From Bretton Woods to World Inflation

July 19, 1944

The drive for a $10,000,000,000 International Bank for Reconstruction and Development illustrates once more the fetish of machinery that possesses the minds of the governmental delegates at Bretton Woods. Like the proposed $8,800,000,000 International Monetary Fund, it rests on the assumption that nothing will be done right unless a grandiose formal intergovernmental institution is set up to do it. It assumes that nothing will be run well unless Governments run it. One institution is to be piled upon another, even though their functions duplicate each other. Thus the proposed Fund is clearly a lending institution, by whatever name it may be called; its purpose is to bolster weak currencies by loans of strong currencies.

One of the difficulties being experienced in the formation of the Bank, however, is the opposite of that found in the formation of the Fund, and serves to illustrate the real nature of the latter. Nations that were fighting for the largest possible quotas in the Fund are fighting for the smallest possible subscriptions to the Bank. That is because the Fund quotas at bottom represented potential borrowing, whereas the Bank subscriptions represent potential lending or losses. It is after the Bank has been set up, and the applications for loans come in, that various nations will again seek the maximum amounts.

Under a free world economy, with private lenders risking their own funds and borrowers seeking to meet their requirements, loans would go to the countries and projects that offered the most attractive terms commensurate with the best prospect of repayment. This means, in general, that capital would go into the countries providing the soundest conditions and into projects promising the greatest economic success. Under such conditions there is the maximum development of world productivity in proportion to the capital invested.

These conditions hardly seem likely to be filled, however, under the proposed international bank plan as envisaged by its framers. Lord Keynes has proposed that the commission to be paid by borrowers should be the same for all members, as it would be “worse than a mistake to attempt the invidious task of discriminating between members and assessing their credit-worthiness.” This seems to mean that bad borrowers with bad records and bad internal policies are to pay interest rates no higher than good borrowers with the best records and sound internal policies. When the criterion of credit-worthiness is dismissed as “invidious,” moreover, the implication is that loans themselves are to be made without regard to it. Under such conditions the proportion of bad loans and of defaults seems certain to be high, and much capital, in a world already faced by grave shortages, is likely to be dissipated in ill-advised enterprises.

This brings us to the proposed nature of the Bank itself. It would be apparently a bank that “guaranteed” loans made by private investors instead of making loans directly itself. But if this guarantee fully covered both capital and interest, then the private investors making the loan would not have to exercise any care or discrimination on their own account. They would have to conform merely with the requirements of the Bank, which would assume all the losses and risks without having the privilege of directly making the loans. The member Governments acting as directors of the Bank would also be the chief borrowers from the Bank.

Many questions of practical operation also arise. Suppose nation X defaults on its share of the loan. Suppose nation Y then defaults on its share of the guarantee. Who is to guarantee the guarantors? Will the subscriptions to the Bank be in gold, or wholly or mainly in each nation’s currency, convertible or inconvertible? Will each nation meet its share of the guarantee merely in its own currency, which may have greatly shrunk in value?

World economic revival will not necessarily flow from a plan under which taxpayers are saddled by their own Governments with losses from huge foreign loans made regardless of their soundness. It is likely, rather, to flow from a situation in which each country, or each industrial venture in it, is encouraged or forced to follow sound policies in order to attract foreign investors.

The Monetary Fund, as set up, I believed would lead to the opposite of its declared purposes. One of those declared purposes, for example, was “to promote exchange stability,” but the specific provisions for the Fund not only permitted but encouraged internal inflation, devaluation and exchange instability.