RES Essay Competition - Joint Winning Essay - Promit Anwar
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Many thanks to Promit Anwar who has kindly allowed us to publish his prize-winning essay for the 2008 RES Young Economist Competition…
“Which economic idea or policy has the most power to improve our lives?”
Promit Anwar
It has been described by the former Chief Economist of the World Bank and Nobel Prize winner Joseph Stiglitz as the ‘single initiative [that] could do more to make globalization work than any other.’ Yet the reformation of the system of global reserves and issuing a universally-recognised and stable form of ‘fiat money’ (paper money that can be readily exchanged into hard currencies) – an idea suggested several decades ago in the writings of Keynes – remains to be realised. The case for its implementation, given its unique ability to aid global financial stability, increase global aggregate demand and finance equitable development projects in third world countries whilst narrowing the income gap between MEDCs and LEDCs, however, is rendered stronger at present than ever before.
Buffeted by financial crises and economic instability, governments of the developing world have sought to increase their holdings of reserves in order to boost liquidity – a phenomenon that the Federal Reserve Chairman Ben Bernanke describes as the ‘global savings glut’. Indeed, developing economies hold over $3 trillion in reserves, increasing at a rate of over 15% a year, typically, in dollar-denominated assets, such as T-bills. However, at the core of the problem is that the developing countries earn a figure for real return on American bonds that is much lower than what they would expect to achieve if that money were spent on high-yielding investments in other developing countries. Stiglitz estimates that the opportunity cost of the market for US securities to developing countries to stand at over £300 billion per annum; a figure that is approximately sufficient to achieve the Millennium Development Goals , which include the eradication of extreme poverty and a reduction of the mortality rate among children under the age of five by two-thirds. Herein lies the claim that the reforming of the global reserve system has the most power to improve the lives of everyone – but in particular, the world’s poor.
Increased demand for T-bills not only reduces the cost of borrowing for America, but is in effect, a loan from the poorer countries to the rich, providing a cheap way for Americans to borrow and finance consumption (the attractiveness of credit has made the resulted in the US household savings rate to become negative for the first time since 1933). The costs of this are numerous. Firstly, as cited previously, instead of lending money for programmes to help their own people, poorer economies are lending to the world’s largest economy, and the rate of return is far less that what could be expected if investment was to be made within the home country. Secondly, the continual demand for T-bills ensure that Americans benefit from cheap credit and consequently save less and this has almost certainly exacerbated, if not been responsible in part for the present credit crisis.
Finally, the reserve system can contribute to global instability. Reserves aim to act as a financial insurance or buffer – yet it is counter-intuitive that the majority of reserves are vested in a single currency, which itself is not immune to exchange-rate fluctuations (the dramatic fall in the value of the dollar from 2002 to 2004 reinforces this point). Just as sound investment practice entails portfolio diversification to dilute risk, global financial turbulence could be minimised if the reserves were held in a number of currencies. But switching to another reserve currency or merely spending the reserves is not straightforward. Countries which have built ‘war-chests’ of reserves are unable to sell significant amounts of dollar-denominated assets without depreciating the dollar to the extent that the value of their remaining reserves fall, making the dollar is no longer suitable as a reserve currency. This is compounded by the fact that in order to finance foreign reserve savings, the USA takes on a daily debt to the tune of $2 billion from poorer countries, which will again, undermine the strength of the dollar . Even if governments switch to holding reserves in other currencies such as the Euro, as China has started to do, the self-defeating circle will repeat for the new reserve currency.
Reform of the global reserve system is therefore required on the premises that it negates these costs and consequences, and ensure a better deal for the developing world in the future. Under new proposals, as global income increases, each country contributes a proportional amount to the IMF or a specifically-created institution and in exchange, receives global banknotes equal in value to the contribution. Whilst the net assets of a country remain unchanged, they receive a stable asset that is liquid enough to be readily spent in times of crisis, or in times of prosperity, be invested in equitable development projects offering higher rates of return rather than in government bonds. (In essence, this can be seen as an extension of the issuance of SDRs – Special Drawing Rights – by the IMF, to include all countries willing to participate and not restrict its issue to one-time use). This would thus break the ‘mutual hostage’ situation that arises in the current situation, as LEDCs are no longer forced to recycle money back to the west for the latter to sustain their deficit spending to buy their goods. The global banknote itself, would have is own index-linked exchange rate, reflecting the relative rates of a basket case of currencies over a period of time, making it significantly more stable in value than conventional currencies.
As such, global financial stability would be enhanced; consequently all countries, including the United States, would benefit in the long-run, by being able to cope better in response to exogenous shocks which adversely affect the economy. Furthermore, it would aid the efficiency of development projects, since soundly-run developing economies will have a source of liquidity that can target the investment on a need-based approach; empowering national and local governments would be far preferable to the conflicting interests of multinational aid programmes, which often bear the caveat of IMF conditionality. The spending of global banknotes is not itself inflationary, as local currency is not being spent, but it can increase global aggregate demand that is deficient (the ‘deflationary bias’) under the system current, facilitating the expenditure of income set aside as reserves, which otherwise would not have occurred, causing an acceleration in world economic growth.
This also negates to some extent, the imbalance of trade. Countries would be able to run small current account deficits without having to decrease net assets in a given period, as reserve accumulation would be decoupled from the trade deficits of reserve currency nations , mitigating the problematic zero-sum nature of the narrowing of one country’s trade deficit representing the increase of another. Though the sum of global deficits will match the sum of global surpluses, a ‘cushion’ equal to the issuing of the world banknote will offset the deficits . Notably, the cycle of a US trade deficit (currently at $827 billion ) and the simultaneous selling of their government securities that give rise to the aforementioned problems, would slowly be reversed. Conversely, countries which ran current account surpluses and bought foreign bonds due to a lack of domestic demand would regain the forgone purchasing power. This represents a net increase in global aggregate demand that is necessary not only so that equilibrium can be achieved nearer to full global employment, but also so that crucial investments are made where they are needed so that lives are saved where they are now lost.
But if excess bonds are not being bought, what could the issuing of the new global banknote finance in a way that our lives could be improved? One of the world’s greatest problems in development is the issue of funding for global public goods – those whose benefits can be reaped by governments and citizens worldwide. Global health, and the spread of diseases such as HIV/AIDS or malaria is but one area in which investment in research and development of medicines is currently far below the socially optimum level. Global banknotes could, therefore, subsidise scientific research into finding potential cures for these and diseases that have claimed the lives of millions. Simply using some of the global banknotes to extend existing immunisation schemes could also save many lives. Alternatively, global banknotes could be invested in potential high-return areas such as finding cleaner alternatives to fossil fuels, or providing primary education to every child. Though the cost of the latter scheme is estimated to be only $10-15 billion a year , the expected returns would be huge, as the labour productivity of the world’s workforce is augmented. The remaining banknotes can be issued to alleviate the burden of debt on poor countries, be allocated to governments on an income per capita basis, or awarded on competitively to private organisations wishing to undertake high-impact development projects, thereby encouraging innovation in the way in which welfare for third-world citizens can be augmented.
Yet arguably the greatest achievement of the new reserve system is that a strong message would be sent from the international community to the developing world, signalling a strong worldwide consensus that the issues which plague these countries are of global concern, and Western governments are indeed committed to ensuring greater equity. It would also create a method whereby there is a means to impose an externality charge for countries which produce excess greenhouse emissions for example. Under the new global reserve system, issue of the global banknotes can be systematically curtailed to countries which confer such negative externalities outside their national borders, so addressing the age-old problem of the ‘tragedy of the commons’. Whilst previously there were little incentives for economic powerhouses such as the US to limit atmospheric pollution, governments would now be financially liable for taking such a blasé approach to a global problem that could threaten to displace millions of citizens from their home countries due rising sea levels by the end of the century. Thus failure for countries to meet obligations such as the Kyoto protocol or deforestation quotas would result in a ‘fine’ (cutback in global banknotes received). The proceeds may be redirected in compensation to the sufferers – a method by which the externality can be internalised.
Furthermore, the issuing of the global banknote would create greater incentives to further open governance and alleviating ‘democratic deficits’. Akin to trade sanction impositions upon rogue countries, despotic national leaders could see their issue of the global banknote withdrawn, furthering pressure from the international community to create a framework that maximises the effectiveness of economic management – one which is transparent and accountable to the public. Likewise, the allocated issue of global banknotes can be suspended from countries still pursuing nuclear proliferation for example, thereby acting as a tool to maintain the political peace in lieu of furthering economic prosperity.
Hence the reform of the global reserve system and the introduction of a worldwide banknote, is, in the minds of a growing number of orthodox economists as well as ‘third way’ thinkers, the cornerstone to ensuring equity and stability as well as enabling the irreversible tide of globalisation to work better for all parties. The scheme is uniquely versatile in addressing a wide range of policy areas – more so than any other initiative; offering potential worldwide benefits in improving living standards and economic. Its priority nature for developing economies is especially evidenced by the huge opportunity cost of the current system; one that could itself finance the achievement of the fundamental MDG targets, such as halving poverty rates by 2015, and significantly lowering the income inequality gap between rich and poor economies both in the short and long run. It is a monumental travesty that the primacy of politics over economics – as so many times before in history – means that the posturing of egocentric figures ensconced on the levers of power in developed nations whose currencies the majority of reserves are held, may prevent this idea from being anything more tangible than a mere vision of a better world.
References:
Joseph E. Stiglitz, Making Globalization Work, (Penguin Books, 2007) pp. 268
John Maynard Keynes, Proposals for an International Clearing Union (1942)
Remarks by Federal Reserve Chairman Ben S. Bernanke (Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia, March 10, 2005)
Joseph E. Stiglitz, Making Globalization Work, (Penguin Books, 2007) pp. 249
www.moneyweek.com/ Article: James Ferguson, King Dollar is still on his throne – but how long can his reign last? (November 11, 2005)
Russ Juskalian, ‘Making Globalization Work’ presents brave observations (USA Today, October 2, 2006)
Bruce Greenwald et. al, A Modest Proposal for International Monetary Reform, (Columbia University, January 4, 4006)
Joseph E. Stiglitz, Making Globalization Work, (Penguin Books, 2007) pp. 265
Economic and Financial Indicators, The Economist, (Mar 3rd – 9th 2008)
Shantanayan Devarajan et. al, Goals for Development: History, Prospects and Costs, (World Bank Policy Research Working Paper 2819, April 2002)
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