Hello, welcome to visit Shanghai Forum
Thank you very much. It is a great pleasurefor me to be here and to be a part of this excellent forum. I share with theother speakers that my subject is different from the others. I am using thistitle “Monetary Unions Free Trade Areas in the World Economy” just to emphasizethe fact that these two issues are connected together, and that there is greatdiscussion about free trade areas all over the world. It is a really big growthindustry and I am very supportive of it. I think it has a big relationship withmonetary unions.
I was, maybe this is a bit of an anecdote,but I was in Shanghai in 2001 at the time of the APEC forum at the Shangri-La hotel.I had a speech that followed George Bush's speech. It was a huge recruit room,and the aisles were all filled when he spoke – they weren't when I was there,but I still had a large audience anyways. I was talking about monetary unionsin a way. Not free trade areas, nor monetary aspects (monetary cooperations)for the APEC, because at that time the APEC plan was to have a free trade areain APEC - a very large trade area - and I always thought that if you hadflexible exchange rates in each country, movements up and done, it vitiates alot of the major issues of the free trade area.
I put these up. These are different typesof monetary unions, in a way. Some of them characterize different phases overthe last century. We always have to look a little bit at history in order totry to see where we are now and to see how we are moving into the future,because there is usually a lot of lead time as the international monetarysystem changes. The bimetallism, when a couple of countries like France and theUnited States, fixed the price of gold and silver. But then the Civil war cameand the US left it, and the Franco-Prussian war came and they left it, and sothen countries moved to gold standards or silver standards. But the goldstandard was the rising one and there was a big movement towards the goldstandard. So most advanced countries, except China, were on the gold standardby the time of the outbreak of World War One (WWI).
That had a big effect at that time becausejust a year before WWI started, the Federal Reserve System came into existence.(This is significant because) the central bank for a country had not justbecome the biggest economy in the world, but (also became) bigger than the nextthree (largest) economies put together. When that country formed a centralbank, it gave it in-facto subsequently the power to determine the internationalmonetary system, or at least to veto any other kind of systems that othercountries may want to have. It took over from the pound sterling as the majoreconomy in the world.
This is another look at these things. Idon't want to go into this historical part but let's, just quickly. When thepound sterling defacto became inconvertible in WWI, the dollar became the mainworld unit of account. After the war, the dollar assumed a particle role, and amore important role than the pound sterling. Europe went back to the world goldstandard. Europe and the world followed. That's what always happens. Whenevercountries go back to a gold standard it creates a deflation. It did that afterthe Napoleonic Wars, it did that in every period in history. This was alikeness that created the deflation that led to the Great Depression.
The US Britain both went off gold and ayear later the US raised the price from 20 something to 35 dollars. That becamethe basic framework, or source-price - the most important price in the worldfrom 1934-1971. When 1944 came, the Bretton Meeting set up the rules of thegold standard. They devised a set of rules that were subsequently modified andit turned into a dollar standard anchored to gold. Because the US dollar wasconvertible into gold for monetary authorities, it wasn't a real gold standardbecause it didn't keep the world price level in lieu with the fixed price ofgold.
Wartime inflations - the Korean War andsubsequent places - eventually made gold undervalued. Europe and the US had tosell about two thirds of their stock to gold. In 1948, the US had about 70% ofthe world's gold. In 1971, they only had about 25%. Most of that went to Europe.In 1971, the reasons were quite clear for taking the dollar off gold, becausethey didn't want to sell anymore gold, because they wanted to keep at leastpart of it there. And then the world broke up into flexible exchange rates.
But the flexible exchange rate movementwasn't in any way prepared - it wasn't a good system. Nobody in the history ofeconomics ever argued, nor was any treatise was ever written, saying it was agood arrangement for ever country to have flexible exchange rates. Yet, that iswhat got stuck in the system with the second amendment to the IMF and to themanagement of flexible exchange rates. This is the monetary system we have inplace now. It is the opposite of the gold standard.
These are just some pages about the age ofthe pound sterling and how it transformed into the age of the dollar. This is apicture of it. These circles, or globes, represent monetary power and are moreor less proportionate to GDP of the area. In 1918, 1919, Britain was the centerof monetary power. But the biggest economy was already the US at that time.This is the way of the gold standard. All currencies were convertible intogold. Up in the left you see China. Mexico wasn't a part of this system; it wason the silver standard. Then, on just the eve of the war, London was still thecenter of the world capital market. When war broke out, capital rushed toLondon. The pound appreciated, but only for a few months, but then peoplerealized that the pound was no longer the safe haven. And after a few monthsin, the dollar became the currency, That was waiting in the winds, so to speak.With the newly created central bank, and the Federal Reserve, it could changethat. Well, the World War changed it - the ascending power. When I think ofthis shift in currency systems, I make a solar analogy ¨C it's like our solarsystem. Gold is the center of it; the sun is this gold and the big center ofgravity there. When one of the planets becomes bigger and bigger than the sun,eventually the planets and the sun itself will rotate around this planet.Jupiter, let's say becomes the biggest planet bigger than the sun itself -it'll become the center of this system. This is more or less what happened tothe United States, especially after the Second World War - it had a superdominant economy in the world.
But the restoration of gold was a mistake -the people who did that hadn't studied history. They should have known thatevery time countries go back to - just as when countries go off gold or silver,they have inflation - and they go onto it, they have a new kind of deflation.So in the 1920s, this is the way it is. The United States was defacto. Eventhough it hadn't set up the gold standard, it was the defacto center of theBretton Wood meetings in Washington. But the gold standard caused the inflationand deflation of the Great Depression. It had the biggest cost to Americantariffs. Then the defacto led to the great devaluation of the dollar in 1974,it created the dollar standard. It became the dollar standard, where the dollarwas anchored to gold until 1971. The convertibility was not for the Americanpeople. The American people after 1933 were forbidden to hold gold.
The rest of the world could be on gold, butthe United States was not. The system then was the US fixed the price of gold,and this price lasted until 1971. Other countries fixed their currencies to thegoldconvertible- dollar. The 1930s brought war-clouds again from Germany -World War broke out. In 1941, President Roosevelt asked his treasury secretaryto begin preparing for a post-war monetary order, and a world currency. TheBritish, Americans and Canadians proposed plans for discussion and that's whatled to the Bretton Woods meeting in July 1944. That's coming up the 70thanniversary. They tried to devise a monetary system. Theory sorta stumbled in alot of different ways, but they got enough of it right so that they got asystem that could last until at least 1971. No world currency had existed -Roosevelt had suggested for a world currency but they didn¡¯t do it, probablybecause 1944 was a Presidential election year and it wouldn¡¯t have been goodpolitics, so it was dropped. The British plan didn¡¯t come into being. TheAmerican plan, the world currency, came out of it.
The twins - we have here Robert Zoellick,the 11th President of the World Bank, one of the world banks that had beencreated in 1974. At that little place in New Hampshire, Mount Washington Hotel,they set up the, or endorsed the, global monetary system that turned into -wasn¡¯t quite the design of the dollar standard. At the end of the conference,Secretary Morgenthau, secretary of the Treasury of the United States, in theconcluding speech, he mentioned that this was the end of monetary nationalism.But that system broke down in three stages: Gold was first of all, overvaluedby raising the price. It was equally valued, properly valued, and then it wasundervalued. There was no mechanism to stop it, but - what I do want to say -when we came to flexible exchange rates, it undid that, it violated that speechMoregenthau had said - ¡°this is the end of monetary nationalism¡± - becausefloating exchange rates was a way of getting back to monetary nationalism. Eachcountry has its own currency and each country has its own inflation rates. Sothe flaws in the system - I don't really want to go into too much detail -there was a short period where we went back to a fixed rate to the dollar in1971, until it broke up.
It was a pure dollar standard and no longerconvertible into gold, so the US was effectively determining the monetarypolicy of the world, and Europe didn't like it because they thought it was tooinflationary. Then George Shultz (the secretary of the Treasury of the UnitedStates), the Minister of Finance in France, and Helmut Schmidt (the Chancellorof Germany and the Minister of Finance of Germany) got together in June anddecided to break up the international monetary system and scrap it - letcountries handle the inflation problem on their own. George Shultz, a goodfriend of mine, was a disciple of Milton Friedman, unfortunately, and Miltondidn't really have a good sense of monetary affairs. Anyways, the system brokedown because it was too inflationary for Europe because, well, this is whatAmerican policy wanted to have for itself, and that was the end of thatepisode.
Let's move to flexible exchange rates. Now,the world looks not so connected together - the globes are floating out inspace and not circulating around the dollar. But, underneath it all, let'sthink. Now we have 188 members of the IMF - not quite 188 currencies, because17 of the countries use the Euro. But just imagine what the world would looklike if we had 170 or so separate currencies, separate countries, and separateexchange rates. There would be no coherency in the system. What made flexibleexchange rates possible was that it never really came into being. The dollarserved a role, still, because of its size as a unit of account of the system.So all exchange rates could be related to the dollar. If you had 200 currenciesin a country, you’d find out you had 19,700 exchange rates coming, cuttingacross the exchange rates. When you get down to it, when you have a numerare,when you can find a numerare, you can get it down to 200 or 199 exchange rates,all based on that one. So there is coherency in it, but the rise in theEuropean block in the 1970s, the crisis in the European monetary system, andthen leading up the Euro itself – all this began to split that American unit ofaccount hegemony block and began to undermine the dollar as a global monetarysystem. It split it in half, so it didn't work.
Here is the point I wanted to make - underthe gold standard there were no systemic crisis. The problem with the goldstandard was maybe too much going on or going off gold. But there was no basicproblem with the system itself. Under the Bretton Woods System, there werenational crises with it, but there were no systemic crises with it. But afterthe system broke up in 1971, when the dollar went off gold, you had floatingexchange rates. Then you had a whole series of crises. I'll just put down theones you remember.
Immediately, the oil crises - suddenlysoaring when the dollar was taken off gold, just within a month after themeeting in the Smithsonian Institution in December 1971. The price of gold -when they were refixing exchange rates, they were still using gold, but no onewas buying or selling it - they raised the price from 35 to 38 dollars. Withina month, OPEC had a meeting and raised the price of oil to the same extent -already you had in motion what was going to happen in 1974, and 1979 with thoseoil crises. And over that period you had a sinking dollar in the late 70s and asoaring dollar in the early 80s. That caused the savings and loans crises, andit caused the international debt crisis. It developed in countries that wouldborrow cheap dollars that were pushed into borrowing. Governments always loveborrowing if they can borrow what they think is cheap. They have to pay back inexpensive dollars later, and Mexico was the one who first created that sort ofcrisis.
Then the exchange rates weren't stable, andthere was the instability involved in that issue. Then the IMF Asian crisis, asit is sometimes called, happened. I have heard the term the “IMF Asian Crisis”first of all in Korea, where it was being called that. Maybe it's not fair tocall it that to the IMF, but the cause of that crisis was that China had devaluedits currency. It raised the dollar from 1994 from 5.5 RMB to 8.7 RMB. Then itwas letting the dollar go down till it got to about 8.28, where it was fixedfor a while. But the important point, the socket point was, after the Mexicancrisis, the dollar had gone down and the Yen had gone up to about less than 80,78 Yen in April 1995. The next three years, the dollar soured against the Yento about 148 Yen. It was this huge depreciation with the Yen against the dollarthat rocked all those countries that were holding onto the dollar into thecrisis. This was the cause of the Asian Crisis - it was instability of majorexchange rates. Someone at the IMF must have realized this, but the IMFcouldn’t say this because the system was promoted by the IMF for flexibleexchange rates.
The next one was the layman shock and theworld crisis. Now it is strange, but what caused the great crisis - of course,we have the sub-prime mortgage thing that went on. In 2007 you had the meetingof August 7th and 8th of the central banks and the World Central Bank and theEuropean Central Bank where they pushed out 95 billion dollars of new money inone day - a big record. Now it doesn’t seem like too much with the numbers weget today, but this was a lot then. And the other central banks added upaltogether, in those 2 days, added up to 300 billion dollars to solve theliquidity, immediately, the balancing problem of the major banks of thatcrisis.
But that wasn't the big financial crisisthat came about. The big financial crisis came with the soaring of the dollar,and the dollar went up by 30% in the summer of 2008. The Euro was 1.64 in June'08 and in October it had fallen to 1.23 in August. That's why Europe, forawhile, escaped the crisis but the United States had it and it was shocked byit - it undermined housing and everything else.
The creation of the Euro aggravated theimportance of swinging exchange rates. Before the dollar could still representthe mainstream. There were now two big blocks out there. Before the Euro, thisis the way it looked. The creation of the Euro concentrated the monetary powerof Europe. After the Euro, you had a big block out there. It was not quite asbig as the United States, as the dollar. At different exchange rates it couldbe higher. When the Euro gets higher, it also gets bigger in terms of how wemeasure.
This created amajor problem. Europe has got important strengths, and the Euro is a greatthing. I was a big proponent of the Euro and of course I made the first planfor it in 1969. But Europe has got a lot of gold, but Europe has weaknesses now- you see lack of fiscal discipline, inactive welfare safe reforms that aren'taffordable, and debt-GDP ratios that were over 100% before they entered the Euro when the condition was 60%,only. Europe gave monetary stability but not fiscal stability. But now theimportant thing is what's under the system. There are six problems - theseproblems were pointed out in 2011 when France became the chairman of the g20.Nicolas Sarkozy enunciated what I call the 'Sarkozy Critique of the System' aschairman of the system.
He said therewas excessive instability of raw material prices, excessive instability inexchange rates and lack of governance in the system. The instability in rawmaterial prices came in that period I was talking about, with exchange rates in2008. Remember when the price of oil went up to 148 dollars, then in 2-3 monthsit came down to 33 dollars. That shocking instability that we had never beforehad the world seen something like that. Euro split the mainstream in the worldin half like that, and it now creates a problem for the system. Here it is,I'll show you this, the way it looks now. The consequence is that the dollar isless useful - it is not an anchor for currencies. Whenever China fixes itscurrency to the dollar, and China does defacto, China thinks it is fixing. Butit's not fixing to the world economy yet, because when the dollar and Euro goup, China can have a crisis. What happened when the dollar went up against theEuro was China had been appreciating slowly, while the dollar was falling. Theystopped that appreciating against the appreciating-dollar in the summer of2008. They fixed it at 6.8 and it was fixed at that for a couple of years atthat, because they couldn't appreciate against the soaring dollar. Fixing tothe dollar no longer gives a country stability. This is the system now. AsChina grows it will become bigger, and at one point it will overtake the dollarin terms of GDP power. It won't have the financial debts yet. We need, RobertZoellick and others, reform. Financial reform - that has to be the next bigthing for China.
What we need tomove toward and think about for the 70th anniversary of the IMF is to see whatwould be the root to restoration of the system. I might add that I read areally nice article by Robert Zoellick that was on a kind of call for a returnto the Bretton Woods System. A kind of stability - I won't go into that butthat's definitely along the lines of what I think we need to have.
To correct thedefects of the system, the swings between the dollar-Euro rates, which are sobig - together they represent 40% of the world economy. If you could fix thatone exchange rate, the dollar-Euro rate, and manage that rate, more or less ina way, oddly enough as John Williams was arguing for about as an alternative tothe Bretton Woods system - he argued for the pound, the sterling, and thedollar to be fixed. But the Euro and the dollar are the key currencies now, sostabilize the exchange rate of those. That means you have to do something aboutcoordinating monetary policies. You can't fix it the way it was fixed underBretton Woods where all the other countries fixed both the bottom and toplimits of their currencies. Now you have sharing of the fixing and coordinationof policies resulting from that.
Without goinginto detail, by the way, when in an instance as QE3 came into being lastOctober, the Euro was a dollar twenty-one, and Europe would have participated.The benefit from that QE3 - if they hadn't let the Euro soar, the Euro soaredto a dollar thirty-seven - if they had stabilized it, Europe wouldn't have hadits secondary recession. There again we go into a problem - if you stabilizethe exchange rate you have a new block there that represents a mainstream ofthe world economy, like the dollar was. What else do we need to do? Wellpolicies, of course, would be needed. There would be several events.
We have tomention China. Let me conclude with this. This is China's exchange rate, theprice of the dollar from 1978 on up. I guess the chart doesn't conclude there.Up until 1994, the big devaluation, that big movement up on January 1, 1994 -when the dollar went to 8.7 RMB. That came down and was fixed until 2005, untilthe spring at 8.28 RMB, and then there was a quick readjustment down so itcould get back down. Now it's getting close to six again. China keeps itscurrency latent to the dollar. Once China - a gradual move - I think the newadministration should move towards a greater consideration of making theChinese currency more convertible. There's no reason why China couldn't be partof this and add to it, the dollar-Euro-Yuan area. And this system as it is nowwould look like that - 50% of the world economy by fixing the two exchange rates.And one of them, the Chinese currency is already fixed, so it is still justfixing the dollar-Euro rate. And you¡¯re fixing the problems of the systembecause you're restoring the anchor of the mainstream of the world economy, andit would go on into it. I won't but we could go on and talk about betteralternatives, but that's ruining up my main message to get to a new system thatwould give us a currency on the world map, a global currency. I call it theINTORP? But whatever - it could be anything else, and that could be what Iwould do to help fix the system.
