Against the Tide

XVII

D—Mark and Dollar*

We seem to be inured nowadays to the unusual and the unprecedented. Yet even for us it should make sensational reading that the United States government is trying to lay its hands on part of the German foreign exchange reserves in order to speed up and facilitate the re-equilibration of the American balance of payments. To begin with, it is striking enough that this is not even couched in the form of a request but put forward as a demand, which, together with indignation about the Germans’ unwillingness, thus is in all the more blatant contradiction with the principle generally accepted so far, at least among the economically highly developed countries, that it is the economic and monetary policy of each nation’s government and central bank that are primarily responsible for its own balance of payments.

The demand has other unsual features. One’s memory would have to be very short indeed if one remained insensitive to the charm of such a demand, addressed by the leading and the richest economic power in the world to a country that only ten years or so ago was regarded as a cripple barely able to stay alive, and that the very economists who are now close to the American government branded as the prototype of a country bent on a catastrophic economic policy. To choose such a country for such a remarkable demand, with the explanation that it is the richest, is perhaps not a very polite form of belated tribute to the economic policy that brought that country to its present state, but it is all the more sincere for that.

It is, then, significant that Germany is the only country to which such an American demand has so far been addressed, and it will repay thinking over why this should be so. It needs no explanation that the government that puts forward this claim is, apart from any other motives, following the line of least political resistance, which means, among other things, that it feels especially sure of the political and ideological loyalty of the country chosen for this demand. If it is held to be good politics to aid those countries whose loyalty is in doubt, it needs only a step to reverse the flow of funds when a country not only appears to be financially strong but also seems to give no cause for concern as regards its loyalty. This can be considered a sort of distinction.

But leaving this circumstance aside, and assuming that the only determining factor is the financial strength of the countries that could possibly be approached for help in equilibrating the American balance of payments, the case still is not fully explained. The gold and foreign exchange reserves of Italy and Switzerland, too, have been rising steadily in the last few years and at a rate quite comparable to Germany’s. If that were enough to motivate the American demand, one may well ask why Washington did not approach Rome and Berne as well. This would, of course, not be a clever thing to do, but apart from this purely tactical consideration, there must surely be some other reason that has to do with the economic peculiarity of the German case.

This is the crux of the matter. More will have to be said presently on whether the American approach to Bonn is justified by convincing economic logic. But even though, as will probably have to be concluded, it is nothing but the translation of bad economics into world politics, it does give expression to a few undoubted facts. The American demand on Germany is not the product of arbitrariness and chance. On the contrary, it dramatically underscores two circumstances. The first is that, similar developments in Italy and Switzerland notwithstanding, Germany does occupy a special position in this respect, insofar as year after year it chalks up balance-of-payments surpluses, which for various reasons have caused the problem of imported inflation to be more pressing, more stubborn, and more intractable in Germany than in any other comparable country. The second meaning of the American demand is that it establishes a link between the balance-of-payments difficulties of the United States and the opposite ones of Germany. The deficits on one side and the surpluses on the other are, in fact, inseparable parts of one and the same worldwide economic process that seriously upsets the balance of international payments, a sort of earthquake in the world economy with the United States and Germany as the two epicenters, not for the first time in modern economic history.

It is no exaggeration to describe the gravity of the problem in these terms, as witnessed by, inter alia, the clash of opinions in Germany regarding the nature of the problem and its best solution. This clash is not incomprehensible if thought is given to what is at stake and what the opposing groups are after.

One of these groups stresses the danger of external surpluses for the domestic purchasing power of money and maintains that the only way of averting this danger is to up-value the external purchasing power of the D-mark. That this group is in a strong position is apparently not denied even by its opponents. There is no easy answer to its argument that the danger, of which it has been warning for years with logic hard to refute, has for some time now begun to materialize, and that all the measures taken against it—barring the one of raising the external purchasing power of the currency—have proved ineffective, both against the source of the domestic diminution of purchasing power, that is, the inflationary effects of the balance-of-payments surplus, and against this diminution of purchasing power itself.

To be sure, economics is notoriously a field of conflicting opinions, but, so the representatives of this group maintain, there has seldom been a case so clear-cut and so compellingly logical as the one here under discussion, and in economic policy hardly another case where all considerations speak so overwhelmingly in favor of one single measure, namely, to raise the external value of the German currency in order to save its internal value. But this is the one measure that is unacceptable to those who officially or unofficially determine the course of German economic policy. They have marshaled continuously changing reasons, one less convincing than the other, in an attempt to explain their refusal to the public, which, of course, is easily confused in money matters, and in so doing have displayed unusual intolerance for the counterarguments originating largely from professional economists. For the representatives of the first group this is a most discouraging experience, which serves better than most to illustrate the almost insuperable difficulties of conducting a sensible economic policy in our day.

The first group feels that its patience is being tried almost beyond endurance, for the price that has to be paid for the rejection of their recommendation seems to be rising all the time, while the chance of deriving some benefit from following it is diminishing to the extent that the danger to be averted, imported inflation, is becoming a reality. While it is getting increasingly harder to deny the upward push of costs and prices inflated by the overheated boom and overfull employment, and while obviously nothing can be done about it by persuasion, and while the monetary restrictions applied from time to time are bound to make the external source of inflation gush all the more strongly, the temptation grows to ease the pressure of external surpluses by artificially expanded capital exports. Whether this expedient would be effective is highly doubtful, but it would most certainly denude Germany of resources and make a country still relatively poor in capital even poorer. Now that the Americans are making ready to take part in this preposterous game of pumping, they are told that German balance-of-payments surpluses must not be confused with German wealth of capital. Such a confusion does, in fact, rest on a mental short circuit unforgivable in a professional economist. But it is often overlooked that the same confusion underlies the plan to combat balance-of-payments surpluses by government-promoted capital exports. The mistaken assessment of Germany’s capacity to pay, as expressed in the American demand, has previously been fully shared by responsible Germans, and it is encouraged by all those in the second group who explain the German external surplus as being in large part due to the dollar expenditure of the American army stationed in Germany, thus unwittingly giving the Americans their cue.

There was never any reason to doubt that a country such as Germany—and Germany less than any other country, for the topsoil of international goodwill is there still extremely thin —could not go on year after year sucking up gold and foreign exchange like an ominously thumping, giant suction pump, without becoming subject to increasing pressure to do something to ease the situation of those pumped empty. Germany will have to pay ransom, and this now has to be added to the high price to be paid for a policy that fails to find an effective solution to the problem of imported inflation. The ransom has to be added to the rise in costs and prices, to the boiling temperature of overfull employment, and to the strains and stresses caused by the ineffective measures against the import of inflation. This is all the more provoking as the moment approaches when the domestic diminution of purchasing power will eventually prove inescapable, the bitterest entry of all to close this bitter-enough, giant reckoning.

So much for the first group. In contrast with it, the second group, the opponents of revaluation, have long been in the weaker position, on the defensive. Their embittered resistance is not quite inexplicable; there are a number of reasons for it. First of all, there is the conflict of interests. While the first group cannot seriously be reproached with selfish motivations, since defense against inflation has always—at least so far—been acknowledged as being eminently in the public interest, it is obvious that in asking for measures against this special form of inflation they are affecting important, sensitive, and very well-organized group interests, that is, the interest of export industries and all the other beneficiaries of an inflationary super-boom. It is true that the advocates of revaluation are not, after all, suggesting that those so affected should sacrifice their special interests to the common interest. It had been thought that it was enough to appeal to an enlightened and farseeing egoism as against an unenlightened, shortsighted one, since the export lead deriving from the undervaluation of the D-mark was bound to be eroded by the rise of domestic costs and prices, so that the only question was whether the special position of German exports was to be brought to an end by external increase or by an internal decrease of purchasing power, with or without hardship to the savers and owners of life assurance policies. But it seems that such an appeal demands more than it was thought reasonable to expect.

There are yet other considerations which must be given their due if justice is to be done to the second group, the opponents of revaluation. It has to be conceded that inflation of such dimensions fed by balance-of-payments surpluses is a novelty rather taxing for people’s capacity to reason and make decisions. It is true that Switzerland, rightly regarded as the paragon of conservative monetary policy, gave the example of how to stop the import of inflation by revaluing the currency, when for years after the last war it deliberately allowed the dollar rate for other than export proceeds (finance dollar) to decline. But this example has generally fallen into oblivion and, in any case, it needs an expert to understand it. Furthermore, to alter the exchange rate is in fact something unusual and contradicts the ideal of a stable external value of money, an ideal that certainly has a lower priority than that of a stable internal value of money but still should be infringed upon only in emergencies. To alter the exchange rate even in the direction of revaluation, otherwise always regarded as something most desirable, cannot, therefore, be an easy decision for a government and a central bank that, for reasons deserving respect, regard stable exchange rates as a lofty aim. And thus they have clung to every conceivable argument that might absolve them from the choice between the once only sacrifice of this aim and the irrevocable sacrifice of the even higher aim of defense against inflation. It is a tragedy that in so doing they only got caught more deeply in the dilemma and had to pay for their hesitation a price that kept rising and is only now apparent in its full measure.

To do justice to the second group, finally, the subject of the controversy must be seen in the international setting to which it belongs. The particular form of inflation under discussion has not primarily come about through monetary laxity in Germany (or Switzerland), but in other countries. What gives it effect is that Germany has been so successful in combating the other forms of inflation that it now finds itself saddled unexpectedly with the new form of imported inflation, but when trying to combat it with the weapons that proved effective in the defense against other forms of inflation, discovers them to be blunt against this insidious form and now lacks the political strength to apply the only remaining effective weapon—that of adjusting the exchange rate, unusual though it is and repugnant to every honest central bank governor. Germany, like Switzerland, has gotten into such difficulties only because the world is still without an international monetary system that enforces an alignment of monetary discipline as the old gold standard did. Imported inflation, therefore, is an expression of a serious defect of today’s world economy. It is a shock imparted to the balance of payments of these countries by other countries that are suffering from the opposite trouble of massive external deficits and thereby are exporting their own domestic inflation, which is fed by well-known internal sources. The leading position among these other countries has for some years been occupied by the United States.

This, roughly, is how the two fronts face each other in this embittered battle of opinions. With the best will in the world for doing justice to the second group and understanding its position, the inescapable conclusion is that the factual arguments of the first group are in large part irrefutable and for the rest are more convincing. Although everything essential has by now been said by both sides, the discussion keeps throwing up new points of interests. This applies especially to Professor Rudolf Meimberg’s soberly factual and therefore engaging study Zum Streit über den Wechselkurs der D-Mark1 but also to the contributions to the debate recently published by the Frankfurter Allgemeine Zeitung of January 28, 1961.

Most interesting of all was the method with which the American economist Professor M. Palyi, who rightly enjoys a high reputation in Germany as well, intervened in the debate to lend a hand to the opponents of revaluation. They celebrated this intervention as a triumph of their cause but realized perhaps too late that it really means a reductio ad absurdum, if so intelligent a man feels compelled to sacrifice all other positions and limits himself to an all but authoritarian condemnation of any alteration of exchange rates as dirigiste—as though a stable exchange rate were not in any case a “political” price requiring to be “directed” by the central bank, and as though in many cases, such as that of the French franc or of the peseta, there had eventually been any other way except to alter the exchange rate. For the rest, there is nothing for it in his eyes, and inflation simply has to be imported. Here, at last, is the admission that in fact the choice does lie between imported inflation and revaluation; while this has the merit of honesty, it is purchased at the price of cynicism. Whoever now cold-bloodedly opens the floodgates to imported inflation is indeed safe from the reproach of double-dealing but has to accept blame for having shamefacedly or shamelessly capitulated to inflation, which so far had rightly been generally termed a crime. He forfeits any credibility as an opponent of inflation, in any shape or form.

After these critical remarks, I am all the more pleased to find myself in full agreement with Professor Palyi on the point that the opposite balance-of-payments trouble of the United States, which directly or indirectly is the main source of Germany’s imported inflation, is essentially the consequence of internal inflationary pressure. To put it more precisely: the American balance of payments has ceased to be in equilibrium because in view of all the circumstances, including especially the economic recovery of Europe and Japan and their increased competitiveness, the United States has become too expensive and less competitive under the impact of domestic inflation, mainly of the wage-push type, and has failed to reconcile the total volume of domestic income and expenditure with its external payments. The Wall Street Journal of January 26 puts it neatly by saying that it is as clear as anything could be that the United States got into their present difficulties by paying out too much abroad and, at the same time, by giving free play at home to deficit spending and inflation. Contrary to some other strange theories given currency, even by people who have to be taken seriously, this is the only diagnosis of the American balance-of-payments crisis that fits the facts and answers economic logic. It is gratifying to note that this opinion is shared by some of the most distinguished American economists, as witnessed, above all, in the article by Professor Gottfried Haberler, of Harvard University, in the January issue of Lloyds Bank Review. But, of course, this was to be expected.

Since the war the United States has chronically suffered from domestic inflation, now wage inflation, now budget inflation, now investment inflation. But as long as the European countries and Japan were economically weak and for the rest outdid the United States in inflationary policy, the strange result was that American inflation was associated with a dollar shortage. But once these countries had powerfully improved their capacity to produce and compete—and in addition had learned monetary discipline, while in the United States wage inflation, especially, continued, and American competitiveness was impaired by trade union and fiscal policy—the dollar shortage turned into today’s “dollar flood,” even though at long last visible progress was made under President Eisenhower in the battle against inflation.

This diagnosis is at the same time the explanation for a very strange phenomenon. I have in mind that fact that, contrary to all experience and expectations, cyclical stagnation in some parts of the world economy, notably in the United States, is associated with high balance-of-payments deficits and an unprecedented boom elsewhere, especially in European countries such as Germany, Switzerland, and Italy, which have high external surpluses. One would have expected the exact opposite, and the normal course would have been for the stagnation tendencies of the United States to spread to the industrial countries of Europe via a flow of payments and a borrowing in the opposite direction, from Europe to America. Thus, the American sneeze would have given Europe the flu, or worse. Nothing of the kind happened. Europe skips about all the more merrily, the more America keeps coughing. The profound reason is that the causal chain in the United States begins not with stagnation, but with a swing of the balance of payments into deficit as a result of the circumstances described, and it is this deficit that generated stagnation at home and inflationary surpluses in Europe and, via the latter, an overheated boom and overfull employment.

But this diagnosis also provides the key to the cure of the dollar weakness. American credit and monetary policy must set their course toward restriction until domestic inflation disappears and with it the external deficits. That is the crucial point, and no deflection from it is permissible by references to the high foreign payments commitments of the United States. What is to be thought of such popular references I had occasion to discuss a few months ago in my article “The U. S. Balance-of-Payments Crisis: Diagnosis and Treatment.”* The Eisenhower Administration was, therefore, on the correct course in keeping the country short. If it is blamed for not being consistent enough, it is only fair to make allowance for the predicament in which the U. S. executive and central banks find themselves in view of a wage inflation so strong and so stubborn that they would have to turn off the money and credit tap more sharply than they dare, in view of the slowdown caused thereby. The result might easily be a combination of stagnation, further price and wage pressure, and an external loss of blood continuing unarrested.

By contrast, President Kennedy, to judge by his program as announced, is hardly on the correct course so far. This is the distressing but inescapable conclusion. Homoeopathy is being undeservedly discredited by an attempt to cure an external deficit, such as the United States suffers from today, by an increased dose of its cause, namely, monetary expansion. This is all the more regrettable, as the new President should not find it too difficult to solve the dollar problem with the correct means without inflicting paralyzing stagnation on the country. The answer is to combine a policy of continued monetary and fiscal discipline with tax reliefs for undistributed profits and with an effort to persuade the trade unions, surely a promising approach in the case of a Democratic president notably sympathetic to the labor movement.

Such a program holds out the prospect of all the quicker success and all the fewer sacrifices for the United States, and the more it can count on help from the European end. It is quite natural that Washington should look first to Bonn in this connection, for the D-mark does in fact exercise a suction effect that can no longer be denied. It is not good politics and is even less good economics to take the money back from the Germans in more or less elegant fashion and via more or less plausible detours. But the Americans are not in the wrong in expecting something of Germany. There are only two things Germany can do. Either Germany does what recently a group of Kennedy’s advisers in an excess of cynicism suggested the Bonn government should be forced to do, namely, to administer a hefty dose of inflation to the German economy, or else, if this is repudiated with overwhelming justification and understandable indignation, Germany must at long last offer Washington the revaluation of the D-mark. If it does neither the one nor the other, it will have an extraordinarily difficult task in protecting its till. Thus, the right treatment for the dollar has its counterpart in the right treatment for the D-mark.

* 1961.

* See Chapter xv of this volume.—Ed.

1 Frankfurt am Main, Fritz Knapp Verlag, 1960.