Aspects of the Pathology of Money

To an itinerant economist one of the salient contrasts between current American and European thinking lies in the attitudes towards the significance and the management of money. What is still a ‘Great Debate’ in the U.S. has been virtually settled in Western Europe. It has been settled in favour of the central bankers and a vigorous use of monetary policy for the promotion of economic welfare and social peace.

The monetary issue is, of course, just one aspect—albeit a crucial one—of the larger issue of free vs. planned economies. In a free society the rôle of the central banker is extraordinarily important. But in a centrally planned economy he is just another civil servant—near the top of the administrative ladder, to be sure, but not influential.

A few years ago economic planning was the rule almost everywhere in Western Europe. Since then Western Europe has undergone a virtually complete change of heart. Its people have learned a great deal from a long series of tribulations and crises, going back to World War I, and culminating in the frustrations of recent years. The English-speaking countries, having had less to suffer in the past from monetary instability, have a weaker ‘conditioned reflex’ to inflation; they are much more afraid of deflation. Continentals know that deflation, if prolonged, can cause great sufferings; but they also know that of which the British and the Americans are less aware, namely that inflation can destroy the whole fabric of society.

This is probably why the Continent has led Britain and the U.S. in rediscovery of the importance of a well-ordered monetary system in the health of nations. In the past few months the British have made the rediscovery, too, though they have yet to draw the full implications for policy. It would seem that we in the U.S. are at the bottom of the monetary class.

The Pioneers

Belgium earned world-wide recognition, of course, for using the classic monetary weapons to stop inflation immediately after the liberation. Camille Gutt, the courageous and selfless finance minister, sacrificed his own political career in carrying out his rigorous programme, but Belgium has stuck to sound money ever since.

Another refuge of sound monetary thinking in the first post-war years was Switzerland; for a time, indeed, Switzerland maintained restrictions on the number of dollars that could be converted into good, hard Swiss francs! The Swiss policy, incidentally, offers an instructive contrast with that of Sweden. Both countries had been neutral in the war, both found themselves at the time of the Allied victory with very strong monetary reserves. But Sweden, led by a socialist government, went in for cheap money, and found its reserve situation steadily deteriorating until it finally was faced with as acute a ‘dollar shortage’ as much less fortunate countries.

Italy broke out of the inflationary current in 1947–48—after coming very close to monetary annihilation. Here the hero was Professor Luigi Einaudi. First as Governor of the Bank of Italy, then as minister of the budget, Einaudi put an end to further monetary expansion, imposed severe credit restrictions, and promoted budgetary equilibrium by such measures as a drastic cut in food subsidies. Unpopular measures, no doubt—yet Professor Einaudi was elected President of the Italian Republic in 1948, and his programme has remained unchallenged ever since.

‘Wouldn’t the Italians have been better off’, Americans sometimes ask, ‘with a bit of inflation and higher production—instead of stable money and a good deal of unemployment?’ To this writer, at least, there is no doubt about the answer. Monetary stability is the one thing that stands between Italy and chaos—and it is the most powerful defence Italy has against communism.

The Exception Becomes the Rule

But Italy, like Belgium and Switzerland, was exceptional. It is only within the last eighteen months that Western Europe as a whole has really broken the grip of inflationary policies. In 1951, Germany, having got into grave and growing indebtedness within the European Payments Union, adopted a programme of credit restriction and monetary rehabilitation, of which the results have been spectacular in the extreme. The advice of Dr Per Jacobsson, economic adviser to the Bank for International Settlements in Basle (the keeper of EPU’s books) and one of the leading authorities in the field of central banking, had much to do with the formulation of the German programme.

Similar policies were shortly adopted in the Netherlands. In that country, too, the strong personality of a central bank president, Dr M. W. Holtrop, exercised a considerable influence, all the more so as he has had a most effective partner in Finance Minister Dr P. Lieftinck, who has not found membership in the Dutch Labour party incompatible with sound and ‘orthodox’ monetary ideas. Having increased the discount rate from 2½ per cent to 3 per cent in September 1950, the Nederlandsche Bank raised the rate to 4 per cent in April 1951. All through the rest of that year the economic position of the country was improving, as was the balance of its external payments. Consequently the discount rate was reduced to 3½ per cent in January 1952, and to 3 per cent early last month. This active use of the rate of interest is in line with the policy expressed in the Annual Report of the National Bank of Belgium for 1951: ‘It is, in fact, wise not to lay down any general rule in favour of a policy either of cheap money or of dear money, but to apply them each in turn as circumstances require.’

The improvement in the Dutch monetary situation was made possible not only by the independence and wisdom of President Holtrop and by the courage and economic sophistication of Finance Minister Lieftinck but also by the very enlightened attitude of Dutch labour. As Dr Holtrop explains, labour in 1951 accepted a 5 per cent reduction in real wages in order to make Dutch exports more competitive and restore equilibrium in the foreign payments of the Netherlands.

In France, meanwhile, the courageous experiments of Prime Minister Antoine Pinay were set in motion. Here, again, the governor of the central bank—in this case Wilfrid Baumgartner of the Bank of France—came into his own. In France, as in Italy, monetary reconstruction is the best way to reduce communist influence: Frenchmen, even if they cast a considerable number of communist ballots, are, at heart, rentiers.

Finally, Great Britain has also rediscovered money since the advent of the Conservative government, although that government has so far given fewer proofs of daring and enterprise than like-minded governments on the Continent. The increase of the bank rate from 2½ to 4 per cent and other credit-tightening measures ended the long era of cheap money. Steps were taken to cut food subsidies and improve the budgetary situation. Monetary controls started to replace ‘direct’ or physical controls. But so far the British public has not got from its government the same sense of basic reorientation that is so plain on the Continent.

Ideas have Consequences

All in all, it is ‘old-fashioned’ economic liberalism, solidly based upon sound and stable currency, that reigns over Western Europe in 1952. An intellectual cycle has come full turn.

Before World War I the importance of ‘good’ money was scarcely challenged anywhere among economists or society at large. After the turmoil of that war and the subsequent rise of economic nationalism, other views began gaining support. The most influential of the new theorists was, of course, John Maynard Keynes. America’s No. 1 Keynesian, Professor Alvin Hansen of Harvard, triumphantly proclaimed the ‘revolution in monetary thinking: . . . Freedom to pursue a programme of internal stability and full employment without regard to the balance of payments. . . . Everywhere nations are at long last. . . committed to the proposition that the balance of payments shall no longer control their internal monetary policy.’

Well, the monetary revolution has been put down and order has been restored—except perhaps in America. Today, in half a dozen nations of Western Europe, one can talk with economic theoreticians, with finance ministers, central bank governors, high civil servants, and parliamentarians and come away with an almost uniform impression: the importance of sound domestic monetary policies and of external solvency secured thereby is fully accepted. So is the rôle of the interest rate and the importance of monetary control as an instrument of economic policy. So is the fact that every country should be guided in its domestic policies by the need to balance its external accounts.

Opportunity for the U.S.

At this point the stage seems to be set for the most crucial measures of monetary reconstruction. Sensible internal policies have put most of the European countries within reach of external solvency. Three major obstacles, however, remain: (1) the artificial structure of exchange rates; (2) the low level of central bank reserves of most of the European countries; (3) the continuing U.S. export surplus and the so-called ‘dollar gap’ resulting from it.

The U.S. can probably do more to help overcome these obstacles than any of the countries directly concerned. To overcome the first obstacle, we must replace the very rigid provisions of the International Monetary Fund with new agreements allowing for some fluctuation in exchange rates and restoring free foreign-exchange markets. In such markets, protected against chance disturbances by the existence of stabilization funds, foreign exchange rates can seek economically justified levels and a realistic pattern of cross rates can be established.

The low level of monetary reserves is a matter that could be improved (but not cured) by an increase in the world price of gold. Such an increase would not upset exchange-rate relationships between the various currencies, but in each country it would strengthen the reserve position of the central banks in settling balances on foreign transactions. In addition, however, major stabilization loans would have to be granted by the U.S. to countries that are prepared to do all in their power to maintain their internal monetary stability and their external solvency. Such loans would be facilitated by revaluation of U.S. gold holdings.

Finally, no international monetary reconstruction will endure unless the U.S. is willing to take more imports.

A Return to Real Money

These, then, are the prerequisites for the restoration of real money to the Western world. We have experimented with regional solutions like the EPU, and with partial solutions like the liberalization of payments arising from certain categories of transactions while keeping exchange controls on others. There is not much hope of success in these timid half-measures. Only the restoration of full convertibility and of free foreign-exchange markets can lead to a real expansion of trade throughout the Western world. Here is one of the biggest and most urgent jobs awaiting the new Eisenhower or Stevenson administration.

The time for a sweeping approach to these problems is drawing very close now. The franc was weakening again in early August, and Pinay will be faced with some crucial tests when the Chamber reconvenes this autumn; a conference of finance ministers of the British Commonwealth is to meet in November; there are signs of restiveness in Belgium and in the Netherlands; the EPU is always threatened, if only because of its geographical limitations, with new crises.

On the whole, the present governments of Western Europe are—and ought to be—to Americans’ liking. But these governments thrive on performance. They cannot simply be taken for granted.

2 Article originally published in Fortune Magazine, New York, September 1952; copyright 1952 by TIME Inc.

• 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.
• 2Post-war European Inflations, World War I A Study of Selected Cases*