The persistent deficit in the United States' balance of international payments and the continuing loss of gold have led to increasing discussion of national policies relating to gold and the dollar. While the issues involved are quite technical and complex, they are important to the future of the nation and the world. Broader understanding of the forces impinging on the nation's balance of payments is essential if the United States is to react properly to the changes in its role in the world economy.

The authors start from the firm belief that the present gold-exchange standard is the most efficient, equitable and powerful international monetary system in the world's history. It has performed remarkably well under conditions of unprecedented world growth, and has contributed significantly to that growth. The objective must be to preserve the present system, while working to improve it by gradually supplementing it with some new source of international liquidity. The key to this proposition is that the official dollar price of gold must remain unchanged regardless of the pressures that might be put on the United States to revalue gold. To achieve this, it is essential to recognize that our responsibility for fiscal and monetary stability extends beyond our borders. Not only are non- inflationary policies desirable for domestic reasons; they are necessary to maintain the purchasing power of the large liquid dollar assets held by foreigners. Foreign dollar holders must feel confident that dollars constitute the best available store of internationally acceptable purchasing power. It should continue to be a major objective of U.S. policy to achieve a viable balance in international payments, but this objective should be pursued through responsible monetary and fiscal policies rather than through new controls over international capital movements, foreign exchange transactions or tourism.

These propositions deviate little from the conventional wisdom. Yet because of the changing position of the United States in the world economy, they have far-reaching implications. There is a reluctance to recognize that the situation has changed radically from only a few years ago, when we had a much larger gold stock and when the leverage that other countries could exercise over us was minimal. Our balance of payments is not independent of actions and policies of other countries. Their coöperation is needed if the present international monetary system is to be preserved and improved, and if we are to reduce or eliminate our balance-of-payments deficit. Other nations can adjust their monetary, fiscal and other policies to offset American efforts to reduce our external deficit. The leverage exercised by foreign central banks through their gold-buying policies could, if carried far enough, force us to take steps detrimental to all nations concerned. It is thus imperative that the United States have a strategy to avert such a contingency, and to minimize the damage to this country and to the world if the contingency should materialize.

II

The evolution of the U.S. balance of payments has passed through three distinct phases. The sharpness of the recent debate on our strategy with respect to gold arises largely because we are in a transition to a fourth phase. This new phase requires a much higher degree of international coöperation than did either of the previous ones, which were based to an unusual extent on the policies and behavior of the United States. Other free nations were nearly powerless to influence U.S. policy, which, in any case, was considered by most to be highly beneficial to all.

The first four years after the war was a period of massive shipments of American goods and services to the rest of the world, particularly Western Europe, for reconstruction and development. Even against all of Europe combined, we were the dominant economic power, our economy having expanded rapidly during the war and quickly converted to peacetime needs. In this period, exports exceeded imports by an average of $8 billion a year. Although some $3.5 billion of this annually was in the form of grants to Europe and elsewhere, and about $2.5 billion a year was financed by long- term credit, the United States had a substantial balance-of-payments surplus. In these years over $5 billion of gold was sold by foreign governments to obtain dollars to finance purchases in the United States, with the result that its gold stock rose to a peak of $24.6 billion. The first postwar phase was one of U.S. balance-of-payments surpluses and gold- stock increases.

During the second phase, 1950 through 1957, the United States continued to be the dominant supplier in an era of rapidly growing world trade. American private investments overseas were swiftly expanding. Moreover, a substantial proportion of exports continued to be financed by U.S. aid programs. Thus, foreign nations actually accumulated dollar balances averaging about $1.7 billion a year, on top of their receiving a net flow of real resources from the United States. These dollar balances were held in official international reserves. The private demand for dollars to finance imports from this country and elsewhere was kept in check by exchange controls and various trade restrictions. Indeed, during this period most of the more advanced nations were trying to build up reserves, and many tended to prefer dollars to gold because they were considered more convenient, earned interest and were virtually riskless in terms of the possibility of depreciation relative to gold. Thus, the second phase was one of U.S. deficits, financed almost entirely by a build-up of foreign short-term dollar balances. This was the period of the "dollar gap," since foreign demand for dollars to use and to hold exceeded the available supply, and the dollar was almost universally considered as good as gold as an international reserve asset.

The third phase, beginning with the worldwide recession in 1958 and extending to about the present time, was one of greatly increased American deficits and substantial outflows of U.S. gold. The $4.2 billion deficit in 1958, due in large part to a sharp decrease in U.S. exports, was financed almost two-thirds in gold. In subsequent years, U.S. trade surpluses varied in size, but capital exports continued to grow as did overseas government spending for aid and defense. Symptomatic of this period was the sharply reduced inclination of a number of important foreign central banks to increase their dollar holdings when their balance of payments was in strong surplus. Thus, Germany, France, Italy, Belgium, the Netherlands and Spain- all surplus countries during most of this period-built up their gold reserves more than their dollar reserves.

The third phase was characterized by a very rapid reduction in U.S. gold stocks from $23.3 billion in 1957 to about $13 billion today. Meanwhile, total short-term dollar liabilities rose to $27 billion, of which about $12 billion is held by foreign central banks, and is technically subject to conversion to gold at the U.S. Treasury. Although the likelihood of any massive conversion is practically nil, the potential damage to our present system from undue withdrawals has been cause for concern. It has made the dollar appear quite vulnerable in the view of those who continue to think in terms of absolute convertibility between dollars and gold, as was the case before 1958 when U.S. gold stocks were far in excess of dollar liabilities.

The problem now is to work out a system consistent with these changing conditions. This undoubtedly will involve some form of new international reserves or substantial increases in international credits having the character of such reserves. But however it is worked out, the role henceforth played by gold clearly will be different than in the past. Since gold has for many decades been the key to the international monetary framework, such a change is bound to touch sensitive political nerves.

III

In the phase we are now entering, it is important to recognize the interrelationship between our economic policies and those of the rest of the world. Within broad limits, other countries tend to adjust their monetary, fiscal and other policies to take account of changes in American policy. Other nations can, and have, kept their interest-rate structure in line with ours, thereby offsetting American efforts to reduce our deficit by the traditional method of tightening credit and attracting an inflow of foreign capital. Furthermore, most other countries, particularly the richer industrialized nations, can adjust more easily than we can to changes in their balance of payments, through monetary and fiscal measures and restrictions on trade and capital flows. They can do this because a larger share of their economies is affected by international trade. The natural consequence has been for some industrial countries to use this ability to adjust in a manner which gives them balance-of-payments surpluses and increasing international reserves. Part of the problem is that some of these countries at one time or another have used their growing reserves to make the United States' position appear weaker than it really is-through rapid build-up of gold holdings. To a considerable degree it is because of this sense of weakness that the United States adopted a series of measures to restrain capital flows, measures of no more than short-run expediency but clearly damaging in the long run.

The leverage exercised by foreign central banks through their gold-buying policies could, if carried far enough, force us to take steps detrimental to all nations concerned.

It is thus imperative that the United States have a plan, in the event of such a contingency, that would minimize damage to our long-term interests. Until recently, at least, it has been accepted by many experts and most laymen in this country as well as in Europe that if such a crisis were to occur, an increase in the price of gold would be virtually inevitable. Such an increase would be welcomed by at least three countries-South Africa, the Soviet Union and France. A number of other countries with substantial gold reserves, principally in Europe, would find a gold-price increase an acceptable, perhaps desirable, solution in the event of a crisis severe enough to force us to suspend the sale of gold.

It is the central thesis of this article that even under the most extreme circumstances, in which the U.S. gold stock was reduced to zero, a gold- price rise would be contrary to the interest of the United States; it would be far preferable for the U.S. Treasury, while maintaining a price of $35 an ounce, to trade in gold only at its discretion. This is important for political reasons because the United States cannot be compelled to raise the gold price; and it is the only country that could lead in a general and worldwide gold revaluation. Before discussing this in greater detail, it may be well to look back at the previous line of reasoning and consider where it may be vulnerable.

Probably the most potent case against the foregoing thesis has been expressed by Robert V. Roosa, partner of Brown Brothers Harriman and formerly Under Secretary of the Treasury for Monetary Affairs. He has been quoted as saying: "There is nothing we can do about gold that would free us from the actual problems in our balance-of-payments deficits." This seems to imply that at least one step in the reasoning above must be wrong, and that the United States can deal with its balance-of-payments problem as if other countries could not, or would not, adapt their own policies so as to offset ours. Certainly, the importance of maintaining non-inflationary fiscal and monetary policies should not be minimized, but Mr. Roosa's view of the problem minimizes both the impact of the United States on the world economy and the propensity of other leading nations to pursue policies that yield balance-of-payments surpluses. And it seems to ignore the legitimate desires of these nations to influence U.S. policy through their own gold policies.

The American economy has a massive impact on other nations. Nearly one- quarter of world trade crosses our frontiers; we provide nearly half the world's private foreign investments; probably more than half of all international money transactions are denominated in U.S. dollars. Because of our economic size, changes in this country are rapidly transmitted to other nations through changes in our exports, imports and capital flows. During a business upswing U.S. imports rise rapidly and have an immediate and profound impact on such countries as Canada, Mexico, Venezuela, the United Kingdom and Japan. In turn, changes in these countries collectively affect all the rest of the world. Similarly a U.S. recession invariably results in slower economic advances throughout the world. It is no accident that the slowdowns in this country in 1954, 1958, 1960 and 1967 correspond to slower advances in most other countries of the world. When the U.S. economy has a recession, other countries have little choice: they must adjust to the decline in their exports to this country and to other countries affected by the United States. To avoid balance-of-payments difficulties, they must conduct tighter monetary and fiscal policies which tend to slow economic expansion but keep up interest rates. On the other hand, when American imports rise, the corresponding rise in other countries' exports relieves the pressure on their balance of payments and allows them to adopt more expansionary fiscal and monetary policies.

If France or Italy experiences balance-of-payments difficulties, it can adopt corrective monetary and fiscal measures with the expectation that few if any offsetting measures will be taken by other countries; the international trade and investment flows of such countries are relatively small. The United States is not so free. Policies that would otherwise lead to a balance-of-payments surplus may be frustrated unless other leading countries pursue policies consistent with those surpluses-namely, policies that lead to smaller surpluses or larger deficits of their own. This they have not done. At least since 1957 most European countries, Japan, Australia and a few smaller countries have preferred to increase their international reserves and have therefore pursued policies leading to surpluses in their balance of payments. We would argue that this tendency, followed by a large bloc of independent countries, is one of the reasons for continued U.S. deficits.

There are other reasons for the deficit, including our heavy military and aid commitments, which involve a large annual dollar outflow. Certainly the Viet Nam conflict has added substantially to this burden. If we were willing to curtail sharply all military and economic aid programs, the balance of payments would undoubtedly improve, but there are questions of broad national interest involved and such action, if taken, must be taken gradually and carefully.

Other extreme methods of dealing with U.S. deficits conjure up the black years of the Great Depression. No one would recommend a severe economic contraction leading to much lower levels of employment and output, even though this could result in large balance-of-payments surpluses. Likewise, no one, or very few, would wish to see the United States drift toward policies involving exchange controls or large increases in tariff barriers, though these measures, also, could give us a balance-of-payments surplus.

It is necessary to find a more just, more productive, way out. But to find this way will require the help and coöperation of other nations. Meanwhile, the United States must make clear what its gold policy will be if such coöperation is not forthcoming. No responsible official of any major industrial country would purposely support policies he believed would lead to an international monetary crisis. Nevertheless, some leading countries have pursued policies that are contrary to American interests. There are several reasons for this.

For one thing other nations have a legitimate desire to influence U.S. policies on matters of direct concern to them. What the United States does in Viet Nam, in its aid program and its military alliances is bound to affect them. Perhaps more important for some nations is concern over the large equity investment by U.S. companies in their industries. While recognizing the benefits of these investments, many foreign leaders have become increasingly worried that control of their economies is slipping into foreign hands. Thus, they would like to see us control the outflow of capital, thereby eliminating the need for individual governments to impose restrictions. To the extent that other governments believe they can influence our actions through gold and balance-of-payments policies, they may be tempted to do so.

A second reason is that most measures that could be taken to reduce payment surpluses would be politically unpopular. Most nations with a surplus have more restrictive non-tariff restraints on trade than the United States, a hangover from the 1940s and 1950s. Yet these restrictions affecting, for example, coal, automobiles and farm products involve protection of home industries and are politically difficult to remove.

But there is no blinking the fact that more could have been done, particularly by the countries of continental Europe, had they felt an urgent responsibility to maintain the gold-exchange standard at the present gold price of $35 per ounce. Until recently, however, there has been a widespread presumption that the price of gold would be likely to go up if balance-of-payments conditions became too difficult for the United States. Recent utterances by American officials should modify that presumption.

IV

Most European central bankers have declared themselves opposed to an increase in the price of gold. Yet, if it were to occur after a run on U.S. gold, many might consider that it was, on balance, a good thing. To be sure, for some countries there would be inflationary pressures that would have to be offset, perhaps by new legislation, to prevent the profits from the gold revaluation from affecting the economy. But gold reserves would be increased by the amount of the revaluation, and the convertibility of gold into dollars would be assured.

For the United States, however, this would pose very serious economic and political problems. It would raise the question of whether the United States should compensate foreign official institutions for the devaluation losses on their dollar holdings, which could have been converted to gold at an earlier time. Failure to do this would seem to imply renunciation of a moral commitment, and would at the least be embarrassing to this country. Furthermore, a gold-price increase would inequitably favor the gold- producing nations, especially South Africa, Canada and the Soviet Union. It would inequitably favor other nations and individuals that have hoarded gold and speculated in favor of a price rise. Yet little would be accomplished in terms of establishing a stable monetary system. With a higher gold price the United States would again become the residual buyer of the world's gold. Gold production throughout the world would undoubtedly increase and over the years we would accumulate vast stocks of gold which would find their way into the vaults of Fort Knox. For these economic reasons the United States has steadfastly refused to consider an increase in the price of gold. Political considerations are also compelling. Any devaluation of the dollar would be regarded as an admission that an administration's economic policies had failed.

A sensible American strategy on gold must take account of four facts about dollars: First, they constitute a stable store of value, their purchasing power having dropped less than that of any other major currency. Second, they can be used in and obtained from an economy that is huge, and that is little affected by external factors. Third, they are widely used both as a transaction currency and as a reserve currency, for which there is no adequate substitute now, nor in prospect for some time. Fourth, the only international asset that can compete with the dollar is gold, and gold can compete only because of the speculative possibility of a price increase.

If there were no possibility of a gold-price rise within the next fifteen years, there would be no incentive to insure against a depreciation of the dollar relative to gold. This would hold true for central banks as well as private citizens. Only the belief that some contingency might arise which would force a gold-price increase makes it worth the gamble to hold gold, which yields no interest, rather than dollar assets, which can. And it is important to remember that only the United States is capable of leading in a worldwide gold revaluation. If we were to raise the price of gold, all other countries would quickly follow suit in order to maintain the same rate of exchange between their currencies and the dollar. No other country or group of countries could do this unless we went along, for by breaking the link between the dollar and gold, they would assume the heavy burden of supporting the higher price.

Since the United States can determine whether or not the gold price will rise and since it is against our interest that it do so, our attitude can be firm. If we make credible our unwillingness ever to consider a gold- price increase, then the incentive of foreign central banks to speculate on a gold-price increase-or to insure against a devaluation of the dollar, which is the other side of the same coin-will be reduced or eliminated, and they will prefer to hold earning assets instead of a sterile metal.

But to make a credible case, official U.S. statements must clearly indicate that we will never support a price higher than $35 an ounce even if other central banks should use their dollars to buy all the gold in the U.S. Treasury. And, to make this credible, it is necessary to register a preference for the consequences of such a policy over the consequences of a gold-price rise. This does not involve threatening our European neighbors. It does involve spelling out our response to a threat to the international monetary framework in the form of an assault on our gold stocks.

If that response were to be a suspension of the privilege now granted by the U.S. Treasury to buy and sell gold, with future sales and purchases of gold made only at the discretion of the Treasury and at the fixed price of $35 an ounce, then the end of the trail would be bleak indeed for all nations, but especially for those with large international reserves, including gold. Under these hypothetical circumstances the United States would lose control over the price of gold and over the foreign exchange value of the dollar. There would, of course, be a gold price on the open market; but it would be up to the European central banks or any combination of central banks to decide whether to stabilize the price, and, if so, at what level.

In any case, they would have to decide what to do with the dollar. They could continue to support the dollar at its current rate, which would be the same as going on a full dollar standard, because if dollars were presented to a central bank by a commercial bank, they would have to be purchased at the present price. This, of course, is what central banks do now. But, under the present setup, if these banks consider their dollar balances unduly large, they come to the U.S. Treasury and demand gold. If we were to buy and sell gold only at our discretion, they could not be certain of this privilege. They would be more unequivocally than ever on a dollar standard.

Their other alternative would be to permit the dollar to float for a while, to support it at some rate other than the present one. This might well be a devalued rate, for a time. But if it were at a devalued rate, European exporters and traders would be at a disadvantage relative to those in the United States. No one in Europe wants to see a devalued dollar. When the German mark and the Dutch guilder were revalued by 5 percent in 1964, many Dutch and German exporters were extremely concerned about the loss of competitive advantage. If the dollar were devalued, let us say, by allowing it to float until it reached a rate at which foreign central banks were content to support it, the disadvantages to European traders would be great. No one believes that the dollar is overvalued in this sense, and no one wants to see it devalued.

There are those who argue that such possibilities would not impress the Europeans; that they have a third alternative based on the Swiss example, during earlier postwar years, of a dual exchange system. Under this system the present exchange rate on dollars for purposes of trade would be maintained, and a separate market established on which dollars used for other purposes would be traded at a devalued rate. This system at first glance would seem to avoid the problem of conducting normal trade transactions with a devalued dollar, and at the same time take care of the "surplus" dollars in a special market. The trouble is that there are simply too many dollars involved; few, if any, central banks would want to mark down the value of their dollar assets by permitting the exchange rate on them to fall-especially since their purchasing power among countries accepting a dollar standard and in the United States itself would be presumably unimpaired. The total volume of dollars held by foreign individuals and banks would be nearly $17 billion, assuming that the total U.S. gold stock were converted. If all of these dollars were channeled through special exchange-controlled markets at a devalued rate, the whole international movement of funds would be grievously impaired, and with no ready substitute for the dollars at hand.

Some have suggested that important financial countries would have little interest in maintaining the parity of the dollar. This comes down to saying that the surplus countries of Europe would prefer a situation involving extensive exchange controls, trade and capital restrictions, confiscations and the chaos this implies, to a more orderly adjustment involving maintenance of the existing currency parities with a gradual reduction of their payments surpluses. It seems unlikely that this argument would be thoughtfully accepted by responsible central bankers in Europe. There might be some conditional endorsement of the idea because it is in the interest of Europeans that the United States act on the assumption that Europe might prefer chaos to an orderly and progressive development of affairs; this enhances their bargaining position. But nothing in European behavior suggests that they would act in such an irrational manner.

One superficially logical explanation of the expected European choice of chaos over an orderly development might be that they would thus be opting for the lesser of two evils-namely, exchange controls and other undesirable devices in preference to continued and permanent financing of the U.S. deficit. However, this is a poor answer, since they have another, and pleasanter, choice. They need not permanently finance our deficit. They need only help us to reduce it, which it is in their interest to do. They can reduce non-tariff barriers to imports, encourage a greater outflow of private capital or increase their aid to the less developed nations. The fact is that if other industrial nations insist on running balance-of- payments surpluses, and pursue policies to that end, the U.S. deficit will continue.

All of this underlines the central theme of this discussion. The present world financial system-the gold-exchange standard resting essentially on the stability of the dollar and the commitment of the United States to buy and sell gold at $35 an ounce-has served the world well. It has evolved with the changing times; witness the development of the International Monetary Fund and such arrangements as the General Agreement to Borrow, and swap agreements among central banks. There is need to continue this process of evolution. It can continue only with the full and close coöperation of the industrial nations. The United States can no longer call the tune, despite its great economic power. Yet it is fully in the interests of other industrial nations to coöperate in this effort, as the above review of the options available to the United States indicates. If the United States adopts a strategy which completely and convincingly rules out any possibility of an increase in the price of gold, the interests of the rest of the world will be clear. All nations can then concentrate on the real problem of making the present system of international finance capable of dealing with the future requirements of world economic growth.

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