OF ALL the main features of the Young Plan, the Bank for International Settlements was the only one upon which the Committee of Experts were agreed practically from the start. Whereas the strictly reparation features of the plan took the experts some seventeen weeks to bring to the point of agreement, they accepted the general framework of the bank within four. In one sense this prompt action was due to the fact that the work planned for the bank in connection with reparations was mainly administrative, and so stood outside the principal field of controversy. But it was also true that its non-reparation functions were designed to satisfy existing needs and so fell in appropriately with hopes and aspirations for anew financial order.

Between these two sets of functions a sharp line should be drawn. While the development of the reparations problem fixed the time and occasion for setting up the bank, and while reparations were expected to furnish it with the nucleus of its business during its formative years, it was believed that as the bank's other functions grew the administration of reparations would sink into secondary importance. It is these other functions, indeed, which justify its structure and the character of its management, and it is to them that one must look for its future importance. Many of them are still in their primary stages of development; but they give the bank its main points of interest for any observer of international financial relations.

Before moving to a consideration of some of these other functions one must recall the set of circumstances which led up to the establishment of the bank. At a very early stage in the work of the Experts' Committee, which met in Paris in February 1929, it was clear that some sort of an organization or institution would have to be created to handle the receipt and distribution of German reparation payments. At the cornerstone of the Young Plan was the intention of relieving Germany of all foreign commissions and agencies of control. This meant winding up the Reparation Commission, which had attempted to combine the functions of a tribunal with those of financial administration, and doing away with the Office for Reparation Payments in Berlin, which had been charged with the duty, among others, of transferring the reparation annuities to the foreign creditors. The abolition of these agencies left a gap; for while the Young Plan placed upon Germany the entire responsibility for the collection and transfer of reparation funds, it was still necessary to have an institution outside of Germany which should carry out for the creditors the various functions connected with receipt and distribution, including mobilization -- that is to say, the public issue of bonds capitalizing a part of the reparation annuities.

Except for the size of the operations involved there was nothing in these remnant reparation functions that was foreign to ordinary banking practice. But since no bank existed to which the countries concerned were prepared to commit the business, a new institution had to be created. By the middle of March 1929, the Experts agreed to a rough outline which summed up in general terms the functions proposed for the bank, both those which had to do with reparations and those which entered upon new fields of banking policy and practice. It is fortunate that agreement was reached thus early upon the broad conception of the bank, for it was possible during the remaining weeks of the conference, which did not terminate until June 7, 1929, to draw up the specific scheme for the bank's future activities in an atmosphere detached from the acrimonious debate which almost every other feature of the Young Plan encountered.

The government representatives, meeting the following summer in The Hague, accepted in principle the plan for the bank, and set in motion the machinery for summoning the Organization Committee which was to consider the plan in all its details and put it in legal form. The Committee met in Baden Baden during October and November 1929; it drew up the charter and statutes, and drafted a contract to be executed by the creditor governments with the bank, fixing its status as trustee for the receipt and distribution of reparation funds. The representatives of the governments, meeting again at The Hague in January 1930, gave these documents in finished form their final assent. The bank opened for business on May 20, 1930, at Basle, Switzerland.

II

The years before the war were years of comparative ease for the central banks. In England, France and Germany, for example, central banking was carried on according to well-tried principles which placed full reliance upon the nearly automatic operation of the gold standard. In the United States there was then no central bank at all. But the extraordinary series of emergencies which the war created and which continued long after the war was over -- immense pressure on the gold stocks, currency expansion, inflation, instability of the foreign exchanges, collapse of entire currency and credit systems, deflation and stabilization -- all of these emergencies called for understanding and collaboration between central banks, for no country was exempt from their consequences whether derived from domestic causes or not. Accordingly, informal relationships developed between the principal central bankers in the effort to effect some working basis for the settlement of common problems. The establishment of the Federal Reserve Banks a few months after the war began and the rapid advance of the United States as an international credit centre brought the American banking system into the international arena of credit discussion and planning.

As at first carried on, these informal relationships were mostly a matter of visits and correspondence. The visits in particular proved a valuable means of furthering collaboration among central banks, and often served to create a common understanding of conditions special to the several countries or, it might be, of international concern.

But they had their drawbacks. Visits made over great distances by the governors of central banks, whose duties at home involved great responsibilities, consumed an undue amount of time; and whenever they attracted public notice it was assumed that the objects sought were even more important than the matters left behind. In the beginning some success was achieved in keeping such visits secret; but as time went on and the circle of the well-informed widened, their furtive character inevitably encouraged curiosity and finally suspicion. It is fair to say that latterly, and perhaps at an earlier stage also, the subjects discussed were far less concrete and less productive of agreement on specific courses of action than the public has been led to believe.

When the time came to plan the Bank for International Settlements it was clear that its operations must not run counter to the policies of the central banks, certainly within any central bank's own market. Accordingly, specific provisions were written into the plan and the statutes which effectively prevent the bank from operating in any market if the central bank concerned objects. But this negative protection was not enough. The purpose was to make the bank a positive agency of collaboration between central banks and so to further central banking solidarity. It was this intention, quite as much as the desire to rid the bank of political entanglements, that led to placing its management in the hands of the central banks. The means used for realizing this purpose was to frame the board of directors around the governors of the central banks themselves. Under the statutes the heads of the central banks of Belgium, France, Germany, Great Britain, Italy, Japan and the United States each receive designation, if they choose to accept it, as ex-officio members of the board; and they are qualified, if they desire, to dominate the selection of the eighteen additional members.

The administration of the Bank for International Settlements, its policy and all of its operations, are subject to the approval of this board of directors and hence of the central banks. Even changes in its statutes cannot be made unless a two-thirds majority of its members agrees. Furthermore, by reason of the provision giving any central bank the general power of veto over any operation which the Bank for International Settlements may contemplate undertaking in its market, any central bank governor sitting on the board has complete protection against his colleagues if he is out-voted.

Because of the positive advantages accruing from membership on the board, and because also of the measures of protection afforded, it is difficult to see on what valid ground the administration at Washington acted when it declared itself opposed to participation in the Bank for International Settlements by a Federal Reserve Bank. By reason of that opposition the two American directors of the Bank for International Settlements -- who are also its President and Alternate to the President -- were not appointed by the Governor of the Federal Reserve Bank of New York, but were elected by five European central banks and the Bank of Japan. As matters have worked out, the loss is not to the Bank for International Settlements but to the Federal Reserve system, because it is impossible for it to maintain directly the natural and useful contact with world-wide financial conditions which participation in the bank would have afforded it.

The economic world has become too closely knit to make a policy of separatism profitable. No market is exempt, save over short periods of time, from the ills or the good fortune prevailing in another. Through ignorance or misunderstanding, salutary measures undertaken in one country may be neutralized by action elsewhere; or, on the other hand, measures deemed necessary in one country may work harm to its neighbor unless the danger is foreseen and guarded against. The economic tide never ebbs and flows at the same time in all countries; its movement is progressive, and early knowledge of its magnitude and direction is essential to intelligent financial administration. The periodic meetings of the directors of the bank, conducted in an atmosphere of collaboration, give the opportunity to exchange opinions and information, to understand personalities and purposes, and to make common plans when such are called for. These interchanges take place quite aside from what may be set out in the order of business for the day.

III

A distinguished banker of a former generation, much impressed at the spectacle of gold crossing the Atlantic in opposite directions at the same time, proposed a remedy for the losses which such movements involve. "I would take all the gold in the world," said he, "and put it on a desert island in the middle of the ocean. I would place it all in boxes, each labelled with the name of the nation owning it. I would then put a hermit in charge, and his sole duty would be to change from day to day the names on the boxes."

In this proposal lay the germ of the idea of an international gold settlement fund, an idea which has appealed for many years to practical bankers and theorists alike. Its purpose is partly one of economy, for it would substitute a simple system of debits and credits for the expensive operations of physical shipment, involving losses of interest, charges for freight and insurance, and so on. Since marginal amounts of gold are almost always under way from country to country, and since the receiver of today is often the shipper of tomorrow, it has seemed entirely within the field of modern banking practice to halt the shipments and effect the corresponding settlements on the books of a central agency. The Secretary of the Treasury of the United States, drawing conclusions from the events of the 1907 panic, declared himself prepared to consider proposals for setting up such a procedure. In its report for 1918, covering a still more difficult period, the Federal Reserve Board said it was ready, "if authorized to do so, to undertake negotiations looking to the establishment of an international gold exchange fund, or to assist in any way in its power in negotiations which may be begun by a government department looking to that end."

In the plan and statutes of the Bank for International Settlements the board of directors has ample authority to establish and operate within its discretion and under its regulations a gold settlement fund for the purpose of clearing accounts among central banks. Furthermore, supplementing its general power to receive and make deposits, the bank also has authority to set up a system of international clearings by the simple expedient of debiting and crediting on its books the accounts of central banks.

The Bank for International Settlements has already made a start in both directions. But the problems involved in operation are far more complex than the simple statement of powers implies. Their nature becomes manifest when one considers what becomes of the savings effected. In the case of a settlement obviating a shipment of gold, the savings would be approximately identical with the costs of freight and insurance, interest on the money value of the gold during transport, and incidental costs of handling and assay. In the case of a settlement effected when foreign exchange quotations are above the point at which gold shipments are commercially profitable, the savings would still be considerable. If one assumes for the moment that francs are obtainable below par in New York, and are convertible through the mechanism of the settlement fund into gold at par in New York, the savings would amount of course to the prevailing market depreciation of the franc. But difficulties enter at once when one asks the question, Who gets the benefit of the savings?

Suppose, for example, that the Bank for International Settlements takes all the savings to itself. In such case it is hard to see why any central bank should have much incentive to make use of its clearing system, because quite as good results in a money sense could be obtained by following the ordinary market procedure. Accordingly, the clearing system would be abortive from the start, and if the Bank for International Settlements undertook any such transaction upon its own initiative it would place itself in the impossible position of having intervened in the foreign exchange market for its own profit -- a motive which the bank's quasi-public character largely excludes from determining its procedures.

Assume, in the second place, that the Bank for International Settlements takes none of the savings for itself, but passes them over in full to the central bank or banks interested in the transaction. The effect of this would be merely to transfer to the profit accounts of central banks the sums now distributed through a variety of hands, and would give no benefit at all to the vast number of banks, shippers and individuals who are more or less constantly engaged in international money transactions. Stating the case in another way, central banks would settle accounts with each other at par, but transactions of others would be subject to discount or premiums as at present.

Suppose, again, that the settlement fund is operated not for the benefit of the Bank for International Settlements or the central banks, but through them for the benefit of all who hold the currency of one country and require the currency of another. This would mean par settlements among all the countries participating in the fund, and would have the effect of eliminating time and space from international payments. Through the gold settlement fund of the Federal Reserve Banks much the same thing is in fact accomplished within the borders of the United States, to the great advantage of American commerce. But the international application of the principle is open to question on several grounds. At the present time the central banks of certain countries have difficulties enough in maintaining their stocks of gold within the statutory limits. Since a currency must fall to a certain discount in the foreign exchange market before gold flows away, there is a small element of protection to the gold stock which would not exist if settlements could be effected at par. In the next place, a visible outflow of gold is still believed to exert a salutary psychological influence on speculation and credit expansion, an effect which might be impaired if the gold were less vividly piped away on the books of an international settlement fund.

Thus there are good arguments against each of the assumed arrangements for dealing with the savings derivable from a gold settlement fund operated by the Bank for International Settlements. But while each proposal taken by itself presents difficulties which for the moment appear insurmountable, all three in combination suggest a workable solution. It cannot be presumed, certainly short of practical test, that any settlement fund will completely eliminate shipments of gold between important financial centers. Accordingly, the Bank for International Settlements should have such share in the savings as will compensate it for the charges on any marginal shipments which it might have to undertake, and beyond this should receive a reasonable fee for its services. The central banks, being charged with the duty above all others of preserving the convertibility of their notes, should have the right to retain out of the present system certain of the advantages it holds from the protection of the gold stock. That implies that each central bank should be able to specify the rates at which it will receive or provide foreign currencies through the mechanism of the fund; but in order that maximum advantages should be passed on to international trade, these rates should gradually approach par. Such a flexible arrangement permits the central banks to maintain control and to adjust their operations to the new conditions in the light of experience.

The effect of this program is to narrow the margin between the gold points -- that is to say, the points in foreign exchange fluctuations at which gold leaves a country and the point at which it enters. But there is nothing new or subversive about such a result. The mobility of gold, in fact, has increased progressively for many years if for no other reason because of technical improvements in transportation. The use of the airplane for moving gold between European countries and the multiplication of fast ships across the Atlantic have both resulted in bringing the gold points nearer together. But these are extraneous causes and unlike the method proposed stand outside the field of central banking influence.

The international settlement fund, if eventually the Bank for International Settlements establishes it, would not -- and it ought not if it could -- keep weak currencies on the gold standard or reëstablish the gold standard in countries not now observing it. But it would effect certain savings, it would reduce the range of foreign exchange fluctuations and make it easier to convert one currency into another. It would give the banker greater assurance that funds invested in a foreign country would not suffer marginal depreciation, and it would give the exporting merchant a more exact expectation with regard to the sums receivable in return for his goods. Like a new means of transportation, it would bring new business with it, and so it would play a part in developing the interchange between nations of goods and money.

IV

Dislocated credit, itself an aftermath of the war, is at the same time one of the factors which prolong the present period of depression. Like many other economic phenomena it is both an effect and a cause, and with certain companion ills it is disposed to function in a vicious circle. Ingenious efforts have been made to break the circle, and other measures have been proposed; but for the most part relief has been left to the slow operation of natural forces -- that is to say, to the complex of motives and actions, of trial and error, which in sum total represent the individual efforts of men to extract themselves from unhappy situations.

The evidence of credit dislocation is to be found, of course, in the vast volume of idle funds awaiting safe and profitable employment in some countries, while in others even essential enterprises suffer from lack of funds. The conduits which in normal circumstances would serve to distribute the excess have largely ceased to function and occasionally even work in the wrong direction, bringing funds from capital-poor markets to those already oversupplied. The explanation is as diverse as the times -- incomplete recuperation from the war, political instability, the desire for security, the elimination of entire nations as free markets, the speculative collapse, the desire to escape taxation, the payment of debt, and a whole row of economic maladjustments. The question that at once presents itself is whether any single agency can summon enough authority to combat or direct the powerful forces now operating, or whether they must be left to work to their own conclusions.

It would be wrong to assume that the Bank for International Settlements has the powers or thus far the experience to make itself such an agency. Yet there is no denying that one of its functions is to relieve credit dislocation, to build a bridge between countries overstocked with credit to those understocked with it. The limitations on its action are those inherent in any credit transaction: the nature and volume of the funds it has to lend, and the fair capacity of the borrower to repay.

The credit-giving powers of the bank are not restricted to any one country, yet the special position of Germany as the country paying reparations makes credit conditions there a matter of particular concern to the bank, and they were so recognized in the Young Plan. During 1930 and up to the present time German credit conditions have been singularly difficult, inasmuch as the pressure on the money markets inherent in the payment of reparations has been aggravated by a large amount of short-dated debt awaiting conversion into long-term debt. By reason of the unwillingness of the American investor to buy foreign bonds, the market for German long-term securities in the United States has been practically closed for nearly a year, and except for scattering amounts of bonds sold in the Swiss, Scandinavian and Dutch markets, Germany has had very little assistance from other quarters. Foreign banks and bankers, it is true, have granted large credits to Germany, but their character as short-term loans failed to meet the principal and pressing need.

The shortage of long-term credits and the pressure exerted on the entire economy from other sources have had profound political consequences. The sudden success achieved by the National Socialists in the Reichstag elections of last autumn, while in the nature of a general protest, was nevertheless due in part to these special conditions. The latent capacity of these and other radical elements to precipitate public disturbances, having a distinct economic basis, will constitute a threat to the stability of republican institutions in Germany until the economic situation clears. The immense volume of short-dated debt owing to foreigners constitutes of itself a special and baffling phase of the problem. Foreign deposits in German banks and other forms of short-term loans from abroad, being subject to prompt withdrawal or cancellation, hamper political action and make it extraordinarily difficult to pursue any program which arouses political opposition abroad or causes alarm to foreign lenders. On two occasions since 1929, once when it appeared that the reparation conference in Paris had failed and again in the autumn of 1930 when the successes of the National Socialists at the polls aroused general apprehension both in Germany and abroad, the foreign-held short debt proved a serious menace to the economic welfare of the country. Large sums were withdrawn by foreigners, and the outward movement was augmented by the action of German depositors themselves, who took alarm and began sending balances abroad.

All of this shows how necessary it is, on both economic and political grounds, for the two fields overlap, to proceed as promptly as possible with the conversion of the German short-dated debt. But it should not be assumed that exigencies of this sort are to be found exclusively in Germany. They are perhaps even more acute elsewhere, as for example among many of Germany's neighbors in Central Europe from the Baltic to the Mediterranean and in almost the whole continent of South America. Relief can come ultimately, of course, through the slow and painful process of saving and liquidation, but the duration and costs of such a procedure can be contemplated only with grave concern. The better prospect, if it can be realized, is to reopen the credit markets and restore normal relationships between lenders and borrowers at long term.

What, if anything, can the Bank for International Settlements do toward bringing about this result? It has, as a matter of fact, invested moderate amounts at long term out of its own funds available for that purpose, and it has given oral and practical encouragement to various projects designed to effect conversion and to bring about long-term investment in countries over-burdened with short debt. But the question is larger than that.

The fact is, of course, that the Bank for International Settlements faces in this crisis a problem requiring for its solution the exercise of powers outside the range of its normal activities and in some sense antagonistic to them. Of all banks in the world, the Bank for International Settlements is probably least justified in committing the cardinal banking error of borrowing short and lending long -- of using funds deposited with it, for instance, as the material for making long-term loans. The reason for this is clear. The Bank for International Settlements is a depositary for central banks, and for such of them as operate on the gold exchange standard it is a holder of part of their statutory reserves. Accordingly, it must exercise special care not to invest its funds for periods beyond the nearest date when they may be called for. Its liquidity must be absolute and complete, a requirement which makes it doubtful whether it will be able during its formative years to exercise a right granted to it in its statutes of issuing its own bonds and using the proceeds for long-term loans -- at any rate for loans running beyond three years.

It is fair, therefore, to rule out any major intervention by the bank in the present crisis if this involves the direct or contingent use of its own credit. Nevertheless, the international character of the bank, the high hopes that were held out for it at the time of the Paris conference and thereafter, its independence and its influence, all create in the public mind the presumption that it can and will act in such an emergency as now exists. The tacit obligation thus incurred cannot be dismissed on technical grounds; instead, the technical grounds prescribe and in a sense limit the form which the relief can take.

The dilemma arising on the one hand from the character of the bank as a depositary for central banks, and on the other from its responsibilities with respect to relieving credit dislocation, was foreseen in 1929 at the Paris conference. In order to reconcile these two sets of obligations a collateral institution was proposed which should be capable of granting long-term credits on its own responsibility and at its own risk. The board of directors of the bank were to have the right to decide within their discretion as to the measure of participation which the bank should have in the proposed institution. The proposal met with opposition in the last days of the conference, but while the clause giving the specific authority was eliminated, the general powers of the board of directors were left broad enough to allow them to act whenever occasion should arise. This remains true under the statutes of the bank as they now exist.

In recent months projects for a collateral institution similar to the one proposed at Paris, and there rejected, have reappeared spontaneously in several European countries, and in one form or another have obtained influential support, particularly in England. The idea as at present conceived is that an institution should be created with its own capital stock, to be subscribed by leading banks and possibly industrial corporations, with authority to issue bonds in its own name, and with the power to grant long-term credits or buy securities in the market. The relation of the Bank for International Settlements to the proposed institution would be of a practical and coöperative character, but sufficiently remote in a financial sense so that it would be relieved of responsibility, moral or otherwise, with respect to the repayment of the obligations to be issued. In this way the technical obligations of the bank would be respected.

Both practical and partisan obstacles stand in the way of establishing such an institution. It is at best a mechanism, but its invaluable function would be to concentrate and accelerate forces now scattered and therefore ineffective. Anyone who recognizes the needs that exist in Central Europe and elsewhere must give the project sympathetic attention, and more particularly those who are sensible of the unspecified but none the less urgent responsibilities of the bank.

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  • SHEPARD MORGAN, Vice-President of the Chase National Bank; formerly Finance Director of the office for Reparation Payments; author of the B. I. S. sections of the Young Plan
  • More By Shepard Morgan