Dugger's Theorem: The Free Market Is Impossible: Remarks upon Receiving the Veblen-Commons Award

By Dugger, William M. | Journal of Economic Issues, June 2005 | Go to article overview
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Dugger's Theorem: The Free Market Is Impossible: Remarks upon Receiving the Veblen-Commons Award


Dugger, William M., Journal of Economic Issues


In Memory of Allan G. Gruchy

New disputes are always arising in a market. If resolved, they result in new rules. If unresolved, they can accumulate until the market breaks down. I will address seven of the issues around which rules and disputes have swirled: (1) the international payment mechanism, (2) information, (3) second mover advantage, (4) trading rights, (5) property rights, (6) enforcement rights, and (7) sanctions. (See Fernand Braudel's great history [1981] for the long view of the market.) After a brief discussion of these issues, I state my conclusions and suggest implications.

Issue 1: The International Payment Mechanism

The international payment mechanism is extremely important but widely taken for granted. It is also the most complicated of market issues. Therefore, my discussion starts with it and devotes the most space to it. The international payment mechanism is best understood by looking first at the foreign exchange market and then at the Bretton Woods system.

The foreign exchange market works according to a set of rules that are largely informal expectations of appropriate behavior. Those rules have changed dramatically over time. Up until the Great Depression, countries were expected to follow the rules of the gold standard, more or less. Nations had come to rely upon central banks as domestic lenders of last resort and tried to maintain a constant value for their currency in terms of gold. As it evolved, the gold standard also came to use the British pound as a key currency. (A classic financial history is Kindleberger 1996.) The whole system collapsed, however, during the Great Depression. The Bretton Woods system replaced the old gold standard after the Second World War. It started out as a fixed exchange rate system but changed into a floating system when the USA floated the dollar in the early 1970s. Today, each country is expected to maintain an exchange rate for its currency consistent with a rough and ready balance in its imports and its exports, with due allowance made for appropriate flows of financial funds into and out of the country. This expectation of global balance arranges countries into two groups, those who can and those who cannot meet the expectation. (See the technical note at the end of the text for a discussion of balance of payments accounting.)

The countries who can meet the expectations have hard currencies while other countries have soft ones. The countries with hard and soft currencies live on two opposite sides of a great divide separating the haves from the have nots. The countries with hard currencies have highly developed economies. Their currencies have stable exchange rates. They are usually powerful nation-states. Their people are predominantly pale and rich. They are in the "First World," where only a small portion of the human species lives. Their governments make the rules of the foreign exchange market. The rules work in their favor. They can usually follow the rules with ease. They are led by the United States.

The United States not only has a hard currency but it also has the key currency. The key currency has replaced gold as the principal form of official government reserves. The country issuing the key currency is the most powerful country in the nation-state system and is an ongoing contradiction. It is expected to run a balance of trade deficit while maintaining a roughly stable exchange rate. Occasional rate adjustments are to be expected, but the key currency country's trade deficit must result in sufficient payment outflow to provide the growing pool of official reserves needed by the other countries' governments. The U.S. payment deficit provides the liquidity needed for the global trading system to grow. While most countries that run huge trade deficits are accused of living beyond their means and are usually forced into making some very painful choices on pain of the collapse of their currency, the global payment mechanism in use today requires the USA to continue running huge trade deficits.

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