The role of monetary gold over the next ten years

8/8/2019 The role of monetary gold over the next ten years

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PER JACOaSSON FOUNDATIOH,WASHINGTON, D .The role of monetary gold over the nextten years e

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LE OF MONETARY GOLDOVER

ALEXAN.DRE".~;~MFALUSSY. ..I .. .. ~. . ... .. .. .

Wilfrid BaumgartnerGuidoCadiL. K. Jha

SUNDAY, 28 SEPTEMBER 1969THE GREAT HALL - NTERNATIONAL MQNETARY FUND


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JACOBSSONOUNDATION) &sL 1 I ./Lecture and Commentaries

byALEXANDR E LAMFALUSSYWILFRIDBAUMGARTNERGUIDOCARL1L. K. JHA

3 p.m., Sunday, 28 September, 1969The Great Hall -.International Monetary FundWashington, D. C.


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FOREWORDProfessor Alexandre Lamfalussy prepared, at the request of The PerJacobsson Foundation, a substantial study on The Role of Monetary

Gold Over the Nex t Ten Yeais, to provide the basis for a discussionof the subject a t the Founda tions sixth meeting, held in W ashingtonon Sunday, 28 September,1969.FollowingProfessorLamfalussysintroduction of the paper, which was distributed in advance, commentswere presented by Mr. W ilfrid Baumgartner, form er Minister of Financeand form er Governor of the Banque de France, Governor Guido Cadiof the Banca dItalia, and Governor L. IS. Jha of the Reserve Bank ofIndia. Professor Lamfalussy respondedo these comments and o writtenquestions sent in by members of the audience. This current volum e ofthe Proceedings contains the tex t of the basic study and of the discussionwhichfollowed.This discussion is the most recent. n a series organized by the Foun-dation in Europe, Latin America, and the U nited States. The papersgiven have been published in English, French and Spanish by the Foun-dation and in other languages by a number of banks; bankers associa-tions and others. A list of the Proceedings so f a r issued will be foundon page 59.The Foundation was established in 19 64 in honor of Per Jacobsson,late ManagingDirector of the InternationalMonetary Fund, to .en-courage the scholarlyexploration of the international inancialandmonetaryquestionswithwhichhewas so intimatelyassociated. Itssupport has come from the Fund, the World Bank, the Bank for Inter-national Settlements, and large numbers of international, governmental,corpor,ate and privatecontributors ed by thedistinguishedgroup ofsponsors shown elsewhere in this booklet.

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Table of ContentsPageOpening Remarks

9 Pierre-Paul Schweitzer. Managing Director.International Monetaryund ........................ 1

T h e Per Jacobssonoundation ...................... 1W Randolph Burgess. President.The R ole of Monetary Gold Over The Next Ten YearsAlexandre L d a lu s s yIntroductionndummary ........................... 3Text ............................................ 10CommentariesWilfrid Baumgartner ................................ 33GuidoCarli ........................................ 35L.K. Jha .......................................... 43Questions and Answers

. Professoramfalussy ................................ 47 Governor Jha ....................................... 50Mr. Schweitzer ..................................... 51Mr. Burgess ....................................... 52Appendices1 Biographies of Speakers ............................ 532. List of Sponsors. Directors and Officers of the Foundation . 553. List of Publications ................................ 59

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OPENING REMARKS

Pierre-Paul Schweitzer:L dies and gentlemen, it is really a great privilege to welcome youhere on behalf of the International Mone tary Fund and The Per- JacobssonFoundation.You know what PerJacobssonrepre-sented for me, as an example and inspiration; and you certainly sharemy emotions today.

We were sorry that Mrs. V iolet Jacobsson could not atten d this time.We all know that' she is with us in heart this aftern oon, and I am happythat so many other members of the family are here. It is a great pleasureto welcome them here o day.There have already been several ectures, but this is the first timethat they have taken place in the building of the International MonetaryFund, which is a very suitable place to hold them. We are happy to beable to welcome you here.I won't take any more time from the speakers, and I now hand overthe proceedings to Ambassador Burgess.

W. andolph Burgess:Let me start bywelcoming you all hereon behalf of ThePerJacobsson Foundation, and particularly y thanking Pie rre Pa ul Schweit-

zer and the Monetary Fund for the great courtesies extended to us, notonly in making available this beautiful hall, b ut m ore so in their con-atant support of the Fo und atio n. We could not get along without the

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THE ROLE OF MONETARY GOLDOVER THE NEXT TEN ,YEARSALEXANDREAMPALUSSYI response to the invitation extended to him by the Foundation,Professor Lamfalussy repared a writ ten stud y n this subject which.was distributed in advance to those attending the lecture meeting.The text o f this paper begins, on page 10.A t the meetin g, Professor

tamfalussy introduced his paper in the statement below.I would like first to sum up very shortly the thesis which I developedin my paper and then to restate it ; because, despite some recent devel-opments, I have not changed my views; yet I think it might be worth-

while to reformulate the various points I developed in a slightly differentwry and then perhaps to spell ou t a certain number of policy conclu-dons by being more explicit than I was in my paper.I started off by observing recent rends in monetary history and Ihave come to theconclusion that we havebeenmoving owardsap l dua l demonetization of gold. Why this conclusion? We can observecbrt goldhas not contributed to the growth of international liquiditymy longer since about ten years. We have watched the establishment

Uld the functioning of the dual gold market. We have seen, moreover,rhrt the gold price on the free market did not rise to a level whichhrb beenexpectedbymanypeople and that, after having reached aIlluimum of about 45 dollars, it has in fact tended to decline over thek t ew months. Finally,we are now approaching the creation of SDRswhich is also, in a certain way, a further step towards the demonetiza-don of gold.

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4 THE ROLE OF MONETARY GOLD OVERTHE NEXT TEN YEARSThe question which I then raised in my paper was whether this waslikely to continue, for I think that the facts which I have just m entioned

can hardly be questioned. My answerwasveryexplicitly no : wewillnot make further progress on the road towards demonetization until wesucceed in improving, and very substantially improving, the adjustmentmechanism and, at the sam e time, in creating in an orderly way an ade-quate amount of new international liquidity.Now on both these points, but especially on the first o n e - o n theadjustment mechanism-, I was and still am rather pessimistic. I do notthink that the adjustment mechanism, as it has been working over thelast five or ten years,has mproved, On the contrary, I think it isbecoming less and less effective. I quoted a certain number of facts 't othat effect in my paper. The reasons I saw were basicallyof three kinds:

-One, the necessity to maintain the dom estic responsibilities f govern--Second, the doubts about the gradual' adjustment in the current ac--And third , the growing importance of capital flows and their inter-

ments nachanging nstitutional ramework.count through relative changes in un it costs.connection with flows in trade and services.As regards the second condition, I have pointed out a certain num-ber of signs of a shortage of international liquidity. I know this is ,nota very fashionable view, but I tried to support it by quoting two series

of facts: Firs t, the spread ing of controls all over the world, especiallycontro ls on capital flows, which certainly can be regarded as a sign ofshortage of international liquidity. Second, the war of escalation in in-terestrates. I do not doubt that the increases in interest rates havebeen motivated to some extent and in some cases by purely domesticconsiderations-the fight against the overheating of the economy-butI simply cannot believe that the rise in interest rates would have been:of the size and of the speed which actually occurred had it not been forbalance-of-paymentsconsiderations or, moreexactly, because of thegovernments wanting to preserve their foreign exchange reserves. This,I think, s a clear ind ication of an insufficiency of international liquidity.

The upshot of all this is that unless we get a fundamental improve-ment on both these counts, we ,will not m ove towards a gradual andorderlydemonetization of gold but much more likely ow.ardsmorecontrols, or towards the dollar standard, or probably towards both a t


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ALEXANDRE LAMFALUSSY- NTRODUCTION AND SUMMARY 5the same time. I suggested some good or bad reasons which made medislike both of these alternatives and especially their -simultaneous oc-currence. This led me, quite logically I believe, to the suggestion thatthe only way out is to improve the Iflexibility of exchange rates.

May I perhaps now restate this hesis in aslightlydifferentway?When I re-read ,my own paper after three months, I asked myself thequestion which probably many of you are tempted to ask: if our present 'monetary system is so deficient, how could it function so well fo r. thelast twenty-fiveyears? Fo r there is little doubt tha t he system hasbeen quite successful. Econom ic growth has r.arely been so strong, sosustained, and so regular as over the last twenty-five years, We havehad a tremendous expansion in in ternational trade, and this continues.And we do have-even after the reimposition of certain controls-afair degree of freedom in international capital transactions. So, by allthree of these crite ria, the system proved to be successful.

Nevertheless, I am ready to argue that someveryundamentalchanges have taken place in th e,world economy which create entirelynew conditions.Hence, he fact that our presentsystem has workedwell until recently does not imply that it will work well in the futu re.Which are these changes? I try to sum them up without attachingany importance. o the order in which I will mention them.The first of these changes is the very substantial increase in dom esticliquidity, first of all in the sheer ac tual volume of domestic liquid assets.You can take any of the developed countries over the last ten or fifteen

years and you' can see that the total .amount of domestic liquidity asoxpressed in national currency has been multiplied by two, three, four,flvt, depending on the definition that you use. This is due partly to thestock of money 'and partly to the stock of quasi-money and of othersemi-liquid inancialassets. But, in addition to the sheerquantitativeoxpansion of liquidity;youmust take into account the qualitativechangeswithindomestic inancialorganizations,: the increased inter-mediation which crea tes greater flexibility and hence a greater degreeof liquidity within the economy. I think this ssomethingabsolutelyfundamental if you com pare today's position with what existed twentyor twenty-five years ago.A second equally important poin t is the liberalization of cap ital move-ments. When the present ystemwas created, the , liber.alization of


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6 THEROLE OF MONETARYGOLDOVERTHE NEXT TENYEARScapital movem ents was considered as a very, very distan t objective, themain objective being the liberaliza tion of trade. Since 1958, we haveacquired a fair degree of freedom in capital transactions. This freedomhas nowbeencurtailed to some extent but it still existsand it doesexist in some new form through the Euro-currency market.The third point which is worth mentioning ishe speed and the spreadof financial information. With the developmentf a new type of journal-ism, with the speed of information in genera l, we have reached a so rtof financial ntegration hrough radio , telex and elevision which wasabsolutely unheard of a few years ago. I remember watching televisionover the last few months, and the kind of financial nformation heygive bears n o com parison with what existed twenty years ago.

Thefourth majorchangewhich I would like to point out is thegrowing interpenetra tion of the Western economies. This applies quiteobviously, of course, and I hardly need to mention it, to trad e flows, butit also applies to direct investment through the substantial developmentof the multi-national corporations and ,lastbut not least, to tourist trade.Millions of people traveling from one country to ano ther, knowing, theprice structu re of each of the countries, com paring the national stand -ards ofiving-allof these fac tors reallyhave crea ted a degree ofinterpenetration of the W esternworldwhichwas otallynonexistenttwenty years ago.

Now consider all these facts at the same ime: growth of dom esticliquidity, hence the growth of the funds which can be shifted quicklyfrom one country to another in case of capital movem ents; second, thefreedom to do so directly o r, ndirectly through the Euro-d ocar m arket;third, the degree of information on whether this happens and throughwhich channels; and fourth, the degree of in terpenetra tion of our econ-omies. You come obviously o the conclusion that we have much grea terpotential and rea l capital movements than a number of years ago. HenceI think that the old philosophy of balance of-paym ents adjustment aloneor principally hrough trade. adjustment sreallysomethingwhich i sentirely out of d ate and.has nothing to do with current economic con-ditions. I also think that an institutional rameworkwhich is builtprimarily on a sort of current account philosophy is also out of date.

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ALEXANDRELAMFALUSSY - NTRODUCTION AND SUMMARY 7This is one set of facts which explain why the problem did not existten, fifteen or twenty years ago and why it has grown gradually intothe situation which we experience today.There are, however, a second series of facts which we have to take

into account: we have been moving away from the synchronization ofeconomic trends in a number of .countries, especially withinContinentalEurope. Whenyou look today at he European economies,youfindthat national trends become tronger and strongerand he sort ofharmonization of economicdevelopmentwhich we did have between1959 and 1963-64 has absolutely vanished. We have special' problemsin France, we have special problems in Ita ly, we have special problemsinGermany, in Belgium.Youcannotpoint ou t one single countrywhich is moving really in unison with the others.Should one reg ard this as a consequence of the lack of coordinationof economicpolicies? To this very important question, m y nswerwouldbe rather dubitative. It may be hat we did not manage oureconomieswellenough or hat we did not succeed in coordinatingeconomic policies in an efficient way; but my suspicion is rather thatwe are in the presence of strong political and social trends in each ofour countries, which go against the growing internationaliza tion of theeconomy. I suggest that a large part of our problems have been brough tabout by this divorce between the fundam ental interpenetration of our

economies and the persistence and strengthening of social and politicaltrends in individualcountries. I do not knowwhether hese trendsare something fundamental, or whether hey are purely accidental .o rwhether hey are due to sheer bad luck.Whatever heir nature 'o rcauses, one cannot doubt their existence. This is why I believe sostrongly that, in order to reconcile these two fundam ental trends, bothof which a re facts of life, we have to find some sort of compromise, and.I cannot see any other com promise than a greater flexibility in exchangerates.

But what kind of flexibility? I do not intend to answer this questionfully because I do not know the answer. Nevertheless, I might perhapsspell ou t very hortlymy own prejudices or policypreferences. Intheory, I would have a preference for the IM F kind of flexibility; inother words, for fixed exchange rates with periodic adjustments in caseof basic imbalance. If the countries which in fact incur basic imbalances


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8 THEROLE OF MONETARY GOLD OVER THE NEXT TEN YEARSdecided to devalue or revaluewhen it was needed, I think the IMFsystem could function perfectly well. It did function in som e instances,especially in the cases of smaller countries, but we have had at least twoor three major cases over the last few years when devaluations did nottake place or took place only too late, and we have a t least one ma jorcasewhereare-evaluation, at least until today, has no t taken place.Hen ce the conclusion that, despite all the advantages of the IM F sys-tem, we may have to find something else, because the experience seemsto suggest that the countries are unab le or unwilling to make the systemwork. T his is why we may have to fall back on some sort of second-best,perhaps on awidening of th e band plus some sort of dynam ic. andcrawling changes in the band itself. I think this is probably the directionwe ough t to take. This sounds fairly pessimistic, because the techn icalfeasibility of such a system s still questionable, and yet I think that,by necessity, we will be d riven to a solution of this kind.

However, I would not like to end my talk simply by being so acutelypessimistic. I think we have two reasons for being somewhat optimistic.The one is that all these problem s are those of agrowingsociety, ofa growing economy. These are no t problems of a declining world. Wetend to forget it sometimes, but this is a very important fact. Our prob-lems a re the result of conflicting trends : national independence andgrowing internationalization. Bo th these conflicts and th eir solution arepart of the process of growth.

My second reason for hope is that we are beginning to understand themechanics of international payments and th at our own minds are alsochanging. The proof for this is that the SDRs are on the verge of beingacceptedand that the idea of a grea ter flexibility of exchange atesmeets an increasingly positive reception.

May I conclude by reading you .a few sentences which I found in apreface written by John Maynard Keynes to his Monetary Reform. nOctober 1923? I quote: Nowhere do conservative notions considerthemselves mo re in place than in currency, yet nowhere is the need ojinnovation more urgent. One is often warned that a scientific treatmen!of currency questions is impossible because the banking world is intel-lectually incapable of understanding its own problems. If this is true,the order of society which they stand for will decay. Bu t I do not be,


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ALEXANDRELAMFALUSSY - NTRODUCTION AND SUMMARY 9lieve it. If the new ideas now developing in many qu arters are soundand right, I do not doubt that sooner or later they will prevail. HenceI dedicate this book humbly and without permission to the Governors ofthe Bank of England who now and for the future. have .a much moredifficult task entrusted to them than in former days.I would like to paraphrase this and say that I dedicate this talk veryhumbly and entirely without permission o the G overnors of the In terna-tional Monetary Fund .


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TH E ROLE OF MONETARY GOLDOVER THE NEXT TEN YEARSbY

ALEXANDREAMFALUSSYThe text below is that of the written paper prepared by Professo r

Lam falu ssy and circulated nadvance to those attending the mee ting.The text of his oral presentation of this paper begins on page 3 .

T e task which has been assigned to me s of undoubtedly com-plex nature. To discuss the long-term prospects of the m o n e t wfunction of gold mpliesnotonlyeconomicanalysisbutalsopolitical onsiderations, nd ven peculation about human nature.Essentially, monetary management is an actf policy as well as politicalaction; international monetary management is even more so. The atti-,tude towardsgold softendetermined,amongpoliticalmen, centrdbankers, private bankers or just ordinary private people, by motivationswhich the economist is unable to assess and which belong more to thefield of a sociologist or a psychologist. However, this paper is that of-an economist, nfluencedbyhisexperienceas a banker,and we a llknow how the expert can simplify when he has to d eal with somethingoutside his own field.

Then, there is the problem of forecasting. We have only to considerthe succession of crises during the last four yea rsj each of which casta doubt, in a more or less unexpected manner, on various points of the'international monetary system as well as on the currency of differentcountries, to realize the extreme fragility of. any attempt to forecast.Furthermore, I have but few illusions on my own capacity as a fore-caster: strictly speaking, therefore, I will not make any actual forecastsbut rather a series of com ments on the present situation and on howit might evolve. For the purpose of provoking and sustaining discussion,I intend to be explicit and argumentative.

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ALEXANDRE LAMFALUSSY- EXT 11Finally, with a subject like this, which touches all aspects of socialand political lifi, it is very difficult to draw a demarcation line betweenanalysis and value udgements,between orecasts and wishful think-ing. You have therefore the right to know my own policy preferences.They are of two kinds. On the one hand, I would like to see gold lose

its monetary function; on theother, however, I would not like a nationalcurrency to assume the &le of a reserve and international currency, ha tis to say, that the unsteady gold-exchange standard be replaced by the.dollar standard. Consequently, I would like tha t the dem onetization ofgold takes place alongside with the creation of an international reservecurrency. At the risk of repeating myself, I would emphasize that theseare my wishes and not my forecasts.

The present situation: an interpretationWe commence our analysis by a brief examination of the gold andforeignexchangeassetsheldby heofficial nstitutions. Throughou tthis report, I will refer to these reserves as the international liquidity,except where expressly re-defined. This definitionf international liquid-ity is somewhat restrictive; t is not whatI would like to use, in principle.The ideal definition would cover a much wider notion: in the case of

ad individual country, its total means of payment, acceptable for inter-nationalsettlements,which hemonetaryauthorities of that countrycould raise a t ,very short notice. This am ount should include not onlyowned eserves but alsoborrowingcapacity, astandunconditional,with other official i&titutions or international bodies. In the .extrem e,it should even include the capacity to borrow on the Euro-currency andEuro-bondmarkets.Unfortunately, it is impossible oassessafigurePor such . a wide definition of international liquidity with sufficient ac-curacy: .thus we propose that we shouldsimplyuse the definition ofInternationalFinancial Statistics which, hough estrictive, s at leastclear-cut. The IMF defmition has the additional merit of limiting theconcept of international liquidity to the amount of reserves over whichthe monetary authorities of a country have unconditional and imme-

. diate command. This is n ot' without importance in a era dominated byvast andswiftmovements of capital,whenspeculative 'attitudes arestrongly influenced by the confidence (o r lack of confidence) one .can


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12 THEROLE OF MONETARY GOLD OVERTHE NEXTTEN YEARShave in the ability of the national authorities to settle their debts im-mediately and unconditionally (* ).

Table I.Amount and composition of reserves held b y official institutions

(World total, at the end of the year, in billions of U.S. dollars)

Gold1958963 .38.0 40.2

196838.9

Foreign currencies 17.0 22.2 30.9Reserve positions with theInternational Monetary Fund 2.6 3.9 6 :5Total, 57.66.46.3

Source: International Financial StatisticsThe striking fact app arent from this Tab le is that over the last tenyears, gold has practically no longer contribu ted to the growth of inter-national liquidity. In ten years, total foreign reserves ose by nearly 19billion dolla rs; the grea ter par t of this increase-some 14 billion-wasdue to increased holdings in foreigncurrencies,whereas the increasein the reserve positions with the Interna tional Monetary Fund was about4 billion. The increase in gold stocks was less than one billion; in fact,there was a decline between 1963 and 1968. Consequently, the share

of gold holdings in total reserves, which was 66 per cent at the end of1958, fell, to 51 per cent at the end of 1968.Two other fac ts should also be taken into account, though they arenot apparen t from the Table. First, there was a considerable slowingdown in thegrowth of international liquiditybetween 1965 and themiddle of 1968. At the end of 1965, the am ount of reserves was 70.4billion dollars; it reached barely 73 billion by the end of June 1968.

(*) On this point, as on some other, I published a recent article in the December1968 number of the Recherche5 Economiques de Louvain.


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ALEXANDRE LAMFALUSSY- EXT 13Between these two dates the yearly growth rate was therefore less than2 per cent. Du ring the last six months of 1968, there was a considerablerise in foreign currency holdings ut, to a large extent, this was a nego-tiated increase and no t the result of the traditional functioning of th egold-exchange standard.

It is precisely this second fact which must be emphasized, as it cannotbe seen from the F unds statistics. During the last five years, the amountof foreign currencies held byofficial institutions went up by som e 9billion dollars : bu t this increase is not the result of the mechanics .ofthe gold-exchange stand ard. This ystem creates reserves und er theimpact of the overall deficit of the balance of payments of the UnitedStates (or the UnitedKingdom)whose urrencies are held pon-taneously by the surplus countries. How ever, as was shown by ProfessorTriffin in a recent statistical note (March, 1969), the whole of the 9billion ncrease-in fact more than this increase-must be attr ibutedto negotiated currency holdings. In adopting this method of calculation,we arrive at the conclusion that, at the end of 1968, foreign currencyholdings of thespontaneousgold-exchange standard typenow rep-resent only about 13 to 14 billion dollars, that is approximately the sameamount, as at the end of 195 8. The negotiated holdings in foreign cur-rencies amounted at the same date to 16 or 17 billion dollars. By addingthis am oun t to ha t of the reservepositionswith the InternationalMonetary Fund, we couldsay therefore (a ) that between 1958 and1968, th e whole of the increase of the intern ational liquidity mu st beattributed to the negotiated creation of reserves either in foreign cur-rencies or .in the reserve positions with the M onetary Fund, since neithergold n or foreign currency held spontaneously have contributed to thegrowth of reserves q d b ) that at the end of the period, the negotiatedreserves represented about 30 per cent of total international liquidity.

It is therefore right to say that over the last ten years an d in particu-lar since 1963-64, we have witnessed a gradual decline in the role ofgold as a means of reserve and its complete disappearance as a sourceof new international liquidity. At the same time, the m echanics of thegold-exchange standard have ceased to function: the creation of reservesby the spon taneous holding of dollars or Sterling has com e to a halt andhas been eplaced by the creation of negotiated eserves.Finally, ifwe disregard the rapid growth of reserves in the last half of 1968, there


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14 THE ROLE OF MONETARYGOLDOVERTHE NEXTTEN YEARShas been a clear slowing down in he expansion of international liquiditysince 1965.

This diagnosis of the present situation, based on facts and. figures,should be supplemented by considerations of another. kind, no less im-portant but of more controversial nature. They touch upon the operationof the gold market and on the a ttitude towards the United S tates 'dollar.

The presen t organization of the gold marke t, the . two-tier system,owes its origin to the waves of speculationagainst the dollar and infavour of a re-valuation of gold, which culminated in the March 1968crisis. Its principa l characteristic is he. isolation of the ordinary goldmarket. rom tha t of monetary gold. The monetary price of gold remainsfixed at 35 dollars per ounce and it is at this price that the central bankstrade between hemselves, and mainly with the Federal Reserve. Theprice on the ordinary market is fixed freely by supply and demand. Thetwo markets are cut off from each other as the majority of the largecentral banks haveagreed to refrain from purchasing or sellinggoldon the ordinary market.

We all know the discussions which have surrounded these measures,the ambiguity of the commitments of some of the centra l banks, thetalks between the United States and South Africa on the latter's salesof gold, the uncertainty regarding the survival of the system. It is notour intention to enter the debate at thisstage. Let us, however, putforward a fundamental proposition. The establishment of a two-tiersystem is an important step towards the demonetization of gold. Thisproposition is not meant to speculate about the intentions of those who,by their decisions, have set up the new system; it simply brings to yournotice its implications,assuming, of course, that the systemsurvives.The first mplication s tha t the gold par t of thereserves cannot beincreased, for lack of purchasing from the ordina ry market. As nobodydoubts the need for increasing international liquidity, this entails n-evitably the relative narrowing .of the gold basis. In other words, th etrends observed in fact between 1958 and 1968 would continue in thefuture. Second conclusion: the prices on the two markets may only bethe same by pure accident. This not to say that the price on the


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ALEXANDREAMFALUSSY - EXT 15ordinary market is the real price (* ) but the absence of purchasesand sales outside the circuit of the centra l banks implies in return thatthe price of monetary gold has become purely arbitrary, Thus, in thelogic of the system, gold becom es a unit of account, destined to fulfillless and less the function of a means of reserve and practically not atall that of a means of settlem ent of debts between cen tral banks. Forthis reason, it would seem legitimate to us to say tha t the system of adoublegold market, by extrapolating the trends alreadynoticed forten years, confirms and foreshadow s the decline-the withering away-of the monetary function of gold.The more recent eventson the gold market seem to confirm hisdiagnosis,although one can benever too careful in interpreting theshort-term fluctuation of a market which has proved to be remarkablyvolatile in the past. During the months-of April, May and June of thisyear, the price of ordinary gold tended to decline and fell to nearly 41dollars these last few days (**) . This fall would not be worth mentian-ing if it were not for the fact that it coincided with the announcement ofa sizable deterioration in the United States balance of paym ents and.especially in the mostsignificant pa rt of this, that is n the currentaccount. Whereaswelvemonthspreviouslymuchmoreavourablebalance-of-payments figures hardly prevented heavy speculation againstthe dollar, .data which are much worse are now accom panied by a fallin the price of ordinary gold! Does this mean tha t the two-tier systemis finally accepted? Is this due to a rather hasty interpretation of theimpact of South African gold sales on the Swiss market? Or is this fallto be attributed simply to the very high interest rates on short-termdollar deposits? We will revert to this curious developm ent later. In themeantime, we will simply note the fact and .consider it as a preliminaryindication tha t the decline of the m onetary function of gold is on itsway and that it is accompanied by a considerable strengthening of theposition of the dollar. .

This interpretation of past events and of the present situation is, ofcourse, not to everybodys aste.Although not denying he facts and( e ) Even in theabsence of effectivepurchases or saleson hismarket by thecentral banks, this price would only become the true price if all the buyersandsellers of themetalacquired heconviction that no centralbankwillever .connect the two markets in any way. As long as this conviction does notexist-and it doesnotappear oexist o-day-thepriceon heordinarymarketwill ake ntoaccountpotentialpurchasesandsales by the officialinstitutions. Quite clearly, the market is at the moment discounting possiblepurchases (rather than sales) by the central banks.

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( *e) Thefirsthalf of June. 1969:


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16 THE ROLE OF MONETARYGOLDOVERTHE NEXT TEN YEARSfigures mentioned above or the rapid degenerationof the gold-exchangestandard, someeconomists-and particu larly Fren ch ones-insist onthe repeated m onetary crises of the last four years and on the generali-zat ion of foreign exchange controls. Because of hese, hey give quitea different interpretation to the facts mentioned in the preceding pages.According to them, the sta gn atbn of official gold holdings, until meas-ures were taken in M arch 1968, was caused precisely by the publicsmistrust of thesystem: it is heprivate hoa rding ofgoldwhichwaspreventing the. central banks from making gold pay its role as c reatorof international reserves. It is hissame mistrust, which made it im-possible for the gold-exchange standard to function properly and whichtherefore led to the negotiated creation .ofreserves.Seen from thispoint of view, the establishm ent of the two-tier system is an act of des-pair,. the survival of which s more than doubtful. Instead of a declineof the monetary function of gold, we are on the road tomore frequentmonetary crises, to exchange restrictions of all kinds and finally -to acollapse of the economy-whichcould be avoidedonly by the re-establishment of the gold standard.

It is obvious to me tha t both interpretation s have some merit. Theyare not in basic opposition over he explanation of past and even presentfacts: for exam ple, it wou ld be difficult to deny that the stagnation ofthe gold holdings of the central banks , between 1963 and March 1968,was due to the increase ngoldhoarding. Furtherm ore, it canno t bedenied tha t the setting up of a two-tier system in the Spring of 1968was an act of defense by the central banks which had no desire to loseeven m ore gold. Having said this, however, it must be admitted, on theother hand, that de facto the monetary role of gold has diminished. Thedivergence, herefore, ies not so much n the interpretation of whathas happened so far, as in forecasting the future.

I have no intention of enter ing the game of forecasting in the propersense of the term, for 1 have no idea what will actually happen to themonetary function of gold in the fu ture, and I do not even see ways andmeans of working ou t sensible forecasts in this field. Hence the rest o fthe paper will deal with the future in a more policy-oriented way. Iwill try to answer the following question: what conditions are requiredfor past trends to be continued? In other words : under what conditionscan we expect the decline in the monetary function of gold to continueand to end in the effective de-monetization of gold?


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ALEXANDRE LAMFALUSSY- EXT 17Two conditions: improvement of the adjustment processand creation of international liquidity

These requirements are of wo kinds: the ad equate functioning ofthe adjustment process and the creationof sufficient in ternational liquid-ity. These two problems, of course, are interdependent: the need forexternalreserves safunction,partially at least, of the speed of theadjustment process, while his latter also depends, to some extent, onthe amount of reserves available which can hasten o r slowdown theuse of appropr iate adjustm ent policies. For the purposes of th is report,however, I will deal with these two problems one after the other, begin-ning with the adjustm ent process.

Whatever the outcome, we may assume tha t if these two conditionsare not satisfied, he decline n the monetary function of gold cannotcontinue. Both lasting disequilibria in external balances (i.e. the weak-ness or inexistence of the adjustm ent process) and the shortage ofinternational liquidity a re apt to create an economic climate dominatedby uncertainty, speculation, controls and crises, which are hardly likelyto encourage the decline of the monetary function of gold. Such eventsare likely to push up the price of gold'on the free market and this, inthe long run and in case of a persistent and substantia l difference be-tween the market price. and 35 dollars, could break the clear separationbetween the two markets.The problem of the adjustment process

It is not easy to sum up our experience of the adjustment processover the last, say, fifteen years. There are, on the one hand, a num berof small countries which have had a fairly satisfactory experience: theseinclude Ho lland, Belgium, Switzerland and some Scandinavian countrieswhich have had. substantia l changes in their balances of paym ents with-out the persistence of prolongedsurplus or deficitpositions. In thiscategory we could nclude,among the large countries, Japan (withlargeand apidvariations of its external balances) and, to a lesserextent, Italy (which, however, had only one period of heavy deficit, in1963-64)..Onhe other hand, we have three Zarge countries-the UnitedStates, the United Kingdom and Western Germany-where the adjust-ment process seems to have failed to function entirely (United States)


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18 THEROLE OF MONETARY GOLD OVERTHE NEXTTENYEARSor worked only in a' very unsatisfactory manner (United Kingdom andWestern G ermany). This classification involves an implicit definition ofthe satisfactory functioning of the adjustm ent process: the absence oflarge and durable deficits or surpluses.

Events of the last eighteenmonthshave evivedanxietyover theproper functioning of the adjustment process. The huge surplus in thebalance of curren t transactions of W esternGermany has beenmain-tained in spite of the considerable expansion of domestic expenditure;the deficit in the British balance of payments has not been reduced atthe ra te expected in spite of a strongly deflationary fiscal policy; neitherhas the A merican economy responded to the fiscal measures introducedthere more than a year ago, nor up to this date (mid June, 1969) to apolicy of monetary restriction. In the case of France, the exchange con-trol has, in fac t, replaced the use of adjus tment policies.

The delays in the adjustment process may be localized in five phasesor points of impact:Delays in the use of the appropriate . restrictive or expansionarypolicies.The application of an appropriate monetary or fiscal policy, theeffects of which are, however, cancelled or weakened by a com-pensating policy in another field (e.g. the effects of a restrictivefiscal policy offset by an expansionary monetary policy, o r viceversa.The domestic expenditure-consumption or investment, o r both-fail to adjus t to the measures taken .In the balance on current account, compensation between theprice and income effects; I have in mind here, for instan& ,- acountrywhoseeconomy s in strong recovery,yetwhere thegrowth of home demand, in full expansion, does not reduce thesurplus on current account as it is accompanied by a net im-provem ent in he country'scompetitivepositionwhichstemsfrom an accelerated growth of productivity.Capital movementsaggravating or prolonging the deficit, n-creasing the surplu s or making i t last longer, or offsetting anytendency of the current account to return to equilibrium.


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ALEXANDRE LAMFALUSSY- EXT 19Of these various causes of delay in the adjustment process, num bers(2) and ( 3 ) will perhaps give less trouble in the fu ture than in the past.Perhaps I am rather optimistic in this regard, but it would no t seemto me to be rash to sta te that some definite progress has been maderecently in the proper use of the policy mix. Having overcome theapparent contradiction between oversimplified Keynesian and quantitytheories of money, the majority of econom ists and experts now recog-nize as valid either the simultaneous use of monetary and fiscal policiesor, at least, the necessity to avoidanyperversecompensation. Weadm it that we know little of consum ers reactions as we do not knowwhether they more willingly accept to change their propensity to saveor thevelocity of circulation of money. In case of doubt, we prefertherefore to place them in a situation where an absence of reaction ontheir part to fiscal and monetary stimulants would bring about a simul-taneous change of the two coefficients-hardly a plausible assum ptionand rarely encountered in econom ic history. We have the impressiontherefore that governmentswill, n the future, pay more attention toensure that the two policies are applied simultaneously, or at least in aco-ordinatedway. In thiscase, it couldalso be expected that homedemand will react with greater speed to rational and concerted policyinjunctions.Unfortunately, this relative optimism can hardly be extended to the

other three causes of the improper functioning of the adjustment mecha-nism. The delay in the application of the appropriate policies or simplythe refusal o allow the external surplusor deficit to act on hom e demandoriginates in the majority of cases from the traditional conflict of ob-jectives of econom ic policy between domestic and external equilibrium.I t would appear from th e policies of most governm ents that their con-cern withdomesticequilibriumstillhaspriorityover hebalance ofpayments and that they are not r e a d y - o r not able-to ab.andon thisattitude. I t is characteristic to note tha t the present Adm inistration ofthe United States, while recognizing the necessity to com bat inflation,is in noposition to acknowledge publicly) heneed for increasingunemployment, and th at businessmen-who expect a swift and vigor-ous expansionist intervention of the Federal Authorities. in the eventof a recession-already ook beyond such temporary recession. Inthe circumstances, it is not surprising that investment expenditure showsno signs of decline. It is also interesting to note that the revaluation of


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20 THE ROLE OF MONETARYGOLDOVER THENEXTTENYEARSthe Deutsche Mark-a tool of adjustm ent policy par excellence-hasbecom e .an electoral question; and we a re told of the sacrifices Ger-mans must take in the event of a revaluation of their currency, whereasa first year student could show you that a revaluation implies (assumingno change in the rate of use of resources) an increase in real incomefor the coun try which revalues. Indeed , it could not b e otherwise: sincehow could there be sacrifices (this time real on es) in the event of adevalua tion if somebody did not benefit from an advantage? There aremany such assertions that could be quoted almost daily proving that .theconcern with dom estic equilibrium (whether well- or ill-conceived) isgrowing rather than declining. This s the m ain reason f o r mybeliefthat we should not expect more rapid application of the appropriateadjustment policies, especially when they risk causing dom estic difficul-ties which would be politically harm ful to the government in power.Scepticism should also be expressed as regards any fu ture improve-men t in the adjustment process achieved indirectly from the relativechanges in the unit cost of labour, that is to say by suppressing perversedevelopments of the ypementioned under heading (4) above. It isoften said th at a rise in wages as well as tha t of productivity are uni-versal phenom ena: consequently, a country sufferingfrom a competitivedisadvantage could improve its position (withou t devaluing) by slowingdown the rise in its labour unit costs relative to the unit costs of itscom petitors. My scepticism of this gradual ad justment process is basedon two considerations. First, on mybelief that there are genuinelyvicious o r virtuous circles in increases of productivity, probab ly viathe volume, the quality and the distribution .b y industry of investments.This implies that a rapid rate of growth of productivity creates condi-tions which lead to further rises in productivity, and viceversa: we nee&only consider the case of Germany and Japan, in on e sense, and thatof Great Britain, in the other. The second observation is derived fromthe almostuniversal failure of incomeandespeciallywagespolicies:experience has shown that it is the relation between supply and demandwhich fixes the level and ra te of increase of wages. The se tw o observa-tions, combined, show clearly the extreme fragility of any hopes of anadjustment based on the gradual changes of re lative unit costs. As anexample, I would quote the case of a non-competitive country which.hopes to -improve its relative competitive position. If it slows down itsgrowth, it will perhaps manage to pu t a brake on the rise of wages but


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ALEXANDRE LAMFALUSSY- EXT 21at the cost of slowing down the rise in productivity; on the o ther han dif it decides to push ahead in the hope of using its productive capacitiesto the fullest possible extent (the French .fuite en avant) and thusincreases its productivity, it risks upsetting its labour market. In bothcases, adjustment will be doubtful or in any case very slow.

Finally, de-stabilizing capital movements are likely to increase in thefuture rather than to diminish. First, because of the constant rise in thevolume of domestic liquid assets in a l l countries. -Second, owing to theacceleration of the information process and means of comm unicationleading to an ever arger and quickerdiffusion of econom icnews,opinions and even expectations, Third, through the increasing intercon-nection between the flow of funds in the balance of current transactionsand those linked with capital movements.This latter source of instability deserves a brief examination apart.I t implies tha t governments are hardly any longer in a position of con-trollingcapitalmovements for thesimple eason that it hasbecomeincreasingly difficult to identify capital ransactions and t o distinguishthem from operations on current account.A possible source of confusion between the two is the ever increasingamount of tourist traffic which few governments are ready to hamper.Travelcan ead to considerable flowsof capital, via transactions inbanknotes, and these can only be stopped either by a strict control atthe border o r by having a special floating exchange rate fo r banknotes.Italys balance of payments is an excellent example of how much capitalcanbeexported hrough the sales of banknotes.Possibilities of thesame nature exist in all thoseEuropean countries where banknotes forma substantial proportion of the stock of money. There are many of them.The secondpossibility of confusion and the more importantone,between current transactions and movements of capital, arises from theincreasing share of intra-firm ettlements of the argemultinational

companies in international trade. These companies pay much attentionto the optimum use of their cash reserves which are usually managed a ttop level, without decentralization. This practice is apt to lead to verylarge capital movementsn at least three ways. First, by substantial leadsculd Zags. Second, by shifting the localization of the financing of tradebetweensubsidiaries:changes are.madeeasilyfrom the financing ofexports to imports, or vice versa, whenever the interest rates make it


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22 . THE ROLE OF MONETARY GOLD OVER THENEXT TEN YEARSslightly more advantageous to bo rrow in one country rather than in theother, or at. the firstsigns of uncertaintyasregards the stability ofexchange rates. I t is, of course, true tha t these a re once-for-all changes.Bu t there is .a third route open to multinational companies to transfercapital through foreign trade: the flows may be changed-and this .timein a lasting manner-by adapting prices at which the transactions be-tween the subsidiaries are settled.Most of theseprices are irbitrary,especiallywhereproducts are exchangedwhich do not have a clearmarket price: this is the case for a large numberf intermediary products.It is precisely this difficulty of defining the profit of a local operationwhich induces most of the multinational companies to be opposed tominority shareholdings in the stock capital of a subsidiary. Profit onlyhas a meaning where it is meant. o be maximized, that is to say for thecompany m a whole. The upshot of all this is that even in theory, thedistinction between current and capital transactions becomes more andmore dificult; and, in practice, both the statistician and the governmentagency in charge of foreign exchange controls will find it exceedinglydifEcult to distinguish trade from capital flows. This is the price to payfor the growing integrationof the Western world.

Capital movements of this kind will, of course, not always go againstthe adjustment process. But they are likely to do so in many instances,especiallywhenholders of liquidassetseither do notbelieve n hegovernments willingness (o r ability) to apply an appro priate policy ofadjustment or do n ot expect such policy to be successful. Hence ourgeneral conclusion: in our present system, where exchange rates appearto have acquired considerable rigidity, the process of adjustment shouldnot be expected to accelerate. On the contrary, it is likely to lengthenand become less effective.,Shortage of international liquidity? 1

There is no general agreement on a simple way of measuring whetherthere is adequate international liquidity or not. Th e O ssola Report in1965 suggested a series of symptomswhich, if theywere to appearsimultaneously, could be taken as a sign of a shortage of external re-serves : the generalization of restrictions on paym ents and internationaltrade, the instab ility of exchange rates, the declineof international prices,


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ALEXANDRE LAMFALUSSY- EXT 23the increase in unemployment. At the moment of writing (June, 1969),there is certainly no sign of a generaliza tion of the last two symptoms,although many economists are counting on their appearance. There alsoappears to be no effective instability of exchange rates-but there is nodoubt that they are potentially instable. The first sympton, on the otherhand, is undeniably present: France and the United Kingdom apply arigorous exchange control; he United States have been using variousmeans for many years to co ntrol the capital outflow; Italy has recentlyintroduced measures the practical effect of which has been to reducecapital exports; Belgium has a system of double exchange rates and, asa result of this, capital exports have been penalized, since about ninemonths,byadollarpremium of 6 to 8 percent;Germany hasintroduced h c a l measures in o rder to reduce the surplus of its balanceof payments. All these measures indicate clearly that governm ents aremore and more concerned with the state of their balance of paymentsand that the preservation of external reserves has acquired priority overother policy objectives._ .The competitive ise n nterest atesconfirms the current im-portance of the balance of payments in econom ic policy. Of course, theseries of increases of thediscount ates n a number of Europeancountries, since the Autum n 1968, aZso fulfil the task to mo derate thedomestic overheating of the economy; but these rises would not havebeen so frequent o r substantial if there had not been the need to checkthe outflow of capital attracted by the very high interest rates in theUnited States and on the Euro-dollar market. In this sense the war ofescalation in discount rates shows the shortage of reserves : it makes itobvious that the freedom of action of governments to apply an auton-omous domestic policy has becom e very limited, indeed more limitedthan most of the democratically elected governm ents would be ready(or could afford) to accept.

I

As regards hequantitativebasis of measuring the reserveneeds,there snoagreementeitherbetween the experts. At themost, it isadmitted tha t in the long run there must be a positive relation betweenthe growth of reserves and that of international trade.I think, however, tha t we could go further by suggesting that the Zevet

of extem al reserves should remain. in a more or less constant relation


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24 THE ROLE OF MONETARY GOLD OVERTHE NEXT TEN Y E A R Swith the total of h e domestic liquid assets.This proposal is' derivedfrom the following reasoning:

The main function of external reserves is to assure governmentsa certain freedom of action in na tional economic policy. This isaccomplished by the financing of deficits in the balance of pay-ments which are temporary, unexpected o r . olerated fo r otherpolicy reasons, while awaiting for the adjus tment process to re-establish the external equilibrium. The need for reservesstherefore a function of the frequency, size and dura tion of ex-ternal deficits.We have seen that two dominant facts seem to characterize theworld today:( a ) the inevitable and o ften unexpected nature of capital move-

ments involving exceedingly arge amounts and the difficultyof separating them from current transactions;(b) the lengthening of the adjustment process either because.'ofthese same capita l flows or fo r political and social reasons,makinga return to balance in the current account itselfboth slow and arduous.The deficits the financing of which has to be provided fo r 'bymeans of drawings on the reserves are therefore those of thebalance of paymentsasawhole, ncluding both curren t andcapital accounts.It is reasonable to assume that where there is freedom in inter-national transactions, the probability of balance-of-paymentsdeficits ncreases with the growth of domestic iquid assets. Itmay also be expected that the du ration of these deficits, tha t isto say the slowingdown of the adjustmentprocessTwil1 alsodepend on the amount of nationa l liquidities and (perhaps evenmore) on the degree of liquidity of the economy. This prob-abilitydoes not concernonly capital movementsdefinedcon-ventionally but also real or fictitious current transactions. h eextent of the leads and ags in trade payments-asalso theaccumulation of stocks of imported products-islearly afunction of the volume of liquid assets held by firms and house-holds. The same stands for the possibility for them to exportcapital in the traditiona l sense of the term.


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ALEXANDRE LAMFALUSSY- EXT 25A comparison of the amount of extern al reserves with tha t of nationalliquidassetsshows,over ime,aconsiderablechange in the relationbetweenhesewo important items. Table II/ a, which hows -t hevolume of external reservesasapercentage of the stock of money,informs us of the decline in these ratios for all the countries listed, the

only exception beingFrance which, however, had notoriously insufficientreserves at the end of 1958.It may be seen from this table that the lowest ratios, at the end' of

1968,were hose for the U nited States, the United Kingdom, Franceand Japan. No wonder that three out of these four countries maintainstrict foreign exchange controls and that the fourth (the United States)uses all available means shor t of an exchange control in the technicalsense to-;prevent.capitalexports. In these four countries, it would onlybe. necessary for the stock of money (defined in its narrow sense) todrop by some 7 o 8 per cent following a deficit in the balance of pay-ments, fo r the financing of it to absorb all extern al reserves. It may beargued, of course, that such a fall in the stock of money could hardlyhappen without setting into motion the adjustment process, by raisinginterest rates or directlyaffecting national expenditure. However, wo

Table II/a.External reserve ratios

United States. UnitedingdomGermany.France

BelgiumSwitzerlandJapan

ItalyHolland

1958 196815.7.913.5 7.959.25.76.8.9 24.0 18.537.1 33.454.95.6 54.1 39.912.0.5

~~

Notes:- External reserve ratios: external reserves at the year end as a percentage- The liquid assets include, in this table, only the stock of money as such.- Thefiguresare for thepositionsattheend of December, 1958 andthe

of the stock of domestic liquid assets..Source: International Financial Statistics.last available for 1968, which vary according to the country.


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26 THE ROLE OF MONETARY GOLD OVERTHE NEXTTENYEARSfacts m ust be kept in mind.' First, the reserves may be very quickly lost,whereas the adjustment process, it may be assumed, would take sometime before having an effect on the balance of payments. Second, ' wecertainlyshouldnotexclude he ikelihood that monetaryauthoritieswill proceed to a compensatory creation of money: I have not seen anycountry since the end of th e war which has not been led to offset-tosom e extent at least-the deflationary effect of a foreign deficitby meansof expanding domestic credit. It could not be said they were entirelywrong: a sudden deficit of some importance in the balance of paymentsis likely to have an unbearable deflationary effect if it was to result in apositive decline in the stock of money. An ad justment process of suchviolence-particularly if it was started by speculativecapital flows-would be politically intolerable in almost all countries.This is the reasonwhy at leas t par tial com pensation s necessary-as akind of shock-absorber-but th is. s also the reason why reserve ratios of 6 to 8 percent are ar too ow for countriesheavily nvolved n nternationaltransactions.

Reserve ratios of the other countries isted n he able are clearlymuch higher, Italy being in an intermediate position. Bu t it should bestrongly mphasized that apart fromGermany, the other ountries(Belgium, Holland and Switzerland) are relativelysmall.This mpliesthat if reserves were distributed evenly between all the countries in thetable, the position of the four large countries suffering from an obviousshortage would be only partially improved at the expense of seriouslydeteriorating the position of the more fortunate countries, ncludingGermany. The tota l external eserves of theninecountries eprfsentonly 15 per cent of their stock of money at the end of 1968, whereasthe reserve ratio was 24 per cent ten years previously. Is this not t h e.definition of an international shortage of liquidity?

These conclusions are strengthened if the stock of quasi-money wasto be included in the denom inator of our ratio. The result is given inTab le I I /b which needs no detailed comment. I t reflects the well-knownfact that near-money assets have grown much faster over the last tenyears in most countries than currency holdings and sight deposits. Ofcourse, these assets could not leave a country without triggering off a'violent adjustment process. But it is precisely for this reason that themonetary authorities will be unable to refuse the compensatory creation


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ALEXANDRE LAMFALUSSY- EXT 27 ,Table II/ b

External reserve ratios1958 1968

United StatesUnited KingdomGermanyFranceItalyBelgiumHollandSwitzerlandJapan

1.0.9n.a.28.26.513.932.327.622.64 .2

3.9n. a.14.38.310.224.417.013.52.4

Notes:- The iquidassets ncludethestockofmoneyassuch and thestockof- Thefiguresare for the positions at the end of December, 1958 andthequasi-money. Source: International Financial Statistics.last available for 1968, which vary according to the country.

of money: no government is in a position to let financial intermediationbreakdown. The internationa l mobility of liquiddom estic inancialassets could therefore lead to the disappearance of the exchange reservesof a coun try well before the adjustment mechanism, operating at a politi-cally accep table rate, could restore the equilibrium of the external ac-counts. In order to avoid this, the country concerned would be obligedto introduce exchange controls o r take measures w hich indirectly wouldachieve the sam e purp ose, even if technically they bore another name.This is. precisely what has happened in a growing num ber of countriessince four years.

In conclusion, therefore, it may be said that at least three series offacts point t o ' a shortage of internationa l liquidity. The war of escalationin interest rates, the generalization of exchange controls and /or of regu-lation of movements of funds across the borders prove the growingconcern of governmentswith he evel of their external reserves; thedecline of these reserves relative to the volume of domestic liquid assetsprovides an economic explanation, based on figures, of this governmentbehaviour.


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28 THEROLE OF MONETARY GOLD OVERTHE NEXT TEN YEARSTowards theDollarStandard?

If the main ines of this reasoning are accep ted, one is tempted tobelieve that the world economy will head not towards an o rderly. andgradua l demonetization of gold but (through repeated crises) eithertowards the dollar-standard or the generalization of exchange controls,or evenprobably owards both at thesame ime.Over the last fewmonths, we have made fast progress in both these directions. I will admitwithout reticence that, for a number of good or bad reasons, I find thishard to swallow.

The contro l of cap ital flows is a strong temptation for all governmentsat present in power: the number of countries which have not p ut thisinto practice one way or another may be couhted on the tips of th efingers. It has ardent defenders in manycircles.Politicalmenrefuseto bear the servitude imposed on themby sudden movements of capital:no t so long ago a certa in Head of State, in a famous speech, stigmatizedcapital exports in the nam e of public morality. Tradition is on theirside : the Articles of Agreem ent of the International Monetary Fundand the reports of the debates at the time should be read again to geta clear idea of the net preference given to the liberalization of currenttransaction over that of capital flows. Many economists claim th at 'th efreeing of foreign trad e enablesus to achieve an optimumallocationof resources without fac tor mobility, thus well justifying political hostilitytow ards free movem ents of capital. I have even heard som e bankers-whose deposits in national currency were attracted by the astronomicalrates on the Euro-dollar market-speakof the good old times before1958 when such things could h,ardly ever happen.

P

I don't think these argum ents can simply be pushed aside. It is ob-vious tha t cap ital movem ents have in some instances caused consider-able difficulty in the managem ent of the domestic economy, leading tosacrifices in welfare. Tradition andpolitical nstincts arenot alwayswrong. It is also t rue th at the dem onstration of economic theory of theequalization of factor rewards through in ternational trade is quite con-vincing. Finally, I do no t need to be persuaded that it is not easy tomanage a bank in an open economy when your depositors possess .dailyinformation on Euro-dollar interest rates. However,whenall his ssaid, a powerful argument may be made against all those who would


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ALEXANDRE LAMFALUSSY- EXT 29like to see a return to the system existing before 1958: a general controlof capi tal flows will b e ineffectivewithout re-introducing restrictions ontrade in goods and services.

I gave you earlier two examples of the interconnection betweencapitalflows and current transactions. A study of the different measures takenover two years by several of the large countries show s how easily thecontrol of movem ents of pure capital overflows into ,tha t of currenttransactions. As an example, there was the B ritish surcharge and m orerecently the deposit of fund s in the case of imports. There are also theGerman measures-for opposite easons, of course,-involving . taxabatement. Then there is the set of Am erican measures which provideus with a text-book case: the subtle definition of capital .exports whichdoes not neglect-forgood r e a s o n s t h e non-repatriation of profitsmade outside the U nited States, although nobody denies that transfersof profits should be considered for all other purposes as current trans-actions. Finally, we could consider the precision of the French exch.angecontro l which covers all the finer points of the financing of foreign trade.

It is all mo re interesting to note that, in spite of these steps leadingtowards the control of current transactions, the measures taken in eachof ,thecountries I have just mentionedhaveprovedunsatisfactory.Statistically they succeeded but, for m ysterious reasons, there h as alwaysbeenadisappointingcompensation in other items of the balance . ofpayments. Exports of capital from the United States fell sharply, duemainly to incoming capita l in search of portfo lio investments; at thesame ime,however, the traditional surplus in he trade balance dis-appeared. In spite of the success of the British exchange con trol, theoverseas trade figures did not respond to economic policy. The Frenchexchange control appears to be exceptionally efficient but, for reasonsunknown to me, the French trade ba lance is still in the red; in fact, ithas deteriorated. The Germans, in their turn, managed to export con-siderableamounts of cap ital in 1967 and 1968 but the surplus fromtheir current account reached an all-time high during the same years.

I am convinced that part of the explanation lies in the fact that thestatistical definition of the current transactions is unsatisfactory, , a s itis inevitable that with the ever .growing volume and redoub table com-plexity of foreign trade and thanks to mans nventivegenius,muchcapital flows through the channelsprovided for movem ents of goods


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30 THEROLE OF MONETARYGOLDOVERTHE NEXT TEN YEARSand services. Furthermore, those cap ital funds, which are un able to doso directly, will do it indirectly, by means of an adjustment mechanismwhichproves hegolden rule of macro-economicanalysis,accordingto which the balance of payments forms a unity which can only be cutup into pieces where there is a general control of all transactions.. Onlysuch a control could prevent changes. n one component of the balanceof payments to. be offset by compensating changes in some other oom-ponents.

The other alternative, the dollar-standard, merits criticism for funda-mental political reasons. Con trary to what has just been said regardingthe control of movements of capital, his alterna tive is by no meansimpossible. On the contrary, it seems highly practicable, at least tech-nically. The power, organization and innovating capacity of the Ameri-can industrymakesuchaformidablecompetitor for he rest of theworld that the latter could hardly accept a devaluation of the dollarrelatively to all the other currencies. If the dollar was to lose its goldparity, the large majority of countries would be obliged to follow thedollar in order to protect the ir competitive position.

This, of course, has been known to us for some time. Until a b u t ayear ago, however, such a dollar standard could not have been estab-lished withou t at least some reaction from the rest of the world. Thisreaction might have taken the form of regional groupings, the establish-ment of regional currencies or monetary areas, involving-admittedly-the risk of increased regional protectionism . While many of us wouldhave regretted a return to protectionism, there would have remahedat leas t som e balance of power in the w orld econom y and this wouldhave mplied the possibility of negotiation and discussions.I do not think that this possibility is any longer open to us. The poli-tical troubles in various European countries, coupled with the weaken-ing of the currency of o ne of the main European countries and the emer-gence of balance-of-paymentsdeficits in others would make it rather

difficult to fo rm a countervailing monetary power in E urope. There-fore there are practically no obstacles in the way of the dollar standard.Recen t market trends confirm this opinion: the re has been no weak-ening of the dollar on the foreign exchange marke ts when the very p oorbalance-of-paymentsfigureswereannounced for the UnitedStates inMay. I do not think tha t this can be explained away by the high interest


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ALEXANDRE LAMFALUSSY- EXT 3 1rates on dollar deposits. There seems to be the recognition that w hilethe U.S. economy may have to .face serious inflationary disturbances,no other countries are immune to these,and that, on balance, it issafer, or at least as safe, to hold dollars as any other currency, with thepossible exception of the D Mark.

However, we must be aware of the most serious implications of thekind of dem onetization of gold which would be im plied by the dollarstandard. W e can have a mild foretaste of these political reactions byreading the European press on the war of escalation in interest rates,triggered off by U.S. borrowings on the Euro-dollar market, which isregarded as the m ain culprit in the financing problems encountered inmany E uropean countries. Th e dollar standard implies that the worldoutside the United States loses all independence n economic policy. Wewould have to ad opt the rate of inflation (o r deflation) chosen by theAm erican economy. I am acking he courage to outline the politicalconsequences of sucha loss of economicsovereignty in face of theUnited States: they are bo und to be disastrous, for the U nited Statesitself as well as for the rest of the world.The way out

To sum up the main line of argument developed on the precedingpages. We can only hope to achieve the progressive de-monetization ofgold if we succeed in improving the adjustment processnd if we manageto ensure, in an orderly way, the growth of international liquidity. Infact, we have seen that the process of adjustment is unlikely to becomemore effective by tself and that there are signs of shortage of inter-national iquidity. We are thusmoving owards epeatedcriseswiththe likely consequences hat the little remaining freedom in internationaltransactions will be abandoned and that we will adopt (implicitly) thedollar standard. If we want to avoid this, we will have to deal with theroot of the problem, i.e. both with the adjustment process and with theinadequatecreation of international iquidity.O n , his second problem, there is some hope now. The m echanics ofspecial drawing rights s a substantial step n the right direction andfollows the logics of th e demonetization of gold. This would be a useful,flexible and rational way of creatingreserves. I t ough t to be pu t infunction as quickly as possible.


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32 THEROLE OF MONETARYGOLDOVERTHE NEXTTEN YEARSOne must add , however, immediately that we would never b e ,ableto create adequate reserves if there was no substantial improvement inthe adqustm ent process. The need fo r reserves increase indefinitely whenthe mechanics of adjustment breaks down. Here we come to the inevit-able conclusion that exchange rates will have to becom e more flexible,

if we are to avoid persistent deficit or surplus positions in internationalpayments. We canno t expect governments to give up their desire (an dduty) to pursue in their economic policy objectives; we have no reasonto expect that in the future spending decisions will react more speedilyto policy measures than in the past; and finally I fail t o see how wecould contro l efficiently capita l movements without putting a brake oninternational trade of goods and services. This leaves us withno alterna-tive: only changes in exchange r a t e - u n y type of chang es-can speedup sufficiently the creaking . adjustment process.

This is no t a very original conclusion. Since the late n ineteen-thirties,we have been teaching n our universities that there is an incompatibilityb'etween igidlypeggedexchange rates, the freedom of internationaltransactions and the simultaneous achievem ent of domestic and externalbalance. Unless we are exceptionally lucky, something must give way:I hop e th at th is will be the rigidity of exchange rates. The expGienceof the last two years tends to suggest that after all economic theory isperhaps not ameaninglessexercise.June, 1969 (


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COMMENTARIESFollowing the presentation of his paper by Professor Lam falussy, the

President of the Foundation called upon each member of the panel inturn for comment.Wilfrid Baumgartner:

May I say first how pleased I am to have this excellent opportunity,thanks to A mbassador Burgess and the Jacobsson Foundation, to meetso many old friends and so many old problems, too.I remember the last words of a Marilyn M onroe film,where the finalsentence was: Nobody is perfect. May I say in respect to Professor

Lamfalussys paper, that it was perfect. I have rarely read and heardSO intelligent an analysis of the present monetary situation in the world.

I should like to begin by saying that I was never a fetishist of gold.I remember refusing to follow the line indicated to me years ago, beforethe war, by my predecessor in a public agency. He said to me: O nething is certain, young man, one thing is certain: a banker should nevergrantanycredit. He had someexcuse,since twas ustafter thedifficult period of the economic crisis of the early thirties; it is obvious,however, that it is normally better to follow a different course.I also remember a British friend who used to explain to me, everytime I ,met him, tha t he saw no essential difference between the minesof South Africa and the vaults of the centralbanks. M ore recently,it has been possible, in my country, to draw a parallel between damagecaused to the French financial situation and speeches made abou t theprice of gold.. These speeches have each been good incentives to furtherhoard ing of gold, which was certainly not to the advantage or interestof the F rench economy and of Frenchmen themselves. I should there-fore be prepared, nprinciple, . to sympathizewithProfessorLam-falussys position,when he says-if I amcorrectly nterpreting histram of thought-that he is not basically an adversary of the de-monetization of gold. In my opinion, the problem is knowing whethersuch a demonetization is possible; to be quite frank, I would doubt itat the present time. Professor Lamfalussy has explained the declining

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34 THEROLE OF MONETARYGOLD OVER THE NEXT TEN YEARS( '

role of gold in what is called the international monetary system. Thistrend certainly exists, but it began a long time. ago. Even in the timeof the so-calledgold standard, the ole of international creditwasalready very important and I have sometimes thought, I must say, thatgold, which was chosen as a standard because of its rarity, may becomeobsolete in the future because ,of he same rarity, in view of world needsfor liquidity. Nevertheless, it was chosen as a basis and has been main-tained as a basis and as such, in my opinion, it is still useful; but i t isprecisely for this reason that one cannot talk of gold prices in the sam e ~way as one talks of other prices.

M onetary policy snot an end in itself. It mustcontribute to arational econom ic development and a progressive mprovement of the , .standard of living for all people and in all countries, many ofwhichdo not m.aintain gold reserves.The maindifficulty s heonewhichProfessorLamfalussyunder-lined so neatly: the problem of the ad justment process, as well as .th atof the amount of w orld liquidity. The latter is obviously the easier ofthe two problems to solve. The proposals made by the InternationalMonetary Fund concerning Special Drawing Rights have ap pe se d tome to be logical and adequate and I am personally satisfied with theapproval which 'almost all governments have now given them. I havealwaysbeenconfident in themanagement of the Fund; it was thisconfidencewhichedme to participate,eightyearsago,with PerJacobsson and some ofmy friends, both Am erican and European , inthe creation of the Group of Ten. In my opinion, the am ount of mone-tary reserves can presently be m ore adequately realized through SDR'sthan through a change in the price of gold. I was delighted, two weeksago, to hear my successor in the French T reasury saying that he wasnot at a ll interested in a modification of 'the price of gold.

Withregard to theproblem of theadjustmentprocess, the recentadjustment in France was of the kind which is tolerated , by the Fundon the grounds that it is better to use surgery than medicine. As far asmedicine s concerned, I am not really prepared to support the ideaof more flexible ates for currencies. I still believe-and this is no tsimply the reaction of the industrialistwhich I have become-thatfixedparitiescontinue to be the bestsolution for the wholeworld.


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COMMENTARIES- ILFRID BAUMGARTNER 35Maybe it would be possible to enlarge a little what used to be calledthe gold points but, in my opinion, no m ore than that.

I do not believe that anything can be said on the problem of th eadjustment process-which sobviously inkedwith the problem ofworld iquidity-that would be more logical than the view expressedin the last report of the B.I.S.:

It &not be said too often that no internationa l monetary systemwi l l work properly unless countries are prepared to follow domesticpolicies thatare compatiblewith the maintenance of externalequi-librium. Th e task of monetary ooperation and coordination s tooperate in a way that assists ountries in achievinghis ssentialgoal. (*)

My only reservation on this text is that it appears to speak only ofmonetaryauthorities, and yet the process of adjustm ent scertainlyprimarily a problem for governments.It is my hope that, in he future , monetary difficulties can be m etby the application of two magic. worlds: for internal policies, serious-ness;2 and for international policy, cooperation.

Guido Cadi:We . must be especiallygrateful to ProfessorLamfalussy for theextremelystimulating paper whichhehassubmitted to us. I greatlywelcome the opportunity to take part in hisdiscussion as, on thewhole, I share hiseconomicpolicypreferencesandhismethod ofapproaching hisproblem.The economic policy preferences which I would like to see realized

in the medium-termare, stated simply,gradualdemonetization ofgold and its replacement by an international monetary reserve asset.Like Professor Lamfalussy, I am deeply concerned about the serious

dangersentailed in an alternativesolution nvolving the replacing ofgold with a national currency, and in particular, about the risks inherentin a situation which would give rise to a dollar standard.*Bank for InternationalSettlements, Thirty-Ninth Annual Report, Bade,9thJune 1969. Page 184.


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36 THEROLE OF MONETARYGOLDOVERTHE NEXTTEN YEARSShould the United States decide to cut the link between the do llarand gold-i.e., to stop buying and sellinggold at a fixedpriqe-thetrading partners of the United States would. have .th e following possi-bilities:-to allow the dollar to fluctuate on their markets;-to tie their currencies to the dollar at a fixed parity, which wouldforce them either to follow a monetary and financial policy similar tothat of the UnitedStates or to accumulate an unlimited amount ofdollarsshould heybecomecreditors, or to depend on U.S. creditsshould they become debtors;-to maintaina fixed parityvis-a-vis hedollar for commercialtransactions, but to allow hedollar to fluctuate reely for financialtransactions, as the Swiss authorities did after the Second World War.The advocates .of the dollar standa rd believe tha t, especially whenthe relatively small influence of the, foreign component on the UnitedStates GNP isconsidered,such a solutionwould not only b.e in theinterest of the United States but would also resolve the complex prob-lems inherent in. the adjustment of the disequilibria between the Am eri-can and the European areas, the latter being an EEC enlarged to in-clude the UnitedKingdomand heScandinaviancountries. I am notagainst limited flexibilityof exchange rates between large monetary areas

wheresuch lexibilityproves to benecessary ocomplete headjust-ment process when demand management policies, even if successful inre-establishing nternal tability, are incapable of achieving.externaladjustment.Nevertheless, I am not indifferent to thedangers of un-limited flexibility between monetary blocs as a re su lt, of a unilateral.decision of the United States.Should such a decision be taken ; the reactions might be much morecomplex than those foreseen by the supporters of the dollar standard.Firs t of all, the currencies of the E EC countries would fluctpate amongthemselves to the extent that thepolicies adop ted by he ndividualEEC mem ber countries differed. As a result, the process of economicintegration presently under way would come to a stop and subsequentlygive way to the breakdown of the Comm unity. Another result might bethe introduction offixed par values vis-a-vis the dollar for the settle-ment of current transactions,while he o-called financial. dollar


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COMMENTARIES- UIDO CARL1would fluchate. However,asystem ike his,whichpresupposes theintroduction of exchangecontrols,would oon be followedby theadoption of quotas and of other qua ntitative. estrictions which wouldultimately restrain thecompetitiveness of Am ericangoods on othermarkets. In fact, thiswould lead to a long period of monetary dis-order, characterizedby unstable exchangerates and the spreading ofadm inistrative controls on the movements of goods, persons, and capi-tal, after which it would be necessary to retu rn to a system of fixedparities.

The dangers of a dollar standard unilaterally imposed by the UnitedStates are therefore quite evident.Moreover, it isdifficult to believethat a similar standard could be introduced by an interna tional agree-ment under whichmembercountries of the international communitywould beallowed to interfere in the shaping of the financial andmonetarypolicies of the UnitedStates.

If we .take into accoun t the various com ponen ts of world reservesand try to determine what is in store for each of them in the future,we cannot but reach the following conclusions:(aF-As regards gold, not only will its proportion in to tal reservesgradually diminish, bu t it will be used less and less for settlement ofinternational transactions. At the present time, gold-holding coun tries

behave practically as if gold did not exist. In the event of a balanceof paymentsdeficit, hey irst resort to their oreignexchange e-serves and then to swaps, or to their reserve position in the F undif theyhaveany.Gold ssoldpracticallyas a last resort, that is,when all or nearly all the cred it tranche has been used, Alternatively,countries in a urpluspositionaccumulatedollars,activate w apsto help debtor countries, add to their reserve positions in the Fund,and extend medium-term credit denominated in national currencies.Only as a last possibility are they able to increase their gold reserves.Paradoxically,gold has become the least liquidcomponent of re-serves. The Washington agreement on the two-tier gold market, thesuccess of which s hardly questionable, has quite clearly created adistinction between m onetary and non-m onetary gold. If, as I hope,this agreemdnt .will continue to be the basis of gold policy of majorindustrial countries, monetary-gold would change as a consequenceonly of decisions to be taken by the IM F, and not of the vagaries


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38 THE ROLE OF MONETARYGOLD OVER THENEXTTEN YEARSof goldproduction. The metalwould ervemainly to satisfy thegrowing needs of industry and the dem and of hoarders. The price ofgold on the free market might still, for som e time, be affected. by theconventional price of $35 per ounce for official ransactions. How-ever, in the long un, it willhave to dependentirely on marketforces.

(b ) As far as major trading currencies are concerned, we stillwitness a gradual reduction of their use as reserve assets.The pound sterling has p ractically ceased to be used as a reserveasset since las t years Basle arrangements, when the m ajor industrialcountriesagreed to finance luctuations in the stexlingholdings ofthe Sterling Area countries. The latter countries tend increasinglyto diversify the composition of their reserves by including new assets

such as the dollar and gold. The French franc is following a some-what similar pattern, though on a smaller scale, because of its lessimportant international role.As f a r as he UnitedStatesdollar sconcerned, although it isincreasingly used n the settlement of internationa l commercial andfinancial transactions it is used less and less as a reserve asset. In-deed, there is an increasing tendency for central banks to maintainin their reserves a sufficientvolume of dollars to intervene on theexchange markets. (I n particular, we may perceive an evolution by

which the dollar will continue to be used as an intervention asseton the exchange markets and for the settlement of commercial andfinancial transactions, bu t progressively less as a reserve asset.)(c) Another reserve asset, which has been used more and m ore inthe last few years, is a members credit position in the Fund, tha t,is,the position resulting from the gold subscription and the use by theFund of the m embers currency to finance external deficits. We are,in fact, referring to the so-called gold and super gold tranche posi-tionswhichhavepractically tripled in the last decade without,however, exceeding 10 per cent of total reserves. .As his eservecomponent snothing but aby-product of thefinancing of extern al deficits, and does not necessarily correspond tothe needs of the system, we cannot expect an adeq uate co

Documents

The role of monetary gold over the next ten years