POSTWAR ECONOMIC STUDIES 

No. 7, September 1947 

INTERNATIONAL 

MONETARY POLICIES 

LLOYD A. METZLER 

ROBERT TRIFFIN 

GOTTFRIED HABERLER 

BOARD OF GOVERNORS 

OF THE FEDERAL RESERVE SYSTEM 

WASHINGTON 

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Published October 1947 

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CONTENTS 

PAGE 

PREFACE Inside Front Cover 

EXCHANGE RATES AND THE INTERNATIONAL MONETARY 

FUND LLOYD A. METZLER 1 

Methods of Setting Exchange Rates 1 

Exchange Rates after the First World War 1 

Exchange Rates after the Second World W7ar 3 

Movements of Currency Values since 1937 5 

General Survey 5 

The Countries Occupied by Germany 7 

The Prewar Sterling Area 9 

The Latin American Countries 11 

Summary of Exchange Rate Movements 14 

Exchange Rates and Prices 16 

The Purchasing Power Parity Theory 16 

Criticisms of Purchasing Power Parity 18 

Parity Rates in Peace and in War 22 

Parity Rates Based upon Wholesale and Retail Prices 24 

Multilateral and Bilateral Comparisons 28 

The Policy of the International Monetary Fund 30 

Alternatives Which Faced the Fund 30 

Reasons for Accepting Current Rates 31 

Dangers of Postponing Action 36 

The "Undervalued'' Currencies 38 

Conclusions 42 

Appendix Tables 44 

NATIONAL CENTRAL BANKING AND THE INTERNATIONAL 

ECONOMY ROBERT TRIPFIN 46 

Central Banking and the Gold Standard 48 

The Correction of International Disequilibria 55 

Cyclical vs. Fundamental Maladjustments 55 

Gold Standard or Sterling Exchange Standard? 58 

A Positive Policy for the International Monetary Fund 63 

Anti-cyclical Monetary Policies 63 

Fundamental Readjustments 75 

Conclusion 79 

iii 

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CONTENTS 

PAGE 

COMMENTS ON "NATIONAL CENTRAL BANKING AND THE 

INTERNATIONAL ECONOMY" 

GOTTFRIED HABERLER 82 

Pure and Mixed Gold Standards 82 

Bank Rate and the British Balance of Payments 87 

Cyclical and Fundamental Maladjustments in the Balance of 

Payments 88 

How to Deal with Balance of Payments Maladjustments in Depressions 90 

"Exchange Control" 92 

Fundamental Disequilibrium 97 

A Tentative Reformulation 99 

iv 

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EXCHANGE RATES AND THE INTERNATIONAL 

MONETARY FUND 

by 

LLOYD A. METZLER1 

Formerly of Division of Research and Statistics, Board of Governors 

The International Monetary Fund, conceived at Bretton Woods in 

1944, commenced operations on March 1, 1947, after having negotiated 

with member countries an initial pattern of international exchange rates. 

These negotiations, which proceeded within an agreed framework laid 

down in the Fund's Articles of Agreement, represented a marked advance 

over previous attempts at securing coordinated action in the international 

monetary field. It is the purpose of this paper to assess the results of this 

new procedure in the highly important and complex field of exchange 

relations. 

METHODS OF SETTING EXCHANGE RATES 

Exchange Rates after the First World War. A major factor in the international economic disturbances and frictions which followed the First 

World War was the unbalanced condition of exchange rates. During the 

war years and in the period immediately following the war, most currencies were divorced from gold, and since exchange controls had to a considerable extent been abandoned at the close of the war, exchange rates 

were subject to substantial fluctuations. These exchange fluctuations created opportunities for speculative capital movements which frequently 

tended further to upset the balance. As a result, in many countries the 

actual exchange rates differed widely from those which would have provided a balanced condition between the supply and demand for foreign 

exchange. When the important trading nations finally stabilized their 

exchange rates by returning to the gold standard, no systematic attempt 

was made to remove the discrepancies which had developed. Instead, each 

individual country simply resumed the purchase and sale of gold at a price 

1A number of people assisted in preparing this paper. Miss Florence Jaffy of the Division 

of Research and Statistics of the Board of Governors of the Federal Reserve System compiled 

the parity estimates. Miss Leila N. Small of the Institute for International Studies at Yale 

University lent helpful assistance throughout the preparation of the paper. The final manuscript was read and criticized by Mr. Walter R. Gardner of the International Monetary Fund 

and Mr. J. Burke Knapp, Assistant Director of the Division of Research and Statistics of 

the Board of Governors. The author wishes to thank all of these people without implicating 

any of them. 

1 

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2 INTERNATIONAL MONETARY POLICIES 

which was determined, for the most part, by unilateral action. Too much 

attention was paid in this process to the superficial aspects of the gold 

standard, such as the commitment of each country to redeem its currency 

in gold, and too little attention was paid to the more fundamental fact 

that the gold standard is a means of establishing or stabilizing the relative 

values of different currencies in international trade. 

The results of the unilateral and haphazard return to the gold standard 

after the first war are well known and need not be repeated in detail 

here.2 It is now generally recognized that the relative values at which a 

number of currencies were stabilized failed to reflect the movements of 

prices and other economic disturbances which had been brought about by 

war. Perhaps the most conspicuous of these discrepancies was the overvaluation of the pound sterling. When the United Kingdom made the 

pound sterling convertible in 1925, the prewar rate of exchange between 

the pound and the dollar— approximately $4.87—was re-established. Since 

prices and costs had increased more in the United Kingdom than in the 

United States, and since a number of the most important British export 

trades, such as coal and textiles, were meeting increased competition from 

other sources, the prewar value of the pound was no longer appropriate. 

A lower price for the pound, in other words, would have contributed to 

equalizing Britain's supply of foreign exchange with her demand. In the 

long run the effects of overvaluation of the pound might have been offset 

by a vigorous attack upon the cost structure through rationalization and 

modernization of British industries. But this is a time-consuming process 

which could not solve the immediate problems confronting the British 

exporters at the time Britain returned to the gold standard. In any 

event, the rationalizing and modernizing of industry did not proceed 

rapidly enough to avoid a serious depression during the twenties in the 

British export trades. 

The difficulties confronting the United Kingdom as a result of the 

initial stabilization of the pound were subsequently aggravated by the 

stabilization of the French franc at a price which, from some points of 

view, appeared to be too low. In the case of the French franc, the problem 

of returning to the gold standard was complicated by speculative capital 

movements. Prices and costs had increased so much both during the war 

and in the postwar years that a return to the old parities between the 

2

 See League of Nations, International Currency Experience: Lessons of the Interwar Period 

(1944), Chap. I. 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 3 

franc and other currencies was clearly out of the question. The external 

value of the franc of course declined as prices increased within the country. Moreover, since the period of postwar inflation in France was also a 

period in which large holdings of money assets were being transferred from 

Paris to London and other financial centers, the depreciation of the franc 

was considerably greater than the relative decline in its purchasing power. 

Between November 1918 and July 1926 the price of the franc in American 

currency declined from 18.37 cents to 2.47 cents. Later, when internal 

financial conditions in France had improved, a repatriation of French 

capital occurred, and the franc accordingly increased in value. When the 

French currency was finally stabilized in 1926 and 1927, however, the 

price of the franc in terms of either dollars or pounds sterling was somewhat low relative to its purchasing power in France. Thus France became 

a cheap market in which to buy, while the United Kindom became a 

relatively expensive market. 

Similar mistakes were made in other countries, but their effects upon 

world trade and finance were less important than the effects of the return 

to the gold standard in France and the United Kingdom. All of this is well 

known and would not need to be repeated here except for the bearing 

which it has on the problem of exchange rates in the present period of 

readjustment. As a result of the planless manner in which exchange rates 

were stabilized after the First World War, the balances of payments of 

many countries were subjected to continuous stresses and strains throughout most of the decade of the twenties and in the early thirties. While some 

of these disturbances were an inevitable consequence of the war, many of 

them could have been avoided by a more systematic approach to the 

problem of postwar exchange rates. 

Exchange Rates after the Second World War. The plan evolved at 

Bretton Woods for setting initial exchange rates, and for subsequent 

adjustments in exchange rates through the International Monetary Fund, 

offers a striking contrast to the stabilization of currencies after the First 

World War. Whether the contrast in final results will be as striking as the 

contrast in method of approach, however, depends almost entirely upon 

how the new international monetary organization is administered, and 

upon the cooperation which the Fund receives from member countries. 

Unlike the unilateral and uncoordinated stabilization of currencies during the twenties, the plan set out in the Articles of Agreement of the Fund 

created an opportunity for establishing relative exchange rates by mutual 

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4 INTERNATIONAL MONETARY POLICIES 

agreement among the members of the Fund. The Fund Agreement provided that unless either the Fund or the member country concerned objected, the initial exchange rate at which the Fund commenced operations 

in a particular currency should be the rate prevailing 60 days before the 

Agreement went into effect. If either the member country concerned or 

the Fund regarded the rate prevailing on that date as unsatisfactory, 

however, a different rate was to be established by agreement between the 

member and the Fund. The feature of this procedure which distinguishes 

it from the stabilizing procedure adopted after the First World War is 

the explicit recognition of the fact that exchange rates, or gold parities, 

are a matter of international interest and cannot be determined satisfactorily by unilateral action. 

In September 1946, Mr. Camille Gutt, the Managing Director of the 

Fund, issued a call to all member countries for information concerning 

their exchange rates, and after an extended period of study and discussion, 

announcement was made in December 1946 of the initial exchange rates 

at which the Fund would begin operations. The purpose of the present 

paper is to discuss some of the problems which were involved in this 

setting of exchange rates, and to describe the approach of the Fund to 

solving these problems. 

The rates finally agreed upon were, in every case, the rates existing at 

the time the Fund made its call for information. In other words, no 

changes were made in the existing pattern of exchange rates when the 

Fund commenced operations. This does not mean, however, that the Fund 

regards all of the present exchange rates as long-run rates, or that it does 

not contemplate changes in some of these rates in the future. In their first 

report, published in September 1946 before the initial rates were agreed 

upon, the Executive Directors of the Fund made a statement on this 

question which is so important that it is worth quoting at some length.3 

We recognize that in some cases the initial par values that are established may later 

be found incompatible with the maintenance of a balanced international payments 

position at a high level of domestic economic activity. Because the entire world is in 

need of goods, some countries may maintain foreign exchange values for their currencies which are not for the time being a great handicap to the sale of their exports, 

but which prove to be too high when production is revived all over the world and the 

immediate shortage of import goods is in large part met. Such countries may later 

find difficulty in selling sufficient exports to pay for their needed imports. When this 

* First Annual Report of the Executive Directors of the International Monetary Fund (Washington, D. C, September 1946), p. 12. Italics added. 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 5 

occurs, the Fund will be faced with new problems of adjustment and will have to 

recognize the unusual circumstances under which the initial par values were determined.... 

Parts of this statement of policy were later repeated in the Fund's announcement of initial exchange rates. It is evident from the statement 

that the Fund has foreseen from the outset that it might be desirable or 

necessary to postpone the downward adjustment of some exchange rates. 

Reasons for this postponement will be discussed in a later section of 

this paper. 

MOVEMENTS OF CURRENCY VALUES SINCE 1937 

General Survey. How do the initial exchange rates announced by the 

Fund compare with rates existing before the war? To give a partial answer 

to this question, initial rates for 20 of the member countries are presented 

in the table on page 6. Average exchange rates during a prewar "base" 

period are also shown in the table. For most countries, the period selected as a prewar base was the nine-month period October 1936 to June 

1937. This period was selected because it was relatively close to the war 

years but at the same time reasonably free of war influences. If an earlier 

period had been used, difficulties would have arisen from the wave of 

currency devaluations which occurred in the early thirties and midthirties. If a later period had been used, on the other hand, complications 

would have been introduced both by the American depression of 1937-38 

and by the effects which the imminence of war had upon foreign exchange 

markets. The base period is one of relative exchange stability which followed the Tri-Partite Agreement between the United States, the United 

Kingdom, and France. The exchange rates prevailing in this base period 

are assumed, in later sections of the present paper, to be more or less 

normal prewar rates, but it is probable that in the unstable international 

economic situation which prevailed before the war no single period can 

be regarded as a completely normal or balanced period. The base period 

exchange rates must therefore be accepted with reservations. 

With the exceptions of Canada, Cuba, Colombia, Costa Rica, and 

Venezuela, the exchange rates at which the Fund commenced operations, 

when expressed in American currency, are all lower than the rates in the 

prewar base period. The extent of depreciation varies from 71 per cent 

in the case of the French franc to only 5 per cent in the case of the Danish 

krone. What were the causes of these changes in currency values and how 

were they related to war and postwar economic conditions? In order to 

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6 INTERNATIONAL MONETARY POLICIES 

answer these questions, it will be necessary to consider not only the exchange rates which have been announced by the Fund, but also the 

present exchange rates of certain member countries for which no rates 

have yet been determined, as well as the rates of a number of nonmember 

INITIAL EXCHANGE RATES ANNOUNCED BY THE INTERNATIONAL MONETARY FUND COMPARED 

WITH PREWAR EXCHANGE RATES FOR SELECTED COUNTRIES 

(In cents per unit of foreign currency) 

Country 

Belgium 

Canada 

Chile 

Colombia 

Costa Rica 

Cuba 

Czechoslovakia 

Denmark 

• Egypt 

France 

India 

Iran 

Mexico 

Netherlands 

Norway 

Peru... 

Turkey.... 

Union of South Africa 

United Kingdom. .. . 

Venezuela 

1

 Unless otherwise indicated. 

2 1936 annual average. 

* July-December 1937 average. 

* 1938 average. 

6 1936-37 average. 

SOURCES: Federal Reserve Bulletin, Foreign Commerce Weekly, and Schedule of Exchange Rates issued by the 

International Monetary Fund. 

countries. Information concerning such rates in both the base period and 

the month of December 1946 is presented in the table on page 7. 

In comparing the present pattern of exchange rates with the pattern 

prevailing in the base period, it is convenient to divide all countries into 

three groups: (1) the countries occupied by the German army; (2) the 

Initial rate 

announced by Fund 

2.28 

100.00 

3.23 

57.14 

17.81 

100.00 

2.00 

20.84 

413.30 

0.84 

30.23 

3.10 

20.60 

37.70 

20.15 

15.38 

35.71 

403.00 

403.00 

29.85 

Rate in base period 

October 1936-June 19371 

3.37 

100.04 

5.17 

57.06 

2

16.26 

399 92 

3.51 

21.91 

503.23 

4

2.88 

37.07 

6.07 

27.75 

54.55 

24.66 

5

25.07 

80.00 

485.70 

490.81 

5

26.53 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 7 

countries in the British Commonwealth of Nations, and other countries 

such as Sweden and Argentina which followed a policy before the war of 

stabilizing the values of their currencies in terms of the pound sterling; 

(3) the Latin American countries, exclusive of Argentina. Although this 

classification is not exhaustive, a consideration of these three broad groups 

will nevertheless serve to indicate the main developments in the movement of exchange rates since 1937. 

EXCHANGE RATES OF SELECTED NONMEMBER COUNTRIES AND or MEMBER COUNTRIES FOR 

WHICH N O OFFICIAL FUND RATES HAVE BEEN ANNOUNCED 

(In cents per unit of foreign currency) 

Country 

Nonmember countries: 

Argentina 

Australia* 

New Zealand 

Sweden 

Switzerland 

Member countries for which rates have not been 

announced: 

Brazil 

Greece 

Italy 

Poland 

Uruguay 

1

 Unless otherwise indicated. 

2 February 1947. 

1

1937 average. 

< 1936-37 average. 

* Admitted to membership on Aug. 5, 1947, after this analysis had been completed. 

SOURCES: Federal Reserve Bulletin and Foreign Commerce Weekly. 

The Countries Occupied by Germany. Among other countries included 

in the tables, Belgium, Czechoslovakia, Denmark, France, the Netherlands, and Norway were occupied by the Germans and their currencies 

were cut off from the dollar and sterling markets during most of the war 

years. In several instances, the postwar exchange rates of these countries 

therefore represented a more or less complete break with the past. When 

the period of occupation came to an end, there were no customary or 

accepted rates which could be used as a guide to the new dollar and sterling rates for these currencies. Each country had to decide for itself, 

perhaps in consultation with other members of the United Nations, what 

Rate in December 

19461 

29.77 

321.07 

322.36 

27.82 

23.36 

5.41 

0.02 

2

0.26 

1.00 

56.27 

Rate in base period 

October 1936-June 1937* 

32.72 

391.08 

394.01 

25.30 

22.90 

6.13 

0.90 

3

5.26 

18.90 

4

79.47 

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8 INTERNATIONAL MONETARY POLICIES 

its exchange rate would be. As a result of German expenditures in the 

occupied countries, prices and costs in most of them had risen during the 

war more than they rose in the United States or the United Kingdom, and 

largely for this reason the rates at which the former occupied countries 

began doing business in dollars and pounds sterling were usually well 

below prewar rates. 

The movement of dollar exchange rates in these countries since 1937 is 

shown in the accompanying chart. The chart reveals a sharp contrast 

PER 

CENT 

120 

100 

8 0 

60 

4 0 

20 

DOLLAR PRICES OF CURRENCIES 

OF FORMERLY OCCUPIED COUNTRIES 

AS PER CENT OF AVERAGE PRICES, OCTOBER 1936-JUNE 1937 

- \ X 

-

-

— 

— FRANCE 

•• NORWAY 

-- BELGIUM 

— NETHERLANDS 

— DENMARK 

oo CZECHOSLOVAKIA 

| 

( 

i 

{ 

/ 

j 

y 

PER 

CENT 

120 

100 

80 

60 

40 

20 

1938 1939 1946 

between postwar and prewar rates both with respect to the level of such 

rates and with respect to exchange movements. In the period from 1938 

to the time of invasion, the dollar rates in most of these countries were 

subject to moderate fluctuations, the general tendency being downward. 

In the period since the occupation came to an end, on the other hand, 

fluctuations in exchange rates have been confined within narrow limits 

by means of general exchange controls. The pre-invasion depreciation in 

Norway, Denmark, the Netherlands, and France is attributable partly to 

capital flights and a general fear psychology, and partly to the depreciation of the pound sterling, which will be discussed later. 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 9 

The Prewar Sterling Area. Index numbers of dollar exchange rates 

for the United Kingdom and Canada, and for two non-British countries 

formerly in the sterling area, are shown in the accompanying chart. The 

chart covers the period 1938 through 1946. As in the case of the occupied 

countries, the inflexible exchange rates of the early postwar period are in 

sharp contrast with the exchange fluctuations of the years prior to 1940. 

DOLLAR PRICES OF SELECTED CURRENCIES 

IN PREWAR STERLING AREA AND CANADA 

PER 

CENT 

110 

AS PER CENT OF AVERAGE PRICES, OCTOBER 1936 - JUNE 1937 

100 k ^ 

90 

80 

70 

60 

1 SW 

y 

EDEN 

li T ' i ' ARGENTINA ^ 

IV] »/CANADA y 

\ 

UNITED Kl NGDOM , 

y 

r

" l 

V-

^UV 

PER 

CENT 

-H no 

100 

90 

80 

70 

60 

1938 1940 

1

 No rates were certified between June 14, 1941, and Feb. 5, 1946. During this period the official Stockholm 

selling rate was 4.20 kronor to the dollar (23.8095 cents per krona), as indicated by the thin broken line. 

2

 Official rate. 

3

 Beginning March 1940, official rate. 

4

 From March 1940 through June 1945, official rate. 

The most striking feature of exchange movements in the prewar sterling area is the general depreciation which occurred between June 1938 

and September 1939. Since the other members of the sterling area had 

stabilized their currencies relative to the pound sterling in the period 

prior to 1938, the depreciation in the sterling area during the immediate 

prewar period may be considered largely in terms of the British currency. 

Many reasons have been given for the depreciation of the pound. As with 

the countries occupied by Germany, the flight of capital was undoubtedly 

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10 INTERNATIONAL MONETARY POLICIES 

a contributing factor. It seems probable, also, that in the face of this 

capital movement the British authorities may have decided to relax the 

efforts at stabilization which they had been making through their Exchange Equalization Account. No doubt the depression in the United 

States was also partly responsible for the depreciation of sterling. In any 

event, the pound sterling depreciated steadily in terms of dollars throughout the second half of 1938. With the outbreak of war in September 1939, 

extensive exchange controls were introduced and the pound sterling was 

sharply depreciated by the control authorities from more than $4.60 to 

$4.03. During the early period of exchange control, a free market in 

pounds sterling developed at rates considerably below the official rate, 

but by the end of 1940 the free rate was approximately the same as the 

official rate, and both the free rate and the official remained stabilized 

throughout the war years. After the war, the single rate of $4.03 was 

maintained and was accepted as the initial rate for the United Kingdom by 

the International Monetary Fund. 

The prewar changes in the value of the currencies of other British countries were almost identical with the changes in the pound sterling. With 

the exception of Canada, these countries continued to maintain stability 

of their currencies relative to the pound sterling, and the dollar prices of 

their currencies therefore declined with the fall in the price of sterling. 

The Canadian dollar, however, remained close to parity with the U. S. 

dollar until the United Kingdom depreciated its currency sharply at the 

outbreak of war. Canada then followed part way by depreciating its 

currency about 10 per cent relative to the American dollar. Between June 

1938 and March 1940, the decline in dollar prices of the currencies of 

Australia, India, New Zealand, the Union of South Africa, and the United 

Kingdom was approximately 18.5 per cent, whereas the decline in the 

price of the Canadian currency in the same period (based upon the official 

rate in 1940) was less than lOpercent. Asinthecaseof the pound sterling, 

the depreciated rates were subsequently maintained throughout the war 

years by means of exchange controls. Except for the Canadian dollar, 

which was appreciated to its former parity with the American dollar 

during 1946, the fixed rates established during the war were also maintained after the end of the war, and for India and South Africa they are 

the official rates of the Monetary Fund. 

The non-British members of the sterling area, including Argentina and 

the Scandinavian countries, also permitted their currencies to depreciate 

during 1938, in conformance with the price of the pound sterling, but when 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY EUND 11 

war began and the pound sterling was rapidly depreciated, these countries 

followed only to a limited extent and the over-all depreciation of their 

currencies between June 1938 and 1940 was therefore somewhat smaller 

than the depreciation of the pound. The exchange rates of two of these 

countries, Denmark and Norway, have been discussed above in connection with the occupied countries. The other two countries, as the chart 

indicates, both had dollar rates at the end of the war which were substantially the same as the rates prevailing in 1940. In the case of Argentina, a slight appreciation occurred in the special export rate in 1944, but 

the official rate remained unchanged, and since the end of the war no 

alterations have been made in the dollar price of the Argentine peso. In 

the case of Sweden, the dollar price of the krona was adjusted upward 

in 1946 by more than 15 per cent, and this adjusted rate is the one which 

is currently being used. 

The Latin American Countries. Movements of Latin American exchange rates are extremely difficult to describe because of the multiple 

currency systems which prevail in many of these countries. When the 

Argentine rate was discussed above in connection with the sterling area, 

movements of the official rate alone were analyzed and the multiplicity 

of rates was disregarded. This is a somewhat dangerous procedure, for 

Argentina, like many other countries of South and Central America, has 

a number of different rates, the particular rate in any given instance 

depending upon the use to which the foreign exchange is to be put or on 

the source from which it is derived. 

There is no need, at this point, to give a detailed description of the 

multiple exchange system. Its origin, for the most part, was in the Great 

Depression of the thirties, when the rapid and pronounced decline in raw 

material and agricultural prices created serious balance of payments problems for the Latin American exporters of such products. For a number of 

reasons, many of these countries felt that outright exchange depreciation 

would not improve their balances of payments. Depreciation would have 

made it possible to reduce the foreign exchange prices of their exports 

while maintaining the domestic prices received by producers, but since 

their exports consisted largely of products for which the demand was 

relatively unresponsive to changes in prices, it was widely believed that 

price concessions would reduce rather than increase the amount of foreign 

exchange accruing to the Latin American countries. If a 10 per cent reduction in the price of coffee, for example, would have resulted in an inDigitized for FRASER 

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12 INTERNATIONAL MONETARY POLICIES 

crease of Brazilian exports of only 5 per cent, the amount of foreign exchange derived from coffee sales would obviously have been smaller 

after the price reduction than before. This situation was regarded as typical of many Latin American exports, and a reduction in foreign prices, 

made possible by currency depreciation, was therefore not considered to 

be a solution to the shortage of foreign exchange. 

The situation was further complicated, in many countries, by the fact 

that substantial amounts of foreign exchange were required by governments to make payments on foreign debts denominated in foreign currencies. Currency depreciation, in such cases, would not have reduced the 

demand for foreign exchange but would merely have increased the price 

which the Latin American countries had to pay in their own currencies 

to service their foreign obligations. While this budgetary problem was 

essentially an internal one, there is nevertheless considerable evidence 

that it played an important part in the decision of some countries 

to adopt measures other than currency depreciation when confronted 

with deficits in their balances of payments. 

In the end, the balance of payments problems during the depression 

were temporarily solved, or postponed, by a widespread adoption of 

exchange controls. Foreign exchange acquired by exporters had to be sold 

to a central authority, at fixed prices, and importers, in turn, purchased 

their needed exchange at rates prescribed by the central authority. Having 

become monopolists in their foreign exchange markets, the governments 

of many of the Latin American countries found it profitable or desirable 

to set up schedules of varying rates for the purchase and sale of foreign 

currencies. Although the details of these multiple exchange systems differed considerably from one country to another, certain features were 

nevertheless common to almost all of them. Preferential treatment was 

accorded, in the first place, to governmental agencies which needed exchange to service their foreign obligations. Dollar or sterling exchange 

was usually made available or acquired for this purpose, at the lowest 

price in the schedule of rates. Favorable prices were also provided for 

importers of commodities which were regarded as necessities, with correspondingly more expensive rates established for luxury imports. A similar 

schedule of rates usually prevailed in the purchase of foreign exchange 

from exporters. High prices were paid for foreign exchange arising from 

the export of products which the government wished to encourage, and 

somewhat lower prices were paid for exchange arising from other exports. 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 13 

Thus, in effect, the Latin American governments frequently depreciated 

their currencies for some purposes such as luxury imports and certain 

classes of exports, but left the rates at the old levels for other purposes, 

such as government debt service and the import of certain necessary 

items. 

In all this maze of rates it is not feasible to give a brief description of 

what happened to the external value of a country's currency in the period 

between 1938 and 1946. The best that can be done, in many instances, 

PER 

CENT 

100 

90 

80 

70 

60 

50 

DOLLAR PRICES OF SELECTED CURRENCIES IN LATIN AMERICA 

AS PER CENT OF AVERAGE PRICES, OCTOBER 1936-JUNE 1937 

hK 

i \ 

£3 '! 

HMtMt W 

J~' 

Ssaaafifissa*"^ 

COLOMBIA 

BRAZIL^ 

'""'"'" 

MEXICO 

^—• • 

URUGUAY & 

| | 

_/1 

»><M»M I 

PER 

CENT 

100 

90 

80 

70 

60 

50 

1938 

BeiiimLig April 1939, free rate. 

2

 Beginning January 1939, controlled rate. No quotations Sept. 1 through Nov. 28, 1939. 

is to select one or two rates which seem to be most representative and to 

describe the movements of these rates. In following this course, however, 

it is well to remember that for many of the Latin American countries no 

single exchange rate can possibly represent a complete picture of exchange 

developments. Movements of some of the more important exchange 

rates for a selected group of Latin American countries are shown in the 

accompanying chart. It is apparent from the chart that the prewar exchange movements for the Latin American countries were much less uniform than the movements of sterling area currencies. While the general 

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14 INTERNATIONAL MONETARY POLICIES 

tendency in 1938 and 1939 was a downward adjustment relative to the 

dollar, there were exceptions to the tendency, as the line for Colombia indicates. Some Latin American currencies, such as the Uruguayan and Argentine pesos, were clearly influenced by the depreciation of sterling, but the 

timing of the downward movement in others is quite out of line with the 

depreciation of the British currency. This suggests that other influences, 

such as the American depression of 1937 and 1938, may have been responsible for some of the immediate prewar depreciation in the Latin American 

currencies. 

Like the European exchange rates, the Latin American rates have been 

rigidly controlled both during the war years and in the postwar period. 

This means, in general, that any depreciation of present dollar prices of 

these currencies compared with the dollar rates in the base period October 

1936-June 1937 is attributable to the depreciation which occurred prior 

to 1941, and cannot be directly ascribed to changes in prices and costs 

which occurred during the war. 

Summary of Exchange Rate Movements. The description presented 

above of exchange rate adjustments since 1937 naturally shows a considerable diversity among countries. Despite this diversity, however, certain more or less general tendencies stand out both in the countries which 

are members of the Fund and in nonmember countries. Since these 

general tendencies are important in the discussion of postwar exchange 

rates, a brief summary may be given here. 

For a period of slightly less than one year after the stabilization agreement was made between the United States, the United Kingdom, and 

France in 1936, fluctuations in exchange rates remained within relatively 

narrow limits. Except for certain Latin American countries and countries 

in Eastern Europe, exchange controls were not widespread at this time, 

and exchange rate fluctuations were controlled largely by indirect means 

such as equalization accounts. Since equalization accounts or stabilization 

funds are known to be relatively ineffective against a pronounced and 

persistent discrepancy between the supply and demand for foreign exchange, it seems likely that the stability of exchange rates in this period 

was indicative of a generally balanced condition in the foreign exchange 

markets. This is one of the reasons why the period from October 1936 to 

June 1937 was chosen as a base period for the comparison of prewar and 

postwar exchange rates. 

Beginning in the middle of 1937, the French franc slowly depreciated 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 15 

in terms of dollars, and this movement was followed, in the middle of 

1938, by a gradual but persistent depreciation of the pound sterling. The 

threat of war and the resulting capital flights, as well as the depression in 

the United States, were no doubt contributing factors in the depreciation 

of both the franc and the pound. After the outbreak of war, the pound 

sterling was sharply depreciated to $4.03 (official rate). In France, the 

movement was similar; the franc depreciated at irregular intervals until 

it had reached a level of approximately 2 cents at the time of the German 

invasion. It was pointed out above that the depreciation of the pound 

sterling, and to a lesser extent the depreciation of the French franc, had 

far-reaching effects on other exchange rates. Although not all of the currencies of South and Central America shared in the movement, there was 

a general tendency for these currencies, like the European currencies, to 

fall in value relative to the dollar during the period between 1938 and 

1940. The period between 1938 and 1940 was thus a period of fluctuating 

exchange rates, the general tendency being a reduction in currency values 

relative to the dollar. In most countries, these currency fluctuations were 

finally stopped after the outbreak of war by the introduction of exchange 

controls, and thereafter the pattern of exchange rates was relatively 

stable throughout the war years. 

Stability of exchange rates did not end with the end of the war. For the 

most part, the exchange controls which were devised in the early war 

years have been continued in operation, and exchange fluctuations have 

been confined within relatively narrow limits. Except for the Swedish 

krona and the Canadian dollar, which were appreciated by official action 

in 1946, the present pattern of exchange rates in the sterling countries is 

substantially the same as the pattern prevailing in 1940. Similarly, among 

the countries of Latin America, present dollar exchange rates are broadly 

the same as the rates prevailing in 1940 or 1941, and the stability which 

is characteristic of postwar rates in other countries also characterizes the 

Latin American rates. This means that the rates announced by the 

International Monetary Fund have made allowance for war-induced 

changes in international economic conditions only to the extent that the 

1940 rates anticipated wartime economic developments. 

In the countries occupied by the German army, postwar exchange rates 

are, in most instances, considerably different from the 1940 rates. A 

different set of rates was inevitable,' since the wartime rise in prices was 

considerably greater in these countries than in most other nations. It 

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16 INTERNATIONAL MONETARY POLICIES 

seems doubtful, however, that the rates established represented the 

results of any careful and deliberate study of changes in economic conditions brought about by the war. The speed with which the new rates had 

to be set up precluded such studies, and in any event there were so many 

uncertainties regarding the economic future that political considerations 

and considerations of expediency inevitably played a dominant part. 

This, in brief, is the evolution of present exchange rates for a selected 

group of countries. A general description of exchange rate movements has 

been given because it was believed that such a background would be helpful in discussing the appropriateness of present rates. In any comparison 

of present rates with prewar rates it is useful to know how the rates got 

where they are from the prewrar level. This, indeed, is an essential part of 

a judgment as to the appropriateness of existing rates. It would obviously 

be impossible, within the limits of a paper such as this, to indicate how 

each individual rate is likely to affect the future course of world trade. 

An attempt is made below, however, to suggest certain probable consequences of the present exchange rate pattern as a whole. 

EXCHANGE RATES AND PRICES 

The Purchasing Power Parity Theory. One of the factors which must be 

taken into account in any discussion of present currency values is the 

general rise in prices and costs which was brought about by the war. 

Even in countries where price controls were maintained throughout the 

war years, the inflationary effects of large government purchases of goods 

and services could not be entirely avoided. If these price increases had 

been uniform throughout all countries, no particular difficulties would 

have arisen as far as foreign trade is concerned. A casual glance at a few 

statistics of prices, however, will convince the reader of the enormous 

disparity which has developed between the price changes in one country 

and those in another. In France, for example, wholesale prices have 

increased about 700 per cent above the prewar level, compared with increases of 200 per cent in Czechoslovakia, 185 per cent in Mexico, and 

45 per cent in Australia.4 In view of these discrepancies, it is obvious that 

relative changes in the internal purchasing power of different currencies 

will have substantial effects on the course of international trade unless 

they are offset by corresponding changes in exchange rates. 

4

 These figures, taken from the appendix table on p. 45, represent a comparison of prewar 

prices with prices prevailing at the end of 1946. 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 17 

After the First World War, the discrepancies between movements of 

price levels in different countries were equally great, and since exchange 

rates in many countries were uncontrolled, these changes in relative purchasing power exerted a considerable influence on exchange rates. Indeed 

the changes in prices and costs were so striking by comparison with other 

economic changes that there was a tendency to explain the observed 

movement of exchange rates entirely in terms of changes in relative purchasing power. This was the doctrine of purchasing power parity which 

enjoyed a considerable popularity among economists in the 1920's. The 

theory of purchasing power parity, in its simplest form, may be illustrated by means of a numerical example. 

Suppose that in some initial period, when international payments are 

in a balanced condition, the exchange rate between the dollar and the 

pound sterling is $4.50 = £l. And suppose that as a result of a war, prices 

and costs in the United States increase uniformly to a level just twice 

their former level, while prices and costs in the United Kingdom rise to 

three times their former level; in other words, the index of prices in the 

United States increases to 200 while the index in the United Kingdom 

increases to 300. According to the purchasing power parity doctrine the 

internal purchasing power of the dollar at the close of the war is one-half 

of its former level, and the internal purchasing power of the pound is onethird its former level. Hence, it is argued, in order to preserve balanced 

trade relations between the two countries, the price of the pound, in terms 

of dollars, must drop to two-thirds of the old price, or to $3 = £l. More 

generally, the so-called parity exchange rate is equal to the price of the 

pound in the base year, in terms of dollars, multiplied by the ratio of the 

price index in the United States to the price index in the United Kingdom. 

The virtue of the parity rate is that it preserves the earlier real exchange ratio between the goods and services of one country and the goods 

and services of another. To see why this is true, suppose in the above 

example that an American product, X, before the war sold for $1.50, 

while a British product, F, sold for £l. At the old exchange rate, American purchasers of Y would have had to pay $4.50 per unit, and the price 

per unit in the United States would thus have been three times the price 

of a unit of the American product, X. We may assume, now, that as a 

result of the war inflation the cost of production and the price of each 

commodity, in the currency of the selling country, rises according to the 

general price rise. In other words, the selling price of X, the American 

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18 INTERNATIONAL MONETARY POLICIES 

product, is doubled while the price of F, the British product, is tripled; 

the new price of X is $3.00, and the new price of Y is £3. At the parityexchange rate of $3 = £1, the American price of the British product is 

thus $9. Once again, therefore, the unit price of the British product, in 

dollars, is three times the unit price of the American product. 

Since the relative price of British goods, compared with the price of 

American goods, is the same after the inflation as before, the general rise 

in prices will not affect the import of British goods; unless tastes or conditions of production and trade have changed, the physical volume of 

British imports will be the same as in the prewar situation, and only the 

monetary units in which these imports are measured will have changed. 

Likewise, in the United Kingdom the sterling price of United States 

goods, relative to the price of British goods, will remain the same as 

before the inflation, and a presumption exists that the physical volume of 

British imports will be unchanged. 

Criticisms of Purchasing Power Parity. While adoption of the parity 

rate is desirable in the solution of some problems, it may be quite undesirable in the solution of others, for in some circumstances it may be 

necessary to change the real terms of trade between countries in order to 

restore a balanced condition in international trade. If this is true, the socalled "equilibrium" rate of exchange will differ from the parity rate. 

Suppose, for example, that the base period chosen for the calculation of a 

parity rate in the numerical example above had been a period in which the 

United States had a deficit in its balance of payments. Other things being 

equal, the parity rate between the dollar and the pound, by perpetuating 

the real terms of exchange between British and American goods, will likewise perpetuate the deficit. Only the money units in which the deficit is 

measured will have changed. In order to restore a balanced condition, 

exports of the United States must be encouraged, and imports reduced, by 

means of a depreciation in the value of the dollar below the parity rate. 

Thus, if the base period is one of disequilibrium, the parity rate, after the 

price rise has taken place, will not be the same as the rate which will 

establish equilibrium in a country's balance of payments.5 

Other factors will also create a disparity between the parity rate and 

the equilibrium rate. Consider, for example, the effects of capital movements. Suppose that in the prewar base period there were no capital move5

 On all of these criticisms of parity calculations cf. Gottfried Haberler, "The Choice 

of Exchange Rates after the War," American Economic Review, June 1945, pp. 311-15. 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 19 

ments, and that after the rise in prices has taken place the United States 

expects to make extensive loans to the United Kingdom. Assuming that 

the base period was one of balanced trade without capital movements, the 

parity rate will also establish a balanced condition, in the absence of 

capital movements, after the price rise has taken place. But if the United 

States is to make large foreign loans an export surplus can and should be 

allowed to develop in the United States balance of trade, and in order to 

bring about such an export surplus, the exchange rate for the dollar must 

be depreciated below the parity rate. Accordingly, we find once more a 

difference between the parity rate and.the equilibrium rate. Changes in 

tastes or in methods of production will create a similar difference between 

the two rates. If, because of such changes, the American demand for 

British goods has increased during the time interval between the base 

period and the period of comparison, the parity rate, by re-establishing 

the earlier ratio of exchange between British and American goods, will 

lead to a deficit in the United States balance even though the initial 

period was one of equilibrium. In order to make the supply of foreign 

exchange equal to the demand, the value of the dollar in this case must 

again be depreciated below the purchasing power parity rate. 

Movements of output and employment are also important in judging 

the validity of parity calculation, for these movements bring with them 

substantial changes in the demand for imports. In times of comparative 

economic stability, the effects of changes in employment upon the equilibrium level of exchange rates can perhaps be neglected, but in a period 

such as the prewar decade of the thirties, when movements of output and 

employment were the dominant feature of economic activity, large discrepancies may develop between the parity exchange rates and the rates 

which would restore equilibrium in a country's balance of payments. To 

see why this is true, suppose that international trade is initially in equilibrium, and that the level of output in a single country is increased while 

output in other countries remains unchanged. As a result of the higher 

output in the expanding country, the demand for imports rises; a greater 

volume of imported materials is required to produce the higher level of 

output and, at the same time, consumers with higher incomes increase 

their purchases of foreign commodities. The expanding country is faced 

with a deficit in its balance of payments which will normally lead to a 

depreciation of its currency even if there are no changes in sellers' prices 

either at home or abroad. In other words, a relative expansion of output 

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20 INTERNATIONAL MONETARY POLICIES 

in one country alters the equilibrium exchange rate in a way which does 

not correspond to the movement of prices; in extreme examples the equilibrium exchange rate can be altered with no changes in prices at all. 

The foregoing criticisms of purchasing power parity have all considered 

the most favorable case for the parity theory in which prices and costs 

rise or fall uniformly within any given country. Although this implied 

assumption may be justified, to a considerable extent, in periods of hyperinflation, the practical application of the parity doctrine is usually complicated by differences in the degree of price rise or fall within each country. When some prices or costs rise more rapidly than others within the 

same country, no simple comparison between price movements in different countries can be made. The best that can be done is to use an average 

or index number of price changes, and if the discrepancies in price movements as between different commodities in the same country are large, 

such an index number, at best, is only a rough indication of the change in 

the value of the monetary unit. Moreover, since several types of price 

index numbers are usually available, the calculation of parity rates is not 

a simple procedure, but involves a considerable element of judgment as to 

what prices and costs are important for a country's balance of payments. 

Considering this element of judgment, it is not surprising that the selection of an appropriate price index has been one of the most controversial 

topics concerning purchasing power parity. Indeed, in some cases the 

difficulty of selecting an index has been the most important single cause 

for the disrepute into which the parity theory has fallen. It has been said, 

on the one hand, that the prices of commodities which do not enter into 

international trade are irrelevant, since these prices, at most, have only 

an indirect influence on a country's balance of payments. And on the other 

hand, it has been argued that international prices, or the prices of goods 

which enter into international trade, cannot be used because these prices 

necessarily adjust themselves to changes in exchange rates. In other 

words, it has been argued that prices for commodities which have a world 

market, such as many agricultural products and raw materials, necessarily adjust themselves, within a given country, to any change in that 

country's exchange rate. 

To clarify this point, suppose that Canada is an exporter of such a 

product, Z, to the United Kingdom. If the exchange rate between Canada 

and the United Kingdom is $4 = £l, and if the British price of Z is onefourth pound per unit, the Canadian price will necessarily be $1.00, since 

Canada is an exporter of Z and its price is governed by the world price. 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 21 

Now suppose the exchange rate is altered to $5 = £l. If the British price 

of Z were to remain unchanged, the price in Canadian currency would 

rise to $1.25, and the relative change in the price of Z between the two 

countries would conform exactly to the change in the exchange rate. 

Since this type of behavior is characteristic of many commodities which 

are sold in competitive international markets, it has been said that the 

prices of internationally traded goods cannot be used in parity calculations. To include such prices, it is said, imparts a bias in the parity calculations which tends to justify the existing exchange rate, whatever it may 

be. If prices of domestic goods cannot be used in the calculations because 

they are irrelevant, and if prices of international goods cannot be used 

because they always adjust themselves to movements of exchange rates, 

it must seem, as it did to some economists, that the theory of parity has 

little substance, and must be replaced by other methods of judging exchange rates. 

One proposed solution of the price dilemma is a substitution of data on 

unit costs of production for price data. In other words, it has been suggested that parity rates might be computed from indexes of costs rather 

than price indexes. If adequate information concerning costs were available this would no doubt be a useful approach, for the cost figures would 

be free, to a considerable extent, of some of the most glaring logical problems which beset the use of price indexes. Unlike some price comparisons, 

it could hardly be said that parity calculations based upon costs of internationally traded goods would inevitably justify existing exchange rates, 

for costs of production do not adjust themselves as quickly or as completely to a change in exchange rates as do the prices of some international goods. 

Although cost comparisons would obviously be preferable to price comparisons in some respects, it is clear that the use of cost data in the parity 

calculations could also present some new difficulties. If costs of production 

for a given product vary as between different firms, for example, which 

firms' costs are to be included in the index of general costs? And if the 

costs for a particular firm vary according to the level of output, at what 

level of output should the parity calculations be made? These questions 

will be recognized as the same difficult questions as those which arose in 

connection with the tariff to equalize costs of production at home and 

abroad, and the answers are no less difficult to find now than they were 

with regard to the tariff. 

The selection of cost data for parity calculations, like the selection of 

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22 INTERNATIONAL MONETARY POLICIES 

price index numbers, involves a more or less arbitrary judgment, and the 

resulting parity rates are thus to be regarded as rough approximations to 

the effects of monetary inflation or currency values, and not as final 

answers to the problem of exchange rates. 

Perhaps the principal advantage of cost comparisons over price comparisons is that costs are likely to represent more or less permanent 

changes in monetary values whereas prices may reflect the transitory 

effects of inflation. At the close of a period of general inflation, it is possible that prices may have increased considerably more than wage rates 

and other costs. In this event a short recession may cause a significant 

reduction in prices without a corresponding reduction in costs. In many 

instances, the permanent effects of inflation on the value of a currency 

will accordingly be measured more accurately by cost changes than by 

price movements. 

Despite the obvious advantage of cost comparisons, it has been impossible to make such comparisons in the present study. Accurate and 

comprehensive data of unit costs of production are seldom published even 

in countries with as much economic data as the United States and the 

United Kingdom possess, and in other countries having less advanced 

statistical services cost information is virtually nonexistent. Changes in 

wage rates, the most important element of unit costs, might be substituted for the unavailable unit cost figures, but here again the investigation 

is confronted with a lack of data, for general indexes of wages are much 

less common than are general price indexes. In considering the effects of 

war inflation on relative currency values it has therefore been necessary 

to employ only price data, even though a comparison of wage changes or 

changes in other costs of production would have been a useful supplement. 

Parity Rates in Peace and in War. The arguments against purchasing 

power parity appeared to be so overwhelming during the interwar period 

that many economists abandoned the theory entirely. It is a curious fact, 

nevertheless, that despite its abandonment in principle the theory continues to be widely used in practice as a means of judging the pattern of 

postwar exchange rates. What are the reasons for this divergence between 

theory and practice? Why is the purchasing power parity doctrine generally discredited and at the same time widely employed? The explanation 

of this inconsistency, the writer believes, is in the fact that the parity 

theory is not a general theory of exchange rates, and that it has been 

applied, in the past, to conditions for which it was not intended. The 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 23 

parity doctrine was used primarily for the purpose of explaining the movements of exchange rates after the First World War, and as a theory of 

postwar exchange rates it retains much validity notwithstanding the arguments against it. The theory was discredited not because it was 

unimportant or irrelevant in the explanation of exchange rates after the 

war, but because attempts were later made to use it in the explanation 

of exchange rates under more normal conditions for which it was not 

appropriate. 

The factors which should be taken into account in setting exchange 

rates after a period of war-induced inflation are obviously quite different 

from those which affect exchange rates under more normal conditions. 

In particular, wartime movements in prices and costs are unusually large, 

and the discrepancies in price movements between different countries 

are likewise large. Examples of these discrepancies, taken from wholesale price statistics, were presented at the beginning of the present discussion of prices and exchange rates. Equally great discrepancies appeared during the war in retail prices. Although retail price movements 

did not always agree with wholesale price movements in any particular 

country, the order of magnitude of the two types of price change was in 

most instances roughly comparable, and the changes in prices, whether 

measured by one index or the other, were so large and so different as 

between one country and another that they immediately impress the 

observer as one of the most important influences on relative currency 

values. 

Perhaps even more important than the amplitude of the price and 

cost movements is the fact that such movements, in times of war, tend 

to be more or less independent of changes in output and employment. 

Indeed, the really large price changes do not occur until output has approached the limits of a country's capacity. In contrast to these war 

developments, price and cost changes in normal years of peace are smaller 

and much more closely related to rising and falling output and employment. The disturbances in a country's balance of payments during nonwar periods are therefore largely attributable to factors other than price 

change, and parity calculations have a correspondingly small significance. 

This was particularly true during the thirties when international payments throughout the world were disrupted by large and divergent 

movements of output and employment as well as by large and rapidly 

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24 INTERNATIONAL MONETARY POLICIES 

prising that a method of estimating equilibrium exchange rates which 

was reasonably satisfactory for conditions of war and postwar inflation 

should have been quite inapplicable to the depressed and unstable conditions of the early thirties. It is unfortunate, however, that the inappropriateness of the parity doctrine to the conditions of the thirties should have 

led to a complete condemnation of purchasing power parity under all 

conditions. Despite the limitations of parity calculations, it ought to be 

recognized that a comparison of price movements in different countries, 

in times of war inflation, provides much useful information regarding 

exchange rates and international equilibrium. In other words, war-induced 

movements of prices and costs should be recognized as an independent 

influence on the flow of foreign payments and receipts. 

Parity Rates Based upon Wholesale and Retail Prices. Without intending to deny the relevance of other forces, a table is presented here 

which indicates roughly to what extent the exchange rates announced 

by the International Monetary Fund have made allowance for war-induced changes in prices. For 19 of the member countries, purchasing 

power parity rates have been computed by using the period from October 

1936 through June 1937 as a base. The parity rate for a given country is 

the rate which w

r

ould make the present purchasing power of that country's 

currency the same, relative to the purchasing power of the dollar, as it 

was in the base period. Reasons for the choice of the base period used 

here have been discussed earlier in connection with the prewar movement 

of exchange rates. Most of the parity rates have been computed as of 

November or December 1946, but in any event the date for which each 

rate was computed is indicated in the table. Since prices seldom moved in 

an entirely uniform manner within a single country, parity rates have 

been computed for two types of average prices, a wholesale price index and 

a cost of living or retail price index. The table shows a rather persistent 

tendency for the rates announced by the Fund to exceed the parity rates. 

Of the 19 countries whose rates are included, 9 countries—Belgium, 

Colombia, Costa Rica, Cuba, Egypt, France, India, Iran, and Mexico— 

have official exchange rates which appear to be well above the parity 

rates, regardless of whether such parity rates are measured in wholesale 

or retail prices. In only three cases—Canada, the Union of South Africa, 

and the United Kingdom—are the rates announced by the Fund substantially lower than the parity rates for the end of 1946. 

The fact, shown by the table, that official rates announced by the 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 2 5 

Fund exceed the parity rates for a considerable number of countries does 

not mean, of course, that the currencies of the countries involved are 

necessarily overvalued by the Fund. The question whether any particular 

rate is too high or too low in terms of dollars is an extremely involved 

question which could not possibly be answered in an over-all survey of 

PARITY EXCHANGE RATES COMPARED WITH THE RATES ANNOUNCED BY THE INTERNATIONAL 

MONETARY FUND1 

(In cents per units of foreign currency) 

Member country 

Belgium 

Canada.... 

Chile 

Colombia... 

Costa Rica. 

Cuba 

Czechoslovakia. 

Denmark 

Egypt 

France 

India 

Iran 

Mexico 

Netherlands. 

Norway 

Peru 

Turkey 

Union of South Africa. 

United Kingdom 

Parity rates 

Wholesale price parity Cost of living parity 

(11/46) 120.33 

(11/46) 3.19 

(11/46) 13.28 

(11/46) 1.90 

(11/46) 18.54 

(7/46) 246.27 

(11/46) 0.63 

(8/46) 

(5/46) 

16.69 

1.54 

(11/46) 15.89 

(10/46) 34.16 

(11/46) 22.80 

(11/46) 15.58 

(9/46) 29.50 

(9/46)425.24 

(11/46)467.59 

(12/46) 1.52 

(11/46) 118.45 

(11/46) 2.35 

(10/46) 39.39 

(11/46) 11.38 

(10/46) 72.17 

(11/46) 1.54 

(9/46) 19.34 

(7/46)251.93 

(9/46) 0.53 

(11/46) 

(5/46) 

(11/46) 

(9/46) 

(11/46) 

21.21 

1.07 

11.63 

42.11 

21.59 

(11/46) 17.40 

(9/46) 35.23 

(9/46) 500.27 

(11/46) 549.46 

Rates 

announced 

by the Fund 

2.28 

100.00 

3.23 

57.14 

17.81 

100.00 

2.00 

20.84 

413.30 

0.84 

30.23 

3.10 

20.60 

37.70 

20.15 

15.38 

35.71 

403.00 

403.00 

1

 Sources of price data are given in the appendix table on p. 45; sources of exchange rates in preceding tables. 

The base period used in calculating these parity rates is the same as the base period for which prewar exchange 

rates are given in the earlier tables. Figures in parentheses indicate the month and year for which the parity rate 

was computed. 

postwar exchange rates such as the present paper. In order to make an 

exact estimate of the exchange rates which would be consistent with a 

balanced position in international trade, it would be necessary to consider 

all of the changes in tastes, techniques, real income, and capital movements mentioned above, in addition to the changes in prices. In other 

words, the parity calculations are only a first approximation which 

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26 INTERNATIONAL MONETARY POLICIES 

indicates to what extent present exchange rates have made allowance for 

the war-induced changes in the domestic purchasing power of various 

currencies. Nevertheless the fact that the parity rates tend to fall short 

of the rates announced by the Fund is, in the author's opinion, a general 

indication that present exchange rates of a number of countries are somewhat higher than the rates which will ultimately be consistent with a 

balanced state of international payments. 

The tendency for present exchange rates to exceed parity rates is also 

apparent in countries which are not members of the Fund, as well as in 

member countries for which no exchange rates have been announced. 

The accompanying table presents parity rates and actual rates as of 

December 1946 for five nonmember countries and for five member 

countries whose official rates have not been agreed upon. Since the general 

picture presented by this table is much the same as that for the member 

countries which have agreed rates, it will not be necessary to comment 

in detail. It may be useful, however, in concluding the presentation of 

parity rates, to make a few remarks concerning the general pattern of 

rates in both member and nonmember countries. So far as possible, 

rates will be considered within broad economic or geographic groups of 

countries. 

The only group of countries for which parity rates are consistently 

higher than actual rates are the United Kingdom and the British 

dominions of Canada, Australia, New Zealand, and South Africa. In all 

of these countries, price controls were effective during the war and to a 

considerable extent have subsequently been maintained. Up to the present 

time, war and postwar inflation have thus been largely avoided, and at 

present exchange rates the purchasing power of the currencies of these 

countries has increased, relative to the purchasing power of the dollar. 

The position of these countries is discussed further in a later section. 

Parity rates for the Western European countries, except for the Netherlands, are to a greater or smaller extent below the actual dollar exchange 

rates. Among the Scandinavian countries, the parity rates for Denmark 

and Sweden are below present rates, while the parity rate for Norway is 

slightly above the actual rate. In any event, the discrepancies between 

parity rates and actual rates for the Scandinavian countries are not large. 

Egypt, India, and Iran all have parity rates which are well below the 

actual rates. The parity rate of the Egyptian pound, for example, is approximately $2.50, compared with an actual rate of $4.13. Likewise, with 

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respect to India, the parity rate for the rupee is between 17 and 21 cents, 

compared with an actual rate of approximately 30 cents. Although these 

figures indicate a substantial change in comparative purchasing power, 

the reader is warned against placing too much reliance upon any particular figure. The price index numbers for these countries are at best rough 

approximations, and more comprehensive indexes might deviate considerably from the ones used in the parity calculations. Moreover, in nonindustrial countries such as these the cost structure is much more flexible 

PARITY EXCHANGE RATES COMPARED WITH RATES IN DECEMBER, 1946, FOR NONMEMBER 

COUNTRIES AND FOR MEMBER COUNTRIES FOR WHICH RATES HAVE 

NOT BEEN ANNOUNCED1 

(In cents per unit of foreign currency) 

Country 

Nonmember countries: 

Argentina 

Australia* 

New Zealand 

Sweden 

Switzerland 

Member countries for which ratesj 

have not been announced: 

Brazil 

Greece 

Italy 

Poland 

Uruguay 

Parity rates 

Wholesale price parity Cost of living parity 

(11/46) 24.66 

(11/46)440.51 

(10/46)395.27 

(11/46) 24.66 

(11/46) 18.77 

(11/46) 0.14 

(9/46) 424.97 

(9/46) 24.11 

(11/46) 21.86 

(11/46) 

(10/46) 

(9/46) 

(10/46) 

(9/46) 

3.87 

0.0083 

0.26 

0.23 

74.94 

Rates in 

December 

1946 

29.77 

321.07 

322.36 

27.82 

23.36 

5.41 

0.02 

0.26 

1.00 

56.27 

1

 Sources are the same as in preceding tables. The base period is the same as in the tables of exchange ratesFigures in parentheses indicate the month and year for which the parity rate was computed. 

* Admitted to membership on Aug. 5, 1947, after this analysis had been completed. 

than in countries like the United States and the United Kingdom. If a 

decline in prices eventually sets in, price indexes for these countries may 

therefore decline quite rapidly. It would accordingly be a mistake to 

assume that the war-induced inflation of prices and costs is as permanent 

in countries such as Egypt and India as it will probably be in the United 

States and the United Kingdom. The same consideration applies, to a 

considerable extent, to prices and costs in Latin America. As the two 

tables show, the Latin American parity rates are, with a few exceptions, 

somewhat below the actual rates. This does not necessarily mean, howDigitized for FRASER 

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ever, that the Latin American countries will experience difficulties in 

exporting at existing rates, for the cost structure is relatively flexible in 

many of these countries, and may adjust itself rather rapidly in a period 

of general deflation. 

Multilateral and Bilateral Comparisons. The foregoing description of 

exchange rates and of the relation of such rates to parity rates has been 

devoted exclusively to a comparison of individual currencies with the 

U. S. dollar. Nothing has been said about such additional problems as the 

relation of the French franc to the pound sterling, or the relation of the 

Scandinavian currencies to those of France, Belgium, and the Netherlands. A bilateral comparison of individual currencies with the dollar, 

such as the comparison above, is obviously important, since the foreign 

trade and foreign financial transactions between the United States and 

other countries will continue to be a substantial part of world trade and 

finance, particularly in the immediate future. A complete description of 

exchange rates and prices, on the other hand, must consider not only 

such bilateral relations but also the multilateral character of all currency 

values and prices. 

In Belgium, for example, the relation of the French franc to the Belgium franc is normally more important than the relation of these two 

currencies to the dollar. Similarly in Denmark, the sterling-krone ratio 

is more significant than the dollar-krone ratio. These "cross rates" should 

therefore be considered as well as the dollar rates. 

Unfortunately, a completely multilateral assessment of exchange rates 

is confronted, at the outset, with tremendous technical difficulties. It is 

possible to consider the balance of payments of a particular country with 

the rest of the world, and to say that with the existing cross rates of 

exchange in the rest of the world the present value of the particular 

currency appears to be too high or too low. But what if these cross rates 

are altered by a change in the value of some other country's currency? 

How will this affect the judgment that the particular country's currency 

is overvalued or undervalued relative to the rest of the world? To the 

professional reader it will be apparent that the problem posed here is 

really a problem of simultaneous equations, and a complete solution cannot be obtained in any other way. For present purposes, therefore, the 

multilateral comparison must necessarily be limited to a few rather 

general observations. 

It may be noted at the outset that so far as price effects are concerned 

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there is no need to make a multilateral comparison in addition to the 

bilateral study of parity rates, for the parity rates of all currencies in relation to a particular currency will establish cross rates which are also 

parity rates for the currencies concerned. To clarify this point, consider a 

numerical example. Suppose that in a base period the price of the pound 

sterling in dollars is $4.50 while the price of the French franc is $0.05. 

The cross rate between the franc and the pound will then be 90 francs to 

the pound. Suppose now, that at the end of a period of inflation, representative price index numbers in the three countries, with the base period 

as 100, are as follows: United States, 150; United Kingdom, 300; France, 

600. The parity rates for the pound and the franc, relative to the dollar, 

are then $2.25 and $0.0125 respectively. This implies a cross rate between 

the pound and the franc of 180 francs to the pound, which is also the 

parity rate of the franc relative to the pound. Thus, as far as price comparisons are concerned, parity calculations and multilateral comparisons 

come to the same thing. Multilateral comparisons must be made only 

when we are considering the complications introduced by capital movements, changes in methods of production, and other nonprice influences 

on a country's balance of payments, or when we wish to study the effects 

of maintaining exchange rates which in some instances do not agree with 

the parity rates. 

The significance of multilateral comparisons is readily apparent in 

some of the regional problems which were suggested above. We have seen 

that, as far as prices alone are concerned, the present value of the pound 

sterling relative to the dollar appears to be somewhat low while the prices 

of the Scandinavian currencies are not far from the dollar parity rates. 

As3uming that no change is made in the value of the pound relative to 

the dollar, this means that the Scandinavian currencies will be expensive 

relative to sterling. Unless Danish exports of agricultural products are 

subsidized, these exports to the United Kingdom may accordingly be 

expensive compared with other prices in the United Kingdom. Thus, if 

the dollar price of the pound remains unchanged it may be necessary at 

some point to change the dollar prices of the Scandinavian currencies 

even though they are at present not far from the dollar parities. 

Similar arguments apply to other cross rates such as that between 

France and Belgium. Although both the French franc and the Belgian 

franc appear to be expensive in terms of dollars, the degree of overvaluation is about the same in both cases; the Belgian dollar parity rate, 

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based on retail prices, is 67 per cent of the actual rate, while the French 

parity is 63 per cent of the actual rate. In export markets where the two 

countries are in competition, overvaluation relative to the dollar is 

thus less significant than it would have been had the degree of overvaluation differed as between the two countries, and Belgium's decision 

concerning any future adjustment of the external value of its currency 

will be greatly influenced by the policy adopted concerning the French 

franc. 

Other examples of cross relationships could be given, but for present 

purposes the ones above should suffice to indicate the complicated character of the multilateral system of exchange rates. Every rate is related to 

every other rate, and changes in one will inevitably have repercussions 

upon many others. 

THE POLICY OF THE INTERNATIONAL MONETARY FUND 

Alternatives Which Faced the Fund. When initial exchange rates were 

under discussion during the last quarter of 1946, the Fund and the 

member countries were faced with two alternative courses of action. 

First, they could have attempted to determine the pattern of exchange 

rates which would be consistent with a long-run balance in international 

payments and receipts, and these rates could then have been adopted as 

the initial rates with which the Fund began operations. This course of 

action would probably have required substantial changes in some exchange rates, but if the original calculations were carefully done there 

might have been a reasonable expectation that subsequent changes 

in rates would be relatively small. The second alternative was to accept 

more or less the existing pattern of exchange rates with the expectation 

that adjustments would be made later when more normal conditions 

returned. In other words, the adjustment of exchange rates to the new 

economic conditions brought about by the war could be postponed until 

a later date. 

In fact, the Fund adopted the second alternative. Although Mr. Gutt, 

in requesting information from the member countries relative to their 

exchange rates, had announced that the Fund must solve its most 

difficult problem—the agreement on initial exchange rates—before it 

commenced operations, in the end a decision was made, in effect, to 

postpone the solution of the problem by accepting the present pattern 

of exchange rates. The member countries requested that the rates at 

which they had stabilized their currencies after the war be used as official 

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rates by the Fund, and after considerable discussion this was agreed to 

in the case of all the countries for which rates were announced. As noted 

earlier, however, it was frankly recognized at the time the initial rates 

were announced that adjustments would probably be necessary later. 

The foregoing discussion of parity rates lends support to this view, for it 

indicates that unless unforeseen changes in prices and costs occur, the 

currencies of a considerable number of countries will probably prove to be 

too high, when normal conditions have returned, to preserve a balance 

between foreign payments and receipts. 

Reasons for Accepting Current Rates. Why were the existing rates accepted as initial rates by the Fund despite the fact that some of them 

were known to be out of line with current prices and costs? And what will 

be the consequences of this action on the flow of international trade? 

Perhaps the most important reason for beginning operations with existing 

rates is that the member countries themselves were anxious to keep their 

present rates, and that most of them had good economic reasons for 

wanting to do so. It is an interesting fact that many countries today 

want to keep the value of their currencies as high as possible, despite 

wartime increases in prices and costs, whereas in the prewar decade these 

same countries, in many instances, were rivals in a general move to 

depreciate their currencies. Although this reversal in attitude may seem 

strange at first sight, it is easily explained in terms of the difference between the primary economic problems of the thirties and those of the 

present day. In the thirties, the over-riding economic problem in almost 

all countries was deflation, inadequate demand, and unemployment. 

Most countries were extremely anxious to increase the demand for their 

products, including the foreign demand, and one means of increasing 

foreign demand was to depreciate the currency. Once this process was 

started, it led to depreciation of other currencies in retaliation or selfprotection, and thus we witnessed a wave of competitive currency depreciation. 

The situation today offers a sharp contrast with conditions in the thirties, and the currency policies followed by individual countries are accordingly different. The problem today is how to avoid a rise in prices 

rather than how to avoid a price decline. A considerable part of the 

world's productive capacity has been destroyed or worn out and at the 

same time the demand for goods in general has reached an unprecedented 

height as the combined result of accumulated war shortages and accumulated purchasing power. Thus the primary problem today is how to 

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produce enough to satisfy the present demand, whereas the problem of 

the thirties was how to find markets for the goods which could be produced. In view of this contrast in economic conditions, it is not surprising that the foreign financial policies of many countries are strikingly 

different from their policies during the thirties. Although many countries 

recognize that their current exchange rates in terms of dollars and pounds 

sterling are probably too high, relative to present prices and costs, most 

of these countries are extremely reluctant to depreciate at the present 

time. 

This reluctance to depreciate is in part attributable to a fear that depreciation would aggravate inflationary developments. Just as currency 

depreciation in the thirties helped individual countries to avoid a fall in 

domestic prices and incomes by creating a foreign demand for their goods, 

so today, the maintenance of high currency values helps many of these 

same countries to retard inflation by keeping down the domestic prices of 

their imports. Despite present inflationary pressures, many countries 

have finally succeeded in achieving a precarious price stability and an 

equally precarious balance between prices and costs by means of price 

controls, wage controls, and rationing. Although these controls in many 

instances are neither as comprehensive nor as strictly enforced as war 

controls, they have frequently accomplished the purpose of preventing 

or retarding a further spiral of increased prices and increased costs. The 

distaste for currency depreciation is in many instances attributable to a 

fear that depreciation, by increasing the domestic prices of imports, will 

disturb the precarious balance and lead to additional increases in both 

prices and wages. If a country's domestic prices for imported goods rise 

as a result of depreciation, this means in many cases a substantial increase 

in the cost of living, and an increase in living costs may easily lead to 

demands for wage increases which will start the entire inflationary process 

anew. Considering this possibility, it is easy to understand why many 

countries, and particularly those countries whose economies were badly 

damaged by war, are reluctant to depreciate their currencies at the 

present time. 

Apart from its effect on the cost of living, currency depreciation in the 

near future might have serious inflationary consequences simply as a 

result of its psychological effects. This is particularly true of the European 

countries in which inflation after the First World War was accompanied 

by a rapid currency depreciation. The people in many of these countries 

have an exaggerated idea of the relation between depreciation and the 

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internal value of a currency and tend in some cases to regard depreciation 

and inflation as synonymous. Depreciation in these countries, under 

present circumstances, might therefore lead to a wave of spending which 

would further aggravate the tendency of prices to rise. It would be assuming a considerable responsibility to insist, in the face of these conditions, 

that an immediate adjustment should be made in the exchange rates of 

the countries whose currencies seem from a long-run point of view to be 

overvalued. 

Apart from the dangers of further inflation, there are a number of 

other convincing arguments against making an immediate adjustment 

in exchange rates. Most countries whose currencies appear to be too 

expensive in relation to their domestic prices are also countries which will 

be borrowing heavily from the dollar area during the next three or four 

years. In other words, the normal condition for these countries during 

the transition years will be an import surplus, the excess of imports to 

be paid for out of dollar loans from such agencies as the Export-Import 

Bank and the International Bank for Reconstruction and Development. 

Thus even if such countries had no import controls and their exchange 

rates were immediately adjusted to a level where their foreign receipts, 

including loans, were equal to their foreign payments, the presence of the 

import surplus financed by loans would mean that the currency values 

of the borrowing countries could be somewhat higher during the borrowing period, relative to prices, than the prewar equilibrium rates. To put 

the matter another way, the equilibrium rates for the borrowing countries 

during the transition period will be above the parity rates. How much 

significance should be attached to this point is difficult to estimate. For 

some countries exchange rates are probably so high, relative to prices, 

that the present rates are above equilibrium rates even if allowance is 

made for borrowing from abroad. In cases where the parity rate indicates 

only a slight overvaluation relative to prices, on the other hand, the 

present exchange rates may not be far out of line. 

Another reason for maintaining present exchange rates during the 

transition years is the condition of the export industries. In many countries whose currencies appear to be overvalued exports are limited not by 

market conditions but by inability to produce. As long as this is the case, 

a depreciation of the currency will not enable the depreciating country 

to increase its receipts of foreign exchange. It is true, of course, that depreciation will enable a country to reduce its export prices, in terms of 

foreign currency, while maintaining or even increasing the prices which 

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domestic producers receive in their own currency, but if the physical 

volume of exports cannot be increased because of limits to productive 

capacity the reduction in foreign prices will not increase the foreign exchange available to the exporting country. On the contrary, depreciation 

in this case will reduce the amount of foreign exchange received in the 

depreciating country and thereby worsen the country's balance of payments. 

In addition to the reasons mentioned above, it seems likely that the 

decision of the Fund to begin operations with existing exchange rates was 

influenced to a considerable extent by the great uncertainty concerning 

the future course of world trade. Although comparisons of price changes 

with changes in exchange rates establish a presumption that many currencies today are too expensive relative to the dollar for a long-run 

balanced world economy, it would be a mistake to assume that the parity 

rates themselves are necessarily the proper rates. Many changes in basic 

economic conditions have occurred during the war and these changes will 

inevitably affect the terms on which goods will be exchanged in the future. 

For this reason, it is not sufficient simply to adjust exchange rates to the 

observed price movements. In addition, an allowance must be made for 

the increased or decreased ability of some countries to export, and for 

changes in the demand for imports. 

Unfortunately, adjustments of this type are extremely difficult to make. 

How, for example, will the decline of Germany and Japan in world trade 

affect the trade balances of other countries? What effect will the rebuilding 

of the devastated countries have on their ability to produce and to 

export? At the present time it is obviously impossible to give precise 

quantitative answers to questions such as these. The network of world 

trade is so complex that it is extremely difficult to trace the consequence 

of Germany's decline or the rebuilding of the French and British economies through all of their ramifications. This uncertainty adds weight to 

the decision of the Fund to postpone exchange adjustments, for only 

actual experience can tell us which countries are likely to have deficits 

and which to have surpluses as a result of the war-induced changes in 

conditions of production and consumption. 

With regard to the course of prices in different countries, uncertainties are almost equally great. It has been said, on the one hand, that 

prices and costs in countries which now have overvalued currencies will 

probably fall as normal production is resumed and the accumulated war 

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Probably even more important so far as price comparisons are concerned 

is the fact that the index numbers upon which these comparisons are 

based are limited, for the most part, to official prices and make only slight 

allowance for the higher black market prices. As output is increased and 

accumulated demands are satisfied, some of these black market prices will 

clearly tend to fall. At the same time, however, it seems highly probable 

that official prices will tend to rise, since the current cost structure almost 

certainly reflects, in part, the high level of black market prices. Taking all 

of these possibilities into account, it seems doubtful, to the present writer, 

whether a significant part of the disparities between current prices and 

exchange rates will be corrected by a fall in prices in the countries with 

overvalued currencies. 

Several of the reasons discussed above for postponing action on exchange 

adjustments were explicitly recognized by the Fund. The announcement 

of initial rates which was made on December 18, 1946, contained the 

following statement: 

The Fund realizes that at the present exchange rates there are substantial disparities in price and wage levels among a number of countries. In present circumstances, however, such disparities do not have the same significance as in normal 

times. For practically all countries, exports are being limited mainly by difficulties of 

production or transport, and the wide gaps which exist in some countries between 

the cost of needed imports and the proceeds of exports would not be appreciably 

narrowed by changes in their currency parities. In addition, many countries have 

just begun to recover from the disruption of war, and efforts to restore the productivity 

of their economies may be expected gradually to bring their cost structures into line 

with those of other countries. Furthermore, for many countries now concerned with 

combating inflation there is a danger that a change in the exchange rate would aggravate internal tendencies toward inflation. 

From this statement it is apparent that the Fund placed considerable 

weight on the numerous reasons for postponing adjustments. Even if the 

Fund had wanted to change some of the present rates, however, there is 

some doubt as to whether it would have been able to establish its authority to require such changes under the present abnormal conditions. 

Article X X of the Articles of Agreement of the Fund stipulates that the 

par value of a currency communicated to the Fund by a member shall be 

the initial value for the purpose of the Fund's operations unless, "(i) the 

member notifies the Fund that it regards the par value as unsatisfactory, 

or (ii) the Fund notifies the member that in its opinion the par value 

cannot be maintained without causing recourse to the Fund on the part 

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of that member or others on a scale prejudicial to the Fund and to members"* 

From this part of the Agreement, it appears that the Fund has only 

rather limited authority in the setting of initial rates. The member 

country itself can apparently object to the communicated par value for 

any reason whatsoever, whereas the Fund can object only if it feels that 

the communicated par value would cause undue recourse to the Fund. 

The difficulty about this criterion is that a number of war-ravaged 

countries, whatever exchange rate they adopt, may be expected to have a 

deficit in their balance of payments over the next year or so of a size 

necessitating their making full use of their annual drawing rights on the 

Fund and yet of such an apparently transitory character as to justify 

use of the Fund's resources. In the case of such countries, the scale of 

recourse to the Fund will not be dependent, in the initial period, upon 

the level of the exchange rate. Of course the Fund might fear that if the 

existing rate were maintained over a period of years, these drafts upon 

the Fund might become chronic. But in view of the uncertainties concerning long-range predictions of balance of payment developments, the 

Fund would find it difficult to offer convincing substantiation for such 

fears. Even if it could, the country concerned might well respond that the 

time for adjustment would arrive only later when the scale of its recourse 

to the Fund actually came to depend upon its exchange rate policy. It 

is not known to what extent this limitation on the Fund influenced the 

decision concerning initial rates, but it may have played some part. 

Dangers of Postponing Action. Unless radical readjustments of prices 

occur in some countries, it seems apparent from the preceding discussion 

that the initial exchange rates at which the Fund has commenced operations are in a substantial number of cases too high for a long-run balanced 

state of trade. This is not necessarily an indication that an immediate 

adjustment should be made, for we have seen that there are strong arguments for postponing the adjustment and continuing during the transition period with existing rates. At the same time, however, it is well to 

recognize that maintaining exchange rates which are too high in relation 

to prices may involve certain dangers for the future of a liberal foreign 

economic program.7 

6

 Article XX, Sec. 4(b). Italics added. 

7

 A substantial number of the advantages and disadvantages of an immediate adjustment 

of exchange rates were listed by Haberler in the article previously cited. In contrast to the 

present paper, however, Professor Haberler concluded that undervaluation of European 

currencies was preferable to the present rather general overvaluation. 

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The principal danger is that once a country has adjusted its trade controls to an overvalued currency the country may later be reluctant to 

relax these controls and depreciate its currency to a level compatible with 

balanced international payments. Apart from the question of national 

prestige, an overvalued currency may be tempting to some countries even 

after the period of reconstruction has ended and the threat of inflation 

has subsided. Rightly or wrongly, there is a tendency to associate a highpriced currency with low prices for imports relative to the prices received 

for exports. In other words, it is widely believed that an appreciated 

currency means favorable terms of trade. Whether this is always true or 

not is beside the point. For present purposes, it is sufficient that many 

people believe it is true, and that some countries may therefore desire 

to maintain overvalued currencies more of less permanently, and to 

preserve balance in their international payments by means of trade controls or other barriers to trade. In other words, if exchange rates are set, 

for a considerable period of time, in a pattern which is not consistent 

with balanced international payments, there is a danger that balance will 

nevertheless be achieved by means of various direct controls, and that 

the pressure for a readjustment of rates arising from loss of external reserves will accordingly be negligible. 

A second danger of the present exchange pattern is that it may freeze 

a system of export subsidies more or less permanently into many economic 

systems. In some countries, exchange rates are so high relative to prices 

that it seems doubtful whether many industries in these countries will be 

able to resume their prewar normal export trade without substantial 

subsidies. Like import controls, these export subsidies may come to be 

regarded as a permanent feature of international trade. If so, the cost 

of postponing adjustments of exchange rates will be a permanent distortion of the price system. 

Whether the dangers of postponing action are real or only apparent 

depends to some extent upon the success or failure of current efforts to 

establish an International Trade Organization. Under the draft charter 

of this proposed organization, the member countries would agree to a 

code of trade practices calling for a general reduction of trade barriers 

and export subsidies. The charter recognizes that quantitative import 

controls may be needed, in some instances, to preserve equilibrium in a 

country's balance of payments, but if equilibrium continues to require 

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justment of exchange rates or of prices and costs, will be undertaken. 

Tariffs and export subsidies are presumably not to be considered, under 

the organization's charter, as means of adjusting the balance of payments 

either temporarily or in the long run. Thus if the charter is accepted by a 

large number of countries there will be less danger that the present pattern of rather abnormal exchange rates will become permanent than 

would otherwise be the case. Although these rates might be compensated 

or offset for a considerable period of time by export subsidies and direct 

import controls, the International Trade Organization would presumably 

exert strong influence on the member countries to reduce their controls 

and subsidies, and to adjust their exchange rates to a level which is compatible with balanced international payments and receipts. Whether 

the International Trade Organization comes into existence or not, however, it seems doubtful to the present writer that the arguments in favor 

of an immediate adjustment of exchange rates are sufficiently convincing 

to offset the serious disadvantages of such action. 

The "Undervalued" Currencies. In discussing the probable consequences 

of the acceptance by the Fund of existing exchange rates, we have considered thus far only the countries whose currencies appear to be too 

expensive relative to the dollar. This, indeed, is the problem which has 

received most attention in current discussions, and it is no doubt the 

most important problem from a practical point of view. Nevertheless, as 

noted earlier, the table of parity rates for members of the Fund shows 

that a few of the present rates are below the parity rates, relative to the 

dollar. In other words, for a few countries depreciation of the currency 

in terms of dollars, relative to the prewar situation, was greater than the 

relative rise in prices. In order to complete the description of present 

exchange rates, we ought to consider briefly the position of these undervalued currencies. 

The countries whose currencies seem to be undervalued in terms of 

dollars are the United Kingdom and the following members of the British 

Commonwealth of Nations: Australia, Canada, New Zealand, and the 

Union of South Africa. Although Australia* and New Zealand are not 

yet members of the Fund, their present exchange rates will nevertheless 

be considered along with the other British currencies. Whether measured 

in wholesale or in retail prices, the parity rates for all of these countries 

are above the actual rates. For convenient reference, the ratio of parity 

* Australia was admitted to membership on Aug. 5, 1947, after this analysis had been 

completed. 

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rates to actual rates in all five countries is given in the following table for 

the end of 1946. 

RATIO OF PARITY RATES TO ACTUAL RATES FOR SELECTED BRITISH CURRENCIES 

(Ratios computed with reference to U. S. dollar) 

Country 

Australia 

Canada 

New Zealand 

Union of South Africa. 

United Kingdom 

In wholesale prices 

1.37 

1.20 

1.23 

1.06 

1.16 

In retail prices 

1.32 

1.18 

— 

1.24 

1.36 

The extent of undervaluation, measured by prices, varies from 6 percent 

to 37 per cent, with an average of perhaps 20 per cent. The actual numbers are not as important, however, as the general direction, for we have 

seen that it is impossible to give a precise interpretation to the parity 

calculations. 

The undervaluation of British currencies shown by these figures is to 

a large extent attributable to the price inflation which has taken place 

in the United States since price controls were abandoned in the middle 

of 1946. In August 1946, parity calculations comparable to those included 

in the present paper were made, and at that time the currency rates for 

the British countries, except for India and Egypt, appeared to correspond 

roughly with parity rates. Subsequently, however, both retail and wholesale prices increased much more rapidly in the United States than in the 

British countries. A few examples will indicate the disparity in price 

movements. Between June and December 1946, the index of wholesale 

prices in the United States increased 25 per cent, whereas the British 

wholesale price index increased by only 4 per cent. During the same 

period, retail prices in the United States increased by 15 per cent, compared with an increase of 2.4 per cent in Canada and virtually no change 

in the United Kingdom. As a result of these changes, the British currencies, including the Canadian dollar, now appear to be low-priced in relation to the movement of prices in general. 

If this is true, why did the countries of the British Commonwealth 

not request an appreciation of their currencies, relative to the dollar, 

when initial exchange rates for the Fund were being considered? A complete answer to this question would be beyond the scope of the present 

paper, since it would require a detailed investigation of economic conditions in each of the countries concerned. It will suffice, at this point, to 

indicate a number of broad considerations bearing on the question. 

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Unlike many other countries, the British countries whose currencies appear to be undervalued do not have an acute problem of inflation. It is 

true, of course, that most of them have a substantial amount of accumulated demand and a corresponding amount of liquid purchasing power, 

but this development, which would otherwise be inflationary, has not 

been permitted to have any appreciable effect upon prices, since wartime 

controls have been carried over into the period of reconstruction. The 

situation is accordingly less precarious in these countries than in many 

others, and there is less danger that a price rise in a particular group of 

commodities such as imports will set off an inflationary spiral of prices 

and costs. This means that countries such as the United .Kingdom and 

Australia do not have to rely on low prices of imports as a means of preventing inflation at home. In other words, their domestic controls are so 

strong that it is not necessary, or at least not imperative, to use their 

exchange rates as instruments of domestic policy. It may be presumed 

that this is one reason why the British countries did not insist upon more 

expensive currencies, relative to the dollar. 

Another factor in the decision, no doubt, was the feeling that the price 

situation in the United States is only temporary, and that prices here will 

eventually fall. Also, price indexes used for the United Kingdom probably 

overstated somewhat the degree of undervaluation of the pound sterling, 

since the cost of living index, at any rate, was known to be relatively 

insensitive to the war-induced rise of prices. The complaint was frequently heard in the United Kingdom that the British authorities had 

stabilized the cost of living index but not the cost of living. This fact, 

together with the belief that prices in the United States may fall to some 

extent from their present high level, means that the price comparison is 

not as valid an indication of the equilibrium rate for the pound sterling 

as would otherwise be the case. The British apparently do not wish to 

appreciate now and be confronted later with the necessity of reducing the 

price of their currency as the result of a decline in American prices. 

Apart from the price factors, additional reasons for not appreciating 

the pound may be found in the state of Britain's balance of payments. 

The British international position is well known and it will not be 

necessary to review it in detail here. Liquidation of British overseas assets 

as well as the great increase in her overseas liabilities which occurred 

during the war will make it necessary for the United Kingdom to export 

a larger volume of goods in order to pay for a given volume of imports 

than was the case in the prewar years. Adjustment to this new situation 

will nf rnnrcp K^ nnQtnnnprl hv flip InnriQ whirh thp TTnifpH l^incrHnm ha* 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 4 1 

received from the United States and Canada, but eventually it is highly 

probable that a rate of exchange for the pound lower than the parity 

rate will be needed in order to increase Britain's exports relative to her 

imports. In the present state of general world shortage of goods, the 

British could no doubt sell as much abroad as they are now selling even 

if they increased their foreign prices. This means that appreciation of the 

pound might, in the immediate future, increase Britain's receipts from 

exports. At a later date, however, when world markets become more 

competitive, it is almost certain that British exports would be affected 

adversely if the pound had been appreciated. In its current export drive, 

the United Kingdom is apparently taking the long view, being willing to 

forego some temporary gains for the benefit of a more lasting position in 

the world's export markets. Moreover, in view of the key importance of 

the sterling-dollar rate in the world rate structure, the British may have 

been very hesitant to upset their existing relationship; they may also 

have had some feeling that the American, public would find it difficult 

to reconcile an upward revaluation in the pound sterling with continued 

British requests for American financial support. 

The Canadian situation is somewhat different from that of the United 

Kingdom. In the United Kingdom, as we have seen, there might be a 

short-run advantage to an appreciation of the pound, but over a longer 

period, when borrowing from other countries has ceased, it is doubtful 

whether a value of the pound as high as the parity rate could be maintained. In Canada, on the other hand, an upward adjustment of the 

currency value might be appropriate as a long-run measure but in the 

immediate future there are pressing reasons for retaining the present 

rate, even though it is low relative to the war-induced movement of 

prices. The Canadians have committed themselves to make postwar loans 

of approximately 2 billion dollars, and Canadian exports must therefore 

be considerably greater than imports, in the near future, in order to 

preserve a balanced state of international payments. Canada is already 

beginning to feel the effects of this situation in a deficit with the United 

States, and there is accordingly little prospect that the Canadian authorities will want to raise the value of their currency. 

With regard to the other countries—Australia, New Zealand, and 

South Africa—little need be added. As in the past, they will probably 

wish to maintain a stable relation between their currencies and the 

pound sterling. As far as relative prices are concerned, there is no reason 

why this should not be possible. In the long run, however, the fact that 

they have reduced their indebtedness to the United Kingdom will mean 

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42 INTERNATIONAL MONETARY POLICIES 

that their exports will be smaller relative to imports than in the past. In 

other words, they will no longer need an export surplus to make service 

payments on their foreign debts, and on this account a long-run appreciation of their currencies, relative to the pound and the dollar, might reasonably be expected. 

CONCLUSIONS 

A contrast was drawn at the beginning of this paper between the 

manner of setting exchange rates after the First World War and the 

procedure provided through the International Monetary Fund for establishing such rates after the Second World War. The uncoordinated, 

almost anarchistic establishment of relative currency values through 

unilateral return to the gold standard after the First World War was 

compared with the deliberations contemplated under the Articles of 

Agreement of the Fund. From the discussion of present exchange rates, 

however, and from the action of the Fund in announcing these rates as 

initial rates for the Fund's operations, it should be apparent that the 

contrast, at the present time, is more in the mechanism for setting rates 

than in the actual results. It was a considerable achievement, even though 

a belated one, to have recognized in the Fund Agreement that gold parities of different currencies are important primarily because they govern 

relative currency values in international trade. It was an achievement, 

also, to have obtained an explicit statement of the importance of multilateral negotiations in establishing gold parities and relative currency 

values. It can hardly be said, however, that progress in exchange rate 

policy has gone much beyond these statements of principle, for we have 

seen that the exchange rates announced by the Fund involve, to some extent, discrepancies similar to those which disturbed world trade after the 

First World War. Many currencies appear to be too expensive, relative 

to prices, while a few are too cheap. 

This is not to say that the Fund made a mistake in deciding to begin 

operations with the rates at which the member countries had pegged their 

exchanges. There are many convincing reasons, as noted above, for 

postponing action in the adjustment of exchange rates, particularly in 

the adjustment of rates which at the present time appear to be too high. 

Inflationary pressures are still strong and persistent in many of the 

countries having currencies which are expensive relative to prices, and 

depreciation at this time would intensify these inflationary tendencies by 

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EXCHANGE RATES AND THE INTERNATIONAL MONETARY FUND 43 

increasing the domestic prices of imports. Depreciation, moreover, would 

not increase the foreign exchange available to such countries from the 

sale of exports, for under present market conditions the limitation on 

exports is usually inability of export industries to produce rather than 

inability to sell, and depreciation would do little, in the short run at least, 

to increase a country's capacity to produce for export. Another reason for 

maintaining rates which in some cases appear to be too high is that the 

countries with apparent overvaluation in their currencies are, generally 

speaking, countries which will be borrowing heavily in the next few years. 

Such borrowing countries will not expect to secure an even balance of 

payments on current account in the near future. They will expect, instead, to have an excess of imports of goods and services over exports, 

and the exchange rate appropriate to this situation, even if no direct 

controls were maintained, would be a rate somewhat above the parity 

rate. For the borrowing countries, apparent overvaluation relative to 

prices is thus not necessarily an indication that a downward adjustment 

is desirable. 

In addition to all of these considerations, a probable further factor 

in the Fund's decision to accept existing exchange rates as initial rates is 

the large amount of uncertainty regarding the future development of 

world trade. The future is uncertain both with respect to the pattern of 

trade and the pattern of prices. The Second World War was much more 

destructive than the first, and as a result it is almost impossible to say, 

at this time, which countries will have a comparative advantage in 

particular commodities when the period of reconstruction has ended. 

Two countries, Germany and Japan, have been almost completely eliminated from world markets and it is not known to what extent their trade 

will revive or what effect their diminished importance will have on the 

trade of other countries. In any event, many uncertainties remain both 

with respect to changes in the pattern of trade and with respect to future 

price movements, and these uncertainties make it almost impossible to 

establish a pattern of long-run exchange rates immediately even if it 

were desirable on other grounds to do so. 

It was probably for all of the reasons given above that the Fund decided 

to postpone the adjustment of exchange rates. The real test of the new 

mechanism for setting exchange rates will thus not come until more normal conditions return. In the meantime, the fact that some exchange 

rates are out of line will not necessarily have serious financial conseDigitized for FRASER 

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44 INTERNATIONAL MONETARY POLICIES 

quences since both trade and payments will be rather strictly controlled 

during the reconstruction years. Eventually, however, when inflationary 

pressures have subsided, when individual economies have been restored 

to a high productive capacity, and when the ability to export has been 

increased, many countries will be in a position to remove import controls 

and exchange controls, to reduce export subsidies, and to adjust the 

values of their currencies downward, in consultation with the Fund. 

When this time comes, and not before, the value of the Fund arrangements for adjusting exchange rates will be given a genuine trial. 

APPENDIX TABLES 

TABLE I 

U. S. WHOLESALE PRICE AND COST OF LIVING INDEXES 

(October 1936 to June 1937 = 100) 

1946: 

March 

April 

May 

June 

July 

August.... 

September. 

October— 

November. 

December.. 

Date Wholesale price index 

127.2 

128.7 

129.7 

131.9 

145.2 

150.8 

144.9 

156.7 

163.1 

164.6 

Cost of living index 

128.7 

129.3 

130.1 

131.7 

139.3 

142.0 

144.2 

146.6 

149.9 

151.9 

SOURCES: Converted to given base from Bureau of Labor Statistics index. 

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TABLE II 

PRICE INDEXES USED IN PARITY CALCULATIONS 

(October 1936 to June 1937 is base period unless otherwise indicated) 

Country 

Argentina. 

Australia.. 

Belgium... 

Brazil 

Canada 

Chile 

Colombia 

Costa Rica 

Cuba 

Czechoslovakia. 

Denmark. 

Egypt.... 

France... 

Greece— 

India 

Iran 

Italy 

Mexico 

Netherlands.. 

New Zealand. 

Norway.... 

Peru 

Poland 

Sweden 

Switzerland.. 

Turkey 

Union of South Africa. 

United Kingdom 

Uruguay 

Venezuela 

Wholesale price index 

Date for 

which computed 

November 1946 

November 1946 

November 1946 

November 1946 

November 1946 

November 1946 

November 1946 

July 1946 

November 1946 

August 1946 

May 1946 

November 1946 

November 1946 

October 1946 

October 1946 

November 1946 

November 1946 

November 1946 

November 1946 

September 1946 

September 1946 

November 1946 

August 1946 

Value of 

index 

216.4 

144.8 

135.6 

264.5 

2

211.5 

302.0 

192.7 

296.7 

4

808.3 

335.0 

512.3 

6

5,884.5 

284.8 

250.2 

156.2 

176.4 

262.5 

167.3 

199.0 

392.9 

165.5 

171.2 

155.6 

Cost of living index 

Date for 

which computed 

September 1946 

December 1946 

November 1946 

November 1946 

November 1946 

October 1946 

November 1946 

October 1946 

November 1946 

September 1946 

July 1946 

September 1946 

October 1946 

November 1946 

May 1946 

November 1946 

November 1946 

September 1946 

November 1946 

November 1946 

October 1946 

September 1946 

November 1946 

September 1946 

September 1946 

November 1946 

September 1946 

Value of 

index 

132.7 

336.7 

237.3 

126.6 

330.1 

*212.8 

2

210.5 

*235.8 

340.8 

163.4 

278.3 

4

787.0 

15,834.2 

262.0 

*753.7 

7

3,344.0 

357.8 

186.8 

171.2 

216.0 

11,900.0 

151.3 

157.0 

4

329.0 

140.0 

133.9 

8

157.9 

1

 February 1937 base period. 

2

1936 base period. 

* July to December 1937 base period; food prices only. 

4

1938 base period. 

6

 March 1936 to March 1937 base period. 

• 1937 base period Index includes black market prices on rationed goods. 

7

 1937 base period; food prices only. 

8

1936-37 base period. 

SOURCES: United Nations statistical bulletins, government publications of Cuba, Poland, France, and China; 

consular reports. Recent cost of living figures for Belgium, Greece, France, and Poland were obtained from consular reports or government publications, and converted to the 1936-37 base period by the use of earlier indexes as 

given by the League of Nations. In other cases, continuous series were available. 

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NATIONAL CENTRAL BANKING AN D THE 

INTERNATIONAL ECONOMY 

by 

ROBERT TRIFFIN 

Formerly of Division of Research and Statistics, Board of Governors 

The growth of nationalistic policies in a world of growingly interdependent nations is one of the apparent paradoxes of our age. Interdependence has proved to have disadvantages as well as advantages, 

and its disadvantages have at times resulted in a resurgence of extreme 

nationalism. Countries have become engulfed in wars which in the 

past would never have concerned them, and they have suffered from 

economic depressions having their origin in far distant lands. Nationalism persists in part as an effort to preserve or rebuild the crumbling 

natural boundaries which once protected countries from the political 

conflicts and economic maladjustments of other parts of the world. 

The many cases in which international crises have been intensified by 

nationalistic measures of defense by one country and retaliatory action 

by others have tended to overshadow the real and challenging problem 

responsible for these measures. Nothing can be gained by denying or 

ignoring its existence. 

Our internationalism is often short-sighted in this respect. In the 

monetary field, for example, we are prone to stigmatize exchange control 

or exchange devaluation, but slow to suggest workable alternatives to 

meet or prevent the exchange shortages which bring about such measures 

of defense. Perhaps this is one reason why so little progress has been 

made in practice toward the elimination of exchange control and competitive devaluation, notwithstanding their condemnation by economists 

and statesmen alike. 

A more constructive approach toward the problem is now in the process 

of effective realization. The recently created International Monetary 

Fund is specifically designed to promote international monetary stability 

through the concerted action of all member countries. The legal powers 

of the Fund may be grouped into two broad categories. First, the Fund 

has the financial machinery to help the members to maintain free and 

stable exchanges by supplementing their gold and foreign exchange 

resources in case of need. Thus at least one cause of monetary insta46 

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NATIONAL CENTRAL BANKING AND THE INTERNATIONAL ECONOMY 47 

bility will be removed or considerably weakened. There is now an 

alternative to unilateral resort to currency depreciation or exchange 

restrictions during a period of severe even though temporary exchange 

shortages. Secondly, the Fund will wield a degree of influence over 

policy decisions of member countries. In some cases the Fund has only 

the power to make recommendations, or the right to be consulted. In 

others, such as parity changes or the establishment of exchange control, 

action by a member is subject to the Fund's authorization or approval. 

In actual practice, however, the effective power and influence of the 

Fund may be far greater, or it may be far smaller, than its legal authority. 

Although the Fund has no right to impose specific domestic monetary 

or credit policies, it may develop a leadership and moral influence far 

beyond the scope of formal official recommendations. On the other hand, 

although in theory the Fund can forbid a country to engage in either 

currency devaluation or exchange control, such prohibition may prove 

to be unenforceable in the face of severe exchange shortages. Currency 

devaluation and exchange control are often the outcome of basic disequilibria in a country's international position and, in such a case, cannot 

be eliminated by mere legal provisions as long as the root causes remain, 

even with the best of will on the part of the country affected. 

The ultimate success or failure of the Fund will depend in no small 

part on its ability to devise, in collaboration with member countries, 

workable and realistic standards of domestic as well as international 

monetary policy. This will require a bold revision of the traditional 

concepts and dogmas associated with the gold standard theory. The 

orthodox gold standard mechanism implied a more or less passive acceptance by each country of the automatic monetary adjustments necessitated by fluctuations in its balance of payments. This view was 

reaffirmed in the twenties by the Cunliffe Committee and played a major 

part in the studies and recommendations of the League of Nations in 

the monetary field. It is in direct contradiction to the increasing trend, 

both in theory and practice, toward independent monetary management 

by individual countries. 

The events of the thirties, the increasing influence of Keynesian economics, and finally the financial impact of World War II have destroyed 

the institutional and ideological framework of the automatic gold standard. Tomorrow's currencies will be managed currencies. The only question 

at issue—and it is a fundamental one—is the direction toward which 

management will work, and the extent to which national objectives can 

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48 INTERNATIONAL MONETARY POLICIES 

be reconciled with international balance. Any attempt to enforce rigid 

solutions patterned after orthodox gold standard doctrines would be 

even more futile in the postwar period than it has proved to be in the 

interwar period. 

The purpose of this paper is to review briefly the interaction between 

the evolution of national central banking and that of the -international 

gold standard, to raise some questions with relation to the actual working 

of the gold standard in prewar years, and to outline tentative suggestions 

with respect to the problem of international monetary stabilization. 

CENTRAL BANKING AND THE GOLD STANDARD 

The main problem considered in this paper is the reconciliation of 

domestic monetary policies with the prerequisites of international balance. 

In its purest form, the gold standard solved the problem automatically 

by eliminating one of its terms: the domestic volume of money escaped 

the control of national authorities and was determined automatically 

by international market forces. Monetary circulation was made up of 

gold and subsidiary coin; it expanded or contracted, not as a result of 

conscious monetary policy, but in accordance with the net movements 

of the international balance of payments. A favorable balance of payments brought gold into a country and expanded the circulating medium. 

An unfavorable balance produced the opposite effect. 

These movements were regarded as self-adjusting through their influence on national price and cost levels and on interest rates. International balance, if disturbed, would be restored because of the effects 

of the ensuing domestic contraction or expansion on relative cost and 

interest levels at home and abroad and the resulting shifts in trade and 

capital movements. The automatic monetary contraction produced by 

gold exports would raise interest rates and attract capital from abroad. 

It would at the same time exert a downward pressure on domestic prices 

and costs, thus stimulating exports and discouraging imports. Both of 

these movements—capital and trade—would tend to correct the balance 

of payments deficit in which they originated.1 A surplus in the balance 

of payments would also be self-corrective. Gold imports would expand 

monetary circulation, lower interest rates, increase prices and costs, 

and stimulate capital exports and merchandise imports while discouraging 

1

 Modern theories of international trade and capital movements would incorporate two 

further major elements in this analysis. One is the elasticity of supply and demand for imports and exports, the other the direct income effects associated with balance of payments 

disequilibria. 

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exports. These processes would continue until foreign payments and 

receipts were again brought into balance, 

This type of analysis contemplates a particularly rigid form of the 

gold standard in which there is no room for national sovereignty over 

currency or money. The only circulating medium is gold itself, i.e., an 

international standard largely impervious to national manipulation or 

management. In actual practice, the gold standard never existed in such 

pure and unadulterated form. The value of the theoretical model discussed 

so far does not lie in its descriptive realism, but in the fact that it inspired 

so much of the academic thinking and legislative controversies regarding 

national and international monetary mechanisms during the nineteenth 

and even the twentieth century. 

The coexistence of national means of payment, side by side with gold 

itself, deeply modified the practical functioning of the gold standard by 

freeing the domestic money supply from rigid dependence on balance of 

payments fluctuations. Little attention is usually paid, in this respect, 

to the latent antinomy between central banking and the classical gold 

standard. And yet the automatic monetary mechanism of the pure gold 

standard would obviously leave little room for what is today conceived 

as one of the primary functions of central banking action; namely, monetary management by the central banking authorities. An element in the 

confusion of thought on the subject is the lack of adaptability of our 

language, which reflects and tends to perpetuate outmoded habits of 

thought. Unchanging terminology has obscured fundamental institutional changes. Just as the gold standard of the twenties was basically 

different from the gold standard of earlier days, the central banks of 

today bear little resemblance to the central banks of the nineteenth 

century. 

Indeed the original pattern of central banking had little or nothing 

to do with monetary management, which was left to the automatic 

regulation of the pure gold standard. The functions of central banks were 

purely ancillary ones, and even their power of issue was not designed to 

interfere with or supplant the controlling role of gold over the money 

supply. The shift from monetary automatism to monetary management 

was slow and gradual. The evolution of the Bank of England is most 

revealing in this respect. 

The Bank Act of 1844 had as its objective the restoration of an unmanaged gold standard, ruled exclusively by fluctuations in the balance of 

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50 INTERNATIONAL MONETARY POLICIES 

payments. Variations in the total note issue of the Bank of England would 

correspond exactly to the movements of gold itself in the reserves of the 

Issue Department. Any inflow or outflow of gold would produce a corresponding increase or decrease in the volume of money, just as would 

have occurred if the circulation had consisted exclusively of gold coin. 

The Issue Department of the Bank of England therefore played a purely 

passive role and could not exert the slightest influence on the volume 

of money.2 

Whatever central banking functions this system left to the Bank of 

England pertained, not to the Issue, but to the Banking Department. 

No such functions, however, were originally intended by the authors 

of the Act. In the years immediately following the Bank Act, the Banking 

Department was regarded merely as a commercial bank "to be managed 

in the same way as any other private bank."3 It was only gradually, 

and at the initiative of the Government rather than of the Bank itself, 

that the special position and responsibilities of the Banking Department 

came to be clearly recognized and accepted by the Bank authorities. 

Even then, these responsibilities did not extend to the broad and modern 

concept of monetary management, but merely to the function of "lender 

of last resort." This function, moreover, did not imply the issue power 

since, in principle at least, fluctuations in the note issue continued to 

correspond exactly to fluctuations in the gold assets of the Issue Department. 

As "lender of last resort," however, the Banking Department, through 

its credit and investment operations, would relieve temporary shortages 

of cash in the commercial banks. In doing so it would interfere with the 

process of readjustment contemplated in the gold standard theory, 

since it would offset the deflationary internal effect of a deficit in the 

balance of payments and thus prevent its ultimate correction. The drain 

on the limited note reserves of the Department would continue until 

their exhaustion made it impossible for the Bank to continue its assistance 

to the market unless the limitation on its fiduciary issue was raised or 

2

 The only channel for interference with market forces lay in changes in the amount of 

the "fiduciary" issue, which was not covered by gold. Outside of one brief and minor exception, no such change occurred prior to the First World War. 

3

 "Evidence of the Governor and Deputy Governor of the Bank of England before the 

Secret Committee of the House of Commons on the Commercial Distress" (Mar. 7, 1848), 

in T. E. Gregory, Select Statutes, Documents and Reports relating to British Banking, 1832-

1928 (London, 1929), Vol. II, p. 28. 

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suspended.4 Thus the "lender of last resort" operations were conceived 

as a mere temporary palliative, to be accompanied by other measures 

tending toward a fundamental readjustment similar to the one which 

would have taken place automatically under the pure gold standard. 

The most important instrument used toward that end was the management of the discount rate. Credit was made available in times of crisis, 

but at higher rates which led to a general rise of interest costs and contraction of credit. In the words of the Cunliffe Committee, this would 

result in "a decline in general prices in the home market which, by checking imports and stimulating exports, corrected the adverse trade balance 

which was the primary cause of the difficulty."5 In this way, central 

banks could perform their mission of lender of last resort—could provide 

credit institutions, in times of need, with the liquid funds necessary to 

tide them over temporary panics and difficulties—while still transmitting 

to the economy the external pressures arising from balance of payments 

disequilibria under the pure gold standard system. They could expand 

credit in times of favorable balances and contract it, except for temporary 

assistance to the banks, in times of unfavorable balances. The general 

effect of this policy would be similar to the automatic results of gold 

inflows or outflows under a purely metallic monetary standard, at least 

as far as the direction of the movements was concerned. 

The hiatus between gold and total monetary circulation introduced by 

deposit banking, however, could greatly increase monetary fluctuations 

and affect their incidence. Under a fractional reserve system of commercial banking, given the fairly stable ratio maintained by British banks 

between cash and deposits, the deposit component of monetary circulation would increase or decrease by several times the amount of the increase 

or decrease in the cash reserves of the banks. Banking expansion and 

contraction would also affect the cash balances of some individuals and 

firms which, under the pure gold standard, might not otherwise have been 

touched, at least directly, by the monetary fluctuations resulting from 

disequilibria in the country's balance of payments. Finally, because of the 

narrow gold base which it maintained, the Bank of England, in order to 

4

 In the first crisis following the Bank Act, the Bank refused full support to the market 

until authorized by the Government to exceed its legal fiduciary issue. Similar authorizations were granted, but not used, in 1857, 1866, and 1914. In the more recent period, further 

expansions have been made possible under the Currency and Bank Notes Acts of 1928 and 

1939. 

6

 "First Interim Report of the Committee on Currency and Foreign Exchanges after the 

War," in T. E. Gregory, op. cit.y Vol. II, p. 337. 

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defend its reserve position, was led to follow credit policies which not 

only permitted but also reinforced the automatic contraction resulting 

from the retirement of its notes in exchange for gold. The net effect of 

the banking superstructure erected upon the gold standard basis was 

monetary fluctuations of far greater amplitude than they would have 

been under a pure gold standard. 

The departure from the pure gold standard mechanism, implicit in the 

operations of deposit banks, was carried even further under the "rules 

of the game" so much publicized in the twenties by central bank and 

League of Nations experts. "Whenever gold flowed in, the central bank 

was expected to increase the national currency supply not only through 

the purchase of that gold but also through the acquisition of additional 

domestic assets; similarly, when gold flowed out, the central bank was 

supposed to contract its domestic assets also. In this way the influence 

of gold movements on the domestic credit base was to be magnified, 

and magnified in accordance with the central bank's reserve ratio. With 

a ratio of 33 per cent, for instance, any net increase or decrease in the 

gold reserve was supposed to create a threefold expansion or contraction 

in the total credit base."6 

The "rules of the game" were presented as synonymous with the rules 

of the gold standard itself. Their effects, however, were vastly different 

from those envisaged by the theory. Under the pure gold standard, 

balance of payments disequilibria produced only an equivalent amount 

of expansion or contraction in the monetary circulation, while under the 

"rules of the game" they fostered in addition a secondary expansion or 

contraction many times the original one. This multiple expansion or 

contraction was defended as a way to speed up international readjustments and to conserve the country's international reserves, but the result 

was achieved only at the cost of much greater domestic instability.7 

No wonder the "rules of the game" encountered increasing resistance, 

and that their breach became more characteristic of monetary policy 

than their observance. 

The breakdown of the gold standard in the interwar period has often 

been ascribed in part to the unwillingness or inability of central banks 

6

 League of Nations, International Currency Experience, 1944, pp. 66-67. 

7

 This instability, moreover, had a very different incidence than that attaching to the 

primary contraction or expansion associated with gold flows under the pure gold standard. 

It bore especially heavily on bank borrowers and investment activities. See F. A. von 

Hayek, Monetary Nationalism and International Stability (London, 1937), pp. 25-32. 

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to play the gold standard game in accordance with its supposed rules.8 

It should again be emphasized, however, that these rules did not fit 

the pure gold standard theory and that consequently their observance 

would have impeded rather than advanced the objectives of the classical 

mechanism of international adjustments. Thus, the monetary policy 

of the United States in the twenties has often been interpreted as a "sterilization" or "neutralization" policy, and criticized as contrary to gold 

standard rules. In fact, however, the total money supply (deposits and 

currency outside banks) increased from June 1920 to December 1924 

by 7.2 billion dollars, or about 4.5 times the increase in gold reserves 

during the same period. In 1925-29, the money supply rose by 7.6 billion 

in the face of a decrease in gold reserves. For the period as a whole, therefore, monetary circulation increased by 14.8 billion dollars, while the 

increase under a pure gold standard would have been less than 1.5 billion. 

Mr. Nurkse's discussion of neutralization policies in the United States 

and other countries demonstrates his point that, contrary to the "rules 

of the game," "central banks' international and domestic assets . . . 

moved far more often in the opposite than in the same direction."9 This 

does not mean, however, that the primary impact of the gold flows was 

fully offset or neutralized, or even that their influence on monetary 

circulation was not multiplied several times by commercial banking 

expansion. Thus, in spite of neutralization policies, gold flows may well 

have exerted at least as much influence on the money market as they 

would have under classical gold standard assumptions. 

The most significant development of the period, however, was the 

growing importance of domestic factors as the final determinant of monetary policies. While international gold flows continued to stimulate 

domestic monetary expansion or contraction, the total volume of money 

was no longer controlled by them. Factors of a purely domestic nature 

also tended to shape monetary developments in a manner totally alien 

both to the classical gold standard mechanism and to its "rules of the 

game" interpretation, or rather misinterpretation. Central bank powers 

were no longer used to transmit automatically to the domestic economy 

the upward or downward pressures of surpluses or deficits in the balance 

of payments, regardless of national policy objectives. On the contrary, 

central banking policies came to be defined less and less with reference 

8

 See especially Lionel Robbins, The Great Depression (London, 1934). 

9

 International Currency Experience, pp. 68-88 and 237-40. 

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54 INTERNATIONAL MONETARY POLICIES 

to the state of the gold reserves or the prerequisites of international 

balance, and more and more in terms of domestic price stability, the 

promotion of fuller employment, etc. This tendency was greatly reinforced 

in the thirties through the general adoption of national recovery programs based on domestic monetary and credit expansion and supported 

by exchange control and currency devaluation. Thus the latent contradiction between the international and automatic monetary regulation characteristic of the pure gold standard on the one hand, and the evolution 

toward autonomous and discretionary monetary management by national 

central banks on the other, was accentuated by practical policies even 

though it was not readily incorporated into theoretical analysis. 

The swing of the pendulum may now have reversed its direction. The 

experience of the thirties has demonstrated the pitfalls of monetary 

isolation along purely national lines and the difficulties of reconciling 

domestic stability and prosperity with international disequilibrium. 

The Bretton Woods Agreements, without returning to the full subordination of national monetary policies to the single goal of exchange stability, 

have sought to re-establish some mechanism designed to protect the 

international economy against autarchic excesses in the monetary field. 

Member countries agree to cede to the Fund a considerable measure of 

control over modifications in their exchange rates or the imposition of 

exchange restrictions. To make possible this partial renunciation of 

national monetary sovereignty, the International Monetary Fund undertakes to make available to member countries, in times of need, additional 

exchange reserves necessary to finance temporary deficits in their balance 

of payments. The Fund, however, does not attempt to restore an automatic international monetary standard. Central banks and other national 

monetary authorities are left free to determine domestic monetary policies as long as they do not use the resources of the Fund "in a manner 

contrary to the purposes of the Fund." The success of the new institution will thus depend largely on the soundness of the national monetary 

policies followed by its members, and on the successful solution by each 

member country of the basic conflict between domestic goals of action 

and the preservation of international balance. Fundamental disequilibria, if not corrected by domestic measures of readjustment, would 

perpetuate the need for new borrowings from the Fund or would force 

recourse to currency devaluation or exchange control. The assistance 

provided by the Fund is a limited right of borrowing, equivalent to a mere 

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increase in the members' international reserves, together with some 

protection against arbitrary and damaging monetary action by other 

members. 

No attempt is made, however, to lay down detailed "rules of the game" 

for the new international standard which would prevent or correct fundamental international disequilibria. And yet, it is well recognized that 

persistent deficits in a country's balance of payments would ultimately 

lead to the exhaustion of its limited drawing rights on the Fund, as well 

as of its gold and foreign exchange reserves. Once such a situation is 

reached, the whole Fund machinery becomes ineffective,10 and no paper 

commitments can maintain free and stable exchange rates. Correction 

of international disequilibria is thus crucial to the successful functioning 

of the new international monetary standard. 

THE CORRECTION OF INTERNATIONAL DISEQUILIBRIA 

Notwithstanding the important divergencies between the classical 

gold standard theory and its modern "rules of the game" version, both 

types of analyses coincide in some important respects. Balance of payments disequilibria are ascribed to international cost and price disparities, 

and their correction is made to depend on the elimination of such disparities through automatic, or induced, domestic monetary expansion 

or contraction. 

These views of the mechanism of international adjustment under gold 

standard assumptions are open to grave question. First, they fail to 

distinguish between a fundamental disequilibrium in one country's 

international position and world-wide disturbances in balances of payments associated with cyclical fluctuations. Secondly, the explanation 

of the readjustment of a country's balance of payments is vitiated by the 

underlying and totally unrealistic assumption of near-perfect competition 

between nations of roughly equal strength and importance in world trade. 

Cyclical vs. Fundamental Maladjustments. The classical explanation 

of balance of payments maladjustments runs in terms of price and 

cost disparities between one country and the rest of the world. While 

applicable to many important instances of disequilibria, this analysis 

does not exhaust all possible causes of deficits in a country's international 

transactions. The most cursory examination of statistical data clearly 

shows that many of the most spectacular disequilibria in balances of 

10

 The day of reckoning could, of course, be postponed as long as the Fund was willing 

and able to grant, under Art. V, Sec. 4, additional drawing rights to meet the deficit. 

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payments are world-wide in scope, and must be traced to cyclical fluctuations of an international character rather than to national price and cost 

maladj ustment s. 

In the decade prior to the war, for instance, the dollar value of world 

trade fell by more than 60 per cent between 1929 and 1932, increased by 

by 23.5 per cent from 1936 to 1937, and fell again by 12.5 per cent during 

1938. If the major cause of these fluctuations had resided in international 

price and cost disparities, it would be expected that high-cost countries 

would have shown a decrease in exports and an increase in imports, while 

low-cost countries would have shown movements in the opposite direction. The striking fact, however, is that, in spite of differences in amplitude, both exports and imports moved in the same direction for practically 

all trading countries. Clearly, the major force impinging upon their trade 

was international in character, and associated with a world cycle rather 

than with maladjustments in individual countries. 

To take a concrete illustration, in the short space of three years (1929— 

31), Colombia lost 80 per cent of its central bank gold and foreign exchange reserves. Total exports fell from 122 million dollars in 1929 to 67 

million in 1932, a decline of 46 per cent. Coffee, the major export item 

(about 60 per cent of total export values), suffered a reduction of 45 per 

cent. If this contraction in coffee exports had been due to disparities in 

production costs between Colombia and other major coffee exporting 

countries in competition with her, we would expect these other countries 

to have expanded their exports at the expense of Colombian producers. 

The fact is, however, that during the same period total exports and coffee 

exports of all other competing coffee countries were also falling in similar, 

or even larger, proportions. This coincidence in time of export fluctuations 

in these countries was also characteristic of the recovery period 1933-

37, the 1937-40 decline, and the record levels of exports reached during 

the more recent war years. It might of course be argued that, even though 

no price disparity was evident as between the various coffee exporting 

countries, all of them were suffering simultaneously from the consequences of excessive price and cost levels as compared with the rest of the 

world, and that the classical prescription for readjustment still remained 

applicable to the group as a whole. This position, however, would be hard 

to defend in view of the fact that the export prices for typical coffee 

grades had fallen to nearly one-half of their 1928 level by 1930 and to not 

far from one-third by 1931, without resulting in any substantial recovery 

of quantities exported. 

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Indeed, for most agricultural countries, large export receipts and favorable balances of payments usually coincide with high and not with low 

levels of domestic and export prices. The reason for this is that their export volume and export prices fluctuate as much with demand as with 

supply conditions, if not more. That is, they are largely determined by 

international rather than domestic factors. Major fluctuations in export 

values result primarily from cyclical movements in economic activity and 

income in the buying countries, and not from changes in the relationship 

of domestic price or cost levels to prices and costs in other competing or 

buying countries. Thus, for many agricultural and raw material countries, 

the international cycle is mainly an imported product. Such is also the 

conclusion of the League of Nations' Delegation on Economic Depressions. "General depressions would seem to result mainly from fluctuations 

in investment and employment in industrial countries."11 

Whenever this is true, the classical prescription for remedial policy 

becomes as misleading as the diagnosis on which it is based. Deflationary 

efforts at readjustment by individual countries are largely self-defeating 

because they aggravate the depression rather than cure the disequilibrium. Any initial success that they may have in curbing imports or 

expanding exports aggravates the difficulties in their supply and export 

markets as well as in competing countries, and leads to similar and mutually offsetting measures of defense or retaliation. It should be noted 

that the argument applies equally to remedial action through currency 

devaluation and through internal price changes. Under the conditions 

described, both price deflation and currency devaluation spread from 

country to country and accentuate the international deflation. While 

some categories of exports may expand under the stimulus of price reductions, the expansion will often be insufficient to compensate for the 

decline in unit prices, especially in the case of agricultural or raw material 

exports faced with an inelastic world demand. The burden of readjustment 

then falls upon imports, the reduction of which further aggravates income 

contraction abroad and the effective demand for each country's exports. 

The situation described presents a strong analogy with that of oligopoly, where efforts by one seller to cut into his competitors' markets are 

"League of Nations, Economic Stability in the Post-War World (1945), p. 291. The clearest case is provided by the brief depression of 1938 in which world exports to the United 

States fell by over 35 per cent in a single year, while United States exports decreased by only 

7 per cent. It is not denied, of course, that other factors—including price disparities—may 

be simultaneously operating in bringing about or accentuating a major depression. 

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thwarted by the competitors' retaliation and the ensuing price war. The 

expansionary effect of a decline in one country's prices upon its exports is 

largely offset by simultaneous, or retaliatory, price decreases by competing countries. Thus the effective elasticity of demand for one country's 

exports becomes merged with the much lower elasticity of world demand 

for products of the types the country exports.12 Sales can be expanded on 

a stable basis only in so far as lower prices stimulate world consumption, 

a result that is not achieved through inroads into other nations' markets. 

It should be noted that this analysis does not conflict in any way with 

the classical theory of balance of payments maladjustments. It merely 

applies to an entirely different set of circumstances. Cyclical disturbances 

of the kind assumed here played little or no part in classical analysis. 

The error made by later economists—and especially by the "rules of the 

game" school—was to extend to world-wide, cyclical disturbances an 

analysis aimed at fundamental maladjustments between one economy 

and the rest of the world. In the latter case, moderate price changes by 

the deficit country may restore its normal export-import balance and 

share of world trade without depressing world prices to any significant 

extent. This is especially true if, as contemplated also in classical theory, 

its exports are broadly diversified rather than concentrated on one or a 

few major items. During a global depression, however, simultaneous 

efforts by many nations at maintaining or increasing their exports in the 

face of a shrinking world demand merely result in an accelerated fall of 

prices and reduction of export proceeds. 

Gold Standard or Sterling Exchange Standard? A second assumption 

underlying the classical theory of the gold standard is that of near-perfect 

competition between many trading nations, more or less coequal in importance. The assumption is obviously unrealistic, and in recent years 

many writers have emphasized the central position occupied by Great 

Britain in the nineteenth century functioning of the gold standard.13 It 

has been suggested that that position "made the prewar gold standard 

essentially a sterling exchange standard system,"14 but the concrete implications of that assertion have not been fully drawn. If examined, they 

12

 In the case of competing oligopolists, the effective demand elasticity is similarly determined by the demand curve for the industry as a whole, rather than by the demand curve 

which would face any one seller if his competitors' prices remained constant. 

13

 See, especially, William Adams Brown, Jr., The International Gold Standard Reinterpreted (New York,' 1940). 

14

 Idem, p. xiii. 

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may suggest one possible explanation both for the relative success of the 

gold standard in Britain and for its failure to operate satisfactorily in the 

least industrialized nations. In many of the latter countries it was adhered 

to only sporadically, and abandoned in times of crisis. When actually 

enforced, it may well have retarded rather than accelerated the rate of 

their economic development. In Great Britain itself the mechanism of 

balance of payments readjustments seems to have operated, in important 

respects, in a manner directly opposite to that described by gold standard 

theory. To a very large extent, increases in the London discount rates 

brought about a readjustment in the British balances of payments, not 

through their effects on the British economy, but through their effects 

on the outside world and especially on the agricultural and raw material 

countries. 

One of the reasons for this has long been recognized. As early as 1840 

it was pointed out by Tooke before a Select Committee of the House of 

Commons on banks of issue, that: "The effect upon the exchange of a 

rise in the rate of interest would be that of inducing foreign capitalists to 

abstain from calling for their funds from this country to the same extent 

as they otherwise might do, and it would operate at the same time in 

diminishing the inducements to capitalists in this country to invest in 

foreign securities or to hold foreign securities, and it might induce them 

to part with foreign securities in order to invest in British stocks and 

shares. It would likewise operate in restraining credits from the merchants 

in tliis country by advances on shipments outwards, and it would have the 

effect of causing a larger proportion of the importations into this country 

to be carried on upon foreign capital."15 

This shift in international capital movements contributed powerfully 

to a rapid restoration of equilibrium in the exchange market. However, 

it tended to relieve rather than accentuate domestic deflationary pressures 

on the economy, and to that extent to delay or prevent the basic readjustment of fundamental price and cost disparities contemplated by gold 

standard theorists. It constituted, in a sense, the equivalent of the compensatory monetary policies so strongly condemned by many gold standard theorists. 

Similarly, the outflow of capital in periods of favorable balances tended 

to check surpluses and thus to reduce external expansionary impacts 

upon the British economy. This again was contrary to the "rules of the 

18

 Quoted by R. G. Hawtrey, The Art of Central Banking (London, 1932), p. 141. 

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game" and tantamount to the opposite policy of sterilization or neutralization of gold movements. 

Debtor countries, however, did not have a similar mechanism at their 

disposal. Capital tended to flow toward them in times of prosperity and 

away from them in times of depression, irrespective of their discount 

policy. The effect of such fluctuations in capital movements was to smooth 

down cyclical monetary and credit fluctuations in the creditor countries, 

but to accentuate them in the debtor countries. To that extent the financial centers could shift part of the burden of readjustment upon the weaker 

countries in the world economy. Their only mechanism of defense was the 

policy consistently followed by the Central Bank of Argentina in the 

recent past with such remarkable success: to offset external drains from or 

accretions to its reserves through domestic policies of expansion or contraction. This was contrary to classical orthodoxy, but in fact equivalent 

to the effects of the British discount rate on capital movements to and 

from Great Britain. 

The readjustment of fundamental price disequilibria which changes in 

the British discount rate were designed to stimulate was thus thwarted 

and delayed by the effects of such changes on capital movements. It is 

still contended, however, that those basic readjustments would obtain 

in the end, capital movements notwithstanding, through the domestic 

effects of discount changes on British prices. The discount rate would be 

raised and credit would be contracted in order to force down excessive 

British prices to levels more competitive with the level of foreign prices. 

On the other hand, the discount rate would be lowered and credit would 

expand when British prices were low relative to foreign prices and tended 

to disequilibrate the balance of payments in Britain's favor. 

It should be noted that, according to this theory, the British deficit 

would be corrected through a deterioration of the British terms of trade 

(i.e., a decrease in British prices relative to foreign prices), such deterioration being considered necessary to restore the international competitive 

position of British producers. Logically speaking, however, the opposite 

assumption is just as plausible. That is to say, the elimination of the 

deficit might also result from an improvement in the British terms of trade, 

decreasing the unit cost of imports and increasing the returns on exports.16 

16

 Reconstruction and statistical verification of balance of payments readjustments would 

have to distinguish between: (1) the relationship of Britain's prices and costs to competing 

countries' prices and costs for similar goods; and (2) the relative price movements of noncompeting import goods (raw materials and foodstuffs) and export goods (manufactures). 

Such a discussion, however, would exceed the scope and purpose of this paper. 

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Statistical evidence may be used to support either theory. During the 

interwar period, the British terms of trade consistently improved in depression and deteriorated during the upswing of the cycle.17

 Before the 

First World War available data are more difficult to interpret and they 

reveal, if anything, sharper rises in export prices than in import prices 

during the crest of the boom. Indexes of export prices for that period, 

however, give relatively little weight to manufactured products and do 

not appear to be truly representative of British exports in general. 

As far as the discount rate is concerned, the interwar period is of minor 

interest for the elucidation of the problem under consideration. The 

discount policy had ceased by then to be a major instrument of monetary 

control and, moreover, Britain was no longer the dominant financial 

center of the world. In the 30 years prior to the First World War, however, the statistical series fail to confirm the traditional view that an 

increase in discount rates contributed directly to a lowering of British 

prices relative to foreign prices. On the contrary, all major rises in the 

discount rate are associated with an improvement of the British terms of 

trade, i.e., with an increase in export prices relative to import prices.18 

The declines in the terms of trade followed the increases in the discount 

rate only after a considerable lag, and actually coincided with decreases 

in the rate. Their most obvious explanation would seem to lie in depressed 

business conditions in Britain, associated with the spread of the international cycle, rather than in any direct influence of the discount rate over 

domestic prices. 

This improvement in the British terms of trade in periods of rising 

discount rates should not be surprising, in view of the special position of 

Britain as a financial center for world trade. On purely a priori grounds, 

it would appear at least as probable as the opposite pattern contemplated 

by the classicists. What was really discussed by them was the case of 

price disparities between one country and a large number of other countries, equal to the first in importance. Under that assumption, deflation 

17

 The ratio of export to import prices, calculated from Board of Trade indexes, declined 

from 104 in 1923 to 98 in 1929, rose during the ensuing depression to a peak of 122 in 1933, 

fell to 107 in the relatively prosperous year 1937, and improved again to 116 during the 1938 

recession. 

18

 Thus the yearly average of discount rates rose gradually from 2.9 per cent in 1885 to 

4.5 per cent in 1890, while the ratio of export to import prices improved from 91 to 106. 

The next sustained rise in the rate, from 2 per cent in 1895 to 3.9 in 1900, was accompanied 

by an increase in the ratio from 97 to 114. The same positive correlation between rising rates 

and better terms of trade continued until the outbreak of war. 

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by the first country would force down domestic prices and costs without 

affecting to any significant extent the level of prices in the rest of the 

world. The position of Britain in the nineteenth century was, however, a 

very different one. Britain was the major center of world trade and 

finance, and British deflationary efforts immediately affected, not only 

the British economy and prices, but also the economy and prices of other 

countries, transmitting to them the cyclical fluctuations experienced by 

Great Britain. Thus, the problem became essentially one, not of disparities between one country and the others, but of a simultaneous upward or downward movement engulfing most other nations along with 

Great Britain. 

We have already seen that the most immediate effect of a rise in the 

British discount rates was to reverse the normal direction of international 

capital movements. The outflow of funds from the other countries toward 

Great Britain exerted an immediate downward pressure on prices and 

income in those countries. In fact, since the great bulk of foreign exports 

was financed through London, and since foreign bills far outweighed inland bills in the London discount market, a tightening in discount rates 

could be expected to affect the prices of foreign goods more drastically 

and directly than domestic prices in Britain. The reverse would be true 

in the case of a credit relaxation or expansion in London. These movements would be further magnified by the banking contraction or expansion thus induced in the foreign countries themselves, especially as 

higher discount rates in those markets would tighten domestic credit 

without attracting, as they did in London, compensatory capital movements from abroad. 

These considerations are reinforced by the fact that a large part of 

Britain's exports consisted of manufactured industrial products, while 

the bulk of her imports was composed of foodstuffs and raw materials. 

Less flexibility of demand and supply conditions could be expected to 

make the prices of the second category of goods especially sensitive to 

credit contraction and expansion, as well as to general cyclical fluctuations. 

The failure of British discount policy to effect the type of readjustments contemplated in classical theory is thus easily understandable. 

It was due primarily to the international character of the London discount 

market, whose expansion and contraction affected foreign prices as much 

as or more than British prices. It is also explainable by the fact that 

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producers of agricultural and raw materials are more vulnerable to cyclical and credit fluctuations than is the British economy.19 

A POSITIVE POLICY FOR THE INTERNATIONAL MONETARY FUND 

One main conclusion emerges from the foregoing analysis. The "rules 

of the game" of the twentieth century gold standard, no matter how valid 

they may be in the case of isolated fundamental disequilibria in one 

country's or a few countries' international accounts, are totally inappropriate for dealing with world-wide cyclical fluctuations. The main 

result of "orthodox" gold standard policies under such circumstances was 

to spread throughout the world at large any cyclical disturbance arising 

in major industrialized nations. Balance of payments deficits would be 

corrected in the end, but mostly through a general contraction in income 

and economic activity, rather than through direct price readjustments. 

Furthermore, the accompanying price changes would leave in their wake 

a basically unbalanced structure of international prices w

T

hen the cyclical 

depression subsided and more normal conditions were restored. 

The success of the International Monetary Fund will largely depend on 

the progressive development and general acceptance of new canons of 

international monetary behavior, to replace the previous "rules of the 

game" code. These new standards of policy should be less crude in their 

application, and more acceptable to the national monetary authorities of 

member countries. They should recognize the primacy of domestic goals 

of stability and high levels of economic performance, and distinguish 

strongly between cyclical and fundamental disequilibria in the balances 

of payments. 

Anti-cyclical Monetary Policies. The International Monetary Fund has 

proclaimed that one of its main purposes is "to facilitate the expansion 

and balanced growth of international trade, and to contribute thereby to ' 

the promotion and maintenance of high levels of employment and real 

income and to the development of the productive resources of all members 

as primary objectives of monetary policy."20 This formulation recognizes 

the basic agreement and interdependence of national and international 

monetary objectives. A large volume of world trade obviously contributes 

to domestic prosperity. Conversely, domestic prosperity in one country 

19

 A somewhat similar observation is made by R. G. Hawtrey in A Century of Bank Rate 

(London, 1938), p. 44, but is not systematically related to the general theory of balance of 

payments readjustments, which it so clearly contradicts. 

20

 Articles of Agreement of the International Monetary Fund, Art. I (ii). 

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redounds to the benefit of other members by maintaining effective demand for imports and thus encouraging exports and production in other 

areas. The responsibility of the largest and more industrialized countries 

is especially heavy in this respect. Major depressions usually originate 

with them, rather than with smaller, agricultural nations, and are especially contagious internationally because of the weight these countries 

have in world trade and finance. The only satisfactory corrective of 

cyclical disequilibria in the balance of payments which are not due to 

fundamental maladjustments in international price levels thus lies for 

most nations, not in internal deflation according to the "rules of the 

game" recipe, but in the restoration of economic activity and purchasing 

power in the centers of the cyclical disturbance. 

Balance of payments disequilibria, however, will continue to occur and 

to threaten domestic stability, especially in countries with undiversified 

economies, heavily dependent on international trade and especially on 

one or a few export products for which demand is inelastic. Variations in 

weather and crop yields as well as cyclical fluctuations in the major world 

markets will result in alternate phases of favorable and unfavorable 

balances, reflected in inflationary and deflationary pressures on incomes, 

cash balances, prices, and costs. Such disequilibria will be of a temporary 

character, and the country should attempt to offset them to the largest 

possible extent by domestic compensatory policies. In doing so, it will 

contribute to international stabilization as well as to the maintenance of 

domestic levels of income and activity. In the absence of compensatory 

action—and even worse, if the automatic upward or downward pressures 

are reinforced in accordance with the "rules of the game" by secondary 

domestic expansion or contraction—not only national but also international balance will be needlessly sacrificed, since domestic "adjustments" to temporary disturbances of equilibrium will result in basic 

maladjustments, once the temporary factors cease to operate and more 

normal conditions are restored. 

Anti-cyclical compensatory policies would thus in general help to 

moderate both national and international depressions and to preserve 

fundamental international balance. Their generalized adoption, however, would tend to amplify the instability of national reserves of gold 

and foreign exchange. As long as the temporary factors of disequilibrium 

are present, reserves will move from the deficit to the surplus countries, 

unchecked by counteracting movements in prices, exchange rates, or 

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national incomes. This redistribution of reserves, even though temporary, 

creates a serious problem. The receiving countries accumulate funds 

which will help them to meet later deficits, but for which they have no 

immediate use or need. On the other hand, the drain on the reserves of 

the deficit countries may be such as to make a continuation of compensatory policies incompatible with the preservation of free and stable 

exchanges. It is precisely this situation which the International Fund is so 

well organized to meet. The drain of reserves is arrested, or moderated, 

by an indirect extension of credit by the surplus countries to the deficit 

countries, through their accounts with the Fund. In this manner 

the deficit countries are enabled to avoid recourse to internal deflation, 

currency devaluation, exchange control, or other restrictive policies, 

while the lending of unneeded accretions to reserves by the surplus countries protects them against the contractionary effects which such measures 

of defense would exert on their exports and domestic economic activity. 

One of the main dangers of the system is the abuse of the Fund's credit 

for the financing of fundamental, as opposed to cyclical or fortuitous, 

disequilibria in a country's international account. In that case, the borrowings would assume a continuous character, and indebtedness to the 

Fund would pile up rapidly until the country's quota was exhausted. 

Adequate safeguards must be provided against such abuse of the Fund's 

machinery, and toward the application of effective remedial action.21 

In the first place, a deficit country should be required to make the 

fullest possible use of its own international reserves. In the Fund's Charter 

this problem is approached in an indirect and incomplete manner through 

the application of the so-called "repurchase provisions."22 Further progress in this direction appears highly desirable in the long run, through 

amendment, interpretation, administration of the Fund's statutes, or 

through the Fund's powers of moral suasion. Such action, however, 

will meet considerable resistance, based on the still prevalent misinterpretation of the role of monetary reserves. In many countries monetary 

legislation as well as public opinion still regards the central bank's gold and 

foreign exchange reserves as the "backing" of the currency. Reserve 

ratios between gold and foreign exchange holdings and the central bank's 

note issue or total sight obligations are viewed by the public as an indication of the currency's soundness, and are generally subject by law to 

minimum requirements. This deep-rooted tradition bars the effective 

21

 See below, pp. 75-78. 

22

 Articles of Agreement, Art. V, Sec. 7. 

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employment of reserves at the time when they are most needed and for 

the only economic purpose which they can usefully serve. 

This anachronistic conception of central bank reserves dates back to an 

entirely different institutional environment, in which gold coin effectively 

circulated as the ultimate legal tender, and central banks were under 

strict legal obligation to convert their notes into gold, not only for balance 

of payment purposes, but also for internal circulation within a country. 

In practice, gold coin does not circulate today as money, and bank notes 

have become the ultimate legal tender for domestic payments. The only 

purpose of a gold or foreign exchange reserve is, therefore, to provide 

available resources to meet, without undue pressure on the currency, a 

deficit in the balance of payments.23 All member countries should be 

induced to accept this viewpoint and to liberate their reserves for effective use in case of need. 

Recourse to foreign borrowings outside the Fund is a second possible 

line of action in case reserves are not adequate to meet a drain. This 

would be especially valuable to meet specific rehabilitation or developmental expenditures, the financing of which is outside the scope of the 

Fund. Financing could be obtained through private investments or 

through the help of such institutions as the International Bank for Reconstruction and Development, the Export-Import Bank, etc. 

The third practical device is the husbanding of reserves for the most 

urgent needs, through a system of priorities in allocating available exchange. Unfortunately the very mention of "exchange control" raises 

such emotional reactions with many people as to prevent any serious 

discussion of the subject. The history of exchange control in the last two 

decades is such as to justify fully the condemnation of most exchange 

control systems used in the past. It does not, however, justify a blind 

condemnation of exchange controls as such, irrespective of their concrete 

forms and of the circumstances leading to their adoption. In some cases 

exchange control has been deliberately used as a weapon of economic 

blackmail and aggression. In other cases, however, it has been adopted 

as the result of sheer necessity and as a lesser evil. The statesmen who 

introduced exchange control in so many countries were not necessarily 

blackguards or fools. Their motives should be understood and, while 

every effort should be made to prevent abuses or unnecessary restrictions, 

23

 The "war chest" argument falls within the scope of this definition, although recent procedures of foreign funds controls weaken greatly the value of gold for purchases in enemy, 

or even neutral, countries. 

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the real purposes which nondiscriminatory controls can justifiably serve 

should not be summarily dismissed. Constructive criticism may succeed 

where dogmatic and purely negative opposition has failed and will 

probably remain as sterile in the future as it has proved in the past. 

Both a member country and the Fund may prefer self-denial through 

exchange restrictions to excessive borrowings, internal deflation, or exchange depreciation. Provision is made for some such cases in the Fund 

Agreement itself. First, the Fund gives the members full freedom "to 

exercise such controls as are necessary to regulate international capital 

movements" not connected with payments for current transactions or 

settlement of commitments.24 Members are even prohibited, in principle, 

from making net use of the Fund's resources "to meet a large and sustained outflow of capital, and the Fund may request a member to exercise 

controls to prevent such use of the resources of the Fund. If, after receiving such a request, a member fails to exercise appropriate controls, 

the Fund may declare the member ineligible to use the resources of the 

Fund.25 

Secondly, the demands made upon the Fund for a member's currency 

may exceed the Fund's ability to supply it. In that case, the Fund may 

ultimately be forced to declare such a currency scarce and to ration its 

supply among the members applying for it. Such a declaration "shall 

operate as an authorization to any member, after consultation with the 

Fund, temporarily to impose limitations on the freedom of exchange 

operations in the scarce currency."26 

Finally, the Fund may authorize a member country to "impose restrictions on the making of payments and transfers [even] for current international transactions."27

 The case would be especially likely to occur 

when a country has exhausted its drawing rights, under Article V, Section 

3 of the Agreement, and when, at the same time, the Fund is reluctant 

to give, under Section 4, special approval for further borrowings. The 

only alternative to such authorization would then be either the enforcement of strong deflationary policies—the results of which might, in any 

case, prove too slow to solve the immediate exchange problem—or currency devaluation. Again, either of these alternatives would be highly 

undesirable in the case of cyclical or temporary disequilibria. 

24

 Articles of Agreement, Art. VI, Sec. 3. 

25

 Ibid., Art. VI, Sec. 1. 

26 Ibid., Art. VII, Sec. 3(b). 

27

 Ibid., Art. VIII. 

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Exchange control may possibly be preferred to excessive loss of reserves 

and borrowings from the Fund, even before reserves and drawing rights 

have been exhausted. A country may feel that borrowings should not be 

resorted to on a very large scale for the sole purpose of financing imports 

of a purely sumptuary character. The Fund might concur with this view 

and authorize some exchange restrictions rather than force further and 

unwanted loans upon the country. Such an attitude on the part of the 

Fund's authorities would not be unlikely in view of the specific limitations 

placed by the Fund Agreement upon the use of the Fund's resources to 

finance capital outflows. While not identical, the two cases present some 

broad similarities. The general tenor of the Chapultepec discussions on 

the desirability of husbanding, for the purpose of economic development, 

reserves acquired in wartime is in harmony with this view. 

The creation of the International Monetary Fund, therefore, should not 

be interpreted as definitely removing, even after the expiration of the 

transition period, all justification for and possibility of exchange control 

measures by member countries. The Fund will greatly reduce the need for 

exchange control, and set up safeguards against unnecessary or discriminatory restrictions. It will not, and should not, blindly and flatly 

prohibit all use of legitimate controls as an instrument of monetary 

policy, when temporary exchange shortages make them the only alternative to drastic deflationary policies or to currency devaluation. As has 

been indicated above, price or currency adjustments may often be wholly 

inadequate to correct balance of payments deficits except through the 

resulting contraction of national income and effective import demand. 

This is especially true in the case of agricultural or raw material producing 

countries faced with an inelastic demand for their exports. Moreover, 

since only a fraction of a country's total income is spent abroad, the 

balancing of foreign transactions by contraction of national income is 

likely to require a decline in the income level several times as great as the 

deficit to be resorbed.28 This is clearly undesirable on national grounds 

and does not, in any way, lessen the unfavorable impact of import contraction on world trade. On the contrary, it aggravates the difficulties 

of competing exporting countries. Finally, it corrects a temporary disequilibrium at the cost of creating a fundamental one, in the other direction, once the transient factors of disturbance have disappeared. Under 

such circumstances, temporary and selective controls of expenditures 

28

 More strictly speaking, this will depend on the "marginal propensity" to import and on 

the elasticity of export supply and demand. 

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abroad are far preferable to indiscriminate and multiple income adjustments. 

The efforts of the International Monetary Fund should thus be directed, 

not toward indiscriminate abolition of all exchange controls, but toward 

the elimination of the abuses which have often characterized them in the 

past. 

The most patent and most crucial defect of exchange control lies in 

the discriminatory practices to which it lends itself. As long as exchange 

is rationed on an individual basis, through arbitrary decisions of the 

national agencies entrusted with the application of the controls, any 

allocation will be open to the accusation of incompetence, favoritism, or 

dishonesty in the distribution of the scarce exchange among importers as 

well as among supplying countries or firms.29 Such a procedure, however, 

is by no means inevitable. 

A promising alternative would be to enforce exchange restrictions 

through flexible and impersonal market forces, leaving the importers free 

to buy whatever they please wherever they please (presumably from the 

cheapest source of supply), subject only to such automatic restrictions as 

would normally result from the free interplay of supply and demand. 

More concretely, what is suggested is a well-organized plan whereby all 

of the current exchange receipts available to the monetary authorities is 

offered for sale in the manner described in the following paragraphs. 

(1) The monetary authorities would make exchange freely available, 

without previous permit or restrictions of any sort, at the normal exchange rates, for payment of all essential and urgent imports or services 

and of contractual obligations, dividends, or reasonable amortization on 

approved foreign investments. 

(2) The remainder of available exchange would be sold by the monetary 

authorities to provide means of payment for deferrable or nonessential 

imports and services, again without quantitative restrictions or import 

permits, through the functioning of one, or a few, auction markets. In 

29

 International acceptance of a "previous representative period" criterion as an objective 

guide for allocation might help to some extent, but would be of limited value. First, it could 

not serve as a pattern for commodity allocation, since any rationing of scarce exchange 

should change the "representative" pattern of imports in favor of more essential and against 

less essential imports. Secondly, the "previous representative period" criterion tends to freeze 

the channels of trade in a very arbitrary and uneconomic manner, especially when it becomes 

necessary to go far back into the past to discover a "representative" period. Structural 

changes brought about by the war make it extremely difficult to accept prewar patterns 

as representative. Difficulties are even greater in the case of the many countries in which 

prewar trade was subject to import quotas and exchange control regulation. 

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other words, the limited supply would be distributed among the buyers, 

not by administrative decision, but as a result of an impersonal pricing 

mechanism. 

In order to provide the central bank with sufficient exchange to assure 

the functioning of these two markets—the normal and the auction—all 

exchange proceeds from exports or other easily controllable sources would 

have to be sold, at the normal exchange rates, to the monetary authorities. 

On the other hand, exchange proceeds from unimportant or practically 

uncontrollable transactions could be freely sold and bought in a free exchange market. This would avoid giving a premium to illegal transactions, where evasion cannot be effectively checked, and would also provide 

an escape valve for the control system. Capital exports, beyond those 

which have access to the official market, could be channelled here without 

harmful repercussions on the rates applying to more essential exchange 

requirements. The higher rates prevailing on the free market in times of 

crises would, moreover, tend to discourage capital exports and encourage 

capital imports. 

The advantages of such a plan are clear. It would eliminate at the 

root arbitrary and discriminatory allocation of exchange, drastically 

simplify the administrative machinery, red tape, and delays, and reduce 

the possibilities of graft or favoritism in the distribution of exchange 

permits. From the international point of view, the main objection raised, 

quite properly, against the traditional forms of exchange control would 

also disappear. Nothing in the system would tend to destroy, or even 

weaken, a multilateral system of world trade. No distinction need be 

made between the various currencies bid for on any auction market; on 

the contrary, all auction premiums should be uniform, in percentage 

terms, for any one category of transactions, no matter what foreign currency is involved. The exact currency requested need not even be specified until the bidding is over and the exchange allocated. Indeed, as long 

as interconvertibility of currencies is maintained, the central bank would 

have no justifiable incentive to sell one currency in preference to another.30 

This method of procedure would enable the Fund to judge whether 

exchange control is justified in the particular circumstances and also to 

supervise exchange control. The plan would not be contrary to the expressed purposes of the Fund, although at first sight it might appear that 

the differential rates implied in the functioning of the auctioning and 

80

 The case of inconvertibility will be discussed below, pp. 73-74. 

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free exchange markets might be interpreted as a multiple currency 

practice. It must be recalled that the problem before both the Fund 

and the country is the allocation of a limited quota of exchange 

among various claimants and that some method of restriction is both 

basic and inevitable. It should be noted that the Fund Agreement (Article 

VIII, 3) specifically permits the adoption of multiple currency practices 

provided approval has been obtained from the Fund. Indeed, the Fund's 

approval is necessary, not only for this case, but for the more general one 

of any system of controls on current transactions (except as applied to 

scarce currencies, or under the transitional arrangements of Article XIV). 

More than that, however, the exact meaning of the "multiple currency" 

clause is open to question. The system here proposed does not constitute 

a multiple currency practice at all, if the term is interpreted to imply the 

setting up of different exchange premiums as between currencies. As 

pointed out above, no distinction is allowed as between currencies, but 

only as between different categories of transactions, irrespective of the 

currencies involved. 

Secondly, the auction and free market premiums are completely 

flexible, and would not—as would rigid multiple rates—introduce any 

effective restriction on exchange transactions independent from and 

additional to the basic and inevitable restriction resulting from the 

allocation among various claimants of a limited quota of exchange. Since 

under the proposed system the monetary authorities would be forced to 

sell fully that quota for whatever rate was offered in an open auction, the 

rate itself would not in any way constitute an independent or additional 

restriction. Foreign exports to the country would be limited only by the 

application of the quota, and would be in no way influenced by the fact 

that the exchange rate diverged from normal. The only significant effect 

would be a purely domestic and entirely desirable one, i.e., the recapture 

by the monetary authorities of the unjustified windfall profits that would 

otherwise accrue to importers. 

It should be kept in mind that any scarcity of exchange which reduces 

imports below the normal demand at the official exchange rates tends to 

drive up domestic prices no matter what the exchange rate charged to 

the importers to which exchange is allocated may be. In the absence of 

price control and rationing, the importers would be led to charge what 

the traffic would bear, or would distribute their short supplies in an 

arbitrary and capricious manner. While price control and rationing might 

reasonably be expected for essential goods of mass consumption, in most 

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countries they would not normally be extended to sales of luxuries and 

semi-luxuries, or would not be effectively enforced. Under the auction 

system, the importers would be forced to compete with one another for 

the exchange offered for sale. Such competition would drive the rate to, 

but not beyond, the point at which profits would be close to competitive 

levels, under competitive pricing conditions. Special problems might, of 

course, arise in the case of collusion or monopolistic practices by the 

sellers, but these would arise as well under a system of administrative 

allocation. They could be taken care of, as far as is administratively and 

politically feasible, without modifying the basic mechanism of control 

suggested above. 

It might be observed in passing that any system of tariff duties is 

equivalent to very real and rigid multiple currency practices. The very 

fact that objections to tariffs are so much milder than objections to 

multiple exchange rates again suggests that we often tend to fight words 

rather than realities. If the problem is viewed without dogmatic preconceptions, it will be realized that the allocation of scarce exchange through 

a free auction system carries no restrictive element that is not implicit in 

the limitation placed on the amount of exchange made available to the 

market. On the other hand, it presents the tremendous advantage of 

eliminating, or restricting considerably, the opportunity for favoritism or 

discrimination on the part of the exchange authorities. 

The supervision of exchange control by the International Monetary 

Fund will not be limited to the avoidance of discriminatory administration of the controls. The Fund will also want to judge whether exchange 

control as such is justified in the concrete circumstances under which a 

member country requests permission to adopt it. As the Fund gets under 

operation, it will have to develop certain general and objective criteria 

for granting or denying such requests, in order to avoid arbitrary, discriminatory, or merely haphazard decisions which would soon breed illwill among the members and endanger their loyalty to the institution. 

The problem is most acute for the smaller countries, whose vote in the 

Fund's councils will necessarily have little weight in reaching a decision. 

These countries should be guaranteed an impartial treatment based on as 

objective rules and principles of policy as can be practically devised by 

the Fund. 

One of the first criteria to be taken into consideration is clearly the level 

of international reserves of the country requesting the authorization for 

the establishment of exchange restrictions. The appraisal of the adequacy 

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or inadequacy of these reserves, from the point of view of balance of 

payments needs, cannot be gauged with reference to the traditional 

reserve ratios relating gold and foreign exchange holdings to note circulation or sight obligations. What is here relevant is the ability of the country 

to finance from its own reserves foreseeable deficits in its international 

transactions. From this point of view, reserves should first be expressed 

as a percentage of the normal requirements for payments abroad, i.e., 

of total annual sales of exchange by the banks. A reserve ratio of 30 per 

cent, for instance, would mean that the central bank could maintain a 

free and stable exchange market for one year in the face of a 30 per cent 

deficit in the balance of payments, or for two years, in the case of a 15 per 

cent deficit. Calculated in this way, the level of reserves would indicate 

the extent of the breathing spell which the monetary authorities would 

have while waiting for an automatic improvement in the balance of 

payments in cases of temporary disequilibria, or for the readjusting effect 

of any corrective policy which they think advisable to adopt when the 

deficit is deemed to be of a persistent or fundamental nature. If the length 

of such breathing spell were too short, the country might be given authorization for direct restrictions over exchange sales. 

Whether a 15, a 30, or a 50 per cent reserve is deemed sufficiently 

critical for the introduction of exchange control would, of course, depend 

upon the previous balance of payments experience of the country in 

question. A country subject to sudden and violent fluctuations in its 

export trade should be recognized as needing a higher critical reserve 

level than a country with more stable sources of foreign exchange receipts. 

Maximum variations in exports or exchange receipts in the past might 

serve as an objective indication in helping to determine the critical 

reserve level. 

A weaker but possibly valid claim for measures of control might be 

made when gold and foreign exchange reserves experienced a violent 

and sustained decline, even though they remained above the critical 

level agreed upon between the Fund and the member country. The 

argument in such a case would be based, as in the Chapultepec discussions, 

upon the desirability of limiting the expenditure of reserves for luxury 

imports, capital flight, etc. Milder controls would suffice in such a case, 

while stronger controls might prove unavoidable if the introduction of 

the controls had to wait until the critical level had been reached. 

As long as currency interconvertibility is maintained, no distinction 

need be made between the various currencies included in reserves, or 

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between currencies and gold. On the other hand, a country should be 

allowed to maintain exchange freedom in general, while restricting the 

sales of a currency in short supply—in accordance with the criteria discussed above—provided that the currency in question could not be 

procured through the Fund, or through the normal conversion into such 

currency of other international reserves at the disposal of the country. 

It would, indeed, be absurd to enforce general restrictions against all 

imports because of the unavailability of one, or a few, currencies,31 and the 

scarce currency clauses of the Fund Charter32 make such a case an exception to the general principle of nondiscrimination and multilateralism. 

The abuses and discriminations resulting from the blocking of some 

currencies cannot be blamed on the country subject to the blocking. 

Responsibility for the maintenance of interconvertibility and multilateralism properly belongs only to the International Monetary Fund and 

to the blocking countries themselves. 

The Fund will also want to guard against retention of exchange 

restrictions beyond the period in which they are required by the balance of 

payments situation. The system outlined above would solve this difficulty 

without necessitating further action by the Fund. Indeed, the control 

system would be self-liquidating, since the auction and free market premiums would automatically decrease and vanish as the exchange situation 

improved. If such improvement did not take place within a reasonable 

period, the disequilibrium of the balance of payments should be recognized as fundamental rather than temporary, and corrective measures 

rather than exchange control should be regarded as the proper remedy to 

adopt. The Fund might encourage this change by reviewing periodically, 

say once a year, the authorization granted to resort to exchange control. 

These proposals are not theoretical. They have been recently embodied 

in the basic monetary legislation of Paraguay and Guatemala and are 

currently under discussion in other countries.33 The Guatemalan law, 

especially, indicates in great detail the precise mechanism whereby the 

suggestions made here can be embodied in a practical manner. Both 

laws, however, express only the limitations to which these countries sub31

 For a discussion of this point, see League of Nations, Economic Stability in the Post-War 

World (1945), pp. 245-47. 

32

 Art. VII. 

33

 See Decreto-Ley No. 10043 que establece el regimen de cambios de la Republica del 

Paraguay (Asuncion, Paraguay), Aug. 29, 1945; and Ley Monetaria (Guatemala City, 

Guatemala), Dec. 10, 1945. A translation of the latter legislation was published in the Federal 

Reserve Bulletin, March 1946, pp. 259-69. 

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jected their freedom of action on their own initiative. Further safeguards 

might of course be desirable on an international plane, through the administration of the Fund's own powers with respect to exchange control. 

Fundamental Readjustments. The main emphasis of this paper 

has been on the inappropriateness of traditional readjustment policies as a 

remedy for temporary or cyclical disequilibria. The opposite danger— 

i.e., the failure to adopt readjustment policies in the case of fundamental 

disequilibria—also faces the Fund, but it has been so widely discussed 

elsewhere that a few comments will suffice here. 

In any case of persistent disequilibrium in one country's economy as 

a result of inflated price or income levels, corrective measures should be 

applied. Neither the use of the country's reserves, nor borrowings from 

abroad, nor exchange control would have any remedial influence on the 

disequilibrium. While this would also be true in the absence of any International Monetary Fund, there is a danger that financial assistance 

available from the Fund would be used in order further to postpone indispensable readjustments. The country's indebtedness would then 

grow without lasting domestic benefit, and the resources of the Fund 

would be wasted in a manner directly contrary to the objectives of the 

institution.34 The Fund, however, can protect itself against such abuses, 

not only through the ceilings placed on each country's presumptive 

borrowing rights, but also through the application of Article V, Section 5 

of the Fund's Charter. 

The diagnosis of a fundamental disequilibrium, however, is not an easy 

task. A deficit in a country's balance of payments is not necessarily 

evidence of an excessive and untenable level of domestic, as compared with 

international, prices. Contrary to the "rules of the game" concept, it 

should not, therefore, be taken as a signal for deflationary policies. 

Compensatory action should be preferred, and supported by the Fund, 

whenever the deficit can be ascribed to accidental causes, such as a 

crop failure, or to a cyclical world depression. Similary, a favorable 

balance of payments, not associated with international cost and price 

disparities, should not be viewed as requiring expansionary policies which 

are disruptive of domestic stability and conducive to inflationary price 

rises. 

Before the existence of a durable disequilibrium calling for corrective 

34

 One of the purposes of the Fund stated in Art. I (vi) is "to shorten the duration and 

lessen the degree of disequilibrium in the international balances of payments of members." 

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measures is assumed, additional evidence should be studied and weighed. 

Any fundamental disequilibrium would manifest itself, not only in a 

deficit in the balance of payments, but also in monetary and banking 

statistics, price and production data, etc. Such series, as well as the course 

of the balance of payments, should be compared with the experience of 

other countries, and especially of those of similar economic structure but 

subject to different domestic influences and policies. Only in this manner 

can a proper diagnosis be arrived at and an adequate policy determined. 

Where clear evidence is lacking, arbitrary decisions are unavoidable. 

The deficit country should probably be given the benefit of the doubt and 

be allowed to pursue compensatory policies for a time with the help of the 

Fund, and possibly under the additional protection of exchange control 

when needed. This interpretation would be confirmed by events if the 

deficit did in fact disappear within a normal period of time. The decision 

would have to be reversed and corrective policies would have to be 

applied, however, if the deficit continued to pile up the country's indebtedness to the Fund, or if the need for exchange control persisted, with 

sustained and substantial premiums on the auction and free exchange 

markets. 

Just as a mere balance of payments deficit is not conclusive evidence of 

a fundamental disequilibrium, the absence of such a deficit is not conclusive proof of a fundamental equilibrium in a country's international 

position. In the absence of compensatory action by the monetary authorities, a fundamental disequilibrium may fail to be reflected in any balance 

of payments deficit, owing to the prompt transmission of external deflationary pressures to domestic prices and incomes. One of the clearest 

cases of a fundamental disequilibrium owing to currency overvaluation is 

the experience of Belgium following the devaluation of the British pound 

in September 1931. And yet, both the balance of trade and the balance 

of payments improved rather than deteriorated during most of the 

overvaluation period. The average import surplus fell from 4.3 billion 

francs a year in 1929-30 to 0.8 billion in 1932-34 and the official gold and 

foreign exchange reserves of the country remained nearly unchanged at a 

level of 15 to 16 billion francs until the end of 1933.35 The impact of the 

disequilibrium was thus felt, not in a deficit in the balance of payments, 

but in a drastic decline in economic activity and incomes, especially in 

35

 A decline to 12.5 billion francs in the latter part of 1934 is to be ascribed primarily to 

capital flight, prompted by the approaching devaluation of the currency. 

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the so-called "nonsheltered" industries which were in competition with 

foreign firms in the national or international markets.36 

It has been argued recently that a country subject to such pressures 

should attempt to protect itself through domestic compensatory policies, 

but should not be allowed to devalue its currency unless and until these 

policies had led to an actual deficit in the balance of international payments.87

 This attitude is open to serious objections. First, it would lead 

to unnecessary disruptions, since labor and other economic factors would 

have to be uprooted and transferred into temporary activities, such as 

public works for instance, and then returned to their normal field of 

employment when currency devaluation again made it profitable and 

economic. Secondly, the scope of compensatory action might be relatively 

limited, especially in undeveloped countries heavily dependent on the 

exportation of primary products. For such countries, currency devaluation 

would often be the most direct, or even the only effective, way of maintaining domestic levels of income. 

It is true, however, that devaluation should not be regarded as a proper 

and legitimate remedy for any domestic depression, whatever its origin; 

but neither should it be regarded as legitimate and desirable merely 

because a country is experiencing balance of payments difficulties. The 

Belgian case showed clear evidence that external pressures resulting from 

the undervaluation of the pound with respect to the franc were at the 

root of a severe domestic depression, but this evidence did not emerge 

from balance of payments data. On the other hand, balance of payments 

deficits are often the result of cyclical rather than fundmental disequilibria, and devaluation in such cases would usually be a most undesirable 

remedy from the national as well as the international viewpoint. 

Thus, the relevance of the balance of payments to the definition of a 

"fundamental disequilibrium'' is of a subtler kind than is often imagined. 

There may exist a fundamental disequilibrium in a country's economy, 

even in the absence of any actual balance of payments deficit. On the 

other hand, a deficit in the balance of payments may be due to cyclical, 

or accidental, rather than to fundamental maladjustments. We might 

define tentatively a fundamental disequilibrium as "a maladjustment in 

a country's economy so grave and persistent that the restoration or 

36

 See Robert Triffin, "La theorie de la sur£valuation mon6taire et la devaluation beige/' 

Bulletin de VInstitut de Recherches Economiques (Louvain, Belgium), November 1937, pp. 

19-52. 

37

 See Gottfried Haberler, "Currency Depreciation and the International Monetary 

Fund," Review of Economic Statistics, Vol. XXVI (November 1944), pp. 178-81. 

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maintenance of satisfactory levels of domestic activity, employment, and 

incomes would prove incompatible with equilibrium in the balance of 

payments, if not accompanied by extraordinary measures of external 

defense, such as a change in the exchange rates, increased tariff or exchange control protection, etc." 

The latter part of this definition also suggests that devaluation is not 

necessarily the only, or even the most appropriate, remedy for a fundamental disequilibrium. The language of the Fund Agreement is interesting 

in this respect. Members agree not to propose a change in the par value of 

their currency except to correct a fundamental disequilibrium. The Fund, 

however, shall concur in the proposed change only if it is satisfied that 

the change is necessary to correct the disequilibrium (Article IV, Section 

5 (a) and (f)). Thus, a fundamental disequilibrium is considered by the 

Fund as a necessary, but not as a sufficient condition for currency readjustment. In some cases, other methods of correction may be preferable, 

from a national as well as from an international standpoint. 

For instance, the difficulties of the Chilean nitrate industry following 

the development of synthetic nitrates were of a fundamental character 

and had a deep impact on the international balance of the country. 

Devaluation, even though probably unavoidable under the circumstances, 

could not by itself have been expected to rectify the Chilean economy. 

Domestic monetary and fiscal policies, changes in the tariff structure, 

diversification of production, and modernization of industrial and agricultural techniques (possibly with foreign help) might have been better 

remedies than currency readjustments, or at least their indispensable 

complements. 

A specially interesting case is the one of colonial economies in which 

income expansion may lead rapidly and direcftly to balance of payments 

disequilibria through its effects on luxury imports, tourist expenditures 

abroad, capital exports, and the like, rather than through any upward 

pressure on domestic wage and cost levels. Devaluation is a blunt and 

indiscriminate instrument and may often be less efficient than selective 

policies designed to plug the main leaks in the balance of payments, with 

a minimum impact on basic economic activities and on production and 

living costs. 

Devaluation is also of limited value as a remedy for pervasive maladjustments, whether cyclical or fundamental, affecting simultaneously a 

large number of countries. Agricultural overproduction, for instance, may 

simultaneously disrupt the international balance of all the competing 

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NATIONAL CENTRAL BANKING AND THE INTERNATIONAL ECONOMY 79 

countries whose exports are largely concentrated on the overproduced 

commodities. Concerted international action designed toward readjustment would be preferable in this case to cut-throat competition through 

lower prices or currency devaluation. The lack of balance between supply 

and demand should be gauged, moreover, not with relation to abnormally 

low levels of demand associated with a world depression, but in terms of 

normal requirements. The ever-normal granary concept should be extended beyond national borders through international commodity agreements. It is true that such agreements may lead to opposite abuses and 

to artificial efforts to maintain prices permanently at higher than competitive levels. The dilemma, however, is an inescapable one. Unfettered 

competition in a market dominated by a few large sellers cannot ensure 

the maintenance of competitive prices. It may often lead either to cutthroat underselling, monopolistic pricing through formal or informal 

cartel agreements, price leadership, or other restrictive practices. This 

is true at the international as well as at the national level. International 

commodity agreements should be so organized as to prevent domination 

of policies by vested interests of the producers or their governments. 

Broad representation of consuming countries, together with the adoption 

of automatic or semi-automatic indicators, might help to avoid major 

errors. In the long run, however, policy decisions can never be dissociated 

from responsibility. The refusal to take action is no solution in the face 

of the breakdown, or unavailability, of the impersonal, competitive 

mechanisms which, in classical theory, justified noninterference with 

market forces. 

CONCLUSION 

The classical theory of international balance and of readjustments to 

balance of payments disequilibria focusses on disparities in a single 

country's price and cost levels with relation to the rest of the world. 

Under such conditions, domestic deflation—if costs are not too rigid— 

or currency devaluation may be able to bring about readjustment through 

the restoration of the country's competitive position in world markets. 

This doctrine was mistakenly extended, especially by the "rules of 

the game* adherents, to world-wide cyclical disequilibria, originating in 

one or a few highly developed and industrialized countries. Efforts by 

other countries to correct resulting balance of payments deficits, either 

through price deflation or exchange devaluation, were then thwarted 

because such action by any one country or group of countries aggravated 

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80 INTERNATIONAL MONETARY POLICIES 

the difficulties in their supply and export markets, as well as in competing 

countries, and led to similar and mutually self-defeating measures of 

defense. Price deflation and devaluation spread from country to country 

without increasing export receipts, espedally if world demand for a 

nation's exports is relatively inelastic.38 The situation presents a strong 

analogy with that of oligopoly, where each effort by one seller to cut into 

the competitors' markets is thwarted by the competitors' price retaliation. 

Thus, the actual elasticity of demand for one country's exports is merged 

with the much lower elasticity of world demand for those products. 

Sales can be expanded only in so far as lower prices stimulate consumption, and not through inroads into the competitors' sales. 

The main result of such policies is therefore to spread throughout the 

world any cyclical disturbance arising in a major economic area., Balance 

of payments deficits may be corrected in the end, but mostly as the result 

of a general decline in income and economic activity. Furthermore, the 

accompanying price changes leave in their wake a basically unbalanced 

structure of international prices when the cyclical depression subsides 

and more normal conditions are restored. 

Whenever balance of payments disequilibria are due, not to international price disparities, but to accidental factors or to cyclical fluctuations in foreign income and demand, compensatory policies should be 

followed to the fullest possible extent. This requires a high level of international reserves, especially in raw material and food producing countries, 

and the willingness to spend these reserves liberally in times of crisis 

and to accumulate them during prosperous years. When reserves are 

insufficient, foreign or international assistance—such as is contemplated 

under the International Monetary Fund—will be necessary. Failing this, 

exchange control should be used as a third line of defense, in order to 

continue compensatory policies and avoid the greater evils inseparable 

from deflation or currency devaluation. The disadvantage of the latter 

policies, as compared to exchange control, is that their corrective effect 

on the balance of payments is likely to depend on a contraction of income 

several times as severe as the international deficit to be plugged. 

Exchange control, however, should be restricted to periods of temporary exchange difficulties, and should not be used to avoid readjustments 

38

 Devaluation may, of course, be preferable because its domestic impact is more favorable. 

For this reason in some cases it may also be less damaging internationally. From the point 

of view of eliminating a balance of payments deficit, however, the initial impact of both 

measures may be very much the same except for their reaction on capital movements. 

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NATIONAL CENTRAL BANKING AND THE INTERNATIONAL ECONOMY 8 1 

to fundamental disequilibria. Even more important, the system of controls to be adopted should preserve the multilateralism and flexibility of 

international trade. It should not lend itself to administrative arbitrariness, rigid and uneconomic allocation of exchange, discrimination and 

bilateralism. These historical evils, associated with exchange control as 

used in the interwar period, should not lead to a blind and dogmatic 

rejection of exchange control as such, but to specific efforts to dissociate 

it from such abuses and to make it a proper instrument for the protection 

of the economy and the currency against temporary pressures on the 

exchange. 

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COMMENTS ON "NATIONAL CENTRAL BANKING AND 

THE INTERNATIONAL ECONOMY" 

by 

GOTTFRIED HABERLER 

Consultant, Board of Governors 

One of the most challenging tasks of rational economic policy and one 

of the most intriguing and controversial problems to economic science is 

how to avoid or eliminate conflicts between domestic prosperity and 

maximum gain from international trade and international division of 

labor. Maximization of national output and income depends on both, full 

employment of resources at home and full utilization of the opportunities 

of international trade. 

Conflicts between the two conditions in the sphere of monetary and 

fiscal policy are quite frequent, because measures appropriate for maintaining full employment are not always conducive to promoting stability 

of foreign exchange and of international trade and vice versa. These 

conflicts are rarely, if ever, irreconcilable, but there is no simple formula 

or easy automatic device which would permit satisfactory conciliation in 

every single case. 

Innumerable proposals for simple, once-for-all solutions, as well as for 

complicated specifications of policy under different circumstances, have 

been made, and many different policies have been tried out. Theoretical 

insight has steadily grown and a vast stock of practical experience has 

been accumulated. Thus, whenever a new attempt is made at finding a 

solution of this problem, as in connection with the setting up of the 

International Monetary Fund, a strong effort is required in order to 

utilize to the fullest extent the lessons of historical experience and the 

latest improvements in theoretical analysis. Dr. Robert Triffin's paper 

is a most notable and stimulating contribution in both directions. 

PURE AND MIXED GOLD STANDARDS 

J. H. Williams once spoke of "a fundamental conflict between the 

principles of central banking and the principles of the gold standard."1 

Similarly, Dr. Triffin (page 49) stresses "the latent antinomy between 

central banking and the classical gold standard." He points out that in 

1

 "Monetary Stability and the Gold Standard," American Economic Review, Supplement, 

March 1932, reprinted in The Postwar Monetary Plans (1944), p. 183. 

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its purest form the gold standard eliminates this conflict by removing one 

of its terms: there is not room for national central banking in a "purely 

metallic" currency system. A purely metallic currency was recommended 

by some of the early classical economists, but it was never completely 

realized in practice. The existence and development of credit and banking 

(not only central but also commercial banking) prevented the gold standard from being a purely metallic currency. It is true, attempts were made 

to make the actual mixed system behave like a purely metallic currency. 

The so-called "Palmer Rule" adopted by the Bank of England in 1827 

and the famous Bank Act (Peel's Act) of 1844 were such attempts, but 

they remained abortive and the gold standard of the nineteenth century 

remained a "mixed system." That is to say, the circulating medium consisted of two parts, a comparatively small base of gold or gold-covered 

bank notes (international money) and a large superstructure of credit and 

fiduciary currency (domestic money). 

Roughly speaking, we may say that the gold standard as it actually 

existed was superior to a purely metallic currency as far as the maintenance of internal stability and progress was concerned, because it 

provided a flexible money supply. But it placed difficulties in the way of 

maintaining external stability which would not have existed or would 

have been much less serious under a pure gold standard. 

Only a few remarks can be made here about the first point, viz., the 

superiority of the flexible, mixed system over the rigid pure gold standard. 

It cannot be denied, of course, that an elastic supply of money and credit 

has its dangers, that it can be and often has been abused for wholly undesirable inflationary experiments. But very few economists would assert 

that change in the money supply is bad of itself and should be avoided. 

According to these few economists, a purely metallic currency would be 

superior in both respects, for the maintenance of external and internal 

stability alike. According to them, depressions and the business cycle as 

such are entirely due to periodic expansion of money and credit; if the 

supply of money and credit were rigid as it would be under a pure gold 

standard, there would be no cyclical depressions.2 

The great majority of economic experts realize, however, that things 

are not so simple; that the business cycle has deeper roots than expansibility of bank credit; that periods of expansion and contraction of 

2

 There are shades of opinion in this group. Some would allow for a slow secular rise in the 

money supply in order to compensate for certain growth factors and to stabilize prices; others 

think that prices should be allowed to fall slowly pari passu with the secular rise in output. 

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money expenditures *nd of output and employment could and would 

occur even if the money and credit supply were rigid, for even if the 

quantity of money were constant there could be fluctuations in hoarding 

and dishoarding, decreases and increases in the velocity of circulation, 

and decreases and increases in the demand for liquidity. There are again 

many shades of opinion. Most writers would concede that expansibility 

of credit contributes to the amplitude of cyclical fluctuations, but many 

would insist, with varying emphasis, that over the long run such an increase in the amplitude of cyclical swings increases the rate of economic 

progress. But this is not the place to go more deeply into these complicated 

questions. Suffice it to say that there are very few economists who would 

seriously recommend making the money supply as rigid as it would be 

under purely metallic currency. 

We come now to the other point, where the pure gold standard would 

be superior to the mixed system. Dr. Trifhn follows Professor Hayek and 

other writers in attributing a large share of the difficulties in dealing with 

international disequilibria to the mixed character of our historical currency systems. The erection of a large superstructure of fiduciary and 

credit money (bank deposits) upon a narrow gold base meant that, 

whenever there was a serious deficit in the balance of payments (drain 

on gold reserves), strong measures had to be taken to protect the gold 

supply and to maintain the convertibility of the currency into gold and 

foreign money. Under a pure gold standard the loss of gold (decrease in 

the international reserve) would lead to a reduction of the circulating 

medium by not more than the amount of the gold loss, but with a large 

credit superstructure it became necessary to contract the circulating 

medium by a multiple of the gold loss. Under the "rules of the gold 

standard game" the central bank of a country that was losing gold was 

required to liquidate domestic assets (withdraw loans or sell securities) 

along with the loss of its international reserves, and the central bank of 

the country that gained gold was supposed to acquire domestic assets 

along with the accretion to its international reserves. This policy of 

"secondary expansion and contraction" could not fail to accentuate price 

reactions to gold flows and thus to increase economic instability. 

Two remarks may be made about this conventional criticism of the 

nineteenth century gold standard. First, it should be emphasized that 

smallness of the gold reserve in the English monetary system was a subject of comment and criticism throughout the century. Professor Viner 

says: "From the late 1820's on to the end of the century a continuous 

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COMMENTS 85 

succession of writers called attention to the inadequacy of the gold 

reserve."3 Even Peel himself was said to have been "aware that the 

metallic base of the currency was extraordinarily narrow, but did not 

think that either the Bank or the people would willingly bear the expense 

of broadening it."4 In the early period, "the practice of extreme economy 

in the maintenance of bank reserves" (Viner) was undoubtedly largely 

due to the fact that a low reserve meant large profits to the Bank. But 

there was a gradual evolution of the Bank from a passive conversion 

fund operating according to certain rules and still influenced by the profit 

motive to a policy-making body fully conscious of its responsibility for 

domestic prosperity and of the possible conflicts between internal and 

international equilibrium. This transition was completed long ago, and 

when the Bank was finally nationalized by the present Labor Government, 

the nationalization was generally regarded as a pure formality. Politically 

it would have been impossible at an earlier date. But as far as the policy 

of the Bank was concerned, it would hardly have made any difference if 

the nationalization had occurred many years ago. 

The second remark concerning the smallness of the reserve and the 

fractional reserve system is this: multiple expansion and contraction in 

response to gold flows was undoubtedly a disturbing factor. But it is 

easy to exaggerate its importance and very difficult to estimate its 

magnitude correctly. It is a fact that as far as central bank money (notes 

outside the Bank plus private deposits in the Bank) is concerned there 

is no multiplication of gold flows visible in the statistical record. For the 

interwar period (1919-39) Professor Ragnar Nurkse has shown that, 

contrary to what was required by "the rules of the game," "central 

banks' international and domestic assets . . . moved far more often in the 

opposite than in the same direction."5 That is to say, central banks, 

instead of magnifying, toned down expansions and contractions resulting 

from gold flows. No such careful study has been made for prewar periods, 

but an inspection of the relevant statistical series shows no trace of 

magnification. The volume of central bank money (notes plus deposits) 

and gold reserves move together, but the changes in the former are in 

most cases smaller than the changes in the latter. This is true not only 

of Great Britain but also of France and Germany. If there was a magnifi3

 J. Viner, Studies in the Theory of International Trade, p. 265. 

* Ibid., p. 267. 

6

 League of Nations, International Currency Experience (1944), pp. 68-69. 

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86 INTERNATIONAL MONETARY POLICIES 

cation, it must have taken place entirely in the field of commercial bank 

deposits. 

In the case of Great Britain, the record definitely shows such a magnification in that sphere. But for statistical reasons the average rate of 

magnification is not easy to determine.6 Moreover, the causal interpretation is a different matter altogether. That is to say, given a certain magnification, it remains still to decide to what extent it is due to (a) changes 

in the supply of central bank money and gold or (b) to changes in demand 

for credit. The criticism of "the rules of the game" implies that changes in 

money supply are all important. But modern business cycle and monetary 

theory definitely tends to lay more and more stress on demand factors. 

This shift in emphasis from supply to demand factors is supported by 

recent business cycle experiences, namely, the occurrence of sharp 

fluctuations in output and employment as well as price and money values 

without significant changes in supply conditions of credit. The slump of 

1937 in the United States is an outstanding example. 

Whatever the last word in these matters will be, it is important not to 

exaggerate the consequences of the fractional reserve gold standard. 

Such exaggerations may easily lead to the conclusion that the elimination 

of that objectionable feature of the gold standard is all that is needed to 

assure a smoothly running international money mechanism. Dr. Triffin 

is, of course, far from committing that mistake. He makes it abundantly 

clear than an increase in international reserves and liquidity as provided 

by the International Monetary Fund, although useful and necessary, is 

by no means a sufficient reform of the existing system. 

8

 The English banks usually did not separate current accounts from (savings) deposits in 

their balance sheets. Moreover, only balance sheets pertaining to a certain day of the year 

were published, with a certain amount of "window dressing" involved; the average amount 

of demand deposits over a period of a year, or even of a quarter, is not known. Another statistical difficulty arises because many banks combined the two cash items "cash on hand 

and at Bank of England" with "cash at call." A considerable amount of fluctuating "surplus" 

money is in the latter category, and can be withdrawn from the brokers at a moment's notice. 

Thus the first impact of a reduction in the money supply falls on call money, while "cash on 

hand and at the Bank of England" is increased. The effect, during the money crisis of 1907, 

on the banks which separate "cash in hand" from "cash at call" serves as an illustration: 

Dec. 31, 1906 Dec. 31, 1907 

Cash on hand £ 80.4 million £ 85.5 million 

Cash at call £ 72.2 million £ 62.0 million 

"Cash at call" was reduced by £ 10.2 million, "cash on hand" increased by 5.1 million during 

the same period. Edgar JaffS, Das tnglische Bankwesen (Leipzig, 1910), p. 326n. See also G. 

Clare, A Money Market Primer (London, 1907), pp. 143ff., for a description of the working 

of the mechanism. 

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BANK RATE AND THE BRITISH BALANCE OF PAYMENTS 

In Great Britain the gold standard was operated largely by means of 

changes in the discount rate of the Bank of England. When a gold drain 

became serious, the bank rate was raised and vice versa. Dr. Triflin criticizes what he thinks is the traditional theory of that mechanism. Actually, 

he says (page 59), the mechanism "seems to have operated, in important 

respects, in a manner directly opposite to that described by gold standard 

theory." According to the classical theory, Dr. Triflin says, a rise in bank 

rate should have depressed British prices and so have influenced favorably 

the British balance of trade. In reality the influence of bank rate changes 

was more through capital movements and through their effects on the outside world, especially on agricultural and raw material producing countries. 

It must be emphasized that these features of the mechanism were 

generally known and commented upon throughout the nineteenth 

century. That a rise in bank rate served to attract capital was known 

and stressed not only by the Banking School, especially by William Tooke 

(whom Dr. Triflin quotes) who was somewhat of a heretic, but also by 

Tooke's chief opponent, Lord Overstone, and the Currency School. 

Professor Viner, writing of the period 1825-65, says: "Most of the discussions of the role of the interest rate referred only to short-run disturbances, including periodic business fluctuations, or 'cycles/ and the changes 

in interest rates were related to specie movements mainly in terms of 

their influence on international movement of short-term funds, and their 

influence on relative prices was commonly held to be too slow-working 

to be an important factor in restoring international equilibrium. Most 

emphasis was put on the international mobility of funds."7 

That higher interest rates in London may affect prices in foreign countries more quickly and powerfully than prices in Great Britain, and that 

therefore a rise in the discount rate in London may tend to turn the trade 

balance against England, has also been observed. R. G. Hawtrey, for 

example, says: "If this deflationary process [started by a rise in bank 

rate] went faster at home than abroad, it made the foreign exchanges 

favorable [for Great Britain] and occasioned an inflow of gold. But it 

7

 Op. cit.y p. 278. See also Elmer Wood, English Theories of Central Banking Control, 1819-

58 (Harvard University Press, 1939), pp. 150-51. As an example of a classical writer stressing 

the influence of bank rate changes on capital flows, compare the following passage from J. 

S. Mill, Principles of Political Economy (Ashley edition), p. 497: "It is a fact now beginning 

to be recognized, that the passage of the precious metals from country to country is determined much more than formerly supposed by the state of the loan markets in different countries, and much less by the state of prices." 

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sometimes went faster in some foreign country (particularly in case of a 

financial crisis there) and caused an outflow."8 But as Dr. Triffin observes, 

this idea has not been systematically elaborated. 

All this serves to show that more can be learned from the older literature 

than Dr. Triffin would make us believe and that business cycle implications were by no means overlooked. This does not mean that the 

nineteenth century gold standard practices are not open to criticism. It 

is misleading, however, to speak of "the" nineteenth century gold standard, for the operation of the gold standard underwent a continuous 

evolution. Slowly but surely the monetary authorities learned many 

useful lessons. That in spite of all improvements in monetary management the business cycle did not show signs of disappearing or of becoming 

noticeably milder should make us cautious not to expect too much from 

purely monetary reforms. 

CYCLICAL AND FUNDAMENTAL MALADJUSTMENTS IN THE 

BALANCE OF PAYMENTS 

Dr. Triffin draws a sharp distinction between "world-wide disturbances 

in balances of payments associated with cyclical fluctuations" on the one 

hand and "fundamental disequilibria in single countries' international 

position." He is on firm ground when, following modern trade theory, he 

emphasizes the great importance of cyclical fluctuations and income 

changes for the functioning of the international money mechanism, 

especially the terrific disrupting force of world-wide depressions. It is very 

unlikely that international monetary agreements and institutions like 

the International Monetary Fund and the International Bank or international commercial policy agreements like the proposed International 

Trade Convention could weather the hurricane of a major world depression; nor is it likely that such agreements and institutions alone, without 

appropriate domestic policies in the large industrial countries, could do 

much to prevent such a storm. It is probably also true that a full realization of the importance of the international business cycle and of depressions in particular is of fairly recent origin, at least as far as systematic, 

theoretical thinking is concerned. But we have seen that not only practical 

men, but also theorists, when they dealt with current problems, were 

always confronted with the reality of the cycle and did not overlook it 

altogether. 

It is questionable whether Dr. Triffin is right when he says that, 

8

 A Century of Bank Rate (London, 1938), p. 44. 

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according to classical gold standard theory in its original form or according 

to its modern "rules of the game" version, any disequilibrium, whatever 

its origin, has to be corrected by automatic or induced price changes 

brought about by domestic monetary expansion and contraction. It is 

even more questionable whether "fundamental disequilibrium" can be 

identified with "noncyclical disequilibrium" (i.e., a disequilibrium not 

caused by a world-wide depression), and whether changes in relative 

price levels (through currency depreciation or domestic price adjustments) 

have to be ruled out as treatment of those maladjustments that emerge 

during world-wide depressions. 

Concerning the first point, it may be sufficient to mention that J. S. 

Mill and other writers drew a distinction between two kinds of external 

gold drains (the term they used for balance of payments disequilibria): 

(a) drains that could be corrected only by changes in relative prices, 

"fundamental disequilibria" we now say, and (b) temporary drains that 

did not require such a treatment.9 Mill criticized the Act of 1844 on the 

ground that it forced the Bank of England to apply the same treatment 

to both kinds of drains. Later he admitted that even under this Act the 

Bank could differentiate between different drains if it kept a sufficiently 

large reserve in the banking department.10 It is interesting that Mill was 

criticized by contemporary writers for exaggerating the ease with which 

in practice the distinction between temporary and lasting disequilibria 

can be made. It is true he did not identify temporary maladjustments with 

cyclical or depression-born maladjustments. In that he was not so wrong, 

however unsatisfactory in other respects his analysis may appear to us 

now! 

Although it is of utmost importance to recognize cyclical fluctuations 

in income and international demand, especially the depression phase of 

the cycle, as breeders of maladjustments in the balances of payments, it 

is impossible to regard cyclical and fundamental disequilibria as mutually 

exclusive opposites. A brief reflection will show that the two concepts 

overlap, especially that depressions frequently breed fundamental as well 

as temporary (reversible) maladjustments. 

The term "fundamental disequilibrium" was introduced by the Bretton 

Woods Agreements, without giving any definition, leaving it to the 

practice of the Fund to evolve suitable criteria. Whatever the precise 

9

 See Mill, Principles (Ashley ed.), p. 665, and Viner, loc. ciL, pp. 261-64, for other references. 

10

 See Viner, ibid. 

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meaning and criteria of a "disequilibrium/' there can hardly be a doubt 

that by a "fundamental" disequilibrium must be meant a serious and 

lasting one. How serious it must be and how long it must last in order to 

be regarded as "fundamental'' cannot and need not be decided here. 

The answer will largely have to depend, as Professor Nurkse has pointed 

out, on the magnitude of the international reserves at the disposal of the 

country concerned (including its credit line w

T

ith the Fund).11 Whatever 

the precise answer in each particular case there can be no doubt, furthermore, that any serious depression can and is likely to create fundamental 

disequilibria which outlast the depression and do not automatically 

reverse themselves as soon as the depression is over. Depressions always 

cause or reveal structural changes; some eminent students of the business 

cycle would even say that depressions are the vehicles for the assimilation 

of structural changes into the economic system. We need not go so far to 

realize that the initial impact as well as the permanent incidence of the 

changes revealed or brought about by depressions is not likely to be the 

same in different countries. Moreover, reactions of different countries to 

depressive forces cannot be assumed to be the same. Some countries may 

yield to deflationary forces and let their prices drop while others may 

institute vigorous anti-depression policies and maintain their price and 

cost levels with varying success and in various degrees. These divergences 

in the impacts of depressions and in the reactions of different countries 

result in lasting maladjustments. 

All this makes it impossible to follow Dr. Triffin when he says (page 

64 and elsewhere) that disequilibria resulting from "cyclical fluctuations 

in the major world markets" are "of a temporary character." We cannot 

identify all depression-born maladjustments with temporary, "reversible," "nonfundamental" disequilibria. It is not generally or even as a 

rule true that cyclical maladjustments are not fundamental; they cannot 

as a rule be expected to reverse themselves completely or suflEiciently and 

it would thus be quite unsafe to assume that they never require correction 

by adjustment in relative price and cost levels (by means of either currency depreciation or internal expansion and contraction). 

HOW TO DEAL WITH BALANCE OF PAYMENTS MALADJUSTMENTS 

IN DEPRESSIONS 

What policies should thus be recommended for balance of payments 

troubles in depressions? Everybody will agree with Dr. Triffin's emphasis 

11

 See Ragnar Nurkse, Conditions of International Monetary Equilibrium (Princeton, 

1945). This is the most thorough and convincing discussion of the subject I have seen. 

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on the responsibility of the largest and most industrialized countries to 

maintain their economies at high levels of employment and production. 

Sharp reductions in output and employment, like the one which occurred 

in the United States in 1937-38 (which fortunately did not last very long), 

would be extremely disturbing for the rest of the world. But Dr. Trifl&n is 

certainly realistic when he says that, in spite of all good intentions, 

depressions and balance of payments disequilibria "will continue to occur 

and to threaten domestic stability, especially in countries with undiversified economies." What should those countries do when they are confronted with a fall in their exports due to a depression abroad? 

In general, he says, an effort should be made everywhere to offset the 

drop in exports to the largest possible extent by domestic compensatory 

policies. Such policies, if generally pursued, will "help to moderate both 

national and international depressions and to preserve fundamental 

international balance." 

But such a policy requires large international reserves. There the International Monetary Fund will be of great help. It provides in itself an 

augmentation of international reserves through various devices and it can 

induce deficit countries to make full use of their own reserves outside the 

Fund. Dr. Triffin is certainly right in saying that the main danger is that 

the Fund's credit may be abused by many countries, that the borrowing 

may assume a continuous character and indebtedness to the Fund may 

pile up rapidly until the countries' quotas are exhausted. But to speak, 

as Dr. Triffin does, of such an abuse only if the Fund's credit is used "for 

the financing of fundamental, as opposed to cyclical or fortuitous, disequilibria in a country's international account" is too narrow, if "cyclical 

disequilibrium" includes any disequilibrium caused by depression abroad. 

Dr. Triffin clearly realizes that with its present resources the Fund 

could hardly hope to finance all deficits which would arise even in the 

course of a mild cyclical depression without taking "remedial actions." 

In other words, if the Fund treated every cyclical deficit as a temporary 

affair, it would in all likelihood run out of important currencies (i.e., 

they would become "scarce") and many of the deficit countries would 

exhaust their quotas before the storm had passed—if it would pass at 

all, one should perhaps add, without remedial actions. 

What should those "remedial actions" be? Dr. Triffin's remedy is 

exchange control of a certain kind, but he rejects currency depreciation 

(as well as the analytically closely related gold standard technique of 

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internal adjustments of costs and prices by means of monetary expansion 

and contraction). 

"EXCHANGE CONTROL" 

Dr. Triffin proposes a kind of nondiscriminatory exchange control 

which it would be better not to describe as exchange control at all but 

as partial and, so he hopes, temporary currency depreciation. There 

would be an official exchange rate and a free, auction price of foreign 

currencies; the former would be stable, the latter would fluctuate according to fluctuations in demand and supply. The low official rate would 

apply to "easily controllable exports'' (which the author thinks would be 

the overwhelmingly larger part of all exports), to certain categories of 

"necessary or essential" imports, and to approved capital exports; the 

higher auction rate would apply to other imports, to uncontrollable 

exports and other exchange proceeds of "unimportant or practically 

uncontrollable transactions." (Dr. Triffin also thinks that capital exports 

beyond those which can be admitted to the official market can be channelled, apparently without special permission, through the auction 

market without any harmful repercussions. "The higher rates prevailing 

in the free market in times of crises would tend to discourage capital 

exports and encourage capital imports." I should like to say, in passing, 

that this seems to me much too optimistic. It assumes a degree of confidence on the part of the prospective capital exporters in the success and 

the self-liquidating character of the whole scheme which is hardly warranted, as the following analysis will show.) 

This is certainly a most ingenious scheme that is well worthy of trial on 

a large scale when need arises.12 It is undoubtedly far superior to anything 

that goes nowadays under the label "exchange control"; therefore Dr. 

Triffin would be well advised not to call it so. But it has certain weaknesses 

and I think Dr. Triffin shows too much enthusiasm and optimism—a 

likeable and understandable trait of every successful inventor—when he 

expects that in most cases his system will be self-liquidating, the higher 

auction rate falling back to the lower official rate when the storm has 

blown itself out. I think the opposite or some intermediate outcome is 

more likely, namely, that the official rate will have to be raised to the 

12

 A similar scheme has apparently been operated in Argentina. Its inventor there was the 

former General Manager of the Central Bank of Argentina, Paul Prebisch. On a smaller 

scale it has been in successful operation since the middle of 1945 in Paraguay, but not yet 

during a severe world-wide depression. 

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auction rate or the two be allowed to meet in the middle. If that is correct, 

the system would prove to be not a partial and temporary depreciation, 

but a first step towards a general and permanent depreciation. 

The plan has the following weaknesses: (1) The administrative difficulties should not be underestimated, even though they are certainly smaller 

than in the case of ordinary exchange control and quota systems. Exporters will have a strong incentive to sell their export proceeds in the 

black market at the auction price or somewhat below. In the case of 

undiversified countries with a few staple commodities as exports this consideration may not be very important, but for practically all European 

countries it is a very serious matter. 

(2) It is an illusion to assume that the system can be operated in an 

entirely automatic fashion in the sense that lists of "necessary" and 

"urgent" imports can be drawn up according to objective criteria before 

any emergency arises, and that then in case of need those prearranged 

plans are simply put into operation without any further arbitrary decision. 

In reality, it will be necessary to extend, restrict, and otherwise modify 

the list of essential imports according to changing circumstances, and 

according to the severity and length of the crisis. A study of the Monetary 

Law of Guatemala,13 which embodies Dr. Triffin's ideas, shows that there 

is danger that in practice the degree of automatism of such a system will 

prove smaller than the theoretical outline as presented in Dr. Triffin's 

contribution to the present pamphlet suggests. For example, Article 57 

empowers the Monetary Board "to amplify and to restrict the list of such 

merchandise [i.e., "essential imports" to which the official exchange rate 

applies] in accordance with the situation in the exchange market." 

Moreover, the creation of more than two categories of commodities and 

more than two rates (official and auction) is provided for. The Monetary 

Board can create any number of groups of imports, "according to the 

degree of essentiality and urgency of the operations and may distribute the offers of exchange among these groups, with the object of assuring an adequate distribution of available exchange in accordance 

with the real needs of the economy." For each group there will be a 

separate (auction?) rate with the proviso that "the distribution [of the 

available foreign exchange among the different groups] must be made in 

such a way as to avoid having the rates corresponding to more essential 

and more urgent operations exceed those applicable to less essential or 

18

 For a translation of the text, see Federal Reserve Bulletin, March 1946, pp. 257-88. 

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less urgent operations" (Article 66). This is a far cry indeed from the 

simplicity of the theoretical scheme and begins to resemble a full-fledged 

exchange control system of the Schachtian type. Moreover there is real 

danger that when an actual test comes and the restrictive measures 

contemplated in the Guatemalan law are put into practice, we shall, 

under the influence of pressures and temptations from interested parties, 

experience further deviation from the theoretical ideal. Something like 

that seems to have happened in Argentina. 

The International Monetary Fund, if it decides to permit experiments 

with the system under consideration—which it would be well advised to 

do in my opinion—will have to exercise much vigilance to preserve in 

practice the simplicity of the system and its semi-automatic character 

which make it so attractive in theory and to prevent it from degenerating 

into the ordinary complicated and arbitrary kind of exchange control. 

(3) The Government or the Central Bank would make a handsome 

profit by selling part of its foreign funds at the auction price while paying 

only the official rate. So "vested fiscal interests" in the system would be 

created. This may be less serious than the creation of vested interests of 

private importers which grow up under ordinary exchange control and 

quota systems. But the history of monetary policy is full of cases where 

fiscal considerations have led to the indefinite postponement of desirable 

reforms. Moreover, would it not be tempting to use the exchange profits 

of the Government to subsidize exports? This brings us to the next 

weakness of the system. 

(4) Under Dr. Triffin's plan, exports would not be stimulated as under 

a depreciation. If there is a depression in the big industrial countries and 

the price level there falls, or even if prices there do not fall, but income 

contracts and the demand of those countries for imports falls—would it 

be advisable for the raw material and food producing countries to make 

no price concessions at all by leaving the value of their currency, as far 

as exports are concerned, unchanged? Would they not run the danger of 

losing part of their market permanently by stimulating competitive 

production in the industrial countries themselves and in third countries?14 

(5) Prices of privileged, "essential" imports would be kept low or 

would fall (because foreign export prices fall in a depression) and com14

 Gold standard theorists would answer that export prices and costs in the raw material 

and food producing countries, in terms of local currency, will, or should be made to, fall; 

this would provide all the stimulation needed even if the exchange rate is kept unchanged. 

This may very well happen, but it would substitute deflation for depreciation, and deflation 

is universally rejected nowadays. 

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peting home industries would be penalized. On the other hand, prices of 

nonprivileged imports—which may not all be in the luxury class, for if 

the deficit is large it will be necessary to shift more and more commodities 

from the privileged to the nonprivileged class—will be kept high and the 

production of domestic luxuries will be stimulated and thus vested interests will be created. 

All this, it seems to me, adds up to a strong case for using the proposed 

plan only for a very limited period of time, say, for a year or two at the 

most. If the situation does not correct itself within a year or two, and 

the scheme has to be kept in force longer, it should be taken as an indication that the official rate has to be adjusted, that is to say, that a general 

depreciation is necessary. It will be an important task of the International 

Monetary Fund to elaborate proper safeguards. This may take the form 

of periodic reviews of the situation, of special permission being required 

for changes in the list of essential and nonessential commodities and 

similar provisions. 

Another conclusion to be drawn from this criticism is that currency 

depreciation should not be ruled out categorically in a depression. 

Of course, a wave of competitive depreciation, as in the early thirties 

when one country after the other depreciated and each tried to undercut the other, must be avoided. Begger-my-neighbor depreciations, 

i.e., depreciations not justified by a serious balance of payments 

deficit, must not be permitted. Only deficit countries should be 

allowed to depreciate, and they should be allowed to do so only after 

they have made substantial use of their international reserves, including their quota in the Fund, and possibly after they have tried 

out Dr. Triffin's "partial depreciation" or, as he calls it, "exchange 

control'' scheme. 

Dr. Triffin's specific arguments against the use of depreciation in 

the case of "world-wide cyclical disequilibria" apply only to such 

abuses and are not convincing when directed against selective depreciation by deficit countries only. Only of competitive depreciation by deficit and surplus countries alike can it be said that it would 

"spread throughout the world any cyclical disturbance arising in a 

major economic area" (page 80). The case of a selective depreciation 

is different. In that case the "major economic areas" in which a 

"cyclical disturbance" (depression) has arisen are the surplus countries. 

If now the deficit countries (after the above-mentioned initial stages) 

are allowed to depreciate, there can be no question of propagating the 

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depression from the major areas to the depreciating countries. Such 

a selective depreciation is a protective measure of the deficit countries. 

Dr. Triffin says that efforts to correct deficits by depreciation (or 

deflation) are thwarted because such action by any one country aggravates difficulties in supply and export markets, as well as in competing countries, and leads to similar, and mutually self-defeating, 

measures of defense (page 79). But does this argument not spring 

from excessive pessimism and defeatism? Just consider what this 

argument amounts to: There are countries which have developed a 

serious deficit, they have exhausted their reserves including their 

quota with the Fund, they have perhaps taken Dr. Triffin's "exchange 

control'' medicine; when their trade deficit persists and they receive 

permission from the Fund to depreciate their currency, is it reasonable 

to assume that the Fund will not be able to restrain the surplus countries from using "self-defeating measures of defense7

'? Defense 

against what? Not against an unprovoked incursion of their markets, 

but defense of a balance of payments surplus created by depression, 

i.e., defense of the illicit fruits of an outlawed beggar-my-neighbor 

policy! Must we really assume that "devaluation will spread from 

country to country"? If it were true that the Fund cannot be expected to be able to prevent competitive devaluations by deficit and 

surplus countries alike, it would seem to me that we might just as well 

give up altogether any hope and any attempt at international regulation of these matters! 

We may, however, mention two arguments against the use of depreciation which Dr. Triffin does not emphasize (quite rightly in my 

opinion), although one of them lurks in the background of his analysis 

and is occasionally alluded to by him. The first is that expected depreciation and its frequent use will lead to disturbing speculative 

capital movements and other speculative anticipations. This argument should not be taken too lightly, but it is mainly directed against 

frequent use of the depreciation weapon, which is not here advocated. 

(The question arises, however, whether fluctuations of the auction rate 

in Dr. Triffin's exchange control scheme would not lead to disturbing 

speculative capital and commodity movements. It seems to me that 

this danger cannot be lightly dismissed, especially because the selfliquidating and temporary character of the scheme is likely often to 

prove illusory in practice.) 

The second argument against depreciation is more complicated. 

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It is based on the now fashionable assumption that the elasticities of 

international demand are often such that a depreciation cannot always be expected to improve the balance of payments. I do not think 

that this is a realistic theory, barring perhaps short-run considerations 

of a few exceptional cases, but it would take too much space to argue 

the matter at this point. Dr. Triffin alludes to it, but does not make it 

a corner stone of his case. 

FUNDAMENTAL DISEQUILIBRIUM 

Dr. Triffin adds some very interesting points to the much discussed 

question of the criteria of a fundamental disequilibrium, the existence 

of which entitles a country under the Bretton Woods Agreement to 

receive permission for depreciation of its currency. 

Dr. Triffin stresses, quite rightly in my opinion, that "a deficit in a 

country's balance of payments is not necessarily" evidence of a fundamental disequilibrium justifying currency depreciation (page 75). But 

he is reluctant to accept the rule that a serious and persistent deficit 

(whether brought about by deflation and depression abroad or by inflationary policies at home or possibly by a sharp shift in international 

demand) should be so regarded, although there are passages which seem 

to suggest that this rule is implicitly applied. For example: It is convincingly argued that the probability of the existence of "a durable 

disequilibrium'' should be judged in the light not only of the actual 

balance of payments but also with due consideration of monetary and 

banking statistics, price and production data, etc. Suppose the conclusion is reached in a particular case that no fundamental disequilibrium 

exists and that hence the country in question be allowed to pursue, 

for a time, compensatory policies with the aid of the Fund. "This interpretation would be confirmed by events if the deficit did in fact disappear," but it would have to be regarded as disproved by the facts "if 

the deficit continued" (page 76). This suggests that a persistent deficit 

(the assumption of which always implies, it should be observed, a forecast 

of future events) is, in fact, accepted as the criterion of a fundamental 

disequilibrium. 

But then Dr. Triffin cites the famous Belgian case of 1934 in which 

a fundamental disequilibrium is said to have existed without a visible 

deficit. The facts of the case are not quite easy to ascertain, because 

accurate figures of short-term capital movements are not available. 

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Moreover, protectionist measures must have contributed (to an unknown extent) to avoidance of a deficit which otherwise would have 

appeared. But it is clear that there was no visible deficit, that is to 

say, that there were no gold losses, although there may have been an 

invisible deficit compensated by an influx of short-term capital. 

Dr. Trifnn then argues against a proposal of mine to the effect that 

a country which suffers from a depression and thinks that it is entitled under the "fundamental disequilibrium clause" of the Articles 

of Agreement to a depreciation should at first attempt to protect itself 

through compensatory domestic policies and should be allowed to depreciate only after a deficit in its balance of payments has actually 

appeared. Dr. Triffin has two arguments against this proposal. 

The first is that this policy would lead to unnecessary disruptions, 

"since labor and other economic factors would have to be uprooted 

and temporarily transferred to other activities/' 

But does that really follow? In an industrial country with highly 

diversified exports, it would always be possible to choose compensatory policies that operate partly on the depressed export industries 

themselves, and partly on domestic industries which are depressed 

because of the depression in the export industries. In the Belgian 

case that would certainly have been possible and it would not have 

been necessary to "uproot'' anybody or to transfer labor temporarily 

into other industries. A deficit in the balance of payments would have 

appeared almost immediately after an offsetting domestic policy was 

started and depreciation could then have been permitted according to 

the proposed rule. (Since that could have been foreseen so easily in 

the Belgian case, I personally would not have hesitated to give the 

permission to depreciate in advance!) Furthermore, it should be 

observed that the Belgian difficulties were caused by a world-wide 

cyclical depression and should therefore, according to Dr. Triffin's 

own rules, have been offset "to the largest possible extent by domestic 

compensatory policies" (page 64), even if there had been a current 

drain of the country's international reserves! The fact that there was 

no visible deficit in the balance of payments would have made, one 

should think, compensatory policies all the more easy and appropriate ! 

Dr. Triffin's second point, that in primary producing countries 

the effectiveness of compensatory domestic action may be very 

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limited, is well taken. I have called attention to these limitations 

myself.15 But that even primary producing countries are not entirely helpless is shown by the "remarkable success/' to use Dr. 

Triffin's own words (page 60), with which the Central Bank of Argentina offset external drains through policies of domestic expansion. 

However, Argentina is in a more favorable position in that respect 

than any other Latin American country. 

A TENTATIVE REFORMULATION 

I shall now try briefly to reformulate some implications of defining 

"fundamental disequilibrium" in terms of balance of payments deficits and discuss a few apparent and genuine exceptions to this rule. 

What is said in the following pages seems to me in substantial agreement with Dr. Triffin's tentative definition of fundamental disequilibrium as a "maladjustment in a country's economy so grave and 

persistent that the restoration or maintenance of satisfactory levels of 

domestic activity, employment, and incomes would prove incompatible with equilibrium in the balance of payments, if not accompanied by extraordinary measures of external defense, such as a change 

in the exchange rates, increased tariff or exchange control protection, 

etc." (page 77). 

This seems to me a most ingenious formulation which contains, in 

a nutshell, all important elements of the problem. The fact that the 

following pages were written before I saw Dr. Triffin's definition is a 

welcome indication that economists' thoughts on these matters are 

veering in the same direction.16 

We speak of a fundamental disequilibrium, if there is a serious and 

persistent deficit in the balance of payments.17 It has been already 

15

 "Some Factors Affecting the Future of International Trade," in Economic Reconstruction, edited by S. E. Harris (1945), p. 330. 

16

 The definition was inserted in a later version of his paper and the references to it were 

subsequently added to my comments. 

17

 Note that an actual or potential deficit in the balance of payments is one of the essential 

characteristics of fundamental disequilibrium also in Dr. Trifiin's definition. It is true that 

in Dr. Trifiin's formulation the "gravity and persistency" of the maladjustment is not defined by the size and persistency of the deficit in the balance of payments. But I do not think 

that this constitutes a serious difference between his views and mine. For suppose he defines 

the "gravity and persistency" in terms of the volume of unemployment or the loss in national 

income. That would necessitate vigorous anti-depression measures which would involve a 

large balance of payments deficit. In any case, the actual and prospective balance of payments deficit in conjunction with the size of the international reserve constitutes the limiting 

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indicated that the question of how large and persistent a deficit must 

be in order to be called fundamental should be answered mainly with 

reference to the magnitude of the international reserve at the disposal 

of a country. It should be clearly realized that the judgment to the 

effect that there exists a fundamental disequilibrium always implies 

a forecast of future events. The fact that a deficit has existed in the 

past or that it is visible at present, without expectation that it may 

continue in the future, should not be regarded as a sufficient reason to 

depreciate the currency. 

From the fact that forecasts of future events are always implied, it 

follows that other data than actual balance of payments statistics have 

to be used in order to ascertain whether there is a fundamental disequilibrium, i.e., whether a serious deficit is to be expected in the 

future. It is only natural that price and cost comparisons between 

different countries will figure prominently, although not exclusively, 

in such a study. This is, however, not the same thing as the adoption 

of a purchasing power parity or a cost parity criterion of the equilibrium exchange. A rigid theory of exchange parity whether in terms 

of wholesale prices, cost of living, production costs, or wages would 

necessarily break down whenever there is a substantial shift in international demand, which may be brought about by a variety of 

factors such as changes in tariffs, other impediments to trade, transportation costs, technological changes, changes in consumer demand 

and last, but not least, the business cycle. Only in conjunction with a 

judgment about these things can price and cost comparisons serve as 

a guide. 

Now a few words about possible exceptions to the rule that a serious 

and persistent deficit should be regarded as the criterion of fundamental disequilibrium. Such a deficit can be prevented from arising 

or be eliminated once it has arisen by a contraction in income and 

employment (depression) or by the imposition of new import restrictions such as tariffs, quotas, exchange control, etc. These are the 

things we wish to avoid. Therefore, a deficit which is being avoided 

or eliminated by ad hoc changes in import restrictions or by a drop in 

factor upon anti-depression policies. It goes without saying that different countries having 

different marginal propensities to import will lose international reserves at different rates 

for a given increase in income and employment. This factor has to be kept in mind in estimating the prospective deficit. 

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real income and employment should be regarded as actually existent.18 

This rule must, however, be interpreted with great care. On the one 

hand, it should not be taken to mean that the mere existence even of 

a severe depression and of mass unemployment entitles a country to 

receive permission to depreciate, even if it could be expected with 

confidence that such a depreciation would alleviate the depression. 

For such an alleviation must not be achieved at the expense of somebody else; it must not be achieved by creating a balance of payments 

surplus which is a deficit of somebody else. Only if the managers of 

the Fund are confident that a depreciation will benefit the depreciating country without creating a serious and persistent surplus, 

should they give permission for depreciation. Now, if a deficit does 

not exist when a depreciation is contemplated, the presumption is that 

a surplus will appear after the currency has been depreciated; for it 

is only in exceptional cases that there will not be a least a considerable 

time lag between the rise in exports and imports. The Belgian case 

cited above is said to have been such an exceptional case. Granted 

that it was, it would not have been easy to diagnose it as such in 

advance. For that reason, I suggested the rule that countries should 

at first try domestic compensatory policies and ask for depreciation 

only after a deficit has in fact arisen. (That in highly specialized 

economies there may be little scope for compensatory domestic policies 

has already been stated at an earlier point.) On the other hand if, 

in the absence of a balance of payments deficit, depreciation is requested on the ground that the appearance of a deficit is prevented by 

undesirable artificial restrictions on imports, the permission to depreciate should obviously be conditioned upon the prior or simultaneous removal of those restrictions on imports. 

Real exceptions to the rule that depreciations should not be allowed, if they are expected to result in an export surplus of the depreciating country may, of course, be granted in exceptional cases: 

small countries which are in a specially difficult situation may be 

allowed to stimulate their economies by developing an export surplus, 

even if it is done at the expense of somebody else. But it should be 

clearly realized that such a policy, if pursued too often or by too many 

18

 This rule has been suggested by Nurkse, loc. cit. This rule again is contained in Dr» 

Triffin's definition, for he speaks of maintenance of satisfactory levels of activity being incompatible with equilibrium in the balance of payments if not accompanied by protectionist 

measures. 

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countries, is not only disturbing internationally and, if others retaliate, 

self-defeating, but it is also open to objections from a purely national 

point of view even when no retaliation is to be feared: for suppose a 

country succeeds in stimulating its economy by creating an export 

surplus (through the working of the so-called foreign trade multiplier); 

it must not be forgotten that, by exporting more than it imports, it 

gives away more goods to foreign countries than it receives from them. 

A domestic policy which increases output and employment without 

creating an export surplus would be clearly preferable even from a 

purely national point of view, unless for some special reasons (for 

example in an undiversified economy) such domestic anti-depression 

policies cannot be undertaken in an efficient manner or the accumulation of gold or foreign assets (the offset to the export surplus) is 

desired in itself. 

There are also cases where the creation of an export surplus in one 

country, with a view to alleviating a depression there, will not only be 

condoned but even welcomed in the import-surplus countries; namely, 

if the import countries are under inflationary pressure. In these 

cases, depreciation will tend to alleviate at the same time deflation in 

one country and inflation in the others. 

One more factor, which affects and complicates all cases discussed 

so far, should be mentioned. Until now we have assumed that a 

depreciation always tends to eliminate a deficit or create a surplus in 

the balance of payments of the depreciating country. This need not 

be true, however, in all cases. I would argue that in the long run 

exceptions are very rare. But in the short run they may not be infrequent. 

Although this brief outline does not, and is not intended to, do full 

justice to the complexity of the problem, it is surely not simplicity in 

itself. Moreover, a set of rules, even if it sounds convincing, should 

not be allowed to obscure the fact that at every stage of its application, 

beginning with the simple question as to the mere existence of a deficit 

whether persistent or not, difficult problems of judgment are involved. 

As Professor Howard S. Ellis once wisely remarked: "To define the 

equilibrium rate formally is one thing; to determine its height or 

probable behavior in a given situation, another. Precisely the latter 

and infinitely more complicated task must be performed by the monetary authorities who have to determine the extent of devaluation.'' 

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