Courtesy Reuters

Prerequisites to Monetary Stabilization

THE international gold standard worked reasonably well before the World War -- so well, indeed, that with hardly a dissenting voice it was reëstablished at the earliest possible moment after peace had been made. The return was accomplished in the belief that monetary stability would provide a basis for necessary readjustments in the wider field of financial and trading relationships which had been distorted during the conflict and the years immediately following. These anticipations were grievously disappointed. The restored gold standard did not prove an effective means of promoting economic stability, and, within a decade, it was everywhere abandoned. In some countries the action was unavoidable; in others it was taken as a voluntary measure of monetary policy.

This striking difference in the results obtained from the gold standard in the prewar and postwar periods was not primarily due to intervening changes of a monetary character such as variations in the amount of monetary gold stocks, in exchange parities, in banking organization and in credit policies. The gold standard worked well in the prewar period because all the more important commercial countries were not far from financial and trading equilibrium. This position was maintained through the persuasive influence exerted under the gold standard, tending to check departures from equilibrium before they became so extreme as to involve difficult changes in costs and in the employment of labor and capital. Of course, payments were never in exact balance. Now one country and then another would experience an unfavorable balance of payments, reflecting fluctuations in export and import trade, tourists expenditures, shipping charges and the like, as well as on account of capital movements. But such unbalanced situations did not become so extreme as to require intolerably difficult changes in the structure of costs and prices. In the postwar period the departure from equilibrium was so extreme that adjustments under the pressure exerted by gold movements seemed impracticable. Immediate collapse was threatened. At all events, policies of coöperative support were adopted by the central banks in the hope that somehow adjustments would of themselves be made. Broadly speaking, the result was a still further departure from equilibrium. Typical manifestations were a large increase in the foreign indebtedness of many countries and a persistent and growing maldistribution of monetary gold stocks. The experience of those years surely leads to the inevitable conclusion that a reasonably close approach to equilibrium must be reached before there can be established an international monetary system which promises to yield satisfactory results and to be permanent. An international monetary system is a means of maintaining equilibrium; it cannot create equilibrium. And it must be further borne in mind that this equilibrium must be established within nations as well as between nations. Domestic conditions must be sufficiently sound to allow continuous adjustments to be made.

In view of recent unhappy experiences with the restored gold standard, it would seem certain that monetary stabilization in the future can be achieved only gradually, as trade recovery proceeds and as international financial and trading equilibrium is by degrees restored. When we examine the stabilization question in the light of this assumption we find that three problems require consideration. We must determine, first, how far from stabilization we now are; secondly, whether we are moving toward a better balance in trade and finance, both internal and external, a development which we may expect to see accompanied and furthered by greater monetary stability; and, finally, in the event that a reasonable measure of de facto stability should be reached, whether definitive stabilization will be desirable.

Two distinct courses have been taken by countries which have abandoned the gold standard. When they departed from gold, some (as, for example, the United Kingdom) went upon an inconvertible paper basis. Others have remained on gold, but with a lower gold content for their monetary unit. These, by appropriate legislation, expressly reserved the power to make further changes. Such, after a short interval of inconvertibility, was the course taken by the United States. We have a gold basis for our currency; but we certainly cannot say that we have more than a temporary or uncertain gold standard. Even so, it does provide some ground for the expectation of de facto stability. This must be maintained if any progress is to be made in the near future toward international stability, for the American currency is the only one which, at present rates, and under existing conditions, is in a superlatively strong position relative to other currencies. In these circumstances, any fresh revaluation of the dollar would inevitably set in motion a further series of revaluations elsewhere, and these would defer indefinitely all possibility of establishing settled currency relationships.

Those countries other than the United States which have remained on gold, though with their money units at a lower gold valuation, seem to have had no alternative open to them. For budgetary and other reasons, confidence in those currencies would have been dangerously weakened if the tie with gold had been broken even temporarily. As all of these countries have only recently revalued, sufficient time has not yet elapsed to determine whether the new values are appropriate to existing and prospective conditions. Further modifications in the present values of some of these currencies would not be inconsistent with progress in the direction of general monetary stability.

An intermediate position is occupied by the United Kingdom and the countries of the sterling area which are still upon an inconvertible paper basis. In all these nations, confidence was sufficiently strong to permit of a departure from gold without danger of a collapse of currency values. As these countries were the first to leave the gold standard, it might be supposed that the value of their currencies would by now have been adequately tested. Such, indeed, has been the case as regards the relationship of these currencies among themselves. In that respect they have been almost as steady during the last two years as if they had been upon gold; and apparently they have achieved this without difficulty and to the accompaniment of a good measure of business recovery. But during these same years, sterling, and with it the currencies of the sterling area, have fluctuated rather widely in relation to the dollar. The extreme range of the pound has been from $4.70 to $5.06. It cannot be said, then, that an appropriate rate for sterling has been indicated by actual experience. In particular, it should be noted that a special influence favorable to sterling was modified, if not removed, upon the realignment of the gold block currencies last September.

Evidently the next step toward monetary stability involves the determination (if that be possible) of an appropriate sterling-dollar rate in existing circumstances. This does not mean the immediate adoption of a new gold content for the pound. If Great Britain followed the example of the United States, that would mean a rate so far below the existing rate for sterling as to set in motion a new series of revaluations everywhere. The proper sterling-dollar rate can be found only as a result of reasonable efforts to maintain some rate sufficiently long to make evident whether it is or is not appropriate. This implies that Britain would adopt, in case of weakness in the foreign exchanges, measures similar to those that would be taken if the country were on a gold basis, i.e. short-term money rates would be advanced, though not perhaps so far as might be done under traditional gold standard practice. If, in spite of moderate advances in rates, a considerable loss of gold occurred, without any coincident reduction in foreign funds in the London market, this experience would offer convincing evidence that a lower rate for sterling was required. On the other hand, if no serious effort is to be made by British monetary authorities to test sterling, if at all costs a policy of abnormally low interest rates is to be pursued, then progress toward monetary stability will be deferred indefinitely.

At this point something should be said of the influence that governmental stabilization funds and agreements can exert in bringing about monetary stability. Much can be accomplished through a stabilization fund when a currency is inconvertible. The fund can be used to acquire gold or foreign currencies when the exchanges are strong, and the gold or currencies thus acquired can be employed to moderate declining tendencies. In the case of a country which is firmly on gold (like the United States), it is hardly too much to say that a stabilization fund is a superfluous mechanism. Gold would move in and out of the country if the business were left to the banks as in former times. Only in the event that the fund is used to acquire and to hold balances in foreign markets which the banks would not venture to acquire, can the fund exert a special influence; but this is a practice which on a large scale is undesirable and which, we may surmise, our Treasury would not embark upon. In view of the transfer of the conduct of monetary policy from the reserve banks to the Treasury, the understandings between it and certain foreign governments are to be welcomed. The main advantage presumably will be to prevent misunderstandings and to establish between the various treasuries the sort of relationships which central banks have long maintained. It is to be hoped that both the American and British Governments have the definite objective of arriving at an appropriate sterling rate. A rate which is too high to be maintained is to no one's advantage. On the other hand, an unduly low rate threatens, as was said above, a new series of revaluations. With the best will in the world, and with the use of all available data regarding costs, prices, foreign trade and movements of funds, it is not possible to fix an appropriate rate for sterling in advance. That, as already noted, can be determined only by actual experience. Only when $4.86, or some higher or lower rate, has been held without serious difficulty, accompanied by a well-maintained and broadened improvement in trade, can we say that it is an equilibrium rate. Happily the appropriate rate will probably prove to be not so far from the existing rate as to impose on other countries the necessity for further currency revaluation. The accuracy of this forecast, however, depends upon the extent to which general financial and industrial equilibrium has been restored.

Certainly the world has made much progress toward equilibrium since the beginning of the depression and the departure of the first group of countries from gold. The cessation of foreign lending that came in 1931, though in many cases it precipitated a collapse, was needed. It brought about, inter alia, the discontinuance of reparations and war debt payments -- payments for which no trade adjustments whatever had been made. The cessation of foreign loans contributed perhaps even more than the departure from gold to make possible low interest rates, particularly in England, and it also stimulated the very desirable diversion of capital into the production of goods and services for home use. In the twenties both production and investment were too greatly influenced by the illusory belief that old channels of trade could and must be restored. The wants of consumers were faultily analyzed. In all the more advanced countries, most of the goods for which there is an elastic demand are necessarily produced locally -- e.g. those involved in providing heating, plumbing, lighting, shelter, and entertainment, in contrast with, let us say, tea and coffee, which require exports in payment. Moreover, an increased demand for raw materials in manufacturing areas provides a sounder basis for trade than a demand that rests largely upon the granting of loans to distant borrowers, whether they be governments or business undertakings. Other factors that have brought about a closer approach to equilibrium have been the liquidation of debt and the scaling down of fixed charges, both of them developments which customarily occur in depressions, though on this occasion they were doubtless facilitated in some countries by the relief afforded through the departure from the gold standard.

These financial and industrial adjustments have by no means been carried through to the same extent in all countries. But they do seem to have gone far enough in a sufficiently large number of countries to warrant the belief that, with an appropriate rate for sterling, de facto stability might be maintained even though some countries were still unable to participate. One small country, Belgium, has successfully maintained itself on a fixed gold basis since revaluation in the spring of 1935. The Netherlands, Java and Switzerland can unquestionably do likewise when they have adopted a definite gold content for their monetary units. The United States, of course, rests firmly -- one is tempted to say almost too firmly -- upon its present gold foundation. The Canadian currency has fluctuated but slightly in relation to the American dollar. If now a stable sterling-dollar rate not far from the existing rate should be found appropriate, all the countries of the vast sterling area might continue to maintain their present stable relationship to the pound. The sterling area includes the entire British Empire, aside from Canada, and the Scandinavian countries. In addition, Japan and Argentina (though not without exchange restrictions) may be mentioned as countries which in practise maintain a stable relationship with sterling. Perhaps no one of these countries, whether those in the sterling group or those previously mentioned, have completely emerged from the depression; but quite certainly they are in no danger of such catastrophic difficulties as marked the depression's initial stages. They all seem in position to test their ability to maintain stable monetary relationships with each other; and they make up so much of the world that they are able to meet possible continued instability elsewhere without resort to further depreciation.

It seems a reasonably safe conclusion, therefore, that progress toward greater monetary stability is both feasible and probable in the immediate future. But what of the more distant future? Can an international gold standard, perhaps with some modifications designed to afford greater elasticity, be reëstablished in the conditions which obtain in the modern world? We must recognize at the outset that, even if there were no other obstacles, confidence in the permanence of any definite stabilization will be far less than it was in the twenties. Then it was everywhere believed that the world would surely remain on gold indefinitely, or at least until the outbreak of another war. The fear of war is itself a new and disturbing factor. In the pre-war period there was far less expectation of war than at present; and the probable consequences of war, both economic and social, were but dimly perceived. The possibility that there might be revolutionary changes, whether to the right or to the left, seemed to lie too far in the future for it to effect monetary policies. Considerations of this character suggest that the credit structure in each country must rest for a given degree of strength more completely upon its own gold resources than was perhaps necessary in the pre-war period. This is particularly true of the British credit structure which, as events in 1931 indicated, could not as in former times adjust itself to strains by means of moderate changes in discount rates.

There is every reason to suppose, however, that monetary gold stocks will be sufficiently large to meet the requirements. As a result of revaluation, of the outflow of gold from non-monetary stocks in India, and of a very general increase in gold production, the gold foundation for the credit structure of the world is far more ample than it used to be. Indeed, it is so large as to suggest the possible danger of world-wide price inflation. This gold still is unevenly distributed, the United States holding some three-fifths of the total. Redistribution by means of loans will serve no useful purpose, however, until other countries succeed in developing a sufficiently favorable balance of payments to be able at least to acquire the gold currently produced from the mines. The ability to do so must be clearly evidenced before definite stabilization plans can be seriously considered.

It remains to inquire whether the economic structure of the world may not have become so complicated and rigid that satisfactory results cannot be expected from a return to the pre-war gold standard even if gold supplies are ample, parities appropriate, and a close approach to equilibrium has been reached. Many who have entertained this doubt have suggested a modified gold standard, with each country reserving the power to change the gold content of its monetary unit when not to do so would force it to attempt difficult changes in its cost and price structure.

This proposal is open to the objection that it would almost certainly lead to a general revaluation of currencies whenever any one important country resorted to revaluation. Obviously a slight revaluation, of the order of one or two percent, would only slightly benefit a country which required considerable reductions in costs and prices in order to maintain equilibrium. But a change of let us say ten percent would certainly force other countries from equilibrium and lead them to take similar action.

The proposal to adopt variable gold parities is objectionable for another and even more fundamental reason. It would weaken the most desirable single quality possessed by the pre-war standard -- its restraining influence in periods of activity. The imposition of restraint at such times is always unwelcome; any lessening of the evident necessity for taking restraining action would be a step in the wrong direction. Experience does not suggest that persistent efforts to maintain easy money conditions during boom periods would have done more than defer the advent of depression. At such times there is small likelihood that maladjustments will be removed under the influence of easy money and the expectation of its continuance, largely because of the tendency of most people to move in herds. They continue to invest more and more capital and labor in the ways that are currently profitable. Some testing of the situation from time to time is in the interest of economic stability. The frequent changes in short-term money rates during the decade and more preceding the World War were not inconsistent with a general economic advance. And again, taking a more recent instance, surely restraint imposed as early as 1928 in the United States would have been helpful in moderating security speculation, and in checking over-development in urban and suburban real estate. Under a policy of credit restraint, reparation and war debt payments would doubtless have ceased at an earlier date and also the flow of British and American funds to foreign countries. Presumably the gold standard would have been abandoned earlier; but in these circumstances the depression itself would unquestionably have been less severe.

As was said at the outset, the international gold standard cannot create economic equilibrium. But that standard without essential change would still seem capable of doing more to maintain equilibrium than can reasonably be expected from it if it is so modified that it loses its restraining influence in periods of business activity. Obviously, the international gold standard cannot be reëstablished at once. Its reëstablishment may, indeed, be a distant objective. But to adopt it as an objective will exercise a more beneficent influence on the immediate course of events than to entertain the more elastic monetary objectives suggested by the emergency requirements of an unprecedented depression.

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