International Order and Economic Integration

III THE FEAR OF AN ADVERSE BALANCE OF PAYMENTS

THE NATURE OF THE PROBLEM

There is hardly another conception which has accompanied the economists of my own generation throughout their professional lives in so persistent and tormenting a manner as the conception of an ‘adverse balance of payments’1). A major part of the struggle between economic common sense and unreason, clarity and obscurity, untrammeled relations with all the world and national segregation has centred round this conception since the first World War. It is, of course, precisely in this field that the strictly conclusive truth of science is more removed from lay thinking than almost anywhere else, and nowhere is such lay thinking more disastrous and tenacious than it is here. Lamentations about the ‘adverse balance of payments’, the ‘scarcity of foreign exchange’, and the ‘dollar gap’ are heard at the bar of every pub, in hairdressers’ salons and in the railway compartments throughout the world, as though this were some kind of an epidemic sent by heaven or due to the evil curcumstances of the times – a plague which one must somehow or other reconcile oneself to, and for which the only remedy is that of ‘saving’, ‘distributing’ and ‘controlling’ foreign exchange, so that the State sees to it that the account tallies. In the worst case, i.e. that of a so-called ‘structural’ deficit, it is considered justifiable to claim international poor relief under the most varied designations (European Recovery Programme, Financial aid for ‘developing countries’, credits from the European Payments Union, etc.).

The idea of an ‘adverse balance of payments’, which can be cured only by exchange control and by American subsidies, has until quite recently been the most popular conception in Europe and in the world, and many people have difficulty in setting it aside even today. At the same time, however, there can hardly be a conception which would be more disastrous to economic policy.

Just think of the lamentable part played by the idea of a ‘fated adverse balance of payments’ – as we called it sarcastically at the time – during the period of the great German inflation after the first World War, as a theory excusing this inflation and paralyzing stabilization. Just bear in mind to what an extent this very fear of an ‘adverse balance of payments’ became a cardinal point of modern neo-mercantilist planned economy and of self-sufficient socialism under National Socialism in Germany, and then after the second World War in so many other European countries.

It must not be forgotten that this same basically wrong economic thinking then led to one of the cardinal errors in the Marshall Aid Programme, namely, that the deficit in the balance of payments of the individual countries was regarded as the indicator of indigence, and the degree to which it was reduced even at the price of uneconomic domestic investments were regarded as the criterium for the success of financial aid. A fraction of this aid would have sufficed, and a more permanent success been achieved as compared with the programme actually carried out, if it had been applied to the actual cause of the adverse balance of payments and used for internal financial and currency reform.

It should be borne in mind how greatly this very fear of an adverse balance of payments has contributed towards spreading the plague of currency control throughout the world and the extent to which it still causes delay in the final abrogation of this system, though nobody who is even half-way acquainted with the facts would dare to dispute its ruinous harmfulness any longer. The fear of an adverse balance of payments, the belief that currency control is indispensable and that it is impossible to restore free convertibility forms the most serious obstacle to restoration of this convertibility. Currency control would surely have been far less long-lived had not the few hundred people on whom decisions depend been spellbound by the wrong conceptions of an ‘adverse balance of payments’, which apparently economists of every generation must struggle to correct. These wrong conceptions are probably basically due to the view that should the misfortune of an adverse balance of payments befall a country – i.e. a surplus in the import of goods and services over exports – this deficit must be met afterwards by raising capital, subsidies and the like. Anybody who habitually reads even serious professional papers with an eye to this mistake or merely to a treacherously obscure style can acquire a handsome collection of frightening examples. It says, for instance, that Germany never achieved a ‘normal equilibrium’ in its trade balance between the two World Wars, or that Austria had had difficulties in meeting the deficit in its trade balance by a surplus on tourism, or that Switzerland’s large adverse balance on trade account had fortunately been met ‘by surpluses on other accounts of the balance of payments’, or that the deficit of Israel’s foreign trade had in the first place been ‘financed’ by foreign credits, and the like.

What is wrong about these statements?

It is the idea that it is luck or chance if a ‘balance’ is achieved, as the deficit of the trade balance would otherwise so-to-say hang in the air ‘without anything around’ like Christian Morgenstern’s famous lattice fence. The truth is, of course, that imports are either paid for by exports or, if this is not the case, and imports are nevertheless procured, these must be paid for by some other means or else be as gift. That is to say: the adverse balance on current account must be matched by some influx of means of another kind, irrespective of the source. What must be corrected is the idea that imports are first of all made at random, and that loans are then raised abroad in wild alarm to cover the balance. This would about amount to saying that Austria’s liqueur balance was unfortunately adverse this year but that it had luckily been possible to compensate it by a favourable ‘leather shorts’ balance.

As a rule things are in reality (that is, apart from direct credits in foreign currency) the other way round; the balance on current account is adverse because the capital balance is favourable and vice-versa. Whether this is a good or bad thing depends on the way in which such capital is raised or disposed of. The obstinately adverse trade balance of Ottoman Turkey – and no less a personage than Böhm-Bawerk drew attention to this in a famous article – was merely the reflection of the extravagant financial policy of the Sultan, who obtained foreign credits year after year in order to cover the deficits of his budget. The case of Germany after the first World War was somewhat different; she received capital from abroad for productive, though not always unobjectionable purposes. It was logical in this case as well that the credit balance of net capital movements should find expression in a corresponding debit balance on trade-account, and nonsensical to imagine that Germany was borrowing abroad, in order to close the awful gap that had appeared in the trade balance. When the capital balance of Germany took a turn around 1930, and more credits had suddenly to be repaid than came in, the deficit on capital account was of necessity matched by a surplus in the trade balance – a surplus which was in no way a preliminary condition enabling Germany to undertake repayment, but represented the precise extent to which repayments were actually taking place. Lastly, Switzerland should be cited as the opposite example of a mature creditor country, whose deficit on transactions in goods and services is balanced by a surplus in capital movements which is due to income or investments from abroad. The deficit in this case means that the country is able to import goods to with the extent of income from capital without having to pay for this with exports, and any lamenting or surprise about such a deficit is therefore quite foolish.

Upon thorough deliberation it will be found that a country’s balance of payments in the sense so far considered must of necessity always be in equilibrium, just like a commercial balance-sheet, whatever the nature of the balance-items may be. This leaves no room, therefore, for a ‘dollar gap’ or for any item which has no foundation in fact. So long as Tito received no dollars there was no room in the Yugoslav balance of payments for an item called ‘dollar gap’ for which the contra-item was missing. Tito simply had to cut his coat according to the cloth and manage without dollars, a fact which the pitiable inhabitants of this granary ruined by socialism came to experience in the form of undernourishment. The Yugoslav balance of payments was in equilibrium. It is only since Tito has been receiving subsidies from America that the Yugoslav balance of payments contains a ‘dollar gap’ on the liability side which is balanced on the assets side by the corresponding dollar amount. The balance sheet shows an additional item both among the assets and the liabilities. To put it challengingly: A ‘dollar gap’ has only existed in Yugoslavia since it was filled. Prior to this it existed merely as a wish and a programme2).

So everything is fine? Certainly not. For so far we have only spoken of the balance of payments in the sense that it must always and of necessity be in equilibrium, that is to say, in a bookkeeping-statistical, i.e. an actual balance-sheet sense. So if some sort of calamity is meant by the term ‘adverse balance of payments’ this cannot occur here. But we have already indicated that this may very well occur in another sense, namely in the sense of a wish or a programme.

Let us take another example, that of West Berlin. The balance of payments of this unfortunate city will, admittedly, always be in equilibrium in the sense so far considered, even if no support is extended by the West. But we need hardly say that this would be a tragedy with unimaginable consequences, against which Berlin, together with the West, successfully defended itself at the time of the unforgotten air-lift. We could at most speak of a structural deficit in the balance of payments, if the problem were not au fond a totally different one. For it is not a case of whether Berlin’s balance of payments will be in equilibrium or not – we know it always will be – but on what level this balancing will take place. In referring to the ‘structural’ deficit in the balance of payments a confusion occurs – as is so often the case – between a problem of equilibrium and a problem of the level. The problem is not that of the balance of payments, but the poverty of such a region.

We can certainly talk of ‘dollar shortage’ in the sense that a politico-social catastrophe might occur if no help is given in a certain case. This was undoubtedly the case in many European countries after 1945. But the more remote this dramatic situation becomes, the more subjective and ultimately the more beggarly does this need for help become, with the exception of such special areas as Berlin. After all, nobody forced the European countries to live beyond their means under the slogan of thoroughly untimely ‘full employment’, of nationalization, of ‘cheap money’, of an unlimited welfare state, to set up programmes of investment and consumption which could be implemented only by American help – and then to insert this aid as a ‘dollar deficit’ in their estimated balance of payments and ‘national budgets’. Why did France have to put into practice the Monnet Plan just at a time when capital had become exceedingly tight, well knowing that it could be put into effect only by inflation and American subsidies, in view of the lack of sufficient savings? What is the sense of talking of a ‘structural’ deficit in the balance of payments here? This attempt to impart to the conception of an ‘adverse balance of payments’ the meaning of a real concern cannot – despite the best of intentions – lead very far. Programmes and wishes are unable to impart a sound meaning to the conception, and even should it involve the very existence of the nation in question, it will be found that the object of this worry fundamentally concerns not the deficit in the balance of payments but the poverty of the country. An ‘adverse balance of payments’ can present a serious problem in a truly objective, logical and legitimate sense only when we consider a third conception of the balance of payments. We previously discussed first of all the balance of payments in the sense of a ‘balance sheet’, and found that it must of necessity be in equilibrium. After that we came to balance of payments programme, in which a deficit together with the expected cover by subsidies is budgetted for, and we will now discuss the so-called balance of payments in the sense of the market which means the relation of supply and demand on the foreign currency market, where all the items of the balance of payments are reflected. Here at last we find the sought-after meaning of the term ‘deficit’ in the balance of payments, which will occur when demand exceeds supply (and of a ‘surplus’, which will result when supply exceeds demand).

But if we call to mind the elementary tenets of the general theory of prices, it will immediately become clear that it is only when the price is prevented from exercising its function of constantly balancing supply and demand that there is any sense in talking of such an excess in demand. Such a deficit in the balance of payments in the sense of the market thus presupposes that the price on this particular market, namely, the rate of exchange, is kept – in contrast to the prices of the usual free market – below the equilibrium price to which it would have to rise to in order to balance supply and demand. The term ‘deficit’ makes sense only in respect of a given rate of exchange, which the foreign exchange authorities wish to keep unchanged.

This comparison of the exchange market with any other market – say, the butter market – at the same time permits of eliminating the difficulty of reconciling two apparently contradictory statements, one being that the balance of payments must in the one sense logically always be in equilibrium, and the other that it can show a deficit in a sense differing therefrom. If the price of butter is kept low by the authorities, it is prevented from balancing supply and demand, so that there is an excess in demand, a ‘shortage of butter’, a ‘butter gap’, and ‘adverse butter balance’, and it shows a common, but very obvious and regrettable lack of logic and insight to use this as a justification for continued ‘control of butter’. It is this kind of disturbance in equilibrium which we mean when we refer to an ‘adverse’ balance of payments, and only when invested with this meaning is there any sense in using this term. But this disrespectful comparison with the butter market immediately demonstrates that the balance of payments in the sense of the ‘balance sheet’ must of necessity be in equilibrium, just as the excess demand on the butter market cannot change the fact that after the market is closed the amount of butter bought tallies to a hair with the amount of butter available and sold.

An excess of demand over supply on the exchange market – that is the problem. Nobody can deny that it must be taken seriously, but now we do at the same time understand its real nature. It is nothing absolute, but something quite relative which depends on another variable. It exists only in respect of a given rate of exchange, which means that there could be another rate of exchange which would make it disappear3). What is to prevent us from chosing another rate of exchange? Or have we overlooked some point?

In fact, what we have so far discovered is by no means the whole truth. The method we have just used of regarding an ‘adverse balance of payments’ as a market disturbance like any other and to explain it by means of the general price laws may admittedly do substantial services because it clarifies essentials, and the nightmare of an ‘adverse balance of payments’ is thus deprived of its demoniac appearance. But this method can be made use of without danger only if it is not forgotten that the exchange market is a very special market, and the rate of exchange a very special price. The merchandise which is traded on this market and – the rate of exchange being the price – paid for in the country’s own currency, is the currency of another country. This means in the first place that there are very weighty reasons why this price, since it determines the external value of our currency, must not be left to supply and demand like a stock-exchange quotation, nor may it on the other hand be thrust into the strait-jacket of currency control. But it means something else as well, and that is the point in question here: Supply and demand on this very special market are decisively determined by the circumstances which we call elements in economic circulation, i.e. the amount and speed of circulation of the money, the aggregate expenditure and income, level of prices and costs, briefly, the plus or minus of the aggregate demand or aggregate supply, the regulation of which in the last analysis is in the hands of the authorities of a country – the Central Bank and the Minister of Finance – who open or close the taps releasing money and credit as the case may be.

In other words: The relationship of supply and demand on the exchange market – the balance of payments in the sense of the market – must be viewed not only as a phenomenon of the price mechanism but at the same time as a monetary phenomenon. The foreign exchange market is not merely a market like any other, where a gap between supply and demand presupposes a ‘false’ price, but it is at the same time the hinge linking the national system of prices, costs, income and expenditure with the international one. An ‘adverse balance of payments’ thus either shows – depending on the angle from which the facts are viewed – that the price, i.e. the rate of exchange in question, does not correspond to this international relationship of circulation elements and that the ‘hinge’ is therefore wrong, or else that this relationship is disturbed and therefore demands a change in that the domestic money and credits tap is turned off. Whether one should view the facts from this side or from the other is of importance for the decision on the expedience of changing the ‘hinge’ or the ‘relationship’ or perhaps both.

It is of maximum importance to understand this ‘dependence’ of the balance of payments on domestic developments and thus to supplement the method of ‘surveying the market’ by the other method of ‘surveying the relative sets of values’. It would perhaps be appropriate to employ an illustration for this purpose which I made use of at this point in the first German edition of this book, when I spoke of the relationship between Geneva and the rest of Switzerland, and the value of which was recently demonstrated by Lionel Robbins in his work ‘The Balance of Payments’ (London 1951). It consists in taking the conditions within a country as a premise, and then putting the simple question why there are no problems regarding the balance of payments between the various regions of a country, though the nature of inland trade in no way differs from international trade, and though conditions of prosperity between the individual parts of the country constantly fluctuate just as they do between nations. If a part of Switzerland experiences economic regression, its inhabitants admittedly suffer from a scarcity of money, but they have no difficulty in paying with their smaller income for the goods they can still afford to buy in other regions.

Why? The answer is a simple one: because all the regions belong to the same monetary system. But this simple answer is of a significance which most people – including the economists who consider themselves superior to such simple things – are not conscious of. For it also shows that the problem of the balance of payments is essentially of a monetary nature. It evolves from the difficulties which can only develop due to a difference in the monetary systems, and which can be eliminated if the various monetary systems are regulated in such a way that they become at least a de facto unit. This is plainly the case when the various monetary systems consist of nothing but coins of the same metal and with a fixed content of metal which is worth the full face value of the coin. The difficulty only starts when the difference in the monetary systems is intimately linked – as it is in our modern reality – with the difference in national systems of credit and finance, which can, at the direction of the central banks and ministries of finance, be put at the service of specific monetary, credit or financial policies. And now it all depends on whether this national monetary, credit and finance policy is of a kind that the national circulation factors at given parities are so co-ordinated that even the de jure difference in credit systems and public finance, does not prevent a de facto unification of the monetary systems.

In view of the difference in the monetary systems there is a possibility that the circulation elements in a country may be so inflated by a policy of sustained monetary expansion, at a given rate of exchange, that a continuous excess of demand on the exchange market, i.e. an adverse balance of payments is bound to result. If absolutely set upon it, any country can create an adverse balance of payments for itself within half an hour (D. H. Robertson)4). Such disturbances, among which is, of course, also the converse one of a deflationary policy, which produces a favourable balance of payments, can only be avoided on one condition: The national monetary and credit systems must be managed in such a way that the national circulation elements and sets of values are brought into a relationship with each other which corresponds with that which would exist under a unified monetary and credit system. The equilibrium of the balance of payments (with simultaneous stability of the rates of exchange) thus presupposes that the national monetary and credit policy be conducted in such a way as though an international unified system were in existence. To date the gold standard has been the only monetary system which fulfilled this condition, thanks to its ingenious ‘thermostatic’ mechanism (always presupposing the will of the governments to maintain the gold standard even if it caused inconvenience) which provided for the opening or closing of the taps in accordance with the fluctuations of the balance of payments. Despite the de jure difference in the national monetary systems, which cannot be overcome by political means, it did result in their de facto unification, i.e. in that ‘quasi’ international money, which we have already encountered earlier on. For this reason the gold standard was the only monetary system which was not faced with problems in respect of the balance of payments, or of ‘pound’ or ‘dollar scarcity’. By consistently and silently complying in this way with the three demands to be made on a truly international monetary system – freedom of exchange, stability of the rate of exchange and international homogeneity of money – it has merited the honorary title of a truly international monetary system and we are still waiting for a new international monetary order to contest its title. It is to be feared that we shall wait in vain. The more obvious it becomes that all efforts to replace the gold standard by another truly international monetary system have failed, the more the prestige of the gold standard triumphs over all misunderstandings and unfair accusations.

Our considerations have thus shown that the balance of payments difficulties can only occur between territories with different monetary systems and even then only if the monetary authorities pursue divergent policies. Far from being a foolish platitude, this statement is of decisive importance, because it indicates the point from which the disturbances can always be eliminated – even if they do not always emanate from it – according to the classical principle that a deficit in the balance of payment calls for a restrictive monetary and credit policy and a surplus for an expansive monetary and credit policy, unless it is preferred to alter the rate of exchange.

We found that the main error in the popular conception of the ‘adverse balance of payments’ was that of regarding it as something absolute, as a given fact and as being beyond the government’s responsibility. We saw that it is on the contrary something absolutely relative, which can be conceived of only in relation to a given rate of exchange. Alter the rate of exchange and it will vanish. But we must now add that it is at the same time relative in another sense, and, if the rate of exchange is given, it can be conceived of only in relation to a definite internal monetary and financial policy. Change the internal circulation factors and it will vanish.

In putting forward our formulations we have done our best to avoid the misunderstanding of appearing to say that the real cause of the deficit must also always be sought in these two elements – the ‘false’ rate of exchange or the ‘false’ circulation factors. Far be it from us to make such a statement, for there are as many possible causes which may produce such a deficit, as circumstances which alter supply and demand on the exchange market. It is true that if a country doubles its national income in relation to another by inflation, its balance of payments must become adverse if the rate of exchange remains unaltered, and it is obvious that in this case a purely monetary cause has become effective. But apart from such monetary causes the equilibrium of the balance of payments can also be disturbed by others which are not derived from money and which we therefore call real ones. Bad harvests, flight of capital, deterioration of the terms of trade (the average relationship of the prices of imported and exported goods), embargo measures adopted by foreign countries – these and many others can be quoted as examples.

And yet – as was done by Ricardo in his famous controversy with Malthus – it is absolutely justifiable to stress the monetary factors in the balance of payments. The above-mentioned real factors, which so easily impart to the adverse balance of payments the appearance of an affliction sent by heaven, can after all become effective only if the rate of exchange remains unaltered, or if no internal monetary counter-measures are adopted. This at the same time means that if an adverse balance of payments – whatever its cause may be – is more than merely transient, the causal share of the monetary factors becomes ever plainer and the responsibility of the authorities who control the internal monetary and credit policy becomes ever clearer. The ‘dollar shortage’ of the European countries after the war may have been influenced by real factors, but the time during which these could still serve as an excuse passed rapidly. To repeat it for the second and last time: Wherever a disturbance in the balance of payments may derive from, it only makes sense to talk of an adverse balance of payments in connection with a given rate of exchange or a given relationship of the internal aggregates, and there will always be a rate of exchange or an internal amount of purchasing power at which equilibrium of the balance of payments is achieved. So if equilibrium of the balance of payments is to be achieved at a stable rate of exchange, the only way left open is that of internal order and adaptation, the regulation of the taps controlling the monetary, credit and financial policy.

THE SOLUTION OF THE PROBLEM

Now that the true nature of the problem of an ‘adverse balance of payments’ has been recognized, a genuine possibility of a solution is also revealed. This presents itself all the more plainly if we first of all review the errors made by most countries after the war because they persistently failed to understand the true nature of the problem in their ‘fear of an adverse balance of payments’. These errors delayed the restoration of an international order by nearly a decade, and the realization that a return from the wrong road to the right road must be undertaken is only now steadily gaining ground.

What can a country do when it is faced with a deficit in the balance of payments, and a fundamental disequilibrium at that, not merely a deficit due to fluctuations5) of the market? It must be stated here that if the country avoids any inflationary policy, powerful influences will in every case be automatically at work to restore the disturbed equilibrium, and this applies even to the present times under the rule of paper currency6). If we go a step further and ask what additional possibilities are available to the government and central bank of a country, a list will first of all result in which we can put down anything by means of which the relationship of supply and demand on the foreign exchange market can be altered, whether it be by increasing the supply (for instance also by successfully combatting import restrictions on the part of other countries), or by reducing the demand. But if we go to the root of the question, we realize that the possibilities of practical importance can be divided into two contrary groups of measures. For the country either attempts to balance the deficit by a policy which forcibly restrains imports and promotes exports by all available means of the same rugged kind (to put it in the words of the country which unfortunately set a postwar example of this: ‘austerity’ and ‘export drive’), or else equilibrium is restored by eliminating the causes of disequilibrium by altering the rate of exchange and by internal monetary and financial discipline. One either contents oneself with influencing the symptoms by the stupidly mechanical means of restricting imports and pushing exports, or else the evil must be eradicated at the real source. The first is an error, the other is the true solution; the first is quackery practised on the epidermis, and the other is real treatment.

The one method is therefore that dictated by the ‘fear of an adverse balance of payments’: prior to 1931 it was that of increasing tariffs, and since the revolution in trade policy which took place at the time it operates mainly with import quotas, state monopoly of foreign trade, direction of imports and exports by a planned economy and exchange control. Why is it wrong? Because it nullifies any beginnings of a new international order and continues the work of disintegrating the world’s economic system which has been in process since 1931. Because it sacrifices the advantages of international division of labour and an economic utilization of national productive resources to the equilibrium of the balance of payments. Because it creates powerful interests which not only resist the progressive removal of this autarkic balance of payments policy tooth and nail, but are inclined to use the ‘fear of an adverse balance of payments’ as grist to their mill.

And what is the good of all this? To achieve an effect which is of doubtful short-term value, but illusory from a long-term aspect. For if the deficit in the balance of payments is due to the fact that the internal purchasing power is inflated at a given rate of exchange, the policy of a direct dosage of the quantities imported and exported cannot eliminate this constant pressure on the balance of payments. Since nothing is done to change the internal economic aggregates, and nothing to relieve foreign trade from the pressure of inflationary internal demand, which continues to make an excessive call both on foreign and domestic goods and thus expands imports while compressing exports, the cause of the external disequilibrium remains unaffected. The position is, in fact, worse, since less goods are available than previously, while purchasing power remains unchanged. The government comforts itself with the idea that something decisive has been achieved by a policy of ‘austerity’, and in all innocence continues with an internal policy of expenditures, a light hand on the reins, excessive investment, unrestricted credit, and an inflation of mass consumption, which causes the country to continue living above its means. Since the evil is not eradicated, the government can make it clear to an unsuspecting electorate that the imperilled balance of payments makes an unlimited extension of its mandate essential to the nation. The economic post-war history of a large part of the world is contained in these few words.

It is of such exceeding importance to understand the error of this autarkic method of squaring the balance of payments, of the policy of ‘austerity’, that it is worth while lingering over it a little longer in order to review somewhat more thoroughly what happens as a result of it.

We cannot repeat sufficiently often that the basic error committed by most European countries after the war was that they lived beyond their means. This mixture of collectivism and inflation, which became a characteristic feature of their economic policy after the war, produced a constant excess pressure in their economic system – in the British system as well as in the Swedish, Norwegian, Dutch, Danish and French systems. The governments and central banks constantly created income in excess of the available supply of goods. In other words: then aggregate consumption and investment was consistently pushed up by government and central bank policy by all conceivable means beyond the quantity of goods available to the economic system from its own internal sources. A persistently inflated overall volume of purchasing power was let loose uninterruptedly in the most various ways and under the most diverse economic, political and social slogans on an inadequate quantity of goods, and despite realization of the foolishness of this policy which has meantime gained ground, some countries nevertheless continue to pursue it.

These are the old facts about the inflation, which our tortured generation of Europeans has become as well acquainted with as it has with bombs, air-raid shelters and forms to be filled in. Something new has, however, been added now, namely an attempt to ‘repress’ the inflation by economic controls and to counteract the inflationary upward pressure of prices by the policed counter-pressure of maximum prices, rationing, exchange control and control of capital7). For if we had to deal with the old type of ‘open’ inflation, a rise in the prices of the goods and an upward trend in the rates of exchange would have to set in, by means of which the equilibrium disturbed by the expansion of purchasing power would be restored, provided that further inflation were now stopped (as was the case in Italy, due to Einaudi’s reform in 1947–1948). Nowadays this is prevented by controls, and the result is that the excess of purchasing power is not absorbed but constantly exerts pressure on the economic system not only at home, but also abroad. This constant inflationary pressure, which we owe the collectivist and inflationary policy of so many European countries to, thus leads to disequilibrium of the economic system not only internally but also externally. The unavoidable result – which is not even yet generally understood – is the dreaded ‘adverse balance of payments’, the ‘dollar shortage’. In the same way that current production does not suffice to satisfy demand in view of the expanded internal purchasing power, the available amount of foreign exchange cannot do so either.

We must constantly bear in mind the nature of the basic evil, if we wish to understand post-war developments in Europe. It is the evil of a creeping inflation in the sense of a persistent overstrain imposed on the resources, of continued inability and unwillingness on the part of the governments and the central banks, which are largely subservient to the former, to limit the demands made on the national flow of goods to that which is available, an inflation in the sense of an incessant attempt to spend more than the economic reserves of the nation permit, of an obstinate tendency to draw more bills on the economic system than it can meet, of an incurable urge of wanting too much at a time – in the sense of the apparantly ineradicable vice of nations of simply living beyond their means.

How can this disturbance in the debit and credit of the economic system be put in order again? There is obviously only one answer: the nation must retrench, cut its coat according to its cloth, and put a brake on all extravagances. But this reply is most ambiguous. It can mean two very different things, which are unfortunately consistently confused.

One of these possibilities is offered by that very policy which has been called ‘austerity’ after the British model. The state assumes the part of a despotic pater familias, who prescribes restriction of consumption with warningly uplifted finger and open threats, and is guided by his own conceptions as to what are necessities and what are luxuries, which – as we thoughtlessly call it – ‘the country cannot afford’.

By compulsory restriction of imports to essentials and by control of domestic consumption the state attempts to compensate for the effects of the excess of self-created purchasing power on the debit and credit of the economic system. With the same aim in view it simultaneously tries to pass on to other countries the high-grade products and non-essentials of its own economy, which are as far as possible withheld from its own subjects, which resulted temporarily in the grotesque state of affairs that the European governments attempted to thrust the pick of their production upon each other, and people had to travel abroad in order to obtain the best goods from their own countries.

Yet this state is a slightly peculiar, not to say highly unpleasant pater familias, who exempts himself from the austerity he preaches to others. After all, it is he himself who is the cause of the extravagance, for it is the state and the central bank ruled by it, whose collectivist and inflationary policy are the causes of the excess purchasing power in the economic system. He himself turned on the tap and thus produced an inundation. He himself created the excess in income which constantly disturbs the equilibrium of the economic system and of the balance of payments, and having done so, he assumes the mien of a puritanic teacher and prescribes how many oranges and cars his subjects may buy, and how much they may spend on trips abroad. Sir Stafford Cripps, the deceased head of this economic vice-squad, once caused amusement in the House of Commons while still Chancellor of the Exchequer, by a classical formulation of this policy of regimentation, for when a question was put about the import of French cheese, he said that he could only admit ‘serious cheese’. While the Socialist Government of Norway makes the luxury of bath-tubs dependent on a medical certificate, and practises the worst of chicanery on the consumers of domestic and foreign goods, it obstinately maintains the fiction by its interest and investment policy that the country is as rich in capital as Switzerland. While the Norwegian Government grudges its subjects the good things of this world, it wastes vast sums on an obviously unprofitable steel works in the Arctic Circle.

This characteristic of the policy of austerity makes all its disadvantages even plainer than in our first summary enumeration. Austerity is quite obviously tantamount to first of all providing the economic system with too much purchasing power, and then to prescribing to the individual in what way and to what extent he may make use of this income.

In the first place this is an astonishing presumption on the part of state bureaucracy, which will be rejected by anyone who has preserved a halfway normal idea of human freedom in our times. In the second place, however, it is a method of economic discipline which is not only unpleasant, but, as we have seen, in addition very ineffective, since it does not eliminate the real cause of the economic disequilibrium, namely, the persistent inflation of purchasing power. If the import of goods considered unnecessary by bureaucracy is forbidden, the economic system is left with a surplus of income which was intended for the purchase of oranges or for a trip abroad. This will be used for other goods, whether it be imported wares, or goods which absorb domestic resources, and the result is either an increase of imports on a reduction of exports. So the austerity calculation cannot work out, unless simply every expenditure were subjected to police control by the Government, or savings were increased by this policy. The former would presuppose a tyranny accompanied by unimaginable terrorism, while an increase in savings as a result of the prescribed limitation of consumption would be thoroughly unlikely. If an Englishman wants to give his wife a Swiss watch as a Christmas present but is prevented from doing so by import restrictions, he is hardly likely to offer her a savingsbook instead – on the contrary, he will probably try to find some other kind of fancy goods.

But another, and far more significant kind of harm is done in addition to that already known to us. If it is a case of balancing the aggregate expenditure within the economic system with the available resources, thus restoring the internal and external equilibrium, restriction of consumption is naturally the more tolerable and the more short-lived, the more it stimulates production. But the policy of austerity does exactly the reverse. By permitting the people to earn their income easily, but then preventing them from utilizing it freely, it deprives them of an important incentive to increase their performance. Anyone desiring the people to do their best, will consider it wise to do the opposite: make it harder for them to gain an income, but in exchange not to deprive them of the good things of life by which people feel rewarded for their efforts. But if – in accordance with this policy, which supposedly favours the masses – this deformation of luxury and semi-luxury goods is coupled with a cheapening of mass-consumer goods due to State price subsidies the incentive to do better is quite simply throttled. For while on the one hand the policy of austerity makes it extremely difficult for people to satisfy luxury wishes, price control campaigns have on the other hand the peculiarity of making it all too easy for them to obtain vital necessities. Why exert oneself when food, controlled housing, and other essential things are artificially reduced so that – particularly when wages are at the same time disproportionately high – the income necessary for a bare existence has soon been earned? And why make great efforts if we have no prospects in any case even with a higher income of owning our own home, a motor-car, and other tempting things? Both these forms of a fictitious ‘social’ policy are in themselves pernicious enough; but a combination of the two together is downright ruinous. It ultimately tempts people to prefer that one luxury which is still left to them, but which is precisely the very thing that such a country really cannot afford, viz., the luxury of leisure and a moderate working tempo. There is no doubt that herein lies the root cause of the low rate of productivity which some countries are still suffering from.

All this should be plain enough. But if we were to seek a reply to the question of what other solution would have been possible for the countries of Europe after the devastations of the war than that collectivist-autarchic method of austerity which, we repeat, corresponds with that of the export drive, we know the answer. It is the liberal ‘policy of the opposite’: the restoration of the general economic equilibrium by eliminating the ‘false’ rate of exchange and the return to the monetary and fiscal discipline at home which removes the pressure of inflation caused by expansive credit and budget policies. It is the way of liberal discipline instead of collectivist austerity. But these are not two mere alternative possibilities side by side; the one is the only solution to avoid a fatal mistake, and the other is a wrong road by which only one thing can be reached with certainty viz., the paralyzation and confusion of domestic economy and the lasting disintegration of international economy. The way of liberal discipline is the only one worthy of freedom-loving people and those who prefer truth to the fictions of a would-be social policy. It is the way successfully followed by Belgium, Italy, and Germany and later, Denmark and the Netherlands8). As regards the adjustment of the balance of payments by changing the rates of exchange, a few explanatory words would seem indicated at this juncture. This method is in no way on the same level as the domestic method of monetary and fiscal discipline. Nor can it replace it in any way. The continued adjustment of the balance of payments cannot possibly be left to freely fluctuating rates of exchange as instability of the exchange rates if it is made the rule would result in uncertainty in all international payments and credits relations and a continued dislocation in price and cost relations which are incompatible with an international order worthy of the name. It would also be a mistake to assume like many protagonists of this method that in following it one could dispense with the inconveniences of adaptation and cutting one’s coat according to the cloth. A reduction of the value of a currency abroad, unless nullified by a new burst of inflation at home, brings in its train that tightening up of internal economic conditions which in turn is, after all, indispensable for the restoration of the equilibrium. Adjustment is not avoided but only pushed in another direction, and precisely owing to the fact that the devaluation of a currency has the effect, often mistakenly deplored, of increasing the prices of import goods, it contributes decisively to adjusting the balance of payments – provided the restricted consumption thus achieved is not cancelled out again by internal rises in income, and thus deprived of any effect. Even more serious is the further objection that the surrender of the stability of exchange rates can upset one of the most important prerequisites of a stable balance of payments, namely confidence in the currency, and give the hyper-nervous foreign exchange market psychological shocks which hamper the adjustment in the balance of payments.

These are all very grave reasons for upholding the ideal of the stability of exchange rates – an ideal which can only be outranked by that of the freedom of the foreign exchange market. But, although direct adjustment (by restrictive monetary and credit policies at home) generally deserves preference to indirect adjustment (by changing the rate of exchange), and although the latter cannot be allowed to develop into the permanent practice of the nations, it must be conceded nevertheless that there are situations in which indirect adjustment is the more expedient and milder form, or even the only feasible one, particularly if adjustment is necessary to a degree in excess of a certain maximum. For there are cases in which the exchange rates of a country are so clearly ‘false’ that their correction is unavoidable. However, there are two things which we must hasten to add. Firstly, such cases must only be regarded as exceptions, as a violation of an ideal that should be double emphasized when it is no longer possible to avoid the lesser evil and ultima ratio of violating it. Secondly, it must be pointed out that even such sacrifice of an ideal is pointless if it is not accompanied by the restoration of the monetary and fiscal discipline at home.

WILL-O’-THE-WISP OF ‘FULL EMPLOYMENT’

The first German edition of this book was compiled at a time (1944–1945) when the points made above were a scandal and a folly in the eyes of the world. With the exception of a few countries, Switzerland where this book was written and published occupying the place of honour at the top, everyone was absolutely against adjustment, monetary discipline, freely working forces and loyalty to the old and tried principles of a good pater familias. People were paralyzed with the fear of large-scale deflation which might overtake the nations again after the war, and thus believed that they could not achieve the goal of full employment excepting by pursuing an audacious policy of expansion. It was thus that the post-war policy of collectivist and inflationary ‘full employment’ came about, which is only now gradually being recognized in all its noxiousness – it and the fatal false predictions on which it was based. I had to expect at that time that what I wrote would be dismissed with the terrifying mention of ‘deflation’.

In the meantime things today are such that, I am happy to say, it would be like bringing coals to Newcastle if I were now to repeat my warnings of the ‘deflation psychosis’, although many of my remarks at that time would probably still be of some interest at present.

In referring those who are still interested in what I said from the 1945 perspective, to the first German edition of this book, I feel that a few explanatory remarks are called for by the world situation in 1953.

I have no hesitation in leaving it to the informed reader to answer the question of who was right and who was wrong then, but I nevertheless feel compelled to emphasize how carefully I at that time tried to repudiate the doctrine of a possible antinomy between a policy based on stability of production and employment and the postulates of a free international order9). The example I quoted then of the United States has in the interval only increased in importance in proportion to the way in which that country has become the undisputed leading power in the international economy of the West. The importance of the American economic situation for the entire world makes it impossible to evade the question of how the other countries should behave in the event of a serious depression in the United States.

But – and here I come to another observation which is important today – this question has never been asked since 1945. A continued period of prosperity has prevailed in the United States during the past eight years – with a few interruptions – and its basis is an inflationary credit and budget policy. In other words, it has always been a capital error to think that if the European countries had wanted to balance their external payments after the war they would have had to put up with a policy of deflation. As the United States had, so to speak, done them the favour of carrying through an inflation it would have been enough if they, on their part, had refrained from taking such a liberty. However, not only did they not do so, but they even outdid the American inflation in spite of the arrears in their own production potential10).

Finally, it should be emphasized very strongly that the idea that economic stability in a country necessitates a rigid and comprehensive control of foreign trade, is a fundamental and dangerous fallacy. True world economy is not, for instance, an element of instability, but an element of stability. It was no coincidence that until 1914 economic fluctuations remained within reasonable limits at the very time when world economic integration had reached its highest level. It should be plain that the extent of the world markets comprising as they do, countries in varying phases of the business cycle has always offered possibilities of adjustment by which the fluctuations of production and employment in the individual countries could be moderated. Conversely, it is very likely that the combination of the great depression after 1929 and a disastrous collapse in world economy was mainly responsible for aggravating and prolonging that depression, and for its fatal degeneration into a ‘secondary depression’. As this aggravation of the depression now drove certain countries further and further along the road to economic nationalism, a vicious circle developed of economic nationalism, intensification of the depression, desperate acts of national policy to raise production and employment, an intensification of economic nationalism, and so on. As regards the situation at present, the conclusion to be drawn from this is that scarcely anything is so likely to promote the economic expansion of all countries as the final liberation of world economy from those hindrances the worst of which is exchange control.

EXCHANGE CONTROL

We have emphasized exchange control in the course of these remarks because it constitutes the actual spanner in the works of international order, and because we can only expect to restore that order and achieve genuine international economic integration by removing that obstruction, i.e., by restoring the free convertibility of currencies11).

As regards the essence of exchange control not much more need be said. It is the classical instrument of that trade policy formerly described as ‘new’, i.e., collectivist and not in accordance with market economy. At the same time it has become the necessary corner-stone of the collectivist and inflationary overall system of the European countries since the war, the chief means of damming a ‘repressed inflation’. It is a form of control where maximum prices are fixed and there is rationing on the exchange market, a particularly serious case of the familiar policy which destroys the adjustment mechanism of the market by forbidding the free formation of prices and fixing a price below the point of equilibrium, and then replaces the lost self-regulating device with the artificial adjustment of supply and demand by forcing reluctant suppliers on to the market and by rationing. Exchange control is an essential part of the system of fictitious and enforced values which is characteristic of ‘repressed inflation’; they are fictitious in the double sense that the official value, in this case the rate of exchange, does not correspond with the real value – which is quoted on the ‘black’ exchange markets –, and that only one – as a rule the smaller – part of the turnovers are cleared at the official rate, whereas the other takes refuge in illegality which the State prosecutes under penal law, with its informers, policemen, prisons, and, finally its executioners, as a ‘crime’ so defined not by the moral code but solely through the arbitrariness of a misguided government.

Exchange control means fighting an adverse balance of payments caused by a false rate of exchange or a false monetary and credit policy, in the spirit and with the means of a commando economy, which merely tackle the symptoms and thus conserve the deficit. It is nothing but the police protection of a false rate of exchange or of an excessive price, income, and expenditure level, a police campaign applied to an exchange rate or a domestic expenditure level which, if they were right, would not require such protection. While this campaign is excused by invoking the ‘shortage of foreign exchange’, it is bound to perpetuate that shortage like any other economic control which causes the demand to exceed the supply by fixing the price below the point of equilibrium. It means the brutal attempt to oppose the adjustment of the balance of payments both via the exchange rate and via the internal system of values, with the executioner.

This ‘monetary iron curtain’ as a wide-spread and effective system is not older than twenty years just as old as the brutal police-State which was necessary to produce it. Classical economists, such as Ricardo and J.-B. Say, had taken for granted that exchange control, gold export embargos and similar interference with foreign payments were simply impossible, but then, these economists were incapable – a fact which speaks highly for them – of imagining the degree of State power and of obedience on the part of the population, the mental servility on the part of the subjects and the brutality on the part of the government without which the very idea of such a fundamental deprivation of freedom seems incomprehensible12). The older generation of economists to which I myself belong, still grew up in this conviction of the classical economists, and the circumstance that it was socialist Russia that after the 1917 Revolution was the first and only country to make exchange control a lasting and effective part of the totalitarian system, only served to confirm us in our opinion. To make use of this solution in critical situations during times of peace seemed to us unworthy of a civilized State. I am sure that I am not alone in still upholding this opinion today.

There is no gainsaying the fact that exchange control which the youngest generation of most nations seems to think is a normal element in nature, constitutes a staggering innovation. As such an innovation it is part of an economic system which must be described as collectivist and of a State system which must be described as despotic. It first became possible as an effective system in peace-time in conjunction with a State whose unrestricted power, whose all-embracing bureaucracy, and whose contempt of the elementary rights of freedom anywhere outside Russia, would have been inconceivable only a few decades ago; they are, moreover, in the long run incompatible with the standards of western political tradition. Exchange control, no matter how relatively innocent the immediate cause of it, has become the corner-stone of the modern collectivist State which only exist in extreme national isolation.

This corner-stone cannot be dislodged without causing the whole building to collapse. Exchange control and a planned domestic economy are as a rule interdependent today. Whoever desires the first-mentioned is bound to have to resign himself in the long run to the latter; whoever does not wish the latter will have to think of abolishing the first. And if you wish the last-mentioned you cannot dispense with the first. Those who wish to ‘control’ the national economy cannot leave foreign trade and its equilibrium to the free market. They must fight to the bitter end in order to continue exchange control, and Neptune would rather surrender his trident than a socialist politician his foreign exchange bureaucracy. The mere thought of abolishing these functions is bound to be considered ‘criminal’, just as the unheard-of action of ‘imagining the King’s death’ was a crime under Old English law.

Collectivism, as we saw earlier, is identical with an extreme form of economic nationalism because it is forced to make of the State frontier by exchange control an impassible rampart with few draw-bridges. It must be a bitter irony for an honest socialist to have to defend exchange control – of which no mention is made in Marx – as the actual key-position in the collectivist system. For it means defending an institution which carries national isolation to an extreme and excludes the possibility of international cooperation. Apart from the absolute State monopoly of foreign trade – there are no measures of economic policy which so radically separate countries from each other as exchange control, none which sub-ordinates foreign trade so unresistingly to State bureaucracy, none which realizes to such a degree the aim of national autarchy, none which would so drastically dissolve the community of nations, political, intellectual, and economic. It is Pandora’s box from which necessarily escape bilateralism, balance of payments crises, obstruction of international trade channels, paralysis of international capital transactions and ‘dollar shortage’. It is the means with which the collective State justifies to the world its monopolist control of economic life. When not even money – minted ‘freedom’, as Dostoyevski calls it – can freely cross the State frontiers, the highest degree of international disintegration has been reached. Nowhere is that more tragic and less tolerable than in Europe. For this reason the final abolition of exchange control must be the ceterum censeo of any truly European policy.

 

NOTES

13. (p. 194) The ‘adverse balance of payments’ as a subject of dispute:

The ‘adverse balance of payments’ (or ‘dollar shortage’) has today become an extremely sensitive spot in the collision of trends in economic policy. Any objective explanation of the logic of this term as undertaken, for instance, by F. MACHLUP in his essay, ‘Three Concepts of the Balance of Payments and the so-called Dollar Shortage’ (Economic Journal, March 1950), is usually received very testily by the exponents of a collectivist and inflationary avant-gardism, firstly, because they object to the proof that the balance of payments rights itself without the polypragmatism of economic planning if only the opposite of their beloved policy is pursued, and secondly because they are bitterly opposed to the proof that their own policy is responsible for the ‘adverse balance of payments’. Cf. in this connection my essay entitled ‘Zentralisierung und Dezentralisierung als Leitlinien der Wirtschaftspolitik’ (Wirtschaftliche Entwicklung und soziale Ordnung (Festschrift Degenfeld) edited by Lagler-Messner, Vienna 1952, pp. 11-26). On the theory of the balance of payments: G. HABERLER, Der internationale Handel, Berlin 1933, pp. 8-93; FRITZ W. MEYER, Der Ausgleich der Zahlungsbilanz, Jena 1938; F. MACHLUP, as above; L. ROBBINS, The Balance of Payments, London 1951; E. KÜNG, Die Selbstregulierung der Zahlungsbilanz, eine Untersuchung über die automatischen Methoden des Zahlungsbilanzausgleichs, St. Gallen 1948; J. E. MEADE, The Balance of Payments, London 1952; ALFRED KRUSE, Die Mechanismen des Zahlungsbilanzausgleichs, Wirtschaftstheorie und Wirtschaftspolitik (Festgabe für Adolf Weber), Berlin 1951, pp. 83-98.

14. (p. 197) Tito and the ‘dollar gap’:

In a publication by the International Monetary Fund the assumption ‘that in some way a deficit develops and financing must then be found for it’ is rightly described as mistaken. ‘Unless it is financed, the deficit cannot come into being’ (Balance of Payments Year Book, 1938, 1946, 1947, International Monetary Fund, Washington D.C., 1949, p. 23.)

15. (p. 200) Balance of payments and exchange rate:

The exponents of an economic policy which, because it is collectivist, cannot admit the possibility of a free adjustment of the balance of payments, have gone to great trouble to dispute the logic outlined in the text, by trying to prove the impossibility of a free equilibrium by means of hypotheses concerning abnormal elasticities of demand in foreign trade. This leads to the assumption however that the foreign exchange market behaves in exactly the opposite way to any other individual market which no one disputes having an equilibrium price where supply equals demand. On the contrary, it should be emphasized that the foreign exchange market is the very one which, composed as it is of numerous individual markets, offers a unique chance for the compensation of any inverse elasticity of demand, and most particularly in the western industrial States with their enormously varied production and requirements programmes. Cf. G. HABERLER, The Market for Foreign Exchange and the Stability of the Balance of Payments, Kyklos, Vol. III., No. 3; F. A. LUTZ, Euopäische Währungsprobleme, Ordo, Vol. IV, 1951, p. 312 etc. Incidentally, we encounter here an important example of the fact that in this field of theory sharp perspicacity very often not only does not prevent a complete misjudgment of the overall situation but is actually the cause of such misjudgment. What a catastrophe can result from this, in putting monetary policies into practice was demonstrated drastically by the Swedish monetary policy after the war, in particular the unfortunate revaluation of the Swedish Krone in 1946 which can be described as a characteristic combination of shrewdness as regards detail coupled with a minimum of common sense.

16. (p. 202) Purely monetary cause of the adverse balance of payments:

The above-mentioned Swedish economic policy after the war is such a striking example of this, for the reason that in this case of an economically exceptionally strong country spared from the war, even the most obstinate person must admit that apart from the monetary and credit policy practically all other real causes are out of the question. This economic policy might even have been deliberately chosen so as to lend conviction with the forcefulness of a laboratory experiment, to the sentence by D. H. ROBERTSON quoted in the text (taken from his essay, ‘The Economic Outlook’, Economic Journal, December 1947). This power of conviction is increased still further by the fact that Switzerland, a country with otherwise comparable economic conditions, at the same time demonstrated the opposite, viz., that monetary discipline can make a currency the hardest in the world. It was extremely difficult to ‘soften’ the Swedish krone, and that task could only be managed by a policy which did its utmost to make sure that there was an inflationary excess of demand to avoid pressing on the resources of that country.

17. (p. 205) Fluctuation and fundamental deficit:

In contrast to the fluctuating deficit which arises owing to chance shifting in supply and demand on the foreign exchange market, the fundamental deficit (‘fundamental disequilibrium’, as it is called in an important provision of the statutes of the International Monetary Fund) reflects an alteration in the causes governing the ‘natural parity’ of a currency. It is the expression of a genuine, serious, and more than temporary disturbance in the external equilibrium of a national economy. This distinction presents great difficulties in theory, but is of extreme importance in practice for the central banks which could safely utilize their reserves to compensate a mere fluctuating deficit, but in the event of a fundamental disequilibrium would be throwing them into a bottomless pit like the German Reichsbank in spring 1923 and the Bank of England during the few weeks of the restored convertibility of the pound in summer 1947. A fluctuating deficit, in as far as it is not met by the self-equilibrating forces of the foreign exchange market or by international interim finance, demands the use of monetary reserves to protect exchange rates stability, whereas in the case of a fundamental disequilibrium such use of reserves would be an irresponsibly applied palliative.

18. (p. 205) Self-adjustment mechanisms:

The most direct of such mechanisms, effective also with a paper currency (if it is not abolished through inflation) functions to the extent that the central bank, in the event of an import surplus, sells foreign exchange from its reserves, withdraws money from circulation to that extent, and thus exercises a restraining effect which liberates more goods for export and curtails the demand for further imports. The opposite – expansive – effect takes place in the case of an export surplus. Thus, the currency reserves of the central bank are seen to have a double function. They not only serve, as shown in the foregoing note, as a direct compensation for a fluctuating deficit, but also indirectly as a means of guiding the monetary conditions of the balance of payments. The use of the currency reserves by the central bank thus becomes a special case of ‘open-market operations’.

19. (p.207) Open and repressed inflation:

Cf.: G. RUEFF, Die soziale Ordnung, Bremen, 1952, in particular pp. 537-706; W. RÖPKE, Offene und zurückgestaute Inflation, Kyklos, I, 1947, No. 1; W. RÖPKE, Repressed Inflation, Kyklos, I, 1947, No. 3.

20. (p. 211) The ‘policy of the opposite’:

Cf. for further details my contribution, ‘Alte und neue Ökonomie’, in the collection ‘Wirtschaft ohne Wunder’, edited by E. A. Hunold, Erlenbach-Zürich 1953. The reader is also referred to my essay, ‘Germany – Rock of Wrong Prophecies’, The Freeman (New York) of 24 August 1953.

21. (p. 213) Balance of payments and market policy:

Reference is had to the following examples from the abundance of literature on this subject: G. HABERLER, Prosperität und Depression, Bern 1948, pp. 388 et seq.; HANS GESTRICH, Geldpolitik und Weltwirtschaft, Berlin 1934;H. RITTERSHAUSEN, Vollbeschäftigung und Außenhandelspolitik, Publications of the Association for Social Policy, new series, Vol. 3, Berlin 1951; FRITZ W. MEYER, Stabile oder bewegliche Wechselkurse? Ordo, Vol. IV, 1951; H. BELSHAW, Stabilization in a Dependent Economy, The Economic Record (Melbourne), April 1939, Supplement; W. RÖPKE, Crises and Cycles, London 1936, § 22; W. RÖPKE, International Economic Disintegration, London 1942, pp. 203 et seq.; W. RÖPKE, Tipo aureo e politica della congiuntura, Rivista Internazionale di Science Sociali, November 1935.

In December 1949, the Secretariat-General of the United Nations published an experts’ report entitled ‘National and International Measures for Full Employment’ which I criticized in my article, ‘The Economics of Full Employment’ (New York 1952). The said report was subsequently withdrawn and replaced by a somewhat more reasonable one (‘Measures for International Economic Stability’, 1951).

22. (p. 213) Europe surpassing American post-war inflation:

No less a person than KEYNES in the last publication of his life (The Balance of Payments of the United States, Economic Journal, June 1946) had described a serious ‘dollar shortage’ after the war as unlikely, particularly because he took for granted that the United States would become ‘a high-living, high-cost country beyond any previous experience’. In other words, he was expecting the pressure of inflation to continue in that country. And his prediction was right. But the mistake he made was that he, strange to say, did not foresee the simultaneous inflation in the countries of Europe, that is, he had not expected them to take his untimely doctrines so seriously.

23. (p. 214) Foreign exchange controls:

For further details see W. RÖPKE, Devisenzwangwirtschaft: das Kardinalproblem der internationalen Wirtschaft, Außenwirtschaft, March 1950.

24. (p. 215) Views of the classical economists:

In his book entitled ‘The High Price of Bullion’ (4th ed. 1811) RICARDO asserts plainly that if it is advantageous to export gold, no law can effectively prevent its exportation. Around the same time J.-B. SAY wrote, ‘Il est impossible, même lorsqu’un citoyen n’émigre pas, d’empêcher l’extraction de sa fortune, s’il est bien décidé à la faire passer dans l’étranger’. (Traité d’Economie Politique, 2nd ed. 1814, Vol. I, Bk. I, Chap. 20).

• 1. (p. 25) The Sociology of War:
• 2. (p. 27) War of Conflict and War of Aggression:
• 3. (p. 31) The inadmissable over-simplification of the peace problem:
• 4. (p. 57) Communist Imperialism:
• 5. (p. 74)
• 6. (p. 75)
• 7. (p. 76)
• 8. (p. 76)
• 9. (P. 77)
• 10. (p. 78)
• 11. (p. 78)
• 12. (p. 79)
• 13That the various factors are interwoven with extraordinary intricacy becomes particularly evident in the dramatic catastrophe of international interrelations which we call war). One of the moral perversities with which our age is afflicted was to deny at times the supremely catastrophic character of war, until two world wars brought disillusionment – let us hope for ever. For centuries the time-honoured belief existed that war was, as a rule, one of the incomprehensible evils of the world system, which – like the other Horsemen of the Apocalypse – Pestilence, Hunger and Death – had to be borne with resignation. Pacifism, in the sense of a mass movement directed towards the abolition of war, only became possible after the beginning of the modern age, when war, like all other things alleged to be the Will of God, came to be regarded in the light of critical and ameliorative reason, and, together with other social institutions, as a work of man which it would be quite possible to alter. Thus instead of being a subject of theology, war became a subject of sociology. Has it in this way become entirely comprehensible? To be honest we must admit that we are still very far from understanding it. Although men have at all times pondered over the phenomenon of war, and although recent generations especially have amassed a gigantic literature on the sociology of war, all that progress adds up to is that we possess a fairly complete list of the possible causes of war and that we realize the extraordinary intricacy which links these causes and which excludes any monistic theory of war sociology. Only a separate and comprehensive volume could do justice to the epistemology which results.
• 14In order to understand in detail what an international peace based on justice must accomplish, the various categories of war must be distinguished. Above all a difference must be made between two types of war, the importance of which is not lessened by the fact that they have often been combined with each other in the course of history and that there are borderline cases in which it is not easy to say whether the one or the other type predominates. A war may arise either through a conflict over concrete claims, which may be compared with a case under civil law (war of conflict), or through an act of violence which corresponds to a breach of the peace under criminal law (war of aggression) ). Whereas individual legal disputes arising from contentions of personal honour or material claims are finally settled by judicial decision, international conflicts of this kind may easily lead to war, as long as a decision by force of arms, which corresponds to the ordeal of the Middle Ages, is not abolished through obligatory international legal procedure, and before this is the case we shall continue to regard war rather as a tragic chain of events than as a vicious action. From their very nature such wars of conflict make it difficult to clarify the question of guilt, provided one of the warring parties – as is however often enough the case – does not misuse the conflict as an excuse for a war of aggression, or does not oppose the readiness of the antagonist to come to an understanding with inexcusable intransigence. This last applies on the whole to the case of the first world war, whereas we should not hesitate to characterize the second in its origin and in all its phases purely as a war of aggression, after it had already been preceded by the wars of aggression in China and Abyssinia.
• 15Is not then the solution of the war problem in reality very simple and only dependent upon the firm determination of the governments and the peoples? If this were our opinion we should be contradicting ourselves, since earlier on we termed just such thinking ‘internationalism’ and warned our readers against it. In actual fact this contradiction is only an apparent one. To explain it we should consider that the problem can be regarded from various angles. In formulating the solution of the war problem so sharply and smoothly above, we were regarding it from the juridical angle. Here in fact everything appears much simpler than it actually is. To be content with such considerations is to lapse into that monistic way of thinking which may be termed legalism and which is no better than economism or any other one-sided outlook. In indicating the legal solution the question has still not been answered as to the conditions under which the peoples and governments would be prepared to accept it firmly and undeviatingly. This question however brings us back to the higher level of the sociological, ethical and political considerations with which we started).
• 16Already in the first German edition of this book, which appeared at the end of the war, attention was diverted, with an outspokenness which at that time was understood by only a few, from the recently overthrown totalitarianism of the Axis powers to the new threat to peace and international order presented by the last remaining totalitarianism of Russian Communism). This danger has meanwhile grown so enormous that all questions of international order today must be considered in its perspective. This fact emerged very clearly in the foregoing section. Everything is of a temporary nature, everything is in a state of constant tension, everything is doubtful, as long as the world is overshadowed by this danger. What is the nature of this danger, and how can it be abolished? A book which deals with the fundamental problems of international order must at least give some indication of the lines along which these questions which weigh so heavily upon us are to be answered, if it is not to lack the foundation of hard and fast reality which the middle of this century demands.
• 17(1) Instead of the world state, which is an indispensable setting for a world economy, but which did not exist, a practicable and robust substitute was found, and that in a way with which, on a limited scale, the Res Publica Christiana of the Middle Ages may be compared). This substitute was the international ‘open society’ (Henri Bergson)) of that liberal age, a sort of unwritten ordre public international, a secularized Res Publica Christiana, which for that reason spread all over the globe. It is the ‘communitas seu res publica hominum sub Deo’ of St. Thomas Aquinas, to which natural law gave the double roots of universalism, which postulates the brotherhood of man, and of personalism, which postulates the inviolability of the individual, but replanted out of the spiritual earth of Christian Theism into the loose soil prepared by the Renaissance, by Humanism, Enlightment and Liberalism, while the addition ‘sub Deo’ was gradually suppressed and finally dropped). No description can be given here either of the complicated structure of this international ‘open society’ of the 19th century and its manifold workings, nor of the theological, philosophical, moral and sociological forces which underlay this effective substitute for a world state and which penetrated among even the lowest intellectual classes). It must suffice to say that these forces which created the universalist system of the ‘open society’ of the 19th century are for the greater part rooted – as indeed is only to be expected – in the same soil which produced the predominantly ‘liberal’ social, political and economic systems of the same age. What first strikes us in considering this order is the respect it enjoyed, which is only accentuated by the bad conscience or apologetics accompanying cases of infringement, which made it possible for international law to be regarded as a genuine law, on a par or even superior to that of the national state; for the world to be united through a network of long-term agreements which therefore made for the stabilization of international relationships; for tensions between large and small states to be continually adjusted – the unjustly suspected ‘balance of power’ – and for a high degree of agreement to exist regarding legal conceptions and national standards of justice. This external order was, however, fostered by the moral and political atmosphere of the ‘open society’, of the secularized Res Publica Christiana; to which a considerable and by no means unwholesome measure of Pax Britannica was added.
• 18(2) If the international ‘open society’ of the 19th century was the creation of a ‘liberal spirit’ in the widest sense, which need not be explained in detail here), this origin appears very clearly in another respect, and in the narrower and more usual sense attached to the expression ‘liberal’, – not as associated with Thomas Aquinas, Suarez, Victoria, Erasmus or Grotius, but with David Hume and Adam Smith. This point is of the greatest importance as explaining the secret of the international order of the recent past. It is the liberal principle that economic affairs should be free from political direction, the principle of a thorough separation between the spheres of the government and of economy, between sovereignty and the apparatus which provides material goods, between the Imperium and the Dominium, between the political power and the economic power (Maclver). This reduced the economic importance of the existence of sovereign states, with their different legal provisions, their frontiers, their independent administrative systems and civil rights, to a minimum. The economic process was thereby removed from the sphere of officialdom, of public and penal law, in short from the sphere of the ‘state’ to that of the ‘market’, of private law, of property, in short to the sphere of ‘society’, and this did away with the greater part of the causes of conflict and problems of order of an economic nature which arise from the side-by-side existence of sovereign states. This principle also solved an extremely important special problem of international integration, which as we said above was of decisive importance in addition to the problem of international law, i.e. the problem of an international monetary system. Just as the universalist liberal ‘open society’ of the nations was able to create something like a world state, an acting substitute for a non-existent world government, with a common code of law for all nations, so did the application of the principle of separation to money give rise to a working substitute for world money and to establish a really international monetary order in the form of gold standard. The lack of a uniform world monetary system which would guarantee free exchange of currencies at stable rates was compensated for by the fact that all the leading countries accepted the gold standard and supported it more or less scrupulously in a manner which merged the whole globe into a payments union and lent the same qualities of homogeneity, stability and convertibility to international payment transactions as characterize national payments. By this means, by the free and universal convertibility of money at fixed rates and the resulting multilateralism of trade – it became possible for the first time to speak of international economic integration in the exact sense in which we speak of economic integration inside a national economy).
• 19(2) If the international ‘open society’ of the 19th century was the creation of a ‘liberal spirit’ in the widest sense, which need not be explained in detail here), this origin appears very clearly in another respect, and in the narrower and more usual sense attached to the expression ‘liberal’, – not as associated with Thomas Aquinas, Suarez, Victoria, Erasmus or Grotius, but with David Hume and Adam Smith. This point is of the greatest importance as explaining the secret of the international order of the recent past. It is the liberal principle that economic affairs should be free from political direction, the principle of a thorough separation between the spheres of the government and of economy, between sovereignty and the apparatus which provides material goods, between the Imperium and the Dominium, between the political power and the economic power (Maclver). This reduced the economic importance of the existence of sovereign states, with their different legal provisions, their frontiers, their independent administrative systems and civil rights, to a minimum. The economic process was thereby removed from the sphere of officialdom, of public and penal law, in short from the sphere of the ‘state’ to that of the ‘market’, of private law, of property, in short to the sphere of ‘society’, and this did away with the greater part of the causes of conflict and problems of order of an economic nature which arise from the side-by-side existence of sovereign states. This principle also solved an extremely important special problem of international integration, which as we said above was of decisive importance in addition to the problem of international law, i.e. the problem of an international monetary system. Just as the universalist liberal ‘open society’ of the nations was able to create something like a world state, an acting substitute for a non-existent world government, with a common code of law for all nations, so did the application of the principle of separation to money give rise to a working substitute for world money and to establish a really international monetary order in the form of gold standard. The lack of a uniform world monetary system which would guarantee free exchange of currencies at stable rates was compensated for by the fact that all the leading countries accepted the gold standard and supported it more or less scrupulously in a manner which merged the whole globe into a payments union and lent the same qualities of homogeneity, stability and convertibility to international payment transactions as characterize national payments. By this means, by the free and universal convertibility of money at fixed rates and the resulting multilateralism of trade – it became possible for the first time to speak of international economic integration in the exact sense in which we speak of economic integration inside a national economy).
• 20Nowhere is the essence of this liberal world order which is characterized by its disassociation from political direction so clearly shown as here. This international monetary system was not dependent upon a world monetary authority nor a world monetary union or any other international pact, which would have tempted the nations to default and made monetary and credit policy controversial questions and the subject of diplomatic contests. It rested, on the contrary, entirely on the law of the individual state, and even the much praised ‘co-operation of the Central Banks’ proved, as it came to gain in importance, rather to be an anti-doctrinal deterioration and evasion of the gold currency than an encouragement to it, let alone an indispensable support of the international mechanism of gold currency. Since the validity of the individual national currencies depended upon gold, the fact that money = gold not only effected a fixed and free coupling of national currencies, but also compelled national governments by means of their national currency regulations to behave in matters of monetary and credit policy in such a way that this fixed and free coupling remained an undisputed permanent institution, irrespective of all trade fluctuations. As will be shown later, a further advantage was that the evil of an adverse balance of payments, and of international shortage of a currency were completely unknown in international case histories. While the governments clung to their national currency regulations, and in the firm belief, which had become a tradition, nay, even an article of faith, that they were serving, not world trade but their own interests, defended the free convertibility of their currency and their parity with the delicately-formed tools of monetary and credit policy, the result, by no means aimed at in the first place, was a genuine international monetary system – the only one which our age has up to now known. Gold currency thus illustrated the saying of Adam Ferguson) (1723–1816), so essential to liberal convictions, that ‘peoples find themselves unexpectedly in possession of institutions which are indeed the outcome of human action, but not the result of human intention’, and it is a proof of the further realization that in the wide field of society and economy such spontaneous co-operation is generally superior to conscious planning. It was a monetary system which rested upon ‘the structural similarity of the national systems’), and which made currency dependent, not upon political decisions of national governments and their direction, but upon the objective economic laws, which applied once a national currency was linked with gold. It was an ‘economic’ and not a ‘political’ currency system. But it was at the same time a phenomenon with a moral foundation. The obligations, namely, which a conscientious conformity with the rules of the gold standard imposed upon all participating countries formed at the same time a part of that system of written and unwritten standards which, as we have seen, comprised the liberal order public international. The gold standard collapsed as one country after another, for one reason or another, began to disregard the rules of the game, which meant that the gold standard was no longer understood, while at the same time the international order crumbled and the final change of the essentially liberal character of the prevailing economic system to one in which interventionism and collectivism played an increasing part deprived the gold standard of its foundation. The increase of political direction in economic life must necessarily result in the destruction of the monetary order, which rested on the principle of the freedom of economic affairs from political direction.
• 21Nowhere is the essence of this liberal world order which is characterized by its disassociation from political direction so clearly shown as here. This international monetary system was not dependent upon a world monetary authority nor a world monetary union or any other international pact, which would have tempted the nations to default and made monetary and credit policy controversial questions and the subject of diplomatic contests. It rested, on the contrary, entirely on the law of the individual state, and even the much praised ‘co-operation of the Central Banks’ proved, as it came to gain in importance, rather to be an anti-doctrinal deterioration and evasion of the gold currency than an encouragement to it, let alone an indispensable support of the international mechanism of gold currency. Since the validity of the individual national currencies depended upon gold, the fact that money = gold not only effected a fixed and free coupling of national currencies, but also compelled national governments by means of their national currency regulations to behave in matters of monetary and credit policy in such a way that this fixed and free coupling remained an undisputed permanent institution, irrespective of all trade fluctuations. As will be shown later, a further advantage was that the evil of an adverse balance of payments, and of international shortage of a currency were completely unknown in international case histories. While the governments clung to their national currency regulations, and in the firm belief, which had become a tradition, nay, even an article of faith, that they were serving, not world trade but their own interests, defended the free convertibility of their currency and their parity with the delicately-formed tools of monetary and credit policy, the result, by no means aimed at in the first place, was a genuine international monetary system – the only one which our age has up to now known. Gold currency thus illustrated the saying of Adam Ferguson) (1723–1816), so essential to liberal convictions, that ‘peoples find themselves unexpectedly in possession of institutions which are indeed the outcome of human action, but not the result of human intention’, and it is a proof of the further realization that in the wide field of society and economy such spontaneous co-operation is generally superior to conscious planning. It was a monetary system which rested upon ‘the structural similarity of the national systems’), and which made currency dependent, not upon political decisions of national governments and their direction, but upon the objective economic laws, which applied once a national currency was linked with gold. It was an ‘economic’ and not a ‘political’ currency system. But it was at the same time a phenomenon with a moral foundation. The obligations, namely, which a conscientious conformity with the rules of the gold standard imposed upon all participating countries formed at the same time a part of that system of written and unwritten standards which, as we have seen, comprised the liberal order public international. The gold standard collapsed as one country after another, for one reason or another, began to disregard the rules of the game, which meant that the gold standard was no longer understood, while at the same time the international order crumbled and the final change of the essentially liberal character of the prevailing economic system to one in which interventionism and collectivism played an increasing part deprived the gold standard of its foundation. The increase of political direction in economic life must necessarily result in the destruction of the monetary order, which rested on the principle of the freedom of economic affairs from political direction.
• 22A tremendous achievement which it were opportune at last to understand and duly respect, and whose significance we only fully realize now that this framework no longer exists. On the other hand, now that the liberal idea of order has been supplanted by the collectivist, the meaning of the attempt made above to characterize the liberal international order becomes painfully clear to us. If we examine more clearly the popular idea of today, to erect an international controlled economy on these ruins of an international order, by means of fragmentary Quota, Clearing and barter Agreements and daily varying payments and trade arrangements between the individual states, we cannot help observing its absurdity, and that for a reason which is very instructive in this connection). Two things immediately become clear: (a) that an international planned economy – we must constantly come back to this – representing as it does the domination of politics over economics on an international level, cannot manage with the international quasi-order of the liberal epoch but presupposes a real super state, and (b) that it was exactly a triumph of the collectivist idea over the liberal one which destroyed this loose quasi-order. International collectivism demands a measure of international statism which would presuppose a very much stronger international frame that that which the liberal age created and which collectivism destroyed. We shall meet this paradox later in another form.
• 23If this completes the picture as we see it of the nature of the problem of international order and its liberal solution, it only remains to say that we have only tried to give an interpretation of international law in the 19th century under the aspect of its economic function. Thus seen the traditional system of international law appears to us as the liberal solution of the problem of international order which has arisen from economic development, this means that this system entered upon a process of disintegration as the liberal idea of order began to decline.) This contention ought to be substantiated in detail by concrete examples. We shall however content ourselves by a single one of predominant importance, the treatment of private property in international relations.
• 24It was in accordance with the principle of the separation of Imperium and Dominium, upon which the liberal world order rested, that private property was practically dissociated from the question of the territorial supremacy of the states and nationalities of the owners and the conflicts connected with them. This broke with an age-long aftermath of tradition from Feudal times. While colonial imperialism still clung to the idea that a territorial supremacy of the State over the areas in question was necessary, in order to ‘secure’ markets, sources of raw material and possibilities of settlement, this was but an anachronistic sophism which thoughtlessly ignored the established principle of liberal world order. ‘Political power has determinate frontiers, economic power has freedom of the world’ (Maclver)). This principle of the separation of sovereignty and property was of special importance in cases of war, in which respect for the private property of the enemy was an obvious consequence of the liberal universal international order. After disregard of the private property of the enemy had became the rule among the belligerents in the first world war, the extension of this disregard by the victors after the second world war in forcing neutral countries to follow suit constituted a high point of that legal cynicism which has dissolved the old liberal world order. Some years ago I wrote the following, to demonstrate the length to which matters had gone: ‘Let us imagine that at the time of the Chinese Boxer Rising (1900) – which bore a distant resemblance to National Socialism – Swiss property had been damaged, and let us further assume that someone conceived the idea of confiscating assets, which had been entrusted by individual Chinese to Swiss banks, to compensate the Swiss who had suffered damage. Can the slightest doubt exist that at that time the very idea would have been swept away by a storm of unanimous public protest? Meanwhile, however, a passport no longer has the qualities of a patent of nobility and an insurance policy, but has also become equivalent to a mandate of expropriation, an order of deportation, a document of moral condemnation, an order for arrest and in the extreme case to a sentence of death)’.