"Origins of the Post-War Payments System" (part 1)

Following my signature is the first part of Marcello de Cecco's fine
essay "Origins of the Post-War Payments System", which appeared in
volume 3 of the 1979 *Cambridge Journal of Economics*.


Bill

*Cambridge Journal of Economics* 1979, 3, 49-61                       <49>

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]

                                                                      <52>

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.

                                                                      <53>

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

                                                                      <54>

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-

                                                                      <55>

     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.

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.

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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.