Repost from Sunday, May 1, 2011
To fight the recession that began in 2008, the Fed cut interest rates to 0.25% to stimulate the economy. This rate change did little, so “Quantitative Easing” began. The definition of QE is: “The practice of increasing the supply of money in order to stimulate economic activity “, aka printing money. Currently there is reason to believe another massive round of quantitative easing will occur before the end of the year.
Where does Keynes come into the picture? Why is his name being pulled through the mud by critics of stimulus spending? Keynes revolutionized economics during the great depression in his paper “General Theory” which argued that aggregate demand rather than aggregate supply drives economies. Therefore government stimulus during economic downturns is required to achieve full employment, which in turn will increase aggregate demand. Sounds like Keynes would support the US in its stimulus attempts to save the country, right?
Wrong. Keynes never believed in the current system. Have you asked yourself why the USD is the world reserve currency? It dates back to the Bretton Woods conference in 1944. The system was originally setup with the USD as a world reserve currency; however, the USD was convertible to gold ($35/oz). This system broke down in 1971, when the convertibility of gold was suspended by Nixon. Keynes was at this conference and proposed a radically different system that was designed to put the world on a path to sustainability. He proposed a new supranational currency called the Bancor.
The Bancor would be used to facilitate trade between nations and be governed by the International Clearing Union. Bancors were backed by a barter system; however the value was expressed in gold ounces. The goal of this system was to put all nations on a level playing field by requiring them to balance imports and exports. A country would export goods and receive a credit in Bancors and when they imported they would pay with Bancors. To keep this system in equilibrium any nation with a high amount of debt or credit would pay interest, discouraging the hoarding of Bancors.
Keynes never believed that one nation should control the world reserve currency and could foresee the problems we are suffering today. His proposal for a sustainable system by ensuring every country’s trade account is balanced was shot down by his powerful American counter parts at the Bretton Woods conference. Why isn’t the current system sustainable? An economist by the name of Robert Triffin explained in the 1960’s that a nation that governs the world reserve currency faces a fundamental dilemma between domestic growth and international growth. Even though the
USD cannot be converted into gold anymore, on March 29th 2009 the head of the Bank of China cited the Triffin Dilemma as to why the USD cannot remain the world reserve currency.
The current stimulus practices of the US government are not Keynesianism, because Keynes believed in a sustainable system where trade and international currencies were backed by something rather than nothing.