Aspects of the Pathology of Money

2 International Monetary Organization1

Preface

The pages that follow represent an attempt to define the principal issues in contemporary monetary policy in their relation to the problem of world peace. The various types of policy aim at a variety of patterns in the organization of international monetary relations. These relations are so closely interwoven with economic relations in general and, ultimately, with political relations, that any discussion of them must take account of this more general setting in which monetary relations between countries take place. Monetary relations between countries reflect the underlying economic relations which bear such a close relationship to political aims and objectives. There are patterns of monetary organization which can be worked only when there is peace; other patterns are a useful instrument of preparation for war. Monetary policy cannot by itself secure peace; but monetary policy can make it easier to prepare for war, while the breakdown of certain types of monetary organization is in itself a very important symptom of conditions whose ultimate outcome is the disruption of peace. Hence the significance of the present inquiry.

The theory underlying this study has been developed in a more complete way in my recently published book on International Monetary Economics (Longmans, Green & Co., London and New York, 1939).

M.A.H

University of California,

Berkeley, California, April 1939.

I Patterns of Monetary Organization

I CLASSIFICATION

Two issues lie at the centre of the contemporary monetary dilemma. One of them relates to the nature of foreign exchange markets, the other to the type of relations between the various national currency units.

The first issue is that of free foreign exchange markets versus exchange control, i.e. a government monopoly of dealings in foreign exchange.

The second issue is that of fixed versus fluctuating exchange rates as objectives of policy.

Both these issues are interdependent, as will be shown presently.

As regards the first, there are three typical patterns of organization to be envisaged; in the order of increasing governmental control and of decreasing freedom of markets, they are as follows:

A. Free markets in which exchange rates are established by ‘normal’ market processes.

B. Government interventions in the free markets with a view to ‘pegging’ rates of exchange or to influencing their fluctuations.

C. Government monopoly of dealings in foreign exchange (exchange control).

The pattern B is best exemplified by the operation of exchange equalization (or stabilization) funds, such as exist in England since 1932, in the United States since 1934, in France since 1936, etc.

The second issue involves also three distinct patterns of international monetary relations; they are the following:

(a) Stable exchange rates between the various national currencies (or exchange rates fluctuating within narrow limits around a fixed parity—as under the traditional gold standard).

(b) ‘Flexible’ exchange rates, i.e. variable relations between the national currency units, these variations subjected, however, to certain rules and determined by certain established criteria (e.g. adjustments of rates of exchange in response to divergent or simply non-parallel price movements in the countries concerned).

(c) Unstable exchange rates, without any limitation of the amplitude of fluctuations, and without the endeavour to maintain a certain stability (as in the preceding case).

The pattern b will be discussed at length presently since it represents the principal alternative to a which finds serious advocates. The unlimited instability of foreign exchanges (pattern c) has hardly ever been chosen as a pattern of monetary relations (one could not call it a pattern of organization!). However, it sometimes follows from economic policies adopted by certain countries and can be eliminated only by changing these policies or by adopting exchange control (see below). It will be argued presently that the transition from b to c is a very easy one and that one may doubt whether in the long run the real alternative does not lie between a and c rather than between a and b.

Leaving out the pattern c save as an eventual outcome of b we are left with five patterns. In describing an operating system we will find it necessary to combine one of the patterns of the first group with one or the other of the second group; we thus obtain six different patterns which we shall now briefly discuss. Let us summarize their characteristics in the following schematic table:

	Free markets	Govt. intervention in free markets	Exchange control
Stable exchanges	Aa	Ba	Ca
‘Flexible’ exchanges	Ab	Bb	Cb

(If we introduce also pattern c, we find that it will be possible only in a combination with A; combined patterns Be and Cc are unlikely, the latter being almost contradictory.) Pattern Aa is the characteristic pattern of monetary organization in a liberal state under a system of economic internationalism. (Under a régime of state socialism the pattern would be Ca). Patterns Bb and Cb are characteristic of monetary relations in a system of economic nationalism. The former will usually be associated with the pursuit of ‘autonomous’ business cycle policies by individual countries, while the latter may become an effective instrument of a policy of preparation for war. The choice between the two patterns will depend upon the degree of control over economic activity assumed by the state. On the other hand, the choice between Ca and Cb will depend upon considerations of what is politically and economically more opportune. As regards, finally, the pattern Ab it may be maintained, under certain circumstances, for a prolonged period of time, but more likely it will degenerate in time into Ac (or exchange chaos).

2 MONETARY NATIONALISM AND INTERNATIONALISM DEFINED2

We have introduced in the preceding paragraph the notions of economic and monetary nationalism and internationalism. Let us now briefly analyse their meaning and significance.

It will be observed, first of all, that international relations are relations between sovereign states; there would be no relations of this type on our planet were it to be politically organized into a single federal state. International relations are therefore relations between politically separate but otherwise interdependent units every one of which is sovereign in deciding upon its policies. Now ‘nationalism’ and ‘internationalism’ represent to the present writer two distinct and opposed attitudes with regard to national policies.

The essential difference between nationalism and internationalism lies in the conception of the relative importance of a country as compared with the world at large. Internationalism situates a country within the framework of a collectivity of interdependent though politically sovereign states; it looks for the solution of an individual country’s problems within the network of international relations. Such is not the case in nationalism for which a country stands supreme and foreign relations are mere accessories or impediments.3

In the next chapter, when discussing the political conditions of monetary internationalism, we shall point out the relations that exist between nationalism and internationalism on the one hand, and world peace on the other. Here we must define further the notions of internationalism and of nationalism with reference to economic and, more specifically, to monetary policies.

Economic internationalism can be defined simply as a policy intended to prevent political boundaries from exercising any disturbing effect on economic relations between areas on the two sides of the frontier. The full realization of economic internationalism is found in free trade, combined with the freedom of international migration and of financial transactions. In a protectionist world, economic internationalism means a development towards reducing obstacles to trade, migration, and financial transactions between countries.

Monetary internationalism means such an organization of international monetary relations as is required to ensure stable exchange relations between the various national currencies and thus to establish throughout the world a state of affairs approximating that which exists within any one country and which would exist in a world state with a single currency. This implies the adoption in the various countries of policies ensuring a long-run stability of balances of payments (since on this depends the stability of foreign-exchange rates). Ultimately this amounts to an international co-ordination of national economic policies (see Chapter II).

Economic nationalism can be defined as a policy opposed to that of internationalism: political boundaries assume a greater importance since a state is sovereign only within its frontiers. Since nationalism maximizes the practical significance of sovereignty, it goes counter international co-operation which tends, on the contrary, to limit sovereignty by agreement. More specifically, economic nationalism can be defined in two ways:

1. As the economic policy of political nationalism, in which sense it amounts very largely to a policy of national self-sufficiency (or autarky);4

2. As a policy of national economic ‘autonomy’ as regards the pursuit of national prosperity through ‘independent’ national business-cycle policies and so forth.

Economic nationalism in the first sense of the word has an entirely political motivation. It will be referred to henceforth as ‘autarkic economic nationalism’.

The second type of economic nationalism results very largely from certain economic doctrines relating to the means of stabilizing a prosperous economic development within a country. It will be referred to from now on as ‘autonomous national economic policy’.

Monetary nationalism represents the monetary aspects of economic nationalism in either sense of that term or, more precisely, the consequences of economic nationalism upon international monetary organization. The first and most important among these consequences of economic nationalism is the surrender either of free foreign-exchange markets or of stable rates of exchange between national currencies, or of both. Thus, the pattern Aa is incompatible with economic nationalism, while monetary nationalism will assume more readily one of the b patterns (or even of the c patterns) or the pattern Ca or Ba. We shall see presently in what way and under what conditions the pattern Aa is abandoned and one of the other ones adopted.

3 MONETARY STANDARDS

The problem of monetary standards5 interests us here only with reference to international relations. We shall therefore limit ourselves to the question of international standards. If we define a monetary standard as ‘a commodity the price of which, in terms of the national monetary unit, is fixed by the monetary law of the country and held stable by the monetary authorities of that country’,6 then an international standard is a commodity the price of which is so fixed in two or more countries. Since, furthermore, if two magnitudes are severally related to a third one, they are, ipso facto, related to one another, all currencies which are based on the same (international) standard have fixed exchange relations to one another (parities). In classifying international monetary standards we shall distinguish between (a) metallic standards and (b) exchange standards.7 Under the first heading we shall be concerned mainly with the gold standard. The second subdivision includes all cases in which the currency of one country is chosen as standard for the monetary systems of other countries. The currency chosen as standard may be, in turn, based on some standard or not. The ‘Gold-Exchange Standard’ which had such a rapid and disappointing career in the twenties, was a hybrid system combining certain characteristics of the gold standard with features of an exchange standard. The failure of that system was due less to its intrinsic features than to the way in which it was operated and, more fundamentally, to the fact that adequate rules for its operation were never worked out.8

The adoption of a policy of monetary internationalism calls almost of necessity for the adoption of an international monetary standard, a helpful instrument for defining reciprocal parities and for working out a long-run equilibrium of international payments. To be quite precise, one must add that an international standard is not indispensable for the working of the pattern Aa of monetary relations; however, in the absence of such a common standard, the system would work in a much more clumsy manner.9 A policy of monetary nationalism, on the other hand, must necessarily result in the adoption of independent monetary standards (should any standards at all be adopted) by the various countries. It will be observed that the meaning of a monetary standard appears most clearly when it is an international one; for the purposes of domestic monetary policy the usefulness of having a ‘standard’ appears much smaller since there is a variety of more fundamental criteria for monetary policy. Even when an international standard is adopted, additional criteria must be found, according to which internal monetary policies will be devised. All that monetary internationalism requires is that the countries having adopted the same ‘standard’ should adopt similar criteria for their domestic policies.

While the opposition between the adoption or non-adoption of an international standard is the one that attracts attention most directly, the fundamental issue is one between the adoption by the various countries of similar criteria or of different ones for this domestic monetary policy. It is hardly necessary to emphasize that the criteria adopted will be economic criteria, in a more general sense of the word, resulting either from the acceptance of one of the many theories about the best way of achieving and maintaining national prosperity, or from the adoption of ‘political’ objectives which require certain specific economic policies (such as the policy of ‘autarky’).10

Let us finally remark that an international standard may be adopted by one group of countries, while another group adopts a different standard, and still other countries maintain a full monetary ‘autonomy’. The coexistence of a ‘gold block’ with a ‘sterling area’ and with various types of internal monetary organization in countries that belonged to neither of these two groups, in 1931 and the following years, is a telling example of such a situation.11 Various patterns of international monetary organization may be coexistent.

4 INSTITUTIONAL ARRANGEMENTS

The term ‘international monetary organization’ has been used thus far without any reference to particular institutional arrangements. ‘Organization’ means here an existing and more or less durable way in which monetary relations between countries are taking place. This may result from an explicit convention or simply represent a de facto situation without legal form. Let us consider, first of all, the various institutional arrangements of monetary internationalism. In the order of increasing precision given to these arrangements, we can classify them according to the following schedule:

(1) Maintenance by the various national monetary authorities of a de facto stability of foreign exchange rates, with or without the help of specially constituted intervention funds (stabilization funds).

(2) Adoption of a common international monetary standard, and of national monetary policies intended to maintain the various national currencies on that standard.

(3) The same as (2) but supplemented by a more explicit co-operation between the various central banks.

(4) Determination, by international agreement among central banks, of the ‘rules of the game’ of monetary internationalism.

(5) The same as (4) but followed up by the signing of a convention, the signatories of which would undertake to follow the ‘rules’.

(6) The establishment of an international financial institute for the purpose of administering the convention referred to under (5) but not endowed with initiative.

(7) The adoption of an international clearing standard so as to replace movements of the standard commodity (gold, under the gold standard) from country to country by entries in the books of the financial institution suggested in (6).

(8) The establishment of a ‘monetary union’ which would involve a further elaboration of the monetary convention referred to under (5) and the adoption of a common monetary unit by the various countries.

(9) The establishment of a world monetary system with a world central bank developing out of the financial institution provided under (6).

Of these nine modes of organization, first corresponds very largely to what exists currently within the group of countries composed by Great Britain, other members of the sterling area (except those which practise exchange control), the United States, France, Belgium, the Netherlands, and Switzerland. The second mode of international monetary organization corresponds to the state of affairs which existed prior to the world war among countries on the gold standard. Mode three has occasionally been realized in the past 15 years between the central banks of England, the United States, France, etc. It has never been more than a sporadic co-operation extending over a period of months, more rarely of a few years. The Genoa Conference of 1922 recommended a conference of central banks for the purpose of working out an agreement on ‘rules of the game’ (as under (4)) and possibly an international convention leading up to mode five. Such a conference was, however, never called. Even when the Bank for International Settlements was established in 1930, thus approaching the sixth mode of international monetary organization, its founding was a corollary to a plan of settling the reparations problem and was neither preceded nor followed by the elaboration of ‘rules’ of monetary internationalism (mode four) nor indeed by the signing of a convention relative to the observance of such rules (mode five). Mode seven is for the time being in the field of theoretical conjecture. Past experience with monetary unions (mode eight) has been very restricted and one may doubt (as the present writer does) whether this form of organization adds much to the seventh mode short of going all the way to mode nine. This last method of organization must, however, be regarded as impossible of realization in a world in which the various countries jealously guard their sovereign rights. A world monetary system can be realized only as a corollary to an international political organization based on a great limitation of national sovereignty. Only a federal world state would be likely to adopt a sort of ‘Federal Reserve System of the world’. It is therefore suggested that, as long as national state sovereignty continues to exist, the maximum monetary internationalism attainable would take the form of the seventh mode of organization.

Monetary nationalism, on the other hand, hardly calls for particular institutional arrangements. There are three attitudes that can be adopted while pursuing a policy of domestic monetary ‘autonomy’:

(1) One can let foreign exchange quotations move freely in response to the each-time position of supply and demand in the respective markets. If this attitude is adopted, there is no foreseeable limit to the amplitude of exchange fluctuations and no reason to suppose that these fluctuations would amount to oscillations around an equilibrium position. There are, on the contrary, reasons making for such fluctuations to be cumulative rather than self-reversible.12 (This case corresponds to the pattern Ac referred to above).

(2) Since an exchange chaos with rates moving freely and without any a priori limitations is rarely (if ever) considered as a desirable lasting state of affairs, there is a tendency, whenever such a situation develops or becomes imminent, to limit the freedom of foreign exchange markets and to establish stable rates of exchange by the means of exchange control (or to determine by an appropriate use of exchange control the scope of fluctuations). This will correspond to the patterns Ca or Cb above. Exchange control will result from the adoption of a policy of monetary nationalism while one is reluctant to allow exchange instability to develop.13

(3) In certain circumstances it may be possible to preserve free exchange markets while pursuing a policy of monetary ‘autonomy’. This will be achieved by resorting to ‘exchange stabilization funds’, large intervention funds by means of which the monetary authorities can affect exchange rates through operations in the free market. The object may be either one of preserving fixed parities (pattern Ba) or one of limiting the scope of exchange fluctuations (pattern Bb). The former might be a corollary to a policy of monetary internationalism, while the latter is characteristic of what one might call a ‘limited nationalism’. Whether this pattern Bb offers only a temporary expedient in times of particular international stress or affords a real alternative to monetary internationalism, on the one hand, and, on the other, to exchange control or exchange chaos, is an important question which will be discussed at length in Chapter IV.

II Conditions of Monetary Internationalism

Having defined in the preceding chapter the notion of monetary internationalism and enumerated the various patterns of institutional arrangements that can be adopted for its realization, we must now inquire more fully into the conditions under which it can be achieved. These clearly fall under two headings: economic conditions and political conditions. We shall assume in the present chapter the existence in all countries concerned of a liberal economic order. It will be assumed, in particular, that foreign exchange markets are entirely free. In the succeeding chapter, we shall then inquire into the effects that direct state control over economic activity exercises upon monetary relations.

It is hardly necessary to emphasize that neither monetary internationalism nor monetary nationalism are aims in themselves. They are tendencies of monetary policy and modes of organization which are best adapted to the types of economic and political relations sought by the various governments. Hence our inquiry into the conditions of monetary internationalism will in reality aim at answering the following question: which are the forms of international relations, political and economic, under which monetary internationalism will be (1) a desirable objective or policy and (2) one susceptible of being realized and maintained?

I ECONOMICS OF MONETARY INTERNATIONALISM

It follows from the definition proposed in Chapter I that monetary internationalism is closely linked with the long-run equilibrium in national balances of international payments. Hence the examination of conditions under which monetary internationalism can operate coincides to a large extent with the discussion of alternative methods of maintaining a long-run equilibrium in international payments.

In order that international payments should be balanced over longer periods of time, it is necessary:

1. that every disturbance of equilibrium should be followed by measures capable of supplying the required correctives;

2. that cumulative causes of maladjustment should be eliminated.

The first point is dealt with by the various theories which explain the ‘mechanisms’ of adjustment of balances of payments to an equilibrium position. The various ‘mechanisms’ represent ‘models’ which are to a greater or less degree realized in the empirical world—most often the empirical situation represents a combined effect of all or some of the various abstract ‘models’. The principal elements involved are the following:

A. The country whose balance of payments shows a deficit will either see its currency depreciate in terms of foreign currencies or lose some of the commodity which constitutes its monetary standard14 (gold, under the gold standard).

B. If the currency depreciation is to be stopped and reversed (thus resulting in an oscillation around an equilibrium rate of exchange15), or if the outflow of gold (or, more generally, of the standard commodity) is to be checked and reversed (thus preventing the monetary system of the country in deficit from being drained of its monetary reserves), the deficit in the balance of payments must be stopped and a surplus must be realized.

C. The deficit may be the result of (a) changes in the structure and value of the country’s foreign trade; (b) changes in international currents of long-term funds (capital movements); (c) changes in the size and direction of short-term credit transactions. Furthermore, the deficit may merely be due to the fact that commercial and financial payments between countries are not equally distributed through time (so that a country may have a deficit in its foreign payments during one part of the year and a surplus during another part of that year), or it may be due to some more deeply rooted causes. ‘Mechanisms of adjustment’, referred to above, are related mainly to the former type of deficit, while the latter type represents more or less serious disturbances which call for appropriate measures devised ad hoc. To a greater or less degree, all these measures involve international co-operation.

D. A deficit in a country’s foreign payments can be remedied only by means of one of the following methods:

(a) increase of exports of the country in deficit,

(b) increase of new borrowing by the country in deficit,

(c) curtailment of imports of the country in deficit,

(d) default on financial obligations of the country in deficit.

For the country having a surplus in the balance of its foreign payments must correspondingly:

(a’) buy more goods (or services) abroad,

(b’) increase foreign lending,

(c’) accept a curtailment of its exports,

(d’) agree to a moratorium on its foreign claims.

It is hardly necessary to emphasize that (d) and (d’) will happen only if the other means of re-establishing equilibrium have failed.

It will be noticed that in wording points (c’) and (d’) the element of agreement has been emphasized. If the ‘creditor’ country should refuse to agree to either (c’) or (d’), while refraining from (a’) and (b’), a deadlock will result with very adverse effects upon the state of international relations. While (d) is in general to be avoided, and (c) is a method which tends to reduce the volume of international trade, the adoption of policies (a, a’) and (b, b’) depends very largely upon the degree of freedom enjoyed by international trade and capital movements, and upon the willingness of countries with a surplus in their balance of payments to increase either imports or foreign credits.

Now under a liberal economic system it is individuals and corporations which are the principal buyers and sellers of goods and services and the principal borrowers and lenders of monetary funds, in the sphere of international as well as of domestic relations. It is therefore necessary, in order to achieve (a), (b), and (c)—and correspondingly (a’), (b’), and (c’)—to set up an appropriate economic ‘mechanism’ which will act in response to disturbances of equilibrium in international payments and to adopt such governmental policies16 as will render the working of that ‘mechanism’ smoother, while refraining from policies which will render its working more difficult and less effective.

As the theory of re-establishing equilibrium in international payments teaches us, the necessary change in international trade will be effected:

1. Through the shifts of purchasing power from one country to the other, which are connected with the very fact of a net payment made by one of them to the other;

2. Through relative price movements (falling prices in the country in deficit, rising prices in the country experiencing a surplus), which result in a change in terms of trade and in the effects (a, a’) and (c, c’).

In order that the first point may be realized, it is necessary that monetary circulation should expand in the country whose balance of payments shows a surplus and contract in the country where there is a deficit. If national monetary policy assists these developments, it is helping the maintenance of ‘monetary inter-nationalism’; in the contrary case it is obstructing it. It is argued by certain authors that these shifts of purchasing power can bring about the required changes in trade without any price movements in the countries concerned. While theoretically quite possible, this will occur only under very particular assumptions not likely to be realized in actual experience. I have discussed this question elsewhere17 here it suffices to say that whenever the adjustment of international payments is made through changes in trade, price movements will take place. Any attempt to prevent such movements through domestic monetary policies will endanger the mechanism of re-equilibrium and possibly destroy monetary stability. The reader will note the important qualification contained in the italicized words; much of the further argument in this paper will turn around that reservation. While the older literature of the subject attached a great importance to price movements as instruments of readjustment of balances of payments, it now appears doubtful whether in the normal course of events such is really the case. The question could be answered, no doubt, by a statistical inquiry into the working of the pre-war gold standard; yet such an inquiry remains to be carried out. In its absence, it seems logical to suppose that movements of short-term funds were the principal element in the pre-war mechanism of equilibrium in international payments. Inasmuch as disequilibria were due to an uneven distribution of receipts and payments over time, it was possible to fill a gap by contracting a short-term loan and to repay the loan with the subsequent surplus ‘on current account’. This method is quicker and more direct than that operating through price movements. Time must pass before a change in monetary circulation induced by losses (or receipts) of gold (under the gold standard) affects prices and before price changes affect the structure and volume of foreign trade—and yet, in reality, adjustments have been known to take place rather speedily. It is to be regretted that this important matter has not yet been taken up by one of the research institutes—an appeal to facts would settle the dispute that exists on this subject and the consequences of which upon policy are far from beneficent. We shall meet with the present issue again when discussing monetary nationalism.

To revert to our analysis: the equilibrating movements of short-term funds will take place in response to differential changes of the money-rate of interest,18 provided that there are no major disturbances in conditions of confidence. From this, two consequences follow:

1. Movements of the money-rate of interest are an indispensable element in the operation of monetary internationalism. The rate must go up in the country in deficit and down in the country with a surplus. If this fails to occur, the whole burden of adjustment is thrust upon commercial transactions, which makes adjustments both slower and more difficult to realize.

2. It is of vital importance that there should be no major shocks to confidence which would cause credit transactions to be guided by considerations of comparative safety, or of comparative returns.19 This ultimately amounts to a plea for economic co-operation and political peace between countries.

The previous pages deal very largely with the mechanism of monetary internationalism as exemplified by the pre-war gold standard. Although very familiar, this mechanism had to be briefly described here on account of the significance of the conclusions to which its discussion gives rise. These conclusions are by no means surprising, but in an age where so much rationalization of economic and monetary nationalism takes place, one may be inclined to forget or unduly discount them. They are as follows:

In the first place, the long-term equilibrium of international payments can be maintained without strains and frictions, mostly through short-term credit operations, provided that there are no major disturbances in international trade, in long-term capital movements, and in the state of international confidence. These three sources of maladjustments will presently be examined.

It is only when certain particular types of disturbances occur that price adjustments may become necessary. It will be shown that these disturbances are either caused by economic nationalism or aggravated by it, and that international co-operation tends to make adjustments easier and smoother.

In the second place, the operation of monetary internationalism described above does not depend upon the adoption of gold as monetary standard. Gold movements are merely a symptom of disequilibrium; the operation of the system would be the same under any other standard, provided it is an international standard. The significance of an international standard has already been discussed. As a matter of fact, the same mechanism would have to be adopted if one were to allow a wider scope to exchange fluctuations while preventing their movements from being cumulative or chaotic.20

In the third place, it follows that, normally, the maintenance of international monetary stability involves no disturbances for domestic economic stability in the various countries. This conclusion must, however, be confronted with the findings of the later sections of this paper.

2MAJOR DISTURBANCES IN TRADE OR FINANCE AND MONETARY INTERNATIONALISM

We have assumed thus far that no major disturbances occur in the economic processes that take place in the various countries. If this assumption were realized in practice, the problem of whether one should adopt an international monetary standard or not would hardly arise. It is when major disturbances take place that the alternative between monetary nationalism or internationalism becomes a real issue.

The various causes of serious maladjustments can be summed up under the following four headings:

(a)divergent price movements in the various countries,

(b)changes in the volume and direction of international capital movements (long-term lending),

(c)movements of short-term balances from country to country (i.e. transfer of these balances from one currency into another) in search of safety,

(d)accidental disturbances in production or markets.

Let us briefly examine these four points.

(a) Whenever prices in a certain country tend to move out of ‘harmony’ with prices elsewhere, the balance of trade of that country is likely to be affected. If the ‘autonomous’ price movement is upward, this will tend to depress the country’s exports and stimulate its imports, thus creating, ceteris paribus, a deficit in the balance of payments. If the price movements in that country had been synchronized with price movements abroad, this effect would, of course, not occur. Now such a divergency of price movements can take place, e.g. when two countries are at the same time in different phases of the business cycle, the one experiencing an upswing and rising prices, the other, a downswing and falling prices, or if being both in the downward phase of the cycle, the one adopts a policy of expansion and the other a policy of deflation. If the countries in question adhered to the rules of an international standard, such divergencies would not be possible. First of all, there is a tendency for cyclical fluctuations of economic activity to be synchronized, generally speaking, when there reigns economic internationalism. Secondly, a country experiencing a deficit in the balance of payments because of prices rising in relation to prices abroad will, under the ‘rules of the game’, adopt a policy aiming at better ‘alignment’ of domestic with foreign prices. The international mechanism will provide an incentive for the adoption of ‘correctives’, so that the international price equilibrium will not be completely destroyed by cumulative maladjustments, but will be promptly restored. An ‘autonomous’ price policy can be carried out only when the international mechanism is defied and international stability is subordinated to the pursuit of certain domestic policies.

Inasmuch as there are differences of opinion between leading business-cycle theorists as to the nature of policies to be adopted in the various phases of the cycle, it may well happen that certain governments decide upon the adoption of one policy, say that of deflation, while other governments adopt a different policy, say an expansionist one. Under such circumstances, international monetary stability will become subjected to violent strains, and possibly collapse in the end. Recent experiences prove that this is far from being a hypothetical case. Thus the extent of agreement that exists between theorists becomes a matter of considerable public interest.

(b)21 The sudden diminution or cessation of international capital movements, particularly of new foreign loans, may be, and has been, an important source of disequilibrium in balances of payments. Since such changes occur only in conditions of economic or political instability, their causes cannot be analysed in detail apart from the historic context in which these changes have taken place. As in movements of short-term funds, considerations of safety play a very important part in causing the sudden and large changes. Occasionally, exceptional anticipations of profits in some national market may keep in that market funds that would otherwise seek foreign investments and even attract funds from the ‘debtor’ countries. Such was the case during the last phase of the 1927–9 boom in the New York stock market. Insecurity may be due to political or to economic reasons. In consequence of what can be called a ‘heterogeneous distribution of confidence in the world’ there may occur geographical changes in the currents of investment or changes in the volume of capital as compared with that of short-term funds. Should this last change take place, effects are likely to be particularly disturbing to monetary stability.

Adjustment to changes in capital movements must be made through changes in trade balances, since short-term credit can, by definition, provide only temporary relief. Moreover, the reasons which bring about changes in capital movements are likely to affect short-term credit operations as well, in such a way that the maladjustment in international payments will be increased rather than diminished. Adjustment through international trade can be most easily obtained if the disequilibrium is relatively small in comparison to the value of trade transactions; and again, the fewer the obstacles that are put in the way of international trade, the easier the process of adjustment will be. The larger is the relative size of the maladjustment and the more drastic and active is protectionism, the less easily can the adjustment be obtained. Much will also depend upon the nature of the exports and imports of the country in deficit and on the respective elasticities of demand for the various goods in question. Should a country be unable to obtain the necessary adjustment then only two courses remain open: either financial assistance by means of international action, or else a cumulative loss of gold in the case of a gold-standard country and cumulative exchange depreciation in a country forced off the gold standard or in a country with a system of inconvertible currency.

(c) One of the major sources of disturbances in international monetary relations consists in large movements of short-term funds, to which reference has already been made. These movements occur whenever people who hold assets in certain country feel that they may be exposed to losing all or part of these assets. Whenever this happens, people tend:

(a) to convert these assets into cash;

(b) to transfer cash holdings into a foreign currency and take them out of the country.

The former may cause a fall in money values in the country in question, the latter results in a deficit in the balance of payments and may lead either to a devaluation of the currency or to the imposition of exchange control.22

Reasons for a ‘flight of capital’ may be numerous, but they all involve apprehensions regarding the future of the economic, social, and political stability of the country. These fears and apprehensions may be due to domestic monetary, economic, or fiscal policies; to internal social disturbances, to prospects of foreign political and military conflicts. Economic nationalism and nationalism tout court may lead to such a state of affairs. Broadly speaking, the danger of important disturbances of this type will be minimized if there is political peace and international economic co-operation.

(d) Let us finally mention accidental causes of disturbances of international monetary stability. These may consist of bad crops or of natural cataclysms of various sorts, on the one hand, and of the loss of markets due to changes in technique or in taste, on the other. The former group of causes will bring about a temporary maladjustment, the latter may necessitate a lasting change of the economic structure of countries whose foreign trade is thus affected. Foreign loans may help to overcome the maladjustment in the case of purely temporary difficulties. In the cases which call for important and lasting structural changes there will be need both for a domestic plan of reconstruction and for foreign assistance, mainly financial, during a period of transition (if the country affected is relatively poor in financial and material resources). It is possible, in the last case, that the currency of the country affected will have to be devalued to a lower parity. While a variety of situations is conceivable, it will be noted that the burden of adjustment can be made lighter, and the transition to a new ‘equilibrium’ smoother through international co-operation, while the absence of such co-operation will tend to increase difficulties and maladjustments.

3 MONETARY INTERNATIONALISM AND WORLD PEACE

The pattern of monetary organization discussed in this chapter is a means of making international trade easier and more stable and international investments safer and more regular. The ultimate objective is to develop economic relations between nations, to further the international division of labour, to diminish the impact of political boundaries upon commercial and financial relations between those who live in different countries. A consequence of all this is an increase of economic interdependence between nations. That such a course of evolution works for peace needs hardly to be emphasized. War, on the other hand, demands the largest possible degree of economic independence of particular countries or groups of countries. If world-wide interdependence is the economic counterpart of organized peace, national or regional autarky is the economic policy of preparedness for war. A country which contemplates military expansion must try not to depend for essential products on trade with possible adversaries; for such a country economic interdependence is anathema.

The twin oppositions arise therefore: interdependence versus autarky (or independence or autonomy) in the economic sphere; peace versus war—in the political sphere.

Monetary internationalism fosters interdependence between the various national economies; it is the monetary pattern of organized peace.

Inversely, war is a death warrant for this type of monetary organization; the fear of war, the policy of preparing for war is a signal for its decline. So is, even in the absence of an actual vision of war, every policy tending to reduce the economic interdependence of and co-operation between nations. We shall see in the next chapter how nationalistic economic planning leads to a dissolution of monetary internationalism and to patterns of monetary organization of a different type. Here it suffices to stress the fact that political unrest tends to discourage long-term lending, to stimulate panic-induced movements of short-term funds, both of which disrupt the equilibrium of balances of payments, while at the same time commercial relations may also be disturbed. In such a political ‘climate’ maladjustments thus tend to develop, culminating either in exchange instability or in the adoption by the state of a full control over foreign exchange transactions.

III Effects of State Control of Economic Activity upon International Monetary Organization

Thus far our discussion has been conducted largely upon the assumption of a liberal economic system with free foreign exchange markets in which rates of exchange would be established by the free play of supply and demand. Government policy was limited (in Chapter II) to measures necessary for securing the smooth working of monetary internationalism.

In the present chapter we shall briefly inquire into the consequences of a larger degree of government control. For a variety of reasons governments can—and often do—intervene powerfully in the operation of the economic system; these interventions can take place within the framework of a privately operated economy; they can lead to the exercise by the state of a complete control over the functioning of that economy; and can result in the assumption by the state not only of full control, but also of the rights of ownership over the productive equipment of society.

It is impossible, within the compass of the present report, to do justice to the important issues involved in the assumption by the state of control over economic life; but several elements of the problem will be briefly indicated on account of their bearing upon international monetary relations.

From the point of view adopted here, the question of private versus public ownership of means of production may be set aside. It is the operation of the system that is particularly relevant for our purposes. We shall therefore make a fundamental distinction between government interventions which make use of the market mechanism, and interventions which consist in replacing that mechanism by centralized authoritarian planning. One could quote many instances where there is a choice between these two methods; in the field of monetary relations a telling contrast is that between ‘exchange stabilization funds’ and ‘exchange control’. Both of these will be discussed in the following chapters.

Whenever the state exercises a high degree of control over economic life, systematic planning becomes necessary. While it is probably not indispensable that socialism should take the form of centralized planning, the latter will be resorted to whenever the state wants to mobilize all the resources of a country for a specified purpose. It will also be resorted to if ideological considerations call for full-fledged collectivism.

In actual contemporary experience there is one case of collectivist planning inspired both by ideological considerations and by the determination to devote all the resources of an economically underdeveloped country towards its rapid, centrally planned industrialization: the case of Soviet Russia.

The other modern cases of totalitarian planning are the result of a different motive: the mobilization of all available resources for building up a powerful war machinery. Whenever the available resources are scarce in comparison with the desired volume of war equipment, civilian demand tends to be sacrificed. This can be done, within a market economy, by taxation and borrowing, as long as the shift in the structure of production that one wants to obtain is not too considerable. If the change in the direction of the income-flow through the economic system is very considerable, the market economy tends to be replaced, in part at least, by direct authoritarian control. This will happen, in particular, whenever there is a general tendency for the state to assume more and more power. The totalitarian conception of the state leads to a centrally planned economy, while the course of authoritarian planning of economic life, for whatever reason it takes place and whatever are its objectives, furthers the development of political relations towards totalitarianism. Under modern conditions the development of the totalitarian doctrines of the state, the revival of imperialism and the preparation for ‘totalitarian war’ are intertwined, and collectivist planning (state socialism) is the corollary of these tendencies. Were it not for imperialism and war preparations, there would be hardly any tendency towards a full state control of economic life and towards limiting international economic interdependence.

In foreign economic relations the tendencies described result in the adoption by the state of a complete control of foreign trade and foreign financial transactions. This may be combined with the abolition of private property at home. Generally, however, property is maintained for large sections of the population, but the use of property is subjected to state regulation and control. Here again this paper can merely indicate the issues involved; our attention must remain centred around the consequences that follow with respect to international monetary organization.

Large-scale government intervention in foreign exchange markets by means of ‘stabilization funds’ is the maximum of what will be resorted to by economically and financially strong countries which wish to maintain a privately operated market economy. Countries which are in a weaker economic position may be led to the adoption of exchange control in order to modify the structure of imports in a way that will assist the policies of the respective governments. No system of exchange control can, however, be effective, in the long run, if it is not associated with an increasing amount of intervention in domestic economic activities.23 Inversely, if totalitarian24 planning is adopted by a country, it is almost certain that exchange control and other methods of directly controlling the volume and structure of foreign trade will follow. If there is a central plan for the whole national economy, various fields of production, various types of consumption, various items in international trade acquire a significance in terms of that plan. Welfare, as the objective of economic activity, is then replaced by a plan adopted by the authority of the state, and state agencies replace the market (meeting-place of individual decisions, choices, preferences) as instruments of ‘planning’ production, deciding the volume, structure, and general orientation of economic activity. Imports and exports must then be subordinated to the requirements of the ‘plan’ rather than to private demands and choices. The whole mechanism described in the preceding chapter will then tend to disappear.

Since it is war economy which is the great driving power of state control over economic activity, imports for civilian consumption tend to be restricted and imports for military needs are developed. Now the former are related to individual incomes and expenditures, while the latter are related to military requirements to which there is no a priori limitation. Hence a discrepancy between the supply of foreign exchange and the ‘need’ for foreign exchange is likely to appear in that latter case, whilst it does not arise in the former in which the size of incomes is a factor limiting demand for imports. Since, under a system of exchange control, the rate of exchange is a controlled price, which is not necessarily identical with the price that would equate demand and supply in a free market, and since nationalism tends to reduce financial transactions and the volume of trade, further friction is likely to develop. I have discussed elsewhere25 the monetary aspects of the so-called ‘raw materials problem’; the analysis given there illustrates the present line of argument.

The above-mentioned line of development: planned (war) economy, state control of foreign trade, exchange control, ‘lack’ of foreign exchange and frictions in international economic relations, is particularly likely to occur whenever:

1. The demand for imports stands in no clear relation to the size of the national income of the importing country; this is particularly the case of military imports.

2. The situation involves a disruption of international trade channels and of currents of financial transactions between countries (as is the case in a highly nationalistic world, in which there is a menace of armed conflicts).

3. There is a tendency towards national self-sufficiency, i.e. towards diminishing international interdependence, also towards developing trade with certain countries rather than with others on account of political affinities.

Under such conditions, when international economic co-operation tends to vanish and nationalistic aims become paramount, there is also a lessening of the emphasis placed on international monetary stability. If maintained by exchange control, that stability is precarious, because it is at the mercy of a political decision. It is true that in a liberal world a political decision can also be taken and can destroy monetary stability, but in doing so, it destroys the then prevailing system of international collaboration. There is a difference between destroying a system that ensures stability, and operating a system which is intrinsically unstable.

Thus far we have envisaged the consequences of totalitarian state control of economic life resulting from nationalistic policies of preparation for conquest (through war or threat of war). It is clear that monetary internationalism must then be replaced by a system of exchange control in which rates are arbitrarily determined by the state and no international mechanism of monetary stability exists. The approximate homogeneity of circulating media throughout the world, such as is achieved by monetary internationalism, is destroyed. This is a symptom and a corollary of economic policies adopted with the aim of diminishing the international division of labour and increasing national economic ‘independence’.

The question can arise, however, whether this must always be the case. Is it not possible that states which plan centrally the economic life of the country and adopt exchange control, etc., should be nevertheless peaceful, co-operating states, trying to maintain the international division of labour and work some sort of economic and monetary internationalism?

In abstracto the supposition is not absurd. But is it likely? Can a sufficient degree of co-ordination be realized under a system of state-controlled national economies to secure both the success of national plans and stability in international relations? This would suppose an international agreement on national plans. This is much less likely to happen, so it appears at least to the present writer, than the achievement of international co-operation between liberal economies such as has been discussed in the preceding chapter. Besides, the important issue must here be raised as to the form of political government and of economic organization that one desires. Under a system of democracy and of private property, there is no scope for this type of international organization. It is mentioned here merely for the sake of completeness.

A final problem concerns relations between liberal and planned economies. This is a very vital question which demands much further work and research. Without attempting to give an answer to it here, I wish to emphasize its importance for the future course of international economic relations.

Two important questions arise in this connexion:

1. Is a compromise between free and regulated economies26 dangerous for the maintenance of the former; does it tend to result in a spread of regulations?

2. Is the maintenance of regulations, where they exist at present, furthering or handicapping the cause of peace? Should one therefore, in the interests of peace, make the economic relations between liberal and regulated economies easier or, on the contrary, exercise certain pressures in order that a liberal economic organization should be re-established in countries which have adopted state controls?

May it be suggested that these two questions need very badly to be answered; but only after a careful scrutiny and inquiry can a final reply to them be given. In the light of recent experiences, the following answers are tentatively proposed as basis for further discussion and research:

1. It would appear that a compromise tends to make free economies less free rather than to reduce control in the regulated ones. Competition is very uneven between the government of one country and private corporations of another country. The government of the latter country may, therefore, step in in order to improve the bargaining position of private industries or trade. If it does that, the road is opened towards the building up of a system of control. While trade between free and controlled national economies is necessary in order to keep the total volume of trade up, it may result in drifting away from liberalism. This must be kept in mind. One may for a variety of reasons decide to adopt one policy or another; each of these attitudes may be argued for or against; but compromise is dangerous since it involves the future of democracy and the future of international relations.

2. Since at present foreign economic relations of certain countries are regulated because of an insufficient degree of international co-operation, while they are regulated in other countries on account of policies of military nationalism, the cause of peace could best be served by the adoption of measures which would reduce these controls and bring back free relations between the various national economies. The former group of countries might abandon their regulation of foreign economic relations if international co-operation is strengthened and if they are helped by stronger economic units to re-enter the sphere of free economic relations. As regards the countries which have adopted a planned economy for nationalist reasons, they might be prevented from succeeding in their policy and induced to reconsider it, if benefits of co-operation between the ‘free’ countries were not extended to them.27 The present writer suggests that a systematic policy which would tend to restore economic liberalism is the proper policy for world appeasement.

The foregoing observations are, to a certain extent, a digression from the central theme of this report. In particular, they amplify the last section of Chapter II and try to add further precision to the setting in which the problem of monetary organization presents itself. The following conclusion may be drawn: under realistic assumptions regarding the causes and effects of state control of economic life in the modern world, that control goes hand in hand with economic nationalism. Hence it leads to a monetary organization which secures a large degree of independence between national monetary systems and policies. This excludes international monetary co-operation and stability based on monetary internationalism. In its stead and to avoid a disturbing currency chaos, exchange control, which offers a precarious stability paid for by frictions and difficulties in international trade and finance, will be resorted to.

IV Monetary Relations in an Unstable World

Let us now direct our attention to the cross-currents that are characteristic of monetary relations between countries in the modern unsettled world.

Monetary internationalism was destroyed by the outbreak of hostilities in 1914; it was reconstructed, apparently at least, in the twenties. This reconstruction did not outlast the shock of the ‘crisis’ of 1929–30 and of the ‘great depression’ that followed. The collapse of what Sir Arthur Salter called ‘the first effort’ released the forces of economic nationalism which, throughout the post-war decade, had worked behind the scenes. Political nationalism grew also, fed upon the discontent engendered by growing unemployment and falling standards of life. The failure of the London Economic and Monetary Conference, in 1933, and the deadlock and disintegration of the Disarmament Conference gave a further impulsion to economic and to political nationalism respectively. Exchange control and quantitative trade restrictions (quotas, etc.) which were the consequence of the former gave important means of action to the latter (as shown in Chapter III above). Among the many questions that arise in this context, the following must be at least briefly referred to in the present paper: (1) the disintegration of monetary internationalism; (2) the ‘new’ forms of monetary organization: exchange control and exchange stabilization funds; the reasons for adopting these devices and the circumstances under which they could be operated; (3) the opposition of flexible exchanges to fixed parities as objectives of monetary policy and patterns of international monetary organization.

I THE DISINTEGRATION OF MONETARY INTERNATIONALISM

The economic history of the post-war decade will, when it is written, show a very contradictory course of events resulting from the coexistence of economic nationalism with the attempt to rebuild monetary internationalism (by reconstructing the gold standard). It will also show what is a very important element in the understanding of the reasons why the ‘first effort’ failed, namely that the economic evolution of the twenties was not based on the assumption of a lasting peace. While the League of Nations was growing stronger, while international co-operation was developing, national economic policies were growing more and more protectionist. There were many reasons for that development; all the arguments of protectionism were advanced at one time or another and in one place or another in the years following 1918. It may not be an exaggeration, however, to say that it is the fact that many sovereign states were suspicious of one another’s intentions while the fear of another war lurked in the background all the time, which accounts very largely for the frustration of the European post-war efforts for freer trade.28

If international trade seemed to recover nevertheless, this was due, to a not inconsiderable extent, to the credit expansion carried out internationally in the middle-twenties. As a result, however, the prosperity which developed was based to a large extent on a continuation of that credit expansion. The maintenance by the United States of the traditional policy of high protection, in spite of that country having become a large creditor country whose foreign investments kept growing, made this credit expansion particularly dangerous. Only an increasingly large amount of new lending made it possible for several years to receive payments of interests and dividends on earlier investments, while maintaining an export surplus in the American balance of trade. When, for various reasons which need not be discussed in the present context, new lending by the United States declined, balances of payments of numerous countries began to show disquieting maladjustments. At the same time the growing obstacles to trade made it impossible to reach a new equilibrium by increasing the exports of the debtor countries. During 1929 these maladjustments became more and more apparent and they had certainly a very direct relationship to the price deflation which preceded the collapse of the 1929 boom and became catastrophic afterwards. The international elements involved in the economic developments of 1925–32 are all too often neglected or insufficiently emphasized; yet these are crucial elements in the causation of the ‘great depression’.

What was particularly disastrous was the lack of international co-operation in these critical years. The pressure on the monetary reserves of the debtor countries became very great. In order to obtain through an export surplus the foreign exchange necessary to meet their financial obligations abroad, these countries had to contract their imports or to expand their exports (or to do both). The former caused retaliations abroad, while the latter was very difficult on account of tariff barriers. Even so, trade statistics reveal a very substantial degree of adjustment that was obtained through changes in the flow of international trade. Had there been more international co-operation, it is possible that the collapse of monetary internationalism might have been prevented. The co-operation should have involved i.a. some agreement on an expansionist business cycle policy to be adopted jointly by the leading economic centres, and some degree of co-operation between central banks to relieve the growing strain on monetary reserves of the debtor countries. To make things worse, the ‘new gold standard’ reconstructed after the war was very vulnerable; furthermore, in the attempt to ‘economize’ on the monetary use of gold, it was managed in a way which diminished its resistance to shocks. Having dealt with this question at considerable length elsewhere, I may refer the reader to that analysis.29 Here it is enough to point out the fact that an increase in the price of gold, by international agreement, would have been very helpful in 1930, for example, in relieving the pressure on monetary reserves of the debtor countries. It would also have improved the relation between England’s short-term foreign indebtedness and her stock of monetary gold and prevented perhaps the collapse of the sterling in 1931

All this is a matter of conjecture. What actually happened was that the general ‘sauve qui peut’ accentuated the competitive deflation and that the debtor countries, unable to cope further with their difficulties and unwilling to let their currency depreciate, adopted exchange control and defaulted on part or all of their foreign debts. Exchange control proved, at the same time, to be an effective means of restricting imports. Some countries devalued their currencies as well. Further instruments of trade restriction were introduced by most countries; the use of import quotas became more and more generalized, while clearing and barter arrangements were resorted to in order to keep the volume of trade up without endangering monetary reserves.

Let us make a further conjectural observation. Had there been a sufficient degree of international co-operation, France, England, and the United States might have adopted a joint policy of economic expansion without going off the gold standard—and the impulsion would have spread to other countries as well. In the absence of such a co-operation the maintenance of the gold standard involved a course of deflationary policy. The only exception might have been constituted by the United States. The great gold reserves of that country could have enabled it to engage in an ‘autonomous’ policy of expansion which gold movements would have communicated to England and France. The gold standard implied deflation only because there was no agreement between the gold standard countries regarding a joint policy of expansion. If properly understood, the adoption of an international monetary standard calls for economic co-operation as well. It is the absence of collaboration, not any inherent ‘defect’ of the standard, that caused the latter’s collapse.

England’s going off the gold standard in September 1931, started a new phase of developments. The ‘sterling area’ was formed, a group of countries whose currencies became dissociated from gold and linked more or less informally to the pound sterling, and which adopted expansionist economic policies. It may be regretted that England gave at the same time a new impulsion to protectionism by ‘going off free trade’ and that France did the same (by developing the ‘quota’ system) instead of joining the sterling area.

In 1932 the British balance of payments resulted in new large surpluses. The pound would have gone up. Instead a new device was adopted: the British exchange equalization account. The sterling rate with relation to gold standard currencies became more or less stabilized and gold moved into the equalization account.

When describing and analysing the economic and monetary events of the thirties, one cannot help wondering how different their course might have been if only certain policies had been adopted and certain other policies dispensed with. And so again one may wonder whether the disintegration of monetary internationalism and the growth of protectionism might not have been arrested, if

1. England had returned to the gold standard in 1932;

2. France (and Holland, Belgium, Switzerland, and Poland) had devalued their currencies somewhat in 1932 without going off the gold standard, and checked the deflationary course of their economic policies;

3. The United States had started a policy of economic expansion in 1932 or 1933 without going off the gold standard.

If all this had happened, international monetary stability would have been maintained from 1932 onwards; the Economic and Monetary Conference of 1933 might have been a success; measures might have been adopted to help the debtor countries to their feet. Much distress and many catastrophic events might have been avoided.

None of these developments, however, have taken place. The course of events that did take place is too well known to be related here. Let us only mention:

1. A further disintegration of monetary internationalism; competitive exchange depreciations; all-round collapse of the gold standard;

2. Spread of exchange control;

3. Spread of commercial ‘bilateralism’;

And, finally, a gradual return of ‘internationalism’ within a limited group of countries.

2 EXCHANGE FUNDS AND EXCHANGE CONTROL30

In the meantime, the ‘new’ device of ‘exchange stabilization funds’ was adopted by the United States in 1934 and by France in 1936; some other countries followed their example.

‘Exchange funds’ and exchange control both aim at the maintenance of a considerable degree of exchange stability in a world where more ‘normal’ mechanisms of stability either cannot work or are not allowed to work. (They may not be able to function satisfactorily on account of the size and suddenness of maladjustments in international payments; they may not be allowed to function on account of divergencies in national economic policies.)

These modes of organization of foreign monetary relations are not equally accessible to all countries. Countries with a weak financial structure and with a tendency towards cumulative deficits in their balances of payments cannot resort to the instrumentality of ‘stabilization funds’. Countries, on the other hand, whose economic position is strong and monetary reserves abundant will hardly resort to exchange control, except as an instrument of state control over foreign trade and finance.

In a system of fluctuating exchanges, ‘exchange funds’ help (1) to stabilize exchange rates and (2) to prevent the inflow or outflow of an internationally accepted ‘standard commodity’ (e.g. gold) from influencing the volume of domestic monetary circulation. Since the United States, England, France, to mention only these three countries, never ‘demonetized’ gold, but only gave up the maintenance of a legally fixed price of the metal, gold remained in use as an international means of payment. Gold movements between the stabilization funds had a definitely stabilizing effect upon foreign exchange markets, or rather an equalizing effect since the object was not to maintain fixed parities but to eliminate sudden and large movements in foreign exchange quotations. On the other hand, since the operations of these funds were dissociated from the usual operations of central banks, it became easy to ‘sterilize’ gold movements, i.e. to prevent them from influencing the volume of domestic monetary circulation.

Both these effects could be achieved only because of the particularly favourable conditions under which the system worked. A more detailed analysis, which would go beyond the scope of the present paper, would show that all the countries which adopted exchange funds pursued, in the years that followed, a very similar course of business-cycle policy, while France underwent a series of consecutive devaluations before finding a rate which could be maintained without further strains. It would be found that exchange funds can preserve exchange stability only if this parallelism of economic policies and therefore a certain degree of parallelism in internal price movements of the various countries is maintained, and if there are no particularly disturbing movements of short-term funds.

As regards these last-mentioned movements, large exchange funds can, on the one hand, reduce their impact upon the economic life of countries from which short-term funds flow out and of those into which they go; this depends, however, on the amount of gold which the funds can lose, on the degree of devaluation which they are willing to accept, and on the cost of sterilizing inflowing gold. In actual practice, exchange funds usually did not prevent ‘flights of capital’ from bringing about an exchange depreciation. Thus exchange funds have only a limited efficiency as a stabilizing mechanism, and ultimately the other elements of monetary internationalism (discussed above in Chapter II) have to be brought into action, if stability is to be maintained. Furthermore, exchange funds will be most effective whenever there is a large degree of parallelism between the various business cycle policies; but whenever this is the case, the full-fledged acceptance of a common monetary standard will secure a larger degree of stability.

It must be observed, however, that a system of monetary internationalism will be much more shock-proof if supported by large stabilization funds—large enough to neutralize (or, at least, attenuate) the effects of large-scale international movements of short-term funds. It must also be noted that the more secure the stability of foreign exchanges is made, the smaller is the risk of capital flights.

In an unstable world, exposed to sudden shocks of confidence, large exchange stabilization funds are a very important element in the set-up of monetary organization, even though their actual use must be regarded in the main as an emergency measure.

As regards exchange control, it can fulfil a dual function, as an emergency measure intended to prevent an uncontrollable currency depreciation, and as a lasting instrument of governmental control over economic activity. Both these functions have already been discussed in the preceding pages. In the actual experience of the past ten years, exchange control has always been adopted as an emergency measure. There are numerous countries today which still practise it as an emergency measure from which they cannot rid themselves unaided. This point will be referred to in the next chapter, when discussing the outlook for the future.

In other countries exchange control has become part and parcel of the economic system; the circumstances are those which were discussed in Chapter III above.

If exchange control is to be abolished in due time, it is necessary to adopt in the country which practises it, measures capable of restoring a durable equilibrium in that country’s balance of payments. This may involve an adjustment in that country’s foreign trade, or an adjustment of its foreign debt, or an inflow of foreign capital, or all these measures combined. While this clearly calls for international co-operation, there are many policies that a country can adopt in order to stimulate her exports (‘Visible’ and ‘invisible’) and to create such political and economic conditions at home as will increase the confidence of foreign capitalists and attract loans. The case of Austrian economic policies in the years 1935–38 is an excellent illustration of what can be achieved in that way.

On the other hand, should exchange control be maintained as an integral part of the economic system of the country which practises it, then it is necessary that the system should become increasingly one of totalitarian control exercised by the state over the whole of economic life. It is not an accident that the development of aggressive nationalism and of war-preparedness in the thirties, along with the magnification of the idea of the state and of its powers, have coincided with a great development of exchange control. The system is not new but never before had it been developed into such a ‘perfect’ tool of control.31

It may be concluded that in certain countries exchange control is developed as an efficient tool of a war economy, while in others it is maintained because of an insufficient degree of international economic co-operation.32 If exchange stabilization funds may be considered as an instrument of monetary appeasement, exchange control is a symptom of disturbed international relations.33

3 THE PROBLEM OF ‘FLEXIBLE’ EXCHANGES

In recent years one often finds in economic literature criticisms of international monetary organization involving fixed parities. Instead flexible exchange rates are advocated. The opposition is made between the maintenance of internal economic stability (by which stable price levels are usually meant) and the maintenance of stable rates of exchange between national currencies. It is argued that both cannot be achieved simultaneously, and that, since one has to be sacrificed, there is an inevitable choice between internal and external stability. This usually leads the advocates of internal stability to denouncing the gold standard which, they argue, sacrifices internal economic stability in the pursuit of stable exchanges. It is argued furthermore that the importance of fixed parities has been exaggerated and that ‘flexible exchanges’ can assure equally good conditions of operation for international trade. It is maintained, finally, that to give up fixed parities does not mean that one accepts ‘wildly’ fluctuating exchanges as the sole alternative; ‘flexible’ exchanges would simply allow price developments in various countries to be divergent.

Various arguments are advanced to support this point of view. It would exceed the scope of this report to analyse them in detail. Mr J. M. Keynes’ arguments advanced in 1923 and in 193034 are at the basis of the modern literature on the subject; I have discussed and attempted to refute them in my recent book on International Monetary Economics.35 Similar views can be found in the writings of Professors Ohlin,36 Whittlesey,37 Harrod,38 etc. All these arguments involve the following elements:

1. The maintenance of stable exchanges between various currencies involves or may involve hardships for some amongst them; the gold standard sacrificed the internal stability of a country’s economic life to the maintenance of fixed parities.39

2. ‘Flexible’ exchanges would involve only such fluctuations as would be made necessary by changes in relative national price levels. (Application of the ‘purchasing power parity’ theory).

3. International trade is not so important as to minimize risks involved in it by means of stabilizing foreign exchanges.40

4. It is necessary for a country to have freedom of action in the conduct of its economic policy41 and a means of avoiding disturbing influences of foreign economic developments.42

These points sound quite plausible; they are, however, misleading. They will be submitted one by one to a brief scrutiny.

(1) The idea seems to be that the mechanism which maintains the equilibrium of international payments on the basis of fixed parities is, or may be, disturbing domestic economic stability by imposing deflation on a country’s price structure or by obliging a country to raise its bank rate in order to attract foreign short-term balances. The latter, it is argued (e.g. by Mr Keynes in his Treatise on Money), may cause the establishment of the rate of interest at a level superior to that which insures a domestic investment-equilibrium and full employment.

Now it must be noted that price adjustments are necessary only if divergent and cumulative price changes have taken place in one of the countries as compared with price movements elsewhere. There is, as far as I know, no instance of a trade depression caused before the world war by the operation of the gold-standard mechanism of equilibrating balances of payments.43 It is true that under an international standard, economic fluctuations will tend to spread throughout the world—which leads to a synchronization of the upward and of the downward phases of the ‘cycle’ in various countries and makes it possible to adopt a common business-cycle policy. That there was not enough co-operation in the late twenties and early thirties to evolve such a common policy is surely not to be blamed on the international standard. Its collapse was largely due to an absence of such collaboration; and so was the severity of the depression. It might be argued, though I cannot do so here, that an ‘international business cycle’ could be more easily attenuated by co-operative policies, than an insulated ‘national cycle’ could be by purely national and independent policies. The matter is surely worth looking into more carefully than has hitherto been the case!

The opposition of stability of prices to stability of parities is largely based on the purchasing power-parity theory; it is argued that every change of price levels abroad must affect either the domestic price level of the country or the rate of exchange between the two currencies. Let us, however, observe that substantial movements of particular prices can take place in every country without this affecting the parities between national currencies. The theory of purchasing power parities is based on oversimplified assumptions and errs also by using price levels instead of price structures.44 It can well be said in this connexion that the opposition between internal and external monetary stability ‘is more apparent than real, and that it arises very largely out of a too-literal acceptance of the abstractions of the gold-standard theory’.45

As regards the question of the rate of interest, the mechanisms for adjusting balances of payments under a system of stable exchange rates involve fluctuations of the bank rate. That rate affects only indirectly and slowly the rate of interest on the capital market, i.e. on the market for long-term investment funds. It is very doubtful whether the type of fluctuations of the bank rate that is necessitated by the functioning of, say, the gold standard can affect at all the volume of investment. Mr Keynes is far from supplying proof that it does—nor has anybody else within my knowledge provided such proof.

(2) It is very unlikely that ‘flexible’ exchanges would move only in response to changes in domestic prices of the various countries. There are not only trade relations between countries—there are financial operations as well. And international finance is certain to be disturbed by exchange fluctuations. The absence of stable exchanges is a deterrent to long-term foreign lending—not the only one, it is true, but a very important one. And as regards short-term financial transactions, exchange fluctuations and their expectations are one of the most powerful incentives to speculation and to ‘flights of capital’. Whenever such financial disturbances happen, exchange fluctuations will easily become large and cumulative. During periods of general economic and political instability, ‘flexible’ exchanges supported by the stabilizing operation of exchange stabilization funds may be, indeed, the only practicable solution; but it is not to be considered as a satisfactory definitive solution, unless one despairs of improving international economic and political relations. One of the characteristic features of homo sapiens is his tendency to rationalize events that happen in spite of his desires and to convince himself that these events have been aimed at consciously all along. There is a great deal of ‘rationalization’ being done currently about prevailing unstable conditions. To accept them as ‘desired’, to accept emergency measures as a summit of improved modern knowledge and technique is to forego the hope of a real improvement. Besides ‘rationalizing’, there is, in the conception of ‘flexible exchanges’, a great deal of wishful thinking since even a short reflection must make it clear that the borderline between ‘flexibility’ and ‘instability’ of exchanges is very slight and very easily overstepped, and that ‘instability’ is the more likely of the two to happen, unless ‘stability’ is the final objective.

The following judicious observations by Professor John H. Williams46 are well worth quoting:

‘After cutting loose from the gold standard, what every country has done—save for the exchange control countries, where it seems obvious that some further action will be necessary—has been, in one degree or another and in one way or another, to tie back on again. As just said, there is no evidence of any desire for a really flexible currency. The United States, after going off gold definitively in April 1933, had returned to a fixed buying and selling price of gold by the end of January 1934. England, which is commonly cited as the country least willing or likely to return to the gold standard, has been acting essentially like a managed gold standard country virtually from the day she went off gold. The equalization account, as thus far operated, has been a device, not merely for ironing out day-to-day fluctuations, but for preventing a rise, and perhaps at times a fall, in the pound, by means of an international gold flow to and from England. Had England really wanted a flexible currency she would have allowed the pound to rise against the franc as capital took flight to London, which might have prevented the second devaluation of the franc. But no one would have seriously advised such a course. The rise in terms of the franc would have been a rise also in terms of other currencies, including the dollar, which would have recreated England’s problem, and would in any case have led to a subsequent fall when the capital flowed out again. England has, therefore, though officially off gold, accumulated more gold than ever before in her history.’

(3) The view according to which international trade is not important enough to be made easier by the maintenance of stable exchanges is implicit or explicit in most arguments about flexible exchanges. A compromise view is held by Professor Ohlin in the following statement:47

‘The first point should be to devise a system which would help to maintain the largest measure possible of internal economic stability in the different countries. This is of more importance for the various national economic systems than the slight increase of international trade that might conceivably result from more rigid measures. Besides, as already observed, it is by no means certain that a rigid system would in the long run result in the development of international relations. It is an illusion to believe that international relations are independent of the state of the home industry. A system which effectively helps to maintain internal stability will also promote international trade and other economic intercourse, even if external currency stability be to some extent sacrificed.’

In answer to this statement, one might say, for example, that if international relations are not independent of the state of home industry, the contrary is at least as true. It is perhaps even more true, since a part of every national economy works for export and all of it depends more or less on imports. The state of international economic relations was a determining factor in the economic difficulties of Great Britain since the war, and of the United States since the depression, and the same is true of all the other countries. The passage quoted is another hardly convincing attempt at ‘rationalization’ of an existing state of affairs. To date, the various efforts of ‘putting one’s house in order’ by purely national means, have contributed very largely to further disturbance in the state of international relations, rather than to bringing about any improvement. It is very significant that after adopting a purely national recovery programme in 1933, the American Government stabilized the currency de facto in 1934 and a few months later adopted an economic ‘good neighbour policy’ represented by the programme of reciprocal trade agreements.

It cannot be emphasized enough that economic nationalism is at the basis of the doctrine of ‘flexible’ exchanges, while economic internationalism calls for exchange stability.

(4) Having already made all the necessary comments on ‘autonomous’ versus ‘co-ordinated’ business cycle policies, there is no need to argue this point further. Once more the contrast is not between gold standard and paper currencies or between domestic versus external stability, but between nationalism and internationalism. There is one comment only that I should like to make in the present context: the view must be denounced according to which economic disturbances and fluctuations are an imported evil, against which a country can insulate itself through fluctuating exchange. The main body of the theory of business cycles is worked out on the assumption of a closed economy. International relations spread and synchronize economic fluctuations, but every country would have these fluctuations on its own, even in the absence of these relations. At the bottom of the doctrine of ‘insulation’ lies the idea that national planning can eliminate business cycles. Whether it really can remains to be proved. Thus far, success in that direction has been claimed only by the totalitarian war economies of Germany and Italy and by the collectivist economy of Soviet Russia. Have they achieved what their leaders claim?—and what has been the price paid for it in terms of human values?—these are important questions though we need not answer them here.

V Suggestions for Policy

Monetary internationalism is a matter of the past; there is not much scope for it in a world torn by conflicting nationalisms and oppressed by the shadow of war. Is it also, however, a matter for the future? The answer depends very largely on the future developments of political relations. If organized peace should be realized, it will involve the revival of economic internationalism; and in monetary organization also the course of international co-operation would be resumed. Monetary stability is necessary for furthering the international division of labour and a swifter international circulation of goods, services, and capital. The greatest foe of economic interdependence, which results from an international division of labour, is war and the preparation for it, and, basically, aggressive nationalism. This has been discussed in some of the preceding pages. There is a correlation between economic interdependence and peace and between both of them and increasing welfare. Hence monetary internationalism is a corollary of a policy of peace. This does not mean, of course, that monetary policy or even economic policy can bring about peace. As Professor Rappard rightly remarks in a recent study of the Post-war Efforts for Freer Trade:48

‘Richard Cobden taught us to seek for peace through free trade. But all recent experience shows both that international trade cannot be free in a world of hostile or potentially hostile and therefore suspicious sovereign states and that trade alone cannot ban international hostility and suspicions. The problem is then more complex, because less exclusively economic, than it appeared to Cobden.’

If peace cannot be achieved through economic policy alone, and if there is little chance for monetary internationalism in a world that is not at peace, it does not mean that monetary organization and economic policy can do nothing to serve the cause of peace.

In order to make the preservation of peace possible, it is necessary to render violations of peace more difficult and less tempting. Since a large degree of economic independence is necessary to wage aggressive warfare, it must be made more difficult for a country or a group of countries to achieve that independence. The struggle for ‘autarky’ must be countered by a drive for greater economic interdependence. This means that countries which profess the desire for peace and for international co-operation should tighten the links of economic co-operation among themselves and attract the co-operation of other countries which might be willing to join them but are in a position in which they cannot take the initiative. Those countries which are members of the League of Nations or which co-operate with the League’s technical activities, as the United States does, are the obvious nucleus of such a scheme of co-operation. Among these countries, the ones that have the greatest freedom of action are those which do not practise exchange control and which are in a strong financial position. There are several elements of such co-operation already in existence:

1. The so-called ‘Tripartite Agreement’, including England, the United States, France, Switzerland, Belgium and the Netherlands; this agreement which was a sort of monetary peace treaty concluded to end the period of monetary disturbances, 1931–6, offers a real basis for a more comprehensive scheme of international co-operation;

2. The Bank for International Settlements, which only waits for an opportunity to develop its latent potentialities and to render the services for which it is so admirably equipped;

3. The informal ‘sterling area’; the ‘Oslo group’;

4. The American reciprocal trade agreements programme.

We have seen that monetary internationalism can work only within the framework of economic and financial collaboration. Partners to the ‘Tripartite Agreement’ could, in conjunction with the Bank for International Settlements, work out a comprehensive plan of monetary co-operation, including a survey of the ‘rules of the game’ to be adopted. A monetary convention could be agreed to, involving a closer degree of co-operation between the various exchange stabilization funds. The B.I.S. could be made the centre of that co-operation. Countries of the ‘Tripartite Agreement’ could adopt, at the same time, stable exchange rates and establish a procedure for modifying them should the need for it arise. A formal return to the gold standard is by no means indispensable at this stage of our programme.

What would be necessary, however, is a settlement of the war-debt controversy, which would clear the way for closer financial relations between members of the group.

All the countries which do not practise exchange control and which would sign the convention mentioned above would become eligible to membership of the group.

Another important measure would consist in supplementing the American trade agreements programme with further commercial agreements, the benefits of which would be confined to members of the group. This does not imply an adoption of free trade, but merely the following measures:

(a)a tariff truce,

(b)gradual tariff reductions,

(c)abandonment of trade restrictions other than tariffs,

(d)a policy of non-discrimination and the maintenance of the ‘most-favoured-nation clause’,

all this as regards relations between the members of the group. The important point is that non-members would not be granted these advantages and might even see the introduction of greater obstacles in the way of their dealings with members of the group. There must be a price attached to co-operation, a penalty to non-co-operation.

Thus the monetary convention would be so extended as to become a general monetary, financial, and commercial pact of co-operation.49

Next comes the extension of the co-operation to other countries—that extension need not wait, in fact, for the ‘pact of co-operation’ to be fully worked out and signed. The sooner the extension of the group starts, the better.

Reference has already been made to countries which have adopted exchange control because emergency demanded it, and which have maintained it because they could not rid themselves of it without foreign assistance. These countries are next in line of co-operation. The road of bringing them into the ‘internationally-minded’ group leads via monetary organization. It is the road going from exchange control to free foreign exchange markets. To abolish exchange control, the countries in question must be given some initial financial assistance pending the establishment of new parities and of public confidence in the new state of affairs. The Bank for International Settlements could act as agent of such financial assistance with the help of a revolving credit fund.

Thus the pattern of monetary organization involving stable exchange (with fixed parities to follow eventually) and free foreign-exchange markets would tend to emerge in this process of a gradual reconstruction of economic internationalism. Commercial measures, suggested above, would similarly be extended to new members of the group.

The larger the group and the greater its economic power, the greater the benefits of freer trade within it, the greater the pressure on ‘outsiders’. It is suggested that the Economic Section of the Secretariat of the League of Nations be entrusted with the task of collecting material that would throw more light on the practical problems involved in the carrying out of such a programme, while the B.I.S. might make an estimation of the size of the ‘revolving fund’ that might be necessary to liberate from exchange control the countries that would like to return to a free economy.

There remains countries which might persist in their desire for autarky, for economic ‘independence’, in their adherence to ‘bilateralism’, to exchange control and the like. There is only one reason why they should persist in these policies. That reason is the persistence of a spirit of militant nationalism, the preparation for expansion that may lead to war. Such countries must be considered as virtual breakers of the peace. It is in the interest of world peace that the attainment of economic independence should be made as difficult as possible for them. The reconstruction of economic interdependence is the economic condition of organized peace, just as the restoration of ‘collective security’ is its political condition.

 

50 This monograph was written in the early months of 1939 for the International Studies Conference held in late August and the first days of September 1939, in Bergen, Norway, under the auspices of the International Institute of Intellectual Co-operation of the League of Nations. It was published by that Institute in August 1939, in advance of the meeting of the Conference. It was originally copyrighted by the International Institute of Intellectual Co-operation, a section of the League of Nations, which has been replaced by UNESCO.

51 Cf. International Monetary Economics, London, Longmans, Green & Co., 1939, Chapter I.

52 This paragraph is quoted verbatim from my earlier study on ‘Monetary Internationalism and its Crisis’, published in The World Crisis, by the Professors of the Graduate Institute of International Studies. London and New York, Longman’s, Green & Co., 1938 (reprinted in the present volume, pp. 75 et seq.).

53 Cf. William E. Rappard, ‘Economic Nationalism’, published in Authority and the Individual, Harvard Tercentenary Publications, Cambridge, Mass., 1937. See also my International Monetary Economics, op. cit., pp. 225 et seq.

54 The reader will find a more complete treatment of this question in my Montiate, crédit et transfert, Paris 1932, Chapter III, and in International Monetary Economics, op. cit., pp. 126–8 and Chapter IX.

55 International Monetary Economics, op. cit., p. 127.

56 Commodities other than metals might be chosen as monetary standards, but never are chosen in actual practice. Since silver has lost almost all its importance as a monetary standard, we may consider the gold standard as the representative instance of metallic standards.

57 The reader may be again referred to International Monetary Economics, op. cit., Chapter IX, where the various types of monetary systems are discussed in greater detail.

58 Ibid., pp. 218–24.

59 See below, pp. 53 et seq.

60 Though currencies of the various countries belonging to the ‘sterling area’ were not on a sterling standard, in the strict sense of the word.

61 The reader will find a lengthy discussion of the theoretical points here involved in my book, already quoted, on International Monetary Economics.

62 See below, Chapter IV (pp. 59 et seq.).

63 Cf. International Monetary Economics, op. cit., pp. 126 et seq.

64 Ibid., pp. 136 et seq.

65 and central bank policies.

66 International Monetary Economics, pp. 153 et seq. (see above, pp. 24 et seq.).

67 As distinct from the capital-rate of interest, i.e. the rate on long-term and medium-term borrowing, mostly for investment purposes. The two rates are only vaguely interdependent, and their movements need not be parallel. See below, p. 68.

68 Cf. International Monetary Economics, op. cit., pp. 98 et seq.

69 International Monetary Economics, pp. 156 et seq. (see above, pp. 26 et seq.).

70 The following two paragraphs are quoted from my International Monetary Economics, pp. 171–3.

71 This case will be discussed below.

72 Cf. International Monetary Economics, op. cit., Chapter X, pp. 237 et seq.

73 or ‘collectivism or ‘centralized’.

74 Cf. ‘The Monetary Aspect of the Raw Materials Problem and the Revival of International Trade’. Paris, International Institute of Intellectual Co-operation, 1938. See in particular Chapter III (reprinted in the present volume, pp. 189 et seq.).

75 It will be noted that governmental interventions that are carried out through operations within the framework of free market economies are not considered here as contrary to the nature of free economies; in the terminology that is adopted in this paper only interventions which tend to destroy the market economy fall under the denomination of ‘state control’.

76 Cf. ‘The Monetary Aspect of the Raw Materials Problem and the Revival of International Trade’, op. cit., Chapter IV (reprinted in the present volume, pp. 196 et seq.). See also below, Chapter V (pp. 71 et seq.).

77 Cf. the interesting study by Professor William E. Rappard, ‘Post-War Efforts for Freer Trade’, Geneva Studies, vol. IX, No. 2. Geneva Research Centre, 1938.

78 International Monetary Economics, op. cit., Chapter IX, parts A and C.

79 Cf. N. F. Hall, The Exchange Equalisation Account, London, 1935; F. W. Paish, ‘The British Exchange Equalisation Fund’, Economica, London, February 1935, February 1936, August 1937; T. E. Gregory, Current Issues of Monetary Policy, Paris, International Chamber of Commerce, 1937; Paul Einzig, Exchange Control, London, 1934; League of Nations, Report on Exchange Control, Geneva, 1938. See also my International Monetary Economics, Chapter IX, Sections C and D.

80 Some consequences have been pointed out in the League of Nations’ Reports of the Committee for the Study of the Problem of Raw Materials, Geneva, 1937, and its Report on Exchange Control, Geneva, 1938. See also my pamphlet on ‘The Monetary Aspect of the Raw Materials Problem’, op. cit., Chapter III (reprinted in the present volume, pp. 181 et seq.).

81 Soviet Russia presents a rather special case since its exchange control is a corollary of collectivist economic planning.

82 I leave aside the question of whether a system of peaceful economic relations can be built up on the basis of generalized exchange control or not. Actually, exchange control exists for reasons which can be traced to an absence of collaboration and to preparation for war.

83 J. M. Keynes, A Tract on Monetary Reform, London, 1923, pp. 155–6; A Treatise on Money, London, 1930, vol. II, pp. 303 et seq.

84 Op. cit., pp. 228 et seq.

85 Cf. Professor Bertil Ohlin’s Report in International Economic Reconstruction, published by the Joint Committee of the Carnegie Endowment and the International Chamber of Commerce, Paris, 1936, particularly pp. 78 et seq.

86 Charles R. Whittlesey, International Monetary Issues, New York and London, 1937. The whole book is devoted to an attack on the gold standard and to an advocacy of ‘flexible exchanges’.

87 R. F. Harrod, International Economics, London and Cambridge, 1933, Chapter VII; The Trade Cycle, Oxford, 1936, pp. 188 et seq.

88 Thus e.g. Professor Ohlin writes (op. cit., p. 79): ‘Should it be possible . . . to maintain absolute external stability of the various currencies, it is probable that the only means of so doing is afforded by a policy which would from time to time exercise a strongly depressing influence on the industry of certain countries. Before the war, the adjustment of a national economic system to international conditions was comparatively easy. . . . But even at that time, recourse was had, in certain cases, to credit restrictions resulting in a national depression at a moment when conditions in other countries were relatively favourable. Such national depressions were, however, as a general rule, neither severe nor of a lasting character, as rapid adjustment was at that time possible.’

89 See e.g. Ch. R. Whittlesey, op. cit., p. 77: ‘No idea is more firmly entrenched in the general and even in the semi-professional economic consciousness than that stable foreign-exchange rates are essential to active foreign trade. Now it may be asked whether the presumption upon which this view apparently rests, namely, that the foreign trade deserves especial guarding against losses, is justified.’

90 ‘If a country is resolutely determined to combat trade depressions by all the means in its power, depreciation of its currency may be the inevitable consequence of the measures it takes’: R. F. Harrod, The Trade Cycle, op. cit., p. 188.

91 ‘. . . freedom of exchange rates should help to insulate a country against the influence of cyclical disturbances or monetary instability originating abroad . . .’: Ch. R. Whittlesey, op. cit., p. 233.

92 In the passage quoted above (footnote (1) page 67) Professor Ohlin refers to such depressions without, however, mentioning even a single one. May I suggest here that it would be most important for the issue in question if he were to publish evidence to support the statement quoted.

93 Cf. my criticism of that theory in International Monetary Economics, op. cit., pp. 128 et seq.

94 John H. Williams, ‘The World Monetary Dilemma’, Proceedings of the Academy of Political Science, New York, April 1934, p. 65.

95 John H. Williams, ‘International Monetary Organization’, in the volume Lessons of Monetary Experience. Essays in Honour of Irving Fisher, New York, 1937, pp. 33–4. The reader of the present report is strongly recommended to read this remarkable essay.

96 B. Ohlin, op. cit., pp. 82–3.

97 Op. cit., p. 66.

98 The suggestions outlined here are very largely analogous to those I submitted to the International Studies Conference on Peaceful Change, held in Paris in June–July 1937. The reader will find the text of these earlier proposals in my pamphlet already quoted on ‘The Monetary Aspect of the Raw Materials Problem and the Revival of International Trade’, Chapter IV, particularly pages 202 et seq. (reprinted in the present volume, pp. 181 et seq.).

• 1To illustrate, see for example the voluminous and penetrating Annual Reports of the Bank for International Settlements.
• 2The IMF takes an entirely neutral attitude towards the Gold Exchange Standard, neither endorsing nor rejecting it.
• 3James 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).
• 4Vide infra, p. 28, a bibliographical footnote on inductive studies.
• 5This is an assumption which, in fact, underlies the whole of this book.
• 6Vide infra, pp. 23 et seq.
• 7In 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.
• 8The 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.
• 9James W. Angell, ‘Equilibrium in International Payments’, op. cit., p. 17.
• 10Ibid., p. 14. Of course no such definition can be quite rigorous and one must keep in mind, here, that short-term credit transactions occur also otherwise than in response to disequilibrium in international payments.
• 11See Jacob Viner’s Studies in the Theory of International Trade, op. cit., Chapter VI pp. 290–387.
• 12This qualification is indispensable; whenever there are credit operations the bank-rate policy appears in order to influence their size and direction.
• 13James W. Angell, ‘Equilibrium in International Payments’, op. cit., p. 15.
• 14‘On Some Applications of the Theory of International Trade’, Quarterly Journal of Economics, 1890. Quoted in Iversen, Aspects of the Theory of International Capital Movements, Copenhagen and London, 1936, p. 202.
• 15As Bastable puts it in the article quoted above, the inhabitants of the creditor country ‘having larger money incomes will purchase more at the same price’, and thus bring about the ‘necessary excess of imports over exports’. Iversen, op. cit., p. 203.
• 16See the discussion between Ohlin and Keynes in the Economic Journal for 1929. Ohlin, in fighting Keynes’s argument about the difficulties of transfer, introduces shifts in demand schedules as a factor making the transfer of reparations easier. Cf. Viner, op. cit., PP. 307–11 and 326–38; Bertil Ohlin, Interregional and International Trade, Cambridge, Mass., 1935, particularly Chapter XX; Keynes, A Treatise on Money, London, 1930, vol. I, Chapter XXI.
• 17R. F. Harrod, International Economics, London and Cambridge, 1933, Chapter VI, also The Trade Cycle, Oxford, 1936, pp. 145–58.
• 18P. B. Whale, ‘The Working of the Pre-War Gold Standard’, Economica, February 1937.
• 19Provided that there are no disturbing time-lags.
• 20Under the gold standard (as opposed to an all-gold currency) this result is obtained by a combination of automatic factors and of appropriate policies.
• 21Vide the following section of this chapter.
• 22Jacob Viner’s Canada’s Balance of International Indebtedness is a ‘classic’ among ‘inductive’ studies relating to this problem. Let us mention also the important studies by: John H. Williams (Argentine International Trade under Inconvertible Paper Money, 1880–1900, Cambridge, Mass., 1920); H. D. White (The French International Accounts, 1880–1913, Cambridge, Mass., 1933); W. E. Beach (British International Gold Movements and Banking Policy, 1881–1913, Cambridge, Mass., 1935); F. D. Graham (‘International Trade under Depreciated Paper. The United States, 1862–79’, Quarterly Journal of Economics, vol. XXXVI, 1922); R. S. Sayers (Bank of England Operations, 1890–1914, London, 1936).
• 23Assuming, as we do, the continued existence of free exchange markets.
• 24Or, more generally, of the commodity used for money or for the monetary standard.
• 25Import tariffs imposed by the country in deficit would, of course, help adjustment. But why should countries with a deficit in international payments have a monopoly of protectionism? and would they have it in fact? To the latter question the most likely answer is in the negative. Tariffs imposed by the country in deficit would be likely to provoke retaliatory measures and in the end adjustment would be rendered more difficult rather than easier. Therefore the argument favouring import tariffs as an instrument of readjustment does not appear to be a strong one. Cf. The Macmillan Report (Committee on Finance and Industry Report), London, 1931, H.M.S.O., Cmd. 3897, Addenda I and III.
• 26The position of the problem here is different from the position of the transfer problem. It clearly results from the notion of balance of payments that a net capital payment must be made by means of an export surplus in the balance of trade of the paying country and of an import surplus in the balance of trade of the receiving country (unless transfer is deferred through credit transactions). In the problem of transfer (or, as some authors call it, of real transfer) the solution depends upon the mechanism of obtaining an export surplus. For our present problem, however, it is indifferent whether equilibrium in international payments is obtained by the means of a ‘real transfer’ of the balance due on current account or through financial operations.
• 27Vide footnote, p. 32.
• 28A similar attitude is adopted by Professor von Hayek in Monetary Nationalism and International Stability, London, 1937, pp. 23–4.
• 29i.e. whenever there is no exceptional maladjustment of the type to be examined in the next section of this chapter.
• 30A similar thesis is developed at greater length in the two very interesting books anonymously published by a well-known Belgian economist and banker under the title La crise de l’étalon-or, Brussels, 1935, and Révision de valeur, Brussels, 1937.
• 31Vide supra, p. 22.
• 32As in a business cycle.
• 33Vide, footnote, p. 31.
• 34It will be noted, as an example of great adaptability of foreign trade to changing conditions, that Germany had in 1927 a surplus of merchandise imports of 2,890 million Reichsmark, while in 1930 there was a surplus of exports of 1,644 million Reichsmark. (League of Nations, Balances of Payments, 1931 and 1932, Geneva, 1933, p. 99.) See the interesting comments on that German experience by Jacques Rueff in his lecture ‘Défense et illustration de l’étalon-or’ published in Les doctrines monétaires à l’épreuve des faits, Paris, 1932, and reprinted in Travaux du Congrès international des Sciences économiques, Paris, 1937, Paris, 1937, vol. I, pp. 275–307.
• 35Op. cit., pp. 228 et seq.
• 36Cf. Professor Bertil Ohlin’s Report in International Economic Reconstruction, published by the Joint Committee of the Carnegie Endowment and the International Chamber of Commerce, Paris, 1936, particularly pp. 78 et seq.
• 37Charles R. Whittlesey, International Monetary Issues, New York and London, 1937. The whole book is devoted to an attack on the gold standard and to an advocacy of ‘flexible exchanges’.
• 38R. F. Harrod, International Economics, London and Cambridge, 1933, Chapter VII; The Trade Cycle, Oxford, 1936, pp. 188 et seq.
• 39Thus e.g. Professor Ohlin writes (op. cit., p. 79): ‘Should it be possible . . . to maintain absolute external stability of the various currencies, it is probable that the only means of so doing is afforded by a policy which would from time to time exercise a strongly depressing influence on the industry of certain countries. Before the war, the adjustment of a national economic system to international conditions was comparatively easy. . . . But even at that time, recourse was had, in certain cases, to credit restrictions resulting in a national depression at a moment when conditions in other countries were relatively favourable. Such national depressions were, however, as a general rule, neither severe nor of a lasting character, as rapid adjustment was at that time possible.’
• 40See e.g. Ch. R. Whittlesey, op. cit., p. 77: ‘No idea is more firmly entrenched in the general and even in the semi-professional economic consciousness than that stable foreign-exchange rates are essential to active foreign trade. Now it may be asked whether the presumption upon which this view apparently rests, namely, that the foreign trade deserves especial guarding against losses, is justified.’
• 41‘If a country is resolutely determined to combat trade depressions by all the means in its power, depreciation of its currency may be the inevitable consequence of the measures it takes’: R. F. Harrod, The Trade Cycle, op. cit., p. 188.
• 42‘. . . freedom of exchange rates should help to insulate a country against the influence of cyclical disturbances or monetary instability originating abroad . . .’: Ch. R. Whittlesey, op. cit., p. 233.
• 43In the passage quoted above (footnote (1) page 67) Professor Ohlin refers to such depressions without, however, mentioning even a single one. May I suggest here that it would be most important for the issue in question if he were to publish evidence to support the statement quoted.
• 44Cf. my criticism of that theory in International Monetary Economics, op. cit., pp. 128 et seq.
• 45John H. Williams, ‘The World Monetary Dilemma’, Proceedings of the Academy of Political Science, New York, April 1934, p. 65.
• 46John H. Williams, ‘International Monetary Organization’, in the volume Lessons of Monetary Experience. Essays in Honour of Irving Fisher, New York, 1937, pp. 33–4. The reader of the present report is strongly recommended to read this remarkable essay.
• 47B. Ohlin, op. cit., pp. 82–3.
• 48Op. cit., p. 66.
• 49The suggestions outlined here are very largely analogous to those I submitted to the International Studies Conference on Peaceful Change, held in Paris in June–July 1937. The reader will find the text of these earlier proposals in my pamphlet already quoted on ‘The Monetary Aspect of the Raw Materials Problem and the Revival of International Trade’, Chapter IV, particularly pages 202 et seq. (reprinted in the present volume, pp. 181 et seq.).
• 50The 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.
• 51The 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.
• 52The 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.
• 53The 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.
• 54The 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.
• 55In 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.
• 56As 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.
• 57The 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.
• 58It 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.
• 59It 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.
• 60While induced re-equilibrium is obtained by the means of policies adopted in response to symptoms of disequilibrium, such as gold-flows from country to country, automatic re-equilibrium is a direct consequence of the maladjustment of international payments. There may be two conceptions of this type of adjustment: (1) there are symptoms of maladjustment such as flows of gold, but no policy needs to be adopted since the consequences (or symptoms) of maladjustment bring themselves the cure that is required; (2) the disequilibrium has direct consequences which prevent even the appearance of the symptoms of maladjustment, considered as the ‘normal’ ones. The first case is that of the ‘classical’ mechanism of adjustment working within the monetary system of a ‘simple specie currency’ where there are no credit operations whatever. The second represents the most ‘modern’ tendencies that prevail in investigations of equilibrium in international payments.
• 61While induced re-equilibrium is obtained by the means of policies adopted in response to symptoms of disequilibrium, such as gold-flows from country to country, automatic re-equilibrium is a direct consequence of the maladjustment of international payments. There may be two conceptions of this type of adjustment: (1) there are symptoms of maladjustment such as flows of gold, but no policy needs to be adopted since the consequences (or symptoms) of maladjustment bring themselves the cure that is required; (2) the disequilibrium has direct consequences which prevent even the appearance of the symptoms of maladjustment, considered as the ‘normal’ ones. The first case is that of the ‘classical’ mechanism of adjustment working within the monetary system of a ‘simple specie currency’ where there are no credit operations whatever. The second represents the most ‘modern’ tendencies that prevail in investigations of equilibrium in international payments.
• 62(2) The modern school of thought, representing what has been called here ‘the theory of automatic adjustments’, consists of ‘those who postulate shifts of international demand schedules to right or to left without any necessary intermediation of gold flows’. Iversen traces this point of view to an article written in 1889 by C. F. Bastable, in which, in opposition to John Stuart Mill, the fact is brought out that changes in purchasing power of the respective countries brought forth by the disequilibrium in balances of payments may in themselves, and without the help of any additional policy, effect changes in the volume and direction of trade between these countries. Thus to formulate the problem briefly, the question consists in finding out whether gold movements on the one hand, and price-changes on the other, are indispensable in order to bring international payments into a new equilibrium. According to the theory which we are now discussing, neither of the two elements is absolutely necessary for an equilibrating mechanism to work. This point of view has been brought to the foreground of economic debate in the course of the reparations discussion. More recently Harrod and Whale make an extensive use of the same mechanism. While there are various nuances as between the different presentations, the essential process here involved consists in changes that are supposed to take place in reciprocal demand schedules that exist in each of the countries for the other country’s products. Thus the country whose balance of payments shows a deficit would buy less goods of the other country (assuming two countries in presence) while the latter country would increase her importations from the former. Since these surplus imports will be financed through the spending of sums due by the debtor country, no price-changes are necessary in order to bring about the adjustment.
• 63(2) The modern school of thought, representing what has been called here ‘the theory of automatic adjustments’, consists of ‘those who postulate shifts of international demand schedules to right or to left without any necessary intermediation of gold flows’. Iversen traces this point of view to an article written in 1889 by C. F. Bastable, in which, in opposition to John Stuart Mill, the fact is brought out that changes in purchasing power of the respective countries brought forth by the disequilibrium in balances of payments may in themselves, and without the help of any additional policy, effect changes in the volume and direction of trade between these countries. Thus to formulate the problem briefly, the question consists in finding out whether gold movements on the one hand, and price-changes on the other, are indispensable in order to bring international payments into a new equilibrium. According to the theory which we are now discussing, neither of the two elements is absolutely necessary for an equilibrating mechanism to work. This point of view has been brought to the foreground of economic debate in the course of the reparations discussion. More recently Harrod and Whale make an extensive use of the same mechanism. While there are various nuances as between the different presentations, the essential process here involved consists in changes that are supposed to take place in reciprocal demand schedules that exist in each of the countries for the other country’s products. Thus the country whose balance of payments shows a deficit would buy less goods of the other country (assuming two countries in presence) while the latter country would increase her importations from the former. Since these surplus imports will be financed through the spending of sums due by the debtor country, no price-changes are necessary in order to bring about the adjustment.
• 64(2) The modern school of thought, representing what has been called here ‘the theory of automatic adjustments’, consists of ‘those who postulate shifts of international demand schedules to right or to left without any necessary intermediation of gold flows’. Iversen traces this point of view to an article written in 1889 by C. F. Bastable, in which, in opposition to John Stuart Mill, the fact is brought out that changes in purchasing power of the respective countries brought forth by the disequilibrium in balances of payments may in themselves, and without the help of any additional policy, effect changes in the volume and direction of trade between these countries. Thus to formulate the problem briefly, the question consists in finding out whether gold movements on the one hand, and price-changes on the other, are indispensable in order to bring international payments into a new equilibrium. According to the theory which we are now discussing, neither of the two elements is absolutely necessary for an equilibrating mechanism to work. This point of view has been brought to the foreground of economic debate in the course of the reparations discussion. More recently Harrod and Whale make an extensive use of the same mechanism. While there are various nuances as between the different presentations, the essential process here involved consists in changes that are supposed to take place in reciprocal demand schedules that exist in each of the countries for the other country’s products. Thus the country whose balance of payments shows a deficit would buy less goods of the other country (assuming two countries in presence) while the latter country would increase her importations from the former. Since these surplus imports will be financed through the spending of sums due by the debtor country, no price-changes are necessary in order to bring about the adjustment.
• 65(2) The modern school of thought, representing what has been called here ‘the theory of automatic adjustments’, consists of ‘those who postulate shifts of international demand schedules to right or to left without any necessary intermediation of gold flows’. Iversen traces this point of view to an article written in 1889 by C. F. Bastable, in which, in opposition to John Stuart Mill, the fact is brought out that changes in purchasing power of the respective countries brought forth by the disequilibrium in balances of payments may in themselves, and without the help of any additional policy, effect changes in the volume and direction of trade between these countries. Thus to formulate the problem briefly, the question consists in finding out whether gold movements on the one hand, and price-changes on the other, are indispensable in order to bring international payments into a new equilibrium. According to the theory which we are now discussing, neither of the two elements is absolutely necessary for an equilibrating mechanism to work. This point of view has been brought to the foreground of economic debate in the course of the reparations discussion. More recently Harrod and Whale make an extensive use of the same mechanism. While there are various nuances as between the different presentations, the essential process here involved consists in changes that are supposed to take place in reciprocal demand schedules that exist in each of the countries for the other country’s products. Thus the country whose balance of payments shows a deficit would buy less goods of the other country (assuming two countries in presence) while the latter country would increase her importations from the former. Since these surplus imports will be financed through the spending of sums due by the debtor country, no price-changes are necessary in order to bring about the adjustment.
• 66(2) The modern school of thought, representing what has been called here ‘the theory of automatic adjustments’, consists of ‘those who postulate shifts of international demand schedules to right or to left without any necessary intermediation of gold flows’. Iversen traces this point of view to an article written in 1889 by C. F. Bastable, in which, in opposition to John Stuart Mill, the fact is brought out that changes in purchasing power of the respective countries brought forth by the disequilibrium in balances of payments may in themselves, and without the help of any additional policy, effect changes in the volume and direction of trade between these countries. Thus to formulate the problem briefly, the question consists in finding out whether gold movements on the one hand, and price-changes on the other, are indispensable in order to bring international payments into a new equilibrium. According to the theory which we are now discussing, neither of the two elements is absolutely necessary for an equilibrating mechanism to work. This point of view has been brought to the foreground of economic debate in the course of the reparations discussion. More recently Harrod and Whale make an extensive use of the same mechanism. While there are various nuances as between the different presentations, the essential process here involved consists in changes that are supposed to take place in reciprocal demand schedules that exist in each of the countries for the other country’s products. Thus the country whose balance of payments shows a deficit would buy less goods of the other country (assuming two countries in presence) while the latter country would increase her importations from the former. Since these surplus imports will be financed through the spending of sums due by the debtor country, no price-changes are necessary in order to bring about the adjustment.
• 67(2) The modern school of thought, representing what has been called here ‘the theory of automatic adjustments’, consists of ‘those who postulate shifts of international demand schedules to right or to left without any necessary intermediation of gold flows’. Iversen traces this point of view to an article written in 1889 by C. F. Bastable, in which, in opposition to John Stuart Mill, the fact is brought out that changes in purchasing power of the respective countries brought forth by the disequilibrium in balances of payments may in themselves, and without the help of any additional policy, effect changes in the volume and direction of trade between these countries. Thus to formulate the problem briefly, the question consists in finding out whether gold movements on the one hand, and price-changes on the other, are indispensable in order to bring international payments into a new equilibrium. According to the theory which we are now discussing, neither of the two elements is absolutely necessary for an equilibrating mechanism to work. This point of view has been brought to the foreground of economic debate in the course of the reparations discussion. More recently Harrod and Whale make an extensive use of the same mechanism. While there are various nuances as between the different presentations, the essential process here involved consists in changes that are supposed to take place in reciprocal demand schedules that exist in each of the countries for the other country’s products. Thus the country whose balance of payments shows a deficit would buy less goods of the other country (assuming two countries in presence) while the latter country would increase her importations from the former. Since these surplus imports will be financed through the spending of sums due by the debtor country, no price-changes are necessary in order to bring about the adjustment.
• 68It is certainly conceivable that the net payment will be made by the means of an appropriate change in the balance of trade brought forth by shifts in demand schedules, without either gold movements or price changes, but is it likely to happen? It will be observed that changes in the structure of trade require time, while gold shipments in response to a certain situation in the foreign-exchange market take place on a very short notice; it is therefore likely that gold movements will take place even before changes in the structure of trade could occur. Inasmuch as gold movements affect the supply of money in the countries concerned, price movements are thus likely to take place with a more or less considerable time-lag. Is it possible that these changes in the supply of money should affect the volume and direction of trade between the particular countries without first causing price-changes? This will depend upon the particular shape of the various demand curves. If the increased demand by the ‘creditor’ country for foreign goods offsets the decrease of internal demand on the markets of the ‘debtor’ country; and if the increased internal demand on the markets of the ‘creditor’ country offsets the fall in exports formerly bought by the ‘debtor’ country; then the price structure will remain intact in both countries. The off-setting would have to take place, however, not only in total values, but in each individual market as well. That this might happen is just conceivable but the probability of its happening is very small. In the contrary case changes in price structures are inevitable. It seems reasonable to conclude that: (1) changes in national price structures are practically unavoidable if equilibrium is to be realized through adjustments of the balance of trade; (2) the fact of net payments from country to country may affect the size and direction of trade between the countries concerned even in the absence of major price movements; changes in the structure of prices would then take place in each country as a consequence of changes in demand schedules; (3) the need of price movements is considerably reduced when the mechanism of re-equilibrium works primarily through credit operations (but in this case it ceases to be automatic).
• 69Thus far the process described has been ‘automatic’; it can be supplemented, however, by appropriate monetary policies. Thus the monetary authorities of the country having a deficit in its international payments may adopt a restrictive credit policy at home and cause a fall in nominal prices; similarly the monetary authorities of the country having a surplus in its balance of payments may adopt a more liberal credit policy and cause a rising price-tendency at home. In acting this way the respective policies would achieve voluntarily what is obtained automatically under a simple specie currency and would speed up the process of adjustment described above.
• 70If we complete the picture by introducing international financial operations, the adoption of certain appropriate policies becomes imperative. As we have seen, a system of freely fluctuating exchanges does not eliminate the possibility of a long-run stability (as distinct from fixity) of exchange rates. If this is the object of policy we find ourselves in a position which is not vitally different from the one described in the preceding section of this chapter. It is quite conceivable that the fluctuation of exchanges around an equilibrium position should (by keeping international payments balanced) be itself an instrument of maintaining a long-run exchange stability. This conception of exchange fluctuations as a mechanism of re-equilibrium is very important, since it conflicts with the view according to which exchange chaos is the only alternative to fixed parities. Now for various reasons fixed parities may appear to be preferable to a long-run stability of fluctuating exchanges; this latter possibility must, however, not be overlooked since it represents an interesting intermediate solution. If it is adopted as a declared objective of policy, capital and money movements may continue on the basis of anticipated long-term exchange stability; in the contrary case the anticipated instability will disorganize financial operations and thus become a real instability. Thus the real opposition is that of organized versus disorganized international monetary relations, not that of one method or organization versus another method (that is of one monetary system versus another system). The choice of methods must then depend on various other considerations, not on that of a long-run stability of foreign exchanges.
• 71In the preceding two sections I have endeavoured to give a brief outline of the principal ‘mechanisms’ through which international payments are or can be equilibrated once their balance has been disturbed. As has been pointed out above, the various mechanisms that operate under conditions of fixed parities can work together; what actually happens in any particular situation can be ascertained only by means of empirical inquiries. While some such investigations have been carried out, very much remains still to be done. This is indeed a fitting subject for institutional research: in order to make the results of such inquiries readily comparable they ought to be carried out by a group of scholars in agreement amongst themselves on the methods to be used and on the problems to be investigated. In the absence of more and better knowledge of actual processes, most detailed discussions of the ‘mechanism’ of re-equilibrium remain in the sphere of the intellectually conceivable; they are precious tools of thought for inductive research. The most that can be said is that actual situations represent variously set-up compounds of these multiple hypothetical methods of adjustment. It is only when our empirical knowledge is more developed that really significant results will be obtained through applying and testing the various abstract ‘models’. In the present study I should like to bring out certain fundamental similarities between the various ‘mechanisms’, in particular the analogies which exist between ‘mechanisms’ moving on the basis of fixed parities and those which work through exchange fluctuations. Some elements of this comparison have been already mentioned in section D of this chapter and in the light of these observations there appears a possibility of formulating a theory of re-equilibrium which would apply to any monetary system. This is what I shall now attempt very briefly to do.
• 72Symptoms of disequilibrium in international payments can be only one of two kinds: (a) flows of gold (under the gold standard); (b) depreciation of one currency in terms of the other. If deficits and surpluses are cumulative, then (a) losses of gold2 by the country in deficit will go on until this particular monetary system breaks down, or (b) the depreciation of the currency of the country in deficit will continue without limitation and monetary instability will set in. It will be noted that even if one starts from the situation (a) one ultimately lands in the situation (b) provided that the cumulative character of the maladjustments lasts long enough. Now currency depreciation, to which there is no known limitation, destroys all regularity in flows of capital and introduces into the economic process more or less wide and erratic movements of short-term funds. The destruction of confidence brings an end to financial and monetary stability; considerations of safety and not considerations of returns guide financial operations henceforth.
• 73Symptoms of disequilibrium in international payments can be only one of two kinds: (a) flows of gold (under the gold standard); (b) depreciation of one currency in terms of the other. If deficits and surpluses are cumulative, then (a) losses of gold2 by the country in deficit will go on until this particular monetary system breaks down, or (b) the depreciation of the currency of the country in deficit will continue without limitation and monetary instability will set in. It will be noted that even if one starts from the situation (a) one ultimately lands in the situation (b) provided that the cumulative character of the maladjustments lasts long enough. Now currency depreciation, to which there is no known limitation, destroys all regularity in flows of capital and introduces into the economic process more or less wide and erratic movements of short-term funds. The destruction of confidence brings an end to financial and monetary stability; considerations of safety and not considerations of returns guide financial operations henceforth.
• 74Most of the ‘mechanisms’ described in the economic literature, and summed up above, work on the assumption that international trade is the principal source of payments that take place from country to country. This easily leads to confusing the balance of trade with the balance of payments and to reducing the disequilibrium in the latter to that in the former. Whenever this is done, conclusions obtained cannot be applied, without more or less serious qualifications, to cases where financial transactions are an important source of international payments. In the assumption that no financial transactions whatever are taking place, the whole readjustment in international payments has to be obtained through export surpluses realized by the country in deficit. If the adjustment is to be made under a system of simple specie currency, the deficit of the balance of payments causes a change in the supply of money in the countries concerned and thus affects trade, (a) directly via shifts in demand schedules brought about by changes in the supply of money; and (b) indirectly through price changes resulting from movements of specie from country to country. The greater the price adjustment, the quicker will the necessary alteration in the balance of trade be obtained. It will be observed that the necessary price adjustment will be smallest when trade is free and that progressive protectionism may seriously interfere with the process of re-equilibrium.
• 75The time has now come to drop the assumption which consisted in limiting international economic relations to commercial transactions. Under modern economic conditions capital movements and short-term credit operations play too important a part to be left out of consideration. On the contrary, they ought to be introduced into the problem of international settlements with a far greater emphasis than is generally the case. If financial transactions are important components of international economic relations, then trade adjustments cannot be regarded any longer as the only, or even as the principal, factor in the process of re-equilibrium.
• 76Let us now ascertain whether this interest-rate policy is indispensable for obtaining re-equilibrium or whether, on the contrary, a mechanism is conceivable which leaves the rate of interest quite outside the process of adjustment. Should the interest rate become dissociated from the mechanism of re-equilibrium, then, under normal conditions of confidence, international credit operations would cease to operate as an instrument helping to bring about equilibrium of international payments. As far as I can see it, there is no means of attracting to a country short-term balances other than offering them a sufficiently high reward, and this can be achieved only by means of an appropriate bank-rate policy. If now, international credit operations cease to take place, the whole load of adjustment is thrown upon the balance of trade. Important consequences follow. Credit operations of the type which we are considering here reduce the net deficit (and surplus) in international payments and reduce in consequence the size of net balances which have to be settled and the volume of ‘real transfer’ which has to carry out the final settlement. The suppression of compensatory credit transactions has the contrary effect. Now it is clear that the greater is the size of adjustments to be brought about by trade items, the greater will be the need for changes in the supply of money on the respective national markets and for differential price movements. These changes in the supply of money may be carried out through open-market operations under conditions which were specified above. Whenever this method can be applied the bank rate need not be changed as soon as the mechanism of re-equilibrium begins to work. It will, however, be noticed that the change of rates is thus merely postponed. Relative changes in the supply of money call sooner or later for changes in short-term interest rates; these cannot be indefinitely avoided if re-equilibrium is to be obtained. Movements in interest rates can only be avoided if one adopts measures the final effect of which is to make the functioning of the mechanism of adjustment impossible. It is hardly necessary, after all the foregoing analysis, to emphasize further the fact that international payments are not likely to be brought into equilibrium if neither short-term credit operations, nor changes in the supply of money and in national prices, are allowed to take place.
• 77There is in the same context another misapprehension which ought to be dispelled. It is usually claimed by those who advocate the system of ‘flexible exchanges’ in opposition to that of fixed parities, that the latter imposes upon countries which are practising it the strains of repeated deflations, or rather of an alternation of inflations and of deflations. This strikes me as a rather fanciful representation under normal conditions. Price movements which enter into a process of adjustment of international payments are not likely to be of an amplitude which would seriously disturb economic activity and amount to a deflation (or inflation). If we had the necessary quantitative information about the pre-war times, we could settle the matter conclusively. While waiting for an adequate documentation to be produced we must depend on the logic of the economic system and be very careful not to exaggerate what probably consisted of relatively minor price movements; very likely the greatest part of current adjustments was carried out (as I pointed out before) by credit operations. The underestimation of the part played by international movements of short-term balances had led to an exaggeration of the rôle of price movements and of their size. A further source of confusion is the lack of differentiation between current adjustments of transactions carried out with a view to maintaining long-run equilibrium in international payments, and adjustments to violent breaks of equilibrium due to special causes and to exceptional circumstances. Under ‘normal’ conditions there is no need to choose between stable prices and stable exchanges. Not only can both be stable at the same time, but it clearly follows from all the foregoing analysis that they must be stable simultaneously, if equilibrium is to be preserved.
• 78There is in the same context another misapprehension which ought to be dispelled. It is usually claimed by those who advocate the system of ‘flexible exchanges’ in opposition to that of fixed parities, that the latter imposes upon countries which are practising it the strains of repeated deflations, or rather of an alternation of inflations and of deflations. This strikes me as a rather fanciful representation under normal conditions. Price movements which enter into a process of adjustment of international payments are not likely to be of an amplitude which would seriously disturb economic activity and amount to a deflation (or inflation). If we had the necessary quantitative information about the pre-war times, we could settle the matter conclusively. While waiting for an adequate documentation to be produced we must depend on the logic of the economic system and be very careful not to exaggerate what probably consisted of relatively minor price movements; very likely the greatest part of current adjustments was carried out (as I pointed out before) by credit operations. The underestimation of the part played by international movements of short-term balances had led to an exaggeration of the rôle of price movements and of their size. A further source of confusion is the lack of differentiation between current adjustments of transactions carried out with a view to maintaining long-run equilibrium in international payments, and adjustments to violent breaks of equilibrium due to special causes and to exceptional circumstances. Under ‘normal’ conditions there is no need to choose between stable prices and stable exchanges. Not only can both be stable at the same time, but it clearly follows from all the foregoing analysis that they must be stable simultaneously, if equilibrium is to be preserved.
• 79There is in the same context another misapprehension which ought to be dispelled. It is usually claimed by those who advocate the system of ‘flexible exchanges’ in opposition to that of fixed parities, that the latter imposes upon countries which are practising it the strains of repeated deflations, or rather of an alternation of inflations and of deflations. This strikes me as a rather fanciful representation under normal conditions. Price movements which enter into a process of adjustment of international payments are not likely to be of an amplitude which would seriously disturb economic activity and amount to a deflation (or inflation). If we had the necessary quantitative information about the pre-war times, we could settle the matter conclusively. While waiting for an adequate documentation to be produced we must depend on the logic of the economic system and be very careful not to exaggerate what probably consisted of relatively minor price movements; very likely the greatest part of current adjustments was carried out (as I pointed out before) by credit operations. The underestimation of the part played by international movements of short-term balances had led to an exaggeration of the rôle of price movements and of their size. A further source of confusion is the lack of differentiation between current adjustments of transactions carried out with a view to maintaining long-run equilibrium in international payments, and adjustments to violent breaks of equilibrium due to special causes and to exceptional circumstances. Under ‘normal’ conditions there is no need to choose between stable prices and stable exchanges. Not only can both be stable at the same time, but it clearly follows from all the foregoing analysis that they must be stable simultaneously, if equilibrium is to be preserved.
• 80(a) If price movements in different countries take place quite independently of one another and we then get ever further away from an ‘international price equilibrium’, cumulative changes in balances of trade are due to take place. This must not, and is not likely to, happen when price movements take place but are internationally co-ordinated. I am not speaking of price fluctuations which are a part of a process of adjustment and bring about equilibrating changes in balances of trade; the price movements referred to in the present context are not fluctuations of a minor amplitude but cumulative tendencies of prices to rise or to fall over longer periods of time. Thus if two countries practise in the downward phase of the cycle, the one an expansionist policy, the other a deflationary policy, frictions are likely to occur, since prices in the former country will rise in relation to prices in the latter: which is bound to affect trade between them. Unless other transactions compensate this development of balances of trade, the strain on foreign exchanges may become considerable. It will be noted that to pursue such divergent price policies is possible in the long run only when the individual countries in question disregard the rules governing mechanisms of adjustment and adopt policies which are in contradiction with those rules. The characteristic feature of the ‘rules of adjustment’ is that they demand the adoption of policies which go counter to the disturbing tendencies; policies which, on the contrary, strengthen these tendencies, such as inflationary or deflationary ones, make the functioning of mechanisms of re-equilibrium difficult or impossible while they accentuate the causes of disequilibrium. The situation is, of course, different when all the countries adopt an expansionist, or when they all adopt a deflationary, business cycle policy. Here the problem of re-equilibrium meets that of business cycle theory as a basis of policy. The divergencies existing between leading theories thus become real causes of disequilibria in international payments and of instability in international economic relations, inasmuch as some of these theories become the guide to action in some countries and others in other countries.
• 81(a) If price movements in different countries take place quite independently of one another and we then get ever further away from an ‘international price equilibrium’, cumulative changes in balances of trade are due to take place. This must not, and is not likely to, happen when price movements take place but are internationally co-ordinated. I am not speaking of price fluctuations which are a part of a process of adjustment and bring about equilibrating changes in balances of trade; the price movements referred to in the present context are not fluctuations of a minor amplitude but cumulative tendencies of prices to rise or to fall over longer periods of time. Thus if two countries practise in the downward phase of the cycle, the one an expansionist policy, the other a deflationary policy, frictions are likely to occur, since prices in the former country will rise in relation to prices in the latter: which is bound to affect trade between them. Unless other transactions compensate this development of balances of trade, the strain on foreign exchanges may become considerable. It will be noted that to pursue such divergent price policies is possible in the long run only when the individual countries in question disregard the rules governing mechanisms of adjustment and adopt policies which are in contradiction with those rules. The characteristic feature of the ‘rules of adjustment’ is that they demand the adoption of policies which go counter to the disturbing tendencies; policies which, on the contrary, strengthen these tendencies, such as inflationary or deflationary ones, make the functioning of mechanisms of re-equilibrium difficult or impossible while they accentuate the causes of disequilibrium. The situation is, of course, different when all the countries adopt an expansionist, or when they all adopt a deflationary, business cycle policy. Here the problem of re-equilibrium meets that of business cycle theory as a basis of policy. The divergencies existing between leading theories thus become real causes of disequilibria in international payments and of instability in international economic relations, inasmuch as some of these theories become the guide to action in some countries and others in other countries.
• 82Adjustment to changes in capital movements must be made through changes in trade balances, since short-term credit can, by definition, provide only temporary relief. Moreover, the reasons which bring about changes in capital movements are likely to affect short-term credit operations as well, in such a way that the maladjustment in international payments will be increased rather than diminished. Adjustment through international trade can be most easily obtained if the disequilibrium is relatively small in comparison to the value of trade transactions; and again, the fewer the obstacles that are put in the way of international trade, the easier it will be. The larger is the relative size of the maladjustment and the more drastic and active is protectionism, the less easily can the adjustment be obtained. Much will also depend upon the nature of exports and imports of the country in deficit and on the respective elasticities of demand for various goods in question. Should a country be unable to obtain the necessary adjustment then only two courses remain open: either financial assistance by means of international action, or else a cumulative loss of gold in the case of a gold-standard country and cumulative exchange depreciation in a country forced off the gold standard or in a country with a system of inconvertible currency. We shall see presently how exchange control comes to be adopted in consequence of a continuing situation of the second type.
• 83Adjustment to changes in capital movements must be made through changes in trade balances, since short-term credit can, by definition, provide only temporary relief. Moreover, the reasons which bring about changes in capital movements are likely to affect short-term credit operations as well, in such a way that the maladjustment in international payments will be increased rather than diminished. Adjustment through international trade can be most easily obtained if the disequilibrium is relatively small in comparison to the value of trade transactions; and again, the fewer the obstacles that are put in the way of international trade, the easier it will be. The larger is the relative size of the maladjustment and the more drastic and active is protectionism, the less easily can the adjustment be obtained. Much will also depend upon the nature of exports and imports of the country in deficit and on the respective elasticities of demand for various goods in question. Should a country be unable to obtain the necessary adjustment then only two courses remain open: either financial assistance by means of international action, or else a cumulative loss of gold in the case of a gold-standard country and cumulative exchange depreciation in a country forced off the gold standard or in a country with a system of inconvertible currency. We shall see presently how exchange control comes to be adopted in consequence of a continuing situation of the second type.
• 84Various arguments are advanced to support this point of view. It would exceed the scope of this report to analyse them in detail. Mr J. M. Keynes’ arguments advanced in 1923 and in 1930 are at the basis of the modern literature on the subject; I have discussed and attempted to refute them in my recent book on International Monetary Economics. Similar views can be found in the writings of Professors Ohlin, Whittlesey, Harrod, etc. All these arguments involve the following elements:
• 85Various arguments are advanced to support this point of view. It would exceed the scope of this report to analyse them in detail. Mr J. M. Keynes’ arguments advanced in 1923 and in 1930 are at the basis of the modern literature on the subject; I have discussed and attempted to refute them in my recent book on International Monetary Economics. Similar views can be found in the writings of Professors Ohlin, Whittlesey, Harrod, etc. All these arguments involve the following elements:
• 86Various arguments are advanced to support this point of view. It would exceed the scope of this report to analyse them in detail. Mr J. M. Keynes’ arguments advanced in 1923 and in 1930 are at the basis of the modern literature on the subject; I have discussed and attempted to refute them in my recent book on International Monetary Economics. Similar views can be found in the writings of Professors Ohlin, Whittlesey, Harrod, etc. All these arguments involve the following elements:
• 87Various arguments are advanced to support this point of view. It would exceed the scope of this report to analyse them in detail. Mr J. M. Keynes’ arguments advanced in 1923 and in 1930 are at the basis of the modern literature on the subject; I have discussed and attempted to refute them in my recent book on International Monetary Economics. Similar views can be found in the writings of Professors Ohlin, Whittlesey, Harrod, etc. All these arguments involve the following elements:
• 88The maintenance of stable exchanges between various currencies involves or may involve hardships for some amongst them; the gold standard sacrificed the internal stability of a country’s economic life to the maintenance of fixed parities.
• 89International trade is not so important as to minimize risks involved in it by means of stabilizing foreign exchanges.
• 90It is necessary for a country to have freedom of action in the conduct of its economic policy and a means of avoiding disturbing influences of foreign economic developments.
• 91It is necessary for a country to have freedom of action in the conduct of its economic policy and a means of avoiding disturbing influences of foreign economic developments.
• 92Now it must be noted that price adjustments are necessary only if divergent and cumulative price changes have taken place in one of the countries as compared with price movements elsewhere. There is, as far as I know, no instance of a trade depression caused before the world war by the operation of the gold-standard mechanism of equilibrating balances of payments. It is true that under an international standard, economic fluctuations will tend to spread throughout the world—which leads to a synchronization of the upward and of the downward phases of the ‘cycle’ in various countries and makes it possible to adopt a common business-cycle policy. That there was not enough co-operation in the late twenties and early thirties to evolve such a common policy is surely not to be blamed on the international standard. Its collapse was largely due to an absence of such collaboration; and so was the severity of the depression. It might be argued, though I cannot do so here, that an ‘international business cycle’ could be more easily attenuated by co-operative policies, than an insulated ‘national cycle’ could be by purely national and independent policies. The matter is surely worth looking into more carefully than has hitherto been the case!
• 93The opposition of stability of prices to stability of parities is largely based on the purchasing power-parity theory; it is argued that every change of price levels abroad must affect either the domestic price level of the country or the rate of exchange between the two currencies. Let us, however, observe that substantial movements of particular prices can take place in every country without this affecting the parities between national currencies. The theory of purchasing power parities is based on oversimplified assumptions and errs also by using price levels instead of price structures. It can well be said in this connexion that the opposition between internal and external monetary stability ‘is more apparent than real, and that it arises very largely out of a too-literal acceptance of the abstractions of the gold-standard theory’.
• 94The opposition of stability of prices to stability of parities is largely based on the purchasing power-parity theory; it is argued that every change of price levels abroad must affect either the domestic price level of the country or the rate of exchange between the two currencies. Let us, however, observe that substantial movements of particular prices can take place in every country without this affecting the parities between national currencies. The theory of purchasing power parities is based on oversimplified assumptions and errs also by using price levels instead of price structures. It can well be said in this connexion that the opposition between internal and external monetary stability ‘is more apparent than real, and that it arises very largely out of a too-literal acceptance of the abstractions of the gold-standard theory’.
• 95The following judicious observations by Professor John H. Williams are well worth quoting:
• 96(3) The view according to which international trade is not important enough to be made easier by the maintenance of stable exchanges is implicit or explicit in most arguments about flexible exchanges. A compromise view is held by Professor Ohlin in the following statement:
• 97Monetary internationalism is a matter of the past; there is not much scope for it in a world torn by conflicting nationalisms and oppressed by the shadow of war. Is it also, however, a matter for the future? The answer depends very largely on the future developments of political relations. If organized peace should be realized, it will involve the revival of economic internationalism; and in monetary organization also the course of international co-operation would be resumed. Monetary stability is necessary for furthering the international division of labour and a swifter international circulation of goods, services, and capital. The greatest foe of economic interdependence, which results from an international division of labour, is war and the preparation for it, and, basically, aggressive nationalism. This has been discussed in some of the preceding pages. There is a correlation between economic interdependence and peace and between both of them and increasing welfare. Hence monetary internationalism is a corollary of a policy of peace. This does not mean, of course, that monetary policy or even economic policy can bring about peace. As Professor Rappard rightly remarks in a recent study of the Post-war Efforts for Freer Trade:
• 98Thus the monetary convention would be so extended as to become a general monetary, financial, and commercial pact of co-operation.