Analysis
White (left) dominated the Bretton Woods conference, but Keynes's idea could be revisited in the wake of Trump's threats. (Supplied: IMF)
On Tuesday last week, Canadian Prime Minister Mark Carney effectively announced the death of the 80-year-old "rules-based world order".
At least that's how his speech to the World Economic Forum in Davos has been taken. Carney said that it was "fading" and was "not functioning as advertised".
In any case, it has become increasingly obvious since the inauguration of Donald Trump a year and five days ago that the new administration of the nation at the heart of that world order is no longer interested in playing that role.
And it was more or less confirmed when Trump spoke at Davos on Wednesday and said, among so many other things: "With all of the money we expend, with all of the blood, sweat and tears, I don't know that [NATO]'d be there for us. They're not there for us on Iceland, that I can tell you."
He meant Greenland.
So the world will now have to revisit the conference that set the system up, held at the Mount Washington Hotel in Bretton Woods, New Hampshire, in July 1944.
Mark Carney gave a passionate speech at the World Economic Forum in Davos, denouncing Trump's assault on the rules-based world order. (AP Photo: Markus Schreiber)
The US's 'exorbitant privilege'
The usual story about Bretton Woods is that it established the International Monetary Fund and a new post-war system of global currencies pegged to the US dollar as the world's reserve currency, fixed to gold at $US35 an ounce.
This was the foundation of the "rules-based world order" and led to the creation of the United Nations and the signing of the UN Charter a year later, which seems now to have been inevitable.
But that was just the proposal put up by the lead US delegate to Bretton Woods, Harry Dexter White, a US Treasury official who was later accused of espionage for Russia. He dominated the 1944 conference, and his plan prevailed.
There was another plan that didn't get up, put by JM (Lord) Keynes, an economist rather than a politician, which would not have had the US as the predominant global financial power and would have led to an entirely different rule-based world order.
Keynes's idea was known as "Bancor", named after the new currency that he proposed. It wouldn't be a unit of money that people could carry in their wallets or, these days, tap with their phones, but a "unit of account" that would be used for transactions between governments and central banks. Its value would be fixed to gold, but adjustable, and all other national currencies would be pegged to it.
In other words, he wanted something other than the US dollar as the world's reserve currency because he knew that it would bestow on the US an "exorbitant privilege", as the French finance minister, and later president, Valéry Giscard d'Estaing, said 20 years later.
The most interesting part of Keynes's idea was how it handled trade imbalances.
In the system that came out of the US-controlled plan put forward by White, the burden of adjustment falls on the debtor (the country buying more than it sells), which is forced to cut spending and endure a recession to balance its books.
Keynes argued that creditors (countries with large surpluses) were just as responsible for imbalances, so his plan included taxes on surpluses that meant countries with excessive Bancor credits would be charged interest (effectively a fine).
There would be a separate system of "use it or lose it" pressure designed to force wealthy nations to spend their surpluses on imports from debtor nations, stimulating global trade rather than letting capital sit idle.
When Richard Nixon ended the dollar's convertibility to gold in 1971 the Bretton Woods system ended, but the dollar became even more powerful. (Reuters/Nixon Library)
An overvalued currency
America's "exorbitant privilege" is that it gets to run endless trade and budget deficits because its currency will always be in demand for trade and foreign exchange balances in central banks.
In fact, to provide the world with dollars, the US had to run deficits, which allowed it to finance the Marshall Plan and the early Cold War military expansion, essentially by exporting pieces of paper.
When Richard Nixon ended the dollar's convertibility to gold in 1971 in what's called the "Nixon Shock", the Bretton Woods system ended but the dollar became even more powerful.
That's mainly because after the 1973 oil shock, the US struck a deal with Saudi Arabia that oil would be priced exclusively in dollars (petrodollars), which meant that every country had to keep large dollar reserves to buy energy.
When foreign nations earn dollars through trade, they don't just keep cash, they buy US Treasury bonds, which is why Japan is the largest owner of American government debt, along with China, the UK and Europe.
Lately they've been buying gold instead, which has led to an 80 per cent rise in the price of gold since Trump's inauguration and a fall in the US dollar.
It means trade surpluses are recycled back to the US government, effectively acting as a low-interest loan that allows the US to fund its budget deficits.
And that is directly responsible for America's economic and military supremacy that Trump is now exploiting.
It also turned into a nightmare, not only because the US government is now $US38 trillion ($55 trillion) in debt, and rising, but also because it produced Trump, who is now blowing up the system that made America rich and powerful.
That's because Bretton Woods resulted in decades of an overvalued currency, which in turn crushed its manufacturing industries, turning the mid-west into the rust belt and led to poverty, inequality and anger — enough anger to vote for a real estate huckster and reality TV star.
That is all now wearing thin, with Trump insulting and berating the allies that voted for Harry Dexter White's plan at the Mount Washington Hotel over Lord Keynes's plan, and pulling out of 66 global bodies, conventions and treaties, including the effort to prevent a climate disaster, and whining about not having Greenland.
The Trump administration needs to sell $US2.5 trillion in new debt every month to replace expiring bonds and fund new spending. (Reuters: Denis Balibouse)
The US is living on its credit card
The week before last, the US Treasury sold $US654 billion worth of government debt.
The auction didn't go well. The yield on US 10-year treasuries spiked to 4.3 per cent, up from below 4 per cent two months ago, even as the Federal Reserve cuts short-term rates.
The Trump administration needs to sell $US2.5 trillion in new debt every month to replace expiring bonds and fund new spending.
Basically, the US is living on its credit card and is very vulnerable to the bond markets — in fact, that is probably the only guardrail on his behaviour that's left, in the absence of either the US Congress or the Supreme Court.
Popularity doesn't seem to be a factor, since Trump evidently plans to rule beyond 2028, perhaps by sufficiently inflaming enough Americans that he can declare martial law, or invoke the Insurrection Act, which he has threatened, and cancel elections.
Meanwhile, some economists and finance ministers are revisiting Keynes's Bancor idea, arguing that a new supranational currency would remove America's financial hegemony, preventing any single country, including China, from dominating global trade and finance.
Also, when a country has a debt crisis, the burden of it falls entirely on that country, with the IMF usually imposing painful austerity. Keynes's plan was unique because it would have also penalised surplus countries that hoarded capital.
So there is a lot of interest in Keynes's "symmetrical adjustment" idea as a way to force wealthy, surplus-heavy nations to spend or invest back into the global economy, preventing the "liquidity traps" seen during the 2008 financial crisis.
And finally, many are sick of the US Federal Reserve calling the global monetary policy shots. When the Fed changes interest rates, it sends shock waves through everyone else, especially emerging markets, so they're very interested in a system that is decoupled from the domestic policy of a single nation.
'The New Development Bank'
There have already been a few attempts at doing something like what Keynes proposed.
The IMF has an existing reserve asset called the SDR (special drawing rights) and in 2009, the governor of the People's Bank of China, Zhou Xiaochuan, called for the SDR to be transformed into a "super-sovereign reserve currency" modelled on Keynes's Bancor to replace the US dollar.
That was opposed by the US and didn't get up, and China didn't have the clout then that it has now.
Instead, China is now working with the other BRICS nations (chiefly Brazil, Russia, India and South Africa) to develop something called "The New Development Bank" and exploring a shared unit of account for trade, which is an obvious attempt to create a mechanism that bypasses the US dollar.
Networks of central bank swap lines mimic the overdraft facility that Keynes proposed with what he called the International Clearing Union instead of the IMF, allowing countries to access liquidity without relying on dollars.
And finally, there's a push to use blockchains to create a transparent, algorithmic version of the Bancor — that is, a global stable coin backed by a basket of commodities or currencies that no single government can control.
Will any of these things turn into a genuine Keynes-style Bancor? Probably not without another meeting like Bretton Woods.
Perhaps it could be held in Canada somewhere and be chaired by Carney.
Alan Kohler is finance presenter and columnist on ABC News and he also writes for Intelligent Investor.
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