"The Dollar Will Be Devalued By a Large Margin" - The Economic Times of India

"We must...have a genuine international currency as the international reserve currency... As a one-time measure, the dollar will be devalued by a large margin..."

Asia seems to be growing increasingly impatient with Ben Bernanke and His Merry Banksters.

The Economic Times
Be Bold Enough to Fight the System from Within
By Ramgopal Agarwala
14 Nov, 2008, 0126 hrs IST

The ongoing global financial tsunami that originated in the US poses a serious threat to the stability of world economy. Already the financial crisis has spread from the US to Europe, Japan and major emerging economies.

The loss of wealth due to decline in share prices alone is in scores of trillions of dollars. Similar trillions are being lost in wealth in real estate. The crisis has spread from the Wall Street to the Main Street with a serious recession in the US which is sure to have a contagion effect across the globe.

Even worse is the scenario of the future of the US dollar. The US is pumping more and more dollars into the world economy, seriously aggravating the burden of its external debt, which is already over $20 trillion. If the confidence in the US dollar is shaken and the dollar goes into a free fall, we may well have what has been called ‘mother of all monetary crises.’

Faced with appreciation of their currencies in relation to dollar and fall in exports, major economies may well embark on competitive devaluations and protectionism, leading to a downward cobweb of production and employment in the world. The Great Depression of the 1930s may well repeat. We must not let that happen. We must make dispassionate analysis of the causes of the crisis and devise corrective measures however bitter they may seem.

While analysing the current US financial crisis, it has become conventional wisdom to blame the ‘greed’ of financial players on the Wall Street. But what else do we expect from the financial players? Profit maximisation is their job, their religion, if you like. It is the job of the regulators to make them work within the rules, which prevent greed turning into macro-economic imprudence. The real failure of the US system lies in its lax regulations that originated from a failed doctrine of self-regulating markets.

Along with the lax regulations, the spending spree in the US was fully supported, nay, encouraged by the authorities in order to prevent recession in the economy, in the wake of dotcom crisis and 9/11. Federal funds rate was brought down from 6.24% in 2000 to 1.35% in 2004 and remained below the 2000 level in 2007. Federal budget balance was changed from a surplus of $236 billion in 2000 to a deficit of $413 billion in 2004 and these may exceed $1 trillion in 2008/9.

In a normal economy, such domestic excesses will be prevented by the need to balance the external account. Unfortunately, the world has been on a US dollar reserve system, and there was no international regulatory mechanism to enforce discipline on the US spending. The world was flooded in the red ink flowing from international deficit financing by the US. Between 2000 and the third quarter of 2007, the US ran a current account deficit of $4.6 trillion!

But now the world must act. There could be a three-pronged strategy.

First, the countries holding US dollars must come forward to recapitalise the financial system of the US (in the US and abroad) by buying up equities of the US companies at the current low—and attractive—prices. In other words, rescue of the US financial system will have to come from the use of dollars in the system that created the problem in the first place rather than pumping more dollars into the system. What the sage of Omaha, Warren Buffet, is doing in billions needs to be done in trillions. Like Buffet, the lenders have to drive a hard bargain and these investments could be prudent over the long term as Warren Buffet’s probably are.

Second, we must go back to the wisdom of Keynes and have a genuine international currency as the international reserve currency. An internationally accepted bancor (as Keynes called it) should be created and exchanged for unwanted dollars. This programme will have a provision for systematic redemption of US dollars over time along with structural adjustment in the US economy. (Who will manage the rate of increase in the world currency, the 'bancor?' - Jesse)

As a one-time measure, the dollar will be devalued by a large margin to help US reduce its net imports and relative stability in real exchange rates will be maintained among major currencies through a system of managed floats. Speculative movements of short-term flows will be discouraged through regulations and taxes. In general, we may have to revive some features of exchange rate management in Bretton Woods agreement.

Third, a coordinated effort will be made to create alternative sources of demand in the world economy as the US net imports decline inevitably. Net additions of bancors needed (which could be more than a hundred billion dollar equivalent) could be used to fund global public goods.

The upcoming G20 summit in Washington DC could be a venue for considering these matters. Unfortunately, as indicated by the White House press release, the US seems to be putting the summit in the framework only of “reform of the regulatory and institutional regimes for the world’s financial sectors” and “strengthen(ing) the underpinnings of capitalism” by discussing how the summit leaders can “enhance their commitment to open competitive economies, as well as trade and investment liberalisation”!

Given the US veto power in Bretton Woods institutions, it can prevent the much-needed restructuring of global financial infrastructure. In that case, Asia should proceed with its own ‘Bretton Woods’ conference to set up a regional financial architecture that will pool its excess foreign exchange reserves in a regional sovereign wealth fund, create its own Asian currency unit as a parallel currency and use the seigniorage provided by the regional currency to fund the urgently needed physical and social infrastructure as well as measures to fight climate change.

This is an ambitious programme, but with a global economic calamity looming large, nothing less will do.

The author is with RIS, Delhi