Aspects of the Pathology of Money

11 Currency Convertibility—Now1

U.S. foreign economic policy, 1945–53, has been a $40-billion disappointment.

It cannot be called an outright failure because the vast sums we have donated abroad have unquestionably contributed some stability, economic and political, to our allies. In several countries, at several times in the past eight years, our dollars did achieve a minimum, negative objective: to prevent chaos. But our dollars have conspicuously failed to create on this side of the Iron Curtain a community of economies capable of balancing their own accounts and paying their own way. All our aid, in short, has failed to create a system of multilateral trade and convertible currencies.

Convertibility is a somewhat technical subject—one of the most portentous technicalities the U.S. businessman and the U.S. politician must deal with. Convertibility is the key to a healthy international movement of goods and capital. The prosperity and indeed the security of the U.S. are deeply involved in the failure to achieve convertibility of the free world’s currencies.

The failure is not America’s alone, of course. But for a variety of reasons, the decisive moves towards freely exchangeable currencies can come only from the U.S. And in the months ahead the U.S. is going to be hearing more and more about its responsibilities and opportunities in this area:

In Washington this month the governors of the International Monetary Fund and the International Bank for Reconstruction and Development will hold their eighth annual meeting. The top monetary-policy makers of fifty-two countries will be waiting to hear whether the Eisenhower Administration has a foreign monetary policy. (At the Mexico City meeting last year it was evident that the Truman Administration did not have one.)

As Congress this summer debated foreign-aid funds, it was clear that ‘donation diplomacy’ had just about run its course. But for all its growing distaste for giving the American voters’ money to foreigners, Congress has not yet accepted the alternative: a loosening of restrictions on trade, including restrictions on imports into the U.S. When and if Congress is willing to let the free world earn more dollars in this market, it will find that this reform will not really pay off unless accompanied by measures looking towards full convertibility of the free world’s currencies.

Now in power in Western Europe—though for how long nobody can say—are governments strongly disposed towards convertibility. In the first five post-war years, and especially at the peak of American aid, much of Western Europe thought it had discovered a new era of monetary knowledge in which it was possible for a country to do what it pleased at home and yet balance its external accounts. It was possible—so long as the U.S. donated the extra dollars every year and so long as import quotas and exchange restrictions remained in lavish use. In 1951 the tide began to turn. By the end of 1952 the Continent had returned to the tenets of economic liberalism, hinged on the time-honoured belief that a country’s external solvency depends on the nature of domestic policies and especially on the avoidance of inflation. (See ‘Western Europe Rediscovers Money’, Fortune, September 1952; reprinted in the present volume, pp. 243 et seq.) This rediscovery, to which, by the way, the U.S. had made no contribution, opened the doors wide to monetary reconstruction and currency convertibility.

What have we done about it? Very little—either in the closing months of the Truman Administration or in the opening months of the Eisenhower Administration.

What should we do about it? A very great deal indeed. Below, we shall outline some of the elements of an American foreign monetary policy, but first let us be quite sure we know what convertibility is and why it is so important, not only for our allies but for our own national future.

The Old Freedom

No U.S. businessman in his thirties, forties, or fifties has first-hand knowledge of a world of fully convertible currencies. But there was such a world, before 1914. In those days convertibility in a currency was, as someone has remarked, like virtue in a lady: part of the definition.

Within each country the various currencies were convertible in gold or silver or foreign exchange. Notes issued by the central bank were predominantly backed by precious metals and by bills of trade representing goods in production or goods in transit, rather than by government securities. The volume of circulating media would fluctuate in accordance with the changing volume of trade (as represented by bills of trade rediscounted by the central bank) and the changing position of the country’s balance of payments (reflected in the central bank’s holdings of precious metals). But fluctuations in the condition of government finances did not have any significant bearing upon monetary circulation.

National currencies, regulated by the semi-automatic system, were freely transferable into other currencies, at their owner’s wish, without permit or licence. Because under the gold standard each national currency was convertible into gold, its transfer into any other currency could take place at rates fluctuating but mildly around a fixed parity. The question of altering a once-established parity, when a country’s economic conditions underwent some fundamental change, was not seriously discussed in those days. But the logic of the system might easily have admitted of such an alteration, provided it was made only in cases of major and fundamental maladjustments and provided it was carried out by mutual consent of the various parties concerned.

The essential feature of a world economy in which currencies are fully convertible is the ensuing freedom of international payments. This means that anybody can spend or invest his money wherever he wants without first obtaining an official licence or permit.

The fact that buying power can be transferred from one currency into another at the market rate of exchange without licence or permit and without restriction assures the world economy of an almost homogeneous monetary circulation comparable to that which exists inside a country. This means, in particular, that price movements taking place in the various countries are related to one another, that their economic fluctuations are organically connected and largely ‘synchronized’, and that the problems of economic growth and stability are viewed in a world-wide rather than in a purely national perspective. Once this concept prevails, an important safeguard against policies of narrow economic nationalism comes into being.

Freedom of international payments is also—and most importantly so—a condition without which multilateral trade cannot expand and flourish. Exchange control, i.e. the subjection of foreign payments to governmental licence and control, tends to favour the bilateral settling of accounts between countries while restricting the aggregate volume of world commerce. If multilateral trade is to flourish, the elimination of exchange controls must be paralleled by the elimination of import quotas. As methods of controlling international economic transactions, exchange controls and import quotas are, of course, intimately related and either of them can serve, up to a point, as a substitute for the other.

Relaxation versus Reform

The basic concept and benefits of convertibility have become obscured, unfortunately, in some of the recent discussions of ‘practical’ policy. Thus Sir Dennis Robertson, one of Britain’s foremost academic economists, addressing the Vienna Congress of the International Chamber of Commerce last May, devoted half of his address to the meaning he personally would attach to the word ‘convertibility’. He had been invited, he said, ‘to discuss the internal and external conditions requisite for the restoration of something called convertibility’. If he were to do that in the short time allotted him, he must ask certain preliminary questions: ‘What exactly is the projected change which we are invited to examine? What persons, who at present are not allowed to do so, are going to be allowed to convert what into what, by what method, on what terms, and for what purposes?’ Robertson’s answer to these questions resulted in his giving the concept of ‘convertibility’ a very limited scope indeed. He discussed only the dollar convertibility of the pound sterling and that only for certain purposes. In other words, he devoted his attention to the problem of relaxing British exchange control and not to that of restoring full convertibility.

Now, from the point of view of an American reflecting upon the future of international economic relations, upon the kind of world economy the U.S. should strive for and the contribution we should be making to its achievement, nothing short of full convertibility will do. This ambitious goal cannot, of course, be reached overnight.

The American Stake

But only when full convertibility has been won will the American investor be able to invest abroad in full assurance that the sole risks he has to face are the usual business risks and that he is free from arbitrary action by foreign governments, especially those that result from the administration of exchange control; it is only then that the American exporter will be able to develop foreign markets without fear of losing them again through the application of discriminatory quotas or exchange restrictions; it is only then that the American productive system will be able to look upon the entire world as its market in full confidence that the ‘merit system’ prevails and that the principles of free markets and free enterprise are acknowledged and respected.

Full currency convertibility means the restoration of the freedom of payments not only on certain transactions but on all of them, including capital movements. It means the elimination not only of exchange control but also of import quotas. It involves convertibility not on a regional basis alone but over the widest possible area, i.e. the largest possible part of the non-Soviet world.

It follows that we must be on our guard against semantic abuses; we must reject, in particular, every attempt to apply the term convertibility to what is merely a liberalization of exchange control and a limited improvement in the transferability of currencies. We must, similarly, realize that arrangements such as the European Payments Union are not a step towards full convertibility but merely a means of alleviating some of the consequences of inconvertibility. The EPU must of necessity go from crisis to crisis because the network of payments that it is designed to clear is not closed and balanced but open and lopsided. Unless we set our sights high and keep them so, we can be entirely certain of getting lost on the way.

A Chronic Shortage?

The dispute over the feasibility of full convertibility is, in effect, a dispute over whether or not there exists in the world a structural and incurable ‘dollar shortage’. Those who believe that there is a fundamental ‘dollar shortage’ conclude that dollar convertibility cannot be obtained and that sights must be set much lower. Such authorities as the Economist of London, Robert Marjolin, the able Frenchman who is Secretary-General of the Organization for European Economic Co-operation (O.E.E.C.) in Paris, Professor John H. Williams of Harvard, to name but a few, are convinced, for reasons that are not necessarily the same in each case, that there exists a basic disequilibrium between the American economy and that of the outside world. They are skeptical, to say the least, about the chances of establishing full convertibility and are persuaded that discrimination against American trade will remain an integral part of international economic relations.

This point of view is controverted by other authorities of no lesser rank, such as Professor Lionel Robbins of London, Jacques Rueff, the prominent French economist, Per Jacobsson of the Bank for International Settlements in Basle, and Jacob Viner of Princeton, again to name but a few. It is the view of this latter group of experts that there is no structural disequilibrium in the economy of the free world. They argue that a proper adjustment of exchange rates and the acquisition of sufficient monetary reserves by various countries, coupled with the pursuit of appropriate domestic policies and all-around trade liberalization, would result in an environment favourable to the achievement and maintenance of currency convertibility.

There can be no doubt that inflationary policies, combined with the pegging of exchange rates at artificial levels, have been responsible for a large part of the payment difficulties of the post-war years. Once they have been reversed—and much progress has been made of late in that direction—there is no valid reason why international accounts should not remain in balance for an indefinite time to come, subject only to reversible fluctuations of relatively short duration.

Those economists who believe in a fundamental structural disequilibrium between the dollar and non-dollar areas will dissent from this conclusion. But only if it should develop that great difficulties remain even after domestic economies have been made solvent and international transactions and payments freed from crippling restrictions, can the contentions of such pessimists become guides to policy. To follow their advice now, to accept trade discrimination as inevitable and convertibility as unattainable, would be an act of sheerest defeatism.

A Policy for the U.S.

Assuming, then, that convertibility can be attained, it is the contention of this article that it must be attained soon if it is to be attained at all. This, in turn, requires that the U.S. Government treat as a matter of real urgency the development of a bold and farsighted foreign monetary policy. Such a programme could be divided into three phases:

(1) Achievement of full currency transferability on current account without necessarily eliminating import quota restrictions against dollar goods.

(2) Following as rapidly as possible upon the completion of phase 1: elimination of import quotas and trade discriminations.

(3) Restoration of full freedom to capital movements and elimination of the last vestiges of exchange control. A lengthy period might have to elapse before we could enter this phase, which requires a far more substantial degree of international confidence than now prevails or can be anticipated in the near future.

Here let us examine the critical first phase more closely. The restoration of currency transferability on current account corresponds to what is frequently and mistakenly regarded as the convertibility problem. But in order to achieve even this first, limited objective, national inflations must be brought under full control and safeguards adopted against their recurrence; central banks must have adequate reserves in gold or dollars in order to meet temporary payments deficits; and free foreign-exchange markets must be restored.

All of these measures, let it be acknowledged at once, present very difficult practical problems, political and economic. Inflations seem to be politically more acceptable than are the stern financial measures that prevent their continuation or recurrence. Governments now in power in Western Europe have accepted the political handicap of anti-inflationary policies on the assumption that currency convertibility and freer trade will follow within a reasonable time. Should the delays become too great, however, these governments might be swept out of office by popular discontent, thereby jeopardizing not only currency convertibility but the entire system of Western co-operation, political as well as economic.2

The discovery of economically correct parities between currencies is as difficult as it is important after nearly two decades of exchange control and ‘pegged’ rates. Foreign-exchange rates must be given enough flexibility to find new equilibrium levels. Thereafter, fluctuations around these new parities should be kept within reasonably narrow limits, albeit less narrow than those that prevailed before 1914. These elements of flexibility will contribute to making future convertibility more secure.

The Crucial Reserves

There remains the thorny question of central-bank reserves. No one denies that the reserves of the United Kingdom (representing the sterling area) and of a number of Continental countries are inadequate at the present time. We run into trouble, however, as soon as we try to define ‘adequate’. There is, of course, no clear-cut quantitative definition. Much depends on the success of anti-inflationary policies, on the prompt finding of ‘correct’ foreign-exchange rates, and, most of all, on the return of public confidence in the various currencies. And the continued unbalance in the foreign payments of the U.S. renders the achievement and maintenance of adequate reserves abroad more difficult. This is why free transferability on current account will have to precede the end of all discrimination against dollar goods.

The future of convertibility will largely depend upon the speed with which the problem of reserves is solved. The year 1952 was one of growing monetary soundness in numerous countries with inconvertible currencies; 1953 has been, in most respects, a year of marking time; 1954 must become the year of improving international liquidity.

There are several theoretical ways in which the countries of the Western world could increase their reserves but most of these are outside the realm of practical policy.

Although a liberalization of U.S. commercial policies must become an integral part of U.S. foreign policy, no large and immediate increase in foreign reserves via dollar earnings is in sight today.

Nor is there much chance of expanding foreign reserves by raising the world price of gold. In theory, and indeed in the light of considerable historical experience, there is much to be said for an increase in the price of gold from $35 an ounce to as much as $70. Many economic authorities argue that much of the economic instability that culminated in the depression of the thirties could have been avoided if, around 1925, the price of gold had been raised from its 1914 level, thereby acknowledging the depreciation of money in terms of goods that took place in the intervening decade. Today, of course, despite another world war and post-war inflation, the official price of gold is still what Franklin Roosevelt said it should be back in 1933. And the fact is that the U.S. Government and people are now strongly opposed to any ‘tampering’ with gold prices, which makes it unrealistic to look in this direction for any early reinforcements of foreign currency reserves.

A Rôle for EPU?

What other solutions are in sight? The European Payments Union or the International Monetary Fund might extend stabilization loans to countries with inadequate reserves, provided, however, there were an increase in their own resources. There are advocates of an expansion of EPU to take in the U.S. and Canada and eventually Latin America, combined with a substantial increase in its resources. Belgium’s Foreign Minister, Paul van Zeeland, a monetary expert in his own right, strongly advocates this solution. So does Robert Marjolin of the O.E.E.C. So do some American economists, such as Robert Triffin of Yale University. The weakness of this recommendation is that it would merely perpetuate the use of a crutch instead of achieving the final cure. An important body of financial opinion in Western Europe, especially strong in the Bank for International Settlements in Basle, opposes the perpetuation of EPU and urges a determined effort aimed at full convertibility.

The use of the International Monetary Fund for the purpose of increasing reserves also has strong supporters, especially in Britain. It is known that the British recently sounded out the U.S. Government on the possibility of raising the dollar subscription to the IMF. (The response was not encouraging.) Lionel Robbins of the London School of Economics has lent his great prestige to this suggestion while coupling it with recommendations for a major reorganization of the Fund’s cumbersome management. Officials of the IMF themselves agree that its dollar and gold resources (currently amounting to $3,255,000,000) are insufficient to bring about convertibility, especially since not all of them can be put at the service of Western Europe and the sterling area.

The Bigger the Cheaper

There remains one final solution to the problem of international liquidity. The U.S. and, to a lesser extent, Canada and Switzerland might extend ‘convertibility loans’ to the central banks of countries with insufficient reserves. This involves the establishment of large ‘convertibility funds’. It is this solution that was advocated last spring by a group of leading authorities brought together by the International Chamber of Commerce and headed by Thomas H. McKittrick of the Chase National Bank.3

In order to create an atmosphere of real confidence these ‘convertibility funds’ would have to be very large. The American fund should, according to advocates of this proposal, run to the order of $10 billion. It is a shock, to be sure, to see such a figure in this context for the first time, but shock is precisely what is needed: the shock of confidence.

The first congressional reaction would doubtless be one of horror. But the ‘convertibility funds’ would be essentially a guarantee, rather than expenditures. As is the case with every successful guarantee fund, actual drawings against it are likely to be relatively small in relation to its authorized size. Disbursements from a large fund are likely to be smaller not only in relative but also in absolute terms than disbursements from a small fund incapable of reviving confidence.

The crucial decisions lie with the U.S. Government. Not until a constructive proposal has been formulated by the Executive and approved by Congress will the problem of international liquidity—and that of convertibility—find a solution. Thus far, the Administration has submitted no such proposal to Congress and there is no evidence that any such proposal is in early prospect.

In the absence of an American plan to deal with the problem of convertibility, foreign governments are coming up with proposals of their own. Since our own objectives in this sphere ought to be more far-reaching than those of most foreign countries, proposals originating abroad may not be acceptable to us. It is most essential, therefore, that an American proposition should become known at an early date. Otherwise we shall be in the position of merely saying ‘No’ to foreign proposals, while our great opportunity in this whole monetary field slips away.

All the Way

As things stand now, we may never reach the second and third phase of the full convertibility programme, having failed to make any headway with the first. But if the Treasury and Congress take a more imaginative view of our responsibilities, and deal successfully with the first phase of the full convertibility programme, they could well deal with the second phase in the life of the present Administration. This second phase, elimination of the international use of import quotas as well as all trade discrimination against dollar goods, is, of course, closely connected with the programme of American trade liberalization. Until we are ready to open our doors far more widely to foreign goods than we do at present, we cannot seriously expect the end of discrimination against dollar goods.

The third and final phase would see the ending of controls on all capital movements. This phase admittedly lies in a more distant future. It presupposes a high degree of international confidence, in political conditions as well as in the stability of the monetary reserves of many countries. The latter must be capable of expanding at a fairly even pace with the growth of international transactions. Finally, certain measures of internal monetary reform will have to be adopted in order to build into the monetary systems of the various countries semi-automatic anti-inflationary devices. This involves a substantial diminution of the rôle played by government securities in the ‘backing’ of national currencies and a corresponding diminution of the scope of monetary ‘management’.

Only when all this has been accomplished will full convertibility come into being and the world economy be stimulated by the full and free play of private enterprise.

Money and Security

To sum up, then, currency convertibility and the revival of multilateral trade are within our reach provided the U.S. Government develops an effective foreign economic policy, monetary as well as commercial. Unless this happens soon, the internal cohesion of the Western world will be subjected to severe strains.

NATO has achieved some military substance and a measure of political reality but the lack of corresponding progress in economic unification has been jeopardizing even the modest successes. This point has been stressed time and again by military men themselves, as well as diplomats and economic experts.

The sound-money régimes in Western Europe have only a tenuous hold in their respective countries and their life will depend on their success in providing for their electorates the economic stimulus of freer trade, to take the place of the unhealthy and now waning stimulus of inflation. Should these governments get so deep into trouble as to give way to leftist régimes, we would find not only currency convertibility going by the board but the NATO system itself. Neutralism, disturbing enough already, would flourish in an economic stalemate; East-West trade, for example, would become almost irresistibly attractive. U.S. foreign monetary policy, in short, may well determine the success of our entire foreign policy.

 

4 Article originally published in Fortune Magazine, New York, September 1953; copyright 1953 by TIME Inc.

5 Monetary policies were not at issue, however, in the Italian Cabinet crisis of midsummer, which had not been resolved at the time this article went to press.

6 The committee included Sir Jeremy Raisman, deputy chairman of Lloyds Bank in London, M. Emmanuel Monick, former Governor of the Bank of France, and Dr Per Jacobsson, economic adviser of the Bank for International Settlements and one of the most influential monetary thinkers in post-war Europe. The writer served as the committee’s rapporteur.

• 1* This monograph was prepared in the years 1943–44 for one of the research institutes in the United States. Circumstances did not allow its publication at the time, although a mimeographed version of my text was circulated to a large body of leading American experts of the day. More recently the institute in question, which wishes to remain unnamed, kindly reverted the copyright to me. May I extend to it my sincere thanks, both for having made the study possible and for having allowed me to publish it now? I should perhaps explain that when this monograph was written, one of the questions which preoccupied American experts a good deal was: how to avoid the inflationary mistakes of the previous post-war period during the years that were to follow the end of World War II. No one of us had the slightest doubt that this end would be victorious.
• 2To illustrate, see for example the voluminous and penetrating Annual Reports of the Bank for International Settlements.
• 3The IMF takes an entirely neutral attitude towards the Gold Exchange Standard, neither endorsing nor rejecting it.
• 4Post-war European Inflations, World War I A Study of Selected Cases*
• 5The fifties were a period of increasingly obvious recovery, both in world monetary affairs and in the economic life of individual countries. The great opportunities offered during that decade, however, for carrying out a sweeping international monetary reform have not been utilized. True, the European Payments Union had been formed at the beginning of the decade, to be dissolved, due to improved conditions in Europe, towards the end of it. But this was at best an attempt at making inconvertibility more liveable with and at undoing part of its evil effects on intra-European commerce. The International Monetary Fund (established by the Bretton Woods Conference in June 1944) could have blossomed up, but did not do so, during the fifties, whereas what actually did take place was a great revival of the Gold Exchange Standard, amplified into the so-called ‘key currency system’. It should also be noted that the alleged (though never really existing) ‘dollar shortage’, which caused rivers of scholarly ink to flow for many years, has been reversed and a far more real dollar glut took its place at the end of the fifties as a result of the large balance-of-payments deficits which the U.S. started to experience in 1958.
• 6The fifties were a period of increasingly obvious recovery, both in world monetary affairs and in the economic life of individual countries. The great opportunities offered during that decade, however, for carrying out a sweeping international monetary reform have not been utilized. True, the European Payments Union had been formed at the beginning of the decade, to be dissolved, due to improved conditions in Europe, towards the end of it. But this was at best an attempt at making inconvertibility more liveable with and at undoing part of its evil effects on intra-European commerce. The International Monetary Fund (established by the Bretton Woods Conference in June 1944) could have blossomed up, but did not do so, during the fifties, whereas what actually did take place was a great revival of the Gold Exchange Standard, amplified into the so-called ‘key currency system’. It should also be noted that the alleged (though never really existing) ‘dollar shortage’, which caused rivers of scholarly ink to flow for many years, has been reversed and a far more real dollar glut took its place at the end of the fifties as a result of the large balance-of-payments deficits which the U.S. started to experience in 1958.