Aspects of the Pathology of Money

3 Monetary Internationalism aud its Crisis1

Introduction

1. International monetary relations have been disorganized, with a short interruption, ever since the outbreak of hostilities in 1914, and, a symptom and corollary of the general breakdown in the field of international relations, the monetary disorder grew even worse in the early post-war period. The first attempt at reconstruction was more or less completed ten years after the armistice, but a year later the collapse of the New York stock market started a new period of economic difficulties which culminated in the financial and monetary ‘debacles’ of 1931. The very foundations of the reconstruction of the twenties, however, were weak, and the World Economic Conference of 1927 insisted upon the importance of changing the tendencies then prevailing in international economic relations and adopting more liberal lines of policy lest the prosperity which existed at that time be exposed to serious dangers. But economic nationalism did not disappear after the war, nor did the fear of another war decrease as time went on. On the contrary, tariff barriers kept growing all the time, industrial countries developed their agriculture and agricultural countries developed their industries which entailed difficulties, actual or virtual, in exporting industrial products by the former countries and agricultural products by the latter. Alongside with these developments a successful attempt at stopping inflations was made and another attempt, less successful, at re-establishing the international gold standard. Both these efforts involved a considerable amount of international collaboration, but, contrarily to the recommendations of numerous conferences, no effective international monetary agreement was arrived at. London lost at least a part of its pre-war financial prestige and New York became the greatest financial centre without taking the lead in shaping international monetary relations, as London had done for several decades before the world war. During the war the United States became a creditor country but both the masses and the governments were either unwilling or unable to abandon certain views and reactions inherited from the times when the United States was Europe’s debtor. The political scene in Europe and elsewhere was unsettled and confidence was not rebuilt upon a sound and durable basis. It was in this general atmosphere that monetary relations went out of chaos only to develop in the direction of increasing nationalism. The crisis of monetary internationalism brought about by the war was followed by the long and still existing period of its decline. Neither international conferences, nor the establishment of a ‘new gold standard’ reversed that evolution. What monetary internationalism is in theory, how it worked in practice before it came to a crisis, what the main contributing factors of its disintegration and decline are, and the conditions of its restoration and workability: these are the four principal questions which we shall endeavour briefly to answer in the following pages.

I The Nature of Monetary Internationalism

2. The question of international relations would certainly not arise if the world were one great state or a federation of states.2 We should then have to deal with inter-local or inter-regional relations involving most of the time purely technical considerations. If the world were a federation of states such as the United States of America, inter-state problems would exist in the fields in which states would individually enjoy sovereign rights; in other fields, where all sovereignty would be invested in the federal authorities, only inter-local and interregional relations would exist. The notion of sovereignty is one that cannot be kept out of any discussion of international relations. If deliberately eliminated it has the irritating habit of returning through the back door. It is therefore preferable to bring it in from the beginning and to give it its proper place in the scheme of things. International problems exist in a world in which there are individual sovereign states whose interests are interrelated but between which there is no organized permanent bond. Only where a plurality of interdependent sovereign political units exists do international problems appear. If individual states were quite independent and had no relations with one another, no international problems would, of course, arise. Nor would such problems exist if all states were merged into one and there was only a single sovereignty in the world. Bearing this in mind we shall now inquire into the effects of the plurality of sovereignties of interdependent states upon the monetary relations between those states.

3. Each state has its own monetary system and its own monetary authorities who decide what policies to adopt and how they will be carried out. The choice of policies depends upon the choice of aims and upon the choice of means. The former is the result of many varied considerations some of which are more properly economic than others; the latter depends upon available means of action, the political and economic conditions of the country, and the existing amount of knowledge on the working of the economic system.

4. The aims of monetary policy can be purely economic, such as the increase of the general welfare of the country; or, they can be more political than economic, such as making the country more economically independent from the rest of the world so as to be stronger in case of war. Aims will generally differ according to whether the durability of peace or the likelihood of war is taken for granted, and whether the development of relations with other countries and making them easier and stabler, or, on the contrary, the ideal of autarky and the restriction of relations with other countries is desired. General lines of foreign policy have much to do with choice of aims for monetary policy, or, more correctly, monetary policy is an instrument of economic policy in general, and the economic policy depends upon the principles upon which the economic policy of a state is constructed and upon anticipations as regards peace or war.

5. We can now make an attempt at defining the concept of monetary internationalism. It consists in the exercise, by different countries, of policies directed towards the maintenance of growing and stable international economic relations. In monetary terms it means the creation and maintenance of conditions under which different national currencies are easily convertible into one another and at stable rates of exchange.

6. Only where such convertibility exists can foreign trade develop smoothly and long-term capital investments be made. This is true not only on account of the effect of stable exchange rates upon commercial and financial transactions, but particularly on account of the underlying policies and conditions which make the maintenance of such stability possible. Stable rates of exchange are only a symptom of those deeper factors which create stability of international economic relations. If rates of exchange could be made to fluctuate according to certain laws and only within certain limits the postulate of their stability could be dropped; but we have no instance of ‘self-regulated instability’ in the past, and therefore cannot take it as a basis for our discussion.

7. A ‘system’ which maintains mutual convertibility of currencies at stable exchange rates over long periods of time approximates the state of affairs that would exist in a world state with a single world currency. This was the case when the gold standard was effectively in operation before the war. Before discussing some aspects of its operation it is necessary to examine the component items of ‘international monetary relations’ in detail, and in order to do so we shall briefly examine the structure of the so-called balance of payments.

8. Transactions that give rise to payments from country to country belong to one of three main groups:3 (1) trade in commodities and services; (2) long-term capital movements (including the debt service and dividend payments): (3) short-term capital movements, or, to use a more precise expression, movements of short-term funds. This last category includes commercial credits, deposits abroad of still unused portions of funds secured on long term, and purely financial banking transactions. A fourth group, gold movements, will be discussed later. It is necessary in order that the balance of payments of a country may be in equilibrium, that surpluses or deficits of the trade balance be compensated by corresponding deficits or surpluses in the balance of financial transactions. Movements of long-term funds, i.e. international capital movements, unless they are cancelled out by capital movements in the opposite direction, give rise either to an increase in trade, or to deposits of short-term funds of the sort mentioned above. The latter are also used in the end for the purchase of commodities (and services) unless they constitute a reserve for meeting future payment arising out of the debt-service.

9. It can therefore be said that the balance of international payments of a country is 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’.4 A stable equilibrium thus defined can exist only under certain conditions the absence of which makes readjustments in international transactions impossible. If certain items cannot be adjusted to changes in others, or if certain fluctuations are not self-reversible, the equilibrium of the balance of payments cannot be maintained. We are speaking here, of course, of long-run equilibrium.

10. The conditions required are the following:

(1) Relatively great freedom of trade, or at least great stability in tariff structures and absence of quantitative restrictions;

(2) Flexibility of national price structures;

(3) Great stability in the international flow of capital;

(4) Absence of large and sudden displacements of short-term funds.

11. Whenever a disruption of equilibrium occurs, it can only be re-established by changes in trade items or changes in capital items, and the gold standard provided an excellent mechanism for making the necessary adjustments. The conditions enumerated above apply, of course, to the workability of the gold standard, but their validity is more general as they relate not to the particular effects of linking monetary systems to gold but to the very nature of transactions that occasion payments between countries.

12. The definition of equilibrium given above in paragraph 9 does not contain any reference to short-term movements of funds. The proper function of these movements is to make other adjustments easier and smoother; as a long-run phenomenon they should cancel out. It is only when they are very great and spontaneous that they become an unbalancing factor, but we shall discuss that case later.

13. When a country buys more from abroad than it sells abroad, and this is not compensated by long-term capital movements, i.e. by international lending, the monetary stock of that country should diminish and that of the other countries should increase. Only in this way can one approach the situation that arises in a country, when one region buys more from, than it sells to, other regions.5 This would involve a deflationary development in a country whose imports have increased more than its exports (capital items remaining unchanged) and an inflationary development in countries whose situation is reversed, and this involves the transfer of purchasing power in some form from the former to the latter country. Short-term movements of funds may reduce the size of adjustments to be made in this way and render the final adjustment slower and smoother. In this latter case, instead of transfers of purchasing power, changes in rates of interest as between countries occur in order to attract short-term funds to the country with a negative balance. Movements of currency supply and of interest rates are, of course, interrelated.

14. This seems to be merely a description of the working of the gold standard, but it must be noted that these processes must take place under any system of balancing international accounts (assuming stable rates of exchange).

15. The developments outlined in paragraph 13 lead to a change in the terms of trade between countries. This in turn will tend to diminish the imports and increase the exports of the deficitary country and to bring about the opposite effect in the other countries. But all this may be rendered impossible by a policy of increasing tariffs in countries whose imports would increase in this way. Here the importance of the first of the four conditions enumerated in paragraph 10 is evident. On the other hand the price structures in the different countries must be sufficiently flexible if the required changes in terms of trade are to be made (condition 3 above).6

16. The maladjustment considered so far could be due to changes in taste or to changes in costs, both reflected in relative movements of imports and exports and in their changing structure. But the maladjustment would be more dangerous if a great and sudden change took place in the volume and the direction of foreign lending and if an export surplus were needed to compensate a big gap in the capital balance. Then the flexibility of prices and the receptivity of markets would have to be very great indeed, and even so more or less serious disturbances might be anticipated due to sudden changes in the structure of international trade and to their repercussion upon the structure of production in the countries concerned. Only in a completely fluid economic system can this problem be disregarded. Hence the vital importance of the second condition stated above for the smoothness of international monetary relations under a gold standard of the pre-war type.

17. Let us now analyse the short-term movements of funds. They can be sub-divided into three main categories: (1) commercial credit; (2) short-term deposits connected with long-term borrowing; (3) financial movements proper. The two former categories are closely associated with trade and capital movements and we can leave them aside so as to concentrate our attention on the third subdivision which consists mainly of banking transfers on demand-deposit-accounts from country to country.

18. These transfers of funds take place for one of two reasons: either to obtain a higher rate of interest than their owners can get at home; or to guarantee them against any depreciation that might take place because of monetary regulations anticipated at home, or for fear of inflation, etc. International movements of short-term funds take place therefore mainly in search either for greater returns or for greater security. The former type of movement has an equilibrating effect upon the balance of payments. The latter, which will be discussed in a later section of this paper, has an essentially unsettling action.

19. In this connexion it might be useful to mention another point which will be more fully analysed later: the volume of short-term funds will usually be found to be more important when their movements are directed by considerations of comparative safety, than when they move from country to country in search for larger returns. The reason for the existence of large short-term funds is to be found in the fact that lack of confidence diminishes willingness to invest abroad or even at home on long term. Thus a great fund may be accumulated, which pending the revival of confidence—when it will be put into investment—remains on current accounts in financial institutions and gets transferred from country to country according to the appreciation of their comparative political and economic security. This factor has played an important part in the disintegration of international monetary relations.

20. It will be observed that instability in long-term capital movements is closely linked with the appearance of large short-term funds. So that conditions 3 and 4 of paragraph 10 tend to be realized or to be violated simultaneously; they are closely, one might say organically, interrelated.

21. Having now seen the principal components of the balance of international payments, let us consider the problem of exchange rates in greater detail. Every time a payment is made from country to country a conversion of certain amounts of one national currency into another becomes necessary, and it takes place in one of the many foreign exchange markets. The different markets are interconnected through the medium of arbitrage transactions while forward transactions tend to smoothen out momentary fluctuations of exchange rates in time. Now a rate of exchange is the price of one currency in terms of another, and its formation is determined, like that of any other price, by the conditions of supply and demand.

22. If international payments made to and by a country balance effectively over a period of time, exchange rates will be stable. If, however, they do not, the price of the currency of the country that has a surplus of payments to make will tend to fall. It must be borne in mind that a national currency is legal tender in its country of origin and only in that country; so that foreign demand for a national currency will depend (if we exclude hoarding) upon the amount of payments to be made in the country of its origin. Its supply, on the other hand, will depend on the payments to be made abroad, as one has to pay with one’s national currency for foreign currencies required to make those payments. The exchange rates will therefore move ‘against’ the country whose balance of payments is negative and will go on in this manner until the situation is reversed either by price movements, or by movements of short-term funds, or both.7

23. If, however, the country which experiences a deficit in its balance of payments carries out an inflationary monetary policy or if its political situation does not inspire confidence, its balance of payments will fail to regain equilibrium and the depreciation of its currency will continue. Only under conditions of internal stability can there be an effective check on exchange fluctuations. That check will operate under any monetary system, though, as we shall see later, exchange fluctuations are the smallest under the gold standard.

24. If we assume internal economic and political stability, it will be observed that fluctuating exchange rates may quicken the process of creating differential price changes and changes in terms of trade: a process which equilibrates the balance of international payments. In countries, however, which depend to a great extent on imported raw materials and foodstuffs, the effect of fluctuating exchange rates may be annihilated by an increase of home prices. Further, if there is some maladjustment in the price structure of the country whose balance of payments shows a deficit and if the excessive cost of producing certain articles is the cause of a falling off of that country’s exports, an exchange depreciation is not likely to be of any help, and may even, in certain circumstances, give rise to inflationary developments.

25. While the effect of fluctuating exchanges as a means of adjusting balances of payments thus finds itself considerably diminished, it is not altogether eliminated. The essential condition of its utility lies in the monetary policies pursued in the countries concerned.

26. This brings us back to the notion of monetary internationalism. We can now narrow down our definition and say that monetary internationalism8 exists when the different national monetary policies are directed towards the creation of conditions under which a lasting equilibrium in balances of international payments can be maintained. Monetary internationalism consists therefore in co-ordination and harmonization of national monetary policies with a view to maintaining international monetary stability. In the order of precedence of aims, monetary internationalism consists in giving stability in international monetary relations priority over purely national objectives of monetary policy. The one full practical realization of monetary internationalism existed in the working of the pre-war gold standard, and we shall now discuss some of its most important features in the light of the preceding analysis.

IIMonetary Internationalism under the Gold Standard

27. Monetary internationalism as it existed before the world war was based on the simultaneous adoption of gold as monetary standard by a certain number of economically important states, under conditions of prevailing free trade or low tariffs, of stability in foreign long-term lending and considerable international confidence. Thus the gold standard operated in a world in which the four conditions discussed above (paragraph 10 and following) were to a large extent realized. It is important to bear this in mind, for it was clearly not only the simultaneous adoption of gold as basis of their respective currencies by a number of countries, but also, and principally, the existence of stable and peaceful commercial and financial relations between nations that made the maintenance of stable international monetary conditions possible.

28. Wherever gold was chosen as monetary standard, the gold content of the national monetary unit was defined by law, and the central bank was entrusted with the maintenance of that gold parity. The means to that end were convertibility on the one hand and purchase of gold by the central bank in unlimited quantities at a fixed price, on the other. In other words, under the gold standard the price of gold in terms of national currency was stabilized and the central bank operated as a sort of ‘gold pool’. As the bank had to sell gold on demand, it had to keep a certain stock of gold and the relation of the gold to the note issue was also defined by law. Whenever the bank lost gold it had to restrict the note issue by more than the amount of gold sold and this was done by raising the rate of interest and restricting the discounts of bills of trade, which formed an important part of assets held against notes not fully covered by gold. Thus the loss of gold by the central bank was followed by a rise of the bank rate and a restriction of the note circulation. The reverse would happen when the central bank obtained gold.

29. Let us now turn to the balance of payments. The fact that different countries had adopted the gold standard meant that the owner of a certain weight of gold could sell it to any central bank of a gold standard country for the respective national currency at a price fixed by law. As each national monetary unit was defined in terms of a determined weight of gold, there existed fixed parities between the different national currencies. All one had to do to convert one currency into another was to buy gold in Berlin, for example, for marks and sell it, say, in London for pounds sterling, both prices being fixed by law. Gold could also be bought or sold at a fixed price in bimetallist countries. The cost of the transaction consisted only in the cost of shipping gold from one place to another (freight and insurance) and this was also the cost of making inter-local payments.

30. If we compare the mechanism described above with that referred to in paragraph 21, we shall see that under the gold standard the two complete one another. The foreign exchange markets remain in operation and exchange rates fluctuate according to the supply and demand. Those fluctuations, however, are no longer unlimited. Whenever the deviation from the gold parities of exchange rates quoted is greater than the cost of shipping gold from the place that has a payment to make to the place which has to receive it, the payment will be made by buying gold at the central bank of one country and shipping it to the other country where it is sold to its central bank. From this moment onwards no transactions in foreign exchanges take place until the deviation of exchange rates from gold parities again becomes less than the cost of shipping gold. Thus under the gold standard fluctuations of exchange rates were limited and the different national currencies were convertible into one another at almost fixed rates.

31. When a country was losing gold under the gold standard, the restrictive monetary policy referred to above would be followed and rates of interest would go up. To what extent and at what moment the appropriate central bank policy would be carried out, was largely a matter of judgment. Even the pre-war gold standard was, to some extent, a managed currency. It is true that the range of discretionary powers enjoyed by central bankers was limited and that the principles of administering the monetary system were very clear and simple, but the fact remains that the system was rather managed than automatic.9

32. The restrictive monetary policy and the slight drop in exchanges had the effect of inducing a change in the terms of trade between the country losing gold and other countries, particularly those receiving that gold, with the result that the imports of the gold-losing country tended to fall and the exports to rise.

33. The simultaneous differential changes in rates of interest were inclined to attract short-term funds into the country losing gold. Thus if the disequilibrium in the balance of her foreign payments was purely accidental, its effects upon prices would be small; if it was due, on the other hand, to maladjustments in the price and cost structure of that country compared to others, the necessary changes could be made quietly over a longer period of time and with less internal disturbances than would be the case in the absence of short-term movements of funds.

34. The extent to which adjustments were brought about in the pre-war days through comparative price changes, and through changes in interest rates and induced movements of short-term funds, is largely a matter of conjecture, while the carrying out of a comprehensive factual inquiry is beyond the scope and working facilities of an individual scholar. It is to be hoped that the question will one day receive a clear answer.

35. Just as in the general case examined in the previous chapter of this paper, inflationistic tendencies in a country with a deficit in its balance of payments would prevent any adjustment, so under the gold standard would such tendencies result in an increasing loss of gold and destruction of confidence. Such a result would follow, for example, from the unwillingness of the gold-losing central bank to raise its rate of interest because of ‘cheap money’ considerations and the like, or from a policy designed to prevent any restrictive effect of an outflow of gold upon the note circulation. If such policies are adopted neither differential price changes, nor compensatory movements of short-term funds can follow. Instead of an inflow of funds in search of higher rates of returns, an outflow, a so-called ‘flight of capital’, may be caused by unfavourable anticipations concerning the country’s monetary outlook. The gold outflow cannot be checked under such circumstances and this may in the end easily lead to a breakdown of the gold standard in the country which thus disregards the ‘rules of the game’. And so the consequences outlined in paragraph 23 are likely to occur. It must be remembered that if the gold standard is to be maintained, gold must eventually return to the country that has lost it; and the ‘rules of the game’ make this reverse of the direction of gold movements possible. Under the gold standard as under any monetary system, internal economic stability10 is a condition without which the equilibrium of the balance of international payments, once broken, cannot be easily re-established. Indeed, under conditions of internal instability the balance of payments cannot remain in a state of durable equilibrium.

36. It has more than once been suggested11 that before the world war, England was on the gold standard while the other gold standard countries were de facto on a sterling standard. While this still remains to be proved, there is no doubt as to the leading part played by London during that period, both as regards the working out of generally recognized principles of monetary policy, and the commercial and financial policies practised. As the centre of a great free trade area, and the greatest banker in the world, London was the centre around which international economic, financial, and monetary collaboration was organized. There was no explicit agreement or convention between the different gold standard countries; but what is much more important, the spirit of co-operation and the willingness to accept certain common principles of conduct existed. Those de facto factors are sufficient, even in the absence of a convention, to establish monetary internationalism on a firm basis; but where those factors are missing no amount of verbal agreements, conferences or conventions can replace them. The important thing before the war was that the different gold standard countries carried out a policy which aimed at the maintenance of that system; national policies were co-ordinated through that common objective and through the general acceptance of the same fundamental principles of monetary policy. Thus the gold standard, working in a world where trade was relatively free and capital movements relatively stable, was a successful achievement of monetary internationalism.

IIIThe Crisis of Monetary Internationalism

37. If we compare the general analysis of monetary internationalism given in Chapter I and the basic characteristics of the pre-war gold standard discussed in Chapter II with the conditions that prevailed after the war, we can hardly be surprised at the decline of monetary internationalism. Of the four conditions given in paragraph 10, not one was fulfilled; economic nationalism reigned supreme; the war possibility overshadowed all international relations; confidence never recovered from the shock of the past war; international conferences followed one another at an increasing rate but the spirit of co-operation, the willingness to sacrifice immediate advantage to a more distant common good were absent. It is beyond the scope of this paper to discuss this troubled period in detail; we shall have to concentrate our attention on two questions: firstly, why did the monetary reconstruction of the middle twenties prove to be so ephemeral; secondly, why did monetary nationalism develop to such an extent?

38. The ‘new gold standard’ was a great edifice built on quicksands. Nothing can ensure stability of international monetary relations but freely expanding trade at home and across political boundaries accompanied by a steady flow of capital directed towards economically sound investments by the anticipation of adequate returns. No artifice of monetary technique can replace confidence that is missing. Before constructing technically perfected monetary systems it is necessary to create conditions in which those systems can live and prosper. The first post-war decade overestimated institutions and underestimated spiritual conditions. Bringing a parliament into existence is not tantamount to establishing the spirit of democracy. Fixing the gold contents of a national monetary unit by law, and drawing up statutes of a central bank is not tantamount to establishing monetary internationalism. These are two of the lessons we have learned in the course of the past fifteen years, and both have been dearly paid.

39. When we look for the reasons of the failure of the monetary reconstruction of 1925–8 we note in the first place that protectionism went on growing throughout the post-war period in spite of resolutions adopted to the contrary by various conferences. The industrialization of agricultural countries and the re-agrarianization of industrial countries progressed considerably. Both were due, to some extent at least, to the feeling of political uncertainty and to the anticipation of a possible new war. The World Economic Conference voiced much alarm on account of these tendencies but the resolutions adopted have remained a dead letter. If international trade expanded nevertheless this was mainly due to a great international credit expansion practised particularly by the United States. While the effects of growing economic nationalism were thus, for a time, covered with a thick veil, maladjustments were increasing underneath. Credit expansion not only allowed the United States to maintain an excess of exports over imports while accumulating a great capital investment abroad; it also gave Germany the means to meet reparations payments and have a surplus left over. This made it possible for Germany to have a de facto creditor position, while accumulating a large debt. She was thus able to avoid making the adjustments in costs and in the structure of production that would allow her to obtain the export surplus which she would have needed in the absence of American loans. Thus maladjustments developed, considerably aggravating the financial difficulties of Germany in the early stages of the depression (1930–31). While the smaller debtor countries practised economic nationalism but were prevented by similar developments in other countries from acquiring excess exports, their monetary reconstruction was made possible with the help of foreign loans. The maldistribution of gold was much discussed. Stocks of that metal accumulated in the United States, in France and, to a minor extent, in a small number of other countries. It was due not so much to a desire of those countries to hold important gold stocks, as to the fact that they were both creditor and protectionist countries and that gold went to their central bank as a result of the position of the balances of payments. Countries which needed gold in order to adopt the gold standard were given loans rather than possibilities of obtaining gold through an active balance of their trade. They remained, therefore, in a position in which they had, but for foreign loans, better chances of losing the gold they had than of acquiring more. The haste of reconstruction was such that a ‘gold saving’ model of the gold standard was very much favoured: the Gold Exchange Standard. It was established while the maldistribution of gold was allowed to subsist. An international monetary ‘system’ was established without breaking down economic nationalism. This antinomy is at the bottom of the troubles that followed.

40. If the countries where gold had accumulated were not particularly anxious to see their gold stocks increased, neither were they prepared to see them considerably diminished. The idea of an impending scarcity of gold was very widespread in the twenties and even the ‘Great Depression’ was at the beginning attributed by some to the inadequacy of the gold supply. The effect of this attitude was that scarcely any countries were willing to part with their gold and that rather than lose the monetary metal trade restrictions and later even exchange controls were introduced. The public anxiously watched the central bank returns and got alarmed every time gold was lost. We shall discuss the effects of these panics later; here it is only necessary to point out that gold movements, not accumulations of gold, are a distinctive feature of the gold standard. Further, under the gold standard the country receiving gold must adopt a policy such that the position of her balance of payments might be eventually reversed. If this does not happen, some countries lose all their gold while in others gold stocks increase to such an extent that an inflationary movement becomes imminent.12 The fear of losing gold has become in the monetary débâcle of the early thirties a very powerful factor working for an increase of trade restrictions and for other impediments in international economic and financial relations.

41. A reference has already been made to the state of mind of the public and to its nervousness about outflowing gold. This brings us to another aspect of the crisis of monetary internationalism, an aspect which is psychological rather than political: ‘flights of capital’. The term is misleading and the phenomenon covered by it, inadequately explored. Essentially, however, it is the fact that large financial payments between countries are brought about by a widespread lack of confidence, by anticipation of monetary devaluations and the like and that the effect of such payments upon the situation in foreign exchange markets is highly disturbing. The payments in question originate either in the conversion of large bank balances from one currency to another or in stock exchange transactions also resulting in payments to be made abroad. As in periods of instability and of lack of confidence large amounts of short-term funds exist, the disturbing effects of the ‘flight of capital’ may become extremely serious. In the period preceding the ‘Great Depression’ short-term funds attained an unprecedentedly high level to which the credit inflation we have already mentioned contributed. Our analysis of the structure of the balance of payments clearly shows how unsettling sudden movements of a large volume of short-term funds can be. It is particularly disturbing if other items of the balance of payments are not sufficiently elastic to have a compensating effect. In the period now envisaged trade was hampered more and more by the increase of protection, while movements of long-term capital lacked the stability they used to have before the world war and became, first a virtual, then a real source of maladjustments. Monetary stability can be maintained with the help of short-term movements of funds; but when such movements are brought about by panic and fear nothing can compensate the unsettling effect they produce upon international monetary relations. Only a revival of confidence can help.

42. Protectionism; unwillingness to lose gold; instability in long-term capital movements; large and erratic movements of short-term funds looking for safety—such are the main factors which contributed to the collapse of monetary internationalism. Let us add two other points. One is the cessation of international migrations. Its effect was twofold. In the first place some countries relied on emigrants’ remittances for the equilibrium of their balances of payments and when deprived of them had difficulties in ‘making both ends meet’. In the second place population pressures thus brought about and the increase of unemployment that followed were in certain cases contributing factors both to increased economic nationalism and to growing political unrest destructive of confidence. It is impossible to discuss this problem more fully within the compass of the present study.

43. The other point is the growing rigidity in national price structures due to the wage policy of trade unions and to the development of cartels and other semi-monopolistic organizations. While the other factors given in the opening sentence of paragraph 42 were much more powerfully destructive of monetary internationalism than the rigidity of prices, that rigidity may be an important obstacle to reconstruction. We have seen what part price and cost adjustments may be called upon to play in the working of an international monetary ‘system’; we shall see in a later paragraph what difficulties the lack of elasticity in the cost structure brought about in England in the period following the return to the gold standard in 1925. The precise extent of these rigidities and their bearing upon the maintenance of stability in international monetary relations still remain to be adequately explored; so far the matter has been perhaps more often referred to than thoroughly looked into.

44. The international monetary ‘system’ which collapsed in 1931 was not, as we know, an exact replica of that which was destroyed by the outbreak of the world war. We have seen how it was introduced into a world where all the prerequisites of monetary internationalism were lacking. Let us now consider the technical aspects which made the system differ from the pre-war gold standard. The principal difference consisted in the adoption, by a certain number of countries, of the so-called ‘Gold Exchange Standard’.

45. The Gold Exchange Standard has been much praised and much criticized. Here we shall merely note that it increased the outstanding amount of short-term international indebtedness; that it created wide possibilities for credit inflation on an international scale; that it destroyed the close correlation between the position of the balance of payments and the restrictive or expansionist policies of central banks, and the fact that this connexion was necessary if the self-correcting mechanism of the balance of payments was to work at all was lost to sight. The need that was felt of saving on the use of gold was due not so much to a real scarcity of the metal but to its maldistribution, which was a result of the defective condition of international trade.

46. While the ‘new gold standard’ was thus a precarious creation, no agreement was worked out for new ‘rules of the game’. Before the war there was no need for an explicit agreement because everybody knew the ‘rules’ and kept them. But after the disintegration of international relations between 1914 and 1918, after the period of mild and wild inflations, the need for some established standard of monetary conduct was very real and different experts and conferences urged the necessity of satisfying it. It was all the more important to come to some agreement because London had lost its unique pre-war position; Paris began to feel autonomous and New York became the greatest lending centre in the world but without the tradition and authority which it would have needed to exercise an influence comparable to that exercised by London before the world war. Instead of one monetary and financial centre there were now three—and the result was far from beneficial.

47. Not even the wide adoption of the Gold Exchange Standard was accompanied by any sort of convention. Countries who kept gold exchange instead of gold as cover for their currencies were free to convert it into gold whenever they wanted to, while countries in which the monetary reserves of the Gold Exchange Standard countries were held were at liberty to carry out any monetary policy they chose and even to devalue their currencies in terms of gold. The absence of agreements on both those points led to additional troubles when the general collapse came.

48. The ‘new gold standard’ was therefore not only brought into existence in a world in which the conditions for monetary internationalism were not realized, but was also technically different from the old system. The differences were numerous, as appears even from the rapid survey made in the last few paragraphs; the most important consisted in the absence of fixed ‘rules’ of the ‘new gold standard’ and in the deterioration of the mechanism of adjusting balances of payments. On the other hand a great subject of controversy arose, namely the relative importance for the economy of a country of internal equilibrium as compared with external equilibrium. The former meant stability of internal prices, the latter—stability of foreign exchanges.

49. England’s unfortunate experience over the stabilization of the pound in 1925 contributed very largely to the importance of that controversy. With a view to restoring London’s former prestige and influence as financial centre, England returned to the gold standard at the pre-war parity, while the pound was in fact depreciated by 10 per cent. This imposed the necessity of deflation so as to reduce gold prices to a level on which British export industries would become again competitive in the world market. The deflation proved, however, extremely difficult to carry through on account of rigidities in the price structure and particularly in the level of wages. The pound remained an overvalued currency and the British export industries suffered severely. This particular maladjustment would not have come into existence had the pound been stabilized at a lower and economically more justified gold parity. The fact that too high a parity imposed a deflationary strain upon the country and, as the deflation did not succeed, resulted in a loss of export trade, has contributed very widely to spreading the idea that all maladjustments between domestic and foreign prices can be cured by a process of devaluation. It did so even more when the devaluation of the pound in 1931 and the formation of a ‘sterling area’ resulted in a great improvement of England’s economic conditions.

50. The dilemma ‘deflation versus devaluation’ has made a great career in the course of the last depression. Its roots are perhaps to be found in the British experience of 1925–32; its success is due to the development of monetary nationalism. 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. Deflation, devaluation, when considered as two horns of a dilemma, are policies determined by purely national motives. From an international point of view one may find that neither of them is a solution—particularly when the problem to be solved is found to consist essentially in the disorganization of international relations.

51. It is only when one takes the state of international relations for granted and has no desire to improve them, when indeed one seeks reasons against improving them, that one or another of the nationalist solutions becomes inevitable. The great development of monetary nationalism is a consequence of abandoning the idea of rebuilding international economic relations on a stable foundation. And this, in turn, is the result of the general development of nationalism in the world.

52. Let us return to our dilemma:13 internal versus external equilibrium, stable prices versus stable exchange rates. We have seen in the first chapter of this study that internal stability is a condition of the maintenance of stable exchange rates; important price movements are necessary only if the price structures of different countries get out of touch with each other, otherwise small movements of prices in the countries whose balance of payments is respectively active or deficitary are all that is needed. Such small variations of prices can hardly destroy internal equilibrium and even those can probably be avoided when short-term equilibrating movements of funds take place between countries. The dilemma is therefore probably rather more imaginary than real;14 a thorough statistical inquiry into the functioning of the pre-war gold standard might definitely settle that question.15

53. The practical case for making a choice between stable internal prices and stable exchange rates is often stated in terms such as the following: ‘Since . . . the rate of exchange of a country’s currency with the currency of the rest of the world (assuming for the sake of simplicity that there is only one external currency) depends on the relation between the internal price level and the external price level, it follows that the exchange cannot be stable unless both internal and external price levels remain stable. If, therefore, the external price level lies outside our control, we must submit either to our own price level or to our exchange being pulled about by external influences. If the external price level is unstable we cannot keep both our own price level and our exchanges stable. And we are compelled to choose.’16

54. Before discussing this point of view, let us make several qualifications. Firstly: the assimilation of all foreign countries to one single country, while often done, is a misleading simplification; many problems arise out of the plurality both of countries and of policies. Secondly: there are no price levels in the real world but only price structures and while international comparisons between changes in national price structures are more difficult than comparisons between price levels they are much more instructive and provide a safer basis for policy. Thirdly: the notion of external influence upon a national economic situation is often used in defiance or in neglect of the fact that a national economy is linked by more than one tie with other national economies. The transition from the notion of ‘external influences’ to that of an ‘independent national economy’ is one of degree only.

55. What the problem really amounts to is this: if the different foreign countries adopt or accept a tendency of prices to fall, should a country join in that policy or should it pursue a different price policy and abandon the parity between her currency and foreign currencies? In other words, what should a country do which wants to adopt an expansionist economic programme while other countries are practising deflation? Or the reverse of the two cases mentioned. Indeed in any case where there is a discrepancy between a country’s monetary policy and the monetary policy of other countries the dilemma arises: to join the policy of other countries and preserve stable exchanges; or to let exchanges go and pursue an independent policy. The dilemma is therefore one between international co-operation on the one hand and nationalism on the other hand.

56. We may refer in this connexion to our definition of monetary internationalism given in paragraph 26. It consists in the co-ordination of national monetary policies; nothing is said about the nature of these policies. They may be deflationary policies, stabilization policies, expansionist policies. So long as they are carried out concurrently by different countries the international stability can be preserved. To be quite correct, one should make an important qualification about this last statement. We do not really know enough about the effect of the different types of national policies upon international economic and monetary relations. We should investigate the effects of different types of policy being carried out simultaneously by different countries and the effects of any given type of policy being carried out simultaneously by all the different countries. Such an inquiry seems to be indispensable if we want to make the notion of monetary internationalism absolutely clear. For one thing appears to be certain: that it is not the fact that managed currencies exist that causes monetary internationalism to decline and monetary nationalism to rise. All currencies are managed; in fact, monetary internationalism depends upon: (1) the type of management adopted, its aims and methods, and (2) the existence or nonexistence of co-ordination between monetary policies of the different countries. The following statement by Professor John H. Williams sums up very ably the relation that exists between managed currency and monetary internationalism: ‘Instead of a dilemma as between the gold standard and internal monetary control, the real dilemma is presented by the complexities of the problem of internal control; and upon our success with this will depend fundamentally the success of the gold standard as well.’17

Conclusions: Outlook for Monetary Internationalism

57. In concluding our study let us look towards the future, not so much in an attempt at prophecy, the least successful of human endeavours, but to discover under what conditions monetary internationalism may be revived in the world.

Its crisis, we have seen, can be considered as one of the particular aspects of the general crisis of internationalism. More specifically, however, it is due to three categories of causes: firstly, economic nationalism, the strife for autarky; secondly, the difficulty of making the necessary adjustments to the great and sudden changes that were taking place in the structure of international payments; thirdly, certain theories underlying modern monetary nationalism.

58. The first of these three causes calls for no further comments. The growth of economic nationalism destroys the very roots of monetary internationalism, after having made its operation increasingly difficult. The failure of ‘the first effort’ at monetary reconstruction was due to attaching insufficient importance to that fundamental opposition.18 Where the spirit of co-operation is missing, no amount of purely external institutional arrangements can replace it.

59. Maladjustments that permanently destroyed the equilibrium of balances of payments and led to increased trade restrictionism, exchange controls, and similar devices were in turn the result of political uneasiness, economic nationalism, and general instability of conditions. It is only in a peacefully co-operating community of nations that trade can go on unhampered, capital movements have a steady flow, and expected returns rather than search for safety direct the currents of short-term funds. And only in such a community of nations can monetary relations be organized on an international scale. If a world state is the necessary prerequisite for a unified world currency under the reign of which there would only be inter-local and interregional and none of the vexing international settlements to make, a harmonious community of nations is the necessary prerequisite for monetary internationalism. This does not mean that we have to wait until the ideal of perpetual peace is realized, but it means that there is no hope for stable international monetary relations as long as war is lurking round every corner, as distrust of one’s neighbour reigns supreme and as all the resources of different countries are used towards making those countries ‘safe for war. The contrast between the effective even if limited monetary internationalism realized within the ‘sterling area’ and the state of affairs in continental Europe gives a striking illustration of this point. It may be added that it is the existence of the sterling area with its possibilities of developing into a sterling-dollar-franc area and the existence of the Bank for International Settlements with all its potentialities that provide us with the most encouraging elements in our outlook for the future.

60. While the re-establishment of monetary internationalism thus depends essentially upon the improvement of international relations in general, its final success will depend upon the way in which it is administered. Too often in the last decade has the notion of ‘managed currency’ been considered as synonymous to that of ‘monetary nationalism’. We have seen that this is not justified. But we have also seen that much progress is still to be achieved in the direction of discovering adequate principles of management which would permit us to realize an effective harmonization of national monetary policies, which is the essence of monetary internationalism. In conclusion, therefore, the revival of monetary internationalism depends upon the progress of international consciousness accompanied by a further development of economic knowledge.

 

19 This essay originally appeared as chapter in the book The World Crisis, by the Professors of the Graduate Institute of International Studies, published to commemorate the tenth anniversary of the founding of the Institute. London, Longmans, Green & Co., 1938, PP. 324–53.

20 Cf. Lionel Robbins, Economic Planning and International Order, London, 1937, Pp. 276–7 and 279–80.

21 There are several items not included in this rough classification, such as immigrants’ remittances, which, important though they may be in certain cases, may be left aside for the purposes of the present analysis.

22 James W. Angell, ‘Equilibrium in International Payments’, in Explorations in Economics, Notes and Essays Contributed in Honour of F. W. Taussig, New York, 1936, p. 17.

23 This point is ably discussed by Professor F. A. von Hayek in lectures given at the Graduate Institute of International Studies, in Geneva, and published under the title Monetary Nationalism and International Stability, London, 1937.

24 Again assuming that the different national currencies can be exchanged for one another at fixed rates.

25 See above, paragraphs 13 to 18.

26 Or ‘an international monetary system’ if we agree to use this expression without any undue emphasis on the word ‘system’.

27 Cf. Leo Pasvolsky, The Necessity for a Stable International Monetary Standard, International Chamber of Commerce, Paris, 1933, pp. 17–18, footnote quoting a correspondence that took place in the last quarter of the nineteenth century between Mr Henry H. Gibbs of the Bank of England and Professor Bonamy Price. See also T. E. Gregory, The Gold Standard and its Future, London, 1932, from which the following statement may be quoted: ‘The international gold standard supplies the world with a mechanism for maintaining fixity of exchange and for keeping in organic touch with one another the price and income structures of the various countries. But the degree to which the second of these functions is in fact adequately performed depends, not on the mere existence of a common currency basis, but on the manner in which the detailed administration of the gold standard in each and all of the countries adhering to it is carried out’ (p. 21).

28 And, let us add, internal political and social stability.

29 E.g. by Professor Smit of Brown University in the Proceedings of the Academy of Political Science, vol. XVI, No. 1, April 1934, pp. 53 et seq.

30 Such is, for example, the situation in the world at the time of writing these pages, early summer 1937.

31 Paragraph 48.

32 Comp. with the following statement by Professor John H. Williams: ‘Under more normal conditions . . . it will probably be found that the dilemma between the aims of external and internal monetary stability is more apparent than real, and that it arises very largely out of a too literal acceptance of the abstractions of gold standard theory.’ Quoted from ‘The World’s Monetary Dilemma’, Proceedings of the Academy of Political Science, April 1934, p. 65.

33 This appears to be a proper subject of inquiry for institutional research.

34 J. M. Keynes, A Tract on Monetary Reform, London, 1923, p. 154 (reprinted in Essays in Persuasion, London, 1931, p. 195).

35 ‘The World’s Monetary Dilemma’, op. cit., p. 68.

36 Cf. Sir Arthur Salter, Recovery. The Second Effort, London, 1932.

• 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.
• 19The 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.
• 20The 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.
• 21The 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.
• 22The 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.
• 23The 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.
• 24In 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.
• 25As 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.
• 26The 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.
• 27It 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.
• 28It 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.
• 29While 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.
• 30While 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.
• 31(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.
• 32(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.
• 33(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.
• 34(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.
• 35(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.
• 36(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.