From Bretton Woods to World Inflation

There is a widespread belief that the United States has a duty to lend or give huge sums to other countries, principally in Europe, if it is to save the world from communism and chaos. This belief is held almost as strongly in the United States, which would make the sacrifices, as it is in the European countries that are expected to benefit from them.

In its most widely held form the conclusion rests on the assumption that the present economic difficulties of Europe are in the main the consequences of the destruction and dislocations of war. It is assumed that there is a definite deficit that America can make up by loans or gifts, that America must supply this if Europe is to recover, that Europe’s economic recovery is essential for America’s prosperity, and that therefore it is “good business” for America to make these gifts or loans, even if the loans are never repaid. The sacrifices in the present, it is argued, will be more than compensated by gains in the future.

This set of assumptions found expression in the celebrated speech of General George C. Marshall, the American Secretary of State, at Harvard on June 5, 1947:

The truth of the matter is that Europe’s requirements, for the next three or four years, of foreign food and other essential products—principally from America—are so much greater than her present ability to pay that she must have substantial additional help, or face economic, social and political deterioration of a very grave character.

The implication of this statement is that Europe’s shortages are being imposed upon her by conditions beyond her control, and that the present import surplus of Europe is solely the result of these shortages and not of other factors. This is also the contention that runs throughout the report of sixteen European nations on the Marshall plan.

It would be ungenerous and short-sighted to minimize the appalling physical destruction and the enormous economic and political problems that the last World War brought upon Europe. We can never forget that in the war against Nazism England stood for a whole year alone. Thousands of her houses and factories were destroyed by blitz. Her peacetime equipment ran down. Her export trade was reduced to less than a third. Most of her foreign investments had to be sold.

Yet when ail this has been admitted, we must go on to ask ourselves in all candor whether it is the destruction and dislocations of the war or the governmental policies followed since that war which are primarily responsible for the present European crisis. And whatever we decide regarding the causes of the present crisis, we must also keep in mind that the central question we have now to answer is not what caused it, but what measures and policies are most likely to cure it. Our real problem is not the past, but the future.

Let us begin, therefore, by taking a closer look at the existing situation in Europe.

The main obstacles to European recovery are the present economic policies followed by the governments of Europe.

When a currency is overvalued (to consider the harmful effects of merely one governmental control) it produces a chronic surplus of imports over exports. The overvaluation of the currency tends, on the other hand, to make the prices of that nation’s imports cheaper than they would otherwise be in terms of that currency. This naturally encourages people in that nation to increase their purchases of imports. The overvaluation of the currency tends, on the other hand, to make the prices of that nation’s exports high in terms of other currencies. This discourages other countries from buying.

Suppose, for example, that a French brandy sells in Paris for 1,200 francs a bottle. The black-market rate for the franc is about 280 to the dollar as this is being written [in 1946]. Let us assume that in a free market the franc would sell a little higher—say about 240 to the dollar. At such a rate the brandy could be bought for $5 a bottle in American money. But the official rate for the French franc, which the American importer is now forced to pay, is 119 to the dollar. This means that the brandy must cost him more than $10 a bottle. The arbitrary exchange rate enforced by the French police raises the price as much as would a 100 per cent American import duty (on top of the duty that we actually impose). And this applies to every French export to this country. Is it surprising, apart from any other factor, that France is exporting so relatively little to us?

In the same way, if we look at the problem from the other side, a typewriter that costs $100 in the United States would cost a French buyer, if he had to pay 240 francs for the dollar, 24,000 francs. But as he is able, thanks to exchange control and American loans, to get the dollar for only 119 francs, the typewriter costs him less than 12,000 francs. And this applies to every American export to France. Is it surprising that Frenchmen should want to buy a great deal from us?

Because the overvaluation of the franc makes French goods expensive in terms of dollars, the would-be French exporter may have to reduce his price in terms of francs if he is to meet the competition of other sellers, foreign or American, in the American market. Yet he may see no reason for doing this, because he can realize a larger margin of profit on his domestic sales. And inflation at home, by causing a rise in domestic money incomes, will cause a rising home demand for goods which otherwise would be exported. As if all these discouragements to exports were not enough, the French government does not allow the French exporter to keep the dollars he has made from his export sales or to convert them freely. He must turn 99 per cent of his dollar proceeds over to the government. And he must turn them over at the official rate.

It is hardly surprising, in the face of such regulations, that in most European countries there is a chronic excess of imports over exports. It is hardly surprising that these countries now buy more than they sell. This trade deficit does not prove, however, as Secretary Marshall’s Harvard speech and the report of the sixteen nations assume, that Europe’s “requirements” are this much greater than “her present ability to pay.” It was not primarily brought about by the destructions of war. This chronic excess of imports is being brought about, on the contrary, by Europe’s own governmental policies. It is being financed today mainly by American governmental loans. It will continue as long as those loans continue, and as long as the internal policies responsible for it continue.

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There will be no long-term economic stability and no real freedom of international trade until nations go back to the gold standard. But the first step toward the resumption of free and normal international trade is the removal of all prohibitions on the rate at which the existing paper currency is bought and sold, either in terms of gold or of other currencies.

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For the purpose of making loans or grants to European governments, we have (surviving the now defunct Lend-lease and UNRRA), the Export-Import Bank, the Commodity Credit Corporation, the International Monetary Fund and the International Bank for Reconstruction and Development. In addition, the Treasury Department has acted as the agency to administer the loan to Great Britain. That ought to be about enough government foreign lending agencies without thinking up still another.

Of the two international institutions, the Fund in its present form ought not to exist at all. Its managers are virtually without the power to insist on internal fiscal or economic reforms before they grant their credits. A $25,000,000 credit granted by the Fund to France, for example, is being used to keep the franc far above its real purchasing power and at a level which encourages imports and discourages exports. This merely prolongs the unbalance of French trade, and creates a need for still more loans. Such a use of the resources of the Fund not only fails to do any good, but does positive harm.

The International Bank also lacks clear power to insist on reforms. As distinguished from the Fund, however, it at least has power to refuse loans unless the borrower is “in position to meet its obligations.”

2 Published in 1947 by The Foundation for Economic Education, Irvington-on-Hudson, New York. A 6,500-word condensation was published in the January, 1948, issue of The Reader’s Digest and in all its foreign issues of that month.

• 1* Published in 1947 by The Foundation for Economic Education, Irvington-on-Hudson, New York. A 6,500-word condensation was published in the January, 1948, issue of The Reader’s Digest and in all its foreign issues of that month.
• 2Excerpts from“Will Dollars Savethe World?”*