Are We Playing the Game?


SINCE the end of the war we have heard much about the doctrine, long recognized as a commonplace among economists, that the debts of one country to another can be settled only through the transfer of goods or services from the debtor to the creditor country. We have been confronted with this doctrine more and more with each succeeding year. We first encountered it when we ventured to form an intelligent opinion on the reparations question — how much Germany could pay and the manner in which she would pay it. We next heard about it when we began to deal with the disturbing problem of war debts — how England, Belgium, France, and Italy were going to pay the interest and principal on their war and post-war borrowings from the American Government. Bringing the matter all the way home, we are now obliged to take fresh cognizance of the doctrine whenever we seriously consider the status of that large group of private American investors who have been buying enormous quantities of foreign bonds — how these investors are to receive the interest or dividends in years to come on the foreign securities they have been putting away in their strong boxes.

In its more refined form the doctrine does not state that a debtor country seeking to effect a settlement of its obligations must send goods direct to the country where its creditors live. On the contrary, it may sell its goods or services in any foreign market. The essence of the doctrine is that a debtor country in its trade relations with the rest of the world must develop an excess of total exports over total imports, an excess approximately equal to the yearly obligations it expects to meet. It will then be in a position to satisfy its foreign creditors. The sale of goods abroad in excess of purchases abroad will leave cash balances, somewhere beyond its own boundaries, on which drafts can be drawn for the payment of external obligations.

Just as a debtor country must sell more than it buys, so a creditor country must buy more than it sells. It must increase its importations of foreign goods, no matter in what country the goods originate, or it must diminish its export trade, if it would receive the money payments which the foreign debtor is trying to make. In short, a creditor country must have an excess of total imports over total exports sufficiently large to permit it to receive in goods or services the interest and principal payments due from the outside.

At times we have given an attentive and sympathetic ear to this doctrine. It has seemed clear to everyone, for example, that Germany could make reparation payments only to the extent that she was able to develop a surplus production of goods and services which outside markets would take. Up to this point there has been no ground for argument. We have accepted the doctrine outright as applied to the method by which a debtor country must discharge its external obligations. But when it comes to fitting the doctrine in with our own status as a great creditor country, foredoomed to receive large payments from foreign debtors, our attitude toward all such doctrine becomes at once lukewarm, then cold, and, on further consideration, openly antagonistic. Surely, we argue, there is some way to beat it.

We have made determined efforts to negative that portion of the doctrine which tells how a creditor country must receive its interest and principal payments from debtor countries. We have shown unequivocally that we do not want foreign goods to compete in our markets with the products of our own manufacture. If foreigners can arrange to send us raw materials which we do not produce, all well and good, but under no circumstances do we want their manufactured products. That has been our answer to the widely proclaimed doctrine of the economists.


Our demonstration of protest began shortly after the end of the war. We had a strong feeling at the time — and it may have been a reasonable feeling — that European countries would make a supreme effort to recover market outlets which had been lost while the war was on. Our feelings in the matter were aggravated by at least three important considerations. In the first place, there lay in the back of our minds the fact that European countries owed the American Government billions of dollars on account of our war and postwar advances which, according to the doctrine of the economists, could be repaid only in the form of goods or services. Secondly, it was realized that Germany in particular had need of a large external market where she could sell her products and build up cash balances with which to pay her reparation obligations. And what more accessible or coveted market was there than ours? Finally, our leaders made much of the argument, though it contained only a modicum of truth, that a nation having a depreciated currency enjoyed special manufacturing and selling advantages not possessed by nations whose currencies were on a gold basis.

Confronted with an international trade situation which seemed ominous, at a time when our own industry was languishing as the result of post-war deflation, we promptly convinced ourselves that drastic action was needed to meet t he trade emergency. In order to safeguard our industries against the alleged dangers of European competition and to ensure the maintenance of our high standard of living, we put through special tariff legislation in 1921 in the form of an Emergency Tariff Act. In the following year we reaffirmed our belief in the efficacy of goods-exclusion principles by passing the Fordncy Tariff Act.

Our return to a high-tariff policy did not inflict great hardship on European countries at the moment. Although heavily indebted to us on open account as a result of the war, they could not immediately pay off these obligations by sending us goods. Their productive efficiency was too far below pre-war standards, their trade was still disorganized. It is impossible to believe that they could have become dangerous competitors in our markets forthwith, even if our tariff had been left unchanged. Be that as it may, the effect of the very substantial increase in our tariff duties was to make their case more hopeless than it would have been otherwise. It not only operated to retard the revival of their internal trade, but it put off still further the day when they could pay their external debts in the ordinary commercial way. Deprived of the power to send us goods, they had no alternative but to send us gold. Here was a product which could be sent in duty-free.

Throughout the three and one-half year period ending January 1924, we had a veritable flood of gold imports. Our gold holdings piled up at an average rate of more than $1,000,000 a day. We became the possessors of one half of the world’s supply of monetary gold. Never before had a single country amassed so large a proportion of the world’s standard money; such a persistent and one-sided movement of the metal had never been considered within the bounds of possibility. It was as if one half of the contents of the Atlantic Ocean suddenly moved over into the Pacific and remained there, notwithstanding an old-fashioned doctrine about water seeking its own level.

Our tariff legislation of 1921 and 1922 was not, of course, the only factor which caused foreign gold to pile up in this country. There were a number of contributing causes, not the least important of which, as will be seen presently, was our manner of dealing with imported gold after it reached our vaults. But when all of the causes of this phenomenal gold movement have been enumerated and appraised, there is no escaping the conclusion that our goods-exclusion policy, as expressed in post-war tariff legislation, forced us to take vast quantities of gold which need never have come and which now constitute a serious problem to be reckoned with.


Had our banking authorities utilized the gold as it came to us, matters would have righted themselves in the course of time in spite of tariff barriers. Gold imports would have set about automatically to create the conditions under which foreign goods could be sold in our markets. The flood of gold coming to our shores would have cheapened the dollar and, in accordance with the predictions of practically all European students of the question, we should have had an inflation in our prices. On the other side of the picture, the countries which were sending the gold to us would have experienced the opposite effects — they would have had a corresponding deflation in their prices. Sooner or later the automatic workings of the gold standard would have created a sufficient differential between our level of prices and that of foreign countries to permit their goods to scale our tariff wall and to create cash balances which they could use to pay their obligations.

Wisely or unwisely, we did not permit the flood of gold to work toward this goal. We astonished the European prophets by temporarily depriving gold of its inflationary power. We deliberately thwarted the intelligent purpose for which it came to us. We delayed the issue.

Putting vast quantities of gold into storage where it could have no stimulating effect upon the volume of credit or the level of prices was an accomplishment without precedent in the world’s banking history. We need not delve into the technical structure of Federal Reserve banking which made this accomplishment possible. It is sufficient to note that we happened to be in a position where a gold-storage, or goldsterilization, policy could be carried out, within certain limits, if we wanted to make the attempt. And we wanted earnestly to make it. We had just come through a painful period of deflation, following the inflation of 1919 when a too liberal use had been made of our gold reserves. Having had that memorable experience with the full cycle of inflation and deflation, we were bent on avoiding a repetition of it.

Moreover, the feeling was general among Federal Reserve authorities that we were only trustees for a large part of the gold which was being sent to us, and that when European countries set about restoring their depreciated currencies we should have to part with some of our holdings. In these circumstances it was deemed the part of prudence that the vast gold supply we were accumulating should be so managed that it might be kept available for redistribution, as the occasion arose, without producing any untoward or disturbing effects on our own trade or financial situation.

Some have objected to the statement that we ‘sterilized’ gold, and a number of other terms have been suggested as more fairly descriptive of our policy. For the present purpose it matters little whether we say that gold was sterilized, valorized, neutralized, buried, warehoused, hoarded, impounded, or conserved. The records show that during the period between August 1920 and January 1924 our net imports of gold amounted to $1,400,000,000, and yet — here is the extraordinary fact — over the period as a whole we had no net expansion in the total volume of credit either at the Federal Reserve banks or at seven hundred of the largest member banks. Whether we sterilized $1,400,000,000 of imported gold or merely conserved it, we did what we could in a financial way, though we must have done it unwittingly, to make the tariff all the more effective in excluding foreign goods.


It is still too early to make a full appraisal of the consequences of our gold-sterilization policy. That there are and will continue to be important consequences of a policy which, whatever its purpose, effectively postponed the date when foreign debtors could pay us in goods, we can rest assured. Or, to state the case in other terms, we can hardly expect to thwart the intelligent purpose of a large and sustained gold movement over a period of three and one-half years without getting consequences of a far-reaching nature, affecting not only ourselves but our foreign debtors as well. A few of the immediate consequences can be seen already.

One of the direct results of refusing to employ the gold we received was that we continued to get more gold. This result was inevitable. In the face of excessive gold supplies we maintained money rates at a high level, a level too high to make it worth while for business to expand and use up some of our dormant credit. We engaged in a kind of price-fixing programme with respect to gold, arbitrarily fixing the interest price at which gold could be used as a basis for credit. Our object, of course, was to prevent inflation, and in this we were partly successful, but the net result of our efforts was to aggravate the problem of excessive gold supplies in a way that was never contemplated.

We could at any time adopt a similar policy with reference to wheat or any other farm product for the purpose of bringing relief to a depressed agriculture. We could enact a law requiring some federal agency to raise the prices of farm products arbitrarily. We have not taken this drastic step as a remedy for agricultural depression because we have known full well that such a step would be unwise. It would stimulate farmers to produce more wheat when we already have too much, and the supplies would eventually become so large that arbitrary price maintenance would break down of its own accord.

Our price-fixing efforts with respect to gold met exactly that fate. The vacuum created by our artificially high interest rates caused more and more gold to be thrust upon us. It was a case involving the operation of a simple economic law which states that goods will move to that market where they can be sold to the best advantage. In response to this law, foreign gold continued to move to our markets until they became congested. By the early part of 1924 our gold stocks had become so large that arbitrary control broke down, — on gold as it would have on wheat, — and all gold which came in thereafter automatically became the basis for credit expansion.

The automatic relationship between gold imports and credit expansion following the breakdown of control may be seen in the developments which took place over the ensuing three and one-half year period, ending July 1927. During this period we had net imports of gold of approximately $400,000,000, and an expansion in the loans and investments of about seven hundred of our largest banks of more than $4,000,000,000. Thus every dollar of gold coming in during this period multiplied itself in credit operations more than ten times. It was impossible for the Federal Reserve banks to prevent this phenomenal expansion. They had reached the end of their power to sterilize imported gold. Once our rain barrel had been filled to overflowing, we could no longer control the use of the additional water that poured into it.

Another consequence of our goldstorage policy — and this consequence was felt acutely by our foreign debtors — was that we brought on a fall in the world’s level of prices. The truth of this statement cannot be demonstrated mathematically, but it stands to reason that the transfer of $1,400,000,000 of the world’s gold stock from foreign bank reserves, where it was being used as a basis for credit, to our own vaults, where it was held in complete idleness, should artificially raise its value. If we warehoused 15 per cent or more of the world’s supply of wheat in the course of a crop year, and kept it warehoused, would not the price of wheat rise? And if we could raise the price of wheat in this manner, would not the storing of 15 per cent of the world’s gold supply raise its value also? The evidence seems to be unmistakable that our storage policy raised the value of gold throughout the world. And raising the value or purchasing power of gold is the same thing as reducing the level of prices.

Theory says that our policy should have caused a fall in prices, and the trend of world prices following the termination of our gold-storing activities bears out the theory. Between January 1925 and July 1927 there was a general decline in wholesale prices in all goldstandard countries, ranging from 10 per cent in the United States to 17 per cent in England. So pronounced an appreciation in the purchasing power of gold — that is what a fall in prices means — was bound to have an adverse effect upon foreign debtors. Their loans had been contracted when the dollar was cheap; now they had to meet interest charges on cheap loans when the dollar was more valuable. It may safely be said that in creating a condition of gold shortage throughout the world we imposed an additional burden upon our foreign debtors of approximately 10 per cent.

It was impossible for foreign countries to overcome the artificial gold shortage by increasing gold production at the mines or by making new economies in the use of gold. There were, however, certain economies that could be made, and our policy compelled the central banks of foreign countries to economize in every possible way. Strange as it may seem, their principal means of economy lay in transferring a part of their gold reserves to our own banks. To accomplish this purpose they had only to buy with their own currencies the dollar balances which were being created through the sale of foreign securities in our markets, or they could make direct shipments of gold. Once they had acquired a deposit balance with our banking institutions, they not only had something which would pay them interest, but also, in many cases, something which the laws of their respective countries allowed them to count as part of their required reserves.

It was in this way that foreign banks responded to the artificial gold shortage we created. They sent us gold, which we did not want, in order to make their reserves do double duty. We have no precise means of knowing the extent to which they practised this particular form of gold economy, or how our international account now stands as the result of these operations. However, we have an estimate of the Department of Commerce for the year 1926, which shows that foreigners had deposits and short-time investments in this country of about $2,250,000,000, and that after allowing for the unfunded items they owed us there remained a net credit to foreign account of about $1,150,000,000. There is every reason to believe that our net debt to foreigners on short-time account is far greater now than it was in 1926.

A good deal of concern has been shown about this situation. It has been suggested that at any moment we might be called upon to convert these short-time investments and deposit balances into gold for export, and that the sudden withdrawal of so vast a quantity of gold would put a serious strain on our credit structure. Whether or not the fears on this score are well founded, it is to be noted that we have here a disturbing problem of our own creation — we are reaping the harvest of years of resistance to natural forces which, if allowed to operate, would have compelled us to take foreign goods in payment for the obligations due us.


The record of our accomplishment thus far shows that we have succeeded, temporarily at least, in negativing the doctrine of the economists — first, through tariff legislation, and then, indirectly, through the pursuance of an adroit monetary policy. In order to defeat this doctrine we chose to go directly against the tide. In so doing we not only created for ourselves serious problems which have yet to be faced, but, what is also important, we inflicted upon foreign debtors certain injuries which are already plainly visible. First of all, our high-tariff policy excluded their goods at the very time they owed us money. This operated to retard the revival of their trade and the restoration of their currencies. Then our hoarding of gold contributed to the same end, preventing the development of a situation where they could have sent goods to us in spite of the tariff. Finally, our gold-storage policy gave rise to a world shortage of gold which deflated foreign prices and made it more difficult than ever for foreign debtors to pay the interest on high-price debts out of low-price products. In the light of these considerations, is it any wonder that there is a growing gulf between the United States and foreign countries? Have we really played the game?

As for ourselves, it is difficult to see wherein we have accomplished anything of a constructive nature. In the six years since our tariff legislation the problem of getting our payments has come no nearer to being solved. It has, in fact, been aggravated by our obstructionist tactics. We have become a great creditor nation with known foreign investments of around $14,000,000,000, on which we expect to receive interest of approximately $1,000,000,000 a year. In addition to these investments, which are held privately, we hold a great mass of European war-debt obligations on which we are receiving interest and principal payments of $200,000,000 a year.

As a creditor nation we ought to be receiving these payments in goods — we ought to be importing more than we are exporting. But we are doing exactly the opposite. We are still showing a substantial export balance ‘in our favor.’ Instead of taking goods in payment for the yearly obligations due us we are taking promissory notes and other pieces of paper on a large scale. During the past year we made loans and investments in foreign countries of $1,500,000,000. This means that we advanced our own money to foreigners on the strength of their promissory notes, and they gave it back to us in payment for goods and past interest accumulations!

Thus far we have fared pretty well on our holdings of foreign bonds. To all outward appearances we have been getting the interest payments on these promissory notes in the normal way. In reality, however, we have been cashing one another’s interest coupons. Tom received interest on his 1926 foreign bond because Dick bought one in 1927. Both will get their interest in 1928 if Harry buys one. As time goes on, Tom, Dick, and Harry must all return to the market at intervals and cash their own interest coupons by buying new bonds, or other bond buyers must be found who will cash the interest coupons for them.

As a nation, our position is not unlike that of the merchant who on making a sale to one of his customers takes the customer’s promissory note, bearing interest. At the end of the year the customer offers another promissory note in payment for the accrued interest. He then proceeds to buy more goods for which he pays with more promissory notes, repeating the same operation year after year. The problem is: How long can the merchant continue to give credit in this manner, and how long before the customer is a bankrupt?

When confronted with this perplexing problem, we are inclined to brush it lightly aside. We have been so successful in cashing the interest coupons on foreign bonds over the past six years that we are not much concerned with philosophical speculations on the future status of debtor or creditor countries. We prefer to dismiss the whole problem by agreeing with the optimist who, falling from the roof of a forty-story skyscraper, at length passed an open window on the third floor, where he was heard to remark, ‘ Everything’s going all right so far.’

With the continued advance in our position as a creditor country, as now seems inevitable, the question arises as to how we are going to get the payments due us if we go on showing resistance to the importation of goods. At the rate our foreign investments have been growing and will probably continue to grow, larger and larger interest payments will be due us each year. We cannot take promissory notes in payment for an indefinite period. There is a limit also to the number of sound promissory notes that can be offered. Suppose we simplify the problem as much as possible by forgetting about such items as interest and principal payments on the war debts, on the assumption that these items may be canceled at some future date by a stroke of the pen. That helps a little. We then have to deal with foreign obligations of about $14,000,000,000, all privately owned, which cannot be got rid of through cancellation. How are the holders of these obligations going to receive their interest in years to come?

Under a goods-exclusion policy, the holders of foreign bonds may get some of their interest payments in the form of duty-free raw materials which do not compete with our own products. They may also get payments in the form of foreign services. For example, the countries in which our tourists travel and spend their money are rendering us a service. The same is true of t hose countries which receive remittances from our immigrant population, which carry our ocean freight, or which insure our cargoes. The more we spend for foreign services and noncompeting raw materials, the easier it will be for the holders of foreign bonds to collect, their interest.

Will these items be large enough to balance the international account and provide cash for the interest coupons? We are gambling that they will be. Who knows whether we shall win or lose in this particular gamble? Mathematically, the chances are all against us. If we put on one side of the scales the rate at which the yearly interest bill of foreign debtors is accumulating, and on the other side the greatest conceivable rate of increase in the importation of services and duty-free raw materials, there is not the remotest possibility of getting a balanced relationship. Only through ‘an act of God,’ as the lawyers say, could the scales be balanced.


Having created the problem of international payments, we alone can solve it. We can approach the problem in the spirit that we are dealing with a purely personal matter of business, affecting only ourselves; or, as befits our newly acquired status as a great Creditor country, we can take the broader view that we have certain responsibilities to our debtors. What are we going to do about it?

There are at least three ways of dealing with the problem. One way is to ignore it, ‘sit tight,’ and ‘let Europe stew in its own juice.’ Under this plan we should manage our trade and monetary affairs for our own immediate advantage. Although continuing to lend freely on the outside, we should have no concern whatever for the rest of the world. Eventually we should find that the countries and foreign industries to which we had made loans and sold goods could not meet their interest charges. The principal of the loans, too, would be wiped out. The problem would then be solved.

Many of the proposals which have been put forward from time to time for credit restriction or goods exclusion could lead to no other result. As a means of balancing the international account a solution of this kind would be effective, but it is surely not the kind of solution anybody wants.

A second method of dealing with the problem would be to remove its principal cause — that is, reduce the tariff and allow a great er quantity of foreign goods to be sold in our markets.

It is beginning to seem clear to the writer that our post-war tariff legislation was a mistake. There was no emergency at the time requiring emergency treatment. We were not being flooded with foreign goods. In the psychology of the moment we let our fears get the better of our judgment. Moreover, we should have realized that it is one of the easiest things in the world to put up the tariff and one of the most difficult things to get it lowered. Once high tariff duties have been imposed, industry promptly adjusts itself to the situation; but when the same duties are taken away, the stimulus to activity is gone, industry languishes, and men are thrown out of employment. The mere uncertainty caused by an agitation for tariff reduction has a depressing effect upon business. Who shall say that because our post-war tariff legislation was a mistake we should now rectify it and deliberately plunge business into depression, as a means of solving the problem of international payments?

The alternative plan is to leave the tariff where it is, utilize more of our gold, and take the consequences. The consequences would consist of credit expansion and inflation, which should eventually lead to a decline in our export balance. Under the influence of rising costs and prices in this country, foreign industries would revive, their goods would find new openings in our tariff wall, and our export trade would encounter fresh obstacles. Sooner or lat er we should have an import balance sufficiently large to provide the cash for our interest coupons. The consequences might not all be pleasant in the long run, but they would seem to be preferable to the consequences of any other plan.

There is a hopeful inference to be drawn from the events of the past year that we have already embarked, in a limited way at least, upon a programme of this kind. Beginning in July 1927, we made an astounding reversal in our monetary policy. Over the preceding period of seven years we had tried, with varying degrees of success, to hold credit expansion in check; now we proceeded to release credit on a grand scale — we began to utilize for credit purposes some of the gold we had sterilized prior to 1924.

The semiofficial explanation for this unexpected move was that we were trying to do something to assist the European situation and to facilitate the exportation of our products. The whole explanation might just as easily have been put in terms of self-interest. Self-interest demanded that we make a change. The continued inflow of gold was, or should have been, a matter of the greatest concern. It must have seemed clear that gold was becoming scarce in the world and that foreign currencies could not be restored to a sound basis so long as we continued to import gold. What should we gain if we absorbed so much of the world’s gold that other countries were unable to restore their currencies to a gold basis and, in desperation, were forced to seek a new standard of value? Instead of being better off we should be worse off. We should find that our vast stock of yellow gold had become a white elephant on our hands.

It was also clear that as fast as we received foreign gold it automatically gave rise to credit expansion. The gold which had been pouring into our overflowing reservoir during the preceding three and one-half years could not be controlled. The moment it flowed over the top it went into use as a basis for credit. We must have been forced at last to recognize that, while credit expansion could not be checked, the further inflow of gold could be stopped. The only effective way of doing this was to get our interest rates down to a point where gold would no longer be attracted.

The new monetary policy quickly accomplished spectacular results. It raised the value of foreign currencies, checked the fall in world prices, and stopped the flow of gold to this country. Incidentally, it provoked a storm of opposition from those who saw in our mounting volume of credit expansion inflationary tendencies.

It is true that the policy produced great credit expansion, on top of an expansion which had already reached phenomenal proportions. It promptly set up new high records in the volume of bank loans and investments, in stockmarket prices and brokers’ loans, and in new capital flotations. But great as the expansion in credit has been, it must go much further yet if it is to create a situation where goods can come in over the tariff wall and provide cash for the interest coupons on foreign bonds. Will our antipathy to inflation dictate our future policy? Shall we stand in the way of a credit solution to the problem of international payments? There is always the risk that we may.

There is still another danger to be faced. When we once reach the stage where we begin to get a substantial import balance, it is probable that we shall want to superimpose new tariff duties. Such action would be strictly in line with our basic theory of tariff making, which is that the duty on a given product should be approximately equal to the difference in the cost of production at home and abroad. From day to day we are endeavoring to apply this theory to individual products under the ‘flexible provisions’ of the Fordney Act. We have in actual operation the machinery which could thus effect a general increase in tariff duties without any new legislation on the subject, merely by singling out for consideration seriatim those products which persisted in scaling the tariff wall. It may be that the flexible provisions of the tariff law have proved a failure thus far, but our questionable tariff theory goes on.

It is time that we gave serious consideration to our situation. We are no longer a nation in isolation. Our commerce and finance have become international. The industrial and financial hegemony of the world has been thrust upon us. We cannot ‘sit tight’ and ignore the responsibilities of this new position without suffering the consequences. We prosper in proportion as we go with the tide, not as we go against it.

The occasion is not one which calls for philanthropic considerations. It is enough that we make sure what self-interest is, and then let ourselves be guided accordingly. If in the course of our business dealings wit h the outside world we are motivated by a genuine desire to better our position, we shall protect the equity of our investors in foreign bonds by keeping our policies in tune with inexorable economic forces; we shall recognize the commercial advantages of an import as well as of an export trade; and, finally, we shall show a disposition to do our part, in an economic way at least, in bridging the gulf between ourselves and foreign countries — a gulf in the making of which our trade and monetary policies have been mighty factors.