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FT Talks Of The Bancor

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Recently Financial Times had an article A Keynesian Solution to Global Imbalances (‼) by Daire Macfedden.

Martin Wolf at FT also discussed global imbalances in Why Global Imbalances Matter with the intro text:

They lie at the intersection of almost everything that matters in geoeconomics and geopolitics.

This is welcome, but you need to keep in mind that Bancor is not a complete solution.

In stock-flow consistent models, you can see that the most important things governing the world economy are fiscal policy and international trade. Hence, you get expressions such as

G+X θ+μ

as a first approximation of GDP, where the variables are, respectively: government expenditure, exports, the tax rate, and the propensity to import.

John Maynard Keynes:

  • was right about global imbalances (even if the terminology is more recent),
  • underestimated the importance of trade,
  • and therefore proposed Bancor—not exactly a complete solution.

The main problem is that we live in an economic order with free trade, and deficit countries are constrained from expanding demand because they face balance-of-payments problems, while surplus countries are constrained by an ideology that discourages demand expansion.

Even deficit countries can expand demand until they hit a binding constraint. But the problem is that politicians and the corporations that fund them are often dogmatically opposed to fiscal expansion. So there is a bias toward tight fiscal policy in both surplus and deficit countries.

So, in his plan for Bretton Woods, Keynes proposed Bancor, along with penalties on creditor nations, and also required them to take measures such as:

(a) Measures for the expansion of domestic credit and domestic demand.
(b) The appreciation of its local currency in terms of bancor, or, alternatively, the encouragement of an increase in money rates of earnings.
(c) The reduction of tariffs and other discouragements against imports.
(d) International development loans.

[The Collected Writings of John Maynard Keynes, Volume XXV: Shaping the Post-War World: The Clearing Union, Chapter 1, The Origins of the Clearing Union, 1940–1942]

Now, the Bancor rules work when Bancor balances move outside a certain range. However, Bancor balances are neither the current account balance nor a stock measure such as the net international investment position.

In fact, Bancor balances can be positive even while a country is running large current account deficits and accumulating a large negative net international investment position.

So while the discussion is moving in the right direction, it is important to realise that pundits may downplay the problem in the same way Keynes did, leaving us with a solution that is far less effective than directly targeting measures such as current account balances and the net international investment position.

Not Bancor, But An International Agreement

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While John Maynard Keynes understood that trade/current account deficits can become a problem, not just for a country with it but also for the whole world, he quite underplayed the role of international trade.

(You can read about the downplaying in Nicholas Kaldor’s essay Keynesian Economics After Fifty Years, in the book Keynes And The Modern World : Proceedings Of The Keynes Centenary Conference, King’s College, Cambridge, written in 1983)

To resolve imbalances, Keynes proposed Bancor, a word which is a combination of the words ‘bank’ and ‘or’, which means gold in French, according to a paper The Eurozone: Similarities To And Differences From Keynes’s Plan by Marc Lavoie.

From the paper:

… The plan is based on a fixed exchange rate system, each foreign currency being expressed as a fixed value of the bancor …

A comprehensive explanation can be found in Marc Lavoie’s paper, which I won’t delve into here. But the important point is that there is a supranational central bank—an International Clearing Bank/ICB—like the ECB, in which national central banks hold accounts and which clears international payments.

Now Keynes proposed various rules, based on settlement balances of national central banks at the ICB, to give a sort of responsibility to surplus countries, such as fines but also that they expand their economies, so that they import more and deficit countries able to take measures such as devaluation.

But there is a problem!

The problem is that surplus/deficit etc are defined from settlement balances of national central banks at the ICB, which are not current account deficits, or not necessarily any indication for other things such as the net international investment position!

Imagine a country such as China which has huge trade or current account surpluses and then the counterpart in the financial account of the balance of payments is the Chinese government accumulating US government bonds. The Chinese central bank’s account at the ICB hardly changes, and the balances show no indication that any surpluses are being built up, and no rules need to triggered.

So obviously Bancor cannot be the solution. The solution is diplomacy at the international level, mainly with current account deficit numbers, but other data in the balance of payments and international investment position too. With responsibilities for surplus countries.