Aspects of the Pathology of Money

16 The Present Monetary Crisis of the West: The First Phase1

‘There marched the Emperor in the procession under the beautiful canopy, and everybody in the streets and in the windows said: “Goodness! The Emperor’s new clothes are the finest he has ever had. What a wonderful train, what a perfect fit!” . . . Never had the Emperor’s clothes been such a success. “But he hasn’t got anything on!” said a little child. “Goodness gracious, do you hear what the little innocent says?” cried the father; and the child’s remark was whispered from one to the other. “He hasn’t got anything on! There’s a little child saying he hasn’t got anything on!” “Well, but he hasn’t got anything on!” the people all shouted at last. And the Emperor felt most uncomfortable, for it seemed to him that the people were right.’

(HANS CHRISTIAN ANDERSEN,The Emperor’s New Clothes.)

I

The thesis I want to put to you today is indeed very disturbing and the point of view adopted by me, after much reflection, is not likely to endear me to anyone save those who agree with me, and their number is very small. It is my contention, if I may go to the heart of the problem without preliminaries, that the West is immersed in an international monetary crisis; that the first phase of this crisis, in which we still are, has been going on for much longer than is generally admitted, and that, unless the monetary problems we are faced with are solved very promptly, we shall, before very long, enter a second, and far more dramatic, phase of the crisis.

Now, this way of looking at things stands in striking contrast with a statement issued on October 2, 1963, in Washington, on behalf of the ‘Group of Ten’ members of the International Monetary Fund, by Mr Douglas Dillon, Secretary of the Treasury of the United States.

The ten countries are: Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States; they are the participants in the Paris ‘Agreement to Borrow’ of December 1961, to supplement the resources of the International Monetary Fund.2 Their finance ministers, central bank governors, and top officials met in Washington prior to the opening of the latest Annual Meeting of the IMF, together with Mr Pierre-Paul Schweitzer, Managing Director of the Fund. From their declaration made public on October 2, 1963, I want to quote the following crucial passages (paragraph 4):

‘In reviewing the longer-run prospects the Ministers and Governors agreed that the underlying structure of the present monetary system—based on fixed exchange rates and the established price of gold—has proven its value as the foundation for present and future arrangements. It appeared to them, however, to be useful to undertake a thorough examination of the outlook for the functioning of the international monetary system and of its probable future needs for liquidity.’

You will have noticed the words ‘and future’ in the first sentence quoted. It indicates that ‘the Ten’ consider that the present international monetary arrangements are not only satisfactory for the present, but also for the future. Having noted this, the second sentence of the quotation appears to be something of a non sequitur: for, indeed, if the present monetary arrangements are judged to be satisfactory now and to continue to be so for the future, it is very difficult to see why there is any need at all to undertake a thorough examination of the outlook for the functioning of the international monetary system! Such an examination would only be necessary, nay, indispensable, if there were considerable doubt as to the ‘seaworthiness’ of the present system. Furthermore the inquiry not only is to be carried out on the assumption that a system of fixed parities and the prevailing price of gold are desirable for the future, but it is to deal essentially with the future needs for international liquidity. And this last point, the concentration on the future liquidity problem, is to my mind just as wrong as the first which declares the existing monetary arrangements to be in the main satisfactory both for the present and for the future.

May ‘the Ten’ governments excuse a dissenting opinion from an independent academic economist! For my part, and I hope to prove this in the course of the present address, I consider the existing monetary arrangements highly unsatisfactory for the present and very dangerous for the future. The main problem to be tackled in order to improve the situation is not the problem of liquidity, but the problem of international monetary order.

Mine is then a wholly heretical attitude. Yet I derive a great deal of comfort from something one of the world’s leading central bankers has said at the Annual Meeting of the International Monetary Fund held in Vienna in September 1961: ‘There could be no greater fallacy’, declared on that occasion Dr M. W. Holtrop, the learned President of the Bank of the Netherlands, ‘than to imagine that the solution of our problems could be found—as it is sometimes suggested—in just feeding the excess reserves of the surplus countries back into the international circuit, so as to enable the deficit countries to continually finance their deficits. This would only create the perfect machine for perpetual inflation.’

This terse sentence is the best-phrased indictment of the prevalent monetary arrangements, i.e. of the current variant of the Gold Exchange Standard, or what is now called ‘key-currency’ or ‘reserve-currency’ system. The fact that the existing monetary arrangements encourage deficit countries, particularly if they are reserve-currency countries, to heap deficits upon deficits, year in and year out, by the simple device of the creditors’ redepositing the balances they have received in their country of origin, thus leaving the internal monetary situation in the deficit country unchanged, is what calls for a basic institutional reform of the present international monetary system. Attention of governments ought to be riveted on this reform. As Dr Holtrop and many other leading central bankers rightly contend, there is at present no shortage of international liquidity. And there will be none as long as large U.S. balance-of-payments deficits continue. The problem is a wholly different one: it is the problem of international order, and this is what I must discuss now at some length.

II

Several years ago, I used to amuse my friends by telling them that, in a few years’ time and unless basic monetary reforms were undertaken, the world will celebrate (if one can use such a gay word for such a dismal occasion) the fiftieth anniversary of international monetary disorders. But time moves fast and in another six months the anniversary will be here. The international gold standard was one of the early victims of World War I. In the first half of 1914, it had still been a thriving international monetary system which, for the previous twenty-five years, had won many new members and a great deal of experience. It was, one might say, an ‘unfinished system’, for much remained to be done, both to increase its geographic scope and to improve its functioning. Its ‘rules of the game’ were unwritten and by 1914, although it was in existence, as an international system, for over 35 years, no international conference of experts had met to discuss its functioning and to define its operating principles. And by the autumn of 1914, the international gold standard was in shambles, due to the outbreak and extension of what was then the European War and was to become later World War I. Evidently the system did not break down because of any inherent weaknesses or imperfections of its own (something that its critics choose to disregard); the causes of its destruction were wholly exogenous.

The fifty years that followed were punctuated by wars, depressions, inflations, and the multiple forms of trouble which the pathology of money can take in peace and in war, in the absence of an established international monetary order. The reconstruction carried out in the twenties proved entirely ineffective, because instead of restoring the gold standard, governments and the experts who guided their decisions preferred to substitute for it the Gold Exchange Standard, i.e. an earlier form of the ‘reserve-currency system’. In the latter twenties, the system proved to be, to borrow Dr Holtrop’s phrase, ‘a machine for perpetual inflation’. But the inflation did not prove to be as perpetual as all that—no inflation ever is, except maybe the Brazilian. It broke down on the occasion of the New York Stock Market crash in the autumn of 1929 and was followed by the deepest depression the modern world has known. That depression led, in 1931, to a run on Britain’s gold (sterling was the principal ‘reserve currency’ of the twenties). There ensued years of competitive currency depreciations, of growing restrictions on international trade and payments, and not till the autumn of 1936 did the United States, the United Kingdom, and France reach a ‘tripartite agreement’ introducing a small but significant degree of order into foreign exchange markets. But the war was almost upon us and further measures of reconstruction could not be planned, let alone adopted.

It is to the great credit of British and American experts and of the governments they were advising, that the problem of international monetary reconstruction was tackled while the second world war was still going strong. Their preliminary efforts led eventually to the Bretton Woods Conference of 1944, which adopted the Charter for the International Monetary Fund, the Fund itself coming into being as soon as the war was over.

The IMF, however, is not an international monetary system; I have often described it in my writings as ‘a first-aid station for temporarily diseased and disabled currencies’, a definition which my old and regretted friend Per Jacobsson disapproved of very much (I am sorry to say), but which does not seem to offend the susceptibilities of his successor.

Why cannot the IMF be regarded as an international monetary system? The question is not one of semantics; it is substantive and very fundamental. An international monetary system worthy of this name must set up and keep up international monetary order; and this implies that it has, as a principal component, a mechanism of prompt re-equilibrium of international payments, of national balance-of-payments disequilibria, whether these are deficits or surpluses. The IMF Charter has no provision requiring its members to practise policies of prompt re-equilibrium. Instead it provides them with facilities of facing balance-of-payments deficits for a longer period of time than their own monetary reserves would allow them to do. This, of course, is not the whole story. It must be said, in fairness to the IMF, that it has very explicit provisions for handling so-called ‘fundamental disequilibria’ in national balances of payments, a notion which is, however, left undefined. A deficit country as well as a surplus country can modify its parity to eliminate a fundamental disequilibrium. Provisions ruling this measure are very detailed and it took much time at the Bretton Woods Conference to work them out. Mostly they must be adopted in agreement with the IMF. The underlying assumption is that a ‘fundamental disequilibrium’ can be always (or nearly always) corrected by a change of parity: this assumption is implicit and it is a highly controversial one.

Then there is the so-called ‘scarce currencies’ article, which provides special measures that might be adopted in the case of countries running chronic and sizeable surpluses in their balance of payments and unwilling to correct these surplus positions. These measures are so drastic and dangerous that they have never been applied. If applied, they would have resulted each time in more or less considerable backsliding into rigorous and discriminatory exchange controls. They are not what one might call economic surgery, let alone therapy: they are outright butchery of international monetary and trade relations. Very wisely, they have never been applied.

The point, however, which needs to be stressed with the greatest possible emphasis, is that to direct attention mainly to ‘fundamental disequilibria’ is to misdirect it. For the maintenance of international monetary order depends on the quick elimination of the non-fundamental disequilibria; their correction is the principal function of a mechanism of re-equilibrium. If deficits (or, for that matter, surpluses) are allowed to grow chronic and large, the problem of eliminating them becomes increasingly difficult and may only be handled by economically expensive and politically unpalatable measures. If corrected promptly, however, deficit and surplus positions of national balances of payments remain relatively small and can be reversed without any trouble by the use of the traditional monetary policies, of which the world has acquired considerable experience during the ‘classical’ period of the gold standard. With the knowledge we have acquired since (for pathology teaches us a great deal about the functioning of healthy organisms), the process of re-equilibrium could undoubtedly be made to work even better in the future than it has worked prior to 1914.

Nothing in what I have said so far, and nothing in what I am going to say later, must be interpreted as a negative attitude on my part towards the existence of the IMF as such. I am convinced that the IMF has served the world well, especially since the late Dr Jacobsson became its managing director, and I am sure that there is important scope for it in whatever new arrangements will be devised in the future. I said that the IMF was in my eyes a ‘first-aid station’: so it is, but we need first-aid stations! I do not believe that, as a matter of practical expediency, its Charter can be modified: in this I fully agree with the views expressed on March 28, 1961, in the House of Lords, by one of the principal architects of the Bretton Woods Agreements, Lord Robbins, who said: ‘The imagination simply boggles at the idea of reopening in peacetime, when there is unlimited time for argument of irrelevancies, negotiations of this sort.’

What is necessary, however, is to supplement the IMF by a tighter and more binding commitment, among at least part of its members, relating to the handling of ‘non-fundamental disequilibria’.

This is why the establishment of the ‘Group of Ten’ should be greatly welcomed. The problem of international monetary reform is, at the present juncture of world affairs, one that can be handled only by the industrially advanced countries of the world. The underdeveloped countries are not at present interested in this type of problems. Sheltering their economic development programmes by a wall of exchange control and of quantitative trade restrictions, their interest is not in the functioning of an international monetary system, but in the supply of capital to finance development. This does not mean that the fate of international monetary relations in the Western world (plus Japan) is of no concern to them. Indeed, should there develop the kind of monetary breakdown which some of us, including myself, feel apprehensive about, it would involve a great wave of deflation in world trade and in the flow of capital which would affect most unfavourably the economic growth of underdeveloped countries. The sounder the monetary system of the West, and the better are the prospects of a speedy growth for all the nations, including of course those who are most in need of growth, the underdeveloped ones. But as it happens, the present monetary arrangements in the West, far from being a system, are very precarious indeed. Although this fact is not widely acknowledged, we are already in a condition of international monetary crisis.

III

The last statement may surprise and is likely to shock. Yet I believe it to be fundamentally true. The beginning of the international monetary crisis might well be dated as of October 20, 1960. That was the day when the dollar price of gold in the London gold market (reopened in March 1954) broke off its moorings and rose to about $40 an ounce. The ‘flurry’ in the London gold market did not last for more than about a fortnight and its importance is that attaching to a symptom. It would take me too long this afternoon to explain why the London gold market got out of hand in the second half of October 1960; there are technical reasons for this, and there are more fundamental reasons connected with the state of confidence in the dollar. It is of those that I want now to say a few words.

It will be recalled that in the first post-war decade much has been said and written about the ‘dollar shortage’. Many learned economists have devoted long monographs and even sizeable books to this subject and it was their contention that the ‘dollar shortage’ was a permanent feature of the world economy, largely due to the technological supremacy of the United States. Some put their case in more sophisticated ways than others, and some arguments are very sophisticated indeed. Surprisingly few were the upholders of the opposite point of view, but they included such prominent figures in the economic theory and practice as Professor Jacob Viner, of Princeton, and Lord Robbins, of the London School of Economics. Actually the Marshall plan has largely disposed of the problem of ‘dollar shortage’ for Western Europe and, as the recovery process moved on, it became increasingly clear to anyone without a doctrinal stake in the controversy that the United States was having a balance-of-payments deficit year in and year out from 1949–50 onwards. As far as I am personally concerned, I thought as of the end of 1950 that the problem of ‘dollar shortage’ was no longer with us and have said so in a lecture delivered before the Economic Society of Belgium in April 1951.3

These deficits in the American balance of payments continued until 1956 inclusively, at a level ranging between $1 and $2 billion a year. They resulted in a minor loss of gold by the United States (its gold stock was $22 billion at the end of 1956 compared to $24.6 billion at the end of 1949), but dollar holdings by foreigners kept increasing ($6 billion at the end of 1949, of which $2.9 billion were held by official holders; $13.5 billion at the end of 1956, of which $8 billion were held by official holders). In 1957, the United States had a single year of balance-of-payments surplus, largely due to the impact of the Suez crisis upon foreign trade. From 1958 onwards, however, the American deficits became very large indeed. In the one year 1958, the United States lost $2.3 billion of gold, while its foreign sight liabilities increased by $1 billion, making a total balance-of-payments deficit of about $3.3 billion. This could have been a temporary situation, due to an over-correction of the 1957 surplus: such things are known to happen. But the deficit continued in 1959 and the following years, so that, between the end of 1958 and the end of September 1963, the United States balance-of-payments deficit totalled about $12,350 million, of which 4,950 million were paid in gold and 7,400 million were added to foreign-held dollar balances.

It is the continuation of the American deficit in 1959 and in the first half of 1960 which resulted in the crisis of confidence which found expression in the purchases of gold in the London market. Now it must be noted that central banks are prevented by the Bretton Woods Agreements from dealing in gold at prices which exceed the range of 1 per cent below parity and 1 per cent above parity. Accordingly the gold buying which forced the price to nearly $40 anounce on October 20th and kept it well above the official upper limit for some time thereafter, was private. There is not much by way of record of who private gold-buyers are, but it is generally assumed that Americans were prominent among them at that particular time. This must have been what prompted the Eisenhower Administration, in one of its last official acts, to forbid American citizens from owning gold abroad (Franklin D. Roosevelt forbade them to own gold at home as far back as 1933).

A crisis of confidence in a currency is a very complex phenomenon and it would be unwise, indeed impossible, to deal with it in the scope of this lecture. For my part I am convinced that what played the determining rôle was the continuation of large deficits without any visible sign that monetary policy was being used in the United States to bring about balance-of-payments re-equilibrium.

In suggesting, a moment ago, that the international monetary crisis can be dated as of October 20, 1960,1 did not, of course, mean to imply that before that date international monetary affairs were in a very good shape. We have had an absence of international monetary order, as noted earlier in this lecture, since August 1914, and more recently we have failed to restore any semblance of order after World War II came to an end. Viewed in this perspective, the crisis to which I refer is merely a more drastic and potentially more dramatic form of monetary disorder. But it also serves notice that time for a basic reconstruction is running short.

IV

It is probably because of this perspective that the events in the London gold market were not taken as seriously as they should have been. To be sure, the United States Treasury realized in due time that it was necessary, henceforth, to intervene in the London gold market through the good offices of the Bank of England (while many commercial bankers expressed freely and vigorously their view that the London gold market should better be closed again—a kind of reasoning very similar to that which leads a patient to break the thermometer because he dislikes the high temperature it registers).

From the autumn of 1960 until now, we have been living in the first phase of an international monetary crisis. The characteristic feature of that crisis is that, in the face of continuing U.S. balance-of-payments deficits of upwards of $3 billion a year, there is active, strenuous, and inventive co-operation on the part of governments and central banks to prevent the (unacknowledged) crisis from getting out of hand. Aspects of this co-operation are much too well known to be described here in detail. They include: the formation of a gold pool which co-ordinates official gold-buying and selling operations in the free gold markets; currency ‘swap’ transactions initiated by the able and dynamic Under-Secretary of the U.S. Treasury, Dr Robert V. Roosa; the issuance by the United States of medium-term bonds labelled in the currency of the country in which they are sold; the setting-up of the already mentioned ‘Agreement to Borrow’ among ten industrially advanced countries of the IMF, at the end of 1961; etc. A full and clear description of these arrangements is to be found in an important article by Dr Roosa, published in the October 1963 issue of Foreign Affairs under the title: ‘Reforming the International Monetary System’.

The ‘system’ emerging from these various measures is not really different from what we have had in the past decade. The principal difference is the willingness of the United States to hold in its reserves small amounts of balances in strong foreign currencies and to deal, through the Federal Reserve Bank of New York, in foreign exchange, something that has not been practised since 1933. The central banking co-operation involves holding on to dollar balances rather than presenting them for payment in gold, which these central banks are entitled to do by virtue of a thirty-year old precedent going back to the American Gold Reserve Act of 1934.

As one looks closely into this situation, however, one finds that the picture is not as clear as one might think. If we take the countries of the Common Market (whose surplus is as chronic as is the American deficit), we find that their total reserves have increased by $6.4 billion between the end of 1958 and the end of September 1963. Of that amount, $5.2 billion was cashed in gold and only $1.2 billion went into increasing their foreign reserve holdings. Still, over-all, the foreign liabilities of the United States have increased during the above-mentioned period by $7,400 million of which $3,700 million represent additions to dollars held by central banks. There has been a correspondingly very large increase of dollars held outside of central banks. Dollar balances reported as being held by foreign commercial banks have increased from $2.6 billion at the end of 1952 to $6.3 billion at the end of October 1963. (In addition, nearly $3 billion were held on that latter date by unspecified private foreign owners.)

Now, another development of recent years which made commercial banks more interested than before in holding short-term dollar balances, was the expansion of the so-called ‘Euro-Dollar’ market. Owing to the great abundance of dollars in the West and to certain peculiarities of the American money market which I cannot develop fully here, the lending of dollar balances (held in the United States by European banks) to customers in Europe and in other continents, has become a very profitable operation. It has certainly helped those of the European central banks which do not wish to hold larger dollar balances for their own account, to encourage commercial banks in their respective countries to hold on to their dollars.4 What will happen the day when a confidence crisis of large proportions determines commercial banks not to hold dollars and makes them offer these dollars for sale to central banks, is an open question. Will the much-famed ‘central bank co-operation’ cause central banks to hold on to large additional dollar balances without converting them into gold? This question can only be asked; it obviously cannot be answered. It indicates, however, one of the ways at least in which the present international monetary crisis might make the transition from its first to its second phase.

V

In a lecture which I delivered in Zurich in December 1959, I indicated how unstable I thought the existing monetary situation was. The world, I suggested, was faced with two dangers. One was a continuation of U.S. deficits, unchecked, to the point when an uncontrollable crisis of confidence would break up the prevalent monetary arrangements. The other danger, I suggested, would result from the U.S. achieving equilibrium in its balance of payments, and possibly even attaining a surplus: in that case the world would be faced, progressively, with the re-emergence of a liquidity problem. Since neither of these perspectives was pleasant to contemplate, I suggested that a major monetary reform was necessary, which would provide a way of keeping national balances of payments in equilibrium without creating a shortage of international reserves. For it was as clear to me then as it is now that the world is faced, not with a dollar crisis, but with a much more fundamental crisis in international monetary relations.

Since the end of the war, the world slipped back into a ‘system’ of reserve currencies and, as of 1950, or thereabouts, the dollar became the principal reserve currency. (Great Britain has had, for the past decade and a half, a remarkable degree of medium-term equilibrium in its balance of payments: sterling liabilities have not grown on average, although they have changed hands and thereby have become more stable while, on the other hand, the gold and dollar reserves of the United Kingdom have, on average, remained stationary too.) The dollar is the active factor in the contemporary Gold Exchange Standard. But it is precisely this system which has reached, or is about to reach, the end of its tether. A reserve currency system increases the volume of international liquidity via deficits of key-currency countries; on the other hand, the functioning of the system encourages these countries to run up sizeable deficits. In a way the U.S. dollar is the victim of the system which places it in the centre of international monetary arrangements. And other victims are the economies of continental Western European countries suffering from almost chronic ‘overheating’ due to the excess liquidity generated by their chronic balance-of-payments surpluses—which are the counterpart of U.S. deficits. Labour shortage is, in that context, a secondary (though very disturbing) phenomenon.

What is needed is to replace the ‘key-currency system’ by something better. The new system must satisfy two requirements: it must provide adequate increases in international liquidity, so as to preserve world trade from deflationary pressures; but it must also—indeed it must principally—restore into being an efficient mechanism of prompt re-equilibrium in international balances of payments.

The present phase of the international monetary crisis can be described as ‘containment’. It can also be described, to borrow a phrase coined, in another context, by the late John Foster Dulles, as monetary ‘brinkmanship’. I am very doubtful, for my part, whether this phase can continue much longer, in spite of the valiant efforts of Dr Roosa and the remarkable co-operation the U.S. receives from European central banks. The crisis, after all, is not just a dollar crisis; it is a crisis of the reserve currencies régime as a whole. Central banks can control a great deal, they cannot control everything. They cannot control shifts in public opinion, especially sudden and turbulent movements of confidence.

There are three ways in which the West can move, as far as its monetary destinies are concerned, from the position in which it finds itself at present. One is a basic monetary reform; the second is moving from the first phase of the crisis into the second via a crisis of confidence in the dollar; the third is to move from the first phase of the crisis into the second via an American balance-of-payments surplus.

The first of these three possibilities would give the world an orderly monetary system for the first time in half a century. The second possibility would result in international monetary chaos which might dwarf the experiences of the early thirties and lead to a serious economic depression; it would certainly lead to a major disaster of the West in the cold war. The third possibility would involve a reappearance of symptoms of ‘dollar shortage’ or, more generally, of liquidity shortage. This could be remedied by the creation of liquidity without restoring international monetary order; but this would be another way of setting up, in Dr Holtrop’s words, ‘a perfect machine for perpetual inflation’. Or it could be corrected by the major reform envisaged as the ‘first possibility’.

VI

Faced with these urgent, as well as fundamental, problems, academic economists display a truly extraordinary divergency of views. The academic monetary ‘grand debate’ has been going on for forty years and shows no signs of abating. Indeed, recent compendia of serious academic opinion, published under the auspices of the Joint Economic Committee of the U.S. Congress, as well as several international symposia, reveal a considerable and disturbing disarray in the realm of academic thinking on these matters. It is because of that disarray that the recent initiative of the International Finance Section of Princeton University, headed by Professor Fritz Machlup, is of particular value. This initiative involved bringing together 32 economists, both American and European, representing the principal schools of thought in this field, for a five-day conference held last January at Bellagio, Italy. The purpose of the discussion was not so much to find out whether these representative economists could be made to agree, as to explore the factual and doctrinal assumptions made by the ones and the others. This meeting is to be followed by others and a series of such conversations is bound to result in more clarity and better understanding among economists of each other’s points of view. Whether it will bring about agreement on policy matters is another question. There are, however, one or two points which were brought out by this confrontation of 32 academic experts and are worth recording.

In the first place, most of them agreed that prompt re-equilibrium of balances of payments is absolutely essential if international monetary stability is to be preserved. They disagreed, of course, as to the best method with which to achieve re-equilibrium. The sharpest opposition developed between advocates of the gold standard and those of floating exchange rates; adherents of a supranational central bank admitted that their projects are concerned exclusively with the creation of adequate liquidity, not with the restoration of a mechanism of re-equilibrium.

In the second place, there was substantial, though not unanimous, agreement on the proposition that the large volume of gold-convertible dollar balances held abroad, and of dollar-convertible sterling balances, represents a grave hazard to the future of monetary stability and that these balances should accordingly be either consolidated on a long-term basis or, in the view of a small minority of which I was a member, repaid in gold at a new price of the metal. Only a few participants thought that the existing monetary situation did not present any major hazards for the future.

As regards monetary reform, there appeared to be three main possible solutions: (1) the creation of a supra-national central bank; (2) the generalized adoption of floating exchange rates; and (3) the readoption of the gold standard based on a new price for gold.

VII

The first of these proposals for reform is intellectually appealing and is propounded with much vigour and talent by Professor Triffin and his adherents. Personally I have three objections to it: in the first place, it leaves entirely aside—and this, Professor Triffin freely admits—the problem of balance-of-payments re-equilibrium, i.e. the problem of international monetary order; it is concerned solely with the creation of adequate additional liquidity, by means other than deficits of certain countries; in the second place, I cannot conceive of a supranational money-creating institution in the absence of a supra-national political organization—and we are extremely far from establishing such an organization, yet time is pressing and, in order to avoid getting into the second and most dangerous phase of the present crisis, we must find a solution very soon indeed. In the third place, Professor Triffin’s proposals inevitably lead to the demonetization of gold—yet gold is what most people throughout the world have far more confidence in than any kind of paper money or credit; maybe the day will come when gold can be dispensed with, but that day is, to my mind at least, very far off.

The floating exchange rate system is something I played around with myself in one of my early writings, published in 1932. A few years later, after the disastrous experiences of the thirties, I gave that up as impracticable. The experience of the forties and fifties has confirmed me in the opinion that this type of monetary arrangement can only result in chaos. And this chaos would lead inevitably, I feel, to a widespread readoption of exchange control, the worst conceivable form of monetary organization.

That leaves me with the gold standard and, as you know from my teaching and my writings, this is the system which I favour now and have favoured for more than a quarter-century. I favour it, not because it is the ideal system, but because it is a good one. I favour it, not because it solves all problems—there is no panacea!—but because it creates an environment of monetary order in which a great many other economic problems can be solved more readily than they can be in the atmosphere of monetary laxity to which we have grown so accustomed. I favour it, finally, because I am convinced that it can be adopted by the industrially advanced countries of the West fast enough to permit the transition from the first phase of the crisis to a solution, rather than to a disastrous second phase.

I have spelled out a programme of action leading to the restoration of the gold standard in the September 1962 issue of Fortune Magazine.5 The essential parts of this article have been rather widely quoted and the article itself has been included in several anthologies on monetary reform which appeared last year in the United States and in Europe. I can accordingly dispense with repeating today what I have written in that article, except, maybe, to say that I have made no changes since in the suggested action programme.

Far be it from me, however, to be sanguine about the chances of my proposals being adopted by governments. Although the doubling of the world price of gold is only an incidental part of these proposals—a condition for the much-needed repayment in gold of dollar and sterling balances which represent such a menace to the monetary stability of the future—it goes counter an oft-repeated policy position of the U.S. Government, and indeed against the terms of reference of the ‘Group of Ten’. The differences between the various schools of thought relative to monetary reform which I have mentioned earlier are, in my opinion, by and large irreductible. Even if, at Bellagio, much agreement was found on matters of immediate policy, fundamental positions remained far apart. This, I think, is inevitable and it places the statesmen of the world in something of a predicament. I do appeal, however, at this place, most seriously, to the ‘Group of Ten’ to proceed pretty much as British Royal Commissions do, or Committees of the U.S. Congress, although with far less publicity. By that I mean that they should hold hearings, in which the principal academic spokesmen for the various points of view should be given an opportunity to present their position and to be cross-examined. After that, the decisions will have to be taken by governments (and this includes, of course, central banks), for they are the only people who can take decisions about practical policy. Let us hope that these decisions will be farreaching, fundamental, and prompt!

P.S. (September 1964) The foregoing essay was written during February 1964. The author kept in close touch with such members of the ‘Group of Ten plus One’ and their deputies as he knew personally, throughout the spring and early summer of 1964. On August 10th, the ministers made public their Report, a thin pamphlet entitled: ‘Ministerial Statement of the Group of Ten and Annex Prepared by Deputies’.

The Report can best be described as a two-page preamble followed by a summarized and presumably ‘bowdlerized’ version of the longer report which the deputies submitted to the finance ministers and central bank governors. The published Report is about as poor as was anticipated by me in February; it leaves the problem of monetary reconstruction entirely open. Indeed a sub-committee will go on working on some aspects of the problem, but I doubt whether, in the absence of really sweeping instructions from the ministers and top-level officials, the sub-committee can produce very much. Accordingly the pessimism expressed throughout this paper remains, alas, in being.

The first Bellagio conference of academic economists mentioned in this lecture was followed, at the end of May and the beginning of June, by a second week’s conference in the same place and the results of our discussions have been published in August 1964 by the International Finance Section of Princeton University under the title: ‘International Monetary Arrangements: The Problem of Choice’. This report casts a good deal of light on the reasons why academic economists disagree in their recommendations, but by the same token provides little guidance for positive action. A number of personal statements by some of the participants are published as an Appendix to this pamphlet; the one I have contributed appears in the Appendix to this article.

 

6 This is the prepared text of my farewell lecture, delivered on February 28, 1964, upon relinquishing the chair of International Economic Relations at the Graduate Institute of International Studies in Geneva. The lecture was actually delivered in French and its corrected shorthand text was published by the quarterly Revue économique et sociale, Lausanne, October 1964, pp. 305–17.

7 The fact that Japan is a member of this group does not make it any less a ‘Western group’. All of its members except Japan are industrially advanced countries of Western Europe and North America and, for the purpose, Japan is a kind of Western country honoris causa on account of being industrially advanced and having contributed to the financial pool established in December 1961. It should be noted that Switzerland, which has made in due course a financial arrangement with the ‘Agreement to Borrow’, took part as a valued observer in the work of the ‘Group of Ten’ which, to all intents and purposes, should be described as the ‘Group of Ten plus One’.

8 Société d’Economie politique de Belgique, Séance du 17 avril 1951, conférence par Michael A. Heilperin intitulée: ‘Convertibilité monétaire et réarmement’ (Brochure No. 205).

9 The contrary, to be true, has happened in 1962–63 in Italy. In that country a mounting balance-of-payments deficit was concealed by foreign dollar borrowings of commercial banks which were then resold to the Banca d’Italia, thus making the reserves of the central bank appear larger than they would otherwise have been. Part of the Italian recovery programme of 1963–64 consists in reversing this operation: the commercial banks have been instructed, towards the end of 1963, to reduce their foreign indebtedness, and to do so they had to resort to the reserves of the Banca d’Italia, which have accordingly shrunk. This case, which is noted here for the sake of completeness, does not invalidate the main point made in the text.

10 Reprinted in the present volume, pp. 269 et seq.

• 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.
• 6Post-war European Inflations, World War I A Study of Selected Cases*
• 7The 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.
• 8The 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.
• 9The 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.
• 10The 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.