"Origins of the post-war payments system" by De Cecco (II)

William S. Lear rael at zopyra.com
Wed Oct 14 12:46:43 PDT 1998

The new US policy line

The theoretical background to the new US international economic policy line was excellent. It was largely due to J. H. Williams, the Harvard economist and Vice-President of the New York Federal Reserve Bank, who had been a long-standing and acute critic of orthodoxy in the fields of trade and monetary theory. In the Keynes and White Plans he recognised a starry-eyed normative exercise, the purpose of which was to establish a Gold Standard mechanism as the basis for post-war international economic relations.


He strongly (and absolutely correctly) believed that the pre-1914 Gold Standard had been not the democratic interplay of countries regulated in their mutual exchanges by a Ricardian adjustment mechanism, but a hierarchical structure based 'around England as the central country'.

'Gold standard theory', he wrote, 'was based on the principle of interaction between homogeneous countries of approximately equal economic size. Gold standard practice in the 19th century operated not on this principle but on that of a common center with which the other countries were connected through trade and finance. But now that we have neither of these principles to work on the unequal size of countries presents problems with which the gold standard cannot cope' (Williams, 1944).

He was convinced that for the US there should never be any question of practicing exchange controls, or varying the dollar, in time of peace. Its foreign trade 'is secondary, as regards effects upon itself, and upon its home trade rest not only its chances for stability but fundamentally that of the others also'. England was in a different position: 'England clearly needs more latitude, but as a great international trade center and as a highly industrialised country whose well being depends predominantly on her foreign trade, she has an obligation, almost equal to our own, to maintain monetary stability and to practice the rules of multilateral trading --- an obligation which in a far-sighted view means as much to her as it does to those with whom she trades.' For these reasons he thought that monetary reconstruction must begin by settling the relations between the centre-countries. The main difference between his and the Keynes and White Plans' approach was in the conception of 'the importance of stabilising the truly international currencies whose behaviour dominates and determines what happens to all others'. Early post-war international co-operation in the monetary field should mainly consist in re-establishing a convertible sterling, which meant finding a stable dollar/sterling rate. Since Williams had categorically excluded revaluation of the dollar, it would be essential to devalue sterling.

In urging an early return to full sterling convertibility, Williams rang a clarion call that appealed to all shades of American opinion. The matter became more urgent as, in a mood of post-Bretton Woods disillusionment, Britain had begun in earnest to weave a Schachtian web of bilateral settlements, export promotion and import substitution in the Sterling Area. The new Labour government, whose accession to power had greatly surprised, even dismayed, the US government and leadership, seemed intent on proceeding to the construction of a Socialist Commonwealth. If this process were in any way to gain momentum, none of the solutions the US sought to enforce would be feasible.

The final showdown

The US government pre-empted British options by terminating lend-lease. As Keynes had feared, this destroyed the unreal equilibrium upon which the Sterling Area had rested up to then.

Suddenly deprived of US aid, the British economy was on its knees. It was easy for the US government to negotiate a financial agreement under which it would give the UK financial aid against a pledge to re-establish sterling convertibility within a year. It was, it is true, only current account convertibility that the British undertook to re-establish. But it was easy then, as it had been before, and has been since, to disguise capital account as current account transactions, especially in a financial system woven together as informally as the Sterling Area, whose legitimacy --- as Keynes correctly apprehended in


1942 --- derived solely from the consent of its members. Once the date of the return to convertibility was fixed, the British monetary authorities tried to enhance the credibility of sterling by the measures they adopted in the intervening period. They gave more, rather than less, latitude to non-colonial members of the Sterling Area to exchange sterling into dollars, by increasing the transfer accounts. They in no way diminished the free circulation of capital within the Sterling Area. Generally speaking, they seemed interested in enlarging and loosening even more a system of payments that was already too loose to stand as trying a test as the return of its currency to external convertibility.

But the British authorities' main mistake was even to consider, let alone strive for, a return to sterling convertibility on the strength of purely current account considerations. They made the same mistake as in 1926; worse still, the British long-term creditor position had become much weaker because of the war, especially when compared with short-term sterling balances.

The long interval that elapsed between the Anglo-American financial agreement, when the pledge to return to convertibility was made, and July 1947, when it was supposed to be enforced, gave holders of sterling all the time they needed to assess the lack of realism of the enterprise, and to equip themselves in order to get out of sterling when it returned to convertibility. The existence of a 'cheap sterling' market in New York, where inconvertible sterling could be sold for dollars, helped to reveal the difference between the official and market parity. All Keynes' apprehensions seemed to come true: it was simply too difficult to keep the Sterling Area together (which required convertibility and free movement of capital within the area), keep sterling inconvertible into non-area currencies, keep the sterling/dollar rate at the pre-war parity, ignore the existence of a free market for sterling in New York (unfettered by US authorities), and, at the same time, declare a date in the near future for the return to convertibility.

Devaluation has generally had few supporters in Britain, especially since the war.[5] In the immediate post-war years so much of British trade was with the Sterling Area, where British exporters had an almost natural monopoly position, that they did not have much truly 'foreign' trade. It was thus logical for British exporters to ignore the potentially higher profits to be derived from devaluation. In addition one must note that British importers have just as traditionally had a natural interest in keeping sterling as highly valued as possible.

Since a 'Devaluation Party' could not be found among the exporters, pressure for devaluation had to come from other quarters. It was difficult to imagine Britain's capital exporters or invisible exporters asking for devaluation. But all these people were interested in a return to sterling convertibility, as this would re-establish London as an international financial centre. The return to convertibility, at the pre-war parity and with the assistance of the American loan, was therefore a prospect which a wide range of interested parties in Britain found palatable. Only so can we explain the conspicuous lack of doubt and criticism in the British press in the months preceding July 1947. Unfortunately non-British holders of sterling had very few reasons to find the return to convertibility at the pre-war rate credible enough to justify a decision on their part not to take advantage of it to get out of sterling. The extraordinary coincidence of elements we have indicated --- loose controls within


the Sterling Area, the wide use of sterling as an invoicing currency, its unrealistic parity with the dollar, which was loudly propagandised by the 'cheap sterling rate' in New York, and finally the existence of huge sterling balances whose holders were motivated neither by patriotism, nor by the expectation of future gain --- made it inevitable for the convertibility experiment to end in complete disaster. In the course of the few weeks that it lasted, a good part of the American loan was transferred to former holders of sterling who wanted to get out. It was, in other words, mostly transformed into non-British demand for American goods.

The convertibility experiment served to highlight the fact that it was just as important for sterling to have an exchange rate that maintained balance in the capital account as to have one that maintained balance in the current account. There were too many holders of sterling too anxious to get rid of it for the nominal limitation of convertibility to current account transactions to be effective. Too many bridges linked the dollar area, unfettered by restriction, to the sterling area where restriction was the rule.

European exchange controls in the 1930s had not prevented Europeans from sending extremely large funds to the US. As Alvin Hansen noted in 1945: 'It is also true that the abnormal gold flow into the US in the thirties was related not solely, or even mainly to a world disequilibrium in the current international account, but largely to capital movements. Thus, of the $16 billion gold inflow [1934-42], $6 billion may be attributable to an export surplus ... while the remaining $10 billion are attributable either to recorded capital inflow ($6 billion) or to unidentified transactions ($4 billion)' (Hansen, 1945).

It was keen awareness of the importance of this phenomenon that had led White and Keynes to suggest in their plans that 'control at both ends' ought to be mandatory if capital flows were to be prevented from distorting what they considered to be the legitimate adjustment mechanism, the one working through current accounts.

But 'controls at both ends' were excluded from the Articles of Agreement of the IMF. There was, as a result, ample scope left, in the post-war international monetary system, for the same pattern that had characterised the 1930s to reappear. Inevitably it did reappear, not only in the Sterling Area but for Europe in general. In the words of Robert Triffin (1957):

To the outside world, the most spectacular manifestation of this

bankruptcy lay in the staggering $9 billion of foreign

disinvestment, borrowings and grants, absorbed by Europe in 1947

in a desperate effort to maintain minimum levels of imports,

consumption and investment. In the absence of foreign aid, such a

deficit would have just about wiped out the total gold and dollar

holdings of Europe ... This enormous deficit could not altogether

be attributed to excessive import levels. In spite of urgent

needs for consumption, restocking, and reconstruction of

war-depleted and war-devastated economies, the volume of imports

was held down to 1938 semi-depression levels. The $9 billion

gross deficit of 1947 appears to be made up of:

(1) An exceptionally high level of capital exports and

capital repayments ($2 billion).

(2) A decrease in the volume of exports.

(3) A worsening in the terms of trade.

Now, if we except the second item in Triffin's list, the first and the third both show that the real problem was a re-emergence of the pre-war pattern: the worsening in the terms of trade was certainly due to the US internal boom and early repeal of price controls, and to US producers making the most of their temporary monopoly position. It also reflected the widespread European practice of under-invoicing exports and over-invoicing imports, a time honoured vehicle for capital exports.

It was thus from capital accounts that the first post-war payments crisis developed.


This is worth affirming with emphasis, as the myth of Europe's excess demand for imports is extremely well established. The '5 to 10% of persons', who Harry White knew would have been sacrificed by his 'controls at both ends' scheme, were left free to find a haven for their funds in Switzerland and the United States. Since it was clear that the US would not impose inward controls on capital movements nor revalue its currency, it was easy for the '5 to 10% of persons' in Europe to find ways of exporting capital in defiance of national exchange controls. US foreign aid was thus, from the very beginning, mainly used to balance European capital exports to the United States. This pattern continued throughout the years of Marshall Aid, so much so that M. G. Hoffman, the distinguished *New York Times* correspondent, could estimate, in July 1953, that 'capital flight from Western Europe in the postwar period had much exceeded US Government foreign aid to that area during the same period' (quoted in Bloomfield, 1954).

The most important factor in capital account turbulence between 1947 and 1949 was the United States' increasing desire to extract exports from Marshall Aid countries by compelling them to devalue their currencies. The US government, not unlike its predecessors in international economic stabilization in the 1920s (especially the Governor of the Bank of England, Montagu Norman), believed that stabilization loans should be given to countries on condition that they undertook to deflate and devalue. This recipe had been suggested by Harry Dexter White in his plan and had been written into the Articles of Agreement of the IMF. The US government soon realised that the Marshall Plan, devised as an instrument to maximise American exports of food, raw materials and capital goods, and at the same time induce the reconstruction of Europe, did not provide enough incentive for European exports; rather the opposite was true.

The US authorities, as a result, turned to the more traditional Norman/IMF stabilisation recipe and began to preach deflation and devaluation to Marshall Aid receivers: 'The Council has given continual attention to the problem of the exchange rates of the participating countries', reported the National Advisory Council on International Monetary and Financial Problems on 5 July 1949.

It concluded that in 1948 a general devaluation of the European

exchange rate was inadvisable in view of the possible internal

repercussions of devaluation on the participating countries in a

period when their economies still exhibited serious inflationary

tendencies, while their levels of production were not adequate to

maintain an expanded volume of international trade. In many of

the participating countries these conditions no longer obtain,

since substantial progress has been made toward recovery in their

levels of production. The Council recognised that if viability of

the European economies is to be attained by 1952 [when Marshall

Aid was scheduled to end] greater progress must be made by the

European countries in redressing their balance of payments

position with respect to the Western hemisphere and in attracting

private foreign investment. *It is Council's opinion that in some

cases the devaluation of currencies may constitute means of

bringing about the desired expansion of exports to the dollar

area which, along with other appropriate measures, will

contribute to more normal methods of financing after 1952*.

While fully aware of the difficulties involved in exchange rate

adjustments, the Council believes that the problem should be

explored with some of the European countries. When adjustments of

exchange rates are indicated, it is expected that member

countries will make appropriate proposals to the IMF (*Federal

Reserve Bulletin*, September 1949).

Six months earlier, in their Annual Report for the year ending 30 April 1949, the executive directors of the IMF had proposed the same solution, deciding that 'where a price reduction ... is necessary to expand exports, it would in many cases seem possible only through an adjustment in the exchange rates'. The US government, acting both directly and through its 'specialized agency', the


IMF, was dictating a drastic change in exchange policy to its debtors, without the slightest regard to the fact that its public pronouncements would activate a gigantic capital outflow from the countries whose currencies it accused of being overvalued. The US authorities, in so doing, were making sure that devaluation, if it did not come voluntarily, would be *forced* upon reluctant governments by capital flight.

The US authorities had every reason to enlist the '5 to 10% of persons' in the various European countries to the cause of devaluation. European governments showed no particular inclination to devalue and every desire to solve their payments deficits by bilateral negotiations. They were of the opinion that not a small part of their troubles derived from the slump that had hit the US economy in 1948 and 1949, thus reducing US demand for imports and encouraging the US supply of exports. Chief propounder of this thesis was the UK government. Having identified the cause of the marked deterioration on the dollar position of the Sterling Area in the US slump, it announced, on 14 July 1949, a new austerity programme which would reduce UK imports from the US and Canada by $400 million in the course of the fiscal year. This was a 25% reduction in UK dollar area imports. At the same time, Commonwealth governments announced equivalent plans to reduce their dollar imports.

It is easy to imagine the effect of these declarations on US business opinion. US businessmen had looked to exports as a safety valve in the current slump of the US economy. The UK had been able to enlist the support of the Commonwealth governments because the slump in US imports had hit them much harder than Britain, and the example of the Sterling Area could be imitated elsewhere. Multilateralism and convertibility, which the US had chosen as the main objectives of its international economic policy, might be postponed indefinitely by the new spate of import controls and bilateral deals induced by dollar famine.

Adopting the 'Williams model', the US authorities concentrated their efforts on Britain on the correct assumption that if she could be won to devaluation, everybody else would follow. In the summer of 1949, after the National Advisory Council and the IMF had encouraged owners of speculative funds to get out of European currencies, negotiations were held first in London and then in Washington, between the UK, the US and Canadian governments. As the UK remained adamant, the US threatened to cut Marshall Aid to Britain. By calling the UK's bluff, the US made sure that sterling would be devalued. Speculative forces set in motion by the earlier declarations of the IMF and the US government had already prepared this path.

On 18 September 1949, Britain devalued by 30%, followed by 25 countries. As Stafford Cripps declared, the huge devaluation was chosen with the explicit aim of discouraging further speculation. No 'current account' explanations were given by British authorities. Their 'elasticity pessimism' had been notorious since 1926 and constituted not a small part of the 'Treasury view'.

The adjustment mechanism proposed by the IMF was brought into action by capital account imbalances, induced by speculation, which made defence of the parity impossible.

But the savage devaluation forced upon Britain by the US and followed by all relevant countries also had momentous effects on the balance-of-payments current accounts of all members of the IMF for the next 25 years. The European economies were, by this drastic exchange-rate re-alignment, transformed into export economies. An 'exporters' lobby' of increasing importance came into existence in all European countries which prevented meaningful adjustments of European currencies until 1971.

<p. 61>


Bloomfield, A. 1954. *Speculative and Flight Movements of Capital in

Postwar International Finance*, Princeton, Princeton UP

Burnham, J. 1941. *The Managerial Revolution*, New York, John Day

Guillebaud, C. 1940. Hitler's new economic order for Europe, *Economic

Journal*, December

Hansen, A. 1945. International monetary and financial programs, in

*The United States in a Multinational Economy*, Washington, Council

on Foreign Relations

Horsefield, J. K. (ed.) 1969. *The International Monetary Fund

1945-1965*, vol. 3, *Documents*, Washington, IMF

Rasminsky, L. 1945. Anglo-American trade prospects: a Canadian view,

*Economic Journal*, June-September

Robertson, D. H. 1945. The problem of exports, *Economic Journal*,


Robinson, J. 1944. Review of *The US in the World Economy*, *Economic

Journal*, December

Triffin, R. 1957. *Europe and the Money Muddle*, New Haven. Yale UP

Williams, J. H. 1944. *Post-war Monetary Plans*, New York


[*] Institute of Economics, University of Siena.

[1] That this was so did not go unnoticed at the time the IMF Charter was agreed upon. Joan Robinson for instance, remarked 'It is interesting to observe that article VI of the Bretton Woods Documents is drafted in such a way as to leave USA free from any inducement to control capital transfers ... It is symptomatic of the fact that the US authorities have no intention of exercising control over capital movements of any kind, so that the adjustment of new lending to the balance on income account is to be left as heretofore to the chances of *laissez faire*. Even if the "hot money" nuisance were kept within bounds by controls in the deficit countries, the major problem of international lending would still remain to be solved' (Robinson, 1944, p. 435 ff).

[2] There were, of course, exceptions: James Burnham, for instance (1941), predicted the integration of Britain into Europe, the loss of her Empire, and the emergence of three pivots of world trade and economic activity: Europe, the US and the Far East. Claude Guillebaud, on the other hand, had examined, as early as 1940, the need to create, after the war, a *Lebensraum* for Germany in Europe, not very different in scope from the Neue Ordnung.

[3] Not surprisingly, however, a basic agreement with these views was vocally expressed by traditional City and Tory quarters. The *Economist* and the *Financial Times* were the standardbearers of this opinion.

[4] A very balanced assessment of the basic conflict which existed between British and American post-war plans was made by Louis Rasminsky, in a paper presented at Harvard in March 1945 (Rasminsky, 1945).

[5] An exception was represented by D. H. Robertson, who in an address given at Chatham House on 21 June 1945 (Robertson, 1945), voiced a heterodox 'elasticity optimism'. But not even he gave any thought to the need to devalue for capital account considerations, i.e. to restore the pound to a parity more related to the ratio of assets to liabilities.

******************************* 0309-166x/79/010049+13 $02.00/0 (c) 1979 Academic Press Inc. (London) Limited

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