A modern form of mercantilism is causing a massive global imbalance, which may end in ruin unless the world adopts measures proposed by Keynes in 1944, writes Andrew Warrilow.
IMAGINE a friendly poker game between, say, a tiger and a monkey.
These two guys love to get together for a social game with a little bit of money down to make it interesting. Both players start out with the same number of chips. Occasionally, the tiger’s aggressiveness will pay off but overall the trend is there. The monkey is the better of the two and the longer the animals play, the more chips end up in the monkey’s hands. The inevitable conclusion comes and the monkey has all the chips. So who has won? In actuality, nobody. Why? Because the tiger has no more chips and the monkey has no one to play with. No more social game. Everybody packs up and goes home.
The sad conclusion to the friendly poker game is analogous to a practice in international trade known as mercantilism. This is where one country, whether by accident or design, ends up exporting far more to its neighbours than it purchases from them and was recognised hundreds of years ago, in 16th century Europe.
Long ago, mercantilism was identified as a less than satisfactory outcome for all nations involved. For the importing nation, who may enjoy the consumption of such product otherwise not available, economic development is stunted and balance of payments issues may arise. On the other hand, the exporting nation amasses a pile of gold or other forms of foreign exchange which, not being spent to import product for consumption at home, will not be used for the benefit of its people. Mercantilism was ultimately viewed by the economists of the time as a self-defeating practice and the free trade theories of Smith and Ricardo were born as a counter to it.
Fast forward several hundred years, from 16th century Europe into the 21st century.
We now observe a world which has forgotten the lessons of that past era. The mantra of free trade is now not being invoked as a weapon against the unsatisfactory outcomes warned against by Smith and Ricardo, but rather used by corporations for profit. Arguments to liberalise trade were used to create an enormous money making machine, generating super normal profits for multinational corporations producing goods cheaply in developing countries, yet sold for high prices in the markets of developed countries. In fact, the downside of such a system does not look dissimilar to the outcomes predicted by Adam Smith and Ricardo. Exporting countries amass large reserves of foreign exchange – for example countries such as China, Germany and Japan which have trillions of dollars in foreign reserves – while countries such as the United States now run chronic trade deficits.
However, there are further flow-on effects of such a system than just the amassing of foreign reserves and its corresponding foreign debt. A major contributor to the global financial crisis of 2008 was the large amounts of capital re-exported from surplus countries (mainly China) back to the United States. Such capital, available cheaply on world financial markets, priced the cost of money – that is, interest rates – excessively low, resulting in over speculation and less than optimal investment decisions. Furthermore, it has been said that the worst move you can make in business is to drive your customer bankrupt. This is exactly what has happened to the Western world, which became the gullible consumer in the largest vendor finance purchasing scheme in the history of humanity.
Now the Western world has maxed out its credit card, it is up to the exporting nations of the world, such as China, Japan and Germany, to do their part in boosting world demand and growth. The problem here, however, is that these countries have been setup – since the end of World War II, in the case of Germany and Japan, and since early 1980 in the case of China – as exporting machines. A relatively far greater share of capital in these countries is allocated for investment than to finance increased consumption. Unless radical changes can be made, we cannot expect the exporting nations to rise to the occasion. As with the monkey and the tiger, the game is now at an end.
One economist who understood the potential of mercantilism to interfere with the benefits of free trade was John Maynard Keynes.
At the Bretton Woods Conference, held to lay the foundation for the economic order for the post-WWII world, Keynes argued for the opportunity to set up a trading system which would avoid the perils of mercantilism. His tool for doing so was the International Clearing Union. This mechanism was designed to encourage nations with trade surpluses to use those surpluses by purchasing imported product from deficit nations. The means Keynes suggested for doing this was by the creation of a unique currency which could be used only for the purpose of international trade. Surplus nations would be further encouraged to import from deficit countries by the use of interest charged on surplus money as a penalty for amassing surpluses. Exporting countries would be literally punished for not spending their surpluses.
Ironically Keynes was thwarted in his endeavour to establish such an innovative trading system by none other than the United States Government at the time. Post World War II, the United States was the world's largest exporter and the world's largest creditor nation. The U.S. Government of the time could therefore see no advantage and only disadvantage in the adoption of such a system.
We live in a world dealing with the consequences of the decision not to adopt the International Clearing Union. Low growth is now entrenched, with very little prospect of that situation changing in the foreseeable future. The current system of world trade has not only directly contributed to the development of a breakdown in demand across the developed world, but is also impeding the release of pent-up demand in the form of the trillions of dollars of reserves held by surplus nations.
Keynes’s idea of an International Clearing Union as a means of encouraging surplus nations to fully reciprocate in the trading exchange may very well be the best means by which the world can extricate itself from the situation of chronic low demand and get back on a high growth track.
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