The Hope of Bretton Woods

by ARTHUR R. UPGREN

1

Two corporate charters for two new international financial organizations were drafted by the representatives of forty-four United and Associated Nations at Bretton Woods, New Hampshire, in July, 1944.

Corporate charters never make interesting reading. When they are international, difficulties increase. One set of words can hardly be expected to satisfy many people speaking many languages. And when the whole melange, covering most of a hundred pages, is put together in three weeks, it may be expected to spell trouble. And it did.

The two institutions set up were: (1) the International Monetary Fund; (2) the International Bank for Reconstruction and Development. Even in defining the titles, the greatest dispute took place about the single word “bank” — perhaps because everybody felt sure he knew what the word meant, and also that it was being used in the wrong place. At least Lord Keynes thought it was!

In the intervening year, discussion — much of which has become increasingly intelligible — has helped us to get a better idea of the two institutions. We find generally that they make good sense. What is that sense?

Any set of institutions must be set up according to the purposes the institutions are to serve. In the case of the Bank— though that institution is not discussed at any length in this article — the purpose is to revive long-term international lending. There is wide agreement that capital lending by the United States will not be revived in the old forms. If it should be revived, it would be fitful, and fitfulness is not a good ingredient in any part of international relations.

For these reasons an arrangement was made whereby all forty-four nations, each to the amount of its subscription, would “jointly and severally” guarantee all international loans made through the Bank. It makes no difference if only a handful of countries make all the loans — they can do so, and of course they would benefit through the resulting expansion of exports and, therefore, domestic employment.¹ The country to which the loan is made would also benefit from the productive capital so obtained; therefore it is required to guarantee any loan for any project within its boundaries. By virtue of their subscriptions to the Bank’s capital, all the other nations participate in what can be called an overall guarantee.

Practically everyone who has looked into the Bank has a good word to say for it. Many, especially those critical of the Fund, have urged that the Bank be given powers to make longer-term stabilization loans. Because of this wide acceptance of the Bank, the remainder of this article is concerned only with the Fund.

2

IT IS on the Fund that the spirited debate has centered. Many critics stress the complicated language of the charter. Nevertheless, it is possible to use an extremely simple illustration to describe the working of the Fund.

In joining the Fund, each of the nations makes its specified payment. A part, one quarter where possible, is to be paid in gold and the rest in its own money. The amount paid in is the quota of each nation. This quota fixes the total amount of other currencies which each contributing country can obtain from the Fund: a member may not purchase foreign exchange with its own currency in a net amount exceeding 25 per cent of its quota in any twelve-month period. The currencies and gold initially paid into the Fund will be placed in the custody of the Fund, which no doubt will keep them in the form of bank accounts at the central bank of each participating country.

For our present purposes it may be clarifying if we agree to put all the payments to the Fund into a unique container— a “forty-eight-pot muffin tin” with fortyfour pots to be used by the United Nations and the others reserved for latecomers, the neutral countries. The pots are of different sizes, but the entire tin is well adapted to hold all the currencies in the different paidin amounts, which are to total $8,800,000,000.

The biggest single pot will be marked “United States Dollars.” Into it our government will pay $2,750,000,000. This makes ours a 31 per cent contribution; and in the Fund, as in the Bank, we shall have that proportion of total voting power.

The next largest pot will be marked “Pounds Sterling.” Into it Britain will pay pounds having a value of $1,300,000,000. For Britain, as for all nations, a rate of exchange for all other currencies is agreed upon as its first payment is made to the Fund. Then $1,200,000,000 will be paid by Russia in rubles. China’s amount will be $550,000,000. France will pay $450,000,000, Canada $300,000,000, and so on, with all the members paying in what have been judged to be appropriate amounts, all the way down to Panama and Liberia, each of which makes a payment of $500,000.

With this tin initially so well supplied with a wide assortment of the world’s currencies, the Fund is prepared to begin operations. As each nation joins, as has been said, agreement must be reached as to the rate of its exchange or the “par value” of its currency in relation to all other currencies. Each member country will indicate the initial par value or rate of exchange for its currency; and unless it is changed by joint agreement, it is to be the rate of exchange prevailing sixty days before the Fund starts initial operations. This rate, however, later can be changed by 10 per cent “with no questions asked.” That much currency depreciation is permitted, perhaps chiefly because no one has the temerity to suggest any initial binding rate. In fact, another 10 per cent depreciation is permitted if consent of the Fund is obtained, and under certain conditions consent cannot be withheld.

The two permissible reductions in par values are limited to a total of 20 per cent. This total may be compared with our dollar depreciation of 41 per cent in 1934. This flexibility endows the Fund with stability without rigidity.

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ONCE the Fund is open for business, how does it operate?

Suppose a French textile manufacturer wants to buy a million francs’ worth of raw cotton and the French banks do not have sufficient “dollars,” the currency needed to buy cotton. The Fund can help out. Into the pot marked “francs” go the one million francs which the French cotton manufacturer does have. Out of the pot marked “dollars,” at the previously agreed rate of exchange of francs for dollars, go the dollars to the American cotton exporter.

A single foreign-trade transaction has been completed. The French textile manufacturer has his vitally needed raw material. A United States cotton planter has been paid in dollars for cotton he has raised and sold. When the French manufacturer has sold his finished goods, say months later to the United States, the dollars American women pay for French textiles are directed back into the dollar pot of the tin. In return for them, the French textile manufacturer receives their equivalent in francs — the kind of money he wants. The tin now has been restored to that even balance which, with substantial accuracy, we may call “economic equilibrium” as the economist uses that term. (Actually all transactions take place in private markets. The Fund comes in only if the regular markets call upon it for the aid which it can give.)

But what has been accomplished?

The Fund has served as a “buffer” for the franc. The financial advance has provided a breathing period for the French manufacturer. For his francs he was able to obtain dollars. To him dollars were synonymous with his needed raw cotton. Cotton growers in the United States were able to find a foreign customer. The Fund permitted the foreign buyer to make payment in dollars. In this way, the Fund constantly serves as an international agency to give the world exchange rates that have been amicably determined.

This is just about the opposite of what the world suffered from in the 1930’s. Then there was one-sided, erratic currency depreciation. That depreciation, for the nation resorting to it, represented an attempt to export some of the depreciating country’s depression to foreign shores. For example, an American wheat grower, depending in considerable part upon foreign markets, saw wheat prices fall as low as 49 cents a bushel in Minneapolis before the value of the dollar was reduced, to compete with an Australian pound depreciated from $4.86 to $3.30.

So far the Fund does not look very complicated. But when there are not enough dollars to go around, trouble begins. Buyers all over the world may be pressing their currencies upon the Fund to secure dollars; large amounts of many currencies are stuffed into all their respective pots and the Fund may run out of dollars. A “fundamental disequilibrium” results.

The remedies the experts have provided for this contingency show us how important the Fund can be, and whether or not it will stand up under disequilibrium.

In the past, under the gold standard, the process of correction of any international disequilibrium started with an outflow of gold from the countries that lacked foreign currencies to countries whose currencies were wanted. This outflow of gold reduced monetary reserves at home. Credit was tightened. Prices and wages fell. Deflation resulted. This process tended to restore equilibrium.

In the country that received the gold there were few serious effects, particularly if the banking system accepted the gold without consequent excessive monetary and credit expansion. Thus, it is generally said that the old equilibrating mechanism required a maximum of adverse adjustment in the debtor or goldlosing country.

Under the Fund, the supply of dollars in the Fund provides a buffer so that gold need not be transferred. There is also an arrangement for the permissible depreciation of the debtor’s currency; this depreciation can help enlarge the volume of exports, which become cheaper as a lower value for the currency is agreed upon. Finally, if dollars become too scarce, the Fund may resort to the rationing of the scarce dollars. If this third step should be taken, the exports of the United States would be forcibly reduced. That, of course, would not be popular.

Many objections to the Fund have been recorded, some in great detail. This much is certain: the extremely chaotic world that lies ahead of us will test the strength of the Fund to its limit.

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THE most fundamental problem is one recognized alike by the Fund’s friends and its critics. It is whether the United States will in the future adopt international economic policies that will secure reasonably close balance in our total international accounts. To be sure, we were making good progress on this problem in the 1920’s. In the 1930’s, however, we retrograded. In the post-war decade the issues appear to be in doubt.

Though our intent for the future can be regarded as greatly improved, future conditions in other parts of the world can deteriorate so much that our improvement will not offset the deterioration abroad. In short, there appears to be reduced ability in the rest of the world — as a result of high prices, high costs, reduced productivity, slow export recovery — to produce goods attractive and competitive enough to yield enough dollars to give the desired buoyancy in the international accounts of other countries. At the same time, though we may not attempt in post-war production to become self-sufficient in all things, some of our new synthetic products may result in a reduction of our imports.

There is only one general policy needed on our part to correct this disequilibrium, or world shortage of dollars: we in the United States must, for our own sake, determine that we are going to get our international accounts into balance. For us the Fund is a buffer too. For a period we may rely on it to help manage, in a planned way, an excess of exports for the first years while we are making corrections.

Because of this buffer we get a breathing period in which we must enlarge the total amount of the dollars that we pay for all goods and services we buy from other countries. In addition to our merchandise imports, we pay for such services as our tourists abroad buy and for many other services, such as shipping, banking, and insurance. These too we may be able to increase.

Some critics have asserted that while we contribute almost one third of the total amount paid into the Fund, the share of what they like to call “internationally valid” money that we provide is more nearly two thirds of the initial amount of all such money that will be held by the Fund. In the phrase “internationally valid,” credit is given to the international acceptability of the dollar and its continued connection with gold.

But if, in the tin, the dollars become scarce, then nearly all other currencies will be plentiful but will possess virtual validity, at least for the United States. These currencies will become valid for us because the process of balancing our international accounts involves exchanging dollars for the other currencies. We are privileged any time to use the world’s currencies in this way to buy the world’s goods. Thus other currencies become valuable because of their power to command goods for us, as the dollar has for them. If, on the other hand, the other countries do not stand ready to sell us their goods, or if we do not intend to balance our international accounts by buying their goods, then other currencies are without validity.

In fact, if we do not balance our accounts, neither the Fund nor, for that matter, the Bank can achieve equilibrium for us. The Fund’s management must then intervene to reduce our exports, since we did not succeed in increasing our imports. The demand for dollars will be reduced and equilibrium can be secured, but it will be at the cost of a reduced world trade.

The issue, therefore, comes down to this: Can we balance our international accounts? If we can, the problem of internationally valid money vanishes.

5

THE second major requirement to maintain economic equilibrium is able management of the large amounts of cash in the Fund. This management, in an organization from which any member may withdraw at any time, must ultimately convert “paper” power into more effective power. Whether or not it does so will depend on whether the currency which the Fund can supply is more valuable to the member than what that member must give.

It is most important to remember that the world has fashioned other weapons that it believes can serve the ends of economic defense. Past reliance upon these weapons, such as import quotas and clearing agreements, partly explains why countries were not prepared to give unusual power to the management of the Fund.

But a world which has not known any very satisfactory substitute for capital-lending, since that was abruptly terminated after 1930, has been willing to give stronger powers to the International Bank. As a result, the Bank can specify more stringent conditions in its contracts. A loan from the Bank is a loan — dollars must be repaid with dollars. Securing money from the Fund, however, is a purchase, because if dollars are obtained, full payment for them, at agreed rates of exchange, is given in Dutch guilders, Canadian dollars, New Zealand pounds, or Indian rupees. It is an exchange at an agreed rate — as when a tourist takes dollars to the American Express office in Paris and gets francs. But it is in setting the rates, and in approving advances, that the Fund management must operate with great sensitivity. It is not fiat action but good judgment plus good cash that is necessary to give the Fund great influence.

In the debate about the Fund there has been considerable overstatement, especially in terms of its purposes and advantages. The purposes are laudable, to be sure, and some advantages are very clear, but they should be studied with care. In the post-war world it would be extremely difficult to restore a system of free exchange, let alone a full gold standard. This difficulty was recognized by those countries which consented to continue existing exchange restrictions. Supporters of the Fund like to cite as a great advantage the removal by the Fund of such controls. But their removal will not be secured for some time, even though the goal is set at five years, and it could be still further delayed.

The Fund has been created in part because the past network of exchange restrictions has hampered world trade. And now the situation for many countries is so gloomy that exchange controls still must be maintained. What is required is that steps must be taken by the Fund to abandon such controls progressively. But it must be recognized that, as in the case for naval disarmament, economic disarmament has not always been sincerely urged by many nations, whatever the attachment some of them have professed for it.

United States foreign-trade interests can be helped and protected by a well-functioning international monetary fund. It is equally true that, since we are by far the greatest creditor nation, the Bank offers substantial possibilities for the promotion of our international interests.

Fortunately the world has one important advantage, even in the difficult conditions that now exist, for trying, via the Fund, to hold to desirable trade policies. That advantage lies in the world’s large supply of gold and dollars outside of the United States — a supply that has never been larger. The total amount of gold held or owned outside the United States is now probably very close to $10,000,000,000. In addition, the world has United States dollars amounting to another $10,000,000,000. Thus liquidity is widespread.

There are excellent prospects that trade can be buoyant after the war because of the world’s wartime accumulated needs and the liquid funds possessed by many countries. Buoyant trade will help greatly to keep the world’s production and employment activity at high levels. Under these conditions the Fund and the Bank can help to fashion a prosperous world — one that is willing, through its experience with two new agencies, to collaborate for economic peace.