A Layman's Guide to Monetary Crises

Since World War Two, the international monetary crisis has become a fixed feature of what people with a gift for cliché call the financial landscape. Through the Fifties and into the Sixties, crises happened in Britain roughly at two-year intervals. There were occasional unspectacular episodes involving the French franc and the Italian lira. In the past six years, the crises have been much more serious, and all have involved the dollar. The summer and autumn of 1971 and the autumn and winter of 1972-1973 produced spectacular episodes, the last blowing up without any seeming reason or warning. Both ended with devaluation of the dollar. Since then, the dollar has wavered and then got stronger. But more crises are ahead--perhaps next time for the pound again and maybe one day even for the yen.

A monetary crisis is, in all respects, a curious thing. It gets large and alarming headlines that are read by people who remain unperturbed. Things are not right in the world; there is mismanagement somewhere, but it is not a thing that will affect people personally. A monetary crisis is bad somewhere, but it does not have an identifiable effect on the life of anyone living in Des Moines, Lyons or London, Ontario. For most of us, it is an important nonhappening.

A further peculiarity is that neither its causes nor its consequences are much understood. Not only are the by-standers confused, which is understandable, but so also are many of the participants. When a crisis comes, the Secretary or Assistant Secretaries of the Treasury, the Minister or Deputy Ministers of Finance, the Chairman of the Federal Reserve and other central bankers fly to meetings in London or Paris or Washington. When they emerge from these meetings, they are described as grim or unsmiling. Reporters question them, and after some thought they say, "No comment." This is not surprising, for a fair number either do not know what is wrong or do not know that they do not know what is wrong. The reporters, all of whom will write alarming pieces on the development, are, needless to say, similarly ignorant.

The problem is that there is no such thing as a purely monetary crisis. What is so described is a manifestation--a symptom--of more deeply seated problems in the economic life of the afflicted countries. And, this being so, it follows that there is no monetary remedy for the disorder. Durable improvement is only possible in consequence of fundamental changes in economic policies of the countries concerned--changes that, because they involve unions, taxes, prices and budget priorities, are not only politically contentious but far beyond the competence of monetary experts to bring about. Being human, the experts do not wish to admit that they are helpless--that they manipulate levers to which no machinery is attached. So they persuade the public, and more urgently themselves, that they have a solution. A little time and international good will, a further deployment of monetary expertise and there will be a new workable world monetary system.

It is hard to believe that such great matters involve such fraud--that those involved are fooling themselves as well as the public. Money is important to almost everyone. Its possession is agreeable and undeniably a solvent for many personal problems. There is a natural mystery as to how anything intrinsically so worthless as a few pieces of paper can do so much for the man who owns them. We want such things understood and handled. So the temptation to believe that there is some priesthood that has penetrated the mystery of money and can, by incantation, resolve its problems is overpowering. And so is the temptation to be a priest. Yet even a moment's thought is sufficient to raise doubts about the omniscience of those involved. The search for a solution to the world's monetary problems, in its modern manifestation, has been proceeding with mounting energy for half a century, without results. This should suggest that the effort, like the pursuit of perpetual motion, could be a chimera.

There is also the instant process by which monetary experts are made. Thus, on February 8, 1971, Mr. John Connally of Texas became Secretary of the Treasury. An eminently successful politician and lawyer, especially in the pursuit of his own ends and those of his more affluent friends, Mr. Connally had never been previously accused of having knowledge, training, background, instinct, insight or other qualification where monetary problems were involved, his own personal assets apart. His accession to office coincided with the onset of a monetary crisis; overnight, he became a world expert. His peer had not been seen since the days of Hjalmar Schacht, John Maynard Keynes or Montagu Norman. In a blaze of publicity that omitted reference only to his personal contribution, he was held to be leading a brilliant search for a solution, and finding it. Then Mr. Connally left office. His standing as an expert dissolved the day he resigned. Soon afterward, so did the remedy that he had negotiated. If such is the nature of the great monetary expert, the layman will perhaps be persuaded that monetary expertise does not come to much. He will be right.

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The latter-day monetary crisis is the consequence of two irreconcilable but inescapable features of modern economic life, together with some subsidiary aggravating tendencies. The first feature is the compulsion of modern national states to manage their economic systems in their own way, in response to differing institutional development. Or, in the case of the United States, to make prayer, rhetoric, faith in the free market and predictions that are derived almost exclusively from hope a substitute for actual management. The second cause is the need, in a closely interconnected world where there must be a good deal of advance planning of economic activity, for some reasonably predictable relationship among currencies. Among the important contributing causes of trouble are the modern transnational industrial and banking enterprises that can shift funds across national lines with consummate ease and, increasingly, persuade the public that any adverse consequences are the shady work of international speculators and Arabian sheiks. Also heavily at fault are economists who have allowed their affection for gadgetry to obscure their judgment.

Divergence in national economic policies naturally causes divergence in the costs and prices of goods among different countries. It makes the costs and prices of tankers or television sets low in Japan, higher in Britain and maybe, as in the case of most ships, prohibitive in the United States. This divergence has profound competitive effects when costs and prices are converted from one currency to another--from yen or marks or pounds to dollars--at a fixed rate of exchange. So much is obvious, but a number of factors have combined to make the divergence in policy and in costs and prices particularly grave in recent times. Of these, the most important is the interaction of wages and prices in causing inflation.

Until sometime after World War Two the main influence inducing inflation was an unduly high level of private borrowing and investment or an undue excess of public expenditures over receipts. The remedies--higher interest rates, higher taxes, less public spending--were more or less equally available to all modern governments. And all or most governments had a tendency to apply the same final rule--to aim at a generally balanced budget unless unemployment or idle plant capacity minimized the danger of inflation and indicated instead the desirability of a deficit and the resulting expansion. In the past quarter century, however, major institutional changes--stronger unions, more competition among unions, a lessened incentive by the modern bureaucratic corporation to resist wage increases, a heightened ability and willingness to pass wage increases along to the public--have made wages in their direct effect on prices and prices in their effect on wages a primary cause of inflation.

The effect of a budget deficit was much the same in all countries. But the impact of wages on prices and the responding effect of prices on wages differ radically among countries, depending on the structure and traditions of the trade-union movement, the stage of development of the corporations and the sensitivity of the unions and corporations to international competitive effects--a sensitivity that is relatively high in Germany and Scandinavia but much lower in Britain and nonexistent in the United States. And, a most important point, as there is no very strong tendency toward convergence in wage-price behavior among the advanced industrial countries, so also is there none in the policy for dealing with it. Some governments, notably those of the United States and Britain, admit of the need for controls in practice but not in principle. Some, as in the case of France, are unbothered by the principle of controls but do little to enforce them. Some use informal restraints. Some have no controls. Where wage-price inflation is concerned, divergent national tendencies must be assumed.

There is also continuing and perhaps increasing divergence among modern states in the productivity of labor. This, too, affects costs. At some stage, with increased industrialization and affluence, it was always imagined that workers would reduce their efforts and substitute leisure or a lower level of diligence for pecuniary return. Numerous philosophers have won a modest reputation and income by warning that the time of increased leisure was near and explaining how it would be used. Such a slowdown evidently has been occurring and, as might be expected, it has come first in the older industrial countries, notably Britain and the United States. But when this enlightened embrace of leisure by the proletariat means not turning up for work on Monday or an occasional week at a time, praise for it is less universal or ecstatic than we were earlier led to expect.

A second factor affecting productivity is that different countries use their capital and technical resources in different ways. Since 1950, the United States has invested technical manpower and capital very heavily in armaments and in the space race, and we've exported them heavily for our Asian war. Germany and Japan, in part because of arms limitations imposed by the victorious powers after World War Two, have been forced to concentrate far more of their resources on their civilian industries, including their export industries. This has added powerfully to their competitive advantage. One wonders if it would not have been wise, in the negotiations seeking an end to the Vietnam war, for Henry Kissinger to have had Hanoi impose a similar restriction on us. I once suggested it, but the idea was not well received.

In the past ten years, all of the divergent factors--wage-price inflation, the predictable slowdown, the differing use of capital and technical resources--have been mostly unfavorable to the United States. Given fixed rates of conversion tying the mark, yen, pound and other currencies with the dollar, the result was inevitable. Where they were in competition, the cheaper overseas products progressively replaced the more expensive American products. This happened in the United States, in the markets of the competitive country and in third countries. The excess of sales over purchases--the favorable commercial balance long a feature of the American relationship with other countries-- dwindled and disappeared. Overseas military expenditures and capital exports continued. So unspent dollars accumulated in foreign hands.

No one could avoid selling to Americans or serving American tourists. And since the dollars could be exchanged at the bank, there was no incentive to avoid us as customers. But since we were not an economical place to buy, the dollars so exchanged and accumulated were not as readily spent. And as dollar holdings increased, so did the anxiety as to their status as an asset. Eventually, the anxiety led to a general effort to be rid of them; and others, sensing the inevitable effect of these fears, borrowed dollars to exchange. It is, indubitably, one of the basic laws of economics that before anyone can sell, there must be someone to buy, and if there is a major desire to be rid of something, there will be a matching repugnance about acquiring it. Thus the currency crisis. Prior to the devaluations of 1971 and 1973, so many wanted to be rid of dollars, so few wanted to buy them that their purchase at fixed rates had to be abandoned.

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In principle--a principle that has greatly captivated economists--currency crises can be avoided by not having fixed rates of exchange. If dollars or pounds are too plentiful and people desire to be rid of them, let them overcome the reluctance of buyers by taking a smaller number of marks, yen or Swiss francs. At some level, reluctance will be overcome. And at the new rate of exchange, since dollars or sterling exchange for less foreign currency, foreign products will be more expensive, domestic products cheaper. At this point, the underlying trade imbalance that produced the surplus of currency in foreign hands will be corrected. This solution, classical if not miraculous in its simplicity, has appealed as a flash of revelation to many economists. It is called the float. The name is used lovingly by the cognoscenti. It has, more than anything else, given rise to the notion that there is a purely monetary solution to monetary crises. Unfortunately, as a solution, it does not exist.

The shortcoming is simple but devastating: There is no way of conducting a vast number of business transactions without knowing, within fairly narrow limits, what you are going to have to pay or receive. There is an element of futurity in nearly every business transaction. This increases as economic life becomes more highly organized. The float makes the value of all future payments uncertain. A buyer can overcome uncertainty as to what he will have to pay by having the transaction in his own currency. But this only transfers the uncertainty to the seller, who does not know what he will receive. He can hedge--ensure against what marks will cost six months from now by buying them now for future (i.e., six months hence) delivery. But there is a charge for this, which, with uncertainty, has been increasing sharply. And it's a solution that is available to the sizable company only and only where the forward market is well developed. For the yen, for example, it has never been good.

The need for some degree of certainty is present in every kind of business transaction. The ordinary tourist planning a trip to Europe wants some reassurance that his dollars will pay for his hotels and meals. He can buy a package tour in dollars; that only transfers the risk to the company that organizes the tour. The company can make dollar arrangements with hotels abroad; that shifts the risk of currency fluctuation to them. As with these simple transactions, so with those who buy and sell automobiles, television sets, textiles, computers, art. To conduct international trade on a vast scale with large and unpredictable fluctuations in the rates of exchange between the relevant currencies may not be impossible. Trade survives many obstacles. But such uncertainty is a massive handicap.

Proponents of the float would agree that widely and erratically fluctuating rates are a handicap. Most of them would also concede that leaving rates to find their own level--reflecting not only the differences in national economic policies but also speculation on the course of these policies and the course of exchange rates themselves--will cause such fluctuation. Here enters one of the subsidiary causes of the present problem: the existence of large international corporations, including very specifically the banks, that are able to move funds between countries in very large amounts at very short notice or even to postpone movements they would ordinarily make. If a floating currency seems likely to fall, they can quickly desert it in large amounts for another that seems likely to appreciate. The act then fulfills the expectation. The resulting fluctuation can be very great. The word float has an ingenuously benign sound. One imagines drifting gently on a calm pool. But institutions and speculative opportunities being what they are, the float takes place on a very tempestuous sea.

The speculation that gives rise to the tempest, it must be emphasized, is under the most reputable auspices. In the crisis of early 1973, large sums were moved from dollars into marks to the eventual profit of those concerned. There was much mention of international speculators and the emerging international financial villains of our time, the Middle Eastern oil sheiks. Until there is absolute evidence of innocence, it had better be assumed that the major operators were the big commercial banks here and abroad and the corporations on one or another of Fortune's lists, foreign or domestic. The U. S. Tariff Commission recently put the short-term liquid assets of corporations subject to such movement (continued on page 248) Monetary Crises (continued from page 94) at 268 billion dollars, a figure that the First National City Bank thinks too high but would cut only to 130 billion dollars. The commission concluded that "much of the funds which flow internationally during a crisis doubtlessly are of multinational corporation origin." We have not only speculation with consequent uncertainty but speculation from sources of the greatest respectability.

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Given the risk and cost of doing business with large and unpredictable fluctuations--i.e., without knowing what one will receive, or taking a heavy discount on exchange because the bank doesn't know what it will get, or paying the cost of hedging--the proponents of the float fall back on an obvious remedy: That is to keep the fluctuations within narrow limits. If the dollar is being driven down or up in relation to the mark, central banks or international authority must step in to buy or sell dollars and arrest the fall or gain. This eliminates uncertainty, giving the American buyer reasonable assurance as to what his money will buy in Germany and giving Volkswagen reasonable assurance as to what it will get for its cars.

A moment's thought will tell the reader where this solution arrives--although advocates of the float are not always so percipient. It goes back to fixed exchange rates. Rates are not absolutely fixed, but, like a horse race, if rates are a little fixed, they are fixed. And among the things that will change them is further trade disequilibrium deriving from the diverse courses of national economic prices and performance leading to a new outbreak of speculation. The risks of currency accumulation will come to seem excessive to the central banks--in recent times, the Swiss government has absorbed the losses of the Swiss National Bank--and the support will fail. A radical change in exchange rates will then occur. In other words, there will be a stable and orderly float until the next currency crisis.

There is another danger from the socalled float. The ultimate solution for international currency problems lies in national policies, a point on which a fair number of authorities--Arthur Burns of the Federal Reserve, Robert Triffin and Henry Wallich of Yale--agree. But if it is supposed that anything so easy as a float is a remedy, it is certain that no more difficult solution will be sought or tried. Rising wages, responding price increases, excess private or public demand, poor use of capital--all damaging to a country's international competitive position--require unpopular action. No government, and certainly not one as given to wish and prayer as opposed to policy as the present U. S. Administration, will ever increase taxes or tangle with unions if everything can be remedied by a little sorcery with exchange rates. And by the time it is discovered that sorcery is not a solution--that it makes everything worse--the sorcerer is likely to be safely back in his Texas law practice or at the University of Chicago teaching his errors to the young.

Also at some stage, deliberate downward floating, more rightly called devaluation, could become an international game, something like chess. To put your currency down is to achieve a competitive advantage in other markets. That advantage others can offset by making their currency go down, too--by offsetting the other country's downward float by an aggressive purchase of that country's currency and counterpart sale of its own. This keeps that nation's products cheap, its employment high, its competitive position strong. In the years since World War Two, in reaction to wartime currency disorder and the competitive devaluation that preceded it, the moral aversion to such action has been strong. It is now weakening. A new era of competitive international currency devaluation is all too probable. It will add a new burden to international trade, a new dimension to international tension. If it happens, the prophets of floating rather than fixed exchanges will bear a heavy responsibility, and one can only hope that, by some magic, they will be tagged with the blame. International trade and even international relations will be adversely affected. International monetary disorder will no longer be a nonevent, even in Des Moines.

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The proper course of action is now evident. There is no monetary solution. The search for such a solution is a form of escapism unworthy of the adult mind. In a closely knit world, there must be some stability and predictability in exchange rates. That can be achieved in only one way--by much greater coordination among national economic policies. One cannot have a stable international system and grossly divergent national policies. It is to the latter that attention must be turned.

This, at first glance, will seem a formidable, even unrealistic proposal. How can we unite or coordinate the wage-and-price policies, or the fiscal policies, or even the monetary and central bank policies of the United States, the Common Market countries and Sweden, Switzerland. Austria and the other countries outside? In fact, coordination will not be accomplished by Assistant Secretaries and central bankers meeting to agree on wage-and-tax policies over which they have no perceptible influence at home. George Meany and the British Trade Unions Council will not easily subordinate their wage demands to international need and convenience when they do not fully accept the need to intervene for domestic reasons. A Secretary or Assistant Secretary of the Treasury who goes to Paris to meet on such policies may not be able to see the President before he leaves or when he returns.

Yet there is no other answer and, oddly enough, this is the way the problem has been solved in the past. Anciently, the gold standard provided fixed rates of exchange between each of the relevant currencies and gold, and thus between all. And in its classical manifestation--more precise in theory than in practice--the gold standard compelled the coordination of the participant countries. Countries with a fiscal policy that was too easy, monetary policy that was too lax, found their prices rising. This manifestation of uncoordinated national policy was then brought into line by the loss of gold, the resulting stringency in bank lending and the warning it served for tax and expenditure policy.

This coordination did not disappear in the years following World War Two. It no longer brought about the movement of gold from one central bank to another. Nor, needless to say, was it the work of officials meeting agreeably and later going out to dinner. It was, above all, the result of a relatively stable and predictable economic policy in the United States, to which other countries could accommodate. Prices in the United States in the Fifties and Sixties were relatively stable. There were steady gains in productivity. In the early Sixties, the guidepost policy eliminated the modest wage-push inflation of the Eisenhower years, and our sanity had not become suspect from misadventures in Vietnam. Wall Street had not yet got into the go-go binge and seemed a good place to send dollar balances. In those years, we were an easy country with which to live. We did not coordinate our policies with other countries', but our policies were predictable, and smaller and more manageable countries could coordinate their policies with ours.

This is the clue to the present need. Nothing depends on monetary solutions. Eventually, the anachronism of national governments in an international economy of transnational business firms will have to be faced, but that will not be soon. The immediate need is for a predictable economic policy in the United States.

The essential features of a predictable policy are without surprise. There must be control--permanent control--in the organized sector of the American economy where union settlements act on prices and prices pull up wages. In the recent past (and even as this is written), there was urgent need for higher taxes to soak up the purchasing power that pulled up prices in the market sector of the American economy. And in the future, there must be willingness to use taxes whenever such restraint on aggregate demand is required. The President of the United States three years ago announced his conversion to Keynes, a man many of the President's followers once equated with Marx. It was an incomplete conversion--in baptismal terms, a partial submersion. A Keynesian will reduce taxes to expand output. Mr. Nixon went that far. But the complete Keynesian will also raise taxes to curb an excess of aggregate demand. This step Mr. Nixon declined to take.

Additionally, there is need for a strong policy of public-service employment. This is important, for it eliminates the need to use crude economic policy measures to carry the full cost of keeping unemployment at an acceptably low level. Jobs can be provided in the number and in the places where they are needed. Even in budget terms, it is a great bargain.

Finally, there will be need, on occasion, for judicious monetary restraint. But this must not be a central reliance. Monetary policy is the most uncertain of all policies in terms of the relation between a given action and the size and timing of the result. And it works with marked discrimination against those industries that, by their nature, must borrow money. Quite a few foreigners recognize that world monetary stability requires, first of all, that the United States get its own house in order. Unfortunately, they confine their further recommendations to proposals for making greater use of high interest rates.

There cannot be a predictable inflation. Price stability is the only possible thing to which other countries can anchor--with which they can coordinate their policy. Given stability, other countries can accommodate. Nor is this an inferior role; it is the natural relationship between small countries and large.

On occasion, no doubt, this coordination can be facilitated by negotiation among the United States, the Common Market countries and Japan. A commitment to a common target respecting prices and perhaps also productivity might have a certain moral effect. And once American policy is in order, the working out of cosmetic details--the demonetarization of gold, strengthening of the Bretton Woods machinery, expanding drawing rights, developing other international monetary gadgetry--will give useful employment to world monetary experts. Restraints on the movement of capital by the banks and multinational corporations need also to be devised. As an interim measure--until dollar balances are reduced and stabilized--this would be very useful, as even conservative banking authorities agree. (Even Switzerland maintains a substantial measure of control over such movements.) But the major point must be emphasized. With proper American policy, everything is possible. Without it, nothing is possible.