In God and the US Dollar We Trust?

Mohan Guruswamy

8 October 2014

Imagine living on an island a part of a small group, and in this group people are assigned specific vocations and tasks. In this system one-person makes clothes, another shoes, some one pots and pans, some one grows food and someone else prints money to facilitate exchange of goods and services. So the shoemaker exchanges his goods with another for money and in turn pays with that money for food or whatever. Since everybody in this system can produce as much as possible, the person who prints the money will be best off among all because he can buy whatever he wants and pay for it with his own money. Take this one step further then. Producers who come to hold more paper than they need then start leaving it with the person who prints them to hold. Expand this to the global scale and we pretty much have a similar world system.

In 2012 the World GDP totaled about $71.83 trillion ($45.73 trillion in 1990 US dollars) and the per capita GDP was $12400. During the past eight years the WGDP grew at about 4% a year. In 1960 the WGDP was $6.85 trillion (1990). The WGDP was just $1.1 trillion in 1900 and took half a century to grow fourfold to $4.01 trillion and grew ten fold to $41 trillion (1990). The big leaps began after US President Richard Nixon unilaterally delinked the US dollar from the international gold standard. 

The total world trade in 2013 was $37.7 trillion, with China (including Hong Kong) the biggest player accounting for $5.31 trillions. The top five global traders account for $19.11 trillions or 50.6% of global trade. Almost a quarter of the global trade is accounted by the USA, Germany and Japan. The EU share of world trade is $4.49 trillions and the USA’s is $ 3.91 trillions also accounting for about a quarter of world trade. 

The total world reserves in 2014-Q2 was $12.00 trillion, of which 60.7% was held in US dollars, 24.2% in Euros, 4% in Yen and 3.9% in UK Pounds. Almost all of these reserves are held by individual countries in the form of bonds, mostly earning very small interest rates. This is like money invested in a bank, but in reality it is money being lent to the issuing country. Since the reserves are mostly in US dollars and Euros, the issuing countries have little reason to hold much as reserves. The USA’s total reserves amount to about $138 billion. Contrast this to India’s $298 billion and China’s $4055 billion. This last figure will tell you how much China is invested in the USA, and also how much leverage the USA can exercise over China to ensure complaint behavior. In 1995, advanced economies held around 67% of total foreign exchange reserves, with 82% of these being allocated reserves. By 2011, the picture had been flipped on its head: emerging and developing countries held 67% of total reserves, with less than 39% allocated. Emerging countries now hold roughly $6.8 trillion in reserve currency. 

The purpose of sharing these three world economy snapshots is to provide a general backdrop to how we have come to this pass. A situation where the rest of the world invests in the USA, so that it in turn can splurge on itself. When it is short, it can just print some more dollars, which the rest of us lap up quite happily. Every time the USA goes into convulsions due to its innate profligacy and economic mismanagement, the world economies go into a tail spin, because the USA is the world’s biggest importer and the it is where the world keeps its money. 

There can be no denying that the international financial system is in a shambles. The world barely escaped a melt down when bank after bank either failed or were on the verge of failing in the USA. The US Administration of President Barack Obama fashioned out a rescue by pumping in almost a trillion dollars to shore up the banks and save the giant US automobile industry, which is still that country’s major industrial driver. This money was made available by putting the printing presses of the various US Federal Reserve Bank’s on overdrive. While the USA is the world’s preferred banker, if it continues with its profligate ways and keeps adding to the supply of dollars, they value of dollar reserves will keep dwindling.

Now lets turn to have the system actually works. Countries like China and India produce goods and services at low cost for consumption in the USA, which in turn pays them in dollars, which they in turn deposit in US banks. Give or take a little. Since money cannot sit still, this money in US banks is then lent to Americans, who today have the highest per capita indebtedness in the world, to splurge on houses, cars, plasma TV’s, computers and play stations which they can often ill-afford. This was well understood, but like the people who kept investing with Bernard Madoff, countries like China, Russia, Japan, Kuwait, India and others keep investing in US securities at interest rates mostly between 1-2%. Thus, in effect the rest of the world was plying the USA with cheap credit, encouraging it to splurge even more. Unfortunately there was and is no global regulator to caution the US on its profligacy or force it to mend its ways.

The Breton Woods Conference of July 1944 took place under the fast receding shadow of the WWII and when the US was literally the last man standing. All other prewar powers including the victors were in shambles. The US was then much more than now the world’s dominant economy and military power. The economists John Maynard Keynes of Britain and Harry Dexter White of the USA led the teams to draft plans to set up a system of rules and institutions to regulate and manage the international monetary system. The immediate result was the establishment of the IMF and the World Bank. 

Lord Keynes had in mind a more elaborate scheme that called for the establishment of an international reserve currency but this had to be shelved in the face of American obduracy. Keynes' proposals would have established a world reserve currency (he proposed it be called "bancor") to be administered by a Central Bank. This Central Bank would have been vested with the possibility of creating money and with the authority to take actions on a much larger scale.

In case of balance of payments imbalances, Keynes recommended that both debtors and creditors should change their policies. As outlined by Keynes, countries with payment surpluses should increase their imports from the deficit countries and thereby create foreign trade equilibrium. Thus, Keynes was sensitive to the problem that placing too much of the burden on the deficit country would be deflationary.

But the United States, as a likely creditor nation, and eager to take on the role of the world's economic powerhouse, baulked at Keynes' plan and did not pay serious attention to it. The U.S. contingent was too concerned about inflationary pressures in the postwar economy, and White saw an imbalance as a problem only of the deficit country. 

Although a compromise was reached on some points, because of the overwhelming economic and military power of the United States the participants at Bretton Woods largely agreed on White's plan. As a result, the IMF was born with an economic approach and political ideology that stressed controlling inflation and introducing austerity plans over fighting poverty. But the fact that the US has been the world’s biggest deficit country for several decades and seemingly least concerned about it seems to have eluded the IMF. This and the fact that the US dollar has become the world’s preferred reserve currency (63.9%) is now the root of the world’s economic problem.

This international system was unilaterally abrogated when in 1971 US President Richard Nixon US delinked the dollar from the gold standard . In the absence of a standard and a useful regulatory function for the IMF, coupled with the Reagan/Thatcher era that followed, the great private banks were given a license to run amok. We are now reaping the bitter harvest. With the US dollar as the world’s preferred reserve currency, the US and its even more profligate citizens have an apparently endless access to easy credit to satiate their sundry appetites. In this way the ever growing annual US trade deficit becomes the de facto engine of growth for many economies, such as China and the ASEAN countries.

The G-20 earlier this year met under this backdrop. It’s a very different world now. For a start there is no towering visionary economist like John Maynard Keynes on the scene. Keynes said after the conference: “We have had to perform at one and the same time the tasks appropriate to the economist, to the financier, to the politician, to the journalist, to the propagandist, to the lawyer, to the statesman-even, I think, to the prophet and to the soothsayer." How can there be one like him when the world economic and financial elite lionized the likes of Alan Greenspan for so long? Or when the world’s economic agenda making was privatized and handed over to dubious NGO’s like the World Economic Forum? There are no tall leaders like Franklin Roosevelt or Winston Churchill either. 

In the past few decades the GWP has been growing at a much faster rate. In 1985 it was growing at 2.76%. In 2005 it grew by 3.56%. Much of this is due to the changing of gear in countries like China and India that began their great leaps forward. China’s growth in particular has been truly astounding. The growth trajectory of these countries has made people to review long held notions about how this century is going to shape up. It seems that in 2050 it will indeed be a very different world economic order. The firm of Goldman Sachs, the major survivor of the Wall Street shakeout has made projections of major GDP’s and this is how the picture is.

The post Cold War era has seen the economic and political rise of a host of nations, Brazil, China and India being foremost among them. Since 2000 and the advent of Vladimir Putin, Russia has with some help from soaring oil prices made impressive economic gains. The new South Africa, based equally on the industrial inheritance of the robust but unequal and exploitative apartheid regime and the bounty of nature, now finds itself as an advancing economic power. Unlike Nigeria that has frittered its oil wealth and has been looted by its native kleptocracy, South Africa has been a relative symbol of responsible government and probity in public life. Each one of these nations is now a major economic player and some already have bigger GDP’s than many in the G-7. Together, in the quarter of a century or so the BRIC’s will outstrip the G-7. (See table below)

With the advent of new world economic and political powers, logic would demand that the global high table be expanded. But there is an inherent problem with exclusive clubs. Expansion means they become less exclusive and with it goes the attendant risk that some already in will become less important. On the other hand those who get admitted will find that their admittance has made it somewhat less exclusive. Groucho Marx captured this paradox when he said: “I don't care to belong to a club that accepts people like me as members.” If the G-7 were to remain an exclusive and powerful club, then the only way to ensure it would be to relegate some of the present members like Italy and Canada to some lesser league. Similarly, if the UN Security Council were to become a truly representative and powerful body than Britain and France might have to be seen out and countries like Brazil and India brought in. Neither Britain nor France has the global economic reach of Germany, till this year the world’s leading exporting nation. Britain’s global power status is kept afloat by leased US nuclear submarines and missiles.

But this is not happening nor is it likely to happen in a hurry. In the meantime the world is changing. So the countries knocking on the doors are trying combinations and these combinations are many. On the basis of economic potential, and thanks to Jim O’Neill, the Goldman Sachs head of global economic research who coined the now familiar and catchy acronym BRIC’s, Brazil, Russia, India and China had come together to form a forum called just that. BRIC’s has now officially become BRICS with the invitation in the end of 2010 to South Africa to join the BRIC’s leadership conference at Sanya, China in mid April 2011. .

This may be or may not be. But the world is a rapidly changing place. The economic balance of power is shifting towards Asia. Like Communism the ideology of the Washington Consensus rammed down the world’ throat has been proved to be a failure. It is time we begin to think differently. Many think that the world’s four fastest growing economies Brazil, Russia, India, China and South Africa (BRICS) must now become the basic building bricks of the new order. That’s why they are now meeting at the highest levels so often. But it does not seem that they have a plan or agenda. Interests often conflict. If the USA reins in its deficit, China has much to lose. The 2009 slowdown cost it over 22 million jobs. India’s GDP dropped two points. Russia’s oil revenues dropped off dramatically.

Yet it devolves upon these five growth engines to bring more order into the world system. Casino capitalism can no longer be the guiding ideology. It must be swiftly discarded and a more responsive and intelligent system best suited to all and not just the USA is the need of the day. It is time we revisited Lord Keynes’ proposal for a global reserve currency and consider establishing a system to regulate and manage it. 

The USA and even the Euro zone will not want to relinquish the duopoly they have established whereby 91.4% of the world foreign reserves are held in their currencies. The dollar alone accounts for 60.7% of reserves. While the USA’s own foreign reserves stand at a measly $138 billion the rest of the world has $12 trillion in reserves. China’s reserves alone stand at $4055 billion while Russia’s is $485 billion. India is way behind here with only $298 billion, but this is still twice those of Germany, France and Britain. Clearly the time has come when we must put to work our money for ourselves and not be vulnerable any more to the gambling and speculative predilections of the so-called and over paid professionals in Wall Street.