KEYNES REVIVAL: the “Bancor” proposal of the 1940s – useful for today?

A virtual round table with three specialists: Paul Davidson, Editor of the Journal of Post Keynesian Economics, author of John Maynard Keynes (Palgrave Macmillan, September 2007) and The Keynes Solution (Palgrave Macmillan, September 2009), Bernard Schwartz Center for Economic Policy Analysis in New Jersey; Rolf J. Langhammer, Vice-President of the Kiel Institute for the World Economy, one of Germany’s leading economic research institutes; and Bill Witherell, Chief Global Economist of Cumberland Advisors, a registered investment advisory firm headquartered in Sarasota, Florida, and past Chairman of the International Roundtable of the National Association for Business Economics.

Recently Keynes came from the shadows of the History of the 1940s due to his proposal at that time for a new international monetary order and a new reserve currency (the so-called “bancor”), quite different from the one finally established in Bretton Woods in the final round of negotiations in 1944. The winners of Bretton Woods – the dollar and the new superpower, the US – take it all. Keynes Plan was “archived” and forgotten – until recently.

Perhaps not a surprise, the International Monetary Fund (IMF) analysed the Keynes solution in a recent study published in April prepared by the Strategy, Policy and Review Department. The study referred to a “sui generis Global Currency” and concluded: “If bancor were to circulate as a parallel currency, but in a dominant role in place of the US dollar, then as in the SDR-based system described above, current account imbalances that reflect today’s situation – namely, surplus countries pegging to bancor with deficit countries floating against it – would adjust more symmetrically, and perhaps more automatically than the current or SDR-based systems since the deficit currencies would be expected to depreciate against the bancor”.

Paul Davidson, who we interview in this article, considered by many macro-economists a “true interpreter of Keynes,” believes that the system imposed by the Nixon Administration after 1971-1973 increased the degree of “Keynesian” uncertainty in the world economy. He criticizes the idea of an “automatic” adjustment of the global imbalances as a “doctrinal ilusion” and “adapted” the Keynes solution in a soften way, proposing an international clearing union, more acceptable politically. Recently, Robert Skidelsky, the Englisg biographer of Keynes, considered the Keynes solution as a starting point for the next “grand bargain” between the US, the leading deficit country, and China, the leading surplus economy.

Even today the dollar is 86% of foreign exchange transactions, 65% share of bank notes held overseas, 65% of international reserves, 59% of cross-border bank deposits, 52% of cross-border bank loans and 46% of debt securities. On a decade, from 1999 to 2009, the international reserve accumulation was huge, with a threefold increase, and remain concentrated in the dollar. Only from 2003 to 2009, global reserves increased from $2.6 trillion to $6.8 trillion. But in the next decade or two, the jump can be insane. Extrapolations suggest demand for reserves would reach levels insupportable by reserve issuers, says the IMF study. China has 24.3% of all the global reserves holdings and Japan 13.4%.

An opportunity to discuss the present complex situation will be later this year with the quinquennial review of the IMF SDR (special drawing rights) basket – today based on the US dollar (dominant, 44%), the euro (34%), the yen (11%) and the pound sterling (11%). One of the discussions can be the inclusion of a non-convertible currency.

A “structural” flaw is embedded in the current monetary system. As Skidelsky pointed out recently: “Unless steps are taken to rebalance global current accounts, we will be walking into the next crisis.”

Virtual Round Table ©, Jorge Nascimento Rodrigues, October 2010

The yuan/dollar peg strategy from China: a de facto agreement

Q: Can we consider that the dollar-yuan peg since 1995 was a de facto change in the managed floating system among major currency areas from 1973? Some analysts even talk about a “Bretton Woods II” between the two great powers…

Paul Davidson: No! Still it did not have managed float between euro and dollar and English pound, etc. Also, in the 1995-2000 years China’s economy was not that big relative do the United States. At the beginning the US could ignore the Chinese peg.

Rolf J. Langhammer: I do not think that the collapse of the Bretton Woods system in the early seventies and the dollar-yuan peg are related to each other. When China began to gradually reform and open its economy in 1978, the country did not play any role in the global economy, neither on the real nor on the financial side. With a completely isolated financial sector, a non-convertible currency, and an initial split between foreigners and locals concerning the use of the local currency, China simply pegged its currency to the dollar as a way to further its international competitiveness in export markets. It thus followed practices which in the post-war period were pursued by countries like Germany and Japan as well.

Bill Witherell: I don’t think it is correct to characterize the period since 1995 as a Bretton Woods II as that implies a conscious international agreement. I think it was an evolutionary process with China becoming an increasingly important player in international commerce, but having a closed financial system and a currency that was not freely convertible. China maintained the peg and for the most part the US went along with it in practice while issuing statements that appreciation of the yuan would be desirable. That might be called a de facto agreement, but the US would deny they ever agreed to it.

Q: The de facto agreement, in recent years, is coming to and end since now China is the second great power, the first one on foreign reserves and the renminbi begins a world strategy?

Paul: The Chinese continuing running of balance of payment surpluses has a depressing effect on its trading partners.

Rolf: This de facto agreement will have still a fairly long lifetime. Risks of severe shocks rattling through world financial markets are threatening the markets should the de facto peg be abruptly abandoned or be perceived by the markets as such an end. The reason is that given the depth and liquidity of the US dollar market, and the roles of the dollar as unit of account, invoice currency, transaction currency and reserve currency, there is not substitute to the role of the dollar as an international currency. The renminbi will have to go long way to acquire one of these functions, not to speak of all of them.

Bill: The situation has changed and is still changing. The Chinese are moving in carefully measured steps towards transforming the yuan to a freely convertible international currency and permitting its value to be determined to an increasing extent (but not yet fully) by market forces. Under current conditions, this means letting the yuan appreciate vs the US dollar. On the other side the US has become increasingly sharp in its criticism of the slow pace of China’s moves in this direction. The now great economic and trading strength of China both motivates the US to press harder and builds the confidence of China that it can and should move to an internationalization of its currency. However, heightened rhetoric on both sides will likely slow the process as the Chinese will not respond positively to name calling, even if they understand it is mainly for domestic US political reasons. China is correct in noting that a too rapid appreciation of the currency could be highly destabilizing in China and that would have serious negative global repercussions.

Keynes’ proposal remains a vision

Q: Professor Davidson, to avoid a global currency war scenario, a solution like the one proposed by Keynes in the Bretton Woods’ negotiations of the 1940s has relevance today?

Paul: The principle behind Keynes’ plan – namely that the burden of ending an imbalance in international payments should be primarily by the creditor nation, and not the debtor- is the basis of a solution to our current problems. Unfortunately Keynes’ plan was based on the formation of a supranational central bank and its currency, the bancor. The European Central Bank has shown that a supranational central bank – without a supranational fiscal authority – can create problems, namely the possibility of sovereign national default. The correct solution requires an international clearing union – but each nation running its own monetary and fiscal system.

Q: Abolishing the use of national currencies as international reserves and substitute bancor in their stead was a truly prescient vision from Keynes?

Paul: Keynes of course was more worried about going back to the gold standard – the idea was to have an accounting mechanism that keeps score among the international payments between nations, but not allowing the public to speculate on this accounting system. I developed a solution in my book ‘The Keynes Solution: The Path to Global Economic Prosperity’.

Rolf: This is a vision and it is very likely that it will remain a vision. I do not think that the bancor would have the reputation and/or the backing of a strong national economy as the US had it for many years. One should not forget that the international role of the dollar was always owed to the dynamics, openness and absorptive capacity of the US economy as well as to its second international role as a “producer” of political security and stability.

Bill: The bancor idea is attractive in many respects, but I think it is very unlikely to be accepted and implemented. Getting the necessary agreement from all the key countries is difficult for me to imagine.

Q: Professor Davidson, rejecting the Keynes’ solution was basically a great power decision from the emergent superpower, the US?

Paul: It was solely a USA decision made by Harry Dexter White, the leader of the US Delegation.

Q: From Keynes’ proposals at Bretton Woods which “detail” or particular aspect impressed you more?

Paul: The need for the creditor nation to have a greater responsibility for solving international payments balance.

Q: But is it viable?

Rolf: There is no other solution than to reduce global imbalances by preferably symmetric commitments of both surplus and deficit countries. In reality, however, the major burden will rest upon the deficit countries. The idea of Keynes to establish an international clearing system that taxes or even confiscates excess gains of surplus countries is like riding a dead horse. No surplus country would commit itself to such a solution.

Q: The Chinese could be interested in an aggiornamento of the Keynes solution? Paradoxically, is it useful for China’s geopolitical and geoeconomic emergence the bancor idea?

Paul: The Chinese are worried about the Exchange rate that makes exports profitable. The bancor by itself does not solve that problem.

Rolf: Presumably yes, but it is also clear that they would be the main victims of any break with the past and probably futile trials to replace the dollar. They know that and they want to avoid these costs. This is why they doubt the sustainability of the current system while supporting it by backing the dollar.

Bill: Yes the Chinese have said as much and there is a recent IMF staff report that takes a positive view of the bancor idea. The Chinese probably would support having the fund develop the idea further.

SDRs are not decoupled from the dollar

Q: The present SDR (special drawing rights) system, created by the IMF and based on a basket of four currencies, has conditions to be developed in the short-medium-term as a transition period for a bancor solution in the future?

Paul: NO!

Rolf: The SDR is basically a credit and payments system among Central Banks. In the currency basket constituting the value of the SDRs the dollar has the largest weight. In this respect, SDRs are not decoupled from the dollar. Furthermore, SDRs so far have not acquired any further functions of the dollar as an international currency as mentioned above.

A bit of History


John Maynard Keynes made six trips across the Atlantic between May 1941 and 1946. In these trips he drafted a proposal he initially labeled “International Currency Union,” later renamed as “International Clearing Union” – what would be known as the “Keynes Plan”. The Basic idea was that each country would have a bancor (a new reserve currency) account which would be administered by an International Clearing Bank. The target of this proposal was for each economy to run a zero balance on this account, and through this ingenious system avoiding the bilateral trade imbalances. By 1942, this Plan was in its fourth draft. The British gives it full support – the former superpower was running a trade balance deficit, having a solvency problem and watching the Sterling Area overstretch. The Plan was the British strategy for the Bretton Woods’ negotiations in New Hampshire, in the US. But, the US has a different agenda – the emerging superpower saw the opportunity. Harry Dexter White, also an economist, was appointed special assistant to the Secretary of the Treasury in 1942 and his “plan” for the Bretton Woods summit was quite different – the US dollar should be at the centre of the international monetary system, not the bancor. The great confrontation took place for three weeks in July 1944 at the Mount Washington Hotel and Keynes suffered a minor heart attack and lost the political-financial battle. The US at that time had surpluses. The Agreement of 1944 set up the International Monetary Fund – a fund, not a bank – to provide short-term financial assistance for countries with balance of payments’ problems, and no solution to stop persistent reserve accumulation. Keynes would suffer a third massive heart attack in Easter 1946 and died. Irony of history, in 1947, Dexter White was accused of being a Soviet spy, although nothing was proven. He died also of a heart attack in 1948. More than 60 years after Bretton Woods, the US is a deficit and debtor nation. The global situation was reversed.

3 Responses to “KEYNES REVIVAL: the “Bancor” proposal of the 1940s – useful for today?”

  1. Frederic Lordon has recently launched a variant of the Keynes plan for the eurozone:euro as the reserve currency inside the European Union .Every year the surplus countries should be forced to appreciate and the defict countries to depreciate their own currency thus harmonizing the national economies at least in Europe and avoid the recurrent crisis.

  2. Euro cannot survive in its present form. Core countries with surplus cud stay. South Europe country may tempraory live and re-enter at new mkt discovered ERM.

  3. […] KEYNES REVIVAL: the “Bancor” proposal of the 1940s – useful for …Unfortunately Keynes’ plan was based on the formation of a supranational central bank and its currency, the bancor. The European Central Bank has shown that … Comments Off […]

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