The financial crisis, the 2008/09 recession, the banking scandals that have followed, and today’s limping recovery are all linked. The common factor is the absence of a real international monetary and banking order. Only when such an order is restored will companies and consumers feel confident to open their wallets again.
At the heart of this revamped order should be a new world currency, one that irrevocably ties money to the real economy. The current dollar-based model is broken and can’t be put together again. The trouble is, governments have yet to recognize this. That failure is the main source of our continuing problems.
After the demise of the Bretton Woods system in the early 1970s, governments built a monetary order round two pillars – central banks and financial regulators. Central banks were charged with ensuring low and stable inflation; regulators were instructed to reduce risks to financial instability (in some countries the central banks doubled up as regulators). This system helped the world economy through the big shocks and geopolitical shifts of the late 20th century – notably volatile energy prices, the collapse of the Soviet bloc, and the emergence of China, India, and other emerging markets. The fact that it proved adaptable and flexible was due in no small part to the “glue” provided by the global use of the US dollar. The euro took its place inside a dollar world.
However, around the turn of the millennium, this order began to fray. Confidence in the US dollar – and, crucially, in the monetary standard it provided – declined as a result of the huge build-up of US foreign indebtedness and growing fiscal problems. Just as important, the major players in the system – governments, banks, financial intermediaries – started to exploit the opportunities offered by the system for their short-term ends.
Governments of countries ranging from the US to Japan and the eurozone found it just too easy to borrow. Bankers were happy to oblige. Households joined in, vastly increasing leverage as property prices continued a seemingly never-ending ascent. Currency values were at the mercy of unpredictable capital flows and often artificially manipulated by governments to server their short-term ends. Western governments pointed the finger at China, but were equally blameworthy for excessive borrowing while regulators simply failed to realize how quickly innovation was leading to a lowering of standards.
Within a very short time, notably in 2005 and 2006, every link in the chain of credit designed originally to provide security for the ultimate lenders became loose. Intermediaries of all kinds fattened profits by lowering credit standards, neglecting due diligence, and buying and selling dodgy derivatives.
Success bred complacency and foolish risk-taking. Yet the resilience of the expansion during Alan Greenspan's tenure as chairman of the Federal Reserve (1987-2006) silenced critics. People who tried to raise concerns were ignored.
Since the crisis, governments and banks have tried to patch up the old model. They have pretended that more regulation would make the banks stable, and that more central bank liquidity could restore growth. These are dangerous delusions, as a growing number of central bankers privately admit.
We need to go back to basics. The dollar is unlikely to be able to provide that key benchmark for the world monetary system in the future. American politics has become too fractious to allow an early resolution of its fiscal problems. Quite apart from that, the world has become too multipolar and diverse to allow one national currency to provide the common currency platform of the future. Nor is providing the world’s main reserve and trading currency any longer unambiguously in the US national interest.
A financial system can only work properly in the context of a strong monetary order. That must go far beyond the usual calls for “enhanced international cooperation” or “coordinated regulation”. It must replicate the classical gold standard in its insistence that governments as well as private agents should obey common rules. For a global economy, those rules also have to be global.
We must also end forever the damaging divorce between money and the real world of jobs that has been the defining feature of the crisis. In my new book, “The Money Trap,” I propose that the global monetary unit – which I call the ikon - be expressed as a fraction of the global portfolio of all productive assets. The closest proxy for this is a diversified basket of global common stock (equity shares). Banks would compete with each other to produce money defined to these standards.
The dollar and other national currencies would continue to circulate, but they would be linked by a silken thread, as they would have a common reference or benchmark. Gradually, this would become the new ‘gold standard’ – the modern, respectable, monetary standard for the 21st century.
If money were linked to global productive capacity, the real value of money would gradually rise. Everybody holding money would, over time, become wealthier. Critics say that a currency defined in this way would be unstable. But the market would provide solutions to that – a means of insuring against such fluctuations in purchasing power. As the underlying value of the unit can be expected to increase in the longer term, market institutions would be able to afford to provide people with deposits guaranteed to be stable against a particular index of purchasing power – if that was what they wanted.
This should be a voluntary standard. But I believe that over the years, it would gradually acquire acceptance, as the most modern currency not only for the US and Europe but for the world as a whole. Then it would indeed become a worthy replacement to the gold standard.
Critics say that adherence to such a standard would involve loss of monetary autonomy. There are two answers to that. Much of the autonomy that countries like the United States and United Kingdom have at present is illusory – often providing an excuse for failing to address real structural and budgetary issues. Tricking the public by such monetary maneuvers was part of the bad old system that landed us all into trouble. Secondly, adherence to a common standard would provide incentives for us all to tackle the real problems and enjoy the real opportunities opened up by the new world economy.
When consumers and businesses – in the US and around the world – gain confidence that governments have correctly diagnosed the problems and are putting in place an adequate response, they will be willing to seize those opportunities and put the world’s economies on a sustainable path of growth.
– Robert Pringle is author of “The Money Trap: Escaping the Grip of Global Finance” and chairman of Central Banking Publications, a financial publisher in London.