The Day After Russia Attacks
What War in Ukraine Would Look Like—and How America Should Respond
IN 1934 the Assembly of the League voted to form a committee "to arrange for an enquiry concerning the causes, scope, methods, and results of compensation and clearing agreements." This committee was composed of competent experts of international reputation. On its own motion the committee "restricted its observations to the causes and results of these clearing agreements and to the possibility of abolishing them or of correcting their defects." Their report, published in March 1935, is excellent, as indeed is almost all the technical work done by the League of Nations. Anyone who has had practical experience with clearing agreements will agree that the report summarizes all important points of view and, in general, draws the correct conclusions from them.
If I venture here to contribute something to this theme it is only because Germany has concluded more clearing agreements and has, unfortunately, had more experience with them than any other country. For this reason Germany offers not only an excellent example of the tendencies which have caused the conclusion of such agreements but a clear picture of their results on international trade.
I should like to preface my remarks by citing a few illuminating statements from the report of the League committee. Their clarity and objectivity serve admirably to illustrate the characteristics of Germany's experience. The first relevant statement connects clearing arrangements to exchange controls, and these in turn to disorders in international trade:
The establishment of clearing agreements arose out of conditions created by the institution of exchange control. . . . Exchange control is only one form of defense against the effects of the general depression on countries whose economic and financial structure was especially vulnerable. The heavy fall in prices and the paralysis of international credit could not fail, in the absence of the regulating influence of the movement of capital, to give rise to a grave disturbance of the currents of international trade.
The report then touches on the question as to whether the creditor countries might not have adopted a policy more appropriate to the conditions with which they were faced. The conclusion of clearing agreements, the committee reported, in itself gives rise to a situation in which the orders of a weak-currency country tend to flow towards those states with which it has clearing relations, to the prejudice of third countries. The report then goes to the heart of the problem by stating that --
creditor countries possessing ample financial resources are called upon to play a highly important part in restoring economic equilibrium. It is essential that these countries, realizing that others in monetary difficulties are at once their clients and their debtors, should, when concluding agreements, display greater breadth of mind and not confine themselves to endeavoring to liquidate their claims; they should bear in mind the economic interdependence which, whether they like it or not, actually exists between the fate of both classes of countries. . . . So long as a creditor country is not prepared to develop and to maintain an unfavorable balance of trade, or at least to compensate a favorable balance by "invisible" imports, no international monetary system can operate successfully.
The committee concluded its report by stating that it regards
the restoration of an international monetary standard, with the conditions of commercial freedom essential to its normal operation, as the most effective safeguard against disturbing action being taken as regards either dealings in foreign exchange or international agreements for the settlement of payments.
I would beg the reader to bear in mind these general truths from the report of the committee when we proceed to examine the special causes and effects of the German clearing system. For this purpose we must go back to the year 1931. Germany's foreign indebtedness amounted at that time to around 26 billions of Reichsmarks. Of this sum about 15 billions were short-term credits and about 11 billions long-term credits. There had been nothing secret about the way these debts arose. The figures were published year by year. Every foreign lender was aware of the situation when he gave Germany credit. The gold and foreign currency reserve of the Reichsbank amounted at that time to about 3 billion Rm. The first impulse towards the clearing agreements was given in 1931 when Germany's foreign creditors, and especially those in the United States, began to call in their claims on Germany at an ever-increasing rate. Whatever may have been their reasons for this procedure -- an examination of this question would only have an academic interest today, and in any case it was not in Germany's power to remove these reasons -- in view of the state of Reparations (Young Plan) and of the statistics on the Reichsbank's short-term debts and gold and foreign currency reserve, the creditors must have been well aware that not all of them could be satisfied in full. It was a simple matter of arithmetic to find out how many of the foreign claims could be satisfied a hundred percent in foreign exchange and how many would have to remain a hundred percent unsatisfied as regards transfer. It should have been clear to everybody that this method would inevitably lead to transfer limitations and, after the exhaustion of transfer possibilities, to a complete transfer moratorium. All the same, or perhaps for that very reason, the foreign creditors vied with one another in calling in their claims, until the German gold and foreign currency reserve had shrunk to a minimum. That Germany's foreign assets could not make any decisive contribution to the solution of the transfer problem must be clear to anyone familiar with the origin and the nature of these assets as well as with Germany's general situation. The Basle Committee, set up in 1931 in London to examine Germany's credit situation, reported: "The Committee is not of opinion that a plan based upon the mobilization of Germany's assets abroad is practicable."
These experiences of Germany with her foreign creditors and vice versa ought to be remembered by future creditors and debtors, if we may be permitted to assume that coming generations are willing to learn from the past. But it is probably asking too much of creditors that the individual should subordinate his own particular interest to the common interest of all the creditors. For this reason it would probably have been better for the creditors as a body if the debtor, Germany, had from the very beginning decided to stop transfers entirely while her reserve of gold and foreign currency was still intact, in order to liquidate the short-term foreign debts and the interest and amortization on the long-term foreign debts after a reasonable and just agreement with all her creditors. But of course an honest debtor will be very reluctant to make such a decision unless he sees no other way out. It is an old bankers' rule that when there is a run on the bank it is the best policy to go on paying out in the hope that the customers will quiet down when they see that they are being paid. In accordance with this rule Germany went on transferring all the credits called in, month after month, in 1931; but the foreign creditors continued to withdraw. In this case, then, the bankers' rule failed. Germany therefore had to adopt other methods, and was forced step by step to resort to restrictions. Then came the foreign exchange control; the regulation of the short-term foreign debts by annually renewed standstill agreements; the gradual limitation of transfers in respect to amortization and interest on long-term foreign debts; and in the middle of 1933 the complete transfer moratorium. This was the second decisive step towards clearing. Up till then trade in commodities had been kept free from transfer restrictions. The creation of a new commercial indebtedness, the evasion of the transfer moratorium, and the increasing shortage of foreign exchange, gradually and inevitably led to an ever increasing interference with transfers connected with the importation of goods. The road from the limitation of transfer on commercial claims to the clearing system was short.
The motives and methods for the conclusion of clearing agreements were not the same in the case of all the countries concerned. There are two distinct groups. To the first group belong the countries which had themselves introduced exchange control and transfer limitations before Germany or at about the same time. At first these countries continued to accept in payment of their exports to Germany the mediums of payment offered by her, either Reichsmarks or foreign exchange. They themselves, however, released foreign exchange for the payment of German exports only as they considered these imports to be necessary and in accordance with their other transfer obligations. The result was that a rapidly accumulating amount of German commercial claims in these countries remained unpaid. The "frozen" German commercial claims increased in a few months to nearly one billion Reichsmarks. Germany, with her own shortage of foreign exchange, her own financial foreign obligations, and her requirements of foreign raw materials, evidently could not sit by and watch such a development with folded arms. She had to insist on receiving payment for her own exports either in money or in kind. Thus the first clearing agreements came about, on the initiative of Germany, with the countries which themselves controlled their foreign exchange. Among them were countries to the east and north of Germany. To this first group of countries were added later a few countries in South America and in Asia which in the course of time had also been compelled to introduce control of the flow of foreign exchange.
Whenever in this article the expression "clearing agreement" is used, the word "clearing" should be interpreted broadly. The form of these agreements was various. In some cases they were concluded not between the governments, but between the banks of issue. In some cases they contained a real clearing in the narrow sense; in others they were payment agreements of a more elastic nature. Some aimed at a balancing of commercial claims only, while others included the regulation of financial obligations as well. Some of them have reserved a foreign currency margin in Germany's favor which is at the free disposal of the Reichsbank; others provide a balance on the ratio of one to one. But all these variations really refer to the technical methods. The effect on international trade is the same in all cases.
The second group of countries is composed of those which could afford an unchecked flow of their foreign exchange, such, for example, as Switzerland, France, England, Holland, Belgium, Sweden, etc. These countries had in common that not only were they financial creditors of Germany but that in every case their trade balances, and in most cases their balances of payment also, were passive in respect to Germany. These countries have one by one confronted Germany with the following alternative: either she must consent to bilateral clearing agreements which will satisfy the financial as well as the commercial claims of these countries; or, if she refuses to do this, they will adopt unilateral clearing measures for the same purpose. The decision which this alternative presented to the German Government was difficult and of far-reaching importance, not only for Germany but also for the other countries and for international trade. After mature consideration the German Government decided to give way to the pressure exerted upon it and agreed to a bilateral clearing.
It is easy to see why Germany should have hesitated. The principal objection was that the countries in question wanted to secure, by means of a clearing, a preferential position for their financial and commercial claims as against the equal treatment which Germany intended to mete out to all foreign claims and had actually meted out by means of exchange control and the transfer moratorium. Of course the German Government foresaw that other countries would reproach Germany with discriminating, or at least with coöperating, in a compulsory discrimination. But what would have happened if Germany, to escape this reproach, had rejected bilateral agreements? The countries in question -- as was conclusively proved by the negotiations -- would then have put into effect the unilateral clearing measures which they had announced. Their claims would thus have received preferential treatment in any case, only this preferential treatment would have been still more pronounced in the event of a conflict -- and Germany's refusal would have meant a conflict. Unilateral clearing measures would have had an even worse result for Germany and thus, indirectly, for the other creditors. International trade would have been seriously disturbed in the event of a conflict. To be sure, Germany would have been spared the reproach of having coöperated in the discrimination. But discrimination there would have been, even more pronounced and more damaging to all the other countries and creditors than it now is. It is easy to reproach the debtor afterwards for having yielded to the pressure of a section of the creditors. But it would be more just to complain of the lack of solidarity among the creditors themselves. The case of the Young Loan illustrates this fact very clearly. The general bond for the Young Loan, which obliges Germany to treat all creditors on a basis of equality, was drafted and approved by the creditors. It is part of the international agreements which were concluded at that time. The equal treatment of all creditors was not only imposed upon the debtor, but was negotiated by the creditors. Yet a section of the creditors has repudiated this obligation and exploited the strong position resulting from their trade balances in order to secure for themselves preferential treatment as against the other holders of Young Bonds.
In the course of time Germany has concluded about thirty clearing agreements with these two groups of creditors.[i] What has been their effect upon Germany's foreign trade and upon international trade? The first effect was surprising for all parties. Germany's active balance of trade with a number of other countries, and especially those on the European continent, began to shrink more and more. Although this development was partially determined by other causes, especially by the import restrictions of the countries in question, there can be no doubt that the clearing agreements themselves were at first responsible for this tendency, in some cases at any rate. The report of the League committee very properly confirms this fact. Once again it was evident that the best-informed experts are hardly in a position to foresee even the immediate and most direct effects of state intervention in the natural developments of trade and industry. The more remote and indirect effects are quite beyond human foresight. The causes of Germany's vanishing active trade balance were of course recognized afterwards. The German manufacturer as a result of exchange control was no longer at liberty to procure his raw materials where he wished; the German merchant was no longer free to buy in all countries the finished goods in which he dealt. Both naturally jumped at the openings left by the clearing agreements for supply and payment. Goods which they formerly procured elsewhere were now ordered from those countries with which clearing agreements had been concluded. Even raw materials produced by third countries were thus procured through the clearing system. To cite one particularly grotesque example: under the clearing system Germany bought up a large part of the wool production of a country which had never been a wool-exporting country and which was thus compelled to import wool from other countries to cover its own requirements. Of course neither the German nor the other government involved intended nor desired this procedure.
To some extent these were merely the initial defects of the clearing system, which could have been eliminated. So long as there were clearing agreements with a few countries only, the German importers naturally concentrated on these countries. As the clearing agreements were extended to other countries, the purchases of the importers were again spread more evenly. Furthermore, such phenomena as those mentioned, which were in the interests of neither party, were corrected by special agreements defining what goods could be bought under the clearing system and in what quantities. But irrespective of these initial defects the active balance of trade between Germany and a number of countries continued to show, and still shows, a strong tendency to decline. The explanation is that the importation of goods from these countries is shifting more and more from finished goods to half-finished goods and raw materials. Consequently, the possibilities of buying from these countries are being exploited more and more.
This brings us to one of the most important points in the problem. Must the clearing system be called a failure on account of this new trend of trade? Perhaps this question must be answered differently for different countries. As far as Germany's position in international trade is concerned, we can say that this development has not been a failure. On the contrary, the clearing agreements have given her the possibility of maintaining her supply of foreign raw materials and half-finished goods in such a way that the great and complicated machinery of German production could on the whole continue to function undisturbed. The fact that Germany's trade balance with a few countries shows a less active trend merely demonstrates that more raw materials and half-finished goods have been bought from these countries than formerly. To be sure, this phase of the trend of trade has been very effectively supported by another parallel development. Prior to the genesis of the clearing system, Germany's imports of raw materials in general continued to come from those producing countries with whom German industry had been accustomed by tradition to trade. The lack of foreign exchange inevitably compelled the German importer to exploit more strongly the possibilities of trade with the newer raw-material countries which the clearing agreements had opened up. This new development of trade was facilitated by the fact that these newer raw material countries were prepared to buy more German commodities in order to balance their clearing accounts. That the anxiety occasionally felt in Germany lest the shortage of foreign exchange result in a dearth of foreign raw materials and a paralysis of German industry has proved unjustified is principally due -- apart from the adaptability, the inventiveness, and the discipline of German trade and industry -- to the new trade possibilities opened up by the clearing system. I have no doubt that, in view of the existing world conditions with regard to currencies, debts, credit, and commercial policy, German trade and industry would not have been able to reach and maintain their present momentum without the clearing agreements. This favorable effect of the clearing system is not limited to Germany; the numerous countries which have been able to increase their exchange of commodities with Germany under that system have also profited from it. The statistics relating to this are interesting, not only as far as Germany is concerned but from the standpoint of international trade. As regards the supply of raw materials for Germany, and the development of trade with the raw-material countries in question, I therefore do not come to so unfavorable an opinion of the clearing system as that given by the League committee.
It must be admitted that as a result of the conclusion of more and more clearing agreements, an increasing part of what Germany receives for her exports is tied up for the special purposes of the clearing. The foreign-currency receipts which can be freely disposed of thus become ever smaller. Today they have been reduced to an amount which seems ridiculously small when compared with the volume and importance of Germany's trade and industry. This is certainly by no means satisfactory. But the decisive question is: Would the situation be better today if clearing agreements had not been concluded? It certainly would not. Those countries which themselves have exchange control would, without these agreements, have disposed as they wished of the payments due to Germany for her exports and would certainly not have released them; nor would they have applied so much of them towards the payment of the raw materials required by Germany as was provided in the clearing agreements. As regards the second group of countries (those which afford an unchecked flow of their foreign exchange) I have already made it clear what would have been the result if Germany had not yielded to their pressure. Though the clearing agreements have not increased Germany's accessible foreign-currency receipts they have permitted her to maintain her supply of foreign raw materials. Incidentally, even the decreased receipts of foreign currency which can be freely disposed of have left Germany enough margin to allot sufficient foreign exchange for imports from countries with which no clearing arrangements exist, leaving these countries no cause to complain of discrimination. To give one instance: Germany was able during the first ten months of 1935 to allot three times as much foreign exchange for the payment of imports from the United States as she herself had received in dollars for her exports to that country.
So far as Germany's position in international trade is concerned, even though I come to a somewhat more favorable conclusion than the committee, I nevertheless thoroughly agree that the clearing system can be regarded as only a "makeshift involving a number of drawbacks, and that it should therefore be abolished as soon as possible." This is not merely the personal opinion of one who has had a good deal of practical experience with commercial politics; it is the opinion of the leading statesmen in Germany. The German Chancellor emphatically voiced this opinion in his proclamation of September 11, 1935, when he characterized the system of barter as nothing less than prehistoric and expressed the hope that it would be replaced by a free and modern trade system as soon as possible. The President of the Reichsbank and Acting Minister for Economic Affairs declared equally emphatically that the whole system of foreign trade which circumstances had forced upon Germany was something abominable. To these two statements could be added any number of similar remarks by German officials and business men. It is communis opinio in Germany that the clearing system should be abolished as soon as possible.
What are the chances of this in the near future? The Geneva committee deserves special credit for having examined carefully and stated clearly the prerequisites for the abolition of the clearing system. In the main these are three: (1) permanent arrangements for the debts; (2) restoration of an international monetary standard; (3) a less restrictive commercial policy, opening the way to the export of increasing quantities of goods from debtor states even in the interest of creditor countries.
These three conditions have in common that their fulfilment does not depend upon Germany and cannot even be essentially influenced by Germany. Agreements as to a permanent regulation of the financial debts depend in the first place upon the will of the creditor. One can consider the problem from a legal point of view, in which case it will remain unsolved for a long time. One can also consider it from an economic and business standpoint, in which case it is clear that the debtor countries can no longer carry their foreign debt. The very fact that only a very few nations are paying their foreign debts in full, and especially in gold, ought to be conclusive proof that liquidation is an economic impossibility, for one cannot assume that the majority of nations are deliberate defaulters. But there also are economic and statistical proofs. I shall here submit for consideration but one argument. For 1913 the entire inter-state indebtedness of all the nations in the world may be reckoned at 150 billion Rm. while the world trade turnover amounted to 160 billion Rm. The world's present inter-state indebtedness amounts to about 220 billion Rm., while the world trade turnover has declined to a figure somewhere between one third and one half of the amount of the inter-state indebtedness. Obviously from an economic point of view an adjustment is necessary.
Of course, it is easy to enumerate in committee reports the prerequisites which must be fulfilled and to state with which countries the decision lies for fulfilling them. Whoever has taken part, as I have, in all the international economic and financial conferences since 1920, besides devoting many years to bring about economic coöperation at Geneva, knows what is the practical value of such conclusions. How much wisdom, experience, and good will have been concentrated upon the resolutions that have come out of all these conferences and investigations, and how little has been achieved! And when, in an exceptional case, some of these resolutions have been put into practice, it has been too late.
I therefore conclude this article on a note of resignation. I do not believe that the time is ripe for the abolition of the clearing system in the near future, for I do not dare to hope that the conditions mentioned in the report of the committee will soon be fulfilled. Those nations which have been compelled by force of circumstance to resort to this makeshift arrangement will have to continue to get along with it. What will be the effect on international trade? The clearing system will not be an absolute obstacle to a gradual revival of the international exchange of goods. But it will automatically guide the exchange of goods between the individual countries into new channels. Even for those which had a hand in bringing about this system it was surprising to see how quickly international trade adapted itself to the new possibilities opened by the clearing system. If it continues to exist for a number of years more, the new trade roads, today still used as makeshifts only, will have become permanent. This means that the older export countries will limit their production of raw materials and foodstuffs, as they are already doing, and that the more recent export countries will increase their production of raw materials and foodstuffs -- which they too are doing, and with success.
[i] The list of countries given in Annex III of the committee's report is no longer complete. A number of new clearing agreements have since been concluded, e.g. with Argentina, Brazil, Estonia, Iran, Poland, Portugal, South Africa and Turkey.