Enlightened Economics

Economics for an Enlightened Age

Posts Tagged ‘monetary system’

• A Global Central Bank and Currency?

Posted by Ron Robins on February 16, 2011

By Ron Robins. First published January 27, 2011, in his weekly economics and finance column at alrroya.com

There are many paths forward for the global monetary system, but the hitherto unthinkable is becoming debatable: a global central bank and currency. However, despite the recent financial distress and potential for further financial calamity, the creation of such a new institution or currency is far off. But would a global central bank with possibly its own currency help bring monetary solace, universal prosperity and humankind together? Or would such a bank and currency result in yet another calamitous monetary failure?

The 2008-2009 financial debacle showed just how unprepared the global financial system was to deal with a loss of faith in, and imploding of, the global banking system. To stave off a global financial meltdown, the central banks of the US, the EU, Japan and many others around the world advanced vast sums in loans and guarantees to banks and financial entities. And the US Federal Reserve (the Fed) in particular loaned out hundreds of billions of dollars to foreign-owned banks, in effect acting as a bank of last resort to the global banking system.

As big as the Fed is, it and other central banks, for many reasons, may not be able to address the demands of a future global financial maelstrom with possibly even larger calls for loans of last resort. For the Fed, this is due to 1) the declining relative importance of the US economy and the dollar in relation to the global economy, and 2) potential political interference in its activities.

The mounting problems and lessening importance of the US economy and its dollar globally are obviously why a new international currency regime is being considered. International Monetary Fund (IMF) data (published in The Economist magazine) shows that while the US now makes up about 24 per cent of global gross domestic product (GDP), its dollar accounts for 84 per cent of foreign exchange transactions. Furthermore, over 60 per cent of international central bank reserves and about 60 per cent of global bank deposits are denominated in US dollars.

The continuing use of the US dollar internationally is largely dependent on the performance of the US economy and its domestic fiscal and monetary policies. Domestically, the US government is growing massive unsustainable debts while the Fed is hugely expanding the creation of new money and the buying of US government bonds (its quantitative easing programs). These actions are likely to further devalue the US dollar globally. Thus, holders of US dollars and assets will increasingly be less interested in retaining them.

Rising to compete with the US dollar has principally been the euro. However, with its member countries’ debt problems, the attention is turning primarily to China’s yuan. It is probably no accident that on January 12 China made a significant step forward in yuan foreign exchange convertibility by allowing it to trade in the US. China has also recently made deals with Russia, Brazil and other countries to settle trade accounts in yuan.

Such gains in the international acceptance of the yuan make it likely to be included in the revised and re-invigorated Special Drawing Rights (SDR) issued by the IMF. The SDR is presently a type of currency used in a limited way among central banks and the IMF. However, its role could eventually be expanded and in the decades ahead might even form the basis of a global currency.

The SDR comprises a basket of currencies that include the US dollar, yen, euro and pound sterling. Besides including the yuan, a revised form of SDR might include additional currencies and even gold or other commodities as well. As gold has an inherent market value, proponents for its inclusion suggest it could help bring further stability to the SDR. Changes to the SDR are favoured by many countries such as Russia and France.

Hence, the IMF may well begin to act in the coming years as a quasi global central bank. However, Barry Eichengreen of the University of California in the US cautions—quoting the Economist magazine of November 4, 2010—that, “no global government… means no global central bank, which means no global currency. Full stop.” Economists like Mr Eichengreen have the weight of evidence on their side regarding the need for a global government before a true global central bank and currency could come about. One only needs to look at the European Central Bank’s problems to see how the lack of an overarching, integrated and authoritative governance structure greatly impeded its ability to deal with the recent crises.

Advocating against the concept of a global central bank and currency are some free market proponents such as Ron Paul, a US Republican and now chairman of the powerful US Congress’s Monetary Policy Sub-committee. He and many others believe currencies should be freely chosen and have intrinsic value, backed by commodities, most likely that of gold. They say without gold backing, any currency and central bank issuing such currency, is deemed to eventual failure due to the historical fact that governments inevitably print excessive amounts of money. This ‘printing’ thereby debases the currency’s value and essentially commits fraud against the holders of the affected currency.

It is possible that the world may proceed towards a global central bank and currency over time. In the near future, the IMF will probably revise, re-invigorate and expand its SDR program to assist in the transition from reserve dependence on the US dollar. But the dangers with the SDR are that it is still largely linked to the viability and variability of national economies and their domestic policies and currencies. Advocates of a completely free market approach such as that proposed by US Congressman Ron Paul might also hold sway. The idea of a global central bank and currency is still just an idea. But it is an idea arising out of the calamity of our present day reality. It deserves hot debate.

Copyright alrroya.com

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• Out of the Ashes. A Global Central Bank!

Posted by Ron Robins on March 12, 2008

Our financial overseers will create a world central bank in the next few years. Growing higher consciousness in the world will enable it to become a reality. This bank will have a mandate to monitor, regulate, and maintain global currency, credit, and debt issuance. It will ensure that growth of these activities roughly matches global economic output. It will come about as the chaos and inadequacies engendered in our present monetary system become evident to everyone and a world central bank seen as the best solution.

Individuals and groups in financial markets everywhere, lacking inner fulfillment, have demonstrated inordinate greed resulting in reckless financial games and gambling – are bringing the financial system to its knees.

Such mismanagement in the financial system, I believe, will require the new world central bank to disallow banks everywhere from continuing in unfettered debt creation and speculative excesses. In search of ever higher returns, banks created overly lax lending standards, highly leveraged loans, obscure financial entities bearing major financial risks unconsolidated in their financial statements, and generally ran down the quality of their assets and reserves to unsafe levels.

‘Shadow banking’ system larger than conventional banking
All the while an even bigger, massively leveraged, totally unregulated, thinly capitalized, ‘shadow-banking’ system was allowed to balloon by bank regulators. And it is now in the process of imploding! Bill Gross, managing director of PIMCO, the world’s largest bond fund, said this recently about the shadow banking system: “Our modern shadow banking system craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage, based in many cases on no reserve cushion whatsoever.”

Due to the enormous growth of irresponsible central bank and banking activities globally, plus the vast, mushrooming credit creation of the shadow banking system – the world’s money supply is expanding out-of-control.

Unprecedented money supply growth creates inflation as bad as 1970s
Globally we see that, “China [is] registering an 18% plus growth in money, India 22.4% a year growth, Singapore 14%, Britain up by 12.3%, Western Europe 11.5%, Australia 16%, Canada 13%, and Saudi Arabia 22%!” So says The Mogambo Guru, Richard Daughty. These are ‘broad money supply’ figures. John Williams of www.shadowstats.com shows the US broad measure of money supply, as of early February 2008, increasing at annual rate of 16.8%. (The US Federal Reserve stopped publishing this measure in March 2006 claiming it costs too much to produce. Many economists suspect that they just wanted to hide the ramping-up of the US money supply.)

Even Marketwatch’s chief economist, Irwin Kellner, is concerned about US money supply growth. He said recently, that, “The rate of growth for highly liquid funds which the St. Louis Fed calls MZM [i.e. physical money, checking and money market accounts, etc.]… soared by an annual rate of 22.7% between December 24, 2007 and February 18 of this year.” He adds, “… it has created a whole lot of inflation.”

The link between an expanding money supply and inflation is firmly established. As the Bank of England’s Governor, Mervyn King quoting a highly respected study, said, that “Over the 30 year horizon 1968-98, the correlation coefficient between the growth rates of both narrow and broad money, on the one hand, and inflation, on the other, was 0.99.” Thus in the words of Milton Friedman, the recently deceased Nobel Economics prize winner, “… inflation is always and everywhere a monetary phenomenon.”

In the US, consumer price inflation using the politically biased, understated, consumer price index (CPI-U) is in January 2008 up 4.3% from a year earlier. But using the CPI methodology as of 1980, it is almost hyperinflationary at close to 12%! Inflation in China is now running at 8.7%, while in the EU and the UK, though more moderate at 3.4% and 3.1% respectively, it is picking-up significantly and well above their respective central bank targets.

The foregoing suggests that the present global monetary and financial system is reaching a state of extraordinary instability. The danger is the possibility of rapidly growing, unstoppable inflation culminating in a hyperinflationary episode such as is now occurring in Zimbabwe. Or, a threat of a deflationary bust similar to the Great Depression.

Higher consciousness the only real answer
The only real answer to such economic threats is higher global consciousness. This, I am convinced, will gain traction. (See my post, The Missing Ingredient In Economics — Consciousness!). In future years, this higher consciousness will, amongst other things, first manifest itself by allowing our financial overseers to see the need for, and create, a world central bank.

In ages past central banks utilized gold to help create monetary order. A new world central bank might well find a role for gold again, but in an updated, modern form. I will write about this in another post.

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© Ron Robins, 2008.

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