The Threat to the Dollar

Born in Belgium in 1911, educated at Louvain university and at Harvard, ROBERT TRIFFIN became an American citizen in 1942 and since then has played a major role in numerous monetary and banking reorganizations in Latin America and in the planning and negotiation of the European Payments Union. He is professor of economics at Yale University and the author of several books, the most recent being GOLD AND THE DOLLAR CRISIS, published last year by the Yale University Press.

THERE are two ways to go broke: a slow one and a fast one. The slow way is to go on, year after year, spending more money than you earn. But if you are rich to begin with, you won’t go broke very fast that way. You will pay for your overspending by depleting your bank balance and other assets and by getting loans from people who trust your capacity to repay them later.

A much faster way to go broke is to finance too much of your overspending by short-term borrowing. Even if you stop overspending, you may then still run into serious trouble if your IOU’s are suddenly presented to you for repayment at a time when your bank balance has fallen too low to cover them. If you still have other, longer-term assets in sufficient amount, you will remain perfectly solvent, but you will be confronted, nevertheless, with what is called a liquidity crisis.

This, in a nutshell, is the United States’s problem today and the reason why our dollar is facing a serious threat in the international exchange markets. We have, over the past decade, spent, lent, and given away about $20 billion more than we earned and covered the difference by cash payments in gold ($6 billion) and also by short-term IOU ‘s ($14 billion), which foreign central banks, private banks, and individuals were, until recently, quite glad to invest in, since the dollar was regarded as safer than any other currency, and even, for the time being, as safe as gold itself.

The Eisenhower Administration woke up belatedly to the problem when gold prices suddenly flared up on the London free market last October and when U.S. gold losses shot up in the followingweeks to a rate of between $400 million and $500 million per month. A wind of panic blew over Washington officialdom, and hurried steps were taken or planned “to restore overall balance in our foreign transactions.”

Although the exact measures adopted may not have been the wisest ones, their objective was highly laudable. We should, of course, steer away from the slow road to bankruptcy. The trouble is that we have not given much evidence so far of any clear understanding of the liquidity, as opposed to solvency, crisis that constitutes the real and most urgent threat to the dollar and of the measures needed to combat this far greater danger.

We might well regain full equilibrium in our overall balance of payments — we are indeed far closer to that goal already than the Eisenhower Administration seemed to suspect — and yet be faced by massive demands for conversion into gold of the short-term debts inherited from our former deficits. Such massive liquidation by foreigners of their present dollar holdings would certainly become less likely as we gave evidence of our determination and ability to put a stop to our persistent deficits of the last decade. It would still exist, however, and might be triggered at any time by speculative rumors — justified or unjustified — or, more simply, by interest-rate differentials between New York and other financial centers, primarily in Western Europe. As long as such a threat is allowed to persist, we may find ourselves unable to manage our own credit and interestrate policies, in the best interests of our economy, without running the risks of large gold outflows from our shores and, ultimately, of a totally unnecessary devaluation of the dollar, disastrous to us and to the rest of the world as well.

Even if we chose to close our eyes to this danger, another major crisis would in time develop from the very success of our efforts to redress our own balance-of-payments position. The elimination of our deficits would indeed dry up at the source two thirds of the annual supply of monetary reserves on which the rest of the world has come to depend for the maintenance of international currency convertibility in an expanding world economy.

The present crisis of the dollar is in fact inextricably bound up with the ill-fated attempt to dig up and dust off an international monetary system which collapsed nearly half a century ago, during World War I, and which must be thoroughly overhauled in order to adapt it to presentday needs and conditions.

This international monetary system is theoretically based on the old, pre-1914 gold standard. In the decade following World War I, the “world gold shortage” was a frequent subject for discussion among academic economists and the main topic on the agenda of a long series of international conferences which culminated in the marathon debates of the Gold Delegation of the defunct League of Nations. The “gold shortage” was temporarily solved in the meantime by the growing use of two national currencies, sterling and the dollar, as international world reserves, along with the gold, in short supply. This, however, could not be more than a makeshift. It ended, disastrously, in the early 1930s with the successive devaluations of both of these currencies and the consequent collapse of the world monetary system.

In the decade following World War II, the basic role played by gold in our international monetary system was all but forgotten. A new slogan came to dominate academic discussions and governmental policies: the slogan of the “world dollar shortage.” These policies were eminently successful. They accelerated the reconstruction of war damage and the expansion of the underdeveloped economies, and stimulated a rate of growth in world trade and world production unprecedented in duration and magnitude in the history of the world.

Yet they, too, were built upon the same makeshifts as in the 1920s. They, too, threatened to end in the early 1960s in a new collapse of world trade and world currencies similar to that of the early 1930s.

This grim parallel has its roots in a common and age-old problem: the routine and inertia which tie man to his past and make him unable or unwilling to effect in time the adjustments necessary to the successful performance, and ultimate survival, of his economic, social, and political institutions in a fast-changing world.

A SIMPLE comparison may be helpful at this stage. We all know too well the need which we have to carry some amount of currency in our pockets and to keep a checking account at our bank in order to bridge the gap between paydays and to be able to pay for our groceries and other purchases. The amounts of currency and deposits which we have to hold for this purpose bear some obvious, even though fairly loose, relation to the level of our income and expenditures. In very much the same way, countries must hold, generally in their central bank, international reserves to bridge seasonal and other inevitable and unpredictable gaps between their receipts from and payments to other countries. The amounts of reserves required for this purpose also hold an obvious, although equally loose, relation to the turnover of trade and production.

Now, imagine how little trade and production could have grown in the United States over the last century if the only means of payment available to all of us, as a group, had been the number of gold coins that could be minted from the haphazard growth of gold mining in California and Colorado. This, fortunately, was never the case, either here or in any other country. Paper currency and bank deposits played, throughout, a large and growing role, alongside declining amounts of gold, silver, and other minor coin, in the national monetary system of every country. Even in the heyday of the gold standard, the total monetary gold stock of the United States, for instance — both in the form of gold coin and central gold reserves — fell from about 30 per cent of the overall means of payment of the country in 1860 to about 8 per cent in 1914. The provision of an adequate, but noninflationary, volume of money for our expanding economy already depended then, as it still does today, upon the soundness and resiliency of our banking institutions and credit policies, rather than on any blind enslavement to the much-vaunted automatic discipline of the so-called — or miscalled — gold standard.

The basic problems which deposit banking has long been able to solve within national borders, under the guidance of national monetary authorities, still remain largely unsolved, however, as far as international payments are concerned. Or, rather, since the world has to go on, they have been solved after a fashion, but only through a succession of makeshifts and at the cost of recurrent international crises manifesting themselves in the form of widespread deflation, currency devaluations, and trade and exchange restrictions.

Under the so-called full-fledged gold standard, prevalent in the last third of the nineteenth century and until World War I, gold was used exclusively, or nearly exclusively, by most central banks as international reserves and as the ultimate means of settlement for temporary imbalance in all major countries’ international transactions. The enormous gold discoveries of the mid-nineteenth century had made possible for a while the adoption of such a system, but the maintenance of adequate gold reserves by central banks the world over was fed in addition, even then, by the gradual replacement of gold coin by currency and deposits in the countries’ national monetary circulation. But this latter process was bound to come to an end and did with the world-wide demonetization of gold in the 1920s and early 1930s. The world gold shortage has been with us ever since, although its timing and acuity have also been vitally affected by the vast price disturbances arising from wartime and post-war inflation and from the Great Depression of the 1930s.

Over the whole period from 1914 through 1959, new gold production outside the Soviet bloc has fed considerably less than half of the average increase in the world’s monetary reserves. In the fifteen years from 1914 through 1928, it accounted for only 38 per cent of reserve increases, another 30 per cent of which was derived from the withdrawal of gold coin from active circulation, and the remaining 32 per cent from the growing use of major national currencies — primarily sterling in those days — as international reserves by central banks, alongside gold itself. This custom had spread under the prodding of British currency experts and the spur of the interest that central banks could earn on such foreign exchange investments— but not, of course, on the gold kept in their vaults. Together with the flight of hot money from the war-torn and inflation-wrecked continent of Europe, it helped the British restore the pound to its pre-war parity in 1925, while Continental currencies sank excessively in value under the impact of speculative money flights from the Continent to London.

This soon proved a very mixed blessing for Britain. The overvaluation of sterling or the undervaluation of other European currencies handicapped British exporters in relation to their main competitors in world markets. Europe boomed while Britain suffered from economic stagnation and unemployment. Britain, moreover, felt impelled to tighten credit and interestrates in order to attract or retain foreign funds in London and avoid unsustainable gold losses. Such monetary policies were bound to aggravate the deflationary pressures already at work on the British economy. They became, in any case, powerless to stem the flow when the later stabilization of currency conditions on the Continent triggered a massive repatriation of the funds which had previously sought refuge in London.

Continental central banks reluctantly agreed to support sterling for a while by moderating their own conversions of sterling funds into gold. This merely postponed the day of reckoning. The collapse of a bank in Vienna unleashed a new wave of currency speculation which led to further withdrawals of funds from London. On a fateful day in September, 1931, Britain threw in the sponge. The collapse of the most powerful currency that the world had ever known spelled the collapse of the international gold exchange standard itself and ushered in a long period of exchange chaos in the world’s monetary relations.

GRIM parallel could easily be drawn between the rise and fall of the sterling exchange standard after World War I on the one hand, and on the other the rise of the dollar exchange standard after World War II and the difficulties which we are facing today. Foreign funds have, ever since 1934, sought a haven in New York rather than in London. These speculative movements played a role in the consolidation of exchange rates — mostly in 1949 — at levels which appear now to have undervalued European currencies with respect to the dollar. Our economy has grown, for the last ten years, at a snail’s pace in contrast to the rates of growth experienced by most European countries. The repatriation of European funds which had previously sought refuge here initiated a gold outflow of more than $2 billion in 1958.

This drain was slowed down to $1 billion in 1959 and to a mere trickle in the first half of 1960 under the impact of a drastic stiffening of interest rates in this country. It again assumed dramatic and even alarming proportions, however, in the second half of last year. This was primarily, at first, the result of the lower interest rates and the darkening Wall Street outlook brought about here by an incipient recession coupled with booming activity and a tightening of interest rates in Europe. Incredible bungling by some of our Treasury officials during the September meetings of the International Monetary Fund poured oil on the fire by allowing a flare-up of gold prices in the London market, which unleashed a wave of speculative gold buying by Americans as well as foreigners. Our gold losses jumped from an average of only $25 million a month during the first hall of 1960 to more than $200 million a month in the third quarter, $300 million in October, and $500 million in November; that is, to an annual rate of nearly $6 billion a year, just about equal to the amount which antiquated and ill-conceived legislative provisions leave us as “free gold” reserves.

Fortunately, other countries have as great a stake as we have in helping the United States ward off a devaluation of the dollar, which would once more usher in a long period of chaos in exchange rates, such as followed the 1931 sterling devaluation, and benefit mostly the two largest gold-producing countries in the world, South Africa and the U.S.S.R. Time is running short, however, and we are each day living more and more dangerously on the edge of the precipice.

The most feasible and constructive way to ward off the international monetary breakdown which a dollar collapse would entail would be to enlarge and streamline the present methods of operation of the International Monetary Fund. This could be done in two stages.

All that the first stage would require would be a mere declaration by the Fund that it stands ready to accept reserve deposits from its member central banks, just as our Federal Reserve System accepts reserve deposits from commercial member banks in this country. Under the rules of the Fund, such deposits would carry a gold-exchange guarantee, making them extremely attractive to central banks. They would be as safe as gold itself and as usable for payments anywhere in the world. Their conversion into any currency needed for payment would be effected most simply, efficiently, and economically by drawing a check on the paying country’s account and depositing it in the account of the country whose currency was purchased.

The Fund, moreover, would be in a position to pay interest on these deposits out of the earnings derived from investment of the assets transferred to it by members in exchange for such deposits. The advantages of interest-earning, gold-guaranteed deposits with the Fund over both sterile gold holdings and exchange-risky balances in national currencies should be sufficient to induce most countries to exchange voluntarily for Fund deposits the bulk of their present foreign exchange holdings and possibly even some portion of the reserves which they now retain in gold.

Countries other than the United Stales and the United Kingdom would constitute, initially, the bulk of their deposits with the Fund by transferring to it the dollar and sterling balances which they now hold as part of their monetary reserves. The United States and the United Kingdom would, as a consequence, owe these balances to the Fund rather than to several scores of foreign central banks. The Fund would hardly wish to liquidate precipitously its holdings of such balances at the risk of precipitating a monetary crisis in the United States or the United Kingdom, and should not, in any case, be allowed to do so. Its right to demand repayment should be limited to a preagreed annual ceiling and should, even then, be exercised only insofar as is useful for the conduct of its own operations. In view of the vast expansion of its resources which the proposed reform would entail, it could, on the contrary, be expected to seek to expand, for several years to come, its dollar and sterling investments, thus giving us a further and useful breathing spell to bring about, in as smooth a manner as possible, the needed readjustments in our overall balance of payments.

The United States and the United Kingdom would, in this manner, recoup the freedom of monetary management—particularly in relation to their interest-rate policies — which is now so severely handicapped by the fear of the gold losses that would accompany the liquidation of foreignowned short-term dollar and sterling balances. As for the other countries, they should also welcome the opportunity of exchanging their overbloated dollar and sterling balances for equivalent Fund deposits. They now hold large amounts of such balances in preference to gold because of the interest earnings which they carry. They do, however, expose themselves thereby to the exchange losses which would be entailed in a dollar or sterling devaluation, to say nothing of the risks of blocking or inconvertibility. Deposits with the Fund would offer them the same incentive of interest earnings — although at a slightly reduced rate — while giving them the full gold guarantees which automatically attach to all transactions with the International Monetary Fund.

This simple suggestion could be implemented all the more easily and rapidly as it does not require any amendment or renegotiation ol the Fund’s Articles of Agreement and as it has already received in England the unanimous blessing of the Radcliffe Committee on the Working of the Monetary System.

The second stage of my plan would require a modification of the Fund’s Charter, but a very simple and unobjectionable one. The present system of arbitrary and rigid quota subscriptions to the Fund’s capital should be dropped and replaced by minimum deposit requirements with the Fund. That is to say, all countries would undertake to hold, in the form of deposits with the Fund, an agreed proportion of their total monetary reserves. They would remain free to convert into gold, if they wished, any amounts accruing to their Fund deposit over and above this agreed minimum.

Such an obligation would adjust automatically and continuously each country’s actual lending to the Fund according to its contributive capacity and to the need of the Fund for the currency of the particular country. It would do away with a system under which the Fund is now flooded with national currency capital subscriptions in bahts, kyats, bolivianos, and other currencies for which it has no earthly use and under which 90 per cent of its lending has in fact been made in dollars, thus aggravating our reserve losses, rather than in the currencies of the countries which were actually accumulating large reserve surpluses in their international transactions.

These proposals have been amply scrutinized and discussed in recent months, here and abroad, by academic, financial, and government experts. They obviously raise a host of questions which cannot be fully examined in this brief article. The real obstacle to action does not lie in their technical details, which could easily be modified in the course of negotiations, but in their long-run political implications. There is no denying the fact that such a reform of the international Monetary Fund could be interpreted as a first step toward the setting up of a supranational monetary authority to which central banks and governments are understandably reluctant to yield any portion of their cherished national sovereignty and independence.

Whatever one’s views are in relation to this broad issue, it should be obvious that none of the measures proposed here would restrict the present real sovereignty of any country any more than it is already restricted. These measures would substitute. in a limited area, collective, mutually debated, and agreed limitations on national monetary sovereignties for the much harsher, haphazard, and often disastrous limitations now imposed upon them by chance events and by the uncoordinated use of sovereignty by several scores of so-called independent countries, with little or no regard to their compatibility and their impact on others.

Clearly, the world cannot tolerate much longer an international monetary system which has become so utterly dependent for its functioning on such accidental sources of reserve supplies as these:

1. Gold digging in a country — South Africa — whose economic life might be paralyzed tomorrow by the eruption of racial warfare.

2. Mr. Khrushchey’s policies about U.S.S.R. gold sales to the West, which were responsible for more than a third of monetary gold increases in both 1958 and 1959 and whose abrupt cessation in 1960 contributed, at least in part, to the recent explosion of gold prices in London.

3. The perpetuation of our balance of payments deficits and the continued acceptance of dollar IOU’s as monetary reserves by other countries; such gold and dollar losses by us have accounted for about two thirds of foreign countries’ reserve increases over the last ten years and cannot continue much longer without undermining confidence in the dollar and its acceptability as a reserve currency.

I have no doubt, therefore, that future events will push us inevitably toward a basic reform of our present international monetary system. The real question at issue is not whether the proposals outlined here, or other broadly similar ones, will be adopted in the end. It is whether political leadership in the United States and the other free countries will prove sufficiently enlightened and dynamic to adopt them in time or whether they will have to be forced upon us by new crises and upheavals such as we experienced thirty years ago, during the first years of the worst international depression that the world has ever known.