THRICE since the end of hostilities have English exchange difficulties assumed the character of a world crisis. The first came when Lend-Lease was ended and it became clear that the United Kingdom could not maintain even the meager civilian existence of wartime without continued assistance. The United States then extended a large credit, "to assist the United Kingdom to meet transitional postwar deficits in its current balance of payments, to help the United Kingdom to maintain adequate reserves of gold and dollars and to assist the Government of the United Kingdom to assume the obligations of multilateral trade." The second crisis came in August 1947, when in accordance with the terms of this credit the Government of the United Kingdom proceeded to remove all restrictions on payments and transfers of sterling for current transactions, and the pressure on reserves was such that the experiment was hastily suspended. And the third crisis occurred in September last, when the drain on diminished British reserves forced the United Kingdom against all the declarations of the Chancellor of the Exchequer, to devalue the pound on the dollar, and to draw down with the pound most of the other currencies of the world.

The crises have all been concerned immediately and primarily with the machinery of international payments. They have been precipitated by Britain's inability to meet, in gold or dollars, an adverse balance with countries which insist on such payments; and as a result the British Government has been unable to allow the unrestricted transferability of sterling earned by one country in payments to other countries. Before examining this difficulty, however, we must look in rather more detail at the occasion and form of exchange control. This at least can be claimed for it--that it is the outcome of the pressure of experience, and a reflection neither of the ideological prejudices of the government in power nor of the momentary fashion of academic economics.

In the year and a half preceding devaluation in September 1949, the United Kingdom eliminated a deficit of £630,000,000 and brought its over-all payments into balance. Unfortunately, in a world divided by the aftereffects of war, over-all balance is not enough; and the United Kingdom like Europe generally, in spite of a reduction in its dollar deficit, was still faced with the problem of restoring a balance with the dollar area. In the year ending June 1949, the deficit of £ 250,000,000 with America was less than half what it had been in 1947 (£655,000,000), while the surplus with the sterling area had expanded sixfold to £ 280,000,000. But this, plus the surplus of £ 50,000,000 with the O.E.E.C. countries, could not be used to meet the deficit on American transactions. Nevertheless, it is apparent that Britain's difficulty lies not in a failure to export enough to pay for imports, but in the failure of other countries with which it has a favorable balance to make as much progress as it has made. The result is that Britain cannot, as before the war, use a surplus with them to offset a deficit with America. To confine attention to the direct merchandise balance between Britain and the United States is to misconceive the problem with which the world is faced--the persistent deficit of the whole of the rest of the world with North America.

It is, perhaps, due to the "bilateral thinking" which concentrates attention on a single pair of countries that the United Kingdom's achievement in bringing its current transactions as a whole into balance is unrecognized or discounted. The increased exports are disparaged as being "easy"--not subject to the competition to which exports to other areas are exposed. They are said to be due, not to the efficiency of the exporter, but to the absence of the restrictions imposed by exchange control on payments to other areas and to the availability of sterling balances which the United Kingdom cannot really afford to repay. To this is added the allegation that, from fear of unemployment, the United Kingdom Government has encouraged exports to the sterling area which should have been diverted to America.

The nature and effects of the restrictions imposed by exchange control will be considered later in this analysis. No doubt the absence of control over transactions between different parts of the sterling area encourages trade; that is the reason why the United Kingdom has maintained, at some risk, this island of free multilateral payments in a divided world. The influence on the Government of the fear of unemployment is, in this case, an illusion. The Government has a morbid fear of unemployment in general; but the Chancellor of the Exchequer and the President of the Board of Trade are fully conscious of the threat which external difficulties offer to the country's prosperity, and they certainly have not refrained from any measure within their power to direct exports to hard-currency areas. That they have not done more is easily explained. On the one hand, there has hitherto been no danger of unemployment in the export industries; on the contrary, the problem with which the Government has been faced (and has failed to solve) has been to find enough workers to meet the needs of these industries. On the other hand, ignoring the danger of unemployment, the Government has shrunk from making itself responsible for the direction of exports; such a totalitarian control of the detailed running of private industry and trade is alien to the ideas even of a Socialist Government in England.

Equally groundless is the criticism directed toward the British industrialist. All he has done, at a time when he could not possibly supply all the demands made upon him, is to reëstablish old connections first and try to satisfy old customers. Certainly such exports are "easy" in the sense that they follow accustomed channels, relying on long-established associations and familiarity with the market's needs. It does not follow that they are uneconomic. Industry might do more to expand exports to America. But the main obstacles to such an expansion of direct exports lie not with the United Kingdom but with America. Before the war the United Kingdom balanced its accounts with the United States, one quarter roughly by direct exports, another quarter by indirect exports of rubber and tin, a third quarter by South African gold, and the remainder by net investment income and the services of British shipping, insurance and banking. The loss of investment income, the unchanged dollar price of gold, the low price of rubber contrasted with the high price of agricultural imports from America, and the relative decline of shipping and other services are obvious difficulties in the way of restoring this method. But it was a pattern of economic exchange which had existed for generations. To reverse it, and to substitute the direct bilateral balancing of United Kingdom exports and imports, would be to reverse a trend that has persisted throughout this century. The trend was set by the industrial development of the United States and strengthened by the McKinley and Dingley tariffs. Essentially it consisted in finding ways of getting around the American tariff by three-cornered and four-cornered trade. Should it not be possible to restore it, the United Kingdom--and the world as a whole--will be faced with a much more difficult task of adjustment than has hitherto been contemplated.

It is in relation to this system of indirect payment for American exports that the sterling balances are important. They do not constitute an easy or simple problem. The British Government pledged itself by the Financial Agreement of December 1945 to make every endeavor to negotiate early agreements to limit the drafts that could be made on these balances. It has presumably carried out this undertaking, and, if the drafts have remained heavy, the explanation is to be found in the real needs of the countries making the drafts or in the difficulties of securing agreement. Agreement was necessary. The matter was not one which the United Kingdom could settle by its own volition--even if unilateral default on international obligations were a good way of inaugurating a multilateral world. The other governments concerned were mainly newly-established and faced with economic problems at least as serious as England's. Marshall Aid was not available to them, yet the Communist threat overhung them as much as it overhung the countries which were included in the Marshall Plan. Even if India's need of foodstuffs and equipment for new industry, for example, had not been greater than England's need of petroleum and American films, it would have been politically impossible to deny the new Indian Government access to the only external asset she could draw on. To invent a new term for the respectable practice of paying one's foreign debts is not an argument; England did not talk about "unrequited exports" before the war when she was the recipient of them.

Nevertheless these balances are the great obstacle to restoring the United Kingdom's balance with America. Not that the exports which go to India and other countries concerned are of a sort that could necessarily be diverted to America. Before the war those countries took the same or similar imports from the United Kingdom as they do now; but, having no other means of paying for them, they had to use the dollar proceeds of their exports to America, and these dollars helped to balance the United Kingdom's American account. Now, these countries use their dollars to buy from America imports additional to the expanded imports they take from the United Kingdom, paying for the latter by the drafts they make on their sterling balances. Any help that America can give, therefore, either by using her influence with the newly-established governments with which she has such friendly relations, or by supplying alternative means of payment for imports additional to those which can be financed by exports, will be the most effective means of relieving the United Kingdom's difficulty in financing its imports from America.


The British system of exchange control is the response of experienced and practical administrators to the difficulties the country has encountered in balancing her external accounts ever since war broke out. Strictly speaking, it is not exchange control at all, but import control; if an import is permitted, permission to pay follows automatically. But there is a wide margin of payments entering into international accounts which are not tied to physical imports, and these are controlled by exchange licensing. Only by such a combination can a check be exercised over transfers on capital account, which it has been almost universally agreed cannot be left to the unfettered discretion of private individuals in the present state of the world.

For the purpose of controlling payments, territories fall into four classes. There is, first, the sterling area, a group of countries with intimate political, commercial and personal links with the United Kingdom, which for generations have kept a part of their monetary reserves in the form of sterling balances and cleared their international payments through London. Within this area there are no restrictions on payments or on imports. Even capital transfers are unrestricted. This is not the result of some artificial arrangement imposed under the stress of war; most of the territory concerned is self-governing, and the United Kingdom only primus inter pares. The system is merely the perpetuation, in spite of war and postwar difficulties, of practices that grew up spontaneously and have worked for a century.

Second is the group of transferable-account countries. The residents of these countries can use any sterling that comes to them in payments on current account for similar payments not only within the same country but in any other transferable-account country. Sterling can, of course, be used to make a payment on current account in any part of the sterling area, and not merely in the United Kingdom; thus transferable-account sterling is transferable over a large part of the world. Probably more than a third of the world's trade comes within this category.

The third group is composed of a number of countries with which the United Kingdom has bilateral agreements. These restrict the use of sterling received by residents to payments (on current account) in the United Kingdom and the rest of the sterling area. They also confine the transfer of sterling to residents in the same country. The fourth group is composed of the countries of the dollar area. Sterling paid to American accounts may be used freely for payment on current account, not only in the sterling area and to other residents in the dollar area but in any country. This unrestricted transferability was a condition of the American credit to the United Kingdom in December 1945.

This distinction among countries is due to differences in their economic relation with the United Kingdom, in respect to their balance of payments with the United Kingdom or the sterling area, and to their willingness to hold sterling. Thus the United Kingdom normally has a favorable balance of payments with the other countries of the sterling area. If the balance is for a time unfavorable, the practice of the other country is to allow the surplus of sterling to accrue to its balances in London; on the other hand, the United Kingdom, when its balance is favorable, is willing to make a sterling advance or, more common by now, to allow the deficit country to draw on any sterling balance she may have. In these circumstances trade with these countries normally involves no threat to the reserves of gold and scarce currencies held in London on behalf of the whole area, and there is no reason to control payments, except occasionally in order to check excessive capital movements. Most of the countries concerned have too limited or specialized a trade to clear all their foreign payments direct; they have always cleared through London and cannot find even today a more convenient center.

The transferable-account countries, similarly, are usually in balance with the United Kingdom and the sterling area as a whole; so that they too offer no threat to the system's gold and dollar reserves. Bilateral agreements, on the other hand, are negotiated with countries with which the sterling area's balance of payments tends to be adverse. The agreements usually take the form of an undertaking to expand trade; to accept each other's currency in payment; to hold it, if it accumulates as a result of a favorable balance, up to certain limits; and beyond those limits to meet deficits in gold or gold currencies. The effective control is by import restriction, but imports may temporarily outrun exports and the provisions for holding currencies are a necessary supplement. Unlike the sterling area countries, these are unwilling to hold sterling, and insist on early settlement in gold of any deficit.

Restrictions do not apply to the countries of the sterling area. By perfectly free agreement between the governments of the different countries in the area, each country controls imports and payments on identical principles. These controls afford reciprocal freedom of transfer and constitute a common policy of restricting purchases from countries with which the area as a whole tends to be in deficit. The problem of determining the drafts on the gold and dollar reserve, to which all contribute and on which all draw, is settled by recurrent conferences at which import programs are discussed in the light of expected earnings and deficits. Imports are restricted if necessary, and, thereafter, countries are left to observe as best they can their undertakings not to exceed the drafts on the common reserve.

The United Kingdom's relation with the dollar area is different. The freedom of transfer permitted is due solely to the Agreement of December 1945, and could not be maintained if the United States did not meet most of the dollar deficit of the sterling area by its free grant of Marshall Aid to the United Kingdom.


Few of those interested, with the exception of doctrinaires who are engaged neither in trade nor in the administration of exchange control, would not rejoice if exchange control could be ended. But let us attempt to forecast the results of removing without further delay the restrictions on the use of sterling. To take the sterling area first: the other countries of the area could, if exchange controls were ended, use the sterling they received for their exports to the United Kingdom to buy, say, American automobiles or Swiss machinery or Belgian textiles. Two results would follow. The deficit which many of these countries have with America would be increased, and the surplus of the rest be decreased; and the deficit of the United Kingdom with the dollar and other hard-currency areas would be increased by the loss of dollars which it used to derive from the rest of the sterling area. Since the United Kingdom by itself, and the sterling area as a whole, are already in deficit with America, the result would be a drain on the common gold and dollar reserve of the entire area. The reserves would quickly disappear if the additional strain due to unlimited transferability of sterling were put upon them.

Assume the reserves exhausted. What then? Would America finance the additional imports from America by dollar credits (replacing among other things the drafts on sterling balances which have financed imports from the United Kingdom)? If not, the whole deficit of the sterling area could be dealt with only by import control. And this control would be country by country; each country would need to secure for its own use all the dollars it earned, and would be driven also to balance its payments with the United Kingdom and the sterling-area countries by controlling imports. The United Kingdom itself could no longer allow drafts on blocked sterling balances to increase its dollar deficit; it too would have to protect its position by limiting imports from both the dollar area and other sterling area countries. The mere removal of restrictions on the transferability of sterling would do nothing to correct the adverse balance of sterling-area countries with America, and of many of them with the world as a whole. The final result would be the destruction of the largest surviving area of multilateral payments in world trade, and a great extension of quantitative import control and strict bilateral payments.

The position of the transferable-account countries is similar. They are all in deficit with America; any transfer of purchases to America would use up their reserves, and hasten the depletion of British reserves. As with the sterling area, the transfer of purchases to hard-currency countries no doubt would be limited; the existing trade relations are the basis of currency arrangements, only to a small extent the outcome of them. But the final result would be the same--exhaustion of reserves, followed by import control and strict bilateralism of payments in place of the present limited, but extensive, transferability.

The bilateral-account countries would at first be the chief beneficiaries of the removal of exchange control. They could use their surplus with other countries to acquire sterling, and convert the sterling into dollars or gold (as they did in 1947), thus accelerating the exhaustion of the reserves of the sterling area and other deficit countries. They could cover their own deficit with America, or extend their dollar purchases, and then, if the United Kingdom reserves held out, increase their own gold reserves and relieve themselves of the necessity of deflating their own national economies to secure a dollar surplus. But their action would only increase the deficit of other countries, exhaust their hard-currency reserves, and bring nearer the day when they had to restore universal bilateral payments and strict import restrictions in order to retain any control over the external value of their currencies.

Gold and exchange reserves outside America are generally inadequate; in looking to the future it would be conducive to clear thinking to proceed on the assumption that they have been exhausted. The problem of international payments arises in its clearest form when reserves are exhausted or reduced to the minimum needed to cover normal daily fluctuations.


The short answer regularly made to any plea for the maintenance of exchange and import restrictions is that the deficit countries should reduce their costs: the implication is that it is only the existing restrictions which prevent them from balancing their external accounts. The E.C.A. is making an authoritative factual reply to this by its examination of protectionist devices which prevent products with lower costs from getting into the American market. But the question is whether a world out of balance can be restored to balance by cost-reduction alone.

The old fashioned method of cost-reduction by credit deflation can be ruled out as not practical politics. It may be doubted whether any democratically elected government would show today the ruthless austerity which Dr. Bruening displayed in Germany in 1931. Certainly none of the parties which contested the recent election in the United Kingdom would attempt it; all are committed to the policy of full employment, which, in a country without such gold reserves as the United States possesses, operates by expanding the home market to offset any decline in employment, and "adjusts" external relations by devaluation. When M. Blum formed his Socialist Government in France in 1936, the franc, which for ten years had been the strongest currency in Europe, was 73 to the pound; it was "adjusted" in the course of that year, and, as a result of subsequent adjustments, is now 960 to a pound that has been devalued 30 percent on the dollar. The reduction in costs which might alleviate the United Kingdom's difficulties is a reduction in "real" costs; and the doubt about this is its relevance to the world's disequilibrium.

International differences in levels of cost are not something new. All the time that international trade was expanding in a multilateral world there were high-cost and low-cost countries. Trade arises from differences in costs, and if all costs were equalized international trade would cease. Economic theory explained trade by reference to differences between countries in the comparative costs of different commodities. Only if the deficit countries reduced their costs more rapidly and sharply than the surplus countries would the balance of trade between them be affected--only, in other words, if the countries which suffered more from the world wars reduced their costs faster than those which suffered less.

Any reduction of costs tends to expand the volume of trade; but it is the balance of the world, rather than the volume of its trade, which the war has upset. This is the fundamental problem with which the United Kingdom was faced in 1945 and still is faced. Britain has still to meet a repetition of the spread of protected markets which undermined her export position after the First World War. It would be rash to assume that her difficulties are over; only a temporary balance has been attained. In 1920, at the corresponding point in the restocking boom, Britain had a surplus on current account of £ 280,000,000, and it will be difficult to keep the volume of imports down to 85 percent or 90 percent of prewar with a population already 5 percent larger. Every effort to get costs down must certainly be made; but a new balance will be attained only as the result of a drastic reorientation both of British industry and of world trade.

The conditions of such an extensive redirection of resources are partly outside British control, partly internal. E.C.A. is attending to the former. British attention should be concentrated on the latter. Two preconditions in particular may be noted. Any redirection requires an incentive to face the need of change, and capital to cover the inevitable cost of change. The maintenance of an inflationary condition in the markets for British industry removes the incentive, or at least lessens it, since it is easy to make profits (and retain employment at good wages) merely by going on making what you are making. The pressure of direct taxation on industrial profits (55 percent on profits retained in the business and 75 percent on distributed profits) depletes at the source the funds from which new and promising developments of all sorts are financed. The destructive incidence of taxation was the chief explanation of the decline in adaptability of industry between the wars; now that the vicious tax is double what it used to be, attention may be attracted to this danger.

But any extensive reorientation of industry must take time. In the interval, the greatest danger to any restoration of multilateral payment is another premature insistence on convertibility.

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  • SIR HENRY CLAY, Warden of Nuffield College, Oxford; Economic Adviser to the Bank of England, 1930-1944; formerly Professor of Social Economics in the University of Manchester
  • More By Henry Clay