Aspects of the Pathology of Money

13 Monetary Reform in an Atlantic Setting1

The Monetary Component of an ‘Atlantic Grand Design’

The Atlantic concept is basic to the policies of the United States and of Western Europe in the cold war. NATO in the military field (and, virtually, in the broader field defined by Article 2 of the North Atlantic Treaty) and the O.E.C.D. in the economic field are the two principal institutional organs of Atlantic co-operation. The membership of the latter, as is well known, is more inclusive than that of the former, due to the existence of the European neutrals. The fact that these countries have been members of the O.E.E.C. and will be members of the O.E.C.D., the successor organization, is of great importance for the grand design because they include economically very important units, such as Switzerland and Sweden.

The grand design is nothing else than a substantial degree of economic integration—and consequently of political understanding—within the entire North-Atlantic group of countries whose combined strength is the best guarantee of peace. The European Economic Community (Common Market) and the European Free Trade Association (EFTA)—nicknamed the ‘Six’ and the ‘Seven’—are steps in the direction of wider economic unity in Europe. Should Britain join the Common Market, which, while not easy, seems now inevitable, the other members of EFTA, except presumably Austria, will follow suit by and by and the ensuing European Customs Union will be a challenge to the two North-American members of the O.E.C.D., the United States and Canada. They can meet the challenge only by entering into tariff negotiations with Europe, for the sake of opening the European market to North American goods, against a corresponding opening of the North American markets to European goods.

For the United States this would involve the need for a new trade legislation to take the place of the obsolescent Reciprocal Trade Agreements Act, due to expire on June 30, 1962. I have set out the basic principles of such a legislation in my article: ‘U.S. Foreign Economic Policy’, Fortune, June 1958.2 The new legislation ought to enable the United States to cut its tariffs down to a small fraction of their present level, without peril-point or escape-clause provisions, preferably ‘across the board’—against a correspondingly sweeping reduction of the European tariff. Thus we should obtain a good approximation to Atlantic free trade, without Congress surrendering its control over the American tariff. Alternatively, the United States could form a free trade area with the European Customs Union. All this would be a gradual process and provision should be made in the American law for giving adequate compensation or other facilities to interests, whether on the labour side or on the investors’ side, which would be adversely affected by the change.3

It would exceed the scope of this paper to discuss these trade proposals more fully. What needs stressing, however, is the basic rôle money plays in the unification (using this term in a deliberately vague sense) of the West. For there can be no stable expansion of international commerce and of international finance without the existence of a well-organized international monetary system or, as I prefer to put it, without ‘an established and stable international monetary order’.

Actually, I have been convinced for many years that Atlantic unity must have, as one of its main components, full monetary convertibility. The following excerpts from a paper I wrote in summer 1958 for limited private circulation among leading statesmen, businessmen, and intellectuals of the Atlantic group of nations, may be of interest in the present context:

‘What are the monetary policies which might best foster the unity of the West? In a word, they are policies of convertibility. By this term I understand a complete absence of exchange control, i.e. freedom of international payments. It means, on the part of the various countries, policies aimed at the long-term equilibrium in their foreign payments. It further involves liberal commercial policies (because the ultimate reason for convertibility lies in the freedom of trade and capital movements, which are thereby fostered). And, finally, to my way of looking at things, convertibility means freedom of exchanging one currency for another at will, at fixed parities.’

I went on to take a stand critical of the adequacy of various forms of limited or near convertibility which so many economists and government officials regard as an entirely satisfactory degree of progress; the various forms of near convertibility ‘have—even at their most liberal interpretation—one major drawback in common, to wit, the continuing existence of exchange control machinery, of its legal and administrative framework. But as long as this machinery remains in being, back-sliding into more drastic controls remains an ever-present alternative to the adoption of sometimes politically difficult and unpopular measures of domestic monetary discipline.

‘In the interest of long-term economic cohesion among the Atlantic countries, we must aim at the complete elimination of exchange controls at least within this inclusive group of countries, if possible, beyond it.’

Convertibility, however, requires the availability of adequate international monetary reserves. Now, I noted in the same paper:

‘The non-Soviet world finds itself on a kind of gold-plus-dollar standard, with gold production providing about one-third of additional reserves and the growth of U.S. foreign liabilities—about two-thirds. This is an inherently very unstable situation.’

This was written, may I repeat, in the summer of 1958, well before the first of the three successive very large U.S. balance-of-payments deficits became fully apparent. None the less, I warned that

‘the United States cannot be safely counted on to continue adding a billion dollars annually to its liabilities in order to buttress the monetary reserves of the outside world’,

and concluded that

‘the problem of international liquidity is entering into a serious phase—and may become acute later on.’

Nearly three years have elapsed since that paper was written. U.S. deficits totalled over $10 billion in 1958-60. No major monetary reforms were undertaken, but the existence of a liquidity problem has been more widely recognized and a number of plans have been proposed by distinguished economists to cope with it. They mostly relate to reforming the International Monetary Fund and they mostly pay scant attention, if any, to international monetary order. They are therefore geographically too ambitious and economically not ambitious enough. Allow me to explain.

They are not ambitious enough in that they settle for some form of near convertibility combined with a substantial dose of (at least implicit) monetary nationalism. My own, more ambitious, position, already indicated in the quotations from my 1958 paper, calls for full convertibility and for domestic monetary discipline. The latter means that a country having either a deficit or a surplus in its external payments would adopt prompt and efficient domestic measures to redress this unbalance. And this is precisely what I mean by international monetary order: a régime of free international payments with fixed parities among currencies and an efficient mechanism of re-equilibrium in international payments.4 But the authors of the recent crop of monetary plans are too ambitious when they envisage a reform on the scale of the IMF. For only relatively few countries are ready for the adoption of monetary order as defined above. Practically all of them are in the Atlantic group of nations (though not absolutely all of the O.E.C.D. countries are ready for the more ambitious monetary reforms). It is worth noting, too, that the Monetary Committee of the O.E.E.C. (as it still is called), established last April, includes all of the Western countries which are capable and might be willing to establish among themselves an international monetary order.

Order and Liquidity in the International Monetary System

Order is defined here as full convertibility at fixed parities coupled with a well-functioning mechanism of international monetary re-equilibrium. By international liquidity is meant the capacity of the various countries to meet balance-of-payments deficits without suspending free convertibility or altering the parity of the national currency. International liquidity consists, since World War II, of gold, sterling, and dollar balances, and drawing rights upon the IMF (as an important subsidiary source of liquidity—which must be, however, repaid after a relatively short time). As long as both the United Kingdom and the United States keep their balances of payments in medium- and long-term equilibrium, the only source of new liquidity (or new reserves) is gold, i.e. the production of new gold outside the Soviet bloc, minus industrial uses of the metal and hoarding, plus sales of Soviet gold in the West. The question hotly debated in the recent years is, how adequate—or inadequate—is the annual increase of gold reserves alone, without increases in holdings of the reserve currencies, to meet liquidity requirements of national monetary authorities? And, if new gold supply is insufficient, what best should be done about the liquidity problem? On all this ‘doctors disagree’.

Before offering my own point of view, there are several points to be cleared up. Most important of these is the relationship between ‘order’ and ‘liquidity’. It stands to reason that in an orderly international monetary system in which balance-of-payments disequilibria are promptly corrected by the countries concerned through the adoption of appropriate domestic correctives, there will be less need for sizeable international settlements than in a system in which disequilibria are allowed to become chronic and large. Now the IMF has only limited powers to impose monetary discipline—or to induce it by persuasion. A surplus country, e.g. the Federal Republic of Germany, can have a chronic and large annual surplus and remain a Fund member in good standing (unless its currency were to be declared ‘scarce’ which has never happened in practice so far). A deficit country which does not appeal to the IMF for help, e.g. the United States, can run up as great a deficit and as chronic a one as it wishes without the Fund having anything to say about it. Only when a member of the IMF applies for credits exceeding 25 per cent of its quota, can the management of the Fund set conditions or formulate requirements in terms of that country’s domestic policies. This is far from being a satisfactory international monetary ‘order’; and it is even less satisfactory if one considers that convertibility under the Bretton Woods Agreements falls rather short of the definition of full convertibility provided earlier in this essay. The régime of exchange control remains intact, with only the wide exception for current transactions as regards countries which are under the scope of Article VIII (but not the many more numerous countries remaining under the rule of the transitional Article XIV). Thus the Bretton Woods Agreements have failed to establish an international monetary order as here defined. But, as has been already stressed, such an order is indispensable for the smooth and steady working of the international economy. And it has been noted, too, that it is too ambitious to seek such an order in a group much wider than the Atlantic community.

This takes me to the second important point that needs to be stressed at this stage of the argument. The many underdeveloped countries of the world care very little for international monetary order, absorbed as they are in the national planning of their economic growth. Their domestic policies involve different degrees of inflation and their monetary parities are protected by exchange control (and, therefore, mostly unrealistic), while their external trade is subject to a wide use of import quotas (which are a twin of exchange control). Their balance-of-payments difficulties are usually met through IMF credits or foreign aid. In fact, these countries are not really interested in accumulating adequate central banking reserves: they are interested in spending as much as possible on imports. In the final analysis what they need is not liquidity but capital. And this requirement cannot be met through a reform of the IMF but through a number of measures, both domestic and international, in the area of capital supply. A plan proposed last winter by the British economist and banker, Mr Maxwell Stamp, aimed at solving simultaneously the liquidity problem of the West and the capital problem of the underdeveloped countries. He proposed that the IMF issue $3 billion of certificates, labelled in gold but not convertible into gold; that these certificates be handed over to foreign-aid dispensing agencies; and that the Western countries, towards which these certificates would eventually move in payment for supplementary exports to underdeveloped countries, should undertake to hold and use them ex aequo with gold, dollars, and sterling. Appropriate changes would be made in the statute of the IMF.5 Without going into the technical problems raised by this imaginative and intriguing proposal, let us just note one basic criticism of it. Mr Stamp wants, in effect, to finance part of the capital requirements of the underdeveloped countries by means of creating a new international currency. Whether it is at all wise to contemplate in 1961 the creation of an international currency is a question to which I shall yet have to revert in connexion with the Triffin plan. But there is a long—a very long—experience of national monetary authorities creating more money to satisfy demands for more capital and the result has always been the same—inflation. Capital is created by savings not by printing presses or (to be up to date) through credit creation by banks, commercial or central.

To conclude on this point: underdeveloped countries cannot be helped by a reform of the IMF but only by measures reaching far more deeply into the structure of the economic process. Nor are these countries much interested in monetary liquidity as such. And even less so, as was noted above, in what is here defined as ‘international monetary order’. It follows that the liquidity problem must be dealt with, and monetary order sought, in a smaller geographic framework than the IMF. The proper framework for dealing with these vital matters is the Monetary Committee of the O.E.E.C. (O.E.C.D.).

Within this smaller group of economically most advanced countries, both international monetary order and adequate international liquidity are needed. With respect to liquidity, what is needed is not only an adequate present position but, in an expanding world economy, an annual rate of growth of reserves which monetary authorities consider sufficient for the handling of always possible imbalances in international payments. Of these two objectives, that of order strikes me as objective No. 1, that of adequate liquidity as objective No. 2. Having, in various writings, advocated solutions to the liquidity problem ever since the early fifties—and long before the present ‘grand debate’ about it started—I now feel convinced that it would be unwise to deal with the liquidity problem without having settled (either first or simultaneously) the problem of order. For, clearly, less liquidity is needed when countries correct promptly and efficiently their balance-of-payments disequilibrium than when they fail to do so. Indeed, there is one school of thought—of which the most prominent exponent is Dr Per Jacobsson, Managing Director of the IMF—who deny the existence of a liquidity problem altogether. They claim that there is enough liquidity in the world today to take care of requirements for years to come, provided countries follow sound internal policies, i.e. keep their balances of payments in equilibrium. The experts of that school see—or appear to see—nothing wrong with the international monetary system now in existence, based on gold and on dollar and sterling balances, plus the recourse to the IMF at times of exceptional difficulties.

Another group of experts regards the liquidity position as inadequate now (e.g. Sir Roy Harrod, of Oxford) or in the future (e.g. Professor Triffin, of Yale, Dr E. M. Bernstein, of Washington, D.C., and many others). They seek an increase of liquidity either through a large upward change in the world price of gold (Harrod) or through the transformation of the IMF into a world central bank (Triffin, Stamp, to a lesser degree Bernstein, others). Some of these experts—primarily Professor Triffin—would modify profoundly the structure of the international monetary system, by substituting for ‘reserve currencies’ (dollar and sterling) deposits with the IMF, an idea which goes back to the wartime (1943) proposals put forward by the late Lord Keynes in favour of an ‘international clearing union’ with an international unit of account, called bancor.

Another, most vital, question has been recently raised by M. Jacques Rueff, the principal author of the French financial and monetary reconstruction of 1958. In an article entitled: ‘The West is Risking a Credit Collapse’ (Fortune, New York, July 1961), he urgently warns against the dangers of the Gold Exchange Standard and points to the need of adopting a new monetary system, preferably the gold standard with its discipline.

‘There is unfortunately’, he writes,

‘only one way to rid ourselves of the risks that are the West’s legacy from 15 years’ operation of the gold exchange standard. This is to pay off in gold all the dollar assets held by central banks outside the United States. Only such a drastic step can banish the danger of sharp deflation or collapse that is inherent in the double-credit structure now based on the U.S. gold reserves.’

Of all the experts, Rueff is the only one who lays great emphasis on the concept of international monetary order (though he uses a different terminology from mine). He refers to the ‘discipline of the gold standard’ as being ‘unconditional and inevitable’, contrary to ‘other multilateral arrangements’ which, ‘being voluntary, would be precarious and uncertain’. As of now, M. Rueff has offered no detailed blueprint for action based upon his diagnosis—but it is a relatively easy matter to work one out starting from his article. To my way of looking at things, this is the path the West should follow. I shall endeavour to show in the third and final section of this paper that this is the road to both international monetary order and adequate liquidity. There is a major hurdle on that road and to this I shall mainly direct my attention: the redefinition of the place of gold in the monetary system and the question of its world price.

Positive Proposals

Let us start with several brief propositions:

1. International monetary organization built in part on gold and in part on gold-convertible currencies—the Gold Exchange Standard—has proven highly dangerous in the interwar years and has slipped back into existence since the end of World War II. It promotes inflation in its optimistic or expanding phase, and deflation (even collapse) in its pessimistic or contracting phase. It tends to encourage balance-of-payments deficits—and to make them chronic—in countries whose currency is used as reserve currency abroad (because these countries do not pay off their deficits, which would result in the adoption of policy correctives, but merely build up a gold-convertible foreign indebtedness).6 The longer the expanding phase of the Gold Exchange Standard lasts, the greater foreign demand liabilities of the key-currency countries become, and the greater the risk of an international confidence crisis, of demands for massive gold payments, and of an eventual international monetary breakdown.

2. If key-currency countries follow policies aimed at balanced external accounts, the supply of their currencies for reserve purposes diminishes. In fact, any gold exchange standard must come to an end either quietly, through sound policies of key-currency countries, or chaotically, through a crisis of confidence in the key currencies and large demands for gold repayments. In 1931 the Gold Exchange Standard based on sterling came to an end under crisis conditions which greatly deepened the depression. At the end of 1960 there almost developed a crisis of confidence in the dollar and a breakdown of the currently prevalent form of the Gold Exchange Standard. We now have a breathing spell for an orderly monetary reform—which should involve an orderly liquidation of the dollar standard. (Sterling, though intrinsically much weaker than the dollar, is consolidated within the sterling area by arrangements and customs of 30 years’ standing.)

3. It may well be that the whole concept of reserve currency, which is a byproduct of the Gold Exchange Standard, should be rejected—in the interest of the countries whose currency is so used, because these countries are thereby exposed to great speculative hazards and uncertainties; and in the interest of the other countries that would be affected by any breakdown of a key currency. This is an acknowledgedly debatable proposition: my hope is that it will be coolly and fully debated.

4. Monetary reforms envisaged here apply only to the Atlantic group of nations. Their new monetary system should be integrated into the wider and looser IMF system.

5. From the point of view of international liquidity alone, we have a wide variety of proposed expedients including wider lending possibilities for the IMF; regional EPU-type arrangements; special bilateral arrangements among central banks (many of which are currently in operation), etc. Another type of expedient would consist in raising the world price of gold to a level at which enough new gold would be produced to dispense with reserve currencies (which will be largely unavailable once the U.S. balance of payments has been brought into equilibrium), but without readopting the gold standard.

6. Should as much attention be paid to international monetary order as to liquidity, we could contemplate real solutions instead of mere expedients. Solutions meeting all the requirements discussed earlier in this study fall into two groups: (a) the establishment, within the Atlantic framework, of a supra-national Triffin-type central bank, with powers of credit (i.e. liquidity) creation; (b) the rehabilitation of gold as central element in the monetary order of the Atlantic world and the adoption of a new gold standard.

Intellectually, the idea of a super-central bank is very tempting and the arguments mustered by Professor Triffin in his book ‘Gold and the Dollar Crisis’ are very plausible. At closer scrutiny, not of details but of basic concepts, I, for one, feel like strongly resisting the temptation. A central bank is an element of organized society, integrated with many other elements of economic organization and policy and of national purpose. Its actions are subject to control—in democratic societies, ultimately, to parliamentary control. In the world of the 1960s, even if confined to the Atlantic countries, there is no organized society as yet in existence and much as one should wish to see one emerge soon, there is no reason for easy optimism in that respect. Accordingly, I find it very difficult to envisage the establishment and operation of an Atlantic central bank. And I find it even more difficult to visualize a purely voluntary discipline in the realm of national monetary and fiscal policies, such as is absolutely required by the existence of a viable international monetary order. And, short of demonetizing gold altogether, I find it perilous to build up a growing credit structure (even if generated by an international institution) on the basis of an inadequate gold supply. And I cannot envision, in the next decades at least, the demonetization of gold. The yellow metal still enjoys over most of the planet more confidence than any currency.

Accordingly, in the search for the bases of an enduring monetary reform, I find myself on the side of some—if not all—of the advocates of the gold standard. Let me qualify my position right away by stressing that what I favour is:

1. An international gold standard, to begin with in an Atlantic setting;

2. A semi-automatic, rather than an automatic, system (the old gold standard was far more ‘managed’ than is admitted by many of its defenders and most of its opponents);

3. A system incorporated into the wider and looser setting of the IMF;

4. An arrangement based on an explicit undertaking by all the participating countries:

(a) to follow the rules of domestic discipline with the aim of prompt re-equilibrium of balances of payments, whenever a deficit or surplus becomes apparent;

(b) to eliminate all exchange restrictions and liquidate the exchange control machinery; and to eliminate import quotas as well;

(c) to settle international accounts (i.e. balance-of-payments deficits) in gold;

(d) not to accumulate any new official holdings of foreign exchange (to avoid a future relapse into the Gold Exchange Standard).

Most balance-of-payments difficulties are due to national inflations or, more generally, to the pursuit of autonomous national monetary policies by the countries concerned. Monetary nationalism is the basic reason for balance-of-payments difficulties and all the restrictive trade and payments policies to which these lead. The opposite of monetary nationalism is international monetary order (as defined earlier); while monetary nationalism is a forerunner of all the other forms of economic nationalism and of international economic disintegration.7 True, there may be also cases where a country experiences ‘flights’ from its currency (hot money); this tends to be the result of one of two main reasons: either the country’s domestic economic policies lead to a crisis of confidence; or the country’s geographic position in an insecure world renders it vulnerable, and monetary transfers ensue. The first reason is best dealt with by the country concerned, which can, through appropriate changes in its fiscal, monetary, and general economic policies, restore confidence in its currency. As to movements of hot money due to political circumstances beyond any single country’s control, the best answer lies in arrangements among friendly nations (such as the Atlantic group) to come to one another’s support either by way of ad hoc arrangements or, preferably, by way of institutional arrangements of a durable character. I can well imagine such arrangements as part of either the NATO or the O.E.C.D. set-up.

Contrary to the nineteenth century, there is widespread concern today over upswings and downswings of employment and economic activity and practically all governments are committed, in one way or another, to policies of full employment. Some opponents of the gold standard argue that this commitment is in opposition to the discipline of the gold standard. I do not share their opinion; in the first place, the monetary discipline is a short-term policy while counter cyclical policies inspired by the concern over full employment are medium-term policies—so that there is scope for a reconciliation of both objectives; in the second place, I am convinced that, gold standard or no gold standard, we need to achieve much more progress than has so far been the case in the direction of an international co-ordination of business-cycle policies. Accordingly, the new gold standard would involve as one of its distinctive features (which the old one did not possess) permanent and institutional machinery for consultation about and co-ordination of national economic policies. Here again, the O.E.C.D. provides a most promising framework.

The real difficulty over rehabilitating gold lies elsewhere. It lies in the fact that the gold standard can only be restored (and the Gold Exchange Standard fully liquidated) if there is enough gold. At the price of $35 an ounce of fine gold there just is not enough gold to rehabilitate it as monetary metal. So long as we have gold in the monetary system in an insufficient amount, we are exposed to all the hazards of the Gold Exchange Standard (even should the G.E.S. be internationalized as proposed by Professor Triffin and others). All the expedients currently discussed in connexion with a more or less far-reaching reform of the IMF fall far short of dealing with this basic weakness of the international monetary situation. As already indicated, I have no confidence in solutions of super-central bank type, and I do not believe that demonetization of gold is at all in the cards. What remains is the full gold standard in a new setting. And this calls for a substantial increase in gold production as well as for a revaluation of the existing gold stock (in order to liquidate the Gold Exchange Standard). This cannot be done without a substantial upward change in the world price of gold.

I fully realize how much opposition there is to such a measure, most of all in the United States. Yet the Bretton Woods Agreements provide for both such a contingency and for machinery to deal with it, under the heading of ‘simultaneous changes in par values of currencies’. The price of gold is an arbitrary price under all circumstances; it is essential that it should be set at a level at which international monetary order can be indefinitely preserved. There were only two instances in the past 150 years when a change in the world price of gold was called for: the first was after World War I, the second after World War II. In the first case, we got the Gold Exchange Standard instead and the great depression. Now we have again embarked upon a Gold Exchange Standard and are faced with the possibility of another depression should something go wrong with our precarious monetary arrangements. If we set the world price of gold at an appropriate level and there is no new world war, I am confident that the price of gold can remain set for another hundred years. By which time the world may be ripe for the Triffin central bank.

No suggestion is offered here concerning the new level of the gold price. I believe that this is a task for experts in gold production. But, most of all, the extent of the rise needed will depend upon the rules of the new gold standard. If we can rely on its discipline, requirements of liquidity may be less than they have been in recent years. I submit that if the main issue, namely what kind of international monetary order we are going to have, is settled, the detailed working out of the problem of the gold price should be decided by central bankers with the help of mining experts. But let the taboo of the $35 price not stand in the way of swift progress towards a durable monetary reform for the Western world.

 

8 Memorandum submitted to the Sub-committee on International Exchange and Payments of the Joint Economic Committee, Congress of the United States, and published in a volume entitled International Payments Imbalances and Need for Strengthening International Financial Arrangements, Washington, D.C, U.S. Government Printing Office, 1961, pp. 331–40.

9 Reprinted as Appendix 7 to my book Studies in Economic Nationalism, Geneva, Publications of the Graduate Institute of International Studies, 1960.

10 See The United States and World Trade: Challenges and Opportunities, final report to the Committee on Interstate and Foreign Commerce, U.S. Senate, by special staff on the study of U.S. foreign commerce, Washington, D.C., U.S. Government Printing Office, March 14, 1961, especially Chapter 7 and Appendix I.

11 See my book International Monetary Economics, London and New York, 1939, Chapter VIII (reprinted in the present volume, pp. 17 et seq).

12 See two articles by Mr Stamp in the Guardian, Manchester, February 10 and 13, 1961.

13 This process is fully explained in M. Jacques Rueff’s above-cited article in Fortune.

14 On all this see my books: International Monetary Economics, London and New York, 1939; The Trade of Nations, 2nd ed., New York, 1952; and Studies in Economic Nationalism, Geneva, 1960.

• 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.
• 4James W. Angell, ‘Equilibrium in International Payments: the United States, 1919–1925’, in Explorations in Economics, Notes and Essays Contributed in Honor of F. W. Taussig, New York, 1936, p. 14, footnote (2).
• 5Vide infra, p. 28, a bibliographical footnote on inductive studies.
• 6This is an assumption which, in fact, underlies the whole of this book.
• 7Vide infra, pp. 23 et seq.
• 8Post-war European Inflations, World War I A Study of Selected Cases*
• 9The 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.
• 10The 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.
• 11The problem of maintaining the equilibrium of balances of international payments, and of restoring it once it has been disturbed, is one of the most discussed questions in the field of international economics. The interest attached to it can be accounted for by the national and international difficulties which disequilibrium in international payments brings about if it is sudden and large or protracted and cumulative. It is the frictions caused by deficits in international payments of a country which have brought the problem of balances of payments into the important position it occupies in international relations, and which have provided the incentive for an extensive literature of the subject, which I cannot hope to discuss or even quote in the pages that follow. As has been pointed out by various writers, the problem of international payments acquires an importance which that of interregional payments does not possess, on account of the existence of various national monetary systems and of more or less uncoordinated national monetary and, more generally, economic, policies. This plurality of currencies results in the problem of foreign exchanges, which is an international and not an interregional one and is closely linked with that of balances of payments. We have seen that fluctuations of foreign exchanges are due to changes in international payments; and that these fluctuations tend to equalize the demand and the supply on foreign-exchange markets, and thus equalize payments made and payments received by a country. As Professor Angell rightly points out, ‘if the foreign exchange rates are free to move without limit in either direction, their movement will in itself keep the two current streams of credit and debit payments always equal . . .’. We shall see presently, however, that under flexible exchanges the problem arises of a possible cumulative devaluation of a currency and of its avoidance, and that the exchange fluctuation itself sets in motion forces affecting the size of transactions from which international payments result. The problem of equilibrium in international payments has its fullest significance upon the assumption of stable exchanges. The question can then be formulated in the following way: given stable exchanges, or given the desire to keep exchanges stable, how can equilibrium be restored in international payments once it has been disturbed? The restoration of equilibrium in international payments is thus a means of maintaining monetary parities by rigorously limiting exchange fluctuations. This in turn is inspired by the consideration that wide exchange fluctuations are undesirable, a position that calls for investigation. The limitation of movements of foreign exchanges calls for a ‘mechanism’ for adjusting balances of payments, and one finds that various ‘mechanisms’ can be constructed as abstract models but that only some of them can operate in the actual economic world. Most writings on this subject fall therefore into one of two groups: (1) construction of ‘models’ of ‘mechanisms’ that are conceivable in abstracto and (2) inquiry into the nature of ‘mechanisms’ that actually did operate in given circumstances. The fundamental problem is not complicated: if payments to be made and payments to be received at a particular moment do not cancel out, and if equality is not obtained through a continuous modification of the exchange relation between the respective currency units, then transactions must occur which will compensate the deficit and restore the balance (since over longer periods of time, payments received must be equal to payments made). Let us for the sake of clarity group the various questions that arise in this context and investigate each group separately. Before proceeding to this examination let us first explicitly state an important assumption that underlies all the reasonings to follow. We are going to discuss processes that are taking place in a free economic community, where there are no governmental interferences, other than tariffs, in the economic relations between countries. More precisely, it is assumed that individuals are not interfered with in either the commercial or the financial transactions which they wish to carry out.
• 12The problem of maintaining the equilibrium of balances of international payments, and of restoring it once it has been disturbed, is one of the most discussed questions in the field of international economics. The interest attached to it can be accounted for by the national and international difficulties which disequilibrium in international payments brings about if it is sudden and large or protracted and cumulative. It is the frictions caused by deficits in international payments of a country which have brought the problem of balances of payments into the important position it occupies in international relations, and which have provided the incentive for an extensive literature of the subject, which I cannot hope to discuss or even quote in the pages that follow. As has been pointed out by various writers, the problem of international payments acquires an importance which that of interregional payments does not possess, on account of the existence of various national monetary systems and of more or less uncoordinated national monetary and, more generally, economic, policies. This plurality of currencies results in the problem of foreign exchanges, which is an international and not an interregional one and is closely linked with that of balances of payments. We have seen that fluctuations of foreign exchanges are due to changes in international payments; and that these fluctuations tend to equalize the demand and the supply on foreign-exchange markets, and thus equalize payments made and payments received by a country. As Professor Angell rightly points out, ‘if the foreign exchange rates are free to move without limit in either direction, their movement will in itself keep the two current streams of credit and debit payments always equal . . .’. We shall see presently, however, that under flexible exchanges the problem arises of a possible cumulative devaluation of a currency and of its avoidance, and that the exchange fluctuation itself sets in motion forces affecting the size of transactions from which international payments result. The problem of equilibrium in international payments has its fullest significance upon the assumption of stable exchanges. The question can then be formulated in the following way: given stable exchanges, or given the desire to keep exchanges stable, how can equilibrium be restored in international payments once it has been disturbed? The restoration of equilibrium in international payments is thus a means of maintaining monetary parities by rigorously limiting exchange fluctuations. This in turn is inspired by the consideration that wide exchange fluctuations are undesirable, a position that calls for investigation. The limitation of movements of foreign exchanges calls for a ‘mechanism’ for adjusting balances of payments, and one finds that various ‘mechanisms’ can be constructed as abstract models but that only some of them can operate in the actual economic world. Most writings on this subject fall therefore into one of two groups: (1) construction of ‘models’ of ‘mechanisms’ that are conceivable in abstracto and (2) inquiry into the nature of ‘mechanisms’ that actually did operate in given circumstances. The fundamental problem is not complicated: if payments to be made and payments to be received at a particular moment do not cancel out, and if equality is not obtained through a continuous modification of the exchange relation between the respective currency units, then transactions must occur which will compensate the deficit and restore the balance (since over longer periods of time, payments received must be equal to payments made). Let us for the sake of clarity group the various questions that arise in this context and investigate each group separately. Before proceeding to this examination let us first explicitly state an important assumption that underlies all the reasonings to follow. We are going to discuss processes that are taking place in a free economic community, where there are no governmental interferences, other than tariffs, in the economic relations between countries. More precisely, it is assumed that individuals are not interfered with in either the commercial or the financial transactions which they wish to carry out.
• 13The problem of maintaining the equilibrium of balances of international payments, and of restoring it once it has been disturbed, is one of the most discussed questions in the field of international economics. The interest attached to it can be accounted for by the national and international difficulties which disequilibrium in international payments brings about if it is sudden and large or protracted and cumulative. It is the frictions caused by deficits in international payments of a country which have brought the problem of balances of payments into the important position it occupies in international relations, and which have provided the incentive for an extensive literature of the subject, which I cannot hope to discuss or even quote in the pages that follow. As has been pointed out by various writers, the problem of international payments acquires an importance which that of interregional payments does not possess, on account of the existence of various national monetary systems and of more or less uncoordinated national monetary and, more generally, economic, policies. This plurality of currencies results in the problem of foreign exchanges, which is an international and not an interregional one and is closely linked with that of balances of payments. We have seen that fluctuations of foreign exchanges are due to changes in international payments; and that these fluctuations tend to equalize the demand and the supply on foreign-exchange markets, and thus equalize payments made and payments received by a country. As Professor Angell rightly points out, ‘if the foreign exchange rates are free to move without limit in either direction, their movement will in itself keep the two current streams of credit and debit payments always equal . . .’. We shall see presently, however, that under flexible exchanges the problem arises of a possible cumulative devaluation of a currency and of its avoidance, and that the exchange fluctuation itself sets in motion forces affecting the size of transactions from which international payments result. The problem of equilibrium in international payments has its fullest significance upon the assumption of stable exchanges. The question can then be formulated in the following way: given stable exchanges, or given the desire to keep exchanges stable, how can equilibrium be restored in international payments once it has been disturbed? The restoration of equilibrium in international payments is thus a means of maintaining monetary parities by rigorously limiting exchange fluctuations. This in turn is inspired by the consideration that wide exchange fluctuations are undesirable, a position that calls for investigation. The limitation of movements of foreign exchanges calls for a ‘mechanism’ for adjusting balances of payments, and one finds that various ‘mechanisms’ can be constructed as abstract models but that only some of them can operate in the actual economic world. Most writings on this subject fall therefore into one of two groups: (1) construction of ‘models’ of ‘mechanisms’ that are conceivable in abstracto and (2) inquiry into the nature of ‘mechanisms’ that actually did operate in given circumstances. The fundamental problem is not complicated: if payments to be made and payments to be received at a particular moment do not cancel out, and if equality is not obtained through a continuous modification of the exchange relation between the respective currency units, then transactions must occur which will compensate the deficit and restore the balance (since over longer periods of time, payments received must be equal to payments made). Let us for the sake of clarity group the various questions that arise in this context and investigate each group separately. Before proceeding to this examination let us first explicitly state an important assumption that underlies all the reasonings to follow. We are going to discuss processes that are taking place in a free economic community, where there are no governmental interferences, other than tariffs, in the economic relations between countries. More precisely, it is assumed that individuals are not interfered with in either the commercial or the financial transactions which they wish to carry out.
• 14In this case we assume that gold is the only money in circulation in the various countries; we further assume that no changes will be made anywhere in the price of gold and that, therefore, there are fixed parities (mint-par) between the various gold currencies. Every net payment between countries is made in gold, and results in a reduction of the amount of circulating medium in a country which has a deficit in its balance of payments, and in a net increase in the amount of circulating medium in countries having a surplus in their balances of payments. We shall discuss later the repercussions of these changes upon the various transactions between the countries concerned and the various policies that may be adopted in response to gold movements. Let us merely point out in the present context that should a country have a persistent deficit in her international payments, the deflation caused by losses of circulating medium may become very drastic. By reason of the frictions that this involves, the country which is going through such an experience may be tempted to change its monetary system. If this should be the case and if the country in question should abandon the system of gold currency, international frictions will follow. Thus while payments in gold can always momentarily restore equilibrium in international payments, changes in international economic transactions themselves must take place if a breakdown of the monetary system is to be avoided. As it happens, however, losses of gold may set in motion some ‘mechanism’, which will be discussed presently, and help to obtain an appropriate adjustment of commercial and financial transactions.