Aspects of the Pathology of Money

14 Plans for Reforming the I.M.F.: Some Basic Criticisms1

I

The present concern over monetary reconstruction—which is taking the form of proposals for a reform of the International Monetary Fund—is the child of worry over impending shortages of international reserves (i.e. of international liquidity). It dates roughly back to the beginning of 1958 when Sir Oliver Franks, Chairman of Lloyds Bank in London, in his annual statement to the stockholders of his bank, drew forcefully attention to the imminent liquidity problem, and suggested that thought be given to transforming the IMF into a kind of super-central bank with capacity to create additional international reserves. His, by the way, was not a plan but an approach; but he might well, if he wished, claim the intellectual grandfatherhood of several of the now most widely discussed ‘plans’.

Years before, from the early post-war onwards, until 1954 inclusively (he died at the beginning of 1955), the great French economist Charles Rist—who had played a major rôle in monetary matters in the interwar years, not only in academic circles but also as adviser to his own and to other governments and to the League of Nations’ Financial Committee—urged a major monetary reform, along gold standard lines, part of which was to create adequate monetary reserves through an upward change in the price of gold.2 Others followed this line of thought but, owing to the formal opposition on the part of the United States (government and leading banking circles) to even discussing the possibility of an upward change in the price of gold, this approach has never, so far, been fully debated. Quite recently, without stressing the price of gold aspect of the problem, the author of France’s monetary reconstruction of 1958, Jacques Rueff, dramatically stressed the perils faced by the world if the precarious Gold Exchange Standard were not to be liquidated soon in an orderly fashion, and the gold standard revived.3

In other writings I am dealing with the gold standard and gold price aspects of the problem of monetary reform. In the context of this symposium I shall concentrate on the IMF reform plans which follow an entirely different approach.

Indeed it can be said of these ‘plans’ that they are the conclusion drawn from a syllogism of which the major premise is: ‘There is an impending problem of international liquidity’; while the minor premise is: ‘The price of gold must on no account be changed’. Assuming then that the only alternative to changing the price of gold is an expansion of lending facilities of the IMF and, eventually, endowing that institution with the powers of creating an international form of means of payments, the conclusion in favour of that ‘only alternative’ inevitably follows. It is the assumption involved in this syllogism that must be carefully examined: theoretically, there may be other alternatives to the change in the price of gold; while practically there may be no alternative at all: in either case the syllogism would break down.

To deal with the first possibility first: the theoretical alternatives to either raising the gold price or transforming the IMF (progressively if need be) into a super-central bank, are two: one is strict exchange control, the other freely fluctuating exchange rates (to take the place of fixed parities). I have dealt elsewhere with—and rejected—both possibilities; exchange control, because it leads to (or stems from) state socialism which I oppose; flexible exchanges, because I regard them as destructive of international monetary and economic order, which I defend.4 In practice, there is no disposition on the part of monetary authorities in most countries to abandon the principle of fixed parities in favour of fluctuating exchange rates and the proposals to do so in a generalized way are not even ‘starters’ in the big race for solutions to imminent monetary problems. As regards exchange control, it remains even now the rule rather than the exception. The Bretton Woods system accepts them as a permanent fixture, though Article VIII of the IMF Charter limits their scope to capital movements proper; however, the ‘transition-period’ Article XIV assigns them a wider scope and all but a handful of members of the Fund are still under the rule of the latter article. However, all of the economically important countries of the West have adopted ‘limited convertibility’ to such an extent that the remaining exchange controls cannot serve as a substitute for adequate liquidity, while the underdeveloped countries, which are the great majority of the Fund’s membership, are attached to national planning of an inflationary kind and to strict exchange control and, when all is said and done, care very little for ‘liquidity’ and for free international payments. This raises a question to which I propose to revert below, namely whether it makes good sense to speak, in the present conditions of the international economy, of monetary reform on an IMF scale?

II

It might be useful at this stage of the argument to make the admittedly pedantic, yet most important, distinction between expedients and solutions. The former make an inherently unsound situation bearable for somewhat longer, hoping (and possibly more than hoping) that it will get cured in the foreseeable future. The latter transform an unsound situation into a healthy one, i.e. carry out the cure. There is, thus, no necessary conflict between expedients and solutions. An example for that is offered by the history of the European Payments Union: it was an expedient designed to promote multilateralism on a regional scale pending its restoration on a wider basis. When the most economically important members of the Union adopted non-resident convertibility and relaxed quantitative controls on trade and payments, the EPU was liquidated (at the end of 1958) in favour of a more satisfying system of international settlements. But the conflict between expedients and solutions may exist: either because the proponents of the former are quite satisfied with their functioning and deny the need for more fundamental solutions; or because solutions, while desired, are considered to be beyond reach. Thus some reformers of the IMF are quite satisfied with their proposals and look no further, even though they would hardly claim that what they propose is more than an expedient. While others, who would favour e.g. some form of world central bank, admit that this is not within their—and our—reach and declare themselves satisfied, for an indefinite time, with mere expedients. The most striking case is that of the ‘Triffin Plan’ in the successive versions of which Professor Triffin carried the ‘self-erosion’ of his original and very bold ideas to a hitherto almost unknown extent (at least as far as independent academic reformers are concerned).

Before going any further, we must inquire about the nature of the international monetary problem; unless we so do, there will remain a good deal of uncertainty as to what are solutions and what are mere expedients. Although the problem is monetary the real objectives are wider. They are: to place expanding multilateral world trade on firm foundations, securing its greatest possible freedom and associating it with an expanding international flow of capital, especially of private capital. These goals cannot be reached without a stable international monetary system which, without being necessarily universal, should encompass at least the principal trading nations. Now I realize that not everybody will agree with these broad international economic objectives: economic nationalists of whatever variety will not. But it seems to me fair to say that these have been the explicit objectives of the West ever since about 1942 or 1943 and that they still are its objectives—though sometimes one wonders why more is not done to promote them.

The monetary means of achieving these goals has been in the nineteenth century a system of interlocking, fully convertible national currencies, all based on the same monetary standard—gold—and tied together through fixed parities and through national policies of keeping balances of payments in equilibrium through appropriate domestic measures. I have discussed elsewhere—and long ago—the ‘mechanism of re-equilibrium in international payments’ and still stand by what I wrote at that time.5

I regarded the mechanism of re-equilibrium, i.e. policies brought into being by a country’s deficit or surplus in its balance of payments, as a most important ingredient of the old gold standard—and I went on to demonstrate (to my own satisfaction at least, though I should note that not one of my critics challenged me on this point!) that my conclusions were valid for any kind of monetary system. In the case of short-term or ‘routine’ deficits and surpluses, these policies involve credit restrictions in deficit countries and credit expansion in surplus countries. These are obtained, to some extent at least, through respectively upward and downward changes in the discount rate of the central banks concerned, thus generating a compensatory flow of short-term funds from surplus centres to deficit centres—which greatly alleviates the impact of the re-equilibrium process on prices and incomes. Should the deficit (or surplus) be due to more fundamental causes, the corrective measures must also reach deeper into the economic fabric of the countries concerned.

It would take me too far, in the context of the present paper, to go more fully into these matters. Let me note, however, that what is termed (but not defined) in the IMF Charter as ‘fundamental disequilibrium’ can be essentially due to one of three causes: (1) protracted policies of monetary nationalism, i.e. the practice of so-called ‘independent monetary policies’; (2) the effects of structural changes in the international economy to which national adjustments may be slow and difficult; (3) political anxieties due to international insecurity and frictions. Of these the first can only be cured by a change of national monetary policies, in the direction of international co-operation; such a change-over may involve the need for a more or less substantial change of parities to acknowledge the consequences of a possibly prolonged period of ‘national inflation’. The second would call for basic economic measures, combined probably with some form of ad hoc foreign assistance, more likely through the I.B.R.D. than through the IMF—and it may or may not involve a change of parity. The third—political insecurity and movements of ‘hot money’ resulting from it—ought to be handled by co-operative action on the part of a group of nations sharing the same political interests and facing the same military perils (albeit not at the same time); I should think that this could best be handled, nowadays, by either the O.E.C.D. (successor to the O.E.E.C.) or the NATO, rather than by the IMF.

To think, as did the authors of the Bretton Woods Agreements, that a change of parity is the sole remedy for ‘fundamental disequilibria’ is to oversimplify the problem altogether too much. Nor should it be forgotten that the causes of such disequilibria referred to under (1) above are better forestalled than cured. And they tend to be forestalled if there is in being an adequately working ‘mechanism of re-equilibrium’. The question that should now be asked is: does the IMF, as constituted, provide such a mechanism? The answer, texts and experience considered, must—I fear—be in the negative.

There is, in the Articles of Agreement setting up the IMF, no provision for a mechanism of re-equilibrium or, as it is often termed, monetary discipline. ‘Fundamental disequilibria’ can be handled through parity changes or through the application of ‘scarce currency provisions’ to recalcitrant surplus countries. Disequilibria which are not ‘fundamental’ are presumably handled through the routine operations of the Fund. Although no clear obligation for member countries to follow specified rules of month-to-month discipline are written into the Charter, the management of the IMF can in fact impose conditions when credit facilities exceeding 25 per cent of a member’s quota are applied for—and it has been using these powers of persuasion often, especially since Dr Per Jacobsson took over the position of Managing Director. But there are limits to persuasion, as shown e.g. in the Fund’s negotiations with the Gaillard government in France, in 1957, which failed to produce a programme of reforms drastic enough to cope with the French ‘fundamental disequilibrium’. The Federal Republic of Western Germany remains a member of the IMF in good standing in spite of its chronic surpluses, while the United States remain a member in good standing in spite of the chronic deficits (for the simple reason that its government has not applied for the Fund’s assistance). The unconditional use of 25 per cent of the quota by member countries makes it impossible for the Fund to give advice in the early stages of disequilibrium. A loss of gold corresponding to the unconditional drawings on the Fund’s resources would have tended, under the gold standard, to set the mechanism of re-equilibrium into motion.

The IMF, as already noted, does not eliminate exchange control; far from it. And it accommodates itself of the international Gold Exchange Standard, such as it developed—based on the dollar—in the past fifteen years. Yet the Gold Exchange Standard is in itself a breeder of potentially dangerous disequilibria.

It must be concluded that the Bretton Woods Agreements have failed to produce an international monetary system with a built-in tendency towards equilibrium in international payments. The IMF is not a new international monetary order (a phrase I personally feel increasingly inclined to use),6 but it is an effective first-aid station for diseased or temporarily disabled currencies. This is a most important function, though it must not be confused in anyone’s mind with the existence of an established international monetary order. Such as it is, the IMF is quite indispensable and any major monetary reform that might be envisaged should be integrated into its framework. That its resources should be large enough to carry out its limited objectives—with that no one could possibly disagree. Some of the proposals now under discussion would widen the scope of the Fund by giving it greater resources; to that extent they are surely useful. I refer in particular to the proposals formulated by Governor Xenophon Zolotas of the Bank of Greece; the more modest versions of the Bernstein Plan and the most modest version of the Triffin Plan come quite close to the proposal from Greece. I hope that some action along that line will be taken. But even if it is, the problem of international monetary order will remain unsolved; as will be the problem of what is to happen to international liquidity after the United States balance of payments has been brought into equilibrium. The problems are, of course, interrelated: for the more efficient is the existing mechanism of re-equilibrium and the more limited the need for large payments by countries to settle their overall balances with the rest of the world. On the other hand, the freer international payments are (which is another aspect of ‘international order’) and the greater may, on occasions, be the need for liquidity.

III

Unless one went very far in the direction of monetary discipline and of complete dismantling of exchange controls, it is difficult to see any useful purpose that would be achieved by trying to reform the IMF as set up at Bretton Woods. And, if the proposed reforms were to be sweeping enough to endow the world with real international monetary order (after nearly half a century of disorders of one kind or another), it is very difficult to see the successful end of negotiations among the present, far-flung, membership of the IMF. Speaking on March 28, 1961, in the House of Lords and referring to proposals for a reorganization of the IMF, Lord Robbins, who was one of the most prominent participants in the Bretton Woods Conference, had this pertinent comment to make: ‘The imagination simply boggles at the idea of re-opening in peacetime, when there is unlimited time for argument of irrelevancies, negotiations of this sort’. As a modest observer of the proceedings at Bretton Woods, I can fully appreciate the wisdom of this remark.

Lord Robbins’s next remark, in the same speech, takes us back to the lively debates which both preceded and followed the Bretton Woods Conference. (And may I suggest, parenthetically, that the debate now going on would greatly benefit from a close look, both by participating protagonists and by the audience, at some of the articles written in the years 1943–46—not to forget the original text of the British White Paper: ‘International Clearing Union’ [April 8, 1943], better known as the ‘Keynes Plan’—a document more often mentioned nowadays than read.)7 ‘Looking back’, Lord Robbins said, ‘I must confess that I sometimes wish that it had been possible to adopt at that time the key currency approach which was advocated by certain American experts—notably by Professor J. H. Williams—rather than this elaborate and more universal approach to the problem (i.e. the IMF). I cannot help thinking that an agreement between the chief central banks . . . would, in our day at any rate, have served our purpose better than the machinery that was ultimately devised.’8

A brief quotation from Professor J. H. Williams’s article on the Keynes and White plans, originally published in 1943, may be helpful at this juncture. Having started by referring to the two plans that were then sponsored, respectively, by the British and the American governments, Professor Williams goes on to say:

‘I have long believed that there is another kind of approach to the problem, and one that deserves equally well the name of international collaboration even though it is constructed on less elaborate lines. This is what might be called the key countries, or central countries, approach to the problem. It is closer in conception than either the Keynes or the White plan to the way the gold standard actually worked, around England as the central country, in the nineteenth century. . . . What I call the key countries approach to monetary stabilization could be tried with or without an international governing board, though I think this is not the main point of difference between the two ways of going at the problem. The main difference is in the conception of how trade and finance are organized in the world, and of the importance of stabilizing the truly international currencies whose behaviour dominates and determines what happens to all the others. Though the organization of trade and finance has undergone much change since the nineteenth century, it still seems true that the stabilization of the leading currencies with reference to each other, combined with co-operation among the countries concerned for the promotion of their own internal stability, would be the best foundation for economic and monetary stability throughout the world. The importance of co-operation upon internal as well as external monetary and economic policies in the leading countries is in line with the current of thought among economists in recent years.’9

Now then, if there is neither much point in nor any practical possibility of reforming or modifying the existing International Monetary Fund, and since the Fund does not represent anything approaching a true international monetary order, the solution would lie, or so it seems to me, in adopting—or maybe I should say, in adapting—the ‘key currencies approach’ as a supplement to the IMF as we know it. Thus Professor Williams’s ‘voice from the past’ may yet become an important guide to the future. What I shall proceed to suggest about it in the next section of this paper is, of course, at my own intellectual risk and peril.

IV

In terms of the 1960s, the key currencies—in addition to the dollar and sterling—are the currencies which can be made fully convertible without much difficulty. I realize that sterling cannot just now ‘be made fully convertible without much difficulty’; but am convinced that any comprehensive monetary reform must enable the United Kingdom to suppress, over the next few years, the remnants of its exchange control. Indeed, I have held for a long time the view that nothing could build up international confidence in sterling better than the monetary discipline—and economic challenge—represented by full convertibility.

Considering the domestic policies of most, if not all, of the underdeveloped countries which lead to chronic inflation and to equally chronic exchange control, restoration of international monetary order based on (1) free convertibility at fixed parities; and (2) an efficient mechanism of re-equilibrium (i.e. monetary discipline at home) appears impossible in a quasi-universal setting. Solutions must be sought, for the time being at least, within the Western group of economically advanced countries. This means, essentially, much of Western Europe and North America. We have grown far more accustomed than we used to be in the nineteenth century to institutional arrangements. Fortunately, an institutional framework exists, just waiting to be used: the Organization for Economic Co-operation and Development (O.E.C.D.). And it is good news that within the O.E.C.D. a Monetary Sub-Committee of the Economic Policy Committee has been set up last spring, under the chairmanship of Mr E. van Lennep, Treasurer-General of the Netherlands. All of the ‘key countries’, or practically all, are represented in that committee.

To sum up: the plans for reforming the IMF seem to me to be largely off the mark as far as a major monetary reform is concerned; they are only useful to the extent of making the ‘first-aid station’ more effective. Unless they involve credit-creating powers for the Fund—which I should regard as quite out of the question today—they cannot solve the liquidity problem that will arise when the flow of dollars brought about by American payments deficits comes to an end—as it must in the interest of confidence in the dollar and of international monetary stability. None of the plans contributes anything to the liquidation of the dangerous Gold Exchange Standard which remains a major hazard in international monetary and trade relations.10 The problem of international monetary order and of international liquidity must be solved in a smaller gremium—the membership of the O.E.C.D.’s Monetary Committee.

So far so good. The really difficult question arises in connexion with that more limited solution—more limited, at least, geographically. When all the plans are examined and sifted, only two basic solutions remain. One of them is to readopt the gold standard (as distinct from the Gold Exchange Standard) and to adapt it to modern conditions without losing any of its great past qualities. The other is to adopt an arrangement which would be an adaptation of the Keynes plan to conditions of this day—and this means the establishment of a kind of supranational central bank. Professor Triffin, in his more ambitious moods, provides us with a blueprint for such an arrangement (albeit an incomplete one).

Of the two solutions, the latter has all the excitement of novelty and of experiment and the forward look so appealing to intellectuals. It runs, however, into several important snags. Leaving aside technicalities (which can be safely left till after the principle is adopted, if it ever is), an international central bank presupposes an international society of which it is one of the many organs. We do not have such a society; even in the Atlantic framework we are, alas, far from it. But can one reasonably contemplate an international (supra-national!) central bank in a vacuum of collaboration at that level in a host of other fields? For my part, I think that the Triffin revival of the Keynes plan is, at best, very premature. Yet we must put order into international monetary relations soon, very soon, if we are to avoid a breakdown the first time something goes seriously wrong in the international economy.

This apart, is the plan desirable per se? Here serious doubts may be permitted. The Keynes plan was rejected for two main reasons: it placed more discretionary powers in the hands of an international board than many countries—the U.S. for one—were willing to accept; and it was regarded as having great potentialities for generating world inflation. The same objections apply to the more modern versions, among which Triffin’s is the most elaborate. A great weakness of the Keynes plan was its insufficient emphasis on ‘monetary discipline’; there is even less emphasis on it in the Triffin plan (and this goes for the Bernstein and Stamp plans as well). The preoccupation of these plans is primarily with liquidity, not with order. On this score, very serious doubts as to their intrinsic desirability are allowed. Another ‘snag’: Triffin wants to substitute, progressively, Fund currency (Keynes’s ‘bancor’?) for national reserve currencies. But is it at all certain that this is feasible? The element of confidence, even if forcibly kept out, tends to creep back into the picture, usually at the most inconvenient and embarrassing time. And the question is wide open whether the Fund’s currency would in fact enjoy the degree of confidence and acceptability enjoyed, even in their weakened state, by the reserve currencies of today, the dollar and sterling.

And then there is the little matter of gold. As long as it remains in the system, the problem of convertibility into gold of other forms of reserves remains open. With a large volume of credit-type reserves built on a slender gold base, massive conversion—in times of a serious confidence crisis—must lead inevitably to a breakdown. I know: Keynes regarded gold as ‘a barbarous relic’, and Triffin wants to demonetize gold in the end—the logic of his proposal calls for it anyhow. But, demonetization of gold is just not in the cards, not in our time. The man in the street in continental Europe and elsewhere in the world still trusts gold more than anything else in the realm of money. Some claim that this is no longer so in the Anglo-Saxon countries. From my rather intimate knowledge of America and the Americans I should hesitate to accept this opinion. And even the Britisher-in-the-street. . . . So we should inquire into two further matters: will Fund deposits inconvertible into gold be as acceptable as are gold-convertible dollars and pounds sterling—not to forget gold itself? And should the new Fund—maybe an ‘Atlantic Fund’—maintain the principle of gold convertibility, are we not falling right back into yet another mutation of the Gold Exchange Standard, which, in the interest of long-run stability, we must get rid of?

Frankly and, I am afraid, a little dogmatically, I have no confidence, as far as the next 25 or 50 years are concerned, in the possibility of carrying into effect without great peril any of the supra-national central bank schemes. Intellectually they are most intriguing; in practice—full of pitfalls. L’on ne peut pas brusquer l’histoire! On the other hand, a basic monetary reform is urgently needed.

This leaves us with one other possibility: the full monetary rehabilitation of gold. I believe this both feasible and, while maybe less inspiring, a very much safer course of action. But as this paper was conceived of as a disquisition on monetary plans now before us, and as the restoration of the gold standard (in a modern and Atlantic setting) is not now a plan before us, I shall stop my discussion right here, without offering my own counter-proposals. These will be presented at length elsewhere—and as soon as feasible.

 

11 Chapter of a brochure originally published by Creditanstalt-Bankverein, Vienna, under the title: ‘Current Problems of International Monetary Policy’, to mark the Annual Meeting of the World Bank and the International Monetary Fund in Vienna, September 18–22, 1961.

12 Charles Rist, La défense de l’or, Paris, 1954; English translation, with an introductory essay by Philip Cortney, The Triumph of Gold, New York, 1961. This small volume reprints the principal of Rist’s post-World War II articles, with an important Introduction from his own pen.

13 Jacques Rueff, ‘The West is Risking a Credit Collapse’, in Fortune Magazine, July 1961 (also Le Monde, Paris, June 27, 28, 29, 1961; The Times, London, same dates; Neue Zürcher Zeitung, June 26, 27, 28, 1961).

14 See my book International Monetary Economics, London, 1939, Chapters VIII (reprinted in the present volume, pp. 17 et seq.) and X, and my article ‘Fixed Parities and International Order’, Banca Nazionale del Lavoro Quarterly Review, June 1955 (reprinted in the present volume, pp. 222 et seq.).

15 See my International Monetary Economics; London, 1939, Chapter VIII, sections E and F (reprinted in the present volume, pp. 28 et seq.).

16 In preference to the more widely used term of ‘monetary discipline’ or indeed of the term ‘international monetary system’—for there are systems which do not include the component of order, e.g. the Gold Exchange Standard.

17 Two articles which should be ‘required reading’ for anyone interested in these questions are: (1) Jacob Viner’s ‘Two Plans for International Monetary Stabilization’, Yale Review, September 1943, reprinted in his collected essays entitled International Economics, Glencoe, Illinois, 1951; (2) John H. Williams’s ‘Currency Stabilization: The Keynes and White Plans’, Foreign Affairs, New York, July 1943, reprinted in his Postwar Monetary Plans and Other Essays, New York, 1947.

18 Hansard, House of Lords Official Report, vol. 230, No. 59, March 28, 1961, col. 83.

19 John H. Williams, Postwar Monetary Plans and Other Essays, New York, 1947, pp. 16–17.

20 Vide the cited article by Jacques Rueff.

• 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.
• 8In using the term ‘re-equilibrium’ for ‘restoration of equilibrium’, I adopt a term introduced by Professor Aftalion, L’équilibre dans les relations économiques internationales, Paris, 1937.
• 9The reader will find it useful to supplement this very summary statement by the excellent treatment of the subject in Jacob Viner’s Studies in the Theory of International Trade, New York and London, 1937, Chapter VII, pp. 388–436.
• 10James W. Angell, ‘Equilibrium in International Payments’, op. cit., p. 17.
• 11Post-war European Inflations, World War I A Study of Selected Cases*
• 12The 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.
• 13The 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.
• 14The 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.
• 15The 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.
• 16The 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.
• 17In 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.
• 18As it has been pointed out above, there are two different ways of approaching this question. One is to indicate the mechanism by which policies adopted in response to a break of equilibrium can bring about compensatory operations, and thus durably restore the disturbed equilibrium of the balance of payments. The other approach consists in demonstrating that disequilibrium releases through its very existence forces which tend to bring about the necessary adjustments in international transactions. The one type of approach arrives at a theory of what I propose to call ‘induced re-equilibrium’, while the other arrives at a theory of ‘automatic re-equilibrium’. This terminology will be justified by the discussion that follows. It will become clear too that the two theories are complementary, not alternative, and that one needs them both in order to explain empirically-known phenomena in a completely satisfactory way. It is to be regretted that most writers on the subject so little realize the complementary character of the various approaches to the problem of re-equilibrium in international payments.
• 19The classical ‘mechanism’ realizes all these effects by the single means of changes in the bank rate. Under modern banking conditions additional policies may be called for, since the monetary circulation not covered by gold is only to a small extent backed by commercial paper and to a very large extent by government securities. In order to obtain the reduction in monetary circulation which the ‘classical’ theory demands, ‘open market’ operations must supplement the movements of interest rates. It will be noted that there is, both in the ‘classical’ and in the ‘modern’ version of this mechanism, a considerable amount of judgment to be exercised by the central banking authorities; thus the mechanism in question is by no means an automatic one.
• 20It can be said that long-term equilibrium in international payments exists if short-term credit operations are always sufficient to restore the balance whenever it is disturbed. Thus Professor Angell gives a definition, which in the light of the foregoing analysis appears to be judicious and acceptable, and according to which international payments of a country are in equilibrium if ‘the net balance of the aggregated commodity, service, interest and dividend and long-term capital operations, so far as these operations entail actual payments, is zero’. Or, reciprocally, ‘a country’s international payments are “out of equilibrium” whenever short-term funds are moving to or from it, net (that is, whenever the net balance of all the other international payment items is greater or less than zero)’. In other words, international payments are in durable equilibrium if, in order to maintain that equilibrium, and in the absence of any new disturbances, no changes in the structure of foreign trade or credit operations are required.