Currencies and the by Richard Douthwaite Oct No one seems by carlmartin


									Currencies and the
by Richard Douthwaite( Oct 2007)
                                            omy, demanded that OPEC increase            to spend money on cutting their energy
No one seems to be saying much              production. OPEC’s response, via Qa-        consumption. For example, they might
about it, but world oil production has      tar’s oil minister, Abdullah al-Attiyah,    put in a more efficient boiler or buy a
passed its peak. As the graph shows,        is that “OPEC can do nothing about the      smaller car.
the historic event occurred in the          high price of oil” a tacit admission that
Spring of 2005, and since then, output      the cartel could increase production        In addition, companies interested in
has dropped by about 1.2 percent.           very little even if it wished to do so.     developing renewable energy sources
The experts who have spent the past                                                     will advance their investment plans.
few years predicting the peak have          The higher oil prices that have been a      In short, after a few months of higher
been strangely silent. A Google search      consequence of tightening supply may        energy prices, the demand for capital
reveals that only Professor Kenneth S.      be affecting the US economy already.        goods - rather than consumption ones
Deffeyes of Princeton University, who       The Federal Reserve said in June 2007       - increases. This demand, Bernanke
compiled the graph from US govern-          that spending on personal consumption       believes, will offset the fall caused by
ment data, has been trumpeting that         was rising more slowly “at least in part”   the cut in consumer demand and could
this historic turning point has been and    because of rising petrol prices. What       even increase national income.
gone.                                       the Fed did not add was that that the
                                            higher interest rates it introduced were    What he does not go on to say is that
Rising Oil Prices                           even more to blame. Higher oil prices       because capital goods require a lot of
                                            themselves will not cause an economic       energy to make, the higher prices for
So what will happen now? Well, after        slowdown or a recession in the US or        energy might actually increase energy
climbing to $83 a barrel for the first      anywhere else. If either happens it will
time in late September, the price of oil    be due to the way the world’s central
soared to a new all-time high of $90 a      banks react to the price increases.         So, if higher energy prices are allowed
few weeks later.                                                                        to stand, they can be expected to
                                            It is true that if people have to spend     provide both a boost to the economies
The subsequent fall in price is likely to   more on heating and transport, they         affected by them and to bring forth
be temporary and some energy analysts       will have less money left for other         the capital investment needed to make
are predicting that oil will soon cost      things and that will cause a weakening      those economies less dependent on
over $100 a barrel if OPEC does not         in demand for consumer goods. But,          fossil fuels. In theory, higher energy
raise its output. Earlier this year, the    according to Ben Bernanke1, the head        prices could help propel the transition
US Energy Secretary, Samuel Bodman,         of the Federal Reserve, once the public     to a low carbon economy. In practise
who had previously stated that $80 a        is convinced that the higher energy         however, this is unlikely to happen.
barrel oil could damage the US econ-        prices are permanent, they will begin
e Future of Money
 Since fossil energy is used , albeit in       cause massive unemployment and              of living or in loan repayments. There’s
 differing amounts, to make everything         destroy the price incentive for people to   no escaping it. Allowing inflation is the
 we buy, when energy costs increase, the       use less energy and to develop renew-       only relatively painless way that every
 price of everything needs to go up too.       able energy sources.                        price in the global economy can change
 That, of course, means a general infla-                                                   by a different amount to reflect the new
 tion, something that every central bank       Our politicians must therefore recog-       energy price level. Such an inflation
 has been told to prevent by its political     nise that asking the European Central       would need to run for several years be-
 masters. Many banks are obliged to            Bank (ECB) to maintain the purchas-         cause, initially, firms would put prices
 intervene if the rate of price increases      ing power of the euro when the cost of      up by only the amount their direct fuel
 exceeds 2-3 percent. So, unless energy        one of the two factors of production,       costs rose. They would consequently
 prices rise remarkably slowly, an infla-      energy, is going to rise sharply in euro    require further increases later when
 tion that will prompt the central banks       terms will cause an economic disaster.      the higher cost of the fuel used in the
 to react is bound to come about.              The only way that the overall value of      products they purchase worked its way
                                               the euro could be maintained when           through to them and had to be passed
 Interest Rates                                energy costs are rising would be to         on.
                                               force down the price of the other factor
 And that’s the problem. The central           of production, labour, in euro terms, so    Resisting this inflation would essen-
 banks will attempt to curb the oil-price      that its fall balances the other factor’s   tially be an attempt to maintain the
 inflation by pushing up interest rates,       rise.                                       purchasing power of money in terms
 exactly as they are doing at present.                                                     of the amount of energy it buys. This
 This has a two-pronged effect. First,         In other words, people would have to        is obviously an inappropriate response
 higher interest payments leave bor-           accept massive wages cuts without any       if energy is getting scarcer and/or re-
 rowers with less for personal spending.       corresponding reduction in their cost       quires more resources to produce. Even
 Second, as people are deterred from                                                       so, the EU’s politicians are unlikely to
 taking out new loans, the money supply                                                    give the ECB new instructions and tell
 contracts (or at least grows less rap-
 idly). This also reduces spending power
                                               “In other words,                            it to allow inflation to proceed. We are
                                                                                           therefore heading for disaster.
 and overall demand. So, at a time when        people would have
 demand is slackening anyway because                                                       Local Currencies
 people are spending more on energy,           to accept massive
 the central banks act to restrict it even                                                 A Feasta team I led recently studied
 more.                                         wages cuts without                          the ways in which the Irish economy
                                                                                           might adapt to much higher energy
 The damage the central banks cause            any corresponding                           prices over the next 25 years. We
 does not stop there. Unfortunately, the                                                   concluded that the most likely outcome
 higher interest rates they use to restrict    reduction in their                          was a scenario in which the ECB con-
 demand actually cause inflation,
 because almost every business relies          cost of living.”                            tracted the money supply and collapsed
                                                                                           the economy, causing high and persis-
 on borrowed money and the higher
 interest rates increase its costs. Firms
 naturally attempt to put up their prices
 to maintain their profit margins and
 this causes more inflation to which the
 central banks respond by raising inter-
 est rates yet again. Essentially, econo-
 mies have to be bludgeoned senseless
 before the inflation battle is won.

 So, if the world’s central banks con-
 tinue to fight against inflation the way
 they are doing now, the danger is that
 they will leave the economies for which
 they are responsible so battered and
 bruised that spending and investment
 will drop sharply around the world.
 This will cut energy demand and allow
 oil prices to fall, removing the inflation-
 ary pressures the banks were fighting
 against. But such and outcome would
 be a Pyrrhic victory since it would
tent unemployment2. We called this            omy shrank by 11 percent. Even food
scenario Enforced Localisation because        sales were 10 percent lower, showing
the only option we saw in those circum-       the depth of the hardship.
stances was for many people to adopt
the approach taken in the early 1990s         In response, existing local currency
and try to create islands of local activity   (“trueque”) systems expanded and
(prosperity would be too strong a word)       many new ones were set up. Entre-
by establishing local currency systems.       preneurs even sold kits for start-ups,
                                              complete with printed notes. Because
Fortunately, there’s no need to reac-         systems accepted each other’s notes, all
tivate LETS, the Local Exchange and           notes lost most of their value when the
Trading Systems that many places in           flood of kit money went into circula-
Ireland established then, and which           tion. Many trueque markets closed.
in one or two cases struggle on. Much         This was a disaster because, up to that
better systems have been devised since        point, thousands had been relying on
then, with perhaps the best examples          them for their livelihoods.
coming from Argentina. For years,
governments there borrowed with               Printing New Money
gusto and, since the banks created the
money rather than transferring it from        The tax received by Argentina’s 26
savers, a lot of additional purchasing        provinces dropped sharply during this
power was created. So much, in fact,          period. Buenos Aires province, home to
that prices soared by 4,929 percent in        38 percent of the country’s population,
1989 alone. Wages failed to keep up,          found itself unable to pay its employ-
savers saw their nest-eggs vanish and         ees and to keep schools and hospitals
shops had to adjust their prices every        going. Unable to borrow, it printed
few hours . Riots broke out and forced        its own money – the patacon – and in
the president, Raúl Alfonsín, to resign.      August 2001 began paying with that in-
                                              stead. For a period, public servants got
The Collapse of the Peso                      90 percent of their wages in patacones.

Carlos Menem, Alfonsín’s succes-              Businesses in the provincial capital, La
sor, brought in a law which required          Plata, were divided over whether to ac-
the central bank to hold a dollar in          cept patacones. The Volkswagen deal-
its reserves for every peso in circula-       ership put a sign up saying it would, the
tion. Within four months this strategy        electricity company announced that 60
brought inflation down to 1.5 percent         percent of its bills could be paid in the
and capital poured into the country.          new money and McDonalds offered a
Everything went well until 1994, when         meal called the Patacombo. But Car-
a Mexican devaluation caused a rush of        refour, a big supermarket chain, turned
money out of the country. Bank depos-         them away until it lost so much busi-
its dropped sharply, and the state had        ness that it was forced to capitulate.
to intervene to prevent a banking crisis.
                                              After that, everyone was prepared to
                                              accept the new money. You could pay
                                              your taxes in patacones, keep them in a
                                              special account at your bank and even
                                              get them out of ATMs alongside pesos
                                              and dollars.

                                              Buenos Aires was the ninth Argentin-
                                              ean province to print its own money. By
                                              November 2001 the provincial curren-
                                              cies made up 15.8 percent of the total
                                              cash in circulation nationwide.

Later on, other countries devalued            In December 2001, the federal govern-
too and, trapped by its link to a rising      ment tried to halt the flood of dollars
dollar, Argentina became seriously            out of the country by limiting with-
uncompetitive. By 2000, unemploy-             drawals from bank accounts to 250
ment had soared to around 20 percent.         pesos (dollars) per account per week.
Believing devaluation was imminent,           This aggravated the money shortage
many better-off Argentines rushed to          and caused the circulation of the pro-
turn their pesos into dollars while the       vincial currencies to soar. Eventually,
one-for-one rate held good. As a result,      at Christmas, the link with the dollar
the number of pesos in circulation            was scrapped and by July the following
dropped by 30 percent and the econ-           year, the peso’s value had fallen 3.5 to

the dollar.                                ment, with the power not only to spend
The provincial currencies were with-       its own currency into use but also to tax
drawn in mid 2003. They were bought        it out again. Every other EU region or
by the federal government for pesos        river basin should have its own money
that it was able to allow the banks to     too, each with its own floating exchange
create now that the fixed relation-        rate with the euro.
ship with the dollar had been broken.
Patacones were bought up at their face     For the system to work effectively,
value – one peso per patacon. In other     wages and loans would have to be in
provinces, however, where the cred-        these currencies. As a result, if one
ibility of the issuing governments had     suffered an economic shock that was
been low due to corruption and unwise      not felt elsewhere, the currency could
spending, the currencies fetched less      be devalued, cutting the people’s wages
than their nominal value.                  in relation to those paid elsewhere
                                           without causing employees problems as
The currencies were scrapped for two       far as the repayment of their debts were
main reasons. One was pressure from        concerned.
the IMF, which felt that Argentina
would be unable to control its money       Indeed, the purchasing power provided
supply - and hence its exchange rate       by their wages would only fall to the
and rate of inflation - if the provinces   extent that they purchased goods and
continued to issue their own monies.       services from outside their region. This
Another, more powerful reason was          would encourage them to buy from
that the federal government felt that      regional suppliers whenever possible,
the currencies gave the provinces too      creating new jobs. The lower local costs
much autonomy and might even lead to       would also create employment by mak-
the break up of the country.               ing it more profitable for firms in the
                                           region to supply goods and services to
Nevertheless, patacones were a re-         customers outside it.
markable success. The fact that at one
stage they comprised over a fifth of the   Such currencies would not be in con-
national money stock is evidence of        flict with the political objectives that
that. Moreover, their issue saved many     led to the establishment of the euro be-
people in Argentina from much greater      cause they would not give nation states
hardships than they actually experi-       any additional powers. Instead, they         Refrences
enced.                                     would strengthen the EU by helping to        1
                                                                                          “Oil shocks and Aggregate Macroeconomic
                                           remove regional disparities, making it       Behavior: the Role of Monetary Policy, a reply”,
                                           less likely to break up. Equally impor-      Ben S. Bernanke et al,Journal of Money, Credit and
Europe’s New Regional                                                                   Banking, Vol. 36, No. 2, 2004.
                                           tantly, they would strengthen regional
Currencies                                 governments as a counterbalance to           2
                                                                                         A draft of the report can be found on the Feasta
Quite soon, if the European Central        both EU-level and national-level power.      website at
Bank persisits with its Canute-like
attempt to prevent an inflation driven     Greater Autonomy
by rising energy prices, we in Ire-
land might need to take the road the       The EU should therefore convert
Argentinians took and start issuing our    itself into a real ‘Europe of the regions’
own money. However, this should not        by seeking to remove any legislative         Richard Douthwaite is an economist and writ-
                                           impediments to every major city and its      er with special interest in climate and energy
involve re-launching the punt. That                                                     issues, local economic development and rural
would be a mistake and run into tre-       hinterland launching its own currency        sustainability. His book Short Circuit (1996)
mendous EU opposition.                     to operate in conjunction with the euro.     gives dozens of examples of currency, bank-
                                                                                        ing, energy and production systems which
                                           Although these city-regions would            communities can use to make themselves less
“Each Irish province                       enjoy a great deal of autonomy because       dependent on an increasingly unstable world
                                                                                        economy. Richard is one of the founder mem-
                                           they would raise most of the money
or river basin dis-                        they spent through their own taxes, this
                                                                                        bers of Feasta.

                                           autonomy would not threaten to tear
trict should have its                      the EU apart in the way that either a
                                           return to national currencies or a rigid
own money and pro-                         insistence that Europe must have an
                                           single currency would. Instead, vital,
vincial government.”                       prosperous and diverse regions would
                                           strengthen Europe as a whole.
Instead, we should convince our local
governments to start their own curren-
cies modelled on the patacon. Ide-
ally, each Irish province or river basin
district (Ireland has five) should have
its own money and provincial govern-


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