Foreign Relations of the United States, 1952–1954, General: Economic and Political Matters, Volume I, Part 1

Eisenhower Library, Randall Commission records, “1953–1954”

Memorandum by John H. Williams of the Commission on Foreign Economic Policy to the Members of the Commission ¹

confidential

[ Washington ,] December 15, 1953.

• Subject:
• Currency Convertibility

1. Convertibility and the Balance of Payments

There have been two attitudes or schools of thought regarding the restoration of currency convertibility.

(a) One school of thought regards the restoration of convertibility as largely a matter of curbing inflation abroad, through the use of appropriate monetary fiscal policies, and of adjusting exchange rates to appropriate levels. If such steps are taken, it is argued, convertibility would be feasible in the near future. This school of thought regards the war-induced disturbances in production and trade as temporary phenomena which have now been surmounted. All that remains for the introduction of convertibility is appropriate monetary-fiscal and exchange rate policies.

(b) Another school of thought regards the problem as much more complicated than this. While agreeing that the curbing of inflation and the fixing of appropriate exchange rates are essential for convertibility, this school argues that such measures may not be enough. It lays emphasis on the structural, longer-run, nature of many of the war-induced distortions in production and trade (especially as they have affected the position of Western Europe). Such distortions include the adverse turn in Europe’s terms of trade, the loss of Europe’s overseas investments and earnings therefrom, the relative decline in primary production in underdeveloped countries due to their industrialization programs, the disarrangement of the prewar triangular pattern of world trade, and other such relatively “intractable” factors.

This school also emphasizes the growing predominance of the United States in the world economy, already apparent long before the last war, which has intensified the effects abroad of short-run economic fluctuations here, and the longer-run disparities in productivity and real income.

Because of these structural developments, this school of thought takes a more cautious attitude regarding convertibility. It does not deny that the restoration of convertibility is possible, but it believes that the approach to it should be more gradual and experimental until there is reason to believe that the chances of its success are more assured.

2. Prospects for Convertibility

The general prospects for convertibility today are better than they have been at any time since the war. Production in Western Europe is now well above prewar levels; Europe’s exports have greatly expanded; the internal financial situation in European countries has much improved; the balance of payments of Western Europe with the dollar area has been brought into balance; and monetary reserves abroad are rising.

In interpreting these favorable changes, however, account should be taken of several facts.

(a) The recent closing of the dollar gap has been accompanied by a favorable change in the terms of trade, due largely to the decline of raw material prices from the high level created by the outbreak of the Korean war. This change, however, may be temporary, since before it occurred the terms of trade had been increasingly adverse to Western Europe because of the large growth of world industrial output since prewar and the relatively small growth of primary production, a relation which, looking to the future, appears to be borne out by the findings of the Paley Report.

(b) Owing to direct restriction abroad of dollar imports, the potential demand for dollar goods and services, in a free market and with convertible currency, would probably substantially exceed the present effective demand.

(c) In recent years American imports have been maximized by the high level of American gross national product. Experience has shown that our imports are very sensitive to our level of national income, and that any recession here has a multiplied effect in reducing foreign exports to this country.

(d) The recent closing of the dollar gap and the increase of monetary reserves abroad (running currently at some two billion dollars a year) has been accompanied by “extraordinary dollar payments” by the United States to other countries of about five billion dollars a year, consisting of disbursements by our military and civilian establishments abroad (and not including our shipments of military goods), off-shore procurement, stockpiling, and economic aid.

Notwithstanding these qualifications, it remains true that conditions abroad have substantially improved and that the prospects for achieving convertibility of currency are now better than at any time since the war. These qualifications, however, together with the other considerations mentioned earlier, lead me to favor a gradual approach, rather than a “dash” for convertibility, such as was favored in some government circles in Britain last year. (I might add that the one British economist outside the government, who was consulted last year by the government, disapproved of the “dash” method, even though he adhered to the more optimistic school of thought to which I referred earlier.) By now, the gradual approach seems clearly to be the generally accepted policy in Britain. It is also generally recognized that the prospects for continued advancement toward sterling convertibility, and for its maintenance once established, would be better the larger the number of countries that currently move toward, or establish, convertibility.

3. Meanings of Convertibility

The term convertibility has undergone changes over the years. Under the old gold standard it implied the convertibility of a currency by residents and non-residents into gold, both internally and externally. But no one thinks today any more in terms of convertibility into gold. In current discussions the term has largely come to mean the right of non-residents of a country to convert into any foreign currency their current earnings in that country’s currency. The term does not necessarily imply the right of non-residents freely to transfer capital out of the country whose currency has become convertible. Nor does it imply the right of residents of that country to export capital freely. On the other hand, if convertibility is to have real meaning, it must be associated with the removal of quantitative trade restrictions, especially those of a discriminatory sort, imposed upon expenditures abroad by residents of the convertible country. It seems to me very doubtful that both of these goals, namely, non-resident convertibility for current transactions and the elimination of discriminatory quantitative trade restrictions imposed on residents, can be achieved simultaneously; a gradualist approach toward both goals seems desirable. Since capital movements by residents and non-residents alike will continue, however, to be controlled for some time to come, the maintenance of an exchange control apparatus will still be necessary even after convertibility and non-discrimination have been restored. In the case of Britain, for example, the outstanding sterling balances held by foreign countries cannot be made fully convertible for some time to come in view of the great pressures that such convertibility would impose upon the pound. It should be added, however, that the situation as to these balances is now much better than at the end of the war.

4. Degree of Convertibility Existing

Within the sterling area there is already virtually complete interconvertibility of currencies and a virtual absence of quantitative trade restrictions. That is, individuals in the sterling area can freely buy in any other country within the area and freely transfer sterling from one sterling area country to another. Sterling area members are also able to convert their sterling holdings into dollars through the dollar pool arrangements, but the extent to which they do so is limited in actual practice by the quantitative restrictions on imports and payments which the various members, in cooperation with Great Britain, maintain against the United States. Within the European Payments Union, also, there is complete interconvertibility of currencies through the clearing facilities provided by the Union and there is also partial convertibility into dollars through the dollar settlement provisions of the Union. EPU countries maintain discriminatory import restrictions against the United States in the same way as do the members of the sterling area. They have, however, made substantial headway with their trade liberalization program designed to remove discrimination among themselves.

As the OEEC witnesses before our Commission emphasized in Paris, one of the chief lessons from the Payments Union experience is that trade liberalization and currency convertibility go hand in hand, and are mutually dependent. One further point about both the sterling area and the OEEC is that recently their exports have become more competitive with ours in third markets, and that some steps have been taken in both areas towards lessening restrictions on dollar goods. These recent developments should not be exaggerated, but so far as they go, they have a favorable bearing on the feasibility of more general convertibility.

5. Approaches to Convertibility

There are various possible ways in which convertibility (and nondiscrimination in trade) can be approached gradually.

(a) One possible method would be through the so-called “commodity convertibility” with which Britain is currently experimenting. That is, non-residents might be permitted increasingly to use their sterling holdings to buy dollar commodities, e.g., non-ferrous metals, on British commodity markets. Since the list of commodities could be gradually enlarged, this would be a way of gradually approaching the goal of full currency convertibility. The advantage of this method is that it permits the country in question to keep a firm hand upon the process of transition toward fuller convertibility and avoids a large and sudden rush by other countries into dollars via sterling, such as occurred in 1947 and would always be a danger so long as a substantial dollar gap exists anywhere in the world.

(b) Another method of gradually approaching convertibility would be for the British to grant the convertibility privilege into dollars to a growing list of countries instead of introducing it to all countries simultaneously.

(c) Another method, which seems to have a considerable amount of support on the continent at the present time, would be gradually to remove quantitative import restrictions against the United States and to introduce convertibility only at a later stage.

(d) Finally, there could be a gradual approach to convertibility within the framework of the European Payments Union itself rather than via a few key currencies such as sterling. Serious doubts, however, exist as to the feasibility of this approach without destroying the Payments Union. The Managing Board of the Union, after having studied the technical problems involved for over a year, have recently been requested by the OEEC Council to study the matter further and report next March. My own view is that it would be desirable to preserve EPU if that can be done without preventing the advance toward convertibility of sterling and other European currencies into dollars, but that since, as the OEEC representatives have always stated, EPU is not an end in itself but only a step toward more general convertibility, the question of its preservation should not be allowed to stand in the way of progress toward more general, world-wide convertibility of the major currencies, particularly sterling.

6. Floating Exchange Rates

If sterling and certain other Western European countries become convertible the British and the other countries concerned may want to let their rates “float,” for a while at least, rather than to hold them fixed as they are today. In fact, the British Government has stated that it will not undertake any substantial steps toward fuller convertibility except on a basis of floating rates. A floating rate would tend to relieve some of the pressures on reserves that might be associated with the introduction of convertibility. For, if the rate tended to decline, exports would tend to be stimulated and imports to be retarded. It is believed also that, if the rate declined, adverse speculative pressures against the currencies concerned would tend to be discouraged, since speculators would fear the losses that would result if the floating exchange rate moved up again, or was pushed up by official support. There is a risk, however, that a floating rate might actually accentuate rather than improve the convertible countries’ positions by increasing the cost of imports, causing inflationary pressures at home, and creating fears that the rate might continue to drop rather than rise.

As the British have said, they want a “floating” rate and not a “sinking” rate. It is therefore necessary to form a judgment whether the internal economy is strong enough to provide reasonable assurance that inflationary and speculative pressures will not get out of hand. Thus the use of a “floating” rate, though technically desirable in that it provides, as Chancellor Butler said, two ways of meeting an external deficit (letting reserves go or letting the currency depreciate) again argues for a gradual and controlled approach toward sterling convertibility.

7. What Might the United States Do?

A great psychological lift to Western Europe would result if the United States gave its verbal blessing and active encouragement to a move toward convertibility by Britain and some other European countries. On the other hand, it is important that we do not put a date on convertibility, as we did in the case of the pound sterling in 1947. The time schedule for, as well as the method of, restoring convertibility is something that should be decided upon by foreign countries themselves and not by us. Finally, the United States might, at the appropriate time, provide the additional reserves to foreign countries that might be needed to support convertibility of foreign currencies.

8. The Question of Monetary Reserves and Stabilization Credits

Despite the recent increase in the monetary reserves of foreign countries, these reserves, and especially those of Great Britain, are much lower, relative to the volume of world trade, than they were before the war. Great Britain has already made it clear that convertibility could not be safely undertaken unless the volume of its reserves is enlarged.

There is a growing insistence that, in order to support a move to convertibility abroad, the gold and dollar resources of the International Monetary Fund, now about 3.3 billion dollars, should be put to much more active use than they have in the past. It is believed, for example, that the Fund could extend a stand-by credit of approximately 2 billion dollars to Great Britain, plus the outer sterling area, to support a move to convertibility. The Fund might also be able to grant small stand-by credits to other countries contemplating convertibility. Attention should be directed to all possible methods by which the Fund’s resources could be put to more active use for this purpose.

The present resources of the Fund, however, would probably be inadequate to satisfy the reserve needs of Great Britain and other countries for a convertibility undertaking. It seems probable, therefore, that additional reserve funds might have to be provided if this goal is to be achieved. One possibility would be to enlarge the resources of the Fund itself by an increased contribution from the United States. Another alternative, which would not involve any public debt transaction, would be the granting of stabilization credits to foreign central banks by the Federal Reserve System. Such credits have been granted in the past and might usefully be granted in the future.

Whichever method of supplementing reserves might be decided upon, the basic purpose of stand-by credits and stabilization credits is to strengthen confidence in the currencies becoming convertible and therefore to discourage speculative pressures that might arise and endanger the continued maintenance of convertibility. Standby credits and stabilization credits should not be regarded as methods of financing continuing dollar deficits of foreign countries. In fact, if such deficits existed, on any substantial scale, convertibility would in any case not be feasible.

In concluding this statement, I will try to bring together my own ideas. To achieve and maintain full currency convertibility a country should be in a strong economic position, internally and externally. It should have removed direct internal controls and have proved its ability to control its money supply and its budget. Externally, it should have overcome its balance of payments deficit or be far along toward that goal, in order to be reasonably sure that convertibility will assist and not endanger progress toward that objective.

I take the more serious view of the world’s dollar problem, namely, that it contains “intractable” elements. The present apparent balance (apart from our military exports) is illusory, in that there are still large “extraordinary” dollar expenditures, the removal of which would reveal a dollar gap of about $3 billion (as against a postwar average of $4 billion) which could easily increase if there were a recession here or if the terms of trade of Western Europe should take an unfavorable turn.

In these circumstances, I think that it would be unwise for us to press the British, or any other country, toward currency convertibility, and that the decision, timing and responsibility should rest entirely on the country concerned. Nevertheless, there has been enough progress, internally and externally, to warrant Britain, and probably some other countries, in taking gradual steps toward currency convertibility. The most important single step, I believe, is that on which the British seem already embarked—that of gradually removing trade restrictions and reopening commodity markets for dollar goods, and permitting the holders of sterling balances owned by third countries to purchase dollar goods. This is a way of gradually expanding the area of currency convertibility through “commodity” convertibility, which seems to me a much more controllable process than the general convertibility that Britain attempted in 1947.

Though I do not favor letting the rate go free to “find its own level,” which presents the danger of a vicious circle of inflation, I am sympathetic toward the British desire to have a “floating rate,” fluctuating around some norm, and I feel certain that the British would not attempt anything like full convertibility on any other basis. Other points on which I think they would insist, and I think rightly, are controlling capital movements (at least outside the sterling area) and taking effective precautions against runs on the previously accumulated sterling balances, even though the situation as to these balances is now much better than at the end of the war.

One further important question, which however we may feel goes beyond our province, is the effect of sterling (and other European currency) convertibility upon the European Payments Union. The British have apparently withdrawn from their position of a year ago, when they were proposing an escape clause permitting withdrawal from EPU on three months’ notice if they decided to make sterling convertible; and as the matter now stands after a year of study by the EPU Managing Board, the Board is requested to report again next March on the question of compatibility of currency (particularly sterling) convertibility and the continued functioning of EPU. My view is that EPU has always been regarded (by its own testimony) as a temporary mechanism with limited objectives—an intra-European multilateral system of trade and payment. But it has achieved an impressive measure of success—above all, it has shown that freeing trade and freeing payment go hand in hand—and we should not sponsor any measures which might wreck it before there is something better to put in its place. This is a problem for the British and the other OEEC countries to thrash out among themselves.

Last and most important, is the question of adequacy of reserves. It must always be borne in mind that sterling is a key currency, i.e., a currency used to finance the trade of third countries. Even now sterling finances about half of the total trade of the world, and if made convertible it would be exposed to trade, financial and speculative pressures to a far greater extent than other European currencies This is indeed why, in proper circumstances, we want sterling to become convertible, in the interests of freer trade and payment in a world-wide multilateral system. But it follows that confidence in sterling must be fully restored, which means, among other things, that Britain’s reserves must be greatly strengthened. I have mentioned earlier the International Monetary Fund and some credit arrangement between the Bank of England and the Federal Reserve System as the most likely possibilities.

In conclusion, it is of course clear that currency convertibility must be examined in the light of the policies pursued by other countries, particularly the United States. Thus all the other aspects of our current study—foreign investment, customs, tariff, agricultural policy, etc., have a bearing. As the British have put it, sterling convertibility depends in part on our pursuing “good creditor policies.” We might have, as I do myself, a more serious view than other countries might have of the difficulties involved in pursuing such a course. But I think we should see that the view that we do take on all these questions will have an important bearing on the speed, the methods, and the timetable involved in achieving convertibility.²

1. For information concerning the Commission on Foreign Economic Policy (Randall Commission), see the editorial note, p. 49.
2. For the Randall Commission’s recommendations concerning currency convertibility, see the Commission on Foreign Economic Policy, Report to the President and the Congress (Washington, 1954), pp. 72–75.