Which Currencies Will Depreciate and Which Will Appreciate
By JC Collins
The need for an international money clearing unit (global unit of account) to replace the domestic USD in global trade, and correct the imbalances which have been created over the last 70 years, is the paramount item which needs to be addressed in the existing monetary framework.
The balance of payments deficits and surpluses which created the deflationary pressure in the lead up years to the financial crisis in 2008 are a direct effect of using the domestic (national) currency of one country, such as the United States dollar, as the international money clearing unit.
This effect is called the Triffin Paradox and has caused most emerging markets, represented largely by BRICS, to grow large trade surpluses. In contrast, western nations have grown large trade deficits. This systemic imbalance has caused volatility in everything from exchange rates to domestic money printing.
The large surpluses in emerging markets has led to a massive program of exporting cheap goods to western nations. Those in these western nations now consume more than is produced, and have spent beyond their means on the back of the expansion of the USD money supply. The variance between what is consumed and what is produced, which is substantial, has been funded by the expansion of debt, which is reflective in the expansion of the dollar supply.
Debtor nations would like to inflate the debt away while creditor nations would like deflation, which increases the nominal purchasing power of the initial debt. (Neither can be fully accommodated.)
Debtor nations devalue currency to close the imbalances between the initial value of the debt and the future nominal purchasing power of the debt.
Creditor nations retaliate by devaluing their own domestic currency to increase exports, which only leads to further accumulation of the international money clearing unit, which in this case is the US dollar.
This “currency war” framework, or argument, as defined above, is obviously a non-starter as a sustainable and lasting solution to the global imbalances. If a continuation of the imbalances isn’t halted soon, debtor nations may have their financial independence arrested and suffer further decreases in domestic production, which will lead to a default situation.
The same structural flaws which have caused global imbalances have also caused imbalances in the European Union, as the disparity between trade surpluses and trade deficits, the sum of which is represented in the balance of payments, has pushed Greece to the verge of debt default, with Spain and Portugal following close.
The geopolitical consequences of not addressing the imbalances could cause creditor nations to wage war against debtor nations in an attempt to collect on the debt. In contrast, the debtor nation could wage war against the creditor nation in order to erase the debt.
Due to the fact that trade imbalances caused the financial crisis in 2008, and the accumulation of large USD reserves of emerging markets, mainly countries in East Asia and the Middle East, such as Saudi Arabia, were directly related to the collapse, the importance of addressing the imbalances will require a global mandate.
The original intent of the Bretton Woods Conference was the creation and implementation of a true international money clearing unit. Economist John Maynard Keynes originally predicted the trade imbalances described above in the 1930’s, and at Bretton Woods attempted to implement a global financial arrangement based on the principles of a non-national unit of account.
Keynes called this arrangement the International Clearing Union. The framework of the agreement was focused on minimizing trade imbalances and the economic and geopolitical tensions which follow. A special unit of account, or international money clearing unit, would need to be used for global trade.
This unit of account was called the bancor.
The bancor would have had a fixed exchange rate with domestic currencies of member countries. This exchange rate would likely have been managed within a band, much like the Chinese currency is managed within a band today against the USD.
The bancor unit of account would have been used to measure trade imbalances. As such, one export would add one equivalent bancor to that countries account with the International Clearing Union. Every export would subtract an equivalent bancor.
To discourage the imbalances which affect the monetary framework today, the ICU would take a percentage of a nation’s bancor trade surplus and put it in a reserve fund. This would encourage surplus nations to buy exports from other member countries.
As such, member countries which imported more than they exported would have their domestic currency depreciated against the bancor. This would encourage other nations to purchase the goods/exports of the member country with the depreciated currency, as the cost of the said exports would now be lower.
This plan of bancor and ICU was vetoed by the United States in a unipolar effort to protect its substantial trade surplus which had been built up in the preceding years. It is important to note that what was initially a record trade surplus for America, became, after 70 years of using its domestic currency as the international money clearing unit, a record trade deficit.
In place of the International Clearing Union the Bretton Woods Conference established the International Monetary Fund to provide additional assistance to member countries who encounter balance of payments challenges.
But with no ICU framework, or international money clearing unit, there was no way to broaden stability and prevent extended trade imbalances.
Since the USD acted as the international money clearing unit, and all other countries were forced to hold dollars on reserve, the United States was encouraged to facilitate the clearing of those dollars through trade agreements which shifted the manufacturing base which had originally contributed to America’s large trade surplus, to emerging economies, who would manufacture the goods and export them back into the United States.
This, in essence, made the US the consumer of last resort in the unipolar dollar system. This heightened consumerism is reflected in the degradation of the western social structure. It is with wonder and intrigue that we see each period of empire devour itself region by region as it attempts to consume its own inequities.
Once consumer saturation has been reached, the Empires fragment and return to the original baseline from which they were formed. Something similar could happen with the United States as Hawaii, and other former independent regions, such as Texas, seek equilibrium in pre-Washington socioeconomic structures and geopolitical borders.
Large trade imbalances can, and already have, caused severe destabilization in the world economy. The situation in Greece is only the tip of the spear for this systemic destabilization. The solution which will be put forth for Greece and the Euro Zone will be a clear indicator of what is to come internationally. Trade rebalancing in the European Union will act as a micro version of what will take place in the macro global economy.
Much like Germany and Greece are locked in a destructive relationship based on trade imbalances and the subsequent economic and geopolitical tension which arises within the European Union, China and the US are linked arm in arm through a similar partnership of debtor and creditor. This dynamic could lead to collapse and/or war, but there are many reasons to conclude that will not happen.
The interdependency between all nations, especially the largest debtor, the US, and the largest creditor, China, should effectively hold everything together and avoid the worst outcomes. Though there may be some volatility and skirmishes along geopolitical hot points, China will have to accept a depreciation of its USD and Treasury holdings.
The United States will have to accept an end to the reserve status of its domestic currency and accept the macroprudential mandates of a true international money clearing unit, as defined by the bancor during the Bretton Woods Conference.
But how can all of this happen?
First, China will have to reduce its trade surplus and encourage domestic growth. This existing policy was reviewed in the post When Will China End the Dollar Peg.
Second, a transition unit of account will have to be utilized in the lead up years to the creation of the bancor as the international money clearing unit.
This transition asset will be the Special Drawing Right of the International Monetary Fund.
Once adopted and implemented as the reserve unit of account, the SDR will begin to replace the dollar and start the process of stabilizing the system while balancing trade. This will take years and there could be problematic regions and some volatility along the way.
There are multiple steps which need to happen along this road to rebalancing the world’s wealth. When we consider that it is mainly the utilization of one domestic currency which have caused the issues, as reflected in the trade imbalances, the first step is to replace the reserve currency with a true international money clearing unit, such as the SDR.
After the implementation of the SDR (as the transition asset to the actual bancor currency), the trade imbalances themselves will have to be adjusted. The trade imbalances are reflected in the chart below as defined by the largest economies in the world, detailed as trade surplus countries or trade deficit countries.
So the first step to rebalancing world wealth is made by adjusting the value of the currencies against the SDR. If trade imbalances are the issue, then by depreciating the value of currencies belonging to trade deficit countries we can expect that the goods produced in that country will become cheaper to export, which will increase production and exports, leading to a reduction in the trade deficit.
As a side note, an increase in domestic production will also increase GDP, which in turn improves the debt-to-GDP ratio, making sovereign debt more manageable in the years to come.
In turn, appreciating the currencies of countries which have trade surpluses will force the goods exported to become more expensive, which in turn will decrease the amount of goods exported and improve the trade surplus which the country is carrying.
With that framework in mind, let’s consider the following:
- Domestic currencies are adjusted upward/downward against the international money clearing unit, in this case, the SDR, but represented by the bancor in years to come. This new exchange rate regime will likely be managed, similar to the managed peg which China holds against the USD.
- Each member country will be allowed a maximum debit balance and quota. The sum of a members imports/exports, being its balance of payments, will be averaged over three years and the quota amount set as determined by this average.
- The adjustments to the managed exchange rate of the domestic currencies against the SDR will be based on this weighted value of the balance of payments, being the sum of imports and exports.
- Any excess surplus or large deficit (debit), can be charged interest. This will help avoid excessive surplus build ups and runaway trade deficits, like the US has experienced. The funds collected through this process can be used to facilitate international aid to troubled regions, and debit countries (those with large trade deficits, or otherwise debtor nations), can borrow from the surplus countries, which would encourage the surplus countries to lend out their surplus (as opposed to being charged interest on it) to the deficit countries.
- In order for a trade deficit country to decrease its quota (debit) amount, the member must depreciate their domestic currency (as defined above), which will grow exports. A transfer of reserves, such as gold or other liquid assets, may also be used to offset debit increases.
- Any excess surplus can be reduced by taking measures to expand domestic credit and domestic demand, both of which China has been doing, along with the appreciation of the domestic currency. This increase in the value of the national currency can be accompanied by an increase in real wages and a reduction in trade tariffs. The large surplus country can also issue international loans to help other countries. This is one of the main purposes of the BRICS Development Bank and the AIIB.
- Member countries may also engage in a one-way exchange, or convertibility of gold into SDR quotas, and in the future bancor credits.
In simple terms, countries with trade surpluses will have their domestic currencies appreciated to facilitate the process of reducing those surpluses, while countries with trade deficits will have their domestic currency depreciated to facilitate the process of increasing exports and decreasing the trade deficit. The larger the surplus/deficit, offset by the country’s ability to implement other tools, as defined above, such as international loaning of surplus, will factor in how much the domestic currency is depreciated or appreciated.
Clearly the Chinese currency will appreciate and the USD will depreciate. This is the only way the imbalances in the global monetary framework can be corrected.
To understand which currency will go up and which will go down, one only need reference the balance of payments of each country and make the determination, based on surplus/deficit levels, and liquidity (along with composition) of foreign reserves. Based on the formula defined above, the countries which are subjected to the harshest western propaganda are the countries which have the strongest position in the emerging framework.
And yet, the interdependency between all ensures cooperation and sustainable solutions to the balance of payments challenges.
The mistakes made at Bretton Woods can be corrected moving forward. The IMF can play the role originally assigned to the International Clearing Union, and the SDR can be used as the “transition international money clearing unit” which will adjust the trade imbalances.
In closing, let’s not look at the European Union and the euro as a failure. Consider it a metamorphoses and trial run for the SDR – bancor transition. The European Currency Unit (ECU) served the same purpose for the creation of the euro which the SDR will serve for the creation of the bancor. The problems in the European Union have brought to the surface the systemic challenges which will face the rise of the bancor and multilateral monetary framework. – JC