Fri, Nov 21, 2008 - Page 9 News List

John Maynard Keynes not to blame for current financial mess

The British economist proposed an ingenious system for persuading creditor nations to spend their surplus money in the economies of the debtor nations

By George Monbiot  /  THE GUARDIAN , LONDON

Poor old John Maynard Keynes. The world’s press has spent the past week blackening his name. Not intentionally — most of the dunderheads reporting the G20 summit that took place last weekend really do believe that he proposed and founded the IMF. It’s one of those stories that passes unchecked from one journalist to another.

The truth is more interesting.

At the UN’s Bretton Woods conference in 1944, Keynes put forward a much better idea. After it was thrown out, Geoffrey Crowther — the then editor of The Economist magazine — warned: “Lord Keynes was right ... the world will bitterly regret the fact that his arguments were rejected.”

But the world does not regret it, for almost everyone — The Economist included — has forgotten what he proposed.

One of the reasons for financial crises is the imbalance of trade between nations. Countries accumulate debt partly as a result of sustaining a trade deficit. They can easily become trapped in a vicious spiral — the bigger their debt, the harder it is to generate a trade surplus. International debt wrecks people’s development, trashes the environment and threatens the global system with periodic crises.

As Keynes recognized, there is not much the debtor nations can do. Only the countries that maintain a trade surplus have real agency, so it is they who must be obliged to change their policies. His solution was an ingenious system for persuading creditor nations to spend their surplus money in the economies of the debtor nations.

He proposed a global bank, which he called the International Clearing Union. The bank would issue its own currency — the bancor — which was exchangeable with national currencies at fixed rates of exchange. The bancor would become the unit of account between nations, which means it would be used to measure a country’s trade deficit or trade surplus.

Every country would have an overdraft facility in its bancor account at the International Clearing Union, equivalent to half the average value of its trade over a five-year period. To make the system work, the members of the union would need a powerful incentive to clear their bancor accounts by the end of the year — to end up with neither a trade deficit nor a trade surplus. But what would the incentive be?

Keynes proposed that any country racking up a large trade deficit (equating to more than half of its bancor overdraft allowance) would be charged interest on its account. It would also be obliged to reduce the value of its currency and to prevent the export of capital.

But — and this was the key to his system — he insisted that the nations with a trade surplus would be subject to similar pressures. Any country with a bancor credit balance that was more than half the size of its overdraft facility would be charged interest, at a rate of 10 percent. It would also be obliged to increase the value of its currency and to permit the export of capital. If, by the end of the year, its credit balance exceeded the total value of its permitted overdraft, the surplus would be confiscated. The nations with a surplus would have a powerful incentive to get rid of it. In doing so, they would automatically clear other nations’ deficits.

When Keynes began to explain his idea, in papers published in 1942 and 1943, it detonated in the minds of all who read it. The British economist Lionel Robbins reported that “it would be difficult to exaggerate the electrifying effect on thought throughout the whole relevant apparatus of government ... nothing so imaginative and so ambitious had ever been discussed.”

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