Thursday May 6, 2010IPE Leiden
Agustin Mackinlay
Session 6. The Political Economy of China’s Economic Development Strategy
________________
[1] ON SOME ISSUES FROM SESSION 5
[2] THE SPIRIT OF THE DOOLEY, FOLKERTS-LANDAU & GARBER PAPER
[3] DOCUMENTS!
[4] TEXT OF NEW ASSIGNMENT
______________
[1] ON SOME ISSUES FROM SESSION 5
Two quotes from Winston S. Churchill. Marlborough. His Life and Times, Vol. II [1938] (The University of Chicago Press, 2002), pp. 506, 507, 652.
All Europe marvelled that in the seventh year of so great and costly a war, when every other state was almost beggared, if not bankrupt, the wealth of England proved inexhaustible. Indeed, it seemed that the government held a magic purse. The yield of high taxation was reinforced by internal borrowing upon the largest scale yet known. The Bank, in exchange for a twenty-one years' extension of their charter, bound themselves to provide four hundred thousand in cash and issue two and a quarter millions of bank-bills. Within four hours of nine o'clock the whole amount was subscribed, and eager would-be lenders were turned away in crowds.
Session 6. The Political Economy of China’s Economic Development Strategy
________________
[1] ON SOME ISSUES FROM SESSION 5
[2] THE SPIRIT OF THE DOOLEY, FOLKERTS-LANDAU & GARBER PAPER
[3] DOCUMENTS!
[4] TEXT OF NEW ASSIGNMENT
______________
[1] ON SOME ISSUES FROM SESSION 5
Two quotes from Winston S. Churchill. Marlborough. His Life and Times, Vol. II [1938] (The University of Chicago Press, 2002), pp. 506, 507, 652.
All Europe marvelled that in the seventh year of so great and costly a war, when every other state was almost beggared, if not bankrupt, the wealth of England proved inexhaustible. Indeed, it seemed that the government held a magic purse. The yield of high taxation was reinforced by internal borrowing upon the largest scale yet known. The Bank, in exchange for a twenty-one years' extension of their charter, bound themselves to provide four hundred thousand in cash and issue two and a quarter millions of bank-bills. Within four hours of nine o'clock the whole amount was subscribed, and eager would-be lenders were turned away in crowds.
Then Churchill cites from diplomatic sources:
Outside England it would appear incredible for this nation, after it had provided four hundred million Reichsthaler during nearly twenty years of war, to be able to produce a further ten millions in a few hours at the low rate of interest of 6 per cent. It must be observed that this has not been done in cash, which is now difficult to obtain, but in paper, particularly bank notes. Indeed, not a penny of these ten millions was paid in cash, but all in banknotes. These banknotes circulate so readily here that they are better than hard coin. So the whole of this wealth appears to be based almost entirely upon the credit of the paper money and the punctual payment of the interest. These prodigies … the City’s mysterious power of manufacturing credit…
Meanwhile, the king of France has to finance the war effort through taxes that are often collected manu militari. Louis XIV does not rely on French Parlements, and cares little about judicial independence. England’s monetary and credit might must have deeply impressed her enemies…
__________________
[2] THE SPIRIT OF THE DOOLEY, FOLKERTS-LANDAU & GARBER PAPER
. It is really important to understand the spirit of the article, more than its technicalities. Key points: Europe/Japan 1945 & China 1980s; stock of productive capital & institutional strength; center-periphery dynamics; cost of capital & cost of labor; second best; the international reserve currency.
____________
[3] DOCUMENTS
Document 1 [REQUIRED READING!]
IN FAVOR OF THE INTERNATIONAL RESERVE CURRENCY SYSTEM. Michael Dooley, David Folkerts-Landau & Peter Garber: “An Essay on the Revived Bretton Woods System”, NBER Working Paper No. 9971, September 2003
. These are the most important parts of the paper:
1. In this paper we explore the idea that the global system that has evolved and grown since the advent of Bretton Woods has maintained a single dynamic structure. In the Bretton Woods system of the 1950s, the US was the center region with essentially uncontrolled capital and goods markets. Europe and Japan, whose capital had been destroyed by the war, constituted the emerging periphery. The periphery countries chose a development strategy of undervalued currencies, controls on capital flows and trade, reserve accumulation, and the use of the center region as a financial intermediary that lent credibility to their own financial systems. [Comment: note the center-periphery dynamics!]
2. Once the capital of these zones had been rebuilt and their institutions restored, the periphery graduated to the center. It had no further need for the fixed rate, controlled development strategy, especially when it perceived that the US, in performing its financial intermediation service, was reaping a large transfer payment. [Comment: a periphery can graduate and become a center of innovation! How can they accomplish that?]
4. We emphasize the idea that it has been a successful development strategy to subordinate the objective of maximizing the value of reserve assets in order to subsidize and build a domestic capital stock capable of competing in international markets. This is not a first best strategy. It would be better to have both an internationally competitive capital stock and reserves that were superior investments. [Comment: (1) central banks who apply the BWII strategy care mostly about keeping their currencies undervalued; they care less about the profit/loss profile of their dollar holdings; (2) the “second best idea”: discussion]
5. When Europe’s development strategy shifted toward free markets, financial controls were lifted and the fixed rate system soon collapsed into the floating regime of the 1970s. [Comment: Western Europe and Japan did graduate from periphery to center! Center & periphery are thus very much dynamic variables!]
6. Most other developing countries, particularly the newly decolonized states, flirted with socialism or systems of import substitution that closed them off from the center. This development strategy was inhospitable to trade and the importation of long-term foreign capital. It fostered a local production of goods that could not compete globally and therefore built an inefficient capital stock that would in the end have little global value. Just as in the communist countries, when these opened to world trade and capital flows, they discovered that their cumulated capital was fit only to be junked. That is, they were in the same real capital-poor position as the post-war European countries. [Comment: a very powerful analogy! Europe/Japan 1945 & communist countries 1980s…]
7 and 8. With the discrediting of the socialist model in the 1980s and then the collapse of communism in 1989-91, a new periphery was melded to the US-Europe-Japan center. These countries were newly willing to open their economies to trade and their capital markets to foreign capital. These countries all were emerging from decades of being closed systems with decrepit capital stocks, repressed financial systems, and a quality of goods production that was not marketable in the center. The Washington Consensus encouraged them in a development strategy of joining the center directly by throwing open their capital markets immediately. [Comment: (a) a new periphery!; (b) why “repressed financial systems”? (remember Session 3); (c) what’s the Washington Consensus?]
9. Others, mainly in Asia, chose the same periphery strategy as immediate post-war Europe and Japan, undervaluing the exchange rate, managing sizable foreign exchange interventions, imposing controls, accumulating reserves, and encouraging export-led growth by sending goods to the competitive center countries. [Comment: that’s China, ladies & gentlemen!]
10. It is the striking success of this latter group that has today brought the structure of the international monetary system full circle to its essential Bretton Woods era form. The Europe-Japan of the 1950s was already large enough so that in our analyses we did not have a "small country" view of the periphery but rather recognized it as the driving force of the international monetary system. Now the Asian periphery has reached a similar weight: the dynamics of the international monetary system, reserve accumulation, net capital flows, and exchange rate movements, are driven by the development of these periphery countries. The emerging markets can no longer be treated as small countries, weightless with respect to the center. At some point, the current Asian periphery will reach a developmental stage when they also will join the center and float. But that point will not be reached for perhaps 10 more years and, most likely, there will be at that time another wave of countries, as India is now doing, ready to graduate to the periphery. [Comment: a bold forecast! Was it successful?]
11. Fixed exchange rates and controlled financial markets work for twenty years and countries that follow this development strategy become an important periphery. These development policies are then overtaken by open financial markets and this, in turn, requires floating exchange rates. The Bretton Woods system does not evolve, it just occasionally reloads a periphery. [Comment: some ‘timing’ issues]
15. In general we know that the US current account would have to adjust if the international monetary system consisted of floating currencies and open capital markets. But we do not live in such a world. We have re-entered a Bretton Woods reality and have to relearn and understand the very different adjustment requirements for the center country in such a system. [Comment: this is the only relevant technical point. We shall talk about the adjustment process]
18. … exporting to the US is Asia’s main concern. Exports mean growth. When their imports do not keep up, the official sectors are happy to buy US securities to finance the shortfall directly, without regard to the risk/return characteristics of the securities. Their appetite for such investments is, for all practical purposes, unlimited because their growth capacity is far from its limit. [Comment: they want exports above all! They are less worried about the value of their foreign exchange reserves]
22. The US … wants finance for its own growth and foreign savings help finance domestic capital formation. [Comment: innovators need capital!]
25. Asian countries in particular (China, Taiwan, HK, Singapore, Japan, Korea, Malaysia) manage their dollar exchange rates; and, as such, they float against the capital account region. Official capital exports finance growth-oriented trade surpluses. Policy is often affected through a system of exchange controls and administrative pricing. Some currencies are explicitly and rigidly fixed (RMB, HKD, MYR); others (JPY, KRW) “float” but still accumulate vast amounts of official reserves in USD. [Comment: central banks recycle trade surpluses back into the US credit markets]
28. In spite of the growing US deficits, this system has been stable and sustainable. The current account structure and asset accumulation have been consistent with the trade account region’s preferences for official investments in the US and, until early this year, the capital account region’s preferences for private financial investments in the US. But as US debts cumulate, US willingness to repay both Asia and Europe comes more naturally onto the radar screen, so the system that was previously stable could run into trouble. [Comment: the system is clearly under pressure now …]
34. Asia’s proclivity to hold US assets does not reflect an irrational affinity for the US. Asia would export anywhere if it could and happily finance any resulting imbalances. But the US is open; Europe is not. Europe could not absorb the flood of goods, given its structural problems and in the face of absorbing Eastern Europe as well. So Asia’s exports go to the US, as does its finance—otherwise, a US, if faced with financing difficulties, might similarly tend toward more stringent commercial policy. Asian officials are unlikely to shift toward Euro assets because of the depressing effect this would have on trade with the US. [Comment: in other words, the US dollar is the key international reserve currency]
35. The irony here is that concern of investors in the capital account region about the risk/return in an increasingly indebted US is misplaced. The US is being underwritten by Asia for the foreseeable future. [Comment: surely a bit too optimistic in light of subsequent events…]
38. More generally, emerging markets now have a choice … If they follow the Asian model, they will do whatever it takes to limit exchange rate changes relative to the dollar and to keep their currencies undervalued to spur exports. The two tools available are controls and taxes on capital inflows and intervention in the foreign exchange markets to peg an undervalued currency. [Comment: as we shall see, to “intervene in the foreign exchange markets” means to finance the US budget deficit]
41. We used to have a view that 1) there was a system (Bretton Woods) that evaporated thirty years ago into no system at all and 2) now a semi-system has emerged anew. But, in fact, the system has been the same throughout, just manifesting itself in different forms because the original emerging markets (Europe and Japan) developed and did not need the center’s intermediation any more. There was no one to replace these countries for two decades. But with the collapse of socialism came a new litter of emerging markets, and the background system that is the incubator of such economies has reanimated itself. [Comment: the “renewed Bretton Woods”, or “Bretton Woods II”]
42. So we can anticipate some issues that were familiar 50 years ago returning to center stage of the economics of international finance. Can the center survive with two reserve currencies? As the dollar replaced sterling as the preferred reserve currency, will the euro replace the dollar? How long can trade account countries insulate their domestic financial markets through capital controls? Does the system benefit and entrench the economic and geo-political power of the center country (i.e. the DeGaulle-Rueff view)? [Comment: we’ll quickly mention the DeGaulle-Rueff view]
____________
Document 2 [REQUIRED READING!]
AGAINST THE INTERNATIONAL RESERVE CURRENCY SYSTEM DURING THE BRETTON WOODS ERA. Jacques Rueff. Le péché monétaire de l’Occident. Paris: Plont, 1971
The process works this way. When the U.S. has an unfavorable balance with another country (let us take as an example France), it settles up in dollars. The Frenchmen who receive these dollars sell them to the central bank, the Banque de France, taking their own national money, francs, in exchange. The Banque de France, in effect, creates these francs against the dollars. But then it turns around and invests the dollars back into the U.S. Thus the very same dollars expand the credit system of France, while still underpinning the credit system in the U.S.
The country with a key currency is thus in the deceptively euphoric position of never having to pay off its international debts. The money it pays to foreign creditors comes right back home, like a boomerang … The functioning of the international monetary system is thus reduced to a childish game in which, after each round, the winners return their marbles to the losers … The discovery of that secret [namely, that no adjustment takes place] has a profound impact on the psychology of nations (la psychologie des peuples) … This is the marvelous secret of the deficit without tears, which somehow gives some people the (false) impression that they can give without taking, lend without borrowing, and purchase without paying. This situation is the result of a collective error of historic proportions.
For more details on Charles de Gaulle, Jacques Rueff and the “dollar battles” of the 1960, you can see [NOT required reading!]: Christopher S. Chivvis: “Jacques Rueff and French International Monetary Policy under Bretton Woods”, Journal of Contemporary History, Vol. 41, No. 4, October 2006, pp. 701-720; Francis J. Gavin. Gold, Dollars, & Power. The Politics of International Monetary Relations, 1958-1971 (The University of North Carolina Press, 2005); Agustin Mackinlay: Charles de Gaulle and the ‘Deconstruction of the Dollar’, unpublished thesis, University of Amsterdam, 2005.
________________
Document 3 [NOT REQUIRED READING!]
UNDERSTANDING THE ADJUSTMENT PROCESS
Understanding the Adjustment Process: the Gold Standard Regime
Step1. Trade surplus. A Dutch exporter sells porcelain crafts to English consumers. He gets paid with a £ Bank note issued by the Bank of England (BoE). But he needs either gold or Dutch guilders to pay his workers and other expenses. Thus, he goes to the Bank of Amsterdam and sells his £; he gets a Certificate of Deposit in return:
Dutch exporter Bank of Amsterdam
. less £ Bank Notes . more £ Bank Notes (assets)
. more CDs (assets) . more CDs (liability)
Step 2. Conversion into gold. The Bank of Amsterdam the goes to the Bank of England to get gold:
Bank of Amsterdam Bank of England
. less £ Bank Notes . less £ Bank Notes (liabilities)
. more Gold (assets) . less Gold (assets)
Step 3. The Adjustment process. The Bank of Amsterdam can make more loans; the Bank of England makes less loans. Interest rates decrease slightly in the Netherlands (more supply of loanable resources) and increase slightly in England (less supply of loanable resources). Wages, consumption and imports tend to rise in the Netherlands; wages, consumption and imports tend to decrease in England. Large deficits are thus quickly corrected through permanent inflows/outflows of gold.
Understanding the adjustment process: China & the USA: the international reserve currency
Step 1. China’s trade surplus. A Chinese exporter sell toys to US consumers. He gets paid in US$. But he needs Yuan to pay for his workers’ salaries and other expenses. He goes to his bank in Shanghai and sells his US$; he gets Yuan in return:
Chinese exporter Bank of Shanghai
. less US$s . less Yuan (assets)
. more Yuan . more US$s (assets)
The Bank of Shanghai then goes to the People’s of China (the Chinese central bank) to get Yuan:
Bank of Shanghai People’s Bank of China
. less US$s (assets) . more US$s (assets)
. more Yuan (assets) . more Yuan (liabilities)
Step 2. The critical move. Instead of selling their dollar, or converting them into gold, the People’s Bank of China buys U.S. Treasury securities from American banks in … New York City! The People’s Bank of China buys U.S. Treasury securities from JP Morgan in New York City:
People’s Bank of China JP Morgan
. less US$s notes (assets) . more US$s notes (assets)
. more U.S. Treasury bonds (assets) . less U.S. Treasury bonds (assets)
This is the key feature of a monetary system that depends on an international reserve currency. Surplus countries channel their foreign currency assets back into the credit market of the country that issues the international reserve currency. They do that for a variety of reasons. Unlike gold (which doesn’t pay interest), U.S. Treasury securities do pay interest; besides, there is a very large market for these securities, which means that the People’s Bank of China has at all time easy access to its funds (this feature of U.S. Treasury securities is sometimes called ‘liquidity’).
__________________
[2] THE SPIRIT OF THE DOOLEY, FOLKERTS-LANDAU & GARBER PAPER
. It is really important to understand the spirit of the article, more than its technicalities. Key points: Europe/Japan 1945 & China 1980s; stock of productive capital & institutional strength; center-periphery dynamics; cost of capital & cost of labor; second best; the international reserve currency.
____________
[3] DOCUMENTS
Document 1 [REQUIRED READING!]
IN FAVOR OF THE INTERNATIONAL RESERVE CURRENCY SYSTEM. Michael Dooley, David Folkerts-Landau & Peter Garber: “An Essay on the Revived Bretton Woods System”, NBER Working Paper No. 9971, September 2003
. These are the most important parts of the paper:
1. In this paper we explore the idea that the global system that has evolved and grown since the advent of Bretton Woods has maintained a single dynamic structure. In the Bretton Woods system of the 1950s, the US was the center region with essentially uncontrolled capital and goods markets. Europe and Japan, whose capital had been destroyed by the war, constituted the emerging periphery. The periphery countries chose a development strategy of undervalued currencies, controls on capital flows and trade, reserve accumulation, and the use of the center region as a financial intermediary that lent credibility to their own financial systems. [Comment: note the center-periphery dynamics!]
2. Once the capital of these zones had been rebuilt and their institutions restored, the periphery graduated to the center. It had no further need for the fixed rate, controlled development strategy, especially when it perceived that the US, in performing its financial intermediation service, was reaping a large transfer payment. [Comment: a periphery can graduate and become a center of innovation! How can they accomplish that?]
4. We emphasize the idea that it has been a successful development strategy to subordinate the objective of maximizing the value of reserve assets in order to subsidize and build a domestic capital stock capable of competing in international markets. This is not a first best strategy. It would be better to have both an internationally competitive capital stock and reserves that were superior investments. [Comment: (1) central banks who apply the BWII strategy care mostly about keeping their currencies undervalued; they care less about the profit/loss profile of their dollar holdings; (2) the “second best idea”: discussion]
5. When Europe’s development strategy shifted toward free markets, financial controls were lifted and the fixed rate system soon collapsed into the floating regime of the 1970s. [Comment: Western Europe and Japan did graduate from periphery to center! Center & periphery are thus very much dynamic variables!]
6. Most other developing countries, particularly the newly decolonized states, flirted with socialism or systems of import substitution that closed them off from the center. This development strategy was inhospitable to trade and the importation of long-term foreign capital. It fostered a local production of goods that could not compete globally and therefore built an inefficient capital stock that would in the end have little global value. Just as in the communist countries, when these opened to world trade and capital flows, they discovered that their cumulated capital was fit only to be junked. That is, they were in the same real capital-poor position as the post-war European countries. [Comment: a very powerful analogy! Europe/Japan 1945 & communist countries 1980s…]
7 and 8. With the discrediting of the socialist model in the 1980s and then the collapse of communism in 1989-91, a new periphery was melded to the US-Europe-Japan center. These countries were newly willing to open their economies to trade and their capital markets to foreign capital. These countries all were emerging from decades of being closed systems with decrepit capital stocks, repressed financial systems, and a quality of goods production that was not marketable in the center. The Washington Consensus encouraged them in a development strategy of joining the center directly by throwing open their capital markets immediately. [Comment: (a) a new periphery!; (b) why “repressed financial systems”? (remember Session 3); (c) what’s the Washington Consensus?]
9. Others, mainly in Asia, chose the same periphery strategy as immediate post-war Europe and Japan, undervaluing the exchange rate, managing sizable foreign exchange interventions, imposing controls, accumulating reserves, and encouraging export-led growth by sending goods to the competitive center countries. [Comment: that’s China, ladies & gentlemen!]
10. It is the striking success of this latter group that has today brought the structure of the international monetary system full circle to its essential Bretton Woods era form. The Europe-Japan of the 1950s was already large enough so that in our analyses we did not have a "small country" view of the periphery but rather recognized it as the driving force of the international monetary system. Now the Asian periphery has reached a similar weight: the dynamics of the international monetary system, reserve accumulation, net capital flows, and exchange rate movements, are driven by the development of these periphery countries. The emerging markets can no longer be treated as small countries, weightless with respect to the center. At some point, the current Asian periphery will reach a developmental stage when they also will join the center and float. But that point will not be reached for perhaps 10 more years and, most likely, there will be at that time another wave of countries, as India is now doing, ready to graduate to the periphery. [Comment: a bold forecast! Was it successful?]
11. Fixed exchange rates and controlled financial markets work for twenty years and countries that follow this development strategy become an important periphery. These development policies are then overtaken by open financial markets and this, in turn, requires floating exchange rates. The Bretton Woods system does not evolve, it just occasionally reloads a periphery. [Comment: some ‘timing’ issues]
15. In general we know that the US current account would have to adjust if the international monetary system consisted of floating currencies and open capital markets. But we do not live in such a world. We have re-entered a Bretton Woods reality and have to relearn and understand the very different adjustment requirements for the center country in such a system. [Comment: this is the only relevant technical point. We shall talk about the adjustment process]
18. … exporting to the US is Asia’s main concern. Exports mean growth. When their imports do not keep up, the official sectors are happy to buy US securities to finance the shortfall directly, without regard to the risk/return characteristics of the securities. Their appetite for such investments is, for all practical purposes, unlimited because their growth capacity is far from its limit. [Comment: they want exports above all! They are less worried about the value of their foreign exchange reserves]
22. The US … wants finance for its own growth and foreign savings help finance domestic capital formation. [Comment: innovators need capital!]
25. Asian countries in particular (China, Taiwan, HK, Singapore, Japan, Korea, Malaysia) manage their dollar exchange rates; and, as such, they float against the capital account region. Official capital exports finance growth-oriented trade surpluses. Policy is often affected through a system of exchange controls and administrative pricing. Some currencies are explicitly and rigidly fixed (RMB, HKD, MYR); others (JPY, KRW) “float” but still accumulate vast amounts of official reserves in USD. [Comment: central banks recycle trade surpluses back into the US credit markets]
28. In spite of the growing US deficits, this system has been stable and sustainable. The current account structure and asset accumulation have been consistent with the trade account region’s preferences for official investments in the US and, until early this year, the capital account region’s preferences for private financial investments in the US. But as US debts cumulate, US willingness to repay both Asia and Europe comes more naturally onto the radar screen, so the system that was previously stable could run into trouble. [Comment: the system is clearly under pressure now …]
34. Asia’s proclivity to hold US assets does not reflect an irrational affinity for the US. Asia would export anywhere if it could and happily finance any resulting imbalances. But the US is open; Europe is not. Europe could not absorb the flood of goods, given its structural problems and in the face of absorbing Eastern Europe as well. So Asia’s exports go to the US, as does its finance—otherwise, a US, if faced with financing difficulties, might similarly tend toward more stringent commercial policy. Asian officials are unlikely to shift toward Euro assets because of the depressing effect this would have on trade with the US. [Comment: in other words, the US dollar is the key international reserve currency]
35. The irony here is that concern of investors in the capital account region about the risk/return in an increasingly indebted US is misplaced. The US is being underwritten by Asia for the foreseeable future. [Comment: surely a bit too optimistic in light of subsequent events…]
38. More generally, emerging markets now have a choice … If they follow the Asian model, they will do whatever it takes to limit exchange rate changes relative to the dollar and to keep their currencies undervalued to spur exports. The two tools available are controls and taxes on capital inflows and intervention in the foreign exchange markets to peg an undervalued currency. [Comment: as we shall see, to “intervene in the foreign exchange markets” means to finance the US budget deficit]
41. We used to have a view that 1) there was a system (Bretton Woods) that evaporated thirty years ago into no system at all and 2) now a semi-system has emerged anew. But, in fact, the system has been the same throughout, just manifesting itself in different forms because the original emerging markets (Europe and Japan) developed and did not need the center’s intermediation any more. There was no one to replace these countries for two decades. But with the collapse of socialism came a new litter of emerging markets, and the background system that is the incubator of such economies has reanimated itself. [Comment: the “renewed Bretton Woods”, or “Bretton Woods II”]
42. So we can anticipate some issues that were familiar 50 years ago returning to center stage of the economics of international finance. Can the center survive with two reserve currencies? As the dollar replaced sterling as the preferred reserve currency, will the euro replace the dollar? How long can trade account countries insulate their domestic financial markets through capital controls? Does the system benefit and entrench the economic and geo-political power of the center country (i.e. the DeGaulle-Rueff view)? [Comment: we’ll quickly mention the DeGaulle-Rueff view]
____________
Document 2 [REQUIRED READING!]
AGAINST THE INTERNATIONAL RESERVE CURRENCY SYSTEM DURING THE BRETTON WOODS ERA. Jacques Rueff. Le péché monétaire de l’Occident. Paris: Plont, 1971
The process works this way. When the U.S. has an unfavorable balance with another country (let us take as an example France), it settles up in dollars. The Frenchmen who receive these dollars sell them to the central bank, the Banque de France, taking their own national money, francs, in exchange. The Banque de France, in effect, creates these francs against the dollars. But then it turns around and invests the dollars back into the U.S. Thus the very same dollars expand the credit system of France, while still underpinning the credit system in the U.S.
The country with a key currency is thus in the deceptively euphoric position of never having to pay off its international debts. The money it pays to foreign creditors comes right back home, like a boomerang … The functioning of the international monetary system is thus reduced to a childish game in which, after each round, the winners return their marbles to the losers … The discovery of that secret [namely, that no adjustment takes place] has a profound impact on the psychology of nations (la psychologie des peuples) … This is the marvelous secret of the deficit without tears, which somehow gives some people the (false) impression that they can give without taking, lend without borrowing, and purchase without paying. This situation is the result of a collective error of historic proportions.
For more details on Charles de Gaulle, Jacques Rueff and the “dollar battles” of the 1960, you can see [NOT required reading!]: Christopher S. Chivvis: “Jacques Rueff and French International Monetary Policy under Bretton Woods”, Journal of Contemporary History, Vol. 41, No. 4, October 2006, pp. 701-720; Francis J. Gavin. Gold, Dollars, & Power. The Politics of International Monetary Relations, 1958-1971 (The University of North Carolina Press, 2005); Agustin Mackinlay: Charles de Gaulle and the ‘Deconstruction of the Dollar’, unpublished thesis, University of Amsterdam, 2005.
________________
Document 3 [NOT REQUIRED READING!]
UNDERSTANDING THE ADJUSTMENT PROCESS
Understanding the Adjustment Process: the Gold Standard Regime
Step1. Trade surplus. A Dutch exporter sells porcelain crafts to English consumers. He gets paid with a £ Bank note issued by the Bank of England (BoE). But he needs either gold or Dutch guilders to pay his workers and other expenses. Thus, he goes to the Bank of Amsterdam and sells his £; he gets a Certificate of Deposit in return:
Dutch exporter Bank of Amsterdam
. less £ Bank Notes . more £ Bank Notes (assets)
. more CDs (assets) . more CDs (liability)
Step 2. Conversion into gold. The Bank of Amsterdam the goes to the Bank of England to get gold:
Bank of Amsterdam Bank of England
. less £ Bank Notes . less £ Bank Notes (liabilities)
. more Gold (assets) . less Gold (assets)
Step 3. The Adjustment process. The Bank of Amsterdam can make more loans; the Bank of England makes less loans. Interest rates decrease slightly in the Netherlands (more supply of loanable resources) and increase slightly in England (less supply of loanable resources). Wages, consumption and imports tend to rise in the Netherlands; wages, consumption and imports tend to decrease in England. Large deficits are thus quickly corrected through permanent inflows/outflows of gold.
Understanding the adjustment process: China & the USA: the international reserve currency
Step 1. China’s trade surplus. A Chinese exporter sell toys to US consumers. He gets paid in US$. But he needs Yuan to pay for his workers’ salaries and other expenses. He goes to his bank in Shanghai and sells his US$; he gets Yuan in return:
Chinese exporter Bank of Shanghai
. less US$s . less Yuan (assets)
. more Yuan . more US$s (assets)
The Bank of Shanghai then goes to the People’s of China (the Chinese central bank) to get Yuan:
Bank of Shanghai People’s Bank of China
. less US$s (assets) . more US$s (assets)
. more Yuan (assets) . more Yuan (liabilities)
Step 2. The critical move. Instead of selling their dollar, or converting them into gold, the People’s Bank of China buys U.S. Treasury securities from American banks in … New York City! The People’s Bank of China buys U.S. Treasury securities from JP Morgan in New York City:
People’s Bank of China JP Morgan
. less US$s notes (assets) . more US$s notes (assets)
. more U.S. Treasury bonds (assets) . less U.S. Treasury bonds (assets)
This is the key feature of a monetary system that depends on an international reserve currency. Surplus countries channel their foreign currency assets back into the credit market of the country that issues the international reserve currency. They do that for a variety of reasons. Unlike gold (which doesn’t pay interest), U.S. Treasury securities do pay interest; besides, there is a very large market for these securities, which means that the People’s Bank of China has at all time easy access to its funds (this feature of U.S. Treasury securities is sometimes called ‘liquidity’).
From an economic point of view, the key thing to remember is the following: the People’s Bank of China does not sell its dollars, nor does it convert them holdings into gold (as surplus countries used to do under the Gold Standard Regime). And because the People’s Bank of China invests those surplus dollars into U.S. credit markets, there is no adjustment through higher interest rates in America! The supply of loanable resources increases in the United States. Thus no adjustment takes place. Because the People’s Banks does not sell, the dollar does not fall in value, which means that wages are kept (artificially) low in China; and because interest rates in the US do not rise, income and wage levels are kept (artificially) high in America. Surpluses accumulate!
(If this was not enough, the People’s Bank may sell bonds to Chinese banks to tighten credit conditions back in China.)
(If this was not enough, the People’s Bank may sell bonds to Chinese banks to tighten credit conditions back in China.)
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Document 4 [NOT REQUIRED READING!]
ON THE GROWTH OF CHINA’S FOREIGN EXCHANGE RESERVES. The Financial Times quotes economist Brad Setser, who analyzes the growth of China’s dollar reserves (*):
The explosion in China’s foreign exchange reserves has been one of the more remarkable episodes in recent financial history. The official total is $1,950 billion, but Brad Setser, of the Council on Foreign Relations, a New York-based think tank, who tracks China’s foreign assets, puts the real figure at nearer $2,300 billion – equivalent to more than $1,600 for every Chinese citizen. From that total, Mr Setser calculates that about $1,700 billion is invested in dollar assets, making the Chinese government by far the largest creditor of the US. Last year, when its economy was under extreme stress, China lent to the US more than $400 billion – equivalent to more than 10 per cent of Chinese gross domestic product. “Day after day, China is the single biggest buyer of Treasury bonds in the market”, he wrote in a recent report. “Never before has the US relied so heavily on another country’s government for financing”.
(*) Geoff Dyer: “China’s dollar dilemma”, Financial Times, February 23, 2009.
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Document 5 [REQUIRED READING!]
THE CRISIS & THE INTERNATIONAL RESERVE CURRENCY. Brad Setser: “Bretton Woods 2 and the current crisis: any link?”, Council on Foreign Relations, December 1, 2008
ON THE GROWTH OF CHINA’S FOREIGN EXCHANGE RESERVES. The Financial Times quotes economist Brad Setser, who analyzes the growth of China’s dollar reserves (*):
The explosion in China’s foreign exchange reserves has been one of the more remarkable episodes in recent financial history. The official total is $1,950 billion, but Brad Setser, of the Council on Foreign Relations, a New York-based think tank, who tracks China’s foreign assets, puts the real figure at nearer $2,300 billion – equivalent to more than $1,600 for every Chinese citizen. From that total, Mr Setser calculates that about $1,700 billion is invested in dollar assets, making the Chinese government by far the largest creditor of the US. Last year, when its economy was under extreme stress, China lent to the US more than $400 billion – equivalent to more than 10 per cent of Chinese gross domestic product. “Day after day, China is the single biggest buyer of Treasury bonds in the market”, he wrote in a recent report. “Never before has the US relied so heavily on another country’s government for financing”.
(*) Geoff Dyer: “China’s dollar dilemma”, Financial Times, February 23, 2009.
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Document 5 [REQUIRED READING!]
THE CRISIS & THE INTERNATIONAL RESERVE CURRENCY. Brad Setser: “Bretton Woods 2 and the current crisis: any link?”, Council on Foreign Relations, December 1, 2008
The current financial crisis has produced its share of surprises even to those who doubted the long-term health of a housing-centric US economy. International economists – at least some of them – have long worried about the risk of a breakdown in what former Treasury Secretary Summers labeled the balance of financial terror and what others have called the “Bretton Woods 2” system of fixed exchange rates — a system where the rapid growth of central bank reserves in China and the oil-exporting economies financed large deficits in the US. They expected a crisis that marked by a fall in the dollar, a loosening of China’s peg to the dollar, a rise in the currencies of key emerging economies and higher interest rate on the US governments borrowing. The current crisis has not followed script: it has been defined by a rise in the dollar, a tightening of China’s peg, a sharp fall in emerging market currencies and fall in the US governments borrowing costs.
In a deep sense, the current crisis has been a crisis in an international financial system defined by the buildup of large surpluses among emerging market governments, a buildup that financed heavy borrowing by American and European households. Defenders of this system argued that it was win/win. China could develop on the back of its exports. They argued that the US and Europe benefited from low and stable interest rates – a constellation that justified heavy borrowing by households and high prices for a host of risky financial assets; unbalanced world need not be a risky world; China (and the Gulf) saved so that the US didn’t have to. Conversely, the US households spent so that China’s government didn’t have too – Menzie Chinn of the University of Wisconsin has accurately noted that the great puzzle of the past few years is why China preferred subsidizing US consumption to subsidizing Chinese consumption.
Crises have a way of clarifying the weak links in any financial arrangement. This crisis is no different. China didn’t actually finance US household borrowing directly. Rather China bought US Treasury bonds. But the inflow from China was still central to the process that allowed the extension of credit in an economy that itself wasn’t saving, and thus wasn’t generating new funds to lend. Think of it this way: when China bought a Treasury bond from an American insurance company or bank, if provided the pension fund or bank with funds to invest in riskier assets that offered a higher yield than Treasury bonds. Wall Street proved more than capable of churning out ever more complex kinds of mortgage backed securities – and securities composed of parts of other mortgage backed securities – to meet this demand.
The flow of credit that allowed American households to keep buying Chinese goods even as they were spending more on imported oil hinged on the willingness of China’s government to take currency risk – converting China’s domestic renminbi savings into demand for US government and agency bonds – and the willingness of Americans to trade their holdings of safe government bonds for riskier, and higher yielding, mortgage backed securities. That meant that American (and, as it turned out European) financial institutions took on ever increasing amounts of credit risk even as China allowed an ever rising share of its national savings to be denominated in dollars. Economists worried that the first leg of the trade might not be stable – China and others might not always be willing to buying depreciating dollars. It turned out though that the second leg of this trade was even more unstable – and even more risky. China’s Treasuries aren’t likely to hold their value in terms of China’s own currency – but China will get more back than those who bought CDOS composed out of subprime mortgages – or the holders of Lehman’s bonds.
The collapse of confidence in US and European financial intermediaries consequently has brought down a key pillar of a global system that allowed emerging markets to grow on the back of American and European demand for their products. American households cannot borrow against their homes – and thus cannot continue to consume more than they earn. In September 2008, US consumption fell sharply – and it would take a brave man to forecast a different outcome for October. China no longer can rely on US and European demand for its exports to drive its own economic development. Unusually strong global growth over the past few years may be offset by an unusually strong global slowdown. The entire global economy is now slowing sharply.
In the long-run, the challenge will be to find a more sustainable basis for global growth. The last few weeks have once again illustrated the difficulties emerging economies looking to finance fast growth by borrowing from the international banking system face. But the past few months have also highlighted the costs of a world where rapid reserve growth in the emerging world finances heavy borrowing by US and European households. US and European taxpayers have been hit with the bill created when their banks lent against inflated home values; Chinese taxpayers will eventually be hit with the bill for borrowing in a currency that is going up (the RMB) to buy currencies (the euro as well as the dollar) that are going down. No one is going to win. The policies of the past few years have not worked; it is time to try something new.
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Document 6 [NOT REQUIRED READING!]
A NOTE ON THE CHINESE CURRENCY. Paul Krugman: “What’s in a name?”, The New York Times, 23 October 2009
Renminbi is the name of China’s currency; but yuan is the denomination of bills, the unit in which prices are measured, etc.. The closest parallel I can think of is Britain’s currency, which is sterling, but whose unit is the pound. In the case of Britain, however, everyone is easy on talking about the pound’s value, the pound’s exchange rate, and so on; if you talk about sterling’s value, most non-Britons will have no idea what you’re talking about. But for whatever reason, using yuan in the same way draws disapproval. But here’s the thing: talking about the number of renminbi per dollar is also, as I understand it, wrong — as wrong as talking about the number of sterling per dollar. Renminbi is the currency, but not a unit of the currency.
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Document 7 [REQUIRED READING!]
DID THE INTERNATIONAL RESERVE CURRENCY SYSTEM CAUSE THE CRISIS? LEHRMAN & MUELLER SAY “YES”. (IT’S A “CURSE”!) Lewis E. Lehrman & John D. Mueller: “Go Forward to Gold. How to lift the reserve-currency curse”, National Review, 15 December 2008
In a deep sense, the current crisis has been a crisis in an international financial system defined by the buildup of large surpluses among emerging market governments, a buildup that financed heavy borrowing by American and European households. Defenders of this system argued that it was win/win. China could develop on the back of its exports. They argued that the US and Europe benefited from low and stable interest rates – a constellation that justified heavy borrowing by households and high prices for a host of risky financial assets; unbalanced world need not be a risky world; China (and the Gulf) saved so that the US didn’t have to. Conversely, the US households spent so that China’s government didn’t have too – Menzie Chinn of the University of Wisconsin has accurately noted that the great puzzle of the past few years is why China preferred subsidizing US consumption to subsidizing Chinese consumption.
Crises have a way of clarifying the weak links in any financial arrangement. This crisis is no different. China didn’t actually finance US household borrowing directly. Rather China bought US Treasury bonds. But the inflow from China was still central to the process that allowed the extension of credit in an economy that itself wasn’t saving, and thus wasn’t generating new funds to lend. Think of it this way: when China bought a Treasury bond from an American insurance company or bank, if provided the pension fund or bank with funds to invest in riskier assets that offered a higher yield than Treasury bonds. Wall Street proved more than capable of churning out ever more complex kinds of mortgage backed securities – and securities composed of parts of other mortgage backed securities – to meet this demand.
The flow of credit that allowed American households to keep buying Chinese goods even as they were spending more on imported oil hinged on the willingness of China’s government to take currency risk – converting China’s domestic renminbi savings into demand for US government and agency bonds – and the willingness of Americans to trade their holdings of safe government bonds for riskier, and higher yielding, mortgage backed securities. That meant that American (and, as it turned out European) financial institutions took on ever increasing amounts of credit risk even as China allowed an ever rising share of its national savings to be denominated in dollars. Economists worried that the first leg of the trade might not be stable – China and others might not always be willing to buying depreciating dollars. It turned out though that the second leg of this trade was even more unstable – and even more risky. China’s Treasuries aren’t likely to hold their value in terms of China’s own currency – but China will get more back than those who bought CDOS composed out of subprime mortgages – or the holders of Lehman’s bonds.
The collapse of confidence in US and European financial intermediaries consequently has brought down a key pillar of a global system that allowed emerging markets to grow on the back of American and European demand for their products. American households cannot borrow against their homes – and thus cannot continue to consume more than they earn. In September 2008, US consumption fell sharply – and it would take a brave man to forecast a different outcome for October. China no longer can rely on US and European demand for its exports to drive its own economic development. Unusually strong global growth over the past few years may be offset by an unusually strong global slowdown. The entire global economy is now slowing sharply.
In the long-run, the challenge will be to find a more sustainable basis for global growth. The last few weeks have once again illustrated the difficulties emerging economies looking to finance fast growth by borrowing from the international banking system face. But the past few months have also highlighted the costs of a world where rapid reserve growth in the emerging world finances heavy borrowing by US and European households. US and European taxpayers have been hit with the bill created when their banks lent against inflated home values; Chinese taxpayers will eventually be hit with the bill for borrowing in a currency that is going up (the RMB) to buy currencies (the euro as well as the dollar) that are going down. No one is going to win. The policies of the past few years have not worked; it is time to try something new.
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Document 6 [NOT REQUIRED READING!]
A NOTE ON THE CHINESE CURRENCY. Paul Krugman: “What’s in a name?”, The New York Times, 23 October 2009
Renminbi is the name of China’s currency; but yuan is the denomination of bills, the unit in which prices are measured, etc.. The closest parallel I can think of is Britain’s currency, which is sterling, but whose unit is the pound. In the case of Britain, however, everyone is easy on talking about the pound’s value, the pound’s exchange rate, and so on; if you talk about sterling’s value, most non-Britons will have no idea what you’re talking about. But for whatever reason, using yuan in the same way draws disapproval. But here’s the thing: talking about the number of renminbi per dollar is also, as I understand it, wrong — as wrong as talking about the number of sterling per dollar. Renminbi is the currency, but not a unit of the currency.
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Document 7 [REQUIRED READING!]
DID THE INTERNATIONAL RESERVE CURRENCY SYSTEM CAUSE THE CRISIS? LEHRMAN & MUELLER SAY “YES”. (IT’S A “CURSE”!) Lewis E. Lehrman & John D. Mueller: “Go Forward to Gold. How to lift the reserve-currency curse”, National Review, 15 December 2008
The most disturbing aspect of the current financial crisis is that no U.S. official has correctly identified its primary cause. Experts variously attribute the economic reverses to subprime lending, derivative trading, excessive leverage, and regulation that was either too lax or too strict (take your pick), but these are symptoms rather than causes. Ignored is the main culprit: the dollar’s role as the world’s main official reserve currency. Though he almost certainly doesn’t realize it yet, President-elect Barack Obama will either set the dollar’s reserve-currency status on the path to extinction or risk becoming the next victim of what we call “the reserve-currency curse.”
Official reserves are money held by governments and central banks for the settlement of international payments. A Spanish bank may not want to accept Indian rupees, and it might be inconvenient for Qatar Petroleum to accept Mexican pesos for a million barrels of oil. An official reserve currency is one everybody agrees to accept, and right now that currency is the dollar. But foreign-exchange reserves are commonly held in the form of government debts of the nation that issued the currency. In the case of the United States, that includes all those government bonds piling up in China and elsewhere. The problem is that, unlike gold, official dollar reserves increase the money supply in one country without decreasing it in another.
To understand how the dollar’s reserve-currency role helped cause the recent bubbles, and the ensuing crisis in the world financial system, we must apply the analysis of the great French economist and central banker Jacques Rueff, who was the first to explain the process. As a financial attaché in London in the early 1930s, Rueff witnessed the collapse of the post–World War I monetary system. He correctly diagnosed the stock-market boom of the 1920s, and the subsequent crash and price deflation, as the result of massive official accumulation — and subsequent liquidation — of foreign-exchange reserves. Foreign countries’ dollar reserves were certainly not the only factor involved, but before and during the Depression they were large enough to play a decisive role.
Many years later, in the 1960s, Rueff correctly predicted (and tried to prevent) the breakdown of the dollar-based Bretton Woods system. This 1944 agreement made the gold-convertible U.S. dollar the official reserve currency of the world monetary regime; it also fixed exchange rates within narrow limits. When the U.S. abandoned gold convertibility in 1971, thereby eliminating fixed exchange rates, the dollar’s reserve-currency role expanded sharply; without gold backing the system, it became a question of confidence, and the world had confidence in the dollar. Rueff died in 1978, but today’s international monetary system — based on the paper dollar, which is backed by nothing but faith in the American economy — has the same potentially fatal flaw that he pointed out in two earlier gold-exchange standards. As was true in the 1920s and the 1960s, the dollar’s reserve-currency role has led to the main pathologies that now plague the world economy: the speculative “hot money” flows that first inflated and then deflated stock, bond, and real-estate prices; the sharp rise and fall of commodity prices, especially of oil and other energy commodities; Congress’s apparently incorrigible fiscal irresponsibility; and the mushrooming U.S. deficit in international trade and payments.
The key difference between a reserve-currency system and the gold standard is that foreign-exchange reserves, in the form of government bonds, are not only assets of the national authority that holds them, as gold was; they are also (unlike gold) debts of the country that issues them. Thus, when foreign monetary authorities acquire U.S. debt securities as reserves, U.S. monetary authorities are, in effect, borrowing the same amount.
Congress has become increasingly addicted to reserve-currency finance by a kind of fiscal version of Parkinson’s Law: Public spending expands to absorb all available tax revenues. Working in tandem with this is Parkinson’s Debt Corollary: Public borrowing expands to absorb all available means of finance. In other words, the government will borrow as much as it can from whoever will lend to it. If tax revenues are Congress’s “allowance” (as Milton Friedman, envisioning Congress as a spendthrift teenager, once put it), then purchases of Treasury securities (by U.S. government trust funds and by the domestic and foreign banking systems) are its “credit cards.” But the congressional teenager’s spending won’t be constrained by a cut in allowance unless the indulgent parents also cut up the credit cards.
Consider the evidence. The federal government’s general operating deficit from 1980 through 2007 has averaged 4.2 percent of GDP. Federal investment in government-owned assets like office buildings and warships represented about 1.3 percent of GDP; this part of the deficit was almost exactly equaled by federal borrowing from non-bank private investors. Current federal consumption of goods and services, meanwhile, has accounted for the remaining 2.9 percent of GDP. About a third of this was funded (mostly) by foreign central banks, and two thirds by spending government trust-fund surpluses to fund the general operating budget — thus expanding the budget while masking the deficit. Relying on currency-reserve financing to expand government spending for current consumption is the wrong prescription.
Similar facts explain why U.S. international trade has swung from a chronic surplus in the early 1960s to a chronic and growing deficit ever since. Increased American consumption and reduced saving have caused an increasing U.S. current-account deficit, and therefore an equal surplus in countries that acquire dollar reserves.
These international imbalances consist almost entirely of goods and services purchased from foreign producers, ultimately paid for by federal deficit spending and financed largely by U.S. official borrowing from foreign monetary institutions.
The dollar’s reserve-currency status provides short-term political advantages to U.S. congressmen seeking reelection, but these are far outweighed by the perennial disruptions it has caused to the world and U.S. economy and to financial markets. There has also been a heavy political cost for presidents whose well-intentioned and sophisticated advisers have not, for two generations, grasped the perversities of the dollar-based world monetary system. This is why the Fed has been surprised repeatedly by large changes in U.S. prices, including housing-price deflation, stock-market selloffs, and commodity-price gyrations.
How can we end the reserve-currency curse? While acknowledging the complexity of the century-old problem, we must in this article simplify the necessary remedies. The essential requirement for restoring a stable international monetary system is that the major countries agree to replace all official foreign-exchange reserves with an independent monetary asset that is not ultimately some particular nation’s liability. Many standards are theoretically possible, but monetary authorities still hold nearly 900 million ounces of gold, and the simplest, most effective, and most tested solution is a modernized international gold standard.
This would require changes in U.S. law and an international monetary agreement. Ending the dollar’s reserve-currency “privilege,” and its inflationary financing of the federal budget, would make it not only necessary to limit budget deficits — which could no longer be financed by foreign central banks — but also for the first time politically and economically practicable to do so. The reform would halt the proliferation of debt resulting from the current currency system
Neither reforming the international monetary system nor balancing the federal budget could be done without serious national and international discussion. But the technical problems have been long studied and are relatively straightforward. The main action item for President Obama should be to put the reserve-currency addiction on the way to extinction before —not after— its congressional and foreign monetary co-dependents irreparably harm themselves and all the innocents they have heedlessly placed in harm’s way.
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Document 8 [REQUIRED READING!]
DID THE INTERNATIONAL RESERVE CURRENCY SYSTEM CAUSE THE CRISIS? DOOLEY SAYS “NO”. Michael Dooley: “Global imbalances and the crisis: A solution in search of a problem”, VOX, 21 March 2009
In our view, the crisis was caused by ineffective supervision and regulation of financial markets in the US and other industrial countries driven by ill-conceived policy choices. The important implication of the crisis itself is that for the next few years, at least, the misbehaviour that flourished in this environment will not be a problem, unless replicated under government pressure to restore the flow of credit to the uncreditworthy … One “lesson” that seems to be emerging is that international capital flows associated with current account imbalances were a cause of the crisis and therefore must be eliminated or at least greatly reduced. The idea that fraud and reckless lending flourished because US financial markets were unable to honestly and efficiently intermediate a net flow of foreign savings equal to about 5% of GDP, while having no problem with intermediating much larger flows of domestic savings, is astonishing to us …
The idea that an excessive compression of spreads and increased leverage were directly caused by low real interest rates seems to us entirely without foundation. The alternative hypothesis is that an effective deregulation of US markets driven by government-dictated social policy, especially in mortgage origination and packaging, allowed the ever-present incentive to exploit moral hazard to flourish ... Clearly we should enforce prudential regulations that discourage people from acting on such expectations. But do we really want to reform away anything that causes real interest rates to fall and asset prices to rise? … The problem was not financial innovation but the failure of regulators to recognise that innovation generated new ways to exploit moral hazard. Even more, it was the wilful ignorance of policymakers in often overriding the instincts of regulators and financial institutions in order to implement a desired flow of funds to uncreditworthy borrowers.
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Document 9 [NOT REQUIRED READING!]
TWO COMMENTS ON THE GOLD STANDARD REGIME.
(a) Martin Wolf on moral hazard under the gold standard regime: “Under the gold standard, the scale of bail-outs was constrained. In a fiat system, there is no limit, until the value of money collapses”. [Martin Wolf: “Why cautious reform of finance is the risky option”, Financial Times, April 28, 2010]
(b) Karl Polyani on liberalism & the gold standard: “The fount and matrix of the [modern economic and political] system was the self-regulating market. It was this innovation which gave rise to a specific civilization. The gold standard was merely an attempt to extend the domestic market system to the international field; the balance-of-power system was a superstructure erected upon and, partly, worked through the gold standard”. [Cited by Robert Gilpin: “The Nature of Political Economy”, p. 14]
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Document 10 [NOT REQUIRED READING!]
ON THE WASHINGTON AND BEINJING CONSENSUS
(a) Charles Gore: “The Rise and Fall of the Washington Consensus as a Paradigm for Developing Countries”, in C. Roe Goddard, Patrick Cronin & Kishore C. Dash (eds.) International Political Economy, 2nd edition. London: PalgraveMacmillan, 2003, pp. 317-340.
(b) Stefan Harper. The Beijing Consensus, How China’s Authoritarian Model will Dominate the Twenty-First Century. New York: Basic Books 2010, 312 pages. See the review by Gideon Rachman: “The dragon’s deals”, Financial Times, April 24-25 2010.
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