Confidence Game: Fritz Machlup, Robert Triffin and Plans to Reform the World Monetary System

Nearly a half-century before the financial crisis of 2008, there was another time when reforming the world monetary system was on everyone’s lips and many academics and policy makers were developing and attempting to promote plans for its reconstruction before illiquidity, speculation and loss of confidence brought the system to a predicted ruin. Not since the Great Depression was the fear of a total financial meltdown so real. This paper examines two competing proposals for reforming the system and the two economists, Robert Triffin and Fritz Machlup, who led the charge, one for central reserves and a common currency, the other for flexible exchange rates. We know in the end that flexible exchange rates prevailed, that the underlying system was not “reformed.” We know also that Triffin believed that the outcome was the result of Fritz Machlup’s influence, through the Bellagio and Burgenstock conferences he convened, on influential policy markers and academics who had strong policy-making ties. As Triffin wrote in Gold and the Dollar Crisis, “They may have received unintended encouragement from the greater stress placed by most of my academic friends (first and foremost Professor Fritz Machlup) on the need to demonetize gold rather than on the need to control the flood of dollars into the world reserve pool. Most of the academic enthusiasm, however, was centered on floating exchange rates…." (Triffin, 1968 p. 8). How the arguments evolved, how their advocates defended the impact of their proposals on monetary reform, how they built consensus around these proposals, and ultimately how the final choice of exchange regime impacted deficits and confidence are the questions addressed in this paper. The paper also sheds light on the public policy influence of academic economists in the period following WWII and through the 1980s. Drawing on the personal papers of Fritz Machlup, housed in the Hoover Institution, the case is made that Machlup and Triffin were close friends who did not underestimate each other’s influence on government and world organizations, but sought through extensive correspondence, conference presentations and publications to convince the other that his proposal was all that was necessary to restore balance and confidence. This paper begins with a review of the literature on confidence and framing (Section 2), then turns to the critical balance of payments problems facing the world after WWII and to a broad discussion of alternative policy options and their advocates (Section 3). The Triffin and Machlup arguments are made in Sections 4 and 5. Section 6 discusses Fritz Machlup’s leadership role in the Bellagio Group conferences to build consensus around confidence as the root cause of financial instability and the confrontation of ideas in the conferences as well as in the journals of the days. Section 7 returns to the question posed in the introduction and draws conclusions. The paper takes an historico-biographical approach, predominantly drawing on the published papers of Robert Triffin and Fritz Machlup, but drawing limitedly on the personal papers of Fritz Machlup, housed in the Hoover Institution, and the Robert Triffin Papers at Yale University. [*Note: This paper is part of a book in progress on Fritz Machlup and the Bellagio Grpup: Plans for Reforming the World Monetary System. The curent version includes a number of changes and includes a bibliography.]