Indian Currency and Beyond

1. Indian Currencyand Beyond Lord Keynes with Dr. H. H. Kung,China's Minister of Finance. Bretton Woods, 2.7.44 The Legacy of the Early Economics of Keynes in the Times of Bretton Woods II Anna Carabelli & Mario Cedrini Università del Piemonte Orientale AHE 11th Annual Conference, Kingston University, London, July 9th - 12th, 2009

2. Carabelli & Cedrini, AHE 2009 Dissemination of economic ideasIndian Currency and Beyond

3. Carabelli & Cedrini, AHE 2009 Dissemination of economic ideasIndian Currency and Beyond • From Asia to Europe then (Indian Currency and Finance), from the periphery to the core of the system (Bretton Woods 2) today • From 1913 (ICF, or Keynes's Bretton Woods 0) to the 1940s (ICU, or Keynes's Bretton Woods 1)‏ • From Keynes to our times (Bretton Woods 2) and – possibly – the future (Bretton Woods 3)‏

4. Carabelli & Cedrini, AHE 2009 Bretton Woods 2 Foreign reserves (Dec. 08, May 09) and reserves/GDP ratio

5. Carabelli & Cedrini, AHE 2009 Bretton Woods 2 The spectacular effects of a “change of ideas in Asia” (JMK)‏ • Global imbalances: the “old” paradox of capital and the “new” phenomenon of foreign lending through exchange reserves (Kregel 04). • Emerging markets and reserves accumulation: a.precautionary motives (Feldstein 99, Rodrik 06): self-protection (policy autonomy) through increased liquidity b.mercantilistic strategies, or the BW2 narrative (Dooley et al. 03): the Asian “hoarding game” (Aizenman 07)‏ c.both “a” and“b” (Aizenman 07, Eichengreen 04)‏.

6. Carabelli & Cedrini, AHE 2009 Bretton Woods 2The social costs of foreign exchange reserves • Capital losses complementarity between private and public investors' portfolio choices (Roubini 06, Eichengreen 04); investors' miopia (Krugman 08)‏ • Opportunity costs external borrowing (Rodrik 06, Stiglitz 03) and failure to reduce short-term debt liabilities (Rodrik 06). • Moral hazard problems Overheated asset markets and macroeconomic risks (Cruz and Walters 08)‏

7. Carabelli & Cedrini, AHE 2009 Bretton Woods 2The puzzle of reserves • The problem: “A decision taken in the context of the decision to adopt or reinforce the neo-liberal strategy of rapid financial liberalisation” (Cruz and Walters 08: 667). • The rationale: “Hoarding international reserves is a key ingredient enhancing the stability of the emerging configuration in an era of greater financial integration” (Aizenman 07: 2). • The benefit: countries insure also against runs on the currency by domestic savers: in the “panic of 2008”, countries with smaller war chests have depreciated (Obstfeld et al. 09).

8. Carabelli & Cedrini, AHE 2009 BW2 and the global reserve systemExpensiveness with instability • An unstable... non-reserve countries's desired level of reserve accumulations compels the reserve country to face chronic growing deficits (Greenwald & Stiglitz 06). • ...inequitable... EMs’ need for “selfinsurance” due to the mix of highly pro-cyclical capital flows and limited policy space (Ocampo 07). • ...and deflationary environment. the system compels the reserve country and world locomotive to act in such a way as to promote mercantilism (Davidson 08).

9. Carabelli & Cedrini, AHE 2009 Indian Currency and FinanceThe why and how of a revival • From the periphery (Asia) to the core of the system: Keynes's look in 1913 and today's Asian challenge. • The proper object of a good currency: “to combine cheapness with stability” (Letter to the Times, 1912, XV: 91). • The continuity in Keynes's attempt to devise a new international monetary system [see Dimand 91 vs Williamson 83] happily combining the interests of debtors with those of creditors and, more generally, freedom with discipline. • A method [see Ferrandier 85, Vicarelli 89, Vines 03] to cope with the complexity of international economic relations.

10. Carabelli & Cedrini, AHE 2009 From the (Asian) periphery...Indian Currency andBeyond • Memorandum on a Currency System for China (1910; XV). • India, Philippines, Straits Settlements, Indo-China, Siam and Java; even Japan (and Russia): the gold exchange standard as “the prevailing form of currency in Asia” (Recent Developments of the Indian Currency Question, 1911, XV: 70). a ... scientific and economical system ... has come into use. If the gold is only required for foreign payments and not for internal circulation, it is cheaper to maintain a credit at one of the great financial centres of the world, which can be converted with great readiness into gold when it is required, and which earns a small rate of interest when it is not required (Memorandum on China: 62).

11. Carabelli & Cedrini, AHE 2009 Cheapness with stability“The object of a good currency” (Letter to the Times, 1912)‏ A preference for a tangible gold currency is no longer more than a relic of a time when governments were less trustworthy in these matters than they are now, and when it was the fashionto imitate uncritically the system which had been established in England and had seemed to work so well during the second quarter of the nineteenth century (ICF: 51). • “It is tacitly assumed that the greater part of what has to be withdrawn from the circulation at a time of crisis would come from the gold portion of the circulation”. On the contrary, “at a time of crisis it is the fiduciary coins which the public are most eager to part with” (ICF: 64).

12. Carabelli & Cedrini, AHE 2009 The legacy on focus and method Complexity • Indian Currency and Finance, an essay in complexity: the Indian system is an exceedingly coherent one. Every part of the Indian system fits into some other part. It is impossible to say everything at once, and an author must needs sacrifice from time to time the complexity and interdependence of fact in the interest of the clearness of his exposition. But the complexity and the coherence of the system require the constant attention of anyone who would criticize its parts. This is not a peculiarity of Indian finance. It is the characteristic of all monetary problems. (ICF: 181-82)‏

13. Carabelli & Cedrini, AHE 2009 The legacy on focus and methodInterdependence The position of a country which is preponderantly a creditor in the international short-loan market is quite different from that of a country which is preponderantly a debtor. In the former case … it is a question of increasing the amount lent; in the latter case it is a question of increasing the amount borrowed. A machinery which is adapted for action of the first kind may be ill suited for action of the second. Partly as a consequence of this, partly as a consequence of the peculiar organisation of the London money market, the ‘bank rate’ policy for regulating the outflow of gold has been admirably successful in this country, and yet cannot stand elsewhere unaided by other devices. (ICF: 13)

14. Carabelli & Cedrini, AHE 2009 The legacy on focus and method:Interdependence (2)‏ If the money market is not a lender in the international market, the bank itself must be at pains to become to some extent one ... by itself entering the international money market as a lender at short notice, place itself in funds, at foreign centres, which can be rapidly withdrawn when they are required. The only alternative would be the holding of a much larger reserve of gold, the expense of which would be nearly intolerable. The new method combines safety with economy. (ICF: 18-19)‏

15. Carabelli & Cedrini, AHE 2009 Safety with economy...What about reserves? • Keynes versus a “powerful, natural, and yet unfounded prejudice”: Gold reserves are meant to be used in times of difficulty, and for the discharge of pressing obligations. It is absurd for a man with a large balance at his bank to default to his creditors, because a feeling of jealousy, in regard to any one in whose favour he draws a cheque, prevents him from ever drawing one. (ICF: 125)‏ • However, “wonderfully few other countries have yet learn that gold reserves, although no doubt they serve some purpose when they are held for show only, exist to much better purpose if they are held for use also” (ib.).

16. Carabelli & Cedrini, AHE 2009 A futuristic “reversal of roles” (Chandavarkar 90), or A “rational” European monetary reform • The sink of precious metals, India’s “love” of gold, “ruinous though it has been to her own economic development, has flourished in the past to the great advantage” (ICF: 70) of Europe. However, if India is thus to turn the tables on the West, she must not delay too long. The time may not be far distant when Europe, having perfected her mechanism of exchange on the basis of a gold standard, will find it possible to regulate her standard of value on a more rational and stable basis. It is not likely that we shall leave permanently the most intimate adjustments of our economic organism at the mercy of a lucky prospector, a new chemical process, or a change of ideas in Asia. (ICF: 71)‏

17. Carabelli & Cedrini, AHE 2009 Rationality of policyKeynes's reasonableness and reserves accumulation there are but few which pursue a rational policy in regard to it. At considerable cost they build up large reserves in quiet times presumably with a view to the next crisis; but when the crisis comes mistaken policy renders them as little able to use gold as if it were not there at all. (CW XI: 247; 1914 crisis and a recurrent idea in WWI memo. A “rational” monetary reform versus: • the “unintended” evolution of Indian gold exchange standard • a gold reserve “thought of as being some sort of charme” (CW XI: 313)‏ • being at the mercy of “a change of ideas in Asia” (ICF: 71)

18. Carabelli & Cedrini, AHE 2009 BW0, (Keynes's) BW1 and BW2In line with the ICU plan, Indian Currency and Finance as... ‏ • Keynes's first critique of the model of commodity money (see Cesarano 03, 06), finally rejected inthe ICU plan. • His first attempt to devise an international monetary system able to establish sustainable relationships between debtors and creditors and to increase policy space available to debtors and emerging nations (see Chang 06). • A guide to rethink the BW2 system and the need of a “rational” international monetary reform combining cheapness (vs. costs unduly produced by the global reserve system) with stability (vs. the deflationary environment it tends to produce).

19. Carabelli & Cedrini, AHE 2009 Rationality and fallacy of compositionThe current reversal of roles and the future of BW2 • Back to the “reserves are to be used not shown” principle at the times of the crisis (see Obstfeld et al. 09)? Not really... • a “fear of losing international reserves [replacing the “fear of floating”] which may signal deterioration in the credit worthiness of a country” (Aizenman 09) has appeared... • still “the safest development strategy in an uncertain world (Dooley et al. 09). • Above all, reserves accumulation in the recent past could but lead to a “fallacy of composition effects that feed into global imbalances” (Ocampo 07; Roubini 06).

20. Carabelli & Cedrini, AHE 2009 From BW2 to BW3: Back to KeynesThe reform of the international architecture • From Bretton Woods 2... i.e. excessive financial liberalisation – shrinking policy space – mercantilism and self-insurance – fallacies of composition – US deficit-importer and persistent global imbalances • ...to a Keynes-inspired Bretton Woods 3 (see Greenwald & Stiglitz 06, Ocampo 07, Davidson 08): decoupling reserves accumulation from the deficit positions of reserve countries – coordinated international adjustment (Kregel 09) with more symmetrical rules – a true global currency as a more rational and stable store of international value.