Economics and The Public Welfare

Chapter 81

Lend-Lease, Bretton Woods, and the British Loan—England’s Postwar Position

In World War I, Britain and France and their allies were able to finance their own purchases of commodities from the outside world, chiefly the United States, from the outbreak of the war in 1914 until our entrance into the war in April of 1917. This story is told in an earlier chapter. They sent us gold, they resold American securities to us, and they borrowed through bonds placed with American investors through investment banking syndicates. After we entered the war, our Congress voted them intergovernmental loans of $10,000,000,000, of which roughly $7,000,000,000 had been taken by the time of the Armistice, in November, 1918.

Financial Resources of France and England in 1939. In the second World War, Britain and France were weaker in their holdings of American securities and cash than they had been in 1914. The Department of Commerce, in a press release of August 29, 1939, gave an estimate which placed the total investments of Great Britain and France in the United States at between $2,800,000,000 and $3,000,000,000. They estimated holdings of $2,050,000,000 in stocks, bonds, and other long-term investments, and dollar balances and other shortterm funds at $850,000,000. This estimate did not include their gold held under earmark in this country. The total earmarked gold for foreign account on July 31, 1939, was $1,287,000,000. Assuming that three-quarters of this was British and French, we have $965,000,000 to add to the totals above, making an aggregate of from $3,765,000,000 to $3,965,000,000. In addition to these resources already available in the United States, we must consider the gold of the Bank of France and the recently consolidated holdings of the Bank of England and the British Equalization Fund. The Bank of France had over $2,700,000,000 in gold, and the British consolidated gold holdings were probably between $2,200,000,000 and $2,400,000,000. Adding these gold holdings at home to the gold, bank balances and investments in the United States, we get nearly 9 billion dollars. In addition, France and England both had investments in many other countries, very substantial parts of which could be converted into cash and foreign exchange. Canada had about $1,400,000,000 in investments and cash in the. United States.

There was another important potential source of cash for the British Empire in the current production of gold in South Africa, Canada, and Australia. As compared with the first World War, when an ounce of gold made only $20.67, an ounce of gold in 1939 made $35. The current flow of gold measured in dollars was very much greater in 1938 than it had been in 1913, as shown by the following table:

Annual Gold Production in Dollars
Country	1913	1936	1937	1938
South Africa	$181,875,000	$396,768,000	$410,710,000	$425,649,000
Canada	16,598,000	131,181,000	143,367,000	165,055,000
Australia	45,619,000	40,118,000	46,982,000	54,264,000

The Vanishing Prestige of Pound and Franc. Both Britain and France in 1914, however, had a further asset which counted for very little in the second World War, namely, the prestige of the pound sterling, the prestige of the franc, and the immense credit of London throughout the world. For most of what they got in the first World War they did not have to pay in cash.

They had resources in 1939 adequate for their foreign purchases for a short war, but it is clear that they felt that these resources must be husbanded. When the pound sterling was blocked, almost immediately after the war broke out, there was the thought that they might get most of what they needed from within the Empire, and the timidity and delays earlier referred to on the part of both British and French purchasing agents in the United States, even after France had been invaded in 1940, may have been in part attributable to this concern about inadequate internationally valid financial resources.

German Conquest of France Leaves British Financial Resources Wholly Inadequate. Moreover, after the German conquest of France, although most of the gold of France managed to escape, that gold was blocked. Our Government would not allow the Petain Government of France to make use of the French gold which had come here, and no other authority was recognized as having the right to use it. England’s own resources alone, on the basis of the figures given above, were thus very inadequate.

American Lend-Lease System to the Rescue. Speedily, however, our own Government began to finance Great Britain, long before we ourselves got into the War. On September 3, 1940, President Roosevelt let the British have 50 overage destroyers to protect their convoys, in exchange for leases of airplane bases in the British Empire. Moreover, on March 11, 1941, we began the “lend-lease” system, under which we allowed countries fighting Germany to get money from our Treasury, not in exchange for promissory notes in dollars, but for whatever consideration the President of the United States should regard as adequate. We seemed to have learned at least one thing from the experience of the first World War, namely, that intergovernmental debts created for war purposes, repayable in cash, create incredible postwar difficulties. Gigantic sums were advanced under the lend-lease arrangements, especially after our entrance into the War, to Britain, to Russia, to France, to China, and to other countries.

Total Lend-Lease Aid—by Country *
March 11, 1941-December 31, 1945
Country	Amount in dollars
British Empire	30,753,304,000
U. S. S. R	11,141,470,000
France and possessions	2,377,072,000
China	1,335,632,000
Brazil	319,494,000
Other American Republics	114,646,000
Netherlands	178,064,000
Belgium	82,884,000
Greece	76,838,000
Norway	37,708,000
Other Countries	100,186,000
Total charged to foreign governments	46,517,298,000
Aid not charged to foreign governments	2,578,827,000
Total lend-lease aid	49,096,125,000

* Twenty-second Report to Congress on Lend-Lease Operations, for the Period Ended December 31, 1945, Table 1, p. 17.

The Growth of Blocked Sterling During the War. Britain’s imports from countries other than the United States, including the Argentine, the British Dominions, and India, were, in very considerable degree, not paid for but rather carried as debts in the form of blocked sterling. Part of this actually took the form of balances in British banks, but a great deal of it was simply in the form of bookkeeping entries or British Government securities. The details are obscure.

Blocked Sterling in India. The worst part of this, and the worst handled part of this, appears to have been in the British relations with India. The Economist (London) of August 7, 1943, gave particulars for seven countries, all but one being within the British Empire, in the following table:

	(£ 1,000’s)	Date
India	500,000	July 16, 1943
Eire	121,458	March, 1943
Canada*	157,300	August, 1943
Egypt	71,200	December, 1942
Malaya	58,000	July, 1943
Australia	64,000	May 31, 1943
New Zealand	34,000	February, 1943
Argentina	17,500	December, 1942

* Interest-free loan.

The Economist added that other accounts not included in the tabulation would bring the total of such sterling indebtedness easily above the one billion mark. This figure would, presumably, include the prewar balances. The Economist further added that the totals were growing, and that, in particular, the sterling assets piling up to the credit of the Reserve Bank of India were likely to rise by an annual increment of about 300 million pounds.

Creates Appalling Inflation in India. Parenthetically, The Economist expressed great concern over the growth of the balances with India, which, it said, “is bestowing on India one of the most pronounced inflations experienced by any belligerent country.” The growth of Indian balances had been held down at first by Indian use of the balances to reduce long term Indian sterling debt, but only £12,250,000 of this debt remained in 1943, and this brake on the accumulation of sterling by India had been virtually removed. A later issue of The Economist, that of October 2, 1943, returns to the subject of the inflation in India, evidently very dangerous, which seems to have been intimately connected with the issue of rupee notes in India against these blocked sterling balances. Indian war finance was clearly badly handled by both British and Indian governments.

No effort is made here to give data regarding direct financial relations between the Indian Government and the British Government. The following figures from the Reserve Bank of India, however, show how enormously the Reserve Bank’s figures for note issue have been swollen against sterling securities.

Issue Department—Reserve Bank of India (Figures in rupees)
	March, 1946	November, 1940
Sterling Securities	11,303,000,000	1,315,000,000
Note Circulation	12,340,000,000	2,291,000,000

The Banking Department of the Reserve Bank of India had, as the two main items in its balance sheet, in May of 1946, “balances abroad,” 5,931,000,000 rupees, and deposits, 6,302,000,000 rupees. These two items, balances abroad and deposits, are close together in size and have risen together. The same figures in November, 1940, were: balances abroad, 423,000,000, and deposits, 606,000,000. A reasonable supposition would be that the balances abroad are chiefly blocked balances in London, and that the swollen deposits of the Banking Department represent the exchange of blocked balances in London for deposits in India.

As the rupee was still quoted in the official exchange rates at 30.182 cents in June of 1946 (a rate that continued in 1948), it is clear that we had here, in Britain’s obligations to India, vast sums. The rupee was very greatly over-valued at this 30¢ figure, and one extraordinary consequence of this was that the American dollar stood at a startling discount in terms of gold in the Indian gold market. Information from a great New York bank in August of 1946, was that in India gold had run as high at $70-$75 per ounce, and this abnormality continued.

The Gigantic Total of Blocked Sterling in 1946. At the Bretton Woods Conference in the summer of 1944, Lord Keynes revealed that the British blocked balances would be $12,000,000,000 by the end of 1944. There was certainty, of course, that they would continue to increase until the War was over. Professor John H. Williams, testifying before the Senate Committee on Banking and Currency regarding the Bretton Woods proposals1 in June, 1945, expressed the opinion that $16,000,000,000 by the end of the War did not seem to him to be too high.

The Economist (London) stated 2 that the Chancellor of the Exchequer, in replying to a questioner, said that the “blocked sterling balances” on March 31, 1946, totaled £3,500,000,000, which, at $4 to the pound would mean $14,000,000,000. The Economist questioned, however, whether the Chancellor’s information was exact, and thought that this might be a net rather than a gross figure. The Economist added that in the case of the Reserve Bank of India, sterling holdings had continued to increase. The Economist thought that there had been much worse deterioration, in the period June 30, 1945, to the end of March, 1946, than the figures would indicate, because Britain had, to some extent, been covering her deficit by living on the lend-lease pipe line and surpluses.

It has been clear since the outbreak of the war, when sterling first broke violently and was then pulled up to $4.02 for “Official sterling”—with free sterling increasingly blocked until almost none remained—that a free pound would go very low in the foreign exchange markets. This volume has criticized Britain’s financial policy in the period of the 1920’s and 1930’s, but during the war, when Britain was fighting for her own life, and when for a long time she alone was fighting for us as well as for herself, there has been no reason why she should not get whatever credit she could wherever she could get it, and on whatever terms she could get it. That this involved great hardship for certain weaker countries in the British zone of influence and for India, is, of course, much to be regretted.

The Keynes-Morgenthau Plan and the Blocked Balances. It seemed right, however, to resist the effort to get a postwar situation in which all this vast blocked debt of England would be validated at the expense of the solvent countries of the world, and primarily of the United States. Particularly indefensible was that part of the Keynes plan for an “International Clearing Union,” 3 which proposed (Section 34) that the Clearing Union should expand credit, so that countries owning these balances should be able to regard them as liquid, while the countries which owed these balances would have no corresponding drain on their liquid resources. And likewise indefensible was that part of the original Morgenthau Plan 4 which appeared at the same time, which provided that the countries in the plan should cooperate to prevent ownership of these blocked balances from being transferred, but that the countries that owned them might sell them to the International Fund, with the International Fund to be gradually repaid up to 80% of these balances by the end of 23 years.5

Lord Keynes may not have known when he made his original proposal in May of 1943, how big these blocked balances were, though one cannot be sure of this because his plan was for a fund, which, as Professor John H. Williams showed, could theoretically expand to $30,000,000,000 with a further expansion possible to the extent that the blocked balances were absorbed. But by the time of the Bretton Woods Agreement, Lord Keynes had withdrawn the proposal that the block balances should be absorbed, and recognized that Great Britain’s figures were far too big to be handled in that way.

Indeed, the blocked balances provisions were dropped as the Keynes-Morgenthau plan was revised by the “Experts of 30 Nations” in the text released by the United States Treasury on Friday, April 21, 1944.

The Evolution of the Bretton Woods Agreements. The power of individual governments before the second World War to control currency depreciation and exchange depreciation, in countries following unsound currency and fiscal policies, had, as we have seen in an earlier chapter, proved utterly inadequate in every country except Hitler’s Germany. The idea arose that if the various governments would only cooperate in this matter, it would be possible for them collectively to do what they pleased with internal currency and finance, and still keep stable exchange rates. They could prevent wicked flights of capital by international coöperation. They could prevent transactions which recognized currency depreciation in terms of gold or of exchange of other countries. Countries which had overexpanded credit could continue to have easy money markets with safety. This is probably the root idea of the original Keynes plan. And Secretary Morgenthau, who had prided himself on reducing interest rates while borrowing many tens of billions a year, probably liked this aspect of the plan, and probably liked also the idea of continuing after the war the numerous controls of international transactions which had been in his hands during the War.

The Keynes-Morgenthau plan evolved through several versions. The original versions of the Keynes plan and the Morgenthau plan will be found in the Federal Reserve Bulletin of June, 1943. There was subsequently a revision of the Morgenthau plan issued by the United States Treasury on July 10, 1943, and a new proposal was presented on October 8 of 1943 by the Treasury, which proposed, as an addition or supplement to the International Fund, an International Investment Bank. These various proposals were subsequently revised, after a conference of representatives of more than thirty nations, in a new text issued by the United States Treasury on April 21, 1944. Finally the Bretton Woods Conference, participated in by representatives of many nations, July 1 to July 22, 1944, culminated in an elaborate document known as the Bretton Woods Agreements.

The Agreements called for an International Monetary Fund and an International Bank for Reconstruction and Development. The Fund was to be concerned with limiting variation in exchange rates, though any country was privileged to drop its exchange 10% merely on its own initiative, and to drop its exchange an additional 10% unless the Fund should object within seventy-two hours.

Each participating country was to put into the Fund certain amounts of gold, if it had it, and less if it did not have it, and to put in its own currency and its own securities, up to certain quotas. And each country was privileged to call upon the Fund for the currencies of other nations needed to meet its current obligations in the other countries up to a certain percentage of its quota per annum.

Participating countries were expected to remove exchange restrictions within five years after the beginning of the operation of the Fund, though Section 4 of Article XIV of the Agreement on the International Fund clearly contemplates the possibility that certain countries will retain their restrictions longer than five years.

The total resources of the Fund, counting gold, and good currencies, and bad currencies, and securities all together were to be $8,800,000,000, of which the contribution of the United States was to be $2,750,000,000. But most of the $8,800,000,000 would not be internationally valid. The actually lendable part would have been about $4,000,000,000. Of that, our contribution would be about 70%.6

The control of the Fund was to be in the hands of an international board with the United States in the minority, though the United States were to have a veto where a change in the gold content of the American dollar was concerned. This was particularly important in connection with Section 7 of Article IV of the Fund agreement, which provided for uniform changes in the par values of all the currencies, but which required every member with 10% or more of the total of the quotas to agree before such changes could be made.

The International Bank was to be primarily an investment institution, buying for its own account, or underwriting for sale in various markets, or guaranteeing for sale in various markets, the obligations of countries needing long-term investment funds. Here again there was international control, with the United States in the minority, although both in the Fund and in the Bank it was recognized that the United States would be the principal creditor. A certain measure of protection for the United States was provided in that the bank could not sell its obligations or obligations guaranteed by it in any country without that country’s consent. But this protection did not apply to the use of funds which a country might already have contributed to the Bank. The subscriptions to the resources of the Bank were to total $9,100,000,000, of which the contribution of the United States was to be $3,175,000,000.

Powerful Opposition to Bretton Woods Plan. Opposition to these proposals was strong and a prolonged fight was made. The United States Treasury made a tremendous propaganda for the measure, using public funds to influence Congressional action in a way which was challenged as not lawful. The technical objections—and the matter was highly technical—were given little weight. The propaganda appealed to the almost universal feeling that international cooperation was necessary after the war, and made it appear that to reject Bretton Woods was to reject international coöperation. This propaganda convinced an important body of excellent people in the country, probably a majority of the able people who were not technically trained in money and banking.

Nevertheless the powerful presentation of the case against the Fund before the House of Representatives Committee on Banking and Currency 7 startled the Treasury and shook the confidence of the Congress in the proposal.

But President Truman Endorsed Plan in “Honeymoon.” The legislation validating the Bretton Woods Agreements would probably have been defeated but for the circumstance that President Roosevelt died in April, 1945, and that President Truman, at the beginning of his “honeymoon period,” endorsed it. The House of Representatives passed the Bretton Woods Agreement Bill, June 7, 1945.

The fight was continued before the Senate Committee on Banking and Currency. The following is an advance summary of the main portion of the present writer’s testimony before that Committee on June 22, 1945, which summarizes the main points in the indictment of the Bretton Woods proposals.

The Fallacies of the Bretton Woods Plan. “The great job of the government in straightening out the postwar world is political, not economic. Governments have long experience and sometimes even great skill in arms, in diplomacy, in justice and police. In the direct handling of economic life, governments are usually clumsy and ineffective. In economic life their main business should be that of traffic cop, not that of driver, and above all not that of back seat driver.

“The Congress has made an immense forward step in the passage of the Reciprocal Tariff legislation designed to help remove governmental restraints on international trade. In the great postwar emergency, we must, of course, do a great deal more than that. We must help Europe both with charity and with loans. We must not disguise charity in the form of loans which cannot be paid.

“In making loans we must meet fully the great obligations of the lender to see to it that the loans are (a) adequate for the purpose; (b) not excessive; and (c) that they are properly employed for the purpose for which they are made.

Experience After Last War. “Loans to stabilize exchange rates which are not accompanied by conditions that assure the stabilization of the weaker currencies, are wasteful and useless loans. Small loans made under proper conditions, designed to stabilize, not exchange rates, but currencies, can really accomplish their purpose. We saw this in the period that followed the last war. We wasted $6 1/2 billion between the Armistice in November, 1918, and September of 1920, first in stabilizing and then in supporting the exchange rates of Europe. Our own Government provided but $3 billion of this in direct loans to European governments. Private creditors put up another $3 1/2 billion. Europe responded by buying from the United States great quantities of commodities, many of which she ought to have been producing herself and many of which she could not afford to consume. She bought finished manufactures instead of the raw materials and the industrial equipment she ought to have been buying. She bought a great many luxuries.

“Meanwhile, Continental European belligerents did nothing toward straightening out internal finances. As long as the foreign exchange markets would take their currencies the finance ministers of the Continental European belligerents took the easy way. They did not tax, they did not borrow from their own people, they met every demand for expenditure and they leaned on the central bank of issue for their money. While our dollars supported that money, this process could go on.

“England, the one belligerent of Europe which was getting on her feet financially, balancing her budget, joined us in this. She interposed her financial strength between us and the weak Continent. We gave her credits by taking sterling and by taking her dollar obligations and we sold her the francs and the lire and the drachmas which our exports created. We also sold her goods which she resold to the continent. Late in 1920 we and England both had had enough of this. We pulled up and the great crash of 1920-21 came.

Must Stabilize Currencies to Stabilize Exchanges. “After this costly lesson of trying to stabilize exchanges without stabilizing currency we did very much more modest things successfully. In 1923, after the Austrian crown had dropped to 14,000 to 1 in terms of gold, under the auspices of the League of Nations, a stabilization loan of about $113,000,000 was made to Austria, placed in the investment markets of various countries, especially the United States. This was accompanied by conditions involving drastic reforms in Austria, curtailed government expenditures, increased taxes, balanced budget and definite stabilization of the currency on a gold basis. It worked.

“In 1924 we did the same thing for Hungary, sending Mr. Jeremiah Smith of Boston over to sit on the lid to countersign checks and to see to it that the funds were used for the purpose indicated. Mr. Smith represented the foreign creditors. My recollection is that the Hungarian loan was about $50,000,000. It worked.

“In 1924 we did the same thing for Germany under the Dawes Plan. This time the loan was $200 million, of which $100 million was provided by New York. This loan was accompanied by drastic conditions—increased taxes, curtailed expenses, a balanced budget and definite stabilization on gold, and foreign supervision of certain of the taxes, a foreign representative in the Reichsbank and a foreign commissioner sitting in Germany.

“Those who wonder how we can ever bring Continental Europe back to the gold standard may reflect upon this episode. The Dawes Plan contained a provision that Germany should come back to the gold standard, but that it was probably inexpedient to do so immediately. This last clause was reluctantly consented to by the Americans on the Dawes Committee. The French and Italians had been sentimental about it. It was not fair that Germany should have the gold standard when France and Italy could not have it. The British were not quite ready to come back to the gold standard, and their view was that Germany should go to the sterling standard and then England would take care both of sterling and Germany. But neither Washington nor New York was satisfied with this clause. Our $100,000,000 participation was necessary for the success of the plan.

“It was quietly made clear that Germany should come immediately to the gold standard if the loan was to be placed in New York. Germany did so! The big creditor is in a position to make reasonable terms when he makes a loan. But he must make his terms then—not afterwards.

“The effect of the restoration of sound currency in Germany was magical. They had been utterly demoralized by the deflation they had gone through. Business started up immediately. There was a strong boom and full employment. This was interrupted by a short-lived crisis in the winter of 1925-26, but full activity and full employment were speedily resumed which carried over into the international difficulties in 1929.

“We did the same thing with Poland with about $72,000,000, sending the Honorable Charles S. Dewey over to act as representative of the creditors and to countersign checks. This worked.

Small Loans Will Do the Job. “Small sums, properly used, lent country by country, will do the job. A few hundreds of millions properly used will stabilize the currencies of Continental Europe. Not all of them will need it. It is not easy to see that France or the Netherlands will need it, for example. Russia has no stabilization problem at all. Her currency does not get into the foreign exchange markets. Her dealings in international trade are in terms of dollars or in the currencies of the other countries with whom she deals. Foreigners do not hold deposits in Russian banks which they can sell in the foreign exchange markets nor are the Russians allowed to throw rubles upon the foreign exchange market.

Opposes International Fund. “I am opposed to the whole idea of the International Monetary Fund. It lends money without proper conditions. It gives quotas to countries which need them, and to countries which do not need them. It gives quotas to countries whose finances are deteriorating and to countries which are getting on their feet. A false analogy has been made between these quotas and lines of credit at a bank. No bank gives lines of credit this way. A line of credit is not one of a set of fixed quotas to a group of would-be borrowers, good, bad and indifferent. A line of credit is a specific understanding with a specific borrower based on the facts of his individual position, and if those facts change, the line of credit is revised. If the would-be borrower lies to the bank about his balance sheet or about his profits, or any other essential point, the bank may cancel the line of credit, and if the borrower fails to notify the bank of any essential change in his financial position the bank may cancel the line of credit. The quotas under the Fund are nothing like lines of credit.

“Sound lending is a process in which the creditor makes conditions. When he is dealing with a strong borrower, he cannot make special conditions, or competing lenders will gladly take the loan, but when he is dealing with an embarrassed borrower he can, should and must, both in his own interests and in the interests of the borrower, make conditions that assure the safety of the loan. The Fund puts the debtors—the borrowers—in control of the lending. The notion that there will be any proper restraints upon the use of the funds under these conditions is absurd. The Fund has very inadequate and vague provisions in any case for restricting or withholding credits within the quotas, and these vague provisions are to be applied by a Board of Governors, a majority of whose members represent necessitous borrowers all of whom want to borrow more. No one of them will impose adequate restraints upon another similarly placed lest he invite retaliation when his own country is involved.

“There should not be any Fund. If we stabilize the currencies one by one, the normal operations of the foreign exchange markets will keep the exchange rates stabilized and no Fund is needed.

Fund Sanctions Exchange Restrictions. “The Fund is erroneously represented as an institution designed to eliminate foreign exchange restrictions. In the first place, it sanctions existing restrictions for at least five years. In the second place, it sanctions new restraints even in the countries which have free exchanges. It proposes to leave exchanges free only on current transactions and proposes international governmental coöperation to control international capital movements. Now this control of international capital movements is something we never talked about in the old days of free exchanges and sound moneys. The problem arises only when you have a shaky currency that people are afraid of. Then men get frightened and try to get their money out of the country. And then the government whose unbalanced budget and whose abuse of credit and currency has caused the money to become shaky, begins to blame the people who are trying to run away and begins to blame the foreigners who are trying to take their funds out of the country. The government itself created ‘hot’ money by making their country a ‘hot’ place for money. The way to avoid ‘hot’ money is to balance your budget and redeem your currency on demand.

“This plan for international control of capital movements is vicious in the extreme. It is designed to shelter unsound finance and unsound currency policies by international governmental coöperation. The plan will generate ‘hot’ money. It will create new nervousness on the part of every man who has funds in a foreign country or who knows how to put funds out of his own country.

Generating ‘Hot Money.’ “There are two other provisions in particular that will generate ‘hot’ money.

“(a) The plan sanctions changes in the gold content of the various countries. They may drop 10% merely on their own initiative and they may drop 20% unless the Fund makes objection within 72 hours. Even then, as Edward Brown has admitted in his Chicago Journal of Commerce article, there is no reason to expect the Fund to make effective objection when a powerful country wants to drop as much as 20%.

“Now this possibility hanging over the markets all the time will create ‘hot’ money which would not otherwise exist. Men will constantly be watching, constantly making plans to shift their funds when they face a chance of a 20% or even a 10% loss on their capital. Foreign deposits paying 3% to 4% in banks of a country whose currency may drop 10% with no notice, or 20% on 72 hours’ notice are not attractive.

“(b) The second amazing provision which will definitely generate ‘hot’ money is that authorizing the Fund to declare a currency scarce and authorizing individual countries in that case to ration out the scarce currency. It is the dollar which will become scarce. What if that happens? Foreign debtors can no longer get dollars with which to pay American creditors for goods that have been shipped. No matter how many francs the French debtor may have, he cannot use them to pay. Exchange transactions, except at par, are forbidden in France and in the United States under the terms of the Fund. There is a fixed exchange rate, but there is no exchange market. In 1919 the American exporter caught with depreciating francs could at least sell his francs, take his loss and pay off his own debts. Or the French importer, obliged to pay dollars, could buy the dollars at a higher price and pay his debts. A depreciating exchange is nothing like so bad as a blocked exchange. It is flexible; it gives warning in advance. Men faced with this possibility of having their funds frozen by a declaration of scarce currencies would be constantly on the lookout ahead to get their funds out of the country where dollars are going to be scarce before the declaration comes.

The Distinction Between Current Transactions and Capital Movements Impossible in Practice. “Now how can a man get his funds out of a country if capital movements are controlled and only current transactions are free?

“There are a multitude of ways. Goods can be shipped out of the country and the proceeds left abroad. You do not need a foreign exchange transaction to do it. Or a business having borrowing relations with banks in New York and in Paris could pay off its New York banks and increase its borrowings in Paris which is a means of transferring capital from Paris to New York. The devices are so multitudinous that Lord Keynes admitted in his original draft of the plan for a clearing union that control of capital movements probably involves control of all foreign exchange transactions, and I would go further and say that it involves control of all borrowing and lending transactions by companies doing business in several countries and of all export and import movements, not to mention the searching of pockets and traveling bags of every traveler, and censorship of the mails. This Fund plan is erroneously represented as a plan for free international transactions.

Criticisms of the Bank. “The International Bank proposed is also subject to the criticism that the borrowers dominate it. In a financial institution the lenders should control. If we are going to lend, and we should lend, let us do our own lending; let us have an American institution. Let this American institution go joint account when suitable with foreign institutions. Let it go joint account with private investment bankers. Incidentally, it is highly desirable that we use private investment funds as far as possible rather than government money in our financial aid to Europe. Moreover, it is far easier for private bankers to negotiate with foreign countries in such a way as to impose proper conditions than it is for government to to do it. The banker does not make demands; he expresses his opinion as to what the investors of his country would require, with great courtesy. He raises no diplomatic issues. An American governmental financial institution could very well let investment bankers initiate and originate many propositions, then pass upon them and decide whether they wish to go joint account.

“One great vice in both these plans is that the whole thing rests on new debt rather than on equity money. There is no provision for equity money. Now, if we have an American governmental institution, it could join American investment bankers in underwriting (not guaranteeing) stocks rather than bonds of European industries for sale to American investors. It is desirable that there should be American investment companies which put out their own stocks in this country, and which use their funds in buying a diversification of European stocks, diversified both by industries and by countries. Such companies should seek venture capital only. They should notify the public that their securities are not for widows and orphans. But the same thing is true of bonds in Europe under existing conditions. Bonds would be good if the countries revive. The wouldn’t be otherwise. Stocks would be good if the countries revive and prosper, and not otherwise.

Advantages of Equity Financing. “The great advantage of the stocks is twofold:

(a) with real revival in Europe, the returns would be large to American investors;

(b) in bad years Europe will not have to pay any dividends. In good years she can pay large dividends. It is risk money that we are putting into Europe, and it should be put in in risk form as far as possible.

“The total amounts of loans contemplated to Europe, taking into account the Fund, the Bank and other proposals, are far too great from the standpoint of Europe’s ability to repay. European governments can repay to the extent (a) they can create excess of taxes over expenditures in their own country, and (b) they can transfer these back to the United States by giving us goods and services. They must pay with hams, with bottles of wine, with diversified manufactures, with shipping services, with entertaining tourists, with a multitude of services. Viewed in this way, it is clear that it is to their interest and to our interest to hold the amounts down to what can be handled, not by the printing of money, but by the movement of goods and services. To the extent that we go beyond this we are giving charity in the guise of loans, and to the extent that we do this we are inviting default, repudiation and international bitterness in the future. Let us give charity where we must. Let us lend when we can safely, but let us, above all, realize that we cannot support Europe.

“The big job of the restoration of Europe is Europe’s job.

“I reject the absurd fear that we can’t get other nations to cooperate if we refuse this plan. By the way, none of them has accepted the plan. Even the experts are not committed, except as they have agreed to refer it to their governments.

But if we are prepared to lend money, the borrowers will certainly cooperate on our terms if these are reasonable.

“We cannot, moreover, amend this measure adequately, even assuming that we want to go on with it in the way which this bill proposes. The bill has tried to protect the framework of the Bretton Woods proposals. The proposals themselves, even if we wish to use them, must be changed. Even the modest changes which the bill seeks to accomplish cannot surely be obtained. We put our money in first, under this bill, and then afterwards ask them to change the plan. That is no way to lend money!

Other Vices of Plan. “But there are further major technical vices in the measure as drawn. One which I would emphasize strongly is that the Fund proposes to use only central banks and stabilization funds in its transactions. We are to use reserve money in making foreign loans. Our reserve money should be the last money used for that purpose, not the first. The desirable way to make foreign loans is with investors’ money, or if the government is going to do it, with taxpayers’ money. Second, in foreign exchange transactions, short-run transactions, commercial banking money should be used. The worst way is to use reserve money.

“When payments are made out of the Federal Reserve Bank to the Fund, the dollars come back into the reserves of our member banks, increasing our bank reserves, making our money rates easier in the United States—making it easier to lend at home because we have lent abroad. This is vicious. The other side of it is that when France borrows from the Fund, putting francs into the Fund to provide dollars for a French importer, this means payments of francs into the Bank of France from French commercial banks, tightening the money markets of France.

“Every foreign exchange transaction of the Fund makes unnecessary money market complications in every country involved. This is technically vicious. If the Fund is going to operate in the foreign exchange markets, it should deal with the market as a whole, and should make large use of the deposits in commercial banks rather than of central banks.

“But the whole plan is vicious, artificial, self-defeating.

“In summary, I reject both the Bank and the Fund. I propose instead an American institution which, cooperating where feasible with other institutions, shall make necessary loans, shall engage in necessary underwriting of equities and, above all, shall make stabilization loans to individual countries one at a time, putting gold into their central banks on conditions of budget balancing and gold stabilization with, where necessary, supervision of the uses to which the funds are put.”

Gift, with Conditions, Needed by England. It was obvious, and indeed recognized in the Bretton Woods Agreements, that the fund could not help in Britain’s great financial problem, which was the problem of unmanageable blocked balances. What was needed was a gift of 3 to 4 billions of dollars to England with strings attached. The grounds for a gift were (1) that England was our partner who had spent herself in our joint life struggle, and (2) that we needed a powerful British Empire in the international picture to help us hold our own with Russia. It should be a gift rather than a loan (a) because England’s ability to repay a loan was doubtful in the extreme, and (b) because the effort to pay this loan would in any case have left her less strong than our interests required her to be. But the gift should have been made with conditions. It should solve England’s blocked balance problem, it should free the pound sterling, and it should stabilize the pound. The condition especially to be emphasized was that England should make compositions with her creditors on the blocked balances on terms that seemed adequate to the United States. Before we turned the money over to Britain we should have a comprehensive plan which America could approve. Part of the gift should be used in “sweetening” the settlements which England made with her creditors, giving them some immediate cash as they consented to scale down the debts, to take long-term obligations for the reduced debts and to reduce rates of interest. We should be sure that the gift really solved England’s problem before we turned the money over.8

The Bretton Woods Plan Adopted. The fight before the Senate Committee was futile.9 The Committee promptly recommended the bill and the Senate promptly passed it. The Bretton Woods Agreements are in effect, and the two institutions have been inaugurated, though Russia did not join either.

The British Loan. In addition, an American loan to Great Britain was negotiated, for a total of $4,400,000,000. Of this, $650,000,000 was to be in settlement of all lend-lease and reciprocal aid obligations of the United Kingdom to the United States, of British acquisitions of American surplus property, and of British acquisitions of the United States Government’s interests in installations located in the United Kingdom. The $650,000,000 was also to include estimated supplies still in the pipe lines headed for Britain after V-J Day, through lend-lease and reciprocal aid channels, less certain sums due to the United Kingdom.

The other and much larger part of the loan to Britain, $3,750,000,000, was to be a line of credit extended by the Government of the United States to the Government of the United Kingdom, which could be drawn upon any time between the effective date of the agreement and December 31, 1951.

The American negotiant, in working out the terms of this loan, was Mr. W. L. Clayton, who had been transferred from the Government loan organizations to the State Department. He did as skillful a job as was possible, considering the limitations under which he worked. Had he been able to negotiate the terms of a gift instead of a loan, better results could have been obtained. But he worked under the necessity of making a loan, with provisions whereby the principal would be repaid and under which some interest at least would be paid. The interest rate agreed upon was 2%, but interest was not to begin until December 31, 1951. Provision was made also for waiver of interest payments in years when the Government of the United Kingdom requested it, and when the Government of the United Kingdom and the International Monetary Fund should make certain representations regarding Britain’s international financial relations.

One of the central purposes in the proposal of a gift to England was that the gift should be used in part for “sweetening” the settlements which Britain would make with her creditors under blocked balances. The terms of the loan agreement, however, precluded this, and the United Kingdom undertook to discharge outstanding obligations to third countries “from resources other than this line of credit.”

“Free Sterling” on Current Account Within One Year. Mr. Clayton succeeded also in making arrangements which seemed to promise free sterling so far as current account transactions were concerned throughout all “Sterling Area” countries, within one year after the effect of the agreement, “unless in exceptional cases a later date is agreed upon after consultation,” and that discrimination arising from the so-called Sterling Area “dollar pool” would be entirely removed, and that each member of the Sterling Area would have its current sterling and dollar receipts at its free disposition for current transactions anywhere.

The Government of the United Kingdom agreed that after the effective date of this agreement, it would not apply exchange controls in such a manner as to restrict (a) payments or transfers in respect to products of the United States imported into the United Kingdom or other transactions between the two countries, or (b) the use of sterling balances to the credit of residents of the United States arising out of current transactions. Mr. Clayton was obliged to concede, however, that nothing in this part of the agreement should effect Article VII of the agreement of the International Monetary Fund, which relates to scarce currencies—a provision discussed above in the summary of testimony before the Senate Committee on the Bretton Woods Agreements.

Mr. Clayton was able, however, to bring Great Britain to agree that after one year she would not continue restrictions on payments and transfers for current transactions, and that she would not invoke the provisions of Article XIV, Section 2, of the Fund Agreement, which permits restrictions on payments and transfers for current international transactions.

The terms of the loan definitely contemplate restoration of multilateral trade and free exchange. But the British have succeeded in bringing in many qualifying clauses.

Both countries ratified this loan agreement, the President signing the American legislation on July 15, 1946.

Britain’s Position in 1946. Britain’s position, even with this loan, remained a difficult one. The British statement regarding the problem which was presented to our Government in connection with the British loan agreement, a British Government White Paper (Cmd. 6707), appears in the Federal Reserve Bulletin of January, 1946. It discusses the prospective financial deficits in Britain’s international relations during the transitional period, “provisionally estimated at from three to five years, before internal and external adjustments can be made in the British economy adequate to restore equilibrium.” The loss of the British export trade during the war was very great and this was, to a large extent, the consequence of a deliberate act of policy. The export trade must be rebuilt. The loss of shipping was very great. The loss of overseas investments was very great. The increase of overseas debt we have discussed. The loss of cash reserves was very great, though they have been, in part, rebuilt.

Britain, having survived the war with her economy still a going concern, should be able to work through these difficulties with the assistance which our loan gives her, if she would follow traditional orthodox economic and financial policies. Whether she can do this, with the large measure of governmental controls which her Labour Government may be expected to continue and even to intensify, and with the cheap money policy which neither political party in England has shown any disposition to change, and with the antipathy to the gold standard and to fixed exchange rates which appears to be widespread in the British electorate, raises grave questions.

To build up an adequate export trade means that the British people must offer their products to the outside world at flexible prices which meet competition. The alternatives here are (1) that Britain develop flexible costs, including wages, or (2) that Britain engage in the process of depreciating her currency in the foreign exchanges. This last alternative, however, is no alternative, if one is trying to build export trade. We saw evidence enough of this in the period following the first World War, in the cases of Germany, France, Belgium, and Italy, the figures for which appear in preceding chapters. The use of this resource on Britain’s part would invite retaliation, and could very easily break the machinery of the International Monetary Fund. Further, the use of this, or the anticipated use of this, would greatly lessen the volume of private credit in the outside world, which Britain will need.

Britain, first among all great countries, needs a large, freely moving international trade, and a large volume of internationally valid cash. If she undertakes to carry through a programme of domestic reconstruction based on expanding bank credit, she speedily runs up against difficulties. A loan by a British bank to a British industry which is dependent on foreign raw materials, may have very limited efficacy in setting the industry going. The borrower can use the money in paying wages at home, but he may not be able to use the money in buying materials with which labor must work. Britain can build a great export trade again only if she can have free access on good terms to the raw materials of the world.

One very important source of Britain’s income has been financial profits in financing the trade of the world. To do this she needs both cash and credit. Very short of lending power today, it would still be possible for Britain, with her great fund of knowledge of credit conditions throughout the world, and her great skill in international lending, to act as middleman in distributing credit, if her own credit in London were good. American banks would gladly go “joint account” with British banks, and would gladly take good British bills representing goods exported, say, from Brazil to France, accepted by British houses or banks, if the rate of interest were right and if the bill were looked upon as prime. But the bill could not be looked upon as prime if there were a chance that sterling might depreciate 10% overnight, or that sterling might depreciate 20% in 72 hours, or if there were a chance that the International Fund might declare the dollar a scarce currency and permit England to ration it out instead of meeting dollar obligations in full.

A policy of cheap money in England, therefore, designed to rehabilitate England’s domestic industries and designed to expand the export trade can easily be self-defeating. The danger of this becomes even greater if the British Government undertakes to carry out large projects of internal improvements, and elaborate plans for social security, partly based on Government money borrowed at cheap rates from British banks.

That the British Government is proceeding on the Keynesian theory that cheap money and foreign exchange depreciation are essential for a full employment programme is strongly indicated in the following passage from the New York Times of October 3, 1946. “The United Kingdom won an important concession from the Governors of the International Monetary Fund today. The Governors agreed that measures taken by a country to protect itself from a threat to its ‘full employment’ program might be considered by the Fund as coming within its authority to allow currency revaluations to correct a ‘fundamental disequilibrium.’ ”

The National City Bank’s monthly letter of November, 1946 (page 125), discusses this and seems to feel that the Fund has not made a final ruling on the point. But both the request of the British Government, and the provisional ruling of the Fund are disquieting. They are particularly disquieting to one who wishes to see England have large access to credit in the outside world, and one who wishes to see sterling strong enough to do its work in foreign trade and in international finance.

The nationalization of the Bank of England which the Labour Government has already put through probably did not change the character of the Bank. The Bank had probably lost all of its independence from the Government well before this happened. The legislation giving the British Treasury power,10 on the recommendation of the Bank of England, to impose policies on the Joint Stock banks, however, may introduce still more drastic control of general banking policy. Banking can function satisfactorily only (a) when the money market is under the limitations of gold reserves, gold exports and imports, and sound central bank policy, and (b) when individual bankers, competing with one another, are free to use good banking judgment in individual transactions. Both England and the world outside need a strong fixed pound sterling, and both need interest rates in London which tell the truth regarding supply and demand of real capital as distinguished from artificially manipulated money market funds.

It may be added that the prospect of Britain’s developing a favorable balance of trade, an excess of exports over imports (including both goods and services), again depends either (a) on orthodox measures of sound money and natural interest rates, or (b) upon a degree of highly intelligent governmental control of the volume of exports and imports which we have little reason to anticipate.

It is, of course, a hard saying that England must, in the postwar years, import less and export more goods, because she is now debtor to the outside world, whereas before the war, even with her great losses, she was still creditor. If this is understood to mean that England must import less for her people to consume than she did during the war years and than she has been doing in the troubled postwar year, 1945-1946, when she still has the necessity of maintaining immense armed forces, in view of the unsettled state of the world, it would be a very hard saying. If, however, we can anticipate a real peace in the world, and can anticipate that British industry can make use of new technology and labor-saving devices, it need not be hard. Unfortunately, on this last point there is uncertainty. Union labor in England is opposed to labor-saving devices, and Britain has a Labour Government. The truth is simply that she must export relatively a great deal more than she imports, comparing the postwar period with the prewar period. It is possible for the British people to do this and still have many more of the comforts and necessities of life than they had in the dark years, 1939 to mid-1946. But in order to maintain her position and in order to assure the necessary imports, it is essential that England greatly increase her exports of goods and services, including shipping and financial services to the outside world.

Free markets, sound money, orthodox money market policy, and free banking machinery will do this automatically. If Britain is paying its external debts with tax money, it is automatically restricting the ability of the British people to consume goods by the collection of the taxes. Britain becomes a less satisfactory place in which to sell and a more satisfactory place in which to buy. If the banks are obliged to tighten their rates of discount and interest as gold moves out or foreign exchange reserves become depleted, when the British Government undertakes to transfer its tax money to foreign countries through purchasing foreign exchange, less credit is available for importers and less credit is available to enable exporters to hold back goods. British exports are encouraged and imports are discouraged. The thing is automatic, and an equilibrium is reached when exports increase sufficiently and imports decrease sufficiently to bring about an equilibrium between debt payments abroad and the export balance. If, however, the British Government undertakes, by control of exports and imports, to accomplish this same equilibrium, there is outcry from the British people against the restriction of imports of food and comforts, and the export of foods and comforts, to which a democratic government is very likely to yield. Hitler could go far in matters of this sort. It is improbable that the British Government can.

With great respect for the intelligence of the British Government and with great respect for the discipline of the British people, one may well question that either the intelligence or the governmental power exists in England, or in any other democratic country, to make a system of this kind work.

(1) “Postwar Stabilization of Foreign Exchange—the Keynes-Morgenthau Plan Condemned—Outline of a Fundamental Solution,” an address before the Los Angeles Chamber of Commerce, May 11, 1943. This was reproduced in full in two installments of the Commercial & Financial Chronicle of May 20 and May 27, 1943. It appears in the Economic Bulletin issued by the Capital Research Company of Los Angeles on May 11, 1943. It was reprinted by the Economists’ National Committee on Monetary Policy, running through several editions there. It appears in full in Vital Speeches of June 1, 1943, and in the May, 1943, issue of the Bankers’ Magazine.

(2) “Post-War Foreign Exchange Stabilization Further Considered,” the Commercial & Financial Chronicle, Dec. 16, 1943.

(3) “International Currency—Gold versus Bancor or Unitas,” an address before the Chamber of Commerce of the State of New York on Feb. 3, 1944. This address appears in full in the proceedings of the Chamber and in the Commercial & Financial Chronicle.

(4) “The Keynes-Morgenthau Plan as Revised by the Experts of Thirty Nations,” Commercial & Financial Chronicle, May 4, 1944.

(5) Testimony before the Senate Committee on Banking and Currency at the Hearings on the Bretton Woods Agreements Act, June 22, 1945, partially reproduced in the text below.

• 1This point will be discussed at length in Chap. 34.
• 2I have not been able to find that this article was ever published. However, the reader will find much of it in two books by Veblen: Imperial Germany and the Industrial Revolution, New York, 1915; and The Nature of Peace and the Terms of Its Perpetuation, New York, 1917.
• 3See my book The Effects of the War on Money, Credit and Banking in France and the United States, published by the Carnegie Endowment for International Peace, Oxford University Press, New York, 1919. For London, see the interesting articles by Mr. J. M. Keynes in the British Economic Journal in late 1914.
• 4O. M. W. Sprague: “Crisis of 1914 in the United States,” American Economic Review, September, 1915; H. G. S. Noble: “The New York Stock Exchange in the Crisis of 1914,” Garden City, N. Y., Country Life Press, 1915. These two papers are classics of permanent value.
• 5The figures of all the State and National banks and trust companies appear only once a year in the Comptroller’s report as of approximately June 30. For dates other than June 30, it is necessary to make estimates. During the war period these estimates are made on the basis of variation in the National Bank figures.
• 6War Industries Board Price Bulletin No. 3, Government Control Over Prices, by Paul Willard Garrett, assisted by Isador Lubin and Stella Stewart, Washington, Government Printing Office, 1920, p. 550.
• 7Mr. Herbert Hoover, in particular, did a superb job in bringing the grain and milling interests into the service of the country. I shall later find occasion to criticize his policies as President, but I wish to pay high tribute to his work in feeding the Belgians before we entered the war, to his work in food control at home during the war, to his postwar work in feeding stricken countries, and to his work under President Truman along similar lines after World War II.
• 8See my “Value and Price Theory in Relation to Price-fixing and War Finance,” an address before the American Economic Association, printed in papers and proceedings, American Economic Review Supplement, March, 1918. Reprinted in the Economic Bulletin issued by the Capital Research Company of Los Angeles, Vol. II, No. 2, Dec. 6, 1940, and reprinted in the hearings of the Senate Committee on Banking and Currency on the Price Control Bill Dec. 16, 1941. See also my testimony of Dec. 16, 1941, before this Committee.
• 9“An Index Number of Production,” American Economic Association, Dec., 1920, published in Papers and Proceedings the following March.
• 10See Federal Reserve Charts on Bank Credit, Money Rates and Business, Feb., 1941, p. 32.