The free flow of capital is often associated with devastating financial crises such as the ones in Mexico in 1994 and Asia in 1997. Some will argue that there is an essential difference between free trade of goods and the free flow of capital. A distinction is also made between direct equity investment in foreign companies and a free flow of capital in the form of loans, especially short term loans. The effect of foreign loans is complicated by the exchange rates between the two currencies involved.

In a perfect world one might hope that the equivalent amount of money bought the same amount of labor in every country so that global economic competition would take place on a completely level playing field. It might even be possible to have a single, universally accepted currency. Needless to say we are not likely to live in such a world any time soon. It may even be that the best way to compensate for the terrain of the playing field is to create even more diverse “local currencies” that can isolate an economy from the slings and arrows of international trade.

Theoretically exchange rates are supposed to reflect differences in the cost of goods and services in each country relative to its currency. Economists make a distinction between the “nominal exchange rate,” i.e. the actual exchange rate determined by a host of market variables, and a “real exchange rate” adjusted for the relative price of goods and services in the two countries. The problem is that such a real exchange rate is difficult to specify because goods and services in the two countries may be valued differently. It doesn’t really make sense to compare the prices of a Big Mac and a pair of blue jeans in the U.S. to their prices in Thailand or Senegal as a way of calculating an appropriate currency exchange rate. Would it even make sense to compare the wages of an apprentice construction worker or a moderately skilled seamstress?

Underneath all these complications is the fact that exchange rates are partially determined by “market” factors and interest rates. When money is a commodity, currency exchange rates are subject to supply and demand for the currencies. Changes in interest rates paid on loans in a specific currency will affect the demand for that currency, and speculators may have as much influence on exchange rates as changes in technology or resources. This means of course that there are psychological factors involved in the determination of exchange rates. If investors believe interest rates are likely to change or inflation is going to undermine the currency of a given country, the demand for the currency will change and its “price” will change. The net result of all this is that the “money market” for derivatives based on exchange rates has all the logic of global weather patterns and probably the same potential for destruction.

The current system for settling trade imbalances is complicated by the fact that the dollar functions both as an international currency and a national currency. Instead of settling accounts by transferring gold, nations now hold dollars or dollar-denominated bonds. Some economists argue that using one nation’s currency as the international currency may bestow some advantage initially on that country, but in the long run it will inevitably cause instability. The “Triffin Dilemma,” named after Robert Triffin, the economist who first analyzed it, describes an inevitable conflict between domestic monetary policy and international policy for a nation whose currency is the international reserve currency.119

Under the current system a persistent trade deficit is likely to translate into a large amount of our “public debt” held by other countries (or their central banks) in the form of short-term Treasury bonds. These bonds are held largely because of their liquidity. Even though the return on the bonds may be minimal, they are easily converted into cash to settle trade transactions with the U.S. or even other countries which are willing to accept dollars. If for some reason the market for short-term Treasury bonds froze up or there was a precipitous drop in their price, then there would be a ripple effect that could spread around the globe like a wildfire.

Obviously without financial markets and interest-bearing loans this vulnerability would go away. The question then becomes how to handle trade imbalances between nations. The solution favored by Amato and Fantacci is a revival of a proposal that Keynes made at the Bretton Woods conference in 1944: an international clearing union which enables multilateral clearing of trade balances denominated in an international currency which is separate from any national currency. Keynes called the international currency the “bancor,” and it was supposed to be purely an unit of account. If international trade balances were ever in a state of complete equilibrium, there would be no bancors in any nation’s account with the clearing union. Any given transaction in international trade would result in credit and debit entries in the bancor accounts of the respective nations, and the system was designed to discourage the accumulation of surplus balances as well as deficit balances. Exchange rates between national currencies and the bancor were to be fixed by agreement but subject to adjustment if trade imbalances exceeded a certain limit.

A clearing union along these lines was actually set up in Europe in 1950 when European countries were still struggling to recover from the devastation of the World War II. The numerous bilateral trade agreements between the countries were replaced with the European Payments Union and many obstacles to trade resulting from imbalances were removed. Countries had favored trade with other countries where they had a credit balance and used restrictive policies with countries where they had a negative balance. With the EPU there was no longer any need for separate trade policies. Having it all come out in the wash with multilateral clearing promoted trade between the countries. The Marshall Plan was tied to this agreement since it was also in the interest of the U.S. to have European economies recovering with the help of intra-European trade.

The key to all this is the fact that money is conceived as a scarce resource, a “commodity” with a “price,” and “financing” therefore requires the “investment” of reserves of cash in some enterprise. If the financing of enterprises in any country is achieved primarily though the extension of credit by the banking system in that country, how would this affect international trade and exchange rates?

A clearing union using an international currency like the Bancor as a unit of account would still need some method of setting exchange rates. It might eliminate the specter of some other nation holding billions of dollars in U.S. debt, but it would not immediately solve the issue of how to set exchange rates for the international currency and all the national or regional currencies. Keynes’s proposal contained incentives to prevent both positive and negative Bancor balances for countries in the union, and it acknowledged that periodic adjustments in a country’s exchange rate my be required if its balance exceeded a certain limit.

When one nation’s currency is used as the de facto international reserve currency it is not possible for that nation to adjust its exchange rate to counter mounting trade imbalances. Any adjustment in the dollar is ineffective if all the other currencies are pegged to the dollar.