The worldwide recession induced by COVID-19 pandemic has caused enormous misery across the world. It was the worst recession the world has seen since World War 2 and caused a 3.4% drop in global GDP just in 2020. A surface level analysis implies that the COVID recession was caused only because of the drastic measures, such as the lockdowns, taken to stop the spread of the disease. The reality is that there are deeper underlying factors behind this. If gone unchecked, these factors can continue to cause worldwide economic downturns in the future.
Comparing the interest rates, money supply, and inflation rates of the US, UK and EU over the past 20 years makes it obvious that these economies follow the US. When the US increases its money supply, other countries often feel justified to increase their own since it generates more money for them to spend. This coordinated expansion of money supplies is a contributing factor to global economic crises.
(Correlation Coefficients of the money supplies, inflation rates, and interest rates of the US, UK and EU from 2002-2022)
The pandemic recession is the latest in a long line of economic disasters which have arisen from this monetary alignment. COVID stimulus packages are an example of how countries coordinate their money supply expansion with the US. The US announced its first package on March 6, 2020, followed shortly by the UK on March 11 and the EU on May 27. Though well intentioned, issued in response to the loss of jobs and economic activity due to lockdowns, these ended up being one of the major contributors to present day inflation.
One can argue that the current recession, which affected one third of the planet, was induced by the COVID-19 pandemic’s impact on the health and productivity of people, and not necessarily due to the coordinated monetary policies. But previous recessions that started with local economic mismanagement have also ended up becoming global economic crises. For instance, the Great Recession of 2007-09 started out as an American problem, where the US banks and lending corporations took on too much bad debt. Once the bad debts came to fruition, it resulted in a market crash that eventually spread to other countries. The coordinated monetary policies of countries were a significant contributing factor in spreading local economic malaise internationally. The timelines of the recessions in the UK and the EU corroborate this. The American recession officially began in December of 2007, while the European recession began in the first quarter of 2008 and finally the British one in the second quarter of 2008.
One may ask why expanding the money supply by the governments for public spending is such a bad idea. Expanding the money supply, in simple terms, means printing more money. Printing money out of thin air leads to inflation and hence increases cost of living. To control the rising inflation, governments raise interest rates. This decreases economic activity and often leads to recessions.
How to Tackle Coordinated Global Recessions?
Decoupling American monetary policy from the monetary policies of other central banks in the West could alleviate coordinated global recessions. Countries can then conduct monetary policy as per the prevailing conditions in their local economies and not driven by a desire to align with the dollar. Here are three potential solutions: Keynes’ bancor system, a modified version of Hayek’s competing private currencies system, and cryptocurrencies.
The first method is from the economist John Maynard Keynes. He, along with his colleague E. F. Schumacher, proposed a new system of international trade. In this system, Bancor, a supranational currency would function as a unit of trade. Exports would credit Bancors to a country’s account while imports would add to its Bancor debt. This is an evolution of Schumacher’s proposed multilateral clearing system. The Bancor system is designed to disconnect international trade from the dollar and American monetary policy. However, it would be a herculean task to establish political buy-in for such a system. Countries across the world would disagree over its adoption and who would control it. While the system allows countries to delink from US monetary policy, practical implementation would be fraught with problems and is unfeasible.
The second method comes from F. A. Hayek. In his book, The Denationalisation of Money, the Austrian economist proposed the abolition of government fiat currency and switching to a system of privately operated currencies, treating money like any other commodity. In Hayek’s model, the money with the most stability, reliability and purchasing power would win in the competitive market and be widely adopted. However, the lack of government control over money is impractical in today’s environment. No government would voluntarily give up control of their nation’s currency, citing instability of private currencies and fragmentation of the payment settlement system.
Hayek’s system can be modified for international trade, however, instead of competing private currencies, we would have competing national currencies. Exchange would not be conducted solely in dollars, rather, it would be conducted in whichever currency countries wish to trade in. This would diversify foreign exchange and alleviate a dollar dependency. An example of this system would be the direct rupee-rouble trade between India and Russia after Russia was sanctioned by the West for perpetrating the Ukraine war. The issue, though, with this system comes in the case of a trade imbalance. If country A holds a balance of payments surplus with country B, it is left with currency it can’t use anywhere else except with country B. In fact, in the previously mentioned example of direct rupee-ruble trade, the Russians have now stopped accepting rupees for this very reason.
Cryptocurrency is the third potential solution. It is the closest we have come to a unified medium of international trade settlement since gold. It can be used for international trade, wherein the trade takes place through cryptocurrency, which can be converted back to the local currency afterwards. Cryptocurrency has certain unique advantages that make it more usable than the dollar for international trade. Countries can buy cryptocurrencies like bitcoin, rather than it being distributed by a supranational authority, like in the Bancor system. Also, cryptocurrencies can be purchased with any national currency, thereby solving one of the problems with direct trading. A country can use their hold of surplus currency to buy cryptocurrency, which can then be used to trade with any other country, since they are not independent of the influence of any one government. However, this also comes with certain practical problems. One, the excessive volatility of cryptocurrencies could discourage countries from conducting their trade through them. The current situation of cryptocurrency in the US has been quite chaotic though, post the collapse of one of the largest exchanges, FTX. This results in a catch-22 that we often see: cryptocurrencies only become stable if they attain widespread adoption, but unless they are stable, people are not willing to adopt them. Also, countries like China dislike cryptocurrencies as it compromises their sovereign right over money supply. In such cases, countries like China can use cryptocurrency for international trade, while continuing to enforce the ban on retail usage. Only the Chinese central bank would have access to cryptocurrency and all trade would flow directly through their central bank. Yet, the concept still stands as a good one if crypto manages to achieve sufficient stability as it matures and derivative markets emerge.
Countries across the world are realising the disadvantages that come with trading in dollars. As more and more economies de-dollarise over the next few decades, we could see significant transformations in how international trade is conducted.
In the long run, private market players and global governments would have to use a combination of all the above approaches to decouple themselves from the dollar and attain true financial independence. As cryptocurrencies mature and associated derivative instruments bring stability, these digital currencies could become the future of international trade.
Saaketha Nalamotu is associated with the Fellowship for Freedom in India.