The United Nations Non-Governmental Liaison Service (UN-NGLS) is an inter-agency programme of the United Nations mandated to promote and develop constructive relations between the United Nations and civil society organizations.
One of the most innovative ideas to reform the global monetary and financial architecture discussed during the International Follow-up Conference on Financing for Development in Doha was a new multilateral regime to stave off currency speculation and provide the policy space for all countries to pursue expansionary fiscal and monetary policies to protect jobs and their domestic economy (counter-cyclical measures) in the face of a recession or financial crisis. This is one of the key proposals that a Task Force set up by the United Nations Conference on Trade and Development (UNCTAD) will present in mid-February 2009.
This proposal was discussed at a number of side events at Doha and was the subject of an interview by NGLS with UNCTAD Chief Macroeconomist Heiner Flassbeck (see below). The issue was clearly framed at an event organized by UNCTAD and the Dutch Government on 30 November on “Financial crises, global imbalances and national policy space.” At the meeting, a senior representative of the International Monetary Fund (IMF) insisted that not all countries were in a position to pursue counter-cyclical measures by running large budget deficits. There was no “one-size-fits-all” in responding to the global financial and economic crisis. Some countries (such as the United States and China) had the lee-way to do so, but others could not afford such measures without being fiscally irresponsible and eventually making matters worse for their economy. For them, “fiscal retrenchment” was inevitable.
Overcoming a fundamental asymmetry in the global economy
At the meeting, Mr. Flassbeck said it was essential to examine this problem from a broader perspective - namely that under the current system, some countries were not allowed to “print unlimited amounts of money” or run large budget deficits without causing their currency to “fall down a very deep hole.” This represented a fundamental asymmetry in the global economy that was in no one’s interest. In effect, countries who are the victims of currency speculation, or “carry-trade” (portfolio investments based on borrowing in low-yielding currencies and investing in high-yielding ones) are forced to take “pro-cyclical” measures (such as interest rate hikes or public budget cuts or freezes) that aggravate the crisis in the real economy in order to reassure international currency speculators. This perverse phenomenon underlined the importance of UNCTAD’s proposal to develop a multilateral framework for an automatic stabilization of real exchange rates that would defeat the purpose of any speculative attack on a currency. This would enable all countries to regain the policy space needed to act in the interest of the real economy and avoid “beggar-thy-neighbour” policies or “devaluation wars” reminiscent of the 1930s.
While this proposal deals with the realm of finance - instituting new rules to manage exchange rates - it is intimately related to a primary factor affecting trade relations. At another side event organized by the Center of Concern on linkage between trade and finance to promote development on 29 November, Mr. Flassbeck said that: “To believe that any breakthrough in the Doha Round of trade negotiations can play a significant role in dealing with the crisis is to live in a world of fiction.” The enormous gyrations in exchange rate volatility due to the crisis and years of currency speculation, he said, are having a much more profound effect on trade flows than any tariff cuts that would result from conclusion of the Doha Round. “Yet no one is seriously addressing the need for an effective multilateral approach to orderly exchange rate management.”
How would the system work?
The technical modalities of the proposal will be detailed in the report of the UNCTAD Task Force on Systemic Issues and Economic Cooperation to be released in February 2009. In a nutshell, the system would work as follows: when a country faces a devaluation attack, the monetary authorities of the revaluing currency would automatically stave off the attack by a symmetrical intervention to stop the “undershooting” with its own currency, which is available in unlimited amounts: it can be printed. Nominal exchange rate changes would be readjusted periodically by governments, not markets - which contrary to neo-classical theory have empirically been proven not to be able to get “the price right.” These adjustments would be based on the objective criterion of changes in Purchasing Power Parity, or “inflation differentials.” Unlike the Post-World War II Bretton Woods system of fixed exchange rates (which was based on the US dollar and collapsed in 1970s), the value of each currency would be anchored to a new artificial global currency based on a basket of currency values, like the European “ECU” was used in Europe prior to Monetary Union.
Such a global reserve currency was part of the original proposals of John Maynard Keynes at the 1944 United Nations Bretton Woods Conference (which he had termed the “bancor”), but it was resisted by the United States at the time. Instead, the IMF constitution enables it to issue an artificial liquidity called “Special Drawing Rights” (SDRs), but its emission has been blocked by the United States’ de facto veto at the IMF and suffers from a number of limitations compared to Keynes’ original proposal, including the IMF’s governance structure. Nobel Prize laureate Joseph Stiglitz, who also chairs the Commission of Experts of the President of the United Nations General Assembly on Reforms of the International Monetary and Financial System, has repeatedly emphasized that the need for a new global reserve system which would be more stable than the US dollar has become more dire today: it is an idea “whose time may have finally come.”
Another essential dimension for the UNCTAD exchange rate proposal to work is an international agreement (or at least commitment) to avoid “wage dumping,” ensuring that wages increase in line with productivity growth in all countries (see interview below).
Political feasibility: regional initiatives
In terms of political feasibility, regional initiatives in this regard could serve as building blocks for developing a full blown multilateral framework. At Doha, this was echoed in the proposal for a “new regional financial architecture” promoted by then Ecuadorian Minister of Economic Coordination, Pedro Páez (also a member of the above-mentioned “Stiglitz Commission”). This would imply intensified regional monetary cooperation towards regional exchange rate mechanisms involving the pooling of reserves and their convertibility into a new regional currency. Minister Páez noted converging efforts towards these objectives among countries in his region, but urged for an “international diplomatic campaign” to promote this approach in all regions. In a similar vein, the Coordinator of Third World Network’s research project on financial policies in Asia, Yilmaz Akyüz (former UNCTAD Chief Macroeconomist) has emphasized the dangers of divergent movements in exchange rates within Asia, which could lead to destructive “beggar-thy-neighbour” policies, and calls for intra-regional consultations in exchange rate policies and more durable regional currency arrangements, building on the post-1997-98 crisis Chiang Mai Initiative.
In advance of the release of the report of UNCTAD’s Task Force on Systemic Issues and Economic Cooperation in February 2009, NGLS interviewed Task Force Chair Heiner Flassbeck on UNCTAD’s proposal to stem currency speculation. The two other issues that the Task Force is addressing are commodity speculation and financial regulation.
NGLS: In Doha, you took issue with the representative of the IMF on her assessment as to why some countries like the United States are in a position to take counter-cyclical measures to fight the recession, while others are pressured to take measures that risk deepening the recession. Why is that?
Mr. Flassbeck: What this amounts to is a fundamental asymmetry in the global economy that urgently has to be redressed. Many countries such as Brazil, Hungary, Iceland, Romania and Turkey (whose private sector is heavily indebted in foreign currency) have been the victims of what is called “carry trade.” It works like this: short-term foreign speculators borrow money in a country with low interest rates and invest it in countries with higher interest rates, this drives up the domestic currency in the high yield country and increases the profit of the speculator. Sooner or later the whole thing collapses as the receiving country has lost competitiveness and market shares. Eventually, the currency comes under pressure to depreciate. Since countries have only limited [foreign currency] reserves to fight the devaluation - and speculators know that the reserves will be depleted at some point or another - national authorities must do the most absurd thing: they must take pro-cyclical measures - meant to recreate international investor confidence, even if this is in fact a fiction - while making things worse in the real economy. These are the policy conditions attached to IMF loans today. They are of the same type as the ones applied during the crises in East Asia and Latin America in the 1990s. This is extremely worrying given the depth and breadth of the current crisis and the potential for a big global depression. This asymmetry is in nobody’s interest, yet it is happening because we do not have a multilateral currency system where countries with an appreciating currency would help those with a devaluing currency to stop the devaluation once a reasonable level of the exchange rate has been reached.
So your system is basically to set up a new set of rules to provide policy space for counter-cyclical measures, which in effect is taken away by the absence of rules in this area?
Yes, first to take out currency speculation. Exchange rates would be adjusted at regular intervals - whether three months, six months, or a year - according to the inflation differentials. If you do that, most of the incentive for currency speculation is gone. What traditional [neoclassical] economic theory has postulated is that currency markets would bring about exchange rate alignments with what is called “purchasing power parity” (the inflation differential). But all the evidence suggests that this is not happening: the market doesn’t get it right, the market even goes into the opposite direction, so this has to be enforced by governments. And if you have such a system in place, you have solved the asymmetry problem, which means that much of the IMF conditionality is automatically out.
Would there be some kind of automaticity to the currency adjustments to avoid politicization of the system?
Yes, it should not be discretionary as under Bretton Woods or under the European EMS [European Monetary System]. There should be an automatic rule adjusting the currency to inflation differentials. That is the simplest way to avoid the worst misallocations and distortions to international trade. The system would stabilize the competitiveness of all countries but not the competitiveness of companies. In this way, for the first time since the end of Bretton Woods [system of fixed exchange rates which collapsed in the 1970s], we would have reasonable trade rules - a level playing field for trade - and would not see the kind of beggar-thy-neighbour policies through currency and wage dumping and the distortions of trade through currency speculation. All this would no longer be possible.
So, in fact, what you are saying is that the new multilateral exchange rate system is in a way more important to stabilizing and improving trade flows than the trade agenda that is being negotiated at the WTO in terms of tariff reductions?
Much more important. Without discounting WTO talks, most international negotiations are dealing with a tiny aspect of the determinants of international trade. In comparison to the sharp gyrations in real exchange rate values and the impact these have on trade flows the “official” determinants are dwarfs. But nobody really asks that question in the context of current trade negotiations.
In addition to bringing stability to trade and private investment, would your system also give more space for broader development objectives, such as investing in green jobs and green infrastructure along the lines that President-elect Barack Obama proposed for recovery in the US context?
Yes, you can do whatever your people agree to pay for over time. There is no external constraint to do what is needed. There is no more threat from international investors (speculators) that would prevent you from doing reasonable things with your fiscal policy. In any case, there is much more room for manoeuvre than people think. The main threat you have to remove is the threat of a collapse of your currency stemming from a judgement of international speculators.
In other words, removing what many civil society and social movements have called the “dictatorship of financial markets”?
Yes, to a very large extent it would be gone.
To move this proposal forward politically, would it make sense to have a bottom-up approach, starting with regional monetary agreements of the type proposed by the Ecuadorian Minister of Economic Coordination, Pedro Páez, in Doha?
Yes, probably, because a global system is not very realistic at the moment. The first choice would clearly be a global system, but this is unlikely to happen straight away, so the first step would be regional systems like the one the Europeans developed.
But it would not necessarily imply a single currency?
No, what it would imply is not a single currency, not at all. What you need is a kind of anchor: Europe had an artificial currency called the ECU, which was the currency that everybody, so to say, anchored on. You need something like that for technical reasons - some kind of “numéraire” to which you adjust your currency given the inflation differential. The mechanics are difficult if you have a group of six currencies and one country has to change vis-à-vis all of them. So it is much easier to create an artificial currency and all are changing vis-à-vis the artificial currency, which would be a basket of the six currencies.
Could it be compared to a regional SDR?
Yes, but the SDR never played that role, but it would be like an SDR
What would you say to people who might worry about the loss of sovereignty in terms of the ability to pursue a competitive real exchange rate policy [through active intervention on capital markets to maintain a competitive domestic economy], which for example helped Argentina recover effectively from its 2001-02 crisis, in spite of persistent opposition from the IMF?
I think, given the circumstances and the overvaluation before its 2001 crisis hit, the Argentinean policy was right. But undervaluation is not a solution for the world, and it may even not be viable over time for Argentina itself. As long as we trade with one another there is no complete sovereignty in monetary affairs. As long as there is a rather open trading system capital movements are unavoidable, hence there is no full autonomy, it’s impossible. Once they have been in trouble, countries like Argentina can liberate themselves for a time because they need a dramatically undervalued currency. But this cannot be done by all countries in the world - if some are undervalued, others have to be overvalued. And these disequilibria are unsustainable.
At the side event in Doha co-organized by NGLS, ILO and Realizing Rights on the impact of the crisis on jobs, you mentioned your concern with “wage dumping.” How does your proposal relate to the UN’s full employment and decent work agenda?
This is an important reminder. Our proposed system either has to be based on unit labour costs directly or we have to make sure that real wages rise in line with productivity in all countries of the world. That is one of the preconditions for the system to work. Otherwise you get the kind of wage dumping we see practiced by Germany inside the Euro area, and this is disastrous. Such dumping has to be strictly avoided.
Would this be a sort of “social clause”?
Well not in the way it is usually understood in the context of trade negotiations. It would be, so to say, a “natural social clause” which is that all countries should give their people [workers] their share of productivity growth. Their wage share should remain at least constant. In reality wage shares have been falling and capital shares have been rising for decades now - and that is a problem not only for internal economic success but also for external trade because it may create undervaluation. In the system we are proposing, people should get at least their share of productivity increases and not less than that.
In many policy circles, there is an almost taken-for-granted trade-off between full employment and higher wages...
Yes and this is plain nonsense. In the labour market as a whole supply and demand are not independent like in the market for potatoes. This part of neoclassical theory is absolutely wrong. We had a wonderful neoclassical experiment in Germany in the last decade and the result is: Beggar-thy-neighbour but a disaster in terms of domestic demand. There is no evidence and not even plausible theoretical reasoning that if you cut wages for the overall economy it will improve employment at the same time so that domestic demand would be stabilized. The evidence shows the opposite: reasonable wage increases help to improve the employment situation. Wage cuts are not part of any economic success story, and reasonable wage growth is necessary for international reasons. So there are two good reasons for going in that direction without delay.
Does this mean ensuring the right to collective bargaining and unionization, or also something more?
Reinstating unionization rights in every company in a country such as the United States, like Mr. Obama promised, would go a long way to help to improve more equitable income distribution. But as you say this may not be enough. You have countries where full-fledged labour rights are not sufficient to lead to wages rising in line with productivity; Germany is the most important example again. And it happened there because of political pressure on unions to help to improve the international competitiveness of the country. This is not justified.
So if the national government must take additional measures to move in that direction, how would appropriate average wage increases be measured?
If the inflation target is 2% and the productivity increase for the economy as a whole is 4%, than the average nominal wage should increase by 6% - that means 4% in real terms.
Contact: Heiner Flassbeck, Director, Division on Globalization and Development Strategies, UNCTAD, Palais des Nations, 1211 Geneva 10, Switzerland, telephone +41-22/917 6048, fax +41-22/917 0389, e-mail