumption, but these are not consistent with the long-term needs of the country, which is to increase savings.

On March 23, Zhou began sharing with the rest of the world his plans for a sustainable international system that could help the world resume sustainable economic growth. His idea was to turn the International Monetary Fund's SDRs (Special Drawing Rights) into an international currency, similar to the "Bancor" proposed by John Maynard Keynes. Here is a selection from Zhou's remarks:

1. Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date. Back in the 1940s, Keynes had already proposed to introduce an international currency unit named "Bancor", based on the value of 30 representative commodities. Unfortunately, the proposal was not accepted. The collapse of the Bretton Woods system, which was based on the White approach, indicates that the Keynesian approach may have been more farsighted. The IMF also created the SDR in 1969, when the defects of the Bretton Woods system initially emerged, to mitigate the inherent risks sovereign reserve currencies caused. Yet, the role of the SDR has not been put into full play due to limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system.

2. A super-sovereign reserve currency not only eliminates the inherent risks of credit-based sovereign currency, but also makes it possible to manage global liquidity. A super-sovereign reserve currency managed by a global institution could be used to both create and control the global liquidity. And when a country's currency is no longer used as the yardstick for global trade and as the benchmark for other currencies, the exchange rate policy of the country would be far more effective in adjusting economic imbalances. This will significantly reduce the risks of a future crisis and enhance crisis management capability.

His idea is very similar to one that we suggested in our 2008 book Trading Away Our Future. We wrote:

Governments should not be allowed to subsidize their exports and limit their imports by accumulating dollar reserves or reserves of any other currency. If they wish to protect themselves from a sudden fall in the value of their own currency, let them purchase SDRs (Special Drawing Rights) from the International Monetary Fund. The International Monetary Fund could, in turn, lend out those reserves to underdeveloped countries that want infrastructure investment. (pages 100-101)

The difference is that we advocate the switch of foreign government reserves to SDR's concurrently with United States actions to balance trade. Zhou is advocating that the switch in foreign government reserves comes first. He is leaving out a very important aspect of Keynes "Bancor" proposal. Keynes recognized that rapid currency devaluations (i.e., currency crashes) have severe side effects. He would let countries with trade deficits take any of the following actions:

  • (i) restrictions on the disposal of receipts arising out of current trade and ‘invisible’ income.

  • (ii) import restrictions, whether quantitative or in the form of ‘duty-quotas’ (excluding however prohibitions genuinely designed to safeguard e.g. public health or morals or revenue collection);

  • (iii) barter arrangements

  • (iv) export quotas and discriminatory export taxes;

  • (v) export subsidies either furnished direction to the state or indirectly under schemes supported or encouraged by the state; and

  • (vi) excessive tariff.

We could implement Keynes advice for a trade deficit country through Warren Buffett's Import Certificates proposal. Limiting imports and subsidizing exports would immediately jumpstart fixed investment in American production and get the United States back on the course toward sustained economic growth. Then if foreign governments started converting their dollar reserves to SDRs, foreign private investors would gobble up the available dollars and use them to build new factories in the United States.

The dollar is pretty precarious right now what with America's huge trade deficits, Bernanke's huge expansion of the U.S. money supply and President Obama's huge budget deficits. If Zhou, as the head of the People's Bank of China, thinks that a dollar collapse is imminent, he will start selling China's $1.7 trillion of dollar reserves, precipitating the collapse. American policy makers have ignored John Maynard Keynes' sage advice and Warren Buffett's sage advice, and our Program for a Strong America. They can't afford to ignore what Zhou Xiaochuan is saying.