CHAPTER THIRTY-SEVEN
Toward a New Form of Money?
SINCE 1973, WHEN FLOATING exchange rates first became the new orthodoxy, two schools of economic thought have been arguing with each other.
One, the majority, believes floating exchange rates are necessary and permanently desirable. This school would consider any return to fixed rates potentially catastrophic because of the periodic crises that seem to build up when governments are charged with adjusting the rates.
The other school, today in the minority, believes that floating exchange rates only encourage fiscal irresponsibility and inflation. It argues for a return to fixed rates as a means of forcing governments to keep their money supplies under control.
The two schools appear to be incompatible. Yet we may well be halfway toward a two-tier monetary and currency structure that institutionalizes both views. One tier would be national currencies issued and manipulated by national governments and floating in relation to each other. The other tier would be a transnational currency consisting of money of account held by the world banking system and denominated in terms of its purchasing power.
Most of the world’s economy’s business and trade is now carried on in “Eurocurrencies”—Eurodollars, Euromarks, Euroyen, Euroswissfrancs, and so on. The textbooks originally defined Eurodollars as dollars deposited in American banks but held abroad. But that definition long ago ceased to bear any relationship to reality. The Eurodollar—or the Euromark or the Euroyen or the Euroswissfranc—is purely transnational money, owned by anyone and deposited anywhere. Commonly, Eurocurrencies are created when a company or individual, perhaps to gain a higher interest rate, makes a deposit in another country.
The Eurodollar became popular in the mid-1960s when President Johnson first retreated from the key-currency role of the U.S. dollar by imposing restrictions on American investment abroad. But it was invented—and this is a delicious irony—by the Soviet state bank in the 1950s when the Soviets withdrew dollars on deposit in the United States, placed them in their London branch, and began making loans based on them. The Soviet intent was to insulate the deposits from being blocked by U.S. Government action; the result was a financial instrument that may have saved the world economy and indeed the free-market system.
It was assumed in the 1960s that Eurodollars would remain a minor adjunct to national and nationally regulated currencies. It was also assumed that the U.S. dollar would remain solid and that the U.S. Government would have both the will and the resources to maintain its internal and external value.
Both were rational assumptions fi fteen years ago. Both have been disproven by events. The Eurocurrencies have become the dominant money of the world economy—with national currencies rapidly becoming the adjuncts. There were, in 1979, $900 billion of Eurocurrency in circulation in the world’s banking system—$600 billion if interbank loans are deducted. [1981 note: The fi gure is substantially higher now.] This is more than all the national bank deposits of the world’s developed free-market countries.
But it is surely also abundantly clear by now that every modern government must be expected to put domestic and short-range considerations—employment, the protection of dying industries, the competitive position of its exports—before concern from the outside world, even though it is of course the world economy that today lays the golden eggs for the developed countries. There cannot, in other words, any longer be any one “key currency” which can be confidently expected to be stable or even predictable for any length of time.
To be sure, some of the authors of the new European currency union, the European Monetary System, which is just making its first tentative and halting steps, are hoping that a European currency based on the German mark will become the monetary and trading support of the world economy. But as the very able German Minister of Finance, Hans Matthofer, said in Frankfurt in the summer of 1979, this assumes (a) that the United States will keep the dollar stable rather than subordinate its foreign exchange value to domestic considerations of employment and of the balance of trade; (b) that the French will be willing to defend the franc at the risk of substantial unemployment; and (c) that the British, under the Conservative government, will do likewise.
Mr. Matthofer thought these reasonable assumptions “for the short term”—but this is hardly good enough to base the future of the world economy on. [1981 note: And clearly Mr. Matthofer was wrong even “for the short term.”]
There are two responses to the development of Eurocurrencies. The first is to attempt to undo it. This is, in effect, what the U.S. Government was aiming at during the Carter Administration, with its well-publicized proposals to force the “stateless money” of the Eurodollar market back under the jurisdiction and regulation of U.S. monetary and financial authorities. That attempt was doomed to fail. Only the Germans supported it, and none too ardently. The British, French, and Japanese governments had no use for it. And if the United States and the Germans had succeeded in emasculating the present system the lenders would, it is quite clear, have designed a new one, as their predecessors, fifteen years ago, had designed the Eurodollar.
The second response is coming from the main lenders in the Eurocurrency markets, the OPEC countries, and the multinationals based in countries with substantial trade surpluses, primarily West Germany and Japan. Those lenders are pushing hard for a shift to a truly transnational currency. They need money that is not tied to any one denomination but linked to purchasing power—e.g., through guaranteed convertibility at fixed rates into a “market basket” of other currencies, through indexing according to the wholesale or manufacturers’ price index of leading industrial countries, or, perhaps, through something like the traditional gold clause of the nineteenth century.
On a 1979 trip through Europe’s main economic centers almost every banker and government economist—in London, Frankfurt, Brussels, Madrid, and Stockholm—talked to me of the shift to such a transnational Eurocurrency as all but inevitable.
As one large banker noted, the OPEC countries have stuck with the dollar for political reasons. How much longer can they afford to do so, considering the rapid depreciation of the dollar and the equally rapid escalation in prices they pay to the industrial world for finished goods? In fact, before the Iranian crisis pushed oil prices way up in 1979 the purchasing power of what OPEC received for its oil had fallen to what it was before the OPEC cartel became effective in 1973. That OPEC’s own actions are largely responsible for this, and that old and well-proven economic theory has long taught that a cartel cannot and will not increase the real income of its industry members unless there is a genuine physical shortage of the product and of the capacity to produce it, is not seen or admitted by the OPEC countries.
Thus even the most responsible and most intelligent members of OPEC see themselves as almost forced to demand that their money on deposit in the world banking system be kept in a form that protects it against expropriation through currency devaluation on the part of the developed world, that is, in a transnational currency. And a German banker in Frankfurt said almost the same thing when talking of his clients, the large German multinationals and their export business.
How fast will the shift come and how far will it go? “Within three years,” said a banker with Arab connections, “one third of the new currency deposits will have become nonnational in their denomination through one device or another.” The banker in Frankfurt thought this to be high—one fifth was more likely in his opinion. [1981 note: The Frankfurt banker was about right.]
Perhaps most plausible was the assessment of the London top executive of one of the big American banks. “The shift has just begun,” he said, “but the trend is sharply upward. And thus the banks will have to put the same purchasing power safeguards on the loans they make against Eurodeposits. We are good at hedging against currency risks—we have to be good. But no one is good enough to hedge against even one tenth of his deposits. And so the loans the banks make will also be in a transnational currency rather than the banks taking on the risk of national currencies themselves.” [1981 note: That began in 1980.]
In the early 1940s, John Maynard Keynes began to advocate a truly transnational money which he called “Bancor” and which he proposed to have managed by a transnational, nonpolitical group of bankers and economists. His proposal was defeated by the American Keynesians at the Bretton Woods Conference of 1944, in part because of their suspicion of “British Imperialism,” in part because they wanted the dollar to become the world’s key currency and were convinced that it could play that role, despite Keynes’ warnings that a “key currency” had become a dangerous self-delusion. Then, in the mid-seventies that arch-non-Keynesian, F. A. Hayek, proposed that governments get out of money completely and turn the job over to individual and competing banks, with the market deciding which bank’s money it was willing to trust.
Neither proposal is likely to become reality. We know today that Keynes greatly overrated the capacity of the “value-free expert” to make nonpolitical decisions and to impose them on national governments. And Hayek’s proposal is unlikely to be accepted in the foreseeable future by politicians, parliaments, or ministries of finance. But the assumption underlying these two proposals—that money is far too important to be entrusted to politicians and governments—is now accepted, I would say, by almost everyone (except perhaps ministers of finance). It is even increasingly accepted by ordinary people who know no economics but who see the purchasing power of their earnings decline month after month.
Surely no one, perhaps not even the ministers of finance, any longer believes, as we so blithely did when I attended the Keynes Seminar in Cambridge in the early thirties, that governments have both the competence and the integrity to manage money responsibly and nonpolitically.
Transnational money for the world economy, that is, money denominated in any one national currency but tied, one way or another, to purchasing power, is thus a logical and perhaps inescapable development. It is unlikely to be as orderly as Keynes’ proposed Bancor would have been, or as rational as Hayek’s free-market, competitive, bank money. It is going to be messy, difficult, complicated, risky, and cause endless friction. And as the history of central banking abundantly demonstrates, there are very real dangers in banks trying to be banks of issue that manage currency and commercial banks concerned with liquidity and profits. Two-tier currencies may be a cure worse than the disease.
But transnational money might work. With all its imperfections, it may well become reality in a world which demands both national currencies that are politically controlled and managed for short-term political expediency and transnational currency stable enough to finance trade and investment in an increasingly interdependent world economy.
(1979)