Should Gold be Scrapped?

COLONEL HILBORN:

Our guest of honour and speaker today was born in Toronto, received his M.A. in Economics from the University of Toronto and degrees from the Universities of Cambridge, Harvard and Manchester. He has written four books and over 100 other publications; has been editor of the Journal of Political Economy since 1960; member of several government commissions here and in the United States; greatly in demand at conferences and as a speaker, and despite all this activity has achieved great eminence as a teacher.

Dr. Harry Johnson, unlike many students of economics, has not only pursued his studies but has effectively overtaken them. Currently Professor of Economics at the University of Chicago, next year he will assume what is probably the highest academic post ever offered to a Canadian in the United Kingdom, the Chair of Economic Theory at the London School of Economics. He is provocative, controversial and topical and not the sort of economist who confines his discussions to problems we wouldn't have if there were no economists. Not long after the war I was privileged to spend several hours with Sumner Slichter, then Economic Adviser to president Truman. With the familiarity that comes from having grandfathers buried in the same Ontario cemetery and with the brashness of comparative youth I held forth on some opinions about free trade that were diametrically opposed to those of Mr. Slichter. I was politely but firmly extirpated and from that day to this I have kept my own modest counsel in the presence of economists. Today, however, I am constrained, in introducing our guest of honour, to comment upon his latest book "The Canadian Quandary". As Dr. Johnson says, much of it is "carefully complex" and some of it is "deliberately simple". What I found so fascinating about it was the extent to which I didn't understand the former and disagreed with the latter. As this excellent volume was published as long ago as 1963 it is rather dated as a compendium. We now have a whole new set of quandaries and have even acquired a few fresh dilemmas. Perhaps a sequel is in order possibly entitled "Son of Quandary".

I have had the feeling when reading Dr. Harry Johnson that we as Canadians somehow disappoint him, but it may be as an earlier Dr. Johnson--Samuel--said, "I never think I have hit hard unless it rebounds."

We welcome Dr. Johnson because it is a good thing to be reminded that there is no magic in monetary policy--or any other policy or power of government--that can ensure prosperity for everyone in perpetuity. I tell my boys to save their money because some day it may be valuable again. Up until recent weeks any idea of returning to the gold standard was generally dismissed as irrelevant nostalgia. Now we find it the centre of world monetary discussion. I don't know how Dr. Johnson feels about the gold standard; I don't know how I feel about the gold standard; in fact the only person whose feelings on the subject are clearly indicated to me are those of General deGaulle. How timely and fortunate it is that we should have with us today one who is renowned internationally as a leading economic analyst and critic to speak to us on the subject "Should Gold Be Scrapped?"--Dr. Harry G. Johnson.

DR. JOHNSON:

When Mr. Hilborn and I selected the problems of the international monetary system as the subject for my address to you today, we had no intimation that the subject would be of such immediate topical concern as it has since become. The problem of gold and its international monetary role has been very much in the news recently. On the other side of the Atlantic, President de Gaulle has raised the issue with his attack on the special status of the pound and the dollar in the present international monetary system, and his invitation to other countries to join France in a return to the gold standard. Of more immediate significance, his Finance Minister, M. Guiscard d'Estaing, has announced a new policy of taking settlement of French balance-of-payments surpluses only in gold. On this side of the Atlantic, the U.S. Administration had earlier moved to increase its supply of "free" gold by eliminating the 25% cover requirement against Federal Reserve Deposits. More recently, disclosure of the drastic and unexpected deterioration of the U.S. balance of payments in the fourth quarter of 1964 has prompted President Johnson to propose a series of new measures, aimed primarily at cutting the volume of U.S. private foreign investment, in order to reduce the U.S. balance-of-payments deficit and the associated threat of losses of gold from U.S. reserves. At the same time, the President's balance-of-payments message to Congress went further than any previous official statement in endorsing the view that the present international monetary system needs to be revised, and specifically in advocating the development of supplementary sources of reserves to relieve the strains which now result from the use of the dollar and sterling as substitutes for gold.

These recent official pronouncements and policy changes, however, have merely brought more nearly into the open a conflict that has been building up over several years, ever since it became evident to international economic experts--with the single important exception of the former Under Secretary of the U.S. Treasury--that the U.S. balance-of-payments deficit was not a transitory phenomenon, but a chronic and deep-seated malaise that would take many years for the natural processes of international economic adjustment to remedy. That conflict centres on the fact that the present international monetary system, in which the dollar plays a key role as an alternative international reserve asset to gold, has enabled the United States to finance its sustained deficit by relying on the willingness of foreigners to hold dollars, and increasingly on the recognition by foreign monetary authorities that they must hold dollars if they are not to precipitate a collapse of the system; at the same time, the fact that foreign monetary authorities could precipitate a collapse of the system has enabled them to exercise pressure on the U.S. Administration to pursue policies designed to mitigate the deficit and accelerate its solution.

Essentially, the conflict derives from the system of fixed exchange rates itself, which requires that a deficit-surplus situation be remedied by some combination of deflation in the deficit country (the U.S.) and inflation in the surplus countries (Western Europe). It has arisen because the United States has taken the position that its contribution to the adjustment should not require it to sacrifice domestic employment, but should properly require it only to prevent its domestic price level from rising while relying on inflation in Europe to restore adequate U.S. competitiveness in world markets; the Europeans, on the other hand, who have already endured a substantial inflation without its resulting in a noticeable trend of improvement in the U.S. balance of payments, and who for historical as well as other reasons intensely dislike inflation, understandably feel that too much of the burden of adjustment is being thrust on their shoulders, and that the United States should do much more than it has done. In effect, the adjustment processes required under a fixed exchange rate system are being blocked by refusal of each side to tolerate the policies appropriate for it to follow under the logic of the system; and this conflict is exasperated by the failure of each side to regard as serious the political reasons that inhibit the other from following the policies appropriate to its position.

The conflict has been further sharpened in the past two years or so by the fact that the continuation of the U.S. deficit has been associated with a substantial increase in private capital outflows from the U.S. to Europe. I say "associated with", though many observers, especially in Europe, assume "caused by" the private capital outflow, because the items in the balance of payments are economically interrelated and not simply additive, so that one cannot assume that an increase in the deficit can be attributed to a contemporaneous increase in one category of payments; and I am myself inclined anyway to relate the increased capital outflow to the continued overvaluation of the dollar relative to the European currencies, together with the attractive effects of the Common Market tariff. Be that as it may, the Europeans feel that by financing the U.S. deficit they are indirectly financing U.S. private investment in Europe, which they resent; and they cannot understand the reluctance of the U.S. authorities either to raise interest rates (which the U.S. authorities fear would create unemployment) or to impose controls on international capital movements (which the U.S. has been forced to move towards doing, though it goes against deep-rooted principles of free enterprise).

Under these circumstances, adjustment of the balanceof-payments disequilibrium between the United States and the European economies is bound to be a prolonged, as well as a politically acrimonious, process, since it depends on countries failing in the course of time to attain their policy objectives. This fact has a major implication for the present international monetary system, which few have appreciated. With long lags in adjustment of this kind, the international borrowing and lending required to finance the disequilibria entails international official capital movements larger in quantity and longer in duration than can be accommodated by reserve movements between central banks of the traditional type. Consequently, the present system really requires supplementation by provision for large long-term international loans, of the type provided under the Marshall Plan to meet the dollar shortage problem; instead, the monetary authorities of the leading countries have attempted to meet the situation by elaborating the technique of short-term international credits, a technique well adapted to overcoming speculative short-term capital movements but inadequate to deal with chronic balance-of-payments disequilibria.

What is really the same point can be made in a different way, more relevant to the current controversy over the international monetary system. If prolonged disequilibria are to be prevented, it is necessary to devise a monetary system that will force either the deficit countries, or the surplus countries, or both to adopt policies that will promote prompt adjustment, despite their other policy objectives. The Europeans believe that the present system, in which the pound and the dollar serve as reserve currencies, enables the U.K. and the U.S. to evade the necessity of prompt adjustment; and they desire revisions of the international monetary system that will reduce or remove the possibility of evasion. General de Gaulle's recent attack on sterling and. the dollar is to be interpreted as an expression of this view-and it is erroneous to believe that his ideas are an eccentricity unrepresentative of European thinking-while his invitation to return to the gold standard involves an extreme of monetary reform that would, if it could be effected, establish a system of imposing ineluctable pressures for prompt adjustment on deficit and surplus countries alike. Nor can this proposal be dismissed, as U.S. officials have dismissed it, as a return to "the gold standard that broke down in 1931"; for the truth is that the standard that broke down in 1931 was not a gold standard of the classical type, but a gold exchange standard precisely like the present international monetary standard, and it broke down precisely because a few national currencies were being used on a large scale as substitutes for gold that did not exist. A return to the gold standard, if it could be effected, would eliminate this grave deficiency in the present international monetary system, since all reserves would be hard metal and not credit money whose use in place of gold depended on confidence. Nor it is really a valid argument against a return to the gold standard that, to make it possible without a sharp deflation of world prices, the price of gold would have to be doubled or tripled, and that this would involve undesirable capital gains to holders and producers of gold. It is simply silly to oppose a change that would promote the general good, on the grounds that some people will derive a windfall profit from it.

The real arguments against attempting to return to the gold standard derive from the very characteristic of gold that gives the gold standard its virtue in the eyes of its proponents-the fact that gold is a commodity the producttion of which entails a real cost. This fact has two crucial implications. First, there will always be an incentive for the financial system to develop credit substitutes for gold, because on the one hand gold yields no interest to the holder whereas credit substitutes do, and on the other hand credit substitutes can be produced (though not maintained as efficient substitutes) at virtually zero real cost. In fact, the history of money is essentially a history of the gradual substitution of credit money for commodity money in response to the interaction of scarcity of the latter and ingenuity in devising the former. The economics involved ensure that a return to the gold standard would be a practical impossibility. Second, tying the international monetary system to a produced commodity-especially a mineral-as the basic money inevitably entails exposing the system to erratic changes in the stock of money resulting from the vagaries of technical change and new discoveries in the industry producing the monetary commodity; inevitably, rationality will suggest-as historically it already has-that these erratic changes can and should be avoided by deliberate monetary management, and that the costs of production incurred in gold mining can be escaped by resorting to credit money. A return to the gold standard would therefore involve a deliberate surrender of the chance to exercise rationality in monetary affairs, in favour of control by erratic and unpredictable forces; such a surrender by organized society of a realized possibility of conscious control is simply inconceivable.

It therefore seems self-evident that the gold standard cannot be restored; fundamental forces of both economicsthe principle of cost minimization through substitution- and of social psychology-the desire to control and improve the environment-are against it. But the present gold exchange standard contains inherent and dangerous weaknesses, which it has increasingly been admitted call for reform of the system. These weaknesses are all connected with the fact that in the present system gold is the ultimate or basic form of international reserve, but is not the only form of international reserve money, being supplemented by the holding of national moneys-primarily the dollar and the pound-as international reserves. Since, as I have just argued, reform cannot move in the direction of increasing the role of gold so as to replace this mixed system by an approximation to the gold standard, it must move in the direction of decreasing and altering the role of gold so as to minimize the dangers that its presence imposes on the system. The logical end of that process is the eventual scrapping of gold as an international money, and replacement of it by some international monetary system based entirely on credit.

International monetary experts who have studied the contemporary international monetary system are agreedand the agreement is recorded in the report of the Group of 32 academic economists (of whom I was one and Professor Rueff, General de Gaulle's economic advisor, another) who met several times at Bellagio and Princeton last year to discuss the matter-that the system poses three serious problems. One is the long-run liquidity problem: the present system leaves the growth of international reserves required to sustain the growth of world trade and payments to depend on the vagaries of new gold production, private hoarding and Russian dishoarding of gold, and the balance-of-payments experience of the reserve currency countries. Further, if new gold supplies are inadequate, the required reserves must be supplied by continuous deficits of the reserve currency countries, which undermines their reserve positions and the confidence in their currencies on which the use of these currencies as substitutes for gold depends. Another is the confidence problem: loss of confidence in one reserve currency leads to conversions of it into other currencies, which disturbs international monetary relationships, and this disturbance may prompt central banks to convert currencies into gold, which conversions could produce an international liquidity crisis (as happened in 1931). The third is the adjustment problem: the lack of a clearcut mechanism of adjustment, which is associated with the ability of reserve currency countries to finance deficits by running up currency debts to others, and of other countries to neutralize reserve changes. All three problems are associated with the use of national currencies as substitutes for gold, which currencies can be converted into gold at the option and whim of the central bank holding them.

It is evident from the definitions of the first two problems that solution of the long-run liquidity problem requires governing the growth of whatever credit money is used as a substitute for gold so as to obtain an increase in the total of this money plus gold equal to the required growth of international reserves, and that solution of the confidence problem requires restricting the convertibility of currencies into one another and into gold by central banks. One possible solution to both problems, towards which the central bankers have been pushed unwillingly by the prolonged dollar deficit, would be to agree to suspend conversions of dollars into gold and to trust the U.S. authorities to provide an appropriate growth of reserves by their balance of payments policies-in other words, for the world to go on a dollar standard. This solution, however, is obviously politically unacceptable to the other countries-and, given recent U.S. balance-of-payments history, not commendable as a solution to the long-run liquidity problem. A solution sufficiently satisfactory to be generally acceptable must obviously replace the dominance of the dollar by some more international form of credit money arrangement, and one subject to more international control.

Two major alternatives have been put forward: the Triffin Plan, which calls for centralization of reserves in an expanded International Monetary Fund, with countries holding their reserves in gold and Fund deposits, the latter in some fixed ratio to the former, the Fund holding national currency assets to back its deposit liabilities, and the Fund also increasing international reserves over time by open market operations; and the Bernstein Plan, or currency reserve unit plan, which calls for the construction of bundles of the leading national currencies with fixed ratios between the amounts of the various currencies in the bundle (the currency reserve unit), countries being obliged to hold these bundles within a certain range of ratios to their holdings of gold, and the total number of currency reserve units outstanding and the required ratios of units to gold being raised by international agreement over time. The Triffin Plan, in short, would substitute a genuinely international credit money for national currencies in international reserves, and subject the quantity outstanding to control by an intemational institution; the Bernstein plan would substitute a composite bundle of national currencies for the pound and the dollar, and have the quantity outstanding controlled by agreement among the major currency countries.

Both schemes would reduce and stabilize the role of gold in the international monetary system; equally, both would reduce-and the Triffin Plan would virtually eliminate-the reserve currency role of the dollar and the pound. The major difference between them, aside from the more radical nature of the Triffin Plan, lies in the nature of control of the quantity of international reserve money supplied, and this difference derives its main significance from the conflict concerning the adjustment mechanism I have already discussed. For in the International Monetary Fund the Europeans have minority voting power and the United States great influence, whereas in a currency reserve unit scheme the Europeans would have a majority vote if not a veto power. This power they would obviously prefer to have, given their views on the inflationary character of the present system, so that the currency reserve unit scheme is almost inevitably the one that will emerge from current deliberations on the reform of the system. Moreover, for this reason, the currency reserve unit scheme is likely to constitute more of a return to something like the discipline of the traditional gold standard than would the Triffin Plan-though the mechanism of adjustments would be vastly different, since indications are that it would include the use of a variety of controls on international trade and capital movements.

In any case, it is clear that the next stage in the evolution of the international monetary system must involve a whittling down of the international monetary role of gold (as well as of the U.S. dollar). The real division between the Americans and the Europeans is no longer over that issue-the American position on it changed abruptly in mid-1963-but over the distribution of the responsibility for adjustment of international disequilibria. The logical end of the process of whittling down the role of gold is, as I have already stated, the scrapping of gold as an international monetary metal, and the establishment of a completely credit international money. This would most likely entail the elevation of the International Monetary Fund into an independent world central bank. And given the political jealousies between Europe and the United States and European suspicion of the I.M.F. as a creature of the United States that event appears to be a long way off.

There is, however, some possibility that the demotion of gold from its monetary role could occur much more rapidly, and by a completely different sequence of events. The international monetary strains of the dollar surplus epoch, as already mentioned, have been the consequence of the attempt to maintain a system of fixed exchange rates without either the deficit or the surplus countries being willing to pursue the required adjustment policies to the necessary extent. In the course of the period, the United States Administration has become greatly disillusioned with the countries of the Common Market, and especially with France. It is possible that, if pushed too far by the ingratitude and chicanery of countries it assisted generously in the postwar reconstruction period, the patience of the U.S. Administration will snap, and the country will simply terminate the convertibility of dollars into gold (or of gold into dollars). In that event, gold would not be scrapped-judging by the 1930's experience of floating exchange rates, the demand for it could conceivably increase but it would become at best a commodity especially suitable for the conducting of intervention operations in foreign exchange markets.

Thanks

Thanks of this meeting were expressed by Dr. Ian Macdonald, a Director of the Empire Club.