Before we consider the future of the American dollar it
may be wise to cast a glance at the glories of, its past and examine the
main causes that have brought, it to its present humiliating state.
The logical starting point in this examination is
Bretton Woods. When the representatives of some forty nations met there
in 1944, heretical monetary notions were floating in the air. Lord
Keynes, who was there, was their chief spokesman. The most definite of
these notions was that the gold standard was a barbarous relic, and
neither could nor should be restored. It put every national econ-omy in
a strait jacket. It prevented full employment; it strangled eco-nomic
growth; it tied the hands of national monetary managers. And all for no
good reason except an outworn mystique. Besides, there wasn't enough
gold in the world to sustain convertibility.
But because some American Congressmen and some
parliaments were thought to have a lingering prejudice in favor of
seemed prudent to compromise, and to set up something that looked almost
like a gold standard - a thinly gold-plated standard. So, through an
International Monetary Fund (IMF), a "sort of world central bank, every
other currency was to be pegged at a fixed rate to the Almighty Dollar.
Each nation, after fixing an official parity for its currency unit,
pledged itself to maintain that parity by buying or selling dollars. The
dollar alone was to be convertible into gold, at the fixed rate of $35
an ounce. But unlike as in the past, not everybody who held dollars was
to be allowed to convert them on demand into gold; that privilege was
reserved to national central banks or other official institutions.
Thus, everything seemed to be neatly taken care of.
When every other currency was tied to the dollar at a fixed rate, they
were all necessarily tied to each other at fixed rates. Only one
currency was tied to the dreadful discipline of gold, and even that in a
very limited way. Gold was "economized" as never before. It was now the
servant, no longer the master.
Automatic Credit
In addition, the Bretton Woods agreements provided that
if any nation or central bank got into trouble, it was entitled to
automatic credit from the Fund, no questions asked.
Thus, not only released from a strict gold standard,
but tempted to imprudence, individual nations felt free to expand their
paper money and credit supply to meet their own so-called domestic
"needs." The politicians and the monetary managers in practically every
country were infected with a Keynesian or inflationary ideology. They
rationalized budget deficits and continuous monetary and credit
expansion as necessary to maintain "full employment" and "economic
growth." As a consequence, there were soon wholesale devaluation's. The
IMF has published hundreds of thousands of statistics; but the single
figure of how many devaluation's there were between the opening of the
Fund and August 15, 1971, when the dollar itself became officially
inconvertible into gold, the IMF has never published.
There were certainly hundreds of devaluation's. To my
knowledge, practically every currency in the Fund, with the exception of
the dollar, was devalued at least once. The record of the British pound
was much better than that, say, of the French franc, but the pound
itself, which had already been devalued from $4.86 to $4.03 when it
entered the IMF, was devalued again from $4.03 to $2.80 in September
1949 (an action that touched off 25 more devaluation's of other
currencies within a single week), and devalued still again from $2.80 to
$2.40 in November, 1967.
Devaluation, let us remember, is an act of national
bankruptcy. It is a partial repudiation, a government welching on part
of its domestic and foreign obligations. Yet, by repetition by all the
best countries, devaluation acquired a sort of respectability. It became
not a swindle, but a "monetary technique." Until the dollar went off
gold in August 1971 and was devalued in December, we heard incessantly
how "successful" the Bretton Woods system had proved.
During the early part of this period, however, the
world suffered from what everybody called a 14 shortage of dollars." The
London Economist, among others, even solemnly argued that there was now
a Permanent "shortage of dollars." Americans thought so too. Our
monetary managers seemed completely unaware of the tremendous
responsibility we had assumed when we allowed the dollar to become the
standard and the anchor for all the other currencies of the world. Our
money managers never dreamed that it was possible to create an excess of
dollars. They issued and poured out dollars and sent them abroad in
foreign aid. Total disbursements to foreign nations, in the fiscal years
1946 through 1971, came to $138 billion. The total net interest paid on
what the United States borrowed to give away these funds amounted in the
same period to $74 billion, bringing the grand total through the 26-year
period to $213 billion.
This amount was sufficient in itself to account for the
total of our Federal deficits in the 1946-1972 period. The $213 billion
foreign aid total exceeds by $73 billion even the $140 billion increase
in our gross national debt during the same years. Foreign aid was also
sufficient in itself to account for all our balance-of-payments deficits
up to 1970.
Internal Inflation
We created a good deal of this money through internal
inflation. From January 1946 to August 8, 1973, the money supply, as
measured by currency in the hands of the public plus demand bank
deposits, increased from $102 billion to $264 billion, an increase of
$162 billion, or of 159 per cent. In the same period the money supply as
measured by currency plus both demand and time deposits increased from
$132 billion to $549 billion, an increase of $417 billion, or 316 per
cent.
Because of what our monetary authorities believed was
the necessity of keeping this enormous inflation going, they adopted one
expedient after another. In 1963, blaming the deficit in our balance of
payments on private American investment abroad, they put a penalty tax
on purchases of foreign securities. In 1965 they removed the legal
requirement to keep a gold reserve of 25 per cent against Federal
Reserve notes. They resorted to a "two-tier" gold system. Next they
invented Special Drawing Rights, or "paper gold." But all to no avail.
On August 15, 1971, they officially abandoned gold convertibility. They
devalued the dollar by about 8 per cent in December, 1971. They devalued
it again, by 10 per cent more, on February 15, 1973.
Exported Inflation
Before we bring this dismal history any further down to
date, let us pause to examine some of the chief fallacies prevailing
among the world's journalists, politicians, and monetary managers that
have brought us to our present crisis.
Because we were sending so many of our dollars abroad,
the real seriousness of our own inflation was hidden both from our
officials and from the American public. We contended that foreign
inflations were greater than our own, because their official price
indexes were going up more than ours were. What we overlooked what most
Americans still overlook-is that we were exporting part of our inflation
and that foreign countries were importing it.
This happened in two ways. One was through our foreign
aid. We were shipping billions of dollars abroad. Part of these were
being spent in the countries that received them, raising their price
level but not ours. The other way in which we exported inflation was
through the IMF system. Under that system, foreign central banks bought
our dollars to use them as part of their reserves. But in addition,
under the rules of the IMF system, central banks were obliged to buy
dollars, whether they wanted them or not, to keep their own currencies
from going above parity in the foreign exchange market. The result is
that foreign central banks and official institutions today hold some 71
billion of our dollars.
These dollars will eventually come home to buy our
goods or make investments here. When they do, their return will have an
inflationary effect in the United States. Our domestic money supply will
be increased even if our Federal Reserve authorities do nothing to
increase it.
Balance of Payments
The meaning of the "deficit" in our balance of payments
has been grossly misunderstood. It has not been in itself the real
disease, but a symptom of that disease. The real question Americans
should have asked themselves is not what consequences the deficits in
the balance of payments caused, but what caused the deficits. I have
just given part of the answer - our huge foreign aid over the last 27
years, and the obligation of foreign central banks under the Bretton
Woods agreements to buy dollars. But the foreign central banks had to
buy dollars because dollars had become overvalued at their official
rate. They became overvalued because the U.S. was inflating faster than
some other countries.
After the United States formally suspended gold
payments, and after the dollar was twice devalued, foreign banks no
longer felt an obligation to buy dollars. The dollar fell to its market
rate, and as one consequence we again have a monthly excess of exports.
The economists who had all along been demanding the restoration of
free-market exchange rates were right. Now that the dollar is no longer
even nominally convertible into gold there is no longer any excuse for
governments to try to peg their paper currency units to each other at
arbitrarily fixed rates. The IMF system ought to be abandoned. The
International Monetary Fund itself ought to be liquidated. Paper
currencies should be allowed to "float" - that is, people should be
allowed to exchange them at their market rates.
But it is profoundly wrong to assume, as many
economists and laymen unfortunately now do, that daily and hourly
fluctuating market rates for currencies will be alone sufficient to
solve the multitudinous problems of foreign commerce. On the contrary,
these wildly fluctuating rates create a serious impediment to
international trade, travel and investment. They force importers,
exporters, travelers, bankers, and investors either to become unwilling
speculators or to resort to bothersome and costly hedging operations.
With 125 national currencies represented in the IMF, there are some
7,750 changing cross-rates to keep track of, and twice as many if you
state each cross-rate both ways. With a gold standard gone, with the
dollar standard gone, there is no longer a single accepted unit in which
all of these rates can be stated.
Some Gain - Some Loss
It is a great gain when currencies can be exchanged at
their true market rates. Since this has happened the American trade
balance has improved. In the second quarter of 1973, for example, there
was again a surplus of exports. In July, 1973, American exports in
dollar terms were the highest for any single month on record. But it is
one thing to allow trade to improve by abandoning arbitrary pegs on
foreign-exchange rates; it is quite another thing for a country to seek
to increase its exports at the expense of its neighbors by deliberate
devaluation. Yet this is what the United States government has very
foolishly done.
In early August, 1973, Frederick B. Dent, the U. S.
Secretary of Commerce, assured the American public that the
devaluation's of the dollar had provided the nation with a "bright
opportunity." "Without question," he added, "the most important factor
in the improving trade trend is the combination of the two
devaluation's." In fact, the U. S. Department of Commerce placed an
advertisement in the issue of Time of July 2, and in other magazines,
declaring that to the U. S. exporter the devalued dollar means "vastly
improved prospects," that it would help him to capture "a bigger share
of oversea markets," and that it was up to him to "start putting the
devalued dollar to work."
The basic fallacy in this euphoric picture is that it
looks only at the short-run consequences of devaluation and even at
these only as they affect a small segment of the population.
It is true that the first effect of a devaluation, if
it is confined to a single country, is to stimulate that country's
exports. Foreigners can buy that country's products cheaper in terms of
their own money. Thus, as the Department of Commerce's ad correctly
pointed out: "For instance, an American product for which a West German
importer paid 1000 deutsche mark only 18 months ago would now cost him
as little as 770 marks. Or about 23 per cent less than before." So the
American exporter stands to sell more goods abroad at the same price in
dollars, or the same volume of goods in higher prices in dollars, or
something in between, depending on whether his product is competitive or
a quasi-monopoly.
So far, so good. But U. S. exports amount to only 4½
per cent of the gross national product. Now let us enlarge our view. if
the dollar is devalued, say, by a weighted average of 25 per cent in
terms of other currencies, something else happens even on the first day
after devaluation. The prices of all American imports go up by that
percentage (or more precisely, by its converse). Every American consumer
has to pay more, directly or indirectly, for meat, coffee, cocoa, sugar,
metals, newsprint, petroleum, foreign cars, or whatever. Even the
American exporter, as a consumer, has to pay more, and also more for his
imported raw ' materials. So the immediate effect of a devaluation is to
force the consumers of the devaluing nation to work harder to obtain a
smaller consumption than otherwise of imported goods and services. Is it
really a national gain for the American people to sell their own goods
for less and buy foreign goods for more?
The belief that devaluation is a blessing, because it
temporarily enables us to sell more and forces us to buy less, stems
from the old mercantilist fallacy that looked at international trade
only from the standpoint of sellers. it was one of the primary
achievements of the classical economists to explode this fallacy. As
John Stuart Mill said:
The only direct advantage of foreign commerce consist
in the imports. A country obtains things which it either could not have
produced at all, or which it must have produced at a greater expense of
capital and labor than the cost of the thing which it exports to pay for
them. . The vulgar theory disregards this benefit, and deems the
advantage of commerce to reside in the exports: as if not what a country
obtains, but what it parts with, by its foreign trade, was supposed to
constitute the gain to it.
Long-Run Effects
So far I have considered only the immediate effects of
a devaluation. Now let us look at the longer effects. The devaluation or
depreciation of a currency soon leads to a rise of the internal price
level. The prices of imported goods, as I have just pointed out, have a
corresponding rise immediately. The demand for exports rises, and
therefore the prices of export goods rise. This rise of prices leads to
increased borrowing by manufacturers and others to stock the same volume
of raw materials and other inventories. This leads to an expansion of
money and credit which soon makes other prices rise. (Often, of course,
the causation is the other way round: an expansion of a country's
currency and a consequent rise of its internal price level will soon be
reflected in a fall of its currency quotation in the foreign exchange
market.) In brief, internal prices soon adjust to the foreign-exchange
quotation of the currency, or vice versa.
We can see more clearly how this must take place if we
look at a freely transportable international commodity like wheat,
copper, or silver. Let us say, for example, that copper is 50 cents a
pound in New York when the deutsche mark in the foreign exchange market
is 25 cents. Then purchases, sales, and arbitrage transactions will have
brought it about that the price of copper in Munich is four times as
high in marks as in dollars plus costs of transportation.
Suppose the dollar is devalued or depreciated so that
the mark now exchanges for 40 cents. Then, assuming that the price of
copper in terms of marks does not change (and though I have been
specifically mentioning marks, dollars, and copper I intend this as a
hypothetical and not a realistic illustration), purchases, sales, and
arbitrage transactions will now bring it about that the price of copper
in New York will have to rise 60 per cent in terms of dollars. To bring
this new adjustment about, more copper will flow from the U. S. to
Germany. But after this temporary stimulus to American export, the new
price adjustment will bring it about that, other things being equal, the
relative amount of copper exported may be no different than before the
devaluation.
A Brief Period of Transition
I have been speaking of
international commodities, traded on the speculative exchanges, and
easily and quickly transportable. In these commodities the international
price adjustments will take place in a few days or weeks. The price
adjustments of most other goods will, of course, take place more slowly.
The main point to keep in mind is that there is a constant tendency for
the internal purchasing power of a currency to adjust to its
foreign-exchange value and vice versa. In other words, there is a
constant tendency for the internal prices in a country to adjust to the
changing foreign-exchange value of its currency - and vice versa. Though
our modern monetary managers and secretaries of commerce seem to know
nothing about this, the purchasing power theory of the exchanges was
first explained a century and a half ago by Ricardo.
In other words, the alleged foreign trade "advantages"
of a devaluation last for merely a brief transitional period. Depending
on specific conditions, that period may stretch over more than a year or
less than twenty-four hours. It tends to become shorter and shorter for
any given country as depreciation of its currency continues or
devaluation's are repeated. Internal currency depreciation usually lags
behind external depreciation, but the lag tends to diminish.
Statistical studies have been made of the relationships
of the internal and external purchasing power of a currency under
extreme conditions - for instance, the German mark during the 1919-1923
inflation. (See The Economics of Inflation, by Constantino
Bresciani-Turroni, 1937.) It would not be too hard for any competent
statistician, with the help of a copy of International Financial
Statistics, published monthly by the IMF, to put together revealing
comparisons of foreign-exchange rates and internal prices for any
country that publishes reasonably honest wholesale or consumers price
indexes.
It is instructive to recall, incidentally, that at the
height of the German hyperinflation, which eventually brought the mark
to one-trillionth of its former value, monthly exports, measured in
tonnages, fell to less than half of what they had previously been, while
the tonnage of imports doubled or tripled.
In brief, the pursuit of a more "favorable" balance of
payments, or a trade "advantage," through depreciation or devaluation of
one's own currency, is the pursuit of a will-o-the-wisp. Any gain of
exports it brings to the devaluating nation is temporary and transient,
and is paid for at an excessive cost - an internal price rise and all
the economic distortions and social discontent and unrest this brings
about.
The usual criticism of currency devaluation is that it
will provoke reprisals; that other countries will try the same thing,
and the world may be plunged into competitive devaluation's and trade
wars. This objection is, of course, both a valid and a major one. But
what I have been trying to emphasize here is a point that few of our
monetary managers have grasped - that even if there is no retaliation,
devaluation as a deliberate policy pursued for the sake of a foreign
trade gain is self-defeating and stupid. The two American devaluation's,
for example, were monumental blunders. If the world's monetary managers
can be brought to learn this one lesson, the economic and political gain
will be immense.
Remedial Measures
What steps should be taken to halt the present world
inflation and return the world to sound money? The immediate steps are
simple and can be briefly stated The United States - and for that matter
every country - should forthwith allow its citizens to buy, sell, and
make contracts in gold. This would be immediately followed by free gold
markets, which would daily measure the real depreciation in each paper
currency. Gold would immediately become a de facto world currency,
whether "monetized" or not. The metal itself would not necessarily
change hands with each transaction, but gold would become the unit of
account in which prices would be stated. Exporters would be insured
against the depreciation of the currencies in which they were being
paid.
The second (and preferably simultaneous) step can be
stated more briefly still. Every nation should refrain from further
increase in its paper money and bank credit supply.
For the United States a special measure would also be
needed. A hundred billion dollars or more are held by foreign central
banks and foreign citizens. Most of these are no longer wanted. They
dangerously overhang the market, and constantly threaten to bring sudden
and sharp declines in the dollar.
The U. S. government must do two things. It must follow
monetary policies that will assure foreign dollar holders that they are
not holding an asset that is likely to depreciate still further but, on
the contrary, one that is likely to keep its value or even to appreciate
a little. Secondly, the U. S. government should volunteer to fund the
dollar overhang. It could do this by offering foreign central banks
interest-bearing long-term obligations for their liquid dollar holdings
- say, bonds that would be repayable and retirable, principal and
interest, in equal installments over a period of twenty-five or thirty
years. It should preferably negotiate with each country separately, and
should guarantee its bonds by making principal and interest repayable,
at the option of the central bank holding them, in either the face value
of the dollars or in the currency of the country holding them, at the
same ratio to the dollar as of the market rate on the day the agreement
was reached. Thus, the Bank of Japan would be paid off, at its option on
any payment date, either in dollars or in yen; the Bundesbank either in
dollars or in marks; and so on.
Ricardo's Recommendations of a Full Gold Standard
Of course, the world should eventually return to a full
gold standard. A gold standard is needed now for the same reason that
David Ricardo gave for it in 1817:
Though it (paper money) has no intrinsic value, yet, by
limiting its quantity, its value in exchange is as great as an equal
denomination of coin, or of bullion in that coin. . . . Experience,
however, shows that neither a State nor a bank ever have had the
unrestricted power of issuing paper money without abusing that power; in
all States, therefore, the issue of paper money ought to be under some
check and control; and none seems so proper for that purpose as that of
subjecting the issuers of paper money to the obligation of paying their
notes either in gold coin or bullion.
A return to gold will involve some difficult but not
insuperable problems, which we shall not attempt to discuss in detail
here. The main immediate requirement is that individual countries stop
increasing their paper money supplies.
But my topic here is the future of the dollar -not what
it ought to be, but what it is likely to be. And I am obliged to say
that the outlook for the dollar - or, for that matter, of national
currencies anywhere - is hardly bright. The world's currencies will be
what the world's politicians and bureaucrats make them. And the world's
politcians and bureaucrats are still dominated everywhere by an
inflationary ideology. Whatever they say publicly, whatever fair
assurances they give, they still have a mania for inflation, domestic
and international. They are convinced that inflation is necessary to
maintain "full employment" and to continue "economic growth." They will
probably continue to "fight" inflation only with false remedies, like
"income policies" and price controls.
The International Monetary Fund is the central world
factory of inflation. Nearly all the national bureaucrats in charge of
it are determined to continue it. Having destroyed the remnants of the
gold standard by printing too much paper money, they now propose to
substitute Special Drawing Rights, or SDR's, for gold - in other words,
they propose to print more international paper money to serve as the
"reserves" behind still more issues of national paper monies. The first
international step toward sound money, to repeat, would be to abolish
the IMF entirely.
In August, 1973, the present American Secretary of the
Treasury, George P. Schultz, named fourteen men as members of a new
advisory committee on reform of the international monetary system. These
included three former Treasury secretaries, all of whom pursued the very
monetary policies that brought the United States and the world to its
present crisis. The whole list of men in this committee included only
two professional economists. I don't want to attack individuals, but to
my knowledge not a single man appointed to the new panel believes in the
gold standard, has ever advocated its restoration, or has ever spoken
out in clear and unequivocal terms even against the chronic increase in
paper money issues. But the climate of opinion is now such in the United
States that I must confess I would find myself hard put to it to name as
many as fourteen qualified Americans who could be counted on to
recommend a sound international monetary reform.
The truth is that everybody is afraid of a return to
sound money. Nobody in power wants to give up inflation altogether
because he fears its abandonment would be followed by a recession. It's
true that if we stopped inflation forthwith we might have a recession,
for much the same reasons as a heroin addict, deprived of his drug,
might suffer agonizing withdrawal symptoms. But such a recession, even
if it came, would be a very minor and transient evil compared with the
catastrophe toward which the world is now plunging.
At the time of the original publication, Mr. Hazlitt
was the well-known economist, columnist, editor, lecturer and author
of numerous books, including What
You Should Know About Inflation.
This article is from a paper
delivered at a regional meeting of the Mont Pelerin Society in
Guatemala, September 4, 1973.
Reprinted with permission from The
Freeman, a publication of The Foundation for Economic Education, Inc.,
January 1974 Vol. 24, No.1.
Yourname@libertyhaven.com
