Normalising International Trade

Source: GPWN (2010)

How to build a better International Trade System with no trade deficits

Using the International Trade System to create a permanent solution to currency instability would strengthen economies and currencies like the Zambian Kwacha.

A fundamental governing principle of monetary theory is that when goods and services enter or leave a fixed medium of money supply (retention) within an economy they respectively cause an appreciation or depreciation of a currency that can be restored or regulated by increasing or decreasing money supply in proportion to goods and services in circulation. When currencies are confined to their respective borders goods and services can move against this retention. A new and well-organised international trading system based on this principle can begin with Central Banks playing a key supervisory role in the relationship between international trade and currency. In this system when external goods enter an economy they inevitably cause an imbalance between the volume of domestic currency in circulation and aggregate goods and services. In monetary terms, imported goods create a deficit effect on money supply. At the same time there are industries within an economy externalising a nation’s resources by exporting goods and services creating a surplus effect on money supply. The deficit created by goods and services entering an economy can be balanced by Central Banks receiving these payments and reintroducing this liquidity using the surplus effect. This liquidity can be re-injected into the economy by paying it to domestic exporters using local currency leaving no doubts as to the cycle of monetary receipts and allocations in international trade. Hence, exports naturally pay for imports when they create a surplus in liquidity and vice versa. The economy remains balanced. Nothing could be simpler. The global trading system is thus allowed to act like an efficient self regulating organism made up of balanced self-regulated domestic macro-economies. There is less complexity, less clutter, less monetary chaos.

In this example the entry into an economy of imports empowers a Central Bank to increase liquidity, which facilitates payments to exporters in domestic currency. With this relationship there is absolutely no need for an importing country to have to source the national or domestic currency of the economy from which it imports goods and services or some internationally accepted trading currency. Having to do this is an unnecessary barrier to international trade that hurts both the exporting and the importing country. Its partner Central Bank already has the domestic currency to effect payment. In fact, no domestic currency whatsoever would need to leave its borders and no foreign currency has to enter them. For example, in this condition there are absolutely no currency exchange barriers to trade that would injure industries in the US that need export markets; the same applies to consumers and industries in Zambia that need to import and vice versa. Both Zambia and the US would face absolutely no currency reserve problems as there would be no need to hold foreign reserves in the first place. Currencies remain territoriality bound and constant (retention) while goods and services move. In essence each nation’s individual currency would act like a single currency that automatically transmutes itself through Central and/or Federal Bank currency supervision partnerships. This facilitates the tranquil movement of goods and services between economies. Commercial banks already follow this approach. Why should a commercial bank physically move money to another country when its subsidiary there already has the facility and resource to make a payment in local currency? For instance, it receives a payment in dollars in the US then instructs its subsidiary in Zambia to make the same payment in Kwacha, vice versa. If it works for commercial banks it can work for the IMF, WTO and Central Banks. The US Federal Reserve Bank (FRB) and the Bank of Zambia (BoZ), or any central bank for that matter, can have a partnership that facilitates and catalyses trade without currencies as barriers that stunt growth. This is what global partnerships are about.

Trade deficits and surpluses can be handled just as easily using this policy. In the United States in 2002 a trade deficit of US$435.2 billion of imported goods threatened the US economy. With GDP at US$10trillion this caused a deficit that could have been solved at the US Federal Reserve simply by balancing its internal liquidity were the international trade system different. Not a single dollar would have escaped the US economy and the FRB due to its partnerships with other central banks. Financial stability in the US, and other individual economies, would mean stability in the rest of the world. The domestic balance between the stock of money and stock of goods and services would be manageable. The US Federal Reserve’s ability to internally control balance of payments and retain a stable economy would increase dramatically. There is a need to see that a general trend in economies today is toward trade deficits due to the ever-increasing complexities of specialisation, comparative advantage and interdependence in the midst of a stagnant international trade system. The current global trade system and mechanisms are ‘pre-historic’ and show a lack of innovation on the part of policy makers.

In a new supervisory partnership of Central Banks supported by the WB, WTO and IMF, and the proper use of monetary policy, even if a country like Japan experienced a trade surplus it would be able to internally regulate the effects of this condition thus protecting itself, its trading partners and the global economy. At present trade deficits and surpluses uncontrollably spill over borders and translate into fluctuating internal and external exchange rates, which create a sickly and now archaic global trade system that destabilises economies. Currencies and goods run amok, hence, nations anxiously horde each other’s currencies in fear of inadequate trading capacity. Within a few months global speculation or induced devaluation can wipe out the value of foreign reserves in a country despite the torturous effort of governments to build them up. Shortages in domestic currency due to it spilling over into neighbouring countries can lead to CBs having to print new money at high costs; or an economy can be destabilised by its own externalised domestic currency being channelled back into its economy by exports or transfers. FDI is threatened as investors fear inadequate hard currency to meet obligations. An export company cannot export as there is inadequate foreign exchange in circulation to buy raw materials which leads back to the problem of insufficient hard currency. A Zambian producer cannot purchase equipment as the economy has no foreign currency or due to the fact that a very high price has to be paid for it that deters productivity and renders growth incapable of repaying national debt. Meanwhile, across the Atlantic manufacturers in the US may sit idle and lay off workers, though warehouses are full of unsold goods, waiting to be hit by the full effect of a recession as potentially vast external markets either do not have access to the dollar, cannot acquire it, find it too expensive to buy or as it is in the case of Zambia, are standing by for copper export revenues to arrive from the LME on 56 Leadenhall Street. All this friction contributes to a global economy slowing down.

Currencies proliferating all over the globe crossing borders and running amok outside the statutory jurisdiction of central banks (CBs) and an attempt to regulate them has become a poor rather than a prudent application of free markets and monetary policy that has increased the vulnerability, risk and exposure of economies to financial instability. There is an alternative to this chaos and the method for operationalising the process by which this takes place is to create an electronic clearing house facility for international trade.

ECH Trade System

The globalisation of money was introduced in Chapter One. The globalisation of money is as important to international development as free trade. In the present system major trading currencies such as the US dollar or Euro have to be obtained before countries are able to acquire imports. To do this they themselves must find exportable products and earn the foreign exchange with which to pay for imports. The capacity to produce exportable goods and services is thus a fundamental barrier to a country’s capacity to acquire foreign exchange and therefore its capacity to participate in international trade. Foreign exchange, though readily available on international markets can therefore be considered a significant barrier to international trade due to the hurdles countries must overcome to be able to acquire it.

There are two possible ways of overcoming this barrier. The less attractive method is to attempt to create a continental currency or internationally acceptable currency owned and controlled by developed countries that overcomes these barriers. The more attractive method is to introduce an electronic clearing house (ECH) for facilitating international trade. An electronic clearing house for international trade entails that when goods and services are traded between countries, exported and imported goods move whilst domestic currencies stay put. This method is more practical and brings with it many new potential benefits.

Using an ECH process, when a country imports goods and services the payments from domestic exports accrue to the Central Bank or an agency appointed by the CB to manage the ECH process. In other words imports entering a country have a positive effect on the balance of payments and are a direct source of income that accrues to government. These funds are then placed in an ECH Import Account. When a country exports goods and services domestic exporters are paid for their exports from funds in the ECH Import Account. Therefore, if imports exceed exports the remaining balance of trade is a surplus to add to government expenditure. Should exports exceed imports the country is not disadvantaged as its exporters are still earning income and a government is able to move toward a positive trade balance with little effort. Therefore, currencies remain domestic whilst goods and services are allowed to move between countries.

In the conventional trade process the formula for Net Trade is as follows

Net Trade = Exports (Ex) – Imports (Im)*
Trade Surplus = Ex > Im
Trade Deficit = Ex < Im

• Under the current trade system there are no direct earnings from trade gained by governments. Direct earnings are only gained by exporters. An example that may be used here is of the United States. Let us assume that in 2005 the United States, as a result of having an open economy, received US$1,036.25 bn in imports and exported US$207.25 bn. The US’s current balance would be as follows:

Net Trade = US$207.25bn – US$ 1,036.25bn = US$829bn (Trade Deficit)

Under the current trade system the United States is punished for allowing imports by having a trade deficit of US$829bn rather than rewarded for having an open economy. This is a contradiction of free markets and open economies encouraged in the modern economy. Furthermore , there are no direct earnings.

In the trade architecture proposed by OLE the formula for Net trade (ECH Balance) is as follows:

ECH Balance (Direct Earnings) = Import Account – Export Account

ECH Balance = ImA – ExA
ECH deficit : ImAExA

Using an ECH system the US’s current account would be worked out as follows:

ECH Balance = ImA – ExA
Net Trade = US$ 1,036.25bn-US$207.25bn = US$829bn (Trade Surplus)

Direct Earnings = US$829 bn
In this system an economy and its government is rewarded by being more open, in the US’s case with US$829 bn in direct earnings. This is profit from economic trade that accrues to government. The CE trade system offers no direct earning benefits of this kind as they all accrue to importers and exporters.

[At present the concept and use of foreign exchange is not smart because it acts as a barrier to international trade. Forcing countries to earn hard currencies through exports before they are able to demand foreign goods and services is moribund, not just poor policy, but poor or shallow thinking at an international level. Imagine the goods and services around the globe that go unsold as a result of this backward pre-historic currency system. Imagine the goods and services in the United States that go unsold every year simply because governments do not have the US dollar to purchase American made goods and services or because the lack of US dollar reserves drives depreciation of domestic currencies making US exports too expensive because the local currency is too weak to-buy-the-dollar to-buy-US-goods-and-services. International trade at present functions with shackles on its hands and feet. Its the main reason why the US remains uncompetitive and unable to outperform other export countries despite being the most powerful economy in the world. The US has difficulty being a leader in exports simply because its own currency is a barrier to selling its goods and services abroad. An ECH Trade System allows domestic currencies from different central banks and governments to act as a single currency, even though the currencies themselves are different nationalities. Not only are governments no longer crippled by shallow reserves, international trade is unfettered and released to explode in increased sales thereby driving global growth as well as spurring economic growth, especially in countries whose potential is being limited by currency barriers.]

.Managing an ECH Trade System

An ECH international trade system should be easier for governments and the World Trade Organisation (WTO) to manage than a conventional CE trade system.
When imports exceed exports this is the ideal condition in an ECH model as it enables governments to earn income directly from imports and supports free market theory and policy. However, the ultimate objective in the management of international trade is a balance between imports and exports. In a global system where some of the surpluses are shared between governments more can be done to improve international trade.
When exports exceed imports and a country faces a deficit governments have better options for dealing with this problem than they have for a deficit experienced in a conventional economy.

[Central banks in the group can create a common foreign exchange reserve and administer a policy that allows any country with surpluses at any one time to lend to countries with deficits at any one time, fortifying the economies of members. Since the members allow international trade and purchases directly in each others currencies, they only require forex for transactions outside the group, reducing their dependence on it. As the membership of the group grows, the lower the dependency on forex. Member countries do not mind purchases in the currencies of other members as they share a common reserve, and their individual currencies behave as though they are a single currency. Creating a common foreign exchange reserve managed by members is essential to the success of this kind of ECH. There is still likely to be some play in exchange rates leaving room for speculation and currency trading, however, in this new trade and currency architecture CBs are better equipped to accommodate this activity because they can shrug of the negative aspects of currency speculation]

[Once an ECH system is in place, its important for CBs to pool together the management of member’s forex reserves. The reason for this is very simple. Before the ECH each member’s domestic currency is only backed by its national reserves. However, when the ECH is formed and members agree on policy to manage their forex reserves in each others interest (one for all, and all for one), then each member’s domestic currency is now backed by the groups forex reserve. The simple fact that each member has reduced the risk associated with its domestic currency by default multiplies not only the confidence in the domestic currency but also technically strengthens the value of local currency. This creates a matrix where each member states that its local currency is backed by the group reserve which has a multiplier effect in terms of the total value of the reserve. This value is real due to how this system mitigates against risk in each member country, thereby multiplying the strength of the ECH group as a whole, in real terms. For the sake of example, from each member’s domestic currency being backed by a national reserve worth just a few billion dollars, each member’s domestic currency is now backed by hundreds of billions of dollars held by the group to which each member is entitled to state its domestic currency is fortified. This backing is real, because it lowers the risk profile of each member. Technically the size of the reserve will consist of the value of the collective reserve multiplied by the number of members, because this is how it will behave. For instance, if the collective forex reserve is worth $100bn and there are 50 members and each member quotes their domestic currency against the reserve, then the $100bn functions and does the work of $5 trillion. This approach to increasing wealth and value as a well managed financial tool or instrument is no different from fractional reserve banking or insurance as well as the risk management that goes with these financial products. It allows the collective forex reserve to do much more work than forex reserves isolated to each individual member. Even though a member may have $2bn in reserve, its domestic currency is now backed by the $100bn collective reserve in terms of risk, even though the collective reserve is $100bn it multitasks for 50 members, in terms of work done and presence, giving it a regional real value of $5 trillion.]

An ECH Trade System Allows for More Stable Currencies

Since money does not move between economies Central Banks have to agree to honour foreign demand for the products they produce. This agreement might resemble the promise made by the Governor of the CB commonly found on notes which reads I promise to pay the bearer on demand except that now as an agreement between governments it might read I promise to pay the bearer of any currency (party to the ECH process) on demand. It allows domestic currencies to function as though they are a single currency and can remove the need for often damaging appreciation or depreciation resulting from changes in the balance of payments between aggregate exports and imports.

The essential result is that it appears as though there exists a single currency between trading partners. In other words not holding foreign currency can no longer prevent a country from obtaining imports from another country. As long as consumers and producers in a domestic economy hold sufficient local currency to demand foreign commodities and finished goods, which they can pay for via the CB they are able to naturally acquire imports. Foreign exchange (forex) is no longer a barrier to international trade.

[History is is one of the most important subjects in the world, because to lose sight of and fail to learn from the past, is to fail to understand how best to secure the future. Currencies hold cultural value and can often be a source of history, national pride, culture and identity. By each member central bank maintaining its national currency this is preserved, however, through the membership the individual currency is no different from any other currency in the collective basket creating a multi-national and multi-cultural single currency able to preserve the history and national heritage of each central bank.]

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