Introduction
- The problem of currencies’ duplication
- Exchange rate fluctuations
- The mystery of the missing surplus
- External debt servicing
- Sovereign debt crisis
- The need for a reform of the international system of payments
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Introduction
Within any given country there is monetary homogeneity. The monetary units issued by banks pertaining to the same banking system are undifferentiated elements of the same set: national currency. Homogeneity, however, is not an intrinsic characteristic of banks’ money but the result of a process leading to the creation of a unique banking system. It is through inter-banking clearing that the monetary units issued by each single bank are made homogeneous. Each commercial or private bank is a different institution whose spontaneous acknowledgement of debt would remain heterogeneous with respect to that issued by any other private bank was it not for the system of clearing operated by the central bank. Through what Schmitt likens to a catalytic process, the different bank monies are given a common form (central money) and become part of a unique national currency. Things are radically different at the international level. Each national currency is obviously distinct from any other, and their heterogeneity is not dealt with by any system of international clearing.
The ‘space’ between country A and the rest of the world (R) has to be covered by a vehicular money capable of conveying to R’s residents the payment of A’s residents and vice versa. Banks in A and R can take charge of the payments made by their residents, but only within the national boundaries of A and R. In order for a payment to be carried over from a country to another, it is necessary to create a structure providing a monetary link between national currencies. Logically and factually, the validity of money A is limited to A’s banking system. Once it abandons its country of origin, a currency’s nature changes and this is why it has to be replaced by an international money whose unique task is to cover the ‘space’ between nations. It is true, of course, that today international payments are carried out by private or public banks without recourse to the intermediation of an international central bank and of an international vehicular money. However, appearances mask a serious disorder that severely hampers especially the world’s developing economies and that, if nothing is done to reform the present situation, will eventually lead to a systemic breakdown, which would be catastrophic.
The problem of international payments is to create a system of international monetary flows connecting national flows. If money were a commodity, payments could be easily traced down, and the flow of money would indicate nothing else than the physical transport of commodity money. Monetary economics would amount to the formal description of these real flows and the whole economic system would have to be worked out only in real terms, along the principles already proposed by neoclassical microeconomics. It is also beyond dispute, however, that modern bank money is no commodity. Being immaterial, money cannot circulate, like commodities, in the traditional sense. A mere acknowledgement of debt whose object is a payment (a flow), money cannot be conceived of as an object or an asset moving from one place to another. The ‘flow of money’ is therefore an instantaneous ‘movement’ to and from the issuing bank. What economists have to investigate is what happens when international payments are carried out by means of the instantaneous (circular) flow of a national currency and compare the results with those that would have obtained if this flow were replaced by that of an international money covering the ‘space’ between countries.
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- The problem of currencies’ duplication
Usually defined as bank deposits denominated in a currency of a given country but held abroad, eurocurrencies are deemed to be the consequence of tax and bank regulations. Thus, we are told that, because of official restrictions introduced by the US government, US banks were selling the dollar deposits of their clients and purchasing, on behalf of these same clients, deposits in dollars formed in their European branches. However, bank deposits are not multiplied by the transfer of claims between US banks and their European branches. The formation of eurodollars requires dollar-denominated credits to be created outside the United States, and this can result neither from an exchange of claims, nor from the lending of claims on dollar-denominated deposits. As macroeconomic analysis shows, eurocurrencies are not a financial innovation suiting economic agents’ desire to diversify their portfolios, but rather the result of a macroeconomic pathology affecting today’s system of international payments. The French economist Rueff was the first to observe that it is through the payment of US net trade deficit that eurodollars are formed. The dollars transferred by the United States in exchange for their net commercial imports are in fact immediately invested in US bank deposits or Treasury bonds, which means that, even though they are entered on the assets side of the creditor country’s banking system, the dollars flow immediately back to the American banking system. Simultaneously deposited with US banks and with the creditor country’s banks, the dollars spent for the payment of US net imports are thus duplicated and enter the international financial market as eurodollars.
Duplication is essentially due to the fact that key currencies are conceived of as the final term of a real exchange between money and imported goods. Hence, the duplication of dollars does not originate in the circular flow of dollars, but rather in the lack of understanding of the fact that dollars are always necessarily used as circular flows. Since any given country’s domestic output cannot simultaneously define the real ‘content’ of the national currency deposited in the domestic banking system and of its duplicate, it follows that eurocurrencies are nothing more than ‘empty’ or valueless duplicates. The phenomenon of eurocurrencies can also be analysed by referring to the distinction between a country and its residents. In particular, it appears that, in today’s system of international payments, the payment of net imports is twofold, and that, when it is carried out by a reserve currency country, it leads to the formation of eurocurrencies.
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- Exchange rate fluctuations
The traditional conception of exchange rates, according to which these rates would merely be the (relative) prices of national currencies as determined on the foreign exchange market is seriously mistaken. The different theories proposed to explain exchange rate fluctuations are all grounded in the assumption that currencies are positive assets traded on the foreign exchange market and subject to the law of supply and demand. Current-account and asset-equilibrium models of exchange rate fluctuations as well as ‘Keynesian’ models focused on both current and capital account transactions are clear examples of the endless proliferation of models attempting to explain exchange rate fluctuations according to a microeconomic point of view. Indeed, if models are to mimic economic agents’ behaviour, experts will always be confronted with a constantly changing parade of exchange rate models and the search for exchange rate stability will prove a hopeless exercise. The traditional approach to exchange rate fluctuations suffers from an even greater shortcoming since, contrary to what is often believed, current and capital account transactions do not affect exchange rates, so that neither monetary disorders such as inflation and deflation, nor interest rates can be a cause of exchange rate erratic fluctuations.
The settlement of commercial transactions between countries implies the perfectly circular use of the money chosen as a means of payment. This is certainly true when commercial imports are covered by equivalent commercial exports, but applies also when a country balances its net commercial imports through a net export of financial claims. The determinant criterion here is that of ‘reciprocity’. If a transaction between two countries defines a reciprocal real exchange (goods and services against other goods and services or against financial assets), the money involved is used in a circular flow and no exchange rate fluctuation can derive from it. This is indeed what happens independently of whether we deal with key currency or non-key currency countries.
Monetary macroeconomic analysis also shows that the same result applies to capital account transactions. Exports and imports of financial assets give rise to reciprocal exchanges that leave exchange rates unaltered. By the same token, it is therefore also easily established that exchange rate fluctuations cannot derive from inflation, deflation, and interest rate variations, since each of these factors could influence exchange rates only through its effect on trade or capital movements. It thus appears that exchange rates fluctuate only insofar as currencies are not used in a circular flow, as simple means of payment. It is only when currencies are considered as if they were (positive) assets, objects of trade on the foreign exchange market, that their ‘prices’ fluctuate through their net sales and purchases. The transformation of currencies from simple means of payment into objects of trade takes place through the process of duplication described by Rueff. Thus, in the present system of international payments euro or xeno-currencies generated by duplication feed a speculative capital market, and the transactions taking place on this market inevitably lead to exchange rate fluctuations. Since duplication arises independently of economic agents’ behaviour, speculation and exchange rate fluctuations are themselves the consequence of a macroeconomic disorder engendering pathological capital rather than the result of microeconomic agents’ decision to invest on the foreign exchange market.
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- The mystery of the missing surplus
As unanimously recognized, a country’s current account surplus/deficit is another country’s (or group of countries’) current account deficit/surplus, so that, on the whole, the world global current account should always equal zero. However, this is not what happens in the real world. Statistical data in fact show that, from 1979 to 2002, the global current account has constantly been negative, the amount spent by LDCs being currently greater than the amount entered as receipt in the rest of the world’s (R’s) current account. Since R’s net commercial exports as well as the net interest on debt owed to it have regularly been paid by LDCs, the world current account discrepancy stands for an excess of payments carried out by LDCs and unrecorded in R’s current account.
Dubbed by Krugman and Obstfeld as ‘the mystery of the missing surplus’, this discrepancy cannot be explained by referring to the microeconomic payments of commercial transactions, nor can it be maintained that LDC’s indebted residents pay their interest on debt more than once. Likewise, one cannot claim either that the missing surplus is nothing more than the effect of capital flight. In its current meaning, capital flight is the result of illegal transactions through which the residents of a given country are able to avoid taxation. By definition, any illegal transaction of this kind goes unrecorded, both in the country from which residents surreptitiously transfer their capital and in the country where the capital is transferred. We shall look in vain for a cause in the world current account discrepancy at the level of microeconomic payments. As confirmed by the two working parties appointed by the International Monetary Fund (1987, 1992) to examine current account discrepancies and world capital flows, the amounts corresponding to the ‘missing surplus’ are far too high to be explained by unreliable data collection. Furthermore, statistical observation shows that their rate of increase has not weakened despite consistent technical improvements. If we consider, moreover, that the longer the period of reference, the lesser the impact of misreporting – since errors tend to compensate – it appears that the increasing amount of world discrepancies is the mark of a macroeconomic disorder whose nature is indeed still mysterious. This first impression is then confirmed by the further observation that world capital and financial accounts do not match either. Does the world capital and financial account discrepancy have the same origin as the world current account discrepancy? Do the two discrepancies result from the same macroeconomic disorder? The aim of quantum macroeconomic analysis is to suggest a way of answering these questions by means of a flow analysis of the balance of payments.
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- External debt servicing
Initially analysed by Keynes (1929), this problem has long been underestimated by mainstream economists, who seem to have entirely missed the originality of a transaction – the payment of interest – that substantially differs from any other international transaction. It is to Bernard Schmitt that we owe the complete and rigorous analysis of net interest payment. His undisputable premise is the fact that net interests on debt are paid out of the indebted country’s current account. Interests are paid by the country’s indebted residents. Yet, the country itself is involved in the payment of its residents, which is entered in the current account balance. The payment of interest by the current account has a precise meaning: it clearly shows that the indebted country (A) pays its interests by transferring to the creditor countries part of its domestic resources. Thus, the payment in real terms of A’s net interests on debt is a net transfer of A’s domestic output. This real transfer is conveyed by a monetary flow of A’s current account.
If the payment of net interests were of the same nature as any other payment, the monetary payment would be identical with the real payment, and the cost total for A would simply equal the amount of interest due. Yet, the payment of interest is of a different nature: it is an ‘unrequited’ transfer that does not allow for the circular flow of money, proper to any other payment. This means that country A does not benefit from the automatic reflux of the money conveying its real payment of interest. It thus follows that the monetary payment of interest has a positive cost added on to that of the real transfer of A’s domestic resources. The total cost of A’s net interest is therefore twice the amount due to its creditors. Half of the cost is paid by the indebted residents – and leads to an increase in A’s external debt when A’s commercial trade is balanced – the other half is paid by their country – and ends up with an equivalent reduction of A’s official reserves.
World Bank’s statistical data confirm the double charge of interest payment. Over a period of 24 years, from 1978 to 2002, indebted countries have paid 1,851,327 million dollars in net interests and, despite benefiting from a net total receipt of 2,428,975 million dollars (foreign direct investments, portfolio investments, and grants), their official reserves have been subjected to a decrease of 1,960,913 million dollars. By showing that the double charge is of a macroeconomic nature, quantum macroeconomic analysis provides at the same time a consistent explanation of the missing surplus. In fact, while the first payment is microeconomic and leads to a debit of A’s current account – defining the payment of A’s residents – and to a credit of the creditor countries’ current account, the second charge is macroeconomic and, though affecting A’s current account, has no effect on the current account of the creditor countries. A’s decrease in official reserves has no counterpart in the balance of payments of the rest of the world, which explains why global balance of payments’ discrepancies have remained a mystery for such a long time.
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- Sovereign debt crisis
Quantum monetary macroeconomics is based on a thorough investigation of the nature of bank money, and provides a new insight into the character of international payments. In particular, it shows that countries’ sovereign debts are entirely pathological, as their very existence is due to the absence of a proper system of international payments. The gravity of the sovereign debt crisis is all too real to insist on the relevance of Schmitt’s investigation. What is immediately unclear in the analysis of mainstream economists is their meaning or understanding of the term ‘sovereign debt’; so it is not surprising to observe that sovereign debt is often wrongly identified as being the debt incurred by the State. The public debt, however, is not co-extensive with the debt of a country defined as the set of its residents, which owes its existence as much to private as to public debts incurred abroad. This lack of a correct definition of sovereign debt is the unavoidable result of misunderstanding the way countries are involved in the external payments carried out by their residents (State included). Quantum macroeconomic analysis makes it clear that sovereign debts are of a macroeconomic nature and can therefore not be imputed on the (mis)behaviour of economic agents. Once again, it is the non-system of international payments that is identified as the cause of this monetary pathology.
The discovery of a pathological duplication affecting the payment of a country’s net interest on debt as well as the formation of a country’s external debt, its sovereign debt, is Schmitt’s last legacy and a key result of quantum macroeconomic analysis. Its relevance for the understanding of financial crises is great, and its outcome is particularly significant because of the reform it calls for. To impute the sovereign debt crisis to the excess of borrowing that countries incur in order to finance their surplus expenditures amounts to maintaining that the balance-of-payments principle, which establishes the necessary equality between each country’s total purchases or imports (commercial and financial) and its total sales or exports (commercial and financial), is systematically disregarded by the present non-system of international payments.
The disregard for the balance-of-payments identity is what characterizes the pathological state of the actual system. This does not mean that, as any other logical identity, the necessary equality between each country’s total sales and purchases can be put in jeopardy by the behaviour of economic agents, in particular by their decision to increase their foreign expenditures. Logical identities cannot be transformed into conditions of equilibrium and cannot be submitted to the goodwill of economic agents. However, so long as these laws are not fully understood and complied with, a discrepancy will always arise between them and the way payments are carried out by banks. When the identity concerning payments among countries is not complied with, then the pathology that emerges from this lack of conformity generates a country’s sovereign debt. Plainly stated, this amounts to claiming that sovereign debts should not exist, that their very formation is of a pathological nature, and that they can and must be avoided through a reform that allows for the implementation of a system of international payments consistent with the balance-of-payments identity.
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- The need for a reform of the international system of payments
The debate over the exchange rate regime best suited for a given country to achieve exchange rate stability has swung from fixed parity – currency boards and dollarization included – to free floating. European currency union excluded, none of these attempts at solution has proven satisfactory, the main reason for their shortcomings being the fact that today’s exchange rate regimes belong to the category of relative exchanges, since currencies are considered as if they were real goods, and exchange rates are defined as their relative prices. Exchange rate instability is the unavoidable consequence of a world in which some national currencies are denatured through duplication and traded on the foreign exchange market. Every attempt at taming erratic exchange rate fluctuations without modifying today’s system of international payments has therefore a cost. Alternatives range from foreign exchange market interventions and interest rate policies to the loss of monetary sovereignty. A price has to be paid even when full exchange rate stability is obtained by the most radical solution: monetary unification. In the case of the European Union, for example, since national currencies no longer exist (at least officially, because a rigorous analysis shows that, in reality, the euro is still far from being the single European currency it is meant to be), no interventions are needed any longer within the euro area. Yet, the loss of monetary sovereignty has a series of negative side-effects that seriously hamper the success of European unification. Free capital flows are the most worrying consequence of monetary unification and, together with the existing economic disparities between EU member countries, are likely to drastically increase unemployment in the regions suffering from capital outflows.
Monetary macroeconomics helps us to envisage a new solution that, while preserving monetary sovereignty, prevents national currencies from being denatured into tradable goods whose price is subject to the law of supply and demand. The key novelty here is the shift from today’s regime of relative exchange rates to a regime of absolute exchange rates, that is, to a system in which each transaction is carried out through the circular flow of money so that the currency used as a means of payment is never the object of a net sale or purchase. The reform proposed by Schmitt and already partially envisaged by Keynes in his plan for the establishment of an international clearing union presented at Bretton Woods in 1944. One of its key features is the intervention of the European Central Bank (ECB) both as a monetary and a financial intermediary. This means that the ECB will have to issue and allow for the circular flow of the euro, and manage a system of inter-European clearing guaranteeing the real content of inter-European transactions. Following this model, a system of fixed and stable exchange rates between three or more major currency areas can easily be worked out. But what about LDCs? Do they have to wait for a world monetary reform in order to avoid the double charge of net interest payments? Fortunately not: as shown by Schmitt, each single LDC can implement its own reform, thus protecting itself from the iniquity of the present system. Avoiding the duplication of its external debt and, by the same token, the second, macroeconomic, payment of interest, such reform will allow LDCs to benefit from a net inflow of foreign exchange and enter a new process of economic and social development.