Origins of the post-war payments system
Marcello de Cecco [*]
Given the enormous significance of short-term capital movements in the post-war international financial system, it is noteworthy that the IMF Articles of Agreement paid little attention to them or indeed to private international capital transactions of any description.
'Members may exercise such controls as are necessary to regulate international capital movements', it is said in Section 3 of Article IV (Horsefield, 1969, p. 194). Section 1 of the same Article asserts that 'A member may not make net use of the Fund's resources to meet a large or sustained outflow of capital, and the Fund may request a member to exercise controls to prevent such use of the resources of the Fund'. The IMF legislators prescribed that, 'If, after receiving such a request, a member fails to exercise appropriate controls, the Fund may declare the member ineligible to use the resources of the Fund.'
This provision seems to contain the crude philosophy of the Bretton Woods agreements: capital flights are bad for the countries that experience them and these countries ought to control them if they want to use the Fund's resources.
However, lest the Article might be taken as being excessively interventionist, the latter part provides that 'no member may exercise these [capital] controls in a manner which will restrict payments for current transactions or which will unduly delay transfers of funds in settlement of commitments' (Article VI, Section 3). Moreover, 'capital movements which are met out of a member's own resources of gold and foreign exchange' should not be affected by the aforementioned Articles, although 'members undertake that such capital movements will be in accordance with the purposes of the Fund' (Article VI, Section 1). The same Article also asserts that the Fund's resources will be available 'for capital transactions of reasonable amount required for the expansion of exports or in the ordinary course of trade, banking, or other business'.
Clearly, short-term capital movements were not regarded as an essential part of the adjustment mechanism foreseen by the Agreements; in fact, they were a nuisance, to be restricted rather than fostered. But all the burden of establishing controls was to fall on the countries from which capital flees and none on those to which it goes.
The original proposals of White and Keynes
Both the Keynes and White Plans had been much more exacting and explicit on the restriction of short-term capital movements. The White Plan was conceived as a highly co-operative effort to achieve equilibrium in international payments. It proposed quite
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bluntly, that
Each country agrees (a) not to accept or permit deposits or
investments from any member except with the permission of that
country and
(b) to make available to the government of any member country at
its request all property in form of deposits, investments,
securities, of the nationals of member countries, under such
terms and conditions as will not impose an unreasonable burden on
the country of whom the request is made (Horsefield, 1969, p.
66).
The explanatory remarks which Harry Dexter White appended to this proposal were even more definite about the need to get rid of short-term capital movements.
This is a far-reaching and important requirement. Its acceptance
would go a long way toward solving one of the very troublesome
problems in international economic relations, and would remove
one of the most potent disturbing factors of monetary stability.
Flights of capital, motivated either by prospect of speculative
exchange gains, or desire to avoid inflation, or evade taxes or
influence legislation, frequently take place especially during
disturbed periods. Almost every country, at one time or another,
exercises control over the inflow or outflow of investments, but
without the co-operation of other countries such control is
difficult, expensive and subject to considerable evasion ...
The search for speculative exchange gains or desire to evade the
impact of new taxes or burdens of social legislation [he
reiterated] have been one of the chief causes of foreign exchange
disturbances. Less hectic and less dramatic yet in the case of
some countries during some stages of their development capable in
the long run of even greater harm, is the steady drain of capital
from a country that needs the capital but is unable for one
reason or another to offer sufficient monetary return to keep its
capital at home. The assumption that capital serves a country
best by flowing to countries which offer most attractive terms is
valid only under circumstances that are not always present
(Horsefield, 1969, pp. 66-67).
Thus White had no place for private capital flows in his blueprint. This is extraordinary, because the adjustment mechanism he envisaged was a sort of *dirigiste* Gold Standard. Since the real Gold Standard had relied on private short-term capital flows as an essential part of its adjustment mechanism, White was proposing to stage a production of Hamlet without the Prince of Denmark. However, he was convinced that it would be possible to enact a sort of 'nationalised Gold Standard' in which nations went through the paces of the classical mechanism without being prompted, or assisted by international short-term capital flows. In this triumph of the concept of the state as monopolistic regulator of international economic relations, White accepted that some social groups would be sacrificed.
Such an increase in the effectiveness of control means, however,
less freedom for owners of liquid capital. It would constitute
another restriction on the property rights of this 5 or 10% of
persons in foreign countries who have enough wealth or income to
keep or invest some of it abroad, but a restriction that
presumably would be exercised in the interest of the people at
least so far as the government is competent to judge that
interest.
The inclusion of this provision does not mean that capital flows
between foreign countries would disappear or even greatly
subside; it means only that they would not be permitted to
operate against what the government deemed to be the interests of
any country (ibid., p. 67).
In Keynes's plan to reconstruct the international monetary system short-term capital movements had no role to play either.
It is widely held that control of capital movements, both inward
and outward, should be a permanent feature of the post-war system
--- at least so far as we [the British] are concerned. If control
is to be effective, it probably involves the *machinery* of
exchange control for *all* transactions, even though a general
open licence is given to all remittances in respect of current
trade. But such control will be more difficult to work,
especially in the absence of postal censorship, by unilateral
action than if movements of capital can be controlled *at both
ends*. It would therefore be of great advantage if the United
States and all other members of the Currency Union would adopt
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machinery similar to that which we have now gone a long way
towards perfecting in this country though this cannot be regarded
as essential to the proposed Union.
This does not mean that the era of international investment
should be brought to an end. On the contrary, the system
contemplated should greatly facilitate the restoration of
international credit for loan purposes. ... The object, and it is
a vital object, is to have a means of distinguishing --- (a)
between movements of floating funds and genuine new investment
for developing the world's resources and (b) between movements,
which will help to maintain equilibrium, from surplus countries
to deficiency countries and speculative movements or flights out
of deficiency countries or from one country to another
(Horsefield, 1969, p. 13).
In Keynes' version the repudiation of short-term capital movements as a part of the adjustment mechanism was much more nuanc\'e and subtle than in White's. The distinction between virtuous and vicious capital flows was proposed and capital controls were seen as a necessary, though not particularly cherished, measure to be suffered by impoverished countries. Keynes saw control *at both ends* as a favour that surplus countries should do for deficit countries, although he nominally justified it in the name of efficiency. This was clearer in the second version of his plan, written almost a year later. There capital flows were considered bad, if induced by 'political reasons, or to evade domestic taxation, or in anticipation of the owner turning refugee' (ibid., p. 31). No mention was made of speculative flights or of arbitrage-induced flights. White's ringing condemnation of the latter was completely ignored by Keynes. So was White's \'etatiste philosophy. Keynes' second proposal simply stated that capital controls just *had to be* 'a permanent feature of the post-war system' and that they had to be exercised by both surplus and deficit countries simply because it was 'more difficult to work [them] by unilateral action on the part of those countries which cannot afford to dispense with [them]'. But he was well aware of the fact that 'those countries, which have for the time being no reason to fear, and may indeed welcome, outward capital movements, may be reluctant to impose this machinery', even though, he added reassuringly, 'a general permission for capital, as well as current, transactions, reduces it to being no more than a machinery of record' (p. 31).
Clearly, between 1942 and 1943, \'etatisme and control had gone out of fashion. Banking and financial interests, certainly in the US and very probably in Britain as well, had considered the earlier versions of both White's and Keynes' plans. Quite probably, White's reference to the need to sacrifice '5 to 10% of persons' had stuck in their throats.
For this reason, or for others, later 'IMF proposals' contained very watered-down formulae relating to capital controls. In the final version quoted earlier, 'bilateral' enforcement of capital controls had disappeared altogether. The denial of IMF assistance if a country experiencing a capital outflow failed to impose controls was a complete about-turn with respect to the earlier plans, which were based on the principle of co-operation between surplus and deficit countries in maintaining payments equilibrium. Short of the drastic scarce currency clause, nothing was foreseen which might put pressure on surplus countries.[1]
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The background of conflicting US and British interests
The IMF Charter bears witness to the gradual worsening of Anglo-American relations between 1942 and 1944. The Articles of Agreement are a far cry from the White Plan blueprint for intense international co-operation with a large measure of supranationalism. This had been designed to buy off British interests by proposing American financial assistance to Britain operated through the IMF, while Britain would be ridding herself of sterling balances and imperial preference and returning to multilateral trade and payments.
As we can see from the Keynes Plan, this offer was taken up by Britain. However it then became known that the sum the US authorities were prepared to pledge was infinitely smaller than the $25 billion which had first been suggested. The figure was scaled down to $2-3 billion and the US solution advanced for sterling balances turned out to have become one of making the owners of these balances shoulder the burden of their funding or even cancellation.
The US attempt to convert Britain to multilateralism in the monetary and trade fields was not accepted without protest by the British. There were lively reactions to all these proposals, even the most generous, emanating from the 'inner sanctum' of British finance, the Court of Directors of the Bank of England. Keynes was probably able to carry his country's authorities with him until the US side began to get cold feet and Harry White began to back down from his supernationalism and financial generosity.
The general picture Keynes and White had in mind for post-war monetary equilibrium had been very much influenced by a background of conflicting US and British interests. White because of his philosophical conviction, and Keynes because of his disillusioned realism about the state of the British economy, had agreed on a blueprint for the future in which multilateral trade and payments were to be re-established among nations in the form of a more-or-less 'nationalized', i.e. highly controlled system. They thought multilateralism would make a higher level of trade possible. But this did not mean unfettered *laissez-faire*, rather the opposite. The $25 billion supra-nationally managed stabilization fund was essential to this picture. Without it, or with only a fraction of it, Great Britain would be throwing away the well tried trading and currency system of the sterling area in exchange for nothing. The new trade and payments system would be justified, for a deficit country like Britain, only if her economy was to be helped to readjust by a large buttress of IMF loans.
These proposals would almost completely have bypassed the large financial institutions of the USA, in particular the New York banks. In the Keynes version the latter would have been excluded from the Sterling Area. As they saw it, sterling convertibility was to be backed by American money while they were prevented from encroaching on the City of London's business.
It must be remembered that the New York financial community saw itself as the natural heir to the international role traditionally played by the City of London. The immediate post-war period seemed the appropriate time for the transfer of power to take place. The representations made by the New York financial community against the Keynes and White Plans were therefore numerous and powerful. The plans were accused of being inflationary and of requiring too much generosity on the part of the USA. Moreover American bankers, hit by the war-time cheap money policy, did not relish the prospect of this being continued in the future under the IMF. Their influence in Washington helped to secure the abandonment of the highly co-operative approach suggested by Keynes and White.
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The erosion of White's proposals was also assisted by the emergence of an increasingly powerful Dixiecrat lobby in the US Congress, which pressed for a return to *laissez-faire* in both internal and international US economic policy.
In order to see his creature, the IMF, delivered into the world, White transformed it beyond recognition, helped not a little by his British counterpart, who reacted to the new American mood by adopting the loss-minimisation tactic of seeking to maintain the *status quo* for as long as possible.
The movement back to a more decidedly *laissez-faire* system continued after the signing of the Bretton Woods Agreement. By subjecting US Directors of the IMF to the scrutiny of the newly established National Advisory Council on International Monetary Policy, by insisting that the IMF be located in Washington, and by several other measures, the US authorities proceeded to strip the institution of its supranational features, so that very soon it became a 'specialized branch of the US', as Peter Kenen was to call it thirty years later.
What is difficult to recapture today, when Britain is reduced to a GNP and share of world trade not much greater than Italy, is the importance of the Sterling Area and of the British Empire in the immediate post-war period. The US determination to do away with both seems hard to believe or to understand. It looks like a lot of fuss about relatively little. To understand the urgency of this determination we must again become convinced, as American businessmen, politicians, farmers and labour leaders were in the 1930s and 1940s, that the historic role of the USA was to replace the United Kingdom in its relations with the Sterling Area and the British Empire.
Even before the end of the war it had become clear that the defeat of the Axis powers would give the US an opportunity to take a large share of markets of the British Empire. With Latin America, these were the only markets that had remained largely untouched by war and which as a result offered an 'effective demand' for American exports.
Traditionally, since before the First World War, the United Kingdom had realised a surplus in imperial markets to spend on imports from the US and Europe. The remainder of the British Empire had realized a continuously large surplus with the US and spent it on imports from Britain. But during the war British industry had been allowed to concentrate on the war effort and Britain had accumulated a large deficit with the Empire in the form of sterling balances.
As a supplier of imperial markets, Britain had been replaced by the US, which had thereby transformed its pre-war deficit with the Empire into a large surplus.
It is easy to understand how the US dreaded the post-war reappearance of the UK as the traditional supplier of these markets. A return to the pre-war settlements pattern was to be prevented because US business had taken over, *vis-a-vis* the British Empire and Dominions, not only British visible trade but also, even more important, invisible trade. The US was therefore adamant in demanding an early termination of Sterling Area arrangements, especially the 'dollar pool', which had put at Britain's disposal the dollar receipts of the whole area.
One must not forget that in 1942-45 the European and Japanese economies were for all practical purposes written off. Only later on, in the new perspective of the Cold War, did they become important again. Until then foreign trade meant, to the UK and the US, trade between the Sterling Area and the dollar area. In the last years of the war nobody saw much hope of reorganising foreign trade on its traditional four pivots: the UK, the USA, Germany and Japan. On the part of some of the victors there was the
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express desire *not* to see such a resurrection of pre-war patterns. Indeed these were the days when the 'Morgenthau Plan' was still official American policy.[2]
All this is recalled here in order to clarify why US policy, since the early days of the war, had been aimed at actively seeking the abolition of what US sources called the 'Sterling Bloc'. One cannot blame US politicians, business and labour leaders, whose most immediate pre-war experience had been the Depression and the slump in American exports, for trying with all their might to undermine a potentially authentic trade and payments bloc, the Sterling Area, where the US had sent 27% of its total exports before the war, and which contained what looked, at least for the immediate feature, the most promising and solvent markets for American manufactures and invisible exports. Because of the war the USA had experienced an increase in exports from $3 billion to $15 billion. Bearing these figures in mind one could not think in terms of post-war trade expansion. In foreign trade the US aim would naturally be that of holding on to its newly won share of the market. 'Multilateralisation' of the Sterling Area was essential to enable continuation of the US in its war-time role as supplier of food and manufactures to Overseas Sterling Area territories.
In view of these realities, the Keynes Plan stands out as a brave attempt to divert the focus of attention from the issues most dangerous for Britain. Keynes was painfully aware of the inherent weakness of the Sterling Area, of its fundamental inadequacy to stand united against US opposition to its existence. What US opinion considered a 'trading bloc' he knew to be an informal arrangement kept together by an array of diverse motives, the most valid of which had been, before the war, the unreliability induced by the depression of the US economy as an absorber of Sterling Area exports, and during the war, mobilisation against the German enemy. In February, 1942, he wrote:
The advantages of multilateral clearing are of particular
importance to London. It is not too much to say that this is an
essential condition of the continued maintenance of London as the
banking centre of the Sterling Area. Under a system of bilateral
agreements it would seem inevitable that the sterling area, in
the form in which it has been historically developed and as it
has been understood and accepted by the Dominions and India, must
fall to pieces.
... If we try to make of the sterling area a compact currency
union as against the rest of the world, we shall be putting a
greater strain on arrangements, which have been essentially (even
in time of war) informal, than they can be expected to bear ...
Is it not a delusion to suppose that the *de facto*, but somewhat
flimsy and unsatisfactory, arrangements, which are carrying us
through the war, on the basis that we do our best to find the
other members of the area a limited amount of dollars provided
that they lend us a very much larger sum in sterling, can be
carried over into the peace and formalised into a working system
based on a series of bilateral agreements with the rest of the
world, accompanied by a strict control of capital movements
outside the Area? (Horsefield, 1969, p. 10).
As Keynes explained:
It is possible to combine countries, some of which will be in a
debtor and some in a creditor position, into a Currency Union
which, substantially, covers the world. But, surely, it is
impossible, unless they have a common banking and economic system
also, to combine them into a Currency Union not with, but
against, the world as a whole. If other members of the sterling
area have a favourable balance against the world as a whole, they
will lose nothing by keeping them in sterling, which will be
interchangeable [in his Plan] with bancor and hence with any
other currency, until they have occasion to use them. But if the
sterling area is turned into a Currency Union, the mem-
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bers in credit would have to make a forced and non-liquid loan of
their favourable balances to the members in debit. ... They would
have to impose import regulations and restraints on capital
movements according as the area as a whole was in debit or
credit, irrespective of their own positions. They would have to
be bound by numerous bilateral agreements negotiated primarily
... in the interests of London. The sterling resource of creditor
Dominions might come to be represented by nothing but blocked
balances in a number of doubtfully solvent countries with whom it
suited us to trade. Moreover, it is difficult to see how the
system would work without a pooling of world reserves.
It is impossible that South Africa or India would accept such
arrangements even if other Dominions were complying. We should
soon find ourselves, therefore, linked up only with those
constituents which were running at a debit, apart from the Crown
Colonies, which perhaps, we could insist on keeping (ibid., p.
10).
If Keynes found it necessary to spell out to his compatriots the reasons why it would be impossible to keep the Sterling Area together as a Currency Union against the opposition (which really mean 'the sheer existence') of a dollar area unfettered by controls of any kind, American objectors could be excused for fearing that a considerable component of the British leadership was stirring towards transforming the Sterling Area exactly into what Keynes exposed as a dangerous chimera, a tight autarchic block.
'Contrary to occasional suggestion from British sources, these blocked sterling balances should most certainly be handled in the good old system of Dr Schacht. As we recall, he used blocked Reichsmark balances to force countries to buy from Germany by leaving them no other way of getting their money back.' Thus spoke Imre de Vegh at the annual meeting of the American Economic Association in February 1945. He was perfectly right: this was exactly the direction in which an important cluster of Labour economic advisers, Balogh and Schumacher prominent among them, had been moving. They had studied the success of Hitler's 'new economic order' and thought that it would be a good idea to reformulate the Sterling Area similarly.[3]
In view of the unanimous backing of American financial, industrial, farming and labour interests for a free trade (meaning free US exports), free payments, solution to world economic problems, as well as the new direction in British economic thinking just mentioned and the desire of the City of London to preserve the Sterling Area at all costs, one cannot be at all surprised by the progressive worsening of Anglo-American economic relations, as the conflict of interests become more and more explicit.[4]
Two tendencies became evident. On the American side the Bretton Woods Agreements began to be criticised because of what was seen as their extreme normative character. On the British side a rentrenchment began to take place, waiting for the American onslaught and trying to minimise the damage when it finally came.