Friday, June 22, 2012

Consequences of Dollar Debasement



LET US BEGIN BY RECALLING TWO COMPARISONS already mentioned. From the end of 1939 to the end of 1968 the United States’ stock of money (hand-to-hand currency plus demand bank deposits) has been increased more than fivefold—from $36 billion to $193 billion. In the same thirty-year period (in spite of a huge increase in industrial production), prices of goods and services increased by an average of 164 per cent.
This debasement of the dollar resulted in a succession of problems, including a chronic “deficit” in the American balance of payments.
The “balance-of-payments problem” has arisen not merely because of our domestic inflation but because of the combination of this with the so-called “gold exchange” standard and the world monetary system set up at Bretton Woods in 1944. Under that system each government undertook to keep its own currency unit within 1 per cent of parity in either direction by buying or selling that currency against other currencies in the foreign exchange market. In addition, the United States Government undertook to make the dollar the world’s “reserve currency” and anchor currency by guaranteeing to keep it convertible at all times (for foreign central banks, but not for its own citizens) into gold at the fixed price of $35 an ounce.
Though only central banks, and neither American nor foreign private citizens, have the right to ask for this conversion, keeping the dollar convertible into gold at this fixed price has proved increasingly embarrassing to our monetary authorities, especially since 1957. During the last decade we have been sending or spending abroad for various purposes—to pay for imports, for foreign aid, and for the support of our armed forces in Europe and in Vietnam—billions of more dollars each year than we have been getting back in payment for our exports and earnings on our capital invested abroad.
This excess of outgoing dollars is called the “deficit” in our balance of payments. From the end of 1957 to the end of 1967 this deficit ran at an average of $2.8 billion a year. At the end of 1968 the cumulative total was in the neighborhood of $30 billion. In early 1969 the deficit on a “liquidity” basis was running at an annual rate of $6.8 billion.
As a result, our monetary gold stock had fallen from $22.8 billion at the end of 1957 to only $10.4 billion in July, 1969. Against these reduced gold reserves the United States had liquid liabilities to foreign official institutions of $10.8 billion, plus short-term liabilities to private foreigners of $22.6 billion—a total of nearly $34 billion.
In much discussion our dollar liabilities to private foreigners are not counted as a potential demand on our gold reserves because private banks, firms, and individuals cannot directly demand gold for their dollars. But under the International Monetary Fund agreements they can always indirectly sell their dollars at par to their respective central banks.
In sum, against United States gold reserves of only about $10 billion there are more than three times as many potential foreign dollar claims for gold.
As our gold has drained out, and as foreign dollar claims against it have mounted, the blame has been put on this “deficit” in our balance of payments. But instead of dealing with the main cause of this deficit—domestic inflation—our governmental authorities have allowed the inflation to go on, and have even increased it, while trying to stop the symptom. They have treated the deficit in the balance of payments as itself the problem, and have adopted desperate measures to try to halt it by direct controls.
Their first major control, imposed in 1964, was a penalty tax on purchases by Americans of foreign securities. To make such foreign investments the culprit responsible for a balance-of-payments deficit was not only arbitrary but implausible on its face. In the five years 1958 to 1962 the aggregate net outflow of $16.6 billion for new foreign investment was offset by $15.4 billion of income from previous investment. Even the Secretary of the Treasury, who had asked for the penalty tax, conceded: “In the long run the outflow of American capital to foreign countries is more than balanced by the inflow of income earned on that capital.”
He urged the tax, in fact, “only as a temporary measure to meet our problem pending more fundamental solutions.” Of course the more fundamental solutions were never adopted, so not only was the “temporary” security tax renewed, but on January 1, 1968, the President added mandatory controls on direct investments by American corporations abroad.
The implication of these measures is that our private foreign investment has been one of the chief causes of the deficit in our balance of payments. This is clearly untrue. It is Federal spending, through foreign aid and military outlays, that has been in deficit. In recent years the private sector as a whole, as a result of export surpluses and income on private investments abroad, has continued to generate a payments surplus.
In 1967 our total new foreign investments—including bank loans, purchases of foreign securities, and direct investments in factories and sales facilities—amounted to $5.6 billion. But the income from these and earlier private investments came to $6.2 billion.
At best, then, all these foreign investment restrictions and prohibitions are shortsighted. Any reduction we make in new foreign investment today means a corresponding reduction in investment income tomorrow.
If the Federal Government, instead of picking foreign investment as the culprit chiefly responsible for our balance-of-payments deficit, had put punitive tariffs on the further import of foreign luxuries—liquors, wines, perfumes, jewelry, furs, and automobiles—its action would still have been a mistake, but much less damaging to our future economic strength. These tight curbs on direct foreign investments by American corporations must severely hamper their ability to compete successfully with other international corporations in Europe and the rest of the world.
The President’s own Economic Report of 1967 pointed out that: “U.S. investment abroad generates not only a flow of investment income but also additional U.S. exports. From a balance-of-payments point of view this is an additional dividend.” The U.S. Department of Commerce found, in fact, that in 1964 $6.3 billion, or 25 per cent of our total exports in that year, went to affiliates of American companies overseas.
It is hardly too much to say that direct foreign investments, with the exports and income to which they give rise, are the greatest single source of long-range strength in our balance-of-payments position.
Still worse, from the standpoint of their direct restriction on personal liberty, were the Johnson Administration’s proposals (fortunately not enacted) to have Congress impose practically prohibitive penalty taxes on Americans travelling abroad.
The whole effort to eliminate our balance-of-payments deficit by direct controls over arbitrarily selected individual items is doomed to failure. Such controls may succeed in changing the relative amounts of different items, but cannot change the end result. At best we can make our immediate balance of payments look better at the expense of our future balance. We cannot unilaterally cut down our purchases or travel or investments abroad without also cutting down our sales abroad and our investment income from abroad. In his Economic Report of 1968, President Johnson himself conceded that “by provoking retaliation” we may “reduce our receipts by as much as or more than our payments.”
The whole so-called “balance-of-payments problem” would never have arisen except under the arbitrarily contrived International Monetary Fund gold-exchange system set up at Bretton Woods in 1944. It could not exist if the United States and other countries were on a pure “floating” paper standard with rates fluctuating daily in a free market, because under such a system the fluctuations would themselves set in motion the self-correcting forces to prevent unwanted deficits or surpluses from arising. Nor could the balance-of-payments problem exist if the United States and other leading countries were on a full gold standard. A “deficit” in the balance of payments would then lead to an immediate outflow of gold. This in turn would lead to immediately higher interest rates and a contraction of currency and credit in the “deficit” country, and the opposite results in the “surplus” countries, and so bring the so-called deficit to a halt.
Under the Bretton Woods system and the “gold exchange” standard, however, no self-correction of this sort is allowed to take place. When we “lose” paper dollars abroad we simply print more at home to take their place. And when Europe gains these dollars they find their way into the central banks, where they become additional “reserves” against which the European governments issue still more of their own currency. Thus further inflation, in both the “deficit” and the “surplus” country, seems to take place automatically.
In the IMF system there are no freely fluctuating market rates for individual currencies to reveal and correct international imbalances. Market rates are not allowed to fluctuate by more than 1 per cent above or below parity. At that point each government is obligated to buy or sell its own or foreign currencies to prevent any further departure from parity.
These currency-pegging operations are supplemented by the so-called gold-exchange standard. This arrangement, which goes back to international agreements in 1921 and 1922, permits central banks to count not only their gold but their holdings of dollars (and of British pounds) as part of their reserves. The arrangement was adopted in the belief that there was a “shortage of gold” and a “shortage of international liquidity.” As a result the world’s monetary “reserves” today consist of about $42 billion in gold plus about $28 billion of “reserve currencies,” of which more than $15 billion are American dollars. As credit and other currencies are issued against these reserve currencies, the reserves themselves are inflated.
The real reason the American monetary authorities fear a continued “deficit” in the balance of payments is that they have given the central banks of other countries the right to demand gold for their dollars at $35 an ounce. They have seen more than half our gold reserves flow out in the last twelve years, and they are fearful of losing any more.
They long ago persuaded the Federal Government to prohibit American citizens from holding or asking for gold. In the last few years they have resorted to increasingly desperate expedients. Where possible, they have brought political pressure on foreign central banks to keep them from asking for gold for their dollars. Early in 1968 they stopped feeding out gold to hold down the price in private markets in London, Paris, and Zurich. They now try to maintain an inherently unstable two-price system, with official monetary gold at $35 an ounce and non-monetary gold free to sell at whatever price supply and demand fix.
Early in 1968 the Administration also got Congress to abolish the remaining gold-reserve requirement of 25 per cent against Federal Reserve notes, on the plea that this was necessary to reassure foreign central banks by making all remaining United States gold holdings available to them. But what this action really did was to remove the last legal limitation on the amount of paper money that the Federal Reserve system may issue.
Finally, the American government has pressed for the creation by the International Monetary Fund of “special drawing rights” (SDR’s), or “paper gold,” to “supplement” dollars as international reserves. The only thing this purposely complicated scheme can do is to adulterate reserves still further and make it possible for nations to issue still more paper money against these paper SDR’s, which are declared with a straight face to be just as good as gold if not better.
All these schemes are unsound, and in the end all of them will prove futile. The truth is that no solution of the monetary problem, national or international, will be possible until inflation is stopped, and that it will not be stopped as long as we have the welfare state.




Man vs. The Welfare State


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