Wednesday, January 2, 2019

Single Currency Trade Mechanism

Trade has been in the news quite a bit lately due to the Trump administration's focus on the trade deficit, particularly that with China, and its desire to significantly reduce the size of the deficit.

The source of the trade deficit is often presented as one of strong and weak currencies, and an imbalance in demand, with a desire in the US for imports greater than the desire in other countries, again in China in particular, for US goods.  American consumers buy foreign goods with US dollar with the result that US currency builds up in the accounts of the surplus nations.  Up until now these surplus countries have been content to either sit on these large piles of cash, or more likely invest them in US bonds, thus leading to even greater deficits in future as the interest that is also accruing adds to the deficits.  Ultimately, these balances of US dollars must be spent in the US in some form at some time.  How and when appear to be up to the surplus countries, and the US is simply ceding control over trade and currency to those countries, and their intermediaries.

True trade deficits were not possible under the old Bretton Woods system, as surpluses of currencies were re-balanced by the transfer of gold from the deficit country to the surplus country.  In effect the surplus country was buying gold from the deficit country using the surplus currency thereby eliminating the surplus.

Another mechanism is possible for facilitating and settling trade balances that eliminates ongoing trade imbalances.  That of the single currency trade mechanism.  Under this system all trade between two nations is carried out in the currency of one of the nations.  E.g. trade with the US would be performed using only the US dollar.  Sales of an export nation (US imports) would accrue US dollars, and purchases from the US (US exports) would consume those dollars.  Under this mechanism, the US would set up an account for each trade partner nation in the export/import bank of the US.  Exports to the US would generate funds in US dollars which would be deposited in the nation's account.  All exports from the US to that nation would be paid for with US dollars from that account.  A limit on the size of the balance held in the account will limit the trade deficit with that nation.  Once the limit is reached no further sales to the US are allowed.  The trade partner nation will need to spend down the account balance by purchasing US exports in order to regain the right to import to the US.  In this way, the trade imbalance with the US never exceeds the set account limit.

The account limit can also be used to eliminate existing trade balance deficits by setting it to a negative value, which implies that the trade partner nation must itself run a trade deficit with the US to create a negative balance.  This negative limit can be reset periodically, say every month, so that the existing trade balance deficit will be progressively paid down by the surplus nation refunding the account each month from its holdings of existing trade deficit US dollars.  When the accrued trade deficit balance is paid off the set account limit will be set to zero or some relatively small amount that is fixed rather than reset monthly.  Thus, the trade from that point on is essentially in balance.

A great advantage of this system is that it completely eliminate currency exchange rates from trade, as all trade takes place in the single currency.  Indeed, exchange rates may then be set by using the price of a basket of goods traded in both countries as a standard, and comparing the price in US dollars for those goods to the price in the foreign currency.  The resulting ratio is the currency exchange rate.  Any alternative mechanism to set the exchange rate, such as a floating exchange rate or a rate set by the trade partner nation, would require that it result in a demand for imports in the trade partner nation equal to the value of exports from that nation.  Issues of currency manipulation by nations or by intermediaries and speculators are eliminated.  In essence, trade is de-financialized, and returned to the barter model that ultimately underlies trade between nations that use differing currencies. 

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