Tim Geithner's Poor Imitation of John Maynard Keynes

by: Felix Salmon

Guest post by Justin Fox

Tim Geithner has proposed to his fellow G-20 finance ministers that trade surpluses and deficits be capped at 4% of GDP. The idea is already running into criticism from countries that run big trade surpluses. German Economy Minister Rainer Brüderle warned against "planned economy thinking," according to Reuters, and "makroökonomische Feinsteuerung und quantitative Zielsetzungen" (macro-economic fine-tuning and quantitative target-setting), according to Reuters Deutschland. "We doubt whether rigid numerical targets should be set," said Japanese Finance Minister Yoshiko Noda.

The sad irony in all this is that some other guy proposed limits on trade surpluses and deficits 66 years ago, and did it in a far more elegant and thought-through manner than Geithner has. And it was the U.S. that torpedoed the plan. To borrow from George Monbiot's lucid summary of John Maynard Keynes' proposal:

He proposed a global bank, which he called the International Clearing Union. The bank would issue its own currency - the bancor - which was exchangeable with national currencies at fixed rates of exchange. The bancor would become the unit of account between nations, which means it would be used to measure a country's trade deficit or trade surplus.

Every country would have an overdraft facility in its bancor account at the International Clearing Union, equivalent to half the average value of its trade over a five-year period. To make the system work, the members of the union would need a powerful incentive to clear their bancor accounts by the end of the year: to end up with neither a trade deficit nor a trade surplus. But what would the incentive be?

Keynes proposed that any country racking up a large trade deficit (equating to more than half of its bancor overdraft allowance) would be charged interest on its account. It would also be obliged to reduce the value of its currency and to prevent the export of capital. But - and this was the key to his system - he insisted that the nations with a trade surplus would be subject to similar pressures. Any country with a bancor credit balance that was more than half the size of its overdraft facility would be charged interest, at a rate of 10%. It would also be obliged to increase the value of its currency and to permit the export of capital. If, by the end of the year, its credit balance exceeded the total value of its permitted overdraft, the surplus would be confiscated. The nations with a surplus would have a powerful incentive to get rid of it. In doing so, they would automatically clear other nations' deficits.

Brilliant, right? Not impossible-to-enforce targets, but a system with incentives built in that would have made big trade imbalances unattractive to both sides. There's that little matter of creating a new global currency and getting everybody to accept it, but this was at the tail end of World War II. If the U.S. had decreed that the International Clearing Union was a go, the International Clearing Union would have been a go. But at the time, the U.S. ran big trade surpluses and assumed it would do so forever. Its delegates at the Bretton Woods meetings were vehemently opposed. So the idea went nowhere. Now Tim Geithner is pushing for clunky trade-surplus caps. It might be better if he just asked for a do-over.