"Origins of the Post-War Payments System" (part 2)

Following my signature is the second (and last) part of de Cecco's
essay.


Bill

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

                                                                      <57>

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

                                                                      <58>

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.

                                                                      <59>

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

                                                                      <60>

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>

Bibliography

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*,
  December

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

Notes

[*] 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.

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