111. Volcker Group Paper1
LONG-TERM ASPECTS OF U.S. INTERNATIONAL MONETARY AND EXCHANGE POLICIES
This subject is discussed in this memorandum under these headings:
- Activation of Special Drawing Rights
- Gold Price Problems
- Interchangeability of Dollars, Gold and Other Reserve Assets
- Exchange Rate Policies and Principles—Fixed Parity or Limited Flexibility
Activation of Special Drawing Rights.—The U.S. looks forward to an early activation of the Special Drawing Rights Plan. Mr. Schweitzer has indicated that it might even be possible to consider activation at the September Annual Meeting of the Bank and Fund. He believes, however, that a Ministerial Meeting of the Group of Ten would probably have to take place, possibly at the Annual Meeting itself. Presumably such a Ministerial Meeting would include the French, even though they might not be participants in the SDR scheme.
Any such timetable would probably mean that the Deputies of the Group of Ten would need to begin work on the problem of activation fairly soon in order to recommend a course of action to the Ministers. We might make a tentative suggestion to Mr. Ossola that he convene the Deputies to begin this work either at the February session of the OECD or on the occasion of the next meetings in Europe in the spring.
The following points are suggested for further exploration in the Volcker Group as to the U.S. position and posture on this problem.
Amount of Reserve Creation.—It has been suggested that the United States would like to see reserves created in the amount of $3 to $4 billion a year, amounting to a 4 or 5 percent annual increase in global reserves. It is not clear whether this target would be the initial asking price, for SDRs alone, or whether it would be adjusted downward (or upward) in the event of a continuing addition to (or subtraction from) world reserves through deficits (or surpluses) of the reserve centers. One question to be examined is whether we should continue to envisage a constant annual amount of reserve creation during the five-year period, or a larger figure in the early years, followed by smaller figures in the later years of the initial five-year period.
U.S. Balance of Payments and European Attitudes.—The question arises as to whether the Europeans will be prepared to move to an early activation if the U.S. resumes a substantial deficit on official settlements account in 1969 and in ensuing years. The sources of reserve creation can become complex, and more than $2 billion was apparently added to world reserves outside the United States in 1968, despite an official settlements surplus of $1.6 billion in the U.S. In order to prepare our position on activation, it will be necessary to make a projection of world reserve creation for five years in the absence of any activation. This projection will depend in part on a corresponding projection of the U.S. balance of payments position during the period. Are we to assume no change in official dollar holdings during the next five years, or an upward trend in these holdings at a moderate figure?[Page 294]
2) Gold Price Problems.—While an early activation of the SDRs would help to set at rest speculation for an increase in the official price of gold, we cannot be sure that an aggressive devaluation by the French would not bring this problem to the center of the stage. Minister Schiller’s continued references to a “realignment of currencies” might also envisage a change in the official monetary price of gold, and hence references to it continue to keep up the hopes of speculators.
The Schiller realignment problem might become serious if the Germans and other Europeans were to delay activation of the SDR and give the French support for a rise in the official gold price. We hope that this technique will not be adopted, and Schiller indicated last November that he was in favor of activation of the Special Drawing Rights. But it seems possible that he is seeking a general realignment of currencies to facilitate and cover a Deutschemark revaluation, and it is reported that he has expressed the view that the dollar is overvalued.
An aggressive French devaluation, which carried with it at least some depreciation of the pound sterling and other European currencies, could present a problem to the U.S. in choosing its future gold and exchange policy. This would be especially true if Germany, Italy, and Japan, for example, were to follow the French with some depreciation. Presumably these strong currencies would move only if the French depreciated by such a large percentage that they would be fearful of the impact on their trade. However, if by any chance there were such a general depreciation by the major countries, the United States would seem to face a decision on these basic alternatives:
- Elimination of full convertibility and aggressive negotiations with other countries on mutually acceptable exchange rates for all major currencies in terms of the dollar. Such an aggressive negotiation might have to be backed up by threats to make illegal transactions in dollars at any other than a mutually agreed exchange rate.
- The adoption of a general system of export subsidies and import taxes to offset foreign depreciation or even gain some advantage for U.S. exports in terms of some countries.
- Depreciation of the dollar in terms of gold and other currencies, which would imply a rise in the official monetary price of gold.
3) Interchangeability of Dollars, Gold and Other Reserve Assets.—Assuming that the problem of the gold/dollar relationship is not brought to a head by some monetary crisis, as mentioned in the preceding section, there is a more fundamental question of the long-term U.S. policy with respect to convertibility of dollars into gold. Various approaches have been suggested which have the effect of limiting the potential strain of convertibility. One of these is the freezing in some way of foreign dollar balances. One is the reserve settlements account of Mr. E.M. Bernstein, which is an advanced method of eliminating convertibility [Page 295] that would present very difficult if not impossible negotiating problems. The third is a continuation of the rather informal way in which convertibility has been to some extent limited through central bank cooperation, the re-channeling of reserves into the international money market, through commercial banks, and other ways of holding down the growth in official dollar reserves.
The fourth approach is the suggestion for a dollar bloc and a gold bloc, with a flexible exchange link between the two.
These various proposals may be judged against the long history of monetary evolution. The convertibility of money into a metallic asset has been steadily restricted until it no longer exists domestically in most advanced countries. For a number of years convertibility into gold has been limited to international transactions. Last year, the two-tier system took a further step, and eliminated the convertibility of dollars into gold at a fixed price for foreign private holders of dollars.
What remains is the convertibility link for foreign monetary authorities. It is this link, and the possible loss of gold associated with it, that provides the major remaining impetus to international adjustment arising out of the balance of payments. But this link also threatens the stability of the monetary system, by permitting a run on the U.S. gold reserve on the part of foreign central banks.
Perhaps one of the most important long-term problems facing the U.S. is how to move out of this commitment in a graceful manner without causing undue disturbance to the monetary system and with a fair measure of international approbation, at some time in the future. It is not yet clear whether this can be done, and a breaking of the link may have to come in the context of some crisis and a threatened run on the dollar.
One possibility, over time, is that the nations of the world come to accept Special Drawing Rights in lieu of gold when they convert dollars into other reserves. Such preference for SDRs over gold may be a long time in coming. The preference of many monetary authorities for gold would be to some extent weakened if it became clear that the commodity gold price could dip below the official price of $35 per ounce.
A partial approach to the problem of reducing our vulnerability to convertibility would be the freezing of dollar balances in some form. Most experts believe, however, that this would not be acceptable to foreign countries without some kind of commitment to the effect that the U.S. would no longer have the flexibility of settling its deficit initially with dollar liabilities instead of reserve assets. There is a feeling in many quarters that it would be dangerous for the U.S. to give up the more favorable bargaining position which it now has, when it can pay out dollars initially and then discuss with foreign monetary authorities [Page 296] the various techniques for handling these dollars if the central bank does not want to hold them in its reserves. The reason for this feeling is that, with the U.S. unable to create new reserves in this form, the European countries might use too harshly their veto over the creation of Special Drawing Rights so that the growth in reserves that would be permitted might fall heavily short of the amounts needed to prevent a steadily tightening shortage of world reserves.
The same considerations apply to the Bernstein plan, which makes no allowance for the role of the U.S. as a continuing reserve center with the potential power to create additional reserves in the form of dollar liabilities. Under that plan, there would be no increase in dollar liabilities held as reserves.
The U.S. still has to develop a clear position as to its long-range objective with respect to the maintenance of convertibility and the interchangeability of dollars and gold.
4) Exchange Rate Policies and Principle—Fixed Parity or Limited Flexibility.—This subject has attracted especial attention during the past year.
Particularly among academic economists, it has been argued that the system of fixed exchange rates has come to place too much pressure on deficit countries to conform to rates of growth and rates of costs and price inflation in the rest of the world. It is argued that, because the pressure to conform is markedly stronger in deficit than in surplus countries, the latter have an exaggerated weight in determining the rate of growth of aggregate demand in the world as a whole, and, consequently, the rate of economic progress.
Against this, the practitioners of the fixed exchange rate system argue the uncertainties for trade and investment under a system of limited flexibility. However, perhaps more important is their fear that limited exchange flexibility would reduce the resistance of governments to inflationary pressure. Many central banks feel that the public and the government can be to some extent aroused to the danger of inflation through the necessity to protect reserves and maintain an established exchange rate.
The November meeting of the Ministers of the Group of Ten in Germany marked perhaps the first occasion on which the finger was clearly pointed at a surplus country by Ministers of other major countries, with a strong implication [Page 297] that an appreciation of the exchange rate was desirable on international grounds. True, the Ministerial Meeting in a sense symbolized this pressure, because the Germans acted in fact just before the Ministerial Meeting. They found a substitute for exchange rate appreciation, as a compromise measure within the German government. This was the border tax adjustment. It is generally believed that an important reason for using this technique instead of exchange rate appreciation was the common agricultural policy in the Common Market, and the effect of a German appreciation on the German budget in the form of additional subsidies to German farmers. These problems were avoided by eliminating the affected agricultural commodities from the proposed adjustment.
Some brief comments on the particular techniques of limited exchange flexibility are included in Attachment A.2
Both the British devaluation of November 1967 and the more recent German corrective border taxes have brought to the fore an additional consideration. In both cases supplementary measures appeared to be necessary affecting domestic demand in order to avoid quick dissipation of the adjustment effects of the action taken.
This calls to mind that any form of international adjustment in the trade and service accounts tends to cut down profit margins in surplus countries and to reduce real income in deficit countries. Both can be resisted by those affected. Also, deficit countries need to shift resources from non-competitive to internationally competitive activity; the reverse movement is needed in surplus countries. There may very well be important differences among countries in the ease of shiftability of their resources. (Compare the U.K. and Japan.) One possible hypothesis is that shiftability is low where there is a) strong resistance to a reduction in real income on the part of the working population, and b) where a relatively small proportion of resources is engaged in internationally competitive activities as against non-competitive production for the internal market.
These two experiences do suggest that it may be easy to over-estimate the effect of limited exchange flexibility in permitting countries to follow more diverse policies with respect to rates of growth and rates of inflation of costs and prices. The further unfolding of the German experience under the border tax arrangements may be instructive in this respect.[Page 298]
It has been suggested that limited exchange flexibility might not make a very large contribution to changing the U.S. trade and current account position. If this were to be the case, the principal effect might be to ease somewhat the pressure on deficit countries abroad, which have smaller economies with a larger segment of total production devoted to foreign trade.
It has also been suggested that limited exchange rate flexibility might have significance for the U.S. in other ways than through the effect on our current account deficit. Conceivably, such flexibility might in fact worsen our current account deficit if it resulted in a gradual depreciation of other currencies as a whole against the dollar. One suggestion is that the adoption of these limited flexibility techniques might be useful because it might permit public attention to be focused on the exchange rate rather than on balance of payments and reserve figures, as at present.
- Source: Washington National Records Center, Department of the Treasury, Volcker Group Masters: FRC 56 86 30, VG/LIM/1-VG/LIM/30. Confidential; Limdis. A January 30 draft indicates the paper was drafted by Willis. (Ibid., Deputy Assistant Secretary of the Treasury for International Affairs, Contingency Planning 1965-1973: FRC 56 83 26) Two other papers, VG/LIM/69-3 (“U.S.-U.K. Arrangements for Joint Contingency Planning,” dated January 31) and VG/LIM/69-4 (“Possibilities for Dealing with Situation Created by ‘Aggressive’ Exchange Rate Action by the French,” dated January 31), are attached. The three papers were to be discussed at the Volcker Group’s February 3 meeting. No record of the discussion was found.↩
- Not printed. The paper explored six options: 1) maintenance of the present Bretton Woods system of fixed exchange rates, subject to adjustment for fundamental disequilibrium; 2) use of border taxes to facilitate adjustment in trade accounts, while maintaining fixed exchange rates; 3) adoption of crawling pegs on a mandatory or discretionary basis; 4) adoption of wider margins, 2 percent or less to 5 percent or more; 5) combination of 3 and 4 above; and 6) a gold bloc and a dollar bloc with a flexible exchange link.↩