W A Wijewardena: John Exter - central banker for all times
Article by Mr W A Wijewardena, Deputy Governor, Central Bank of Sri Lanka, on the first anniversary
of the death of Mr John Exter (Founder Governor of the Central Bank of Ceylon/Sri Lanka), issued to
Sri Lankan newspapers, 28 February 2007.
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The first death anniversary of John Exter, Founder Governor of the Central Bank, falls on 28th of
February. He died in 2006 after living a very productive life for 95 long years.
John Exter can be regarded as one of the history makers in modern Sri Lanka. He lent his wisdom,
intellect and experience, without any reservation, for the establishment of the Central Bank of Ceylon,
the name of the Bank at that time. The Bank was established in 1950 on the basis of the
recommendations made by him as a one man committee, the report of which is now known as the
Exter Report. He made history once again by becoming the governor of that maiden bank at the
young age of 39, an age normally considered as too low for that prestigious and demanding position.
His task was to establish the bank, staff it and lead it in the first few formative years, so that it could
eventually be taken over by a Sri Lankan management. His history making did not end there. As
undertaken by him at the time of appointment, exactly after three years, he relinquished his
responsibilities as governor to pave way for a Sri Lankan to occupy that high post.
The Central Bank is, forever, deeply indebted to John Exter. The rationale and philosophy of the
central bank which he evinced in his report in the late 1940s are equally valid for today as well. His
report is unique in that sense, because it carries a justification of each and every section of the
Monetary Law, so that the later generations of central bankers would not have any ambiguity of what
was meant by them. As a result, even today, the Exter Report is used by both central bankers and
academics as their bible. Hence, by any standard, Exter is a central banker for all times.
The appointment of John Exter to a one man committee on the establishment of a central bank is also
marked by an interesting legend. Edmund Eramudugolla, a former Senior Deputy Governor of the
Central Bank, has narrated this legend in his Reminiscences of the Central Bank of Sri Lanka.
According to him, the government of newly independent Ceylon decided to replace the Currency
Board System which it had inherited from the British with a more flexible central bank. Accordingly, the
government decided to seek foreign assistance to prepare a blueprint for a central bank based on the
country's specific position and future prospects. However, for reasons not very clear, this assistance
was sought from USA and not from the UK, the traditional advisor of the country. Thus, the Federal
Reserve Bank of New York was approached by the then Minister of Finance, J. R. Jayawardene, to
obtain the services of a suitable consultant. The Bank, in turn, informed the government that it could
not release its best consultant, namely, David L Gosse, for this purpose, because he had been
occupied in some other assignment at that time. Gosse was considered the ideal expert for the job,
because he already possessed the required experience for the job at hand by pioneering the work
relating to the establishment of the Central Bank of the Philippines. However, Gosse was kind enough
to recommend his assistant, John Exter, for the job. Hence, Exter was not the first choice, but an
engagement done by default. Yet, the wisdom, erudition and professionalism shown by Exter in both
making the recommendations and subsequent running of the Bank, is a testimony that he was the
correct choice for the job at hand.
John Exter had an illustrious academic as well as professional career. After graduating from the
College of Wooster, he completed post graduate work at both the Fletcher School of Law and
Diplomacy and Harvard University. After a brief stint at MIT during World War II, he joined the Federal
Reserve System as an economist. Then, in 1948, he was on release to serve the Government of the
Philippines as advisor to its Secretary of Finance. It is from there that he came to Ceylon as the
consultant on the establishment of a central bank, still on release from the Federal Reserve System.
After serving his term as Governor of the Central Bank, Exter did not return to the Federal Reserve
System. Instead, in 1953, he joined the World Bank and was offered the position of the division chief
for the Middle East. After a year with the World Bank, he came back to the Federal Reserve System
as its Vice President on international operations at the Federal Reserve Bank of New York. His career
at the Federal Reserve System ended in 1959 when he decided to join the First National City Bank
which later became the Citibank. From 1960 to 1972, he was the Senior Vice President of the Citibank
in charge of its relations with foreign central banks and governments. With a huge fortune made on the
gold market by using his own expertise on the foresight of irresponsible central banking and its
inevitable consequences, Exter took an early retirement in 1972 and went into private consultancy
work.
According to his own admission, the prospect for his fortune on gold dawned on him after a friendly
debate he had in 1962 with his one time Harvard buddy and Nobel Laureate Paul Samuelson. In that
debate on why the dollar was becoming weak and USA was losing gold, Exter gave his diagnosis
which was based on his experience with the Federal Reserve System. "Paul, it is very simple. The
Fed is printing too many dollars and they flow out of the country into foreign central banks
who demand gold" Exter is reported to have said. But, Paul Samuelson did not accept it and wanted
to explain the malady in terms of productivity differences between USA and other countries, namely,
Europe and Japan. Samuelson's thesis was that the latter category of countries had a higher
productivity than USA and therefore the dollar was becoming weaker. Exter says that he countered
Samuelson saying that Japan was in more trouble than USA, because "the Bank of Japan was
running its printing press even faster than the rest of the central banks around the world" Exter
had decided then and there that the irresponsible government expenditure by the Kennedy
administration could not keep the dollar stable in the long run and one day, gold would become the
preferred asset by the world's nations. Hence, he says that he converted all his savings into gold
based assets and waited patiently. He was amply compensated in 1971 when the US government was
forced to sever dollar's link with gold under the gold exchange standard and allow the gold prices to be
determined in the free market. Overnight, gold prices doubled from $35 per ounce to $70 per ounce.
So did the gold based assets portfolio held by Exter.
This wisdom which Exter demonstrated in his practical life could be discerned throughout the Exter
Report and his later writings. He belonged to the old guard of economists who believed that economic
prosperity cannot be attained by printing money. This was indeed going against the popular tides of
the late 1930s and 1940s. At that time, Keynesianism had been accepted by the mainstream
economists on both sides of the Atlantic as a new religion. It explicitly advocated the desirability of
deficit financing as a strategy for attaining full employment. Exter doubted the validity of this claim both
in his public speeches and writings. At one stage, even Paul Samuelson had teased him that 'though
Exter may be right, he was lonely in his opinion'. The fact that there were no supporters for his view
did not prevent Exter from making public what he believed to be true. On the very first day of the
establishment of the Central Bank of Ceylon, in a press interview he gave as the first Governor of the
Bank, he warned against the use of the Bank for things which it cannot fulfill.
"Today, we can only be filled with high hopes for the future. It would be a mistake to expect
startling results immediately from the establishment of the Central Bank. There is no financial
wizardry by which the Bank can suddenly pull out of a hat a higher standard of living for
everybody. The Bank's contribution must necessarily be a long-run contribution. The Bank
does not itself produce goods and services, but it should, by creating the right monetary
conditions enable the country..." to do so.
What Exter repeatedly maintained was that the Central Bank was only a necessary condition for future
prosperity. That necessary condition was to be created by maintaining price stability so that the
economic agents could make economic decisions based on long run prospects. Since the central bank
does not produce goods and services, it cannot directly get involved in economic activities. It is
therefore the task of the government and the private sector to take appropriate measures to create
wealth in the society. The Central Bank's only weapon is to print money and such money, by changing
the price levels, acts only as an illusion. Hence, Exter thought it necessary to warn those who had
been harboring the Keynesian type of ideology to raise governmental expenditure through printed
money.
In the Exter Report, he argued that higher income created through money creation would simply
stimulate consumption of imported goods and precipitate serious balance of payments difficulties.
Given the underlying domestic production capacity, deficit financing may be an efficacious policy in
developed countries that are largely dependent on foreign trade. But, it would not be the case with a
developing economy. Hence, the Exter Report highlighted that, "this should serve as a warning to
those who might hope that some of the policies growing out of Keynesian economics can be
uncritically adapted to Ceylon". As a safeguard, a provision was included in the Monetary Law
prohibiting the Central Bank to engage in trade or otherwise have a direct interest in any commercial,
industrial or other undertaking. In Exter's opinion, such interests would lead to money creation,
generate conflicts of interest and prevent making investment decisions based on hard-core economic
principles. As such, Central Bank's involvement in economic activities would be sub-optimal.
A central bank, by nature, is in a position to acquire assets by creating liabilities. These liabilities take
the form of new money issued by a central bank. Hence, any asset acquisition by a central bank is
done at the expense of its main objective, namely, price stability. As such, a central bank should not
pursue profit making as a goal. Technically, profit seeking has no meaning, because a central bank
could make any amount of profits by inflating the economy. Hence, profits may arise from the central
bank's activities as a side product, but they do not form the main business of a central bank. As a
result, a special procedure has to be adopted for the application of the profits of a central bank. Exter
knew this requirement very well. In the Exter Report, he has argued that the Central Bank's profits
deserved special attention because of the inflationary or deflationary effects which their payment or
non-payment could have on an economy. He has recognized that when such profits are paid out and
spent by the government, they would find their way into the reserves of commercial banks raising their
multiple credit creating capability. In order to minimize the ill effects of using a central bank's profits for
government expenditure, Exter has made special provisions in the Monetary Law regarding the
application of profits of the Central Bank. Accordingly, out of the surpluses of the Central Bank, the
first charges should be to build the reserves of the Bank to support the currency it issues. Any
remaining balance should be utilized to retire the government's borrowings from the Central Bank or
paid into the government as a normal profit transfer. However, it has to be done collaboratively by the
Minister of Finance and the Monetary Board, having taken into account the inflationary impact of each
such measure. As such, the government does not have the first claim on the profits of the Central
Bank, though it is owned by the government. The profit criteria that are applicable to other
governmental institutions are, therefore, not applicable to the Central Bank.
A general concern which has often been raised at numerous public fora has been the existence or the
absence of the independence of the Central Bank. Many have found fault with Exter for making the
Secretary to the Ministry of Finance a member of the Monetary Board. They have argued that this
official member with his own self interest in funding the government expenditure programs would use
the opportunity to dictate terms to the Monetary Board, thereby permitting the fiscal policy to override
monetary policy. It has been equated by some critics to the case of permitting a child to put his hand
into the cookie jar as many times as he wishes. While these criticisms may have some validity, Exter's
wisdom has been to create an environment for both the government and the Central Bank to have a
peaceful and amicable cohabitation. Exter has argued in his report that "...there are, however, many
important problems of monetary policy, especially those relating to fiscal policy, on which a
central bank should work in close harmony with the government". Accordingly, a degree of
independence has been afforded to the Central Bank unlike other governmental bodies. This
independence extends to the budget of the Central Bank, job security of the key central bank officials,
and power to make monetary policy without consulting the government. The wisdom of Exter was that
the central bank should as far as possible work in consultation with the government, rather than in
isolation. He believed that the true independence of the Central Bank could be preserved only through
that consultative method. In the words of Exter, "the ideal is ... one in which there will be
continuous and constructive co-operation between the Monetary Board and the government.
The principal instrument for achieving this co-operation should be the Permanent Secretary to
the Ministry of Finance whose membership on the Board will ensure at all times that his
Minister's views will be made known to the other members of the Board". However, Exter did not
expect this arrangement to be effective at all times. Hence, he made the proviso that "it would
depend on the men occupying the key positions" and not on any legal formula. He argued quite
correctly that such complex and delicate relationships cannot be established full-blown by a piece of
legislation. It must be the result of years of experience and the slow growth of political conventions.
The writer has been questioned on this point on many occasions at numerous public fora. The position
taken by him agrees fully with that of Exter. This position requires the critics to compare central bank's
independence with the relationship within a family unit. Both spouses have their personal interests, but
work together for the well-being of the family unit. There are at times occasions where one spouse
overrides the other. But, as a normal rule, the family unit moves forward without publicizing those
internal family debates and sometimes family fights.
This is the main lesson which Exter has left for us in the twenty first century. That is, both the
Governor of the Central Bank and the Secretary to the Ministry of Finance should know their rights and
responsibilities well and act on an ethical platform in which they continue to appreciate the distinctive
roles to be played by them for the well being of the country.
John Exter, in his wisdom, firmly believed that when laws fail, human beings working with moral
consciousness could do wonders.