Lessons from International Monetary Experience in 1969

MR. MACDONALD:

At the time of the formation of the European Common Market, I recall a New Yorker cartoon of a prosperous lady and gentleman being served "brunch" on the balcony of a Riviera villa. The lady turned to her husband and proclaimed in a mixed tone of bewilderment and disdain: "But, George, I cannot understand what business you would have in a common market."

Today, we welcome to the Empire Club of Canada a man who has not only created business in the Common Market, but a man who has also played a part in financing business around the world as well as studying the means of bringing business to the developing nations.

The Deutsche Bank A.G. of Frankfurt, West Germany is one of the world's great banks and Dr. Wilfried Guth is one of the world's great bankers. Undoubtedly, his breadth of interest and influence is a product of his formidable education, a process which took him to the Universities of Bonn, Heidelberg, and Geneva as well as the London School of Economics. Surely a combination of the thorough discipline of Bonn and Heidelberg, the world outlook of Geneva and the radical tinge of London has made him a "man for all reasons".

Dr. Guth's formal banking career was launched in the research department of the central bank of West Germany the Deutsche Bundesbank--in 1953. In 1959, he began a threeyear session in Washington as the Executive Director for the Federal Republic of Germany at the International Monetary Fund. During this period, his interest in and experience of international finance deepened and broadened, securing for him an enviable reputation. In 1962, he returned to Germany as a Member of the Board of Managers of the Reconstruction Loan Corporation, where he remained until 1968 when he accepted a position as a member of the Board of Managers of the Deutsche Bank A.G.

In addition to responsibilities in investment banking, which take him to all corners of the globe, he is chairman and member of the supervisory board of several other companies and non-profit organizations. Yet, he has remained a scholar and his numerous publications include an important study, published in 1957, called "Capital Exports to Less Developed Countries".

On August 19, 1968, The Right Honourable L. B. Pearson accepted an invitation from Robert S. McNamara, President of the World Bank, to form a Commission to study international co-operation for economic development. Mr. Pearson invited seven outstanding world authorities to join him on the Commission in a private capacity: The Right Honourable Sir Edward Boyle, the British parliamentarianeconomist, The Hon. Roberto de Oliveira Campos of Brazil, The Hon. C. Douglas Dillon, former Secretary of the United States Treasury, Professor W. Arthur Lewis of Jamaica, Dr. Robert E. Marjolin, a former Vice-President of the European Economic Community, Dr. Saburo Okita of the Japanese Economic Advisory Bureau and, not surprisingly, Dr. Wilfried Guth of the Federal Republic of Germany. The Report, "Partners in Development" was concluded and presented a few months ago.

During that same period, the international community was gripped by excitement of another kind-major currency speculation and the prospect of reform, centring on economic uncertainty in France. Cecil Rhodes had different circumstances in mind when he wrote, in 1901, that: "A good understanding between England, Germany and the United States of America will secure the peace of the World," whereupon he proceeded to set up scholarships in those nations. Yet, the same observation was just as appropriate in the international monetary world of 1969, when we experienced one of the major currency reforms of the postwar era.

The first invitation which I had the honour to extend on behalf of this Club was to Dr. Guth, in his Frankfurt office last May. Because you have taken the trouble to pay a special visit to the Empire Club, Sir, we are particularly grateful that you are our guest today, and what trouble, including nearly eighteen hours of travel via London, Halifax and Montreal before arriving here at midnight! Because you were a part of that recent monetary history, we look forward to your insight to "Lessons from International Monetary Experience in 1969" as seen by a banker, a scholar and a citizen of the world.

MR. GUTH:

Monetary experience has been quite exciting, at times even turbulent over the last twelve or eighteen months. We have experienced some extraordinary waves of speculation, two major parity changes--or rather three if we look back somewhat longer and include sterling partly as a result of that speculation, the introduction of a new reserve element into the Bretton Woods system, an astonishing fall of the gold price to its official level of $35, a new deterioration of the American and, at last, an improvement of the British balance of payments. The year has ended with new unexpected heights of interest rates and a severe liquidity shortage almost everywhere. These are not easy times for bankers or industrialists and still business was generally good in 1969, world trade has been growing rapidly and international capital movements were again on a very high level.

I deliberately stress these latter facts as an introduction to my speech in order to show that our world monetary system cannot be and is not as bad as some of its critics want us to believe. One should add that the system has been well managed and although countries are far from having learnt how to avoid crises we must admit that the art of international crisis management has been highly developed. But even in this field there are some unresolved problems to which I want to draw your attention later on.

It would be inappropriate in my opinion, particularly in the first weeks of a new year, to elaborate in detail on past events which you are all more or less familiar with. What I propose is to comment on these events only to the extent that they provide lessons of a rather general nature for the future conduct of our international monetary affairs.

If I may begin with the parity changes and here particularly the revaluation of the D-Mark one lesson is so obvious that it seems almost unnecessary to state it here. Parity changes, particularly of the more important currencies, cannot be discussed publicly and at great length without endangering the regular flow of world payments. As a German, I am ashamed to have to admit that we have set anything but an example in this respect. By way of contrast our French friends have demonstrated how to carry out such an operation efficiently and as a perfect surprise to speculators.

The German experience of repeated waves of speculation into a currency likely to be revalued was not entirely new. The world has seen such movements also before the first German revaluation of 1961 and opposite movements out of sterling on several occasions. What has been new is the size of these speculative flows. To quote some figures, there have been three main waves of speculation in the DMark. The first in the autumn of 1968 brought the Bundesbank an inflow of almost 21/2 billion dollars, the second in April/May 1969 washed more than 4 billion dollars into Germany and the last in September 1969 caused another inflow of 11/2 billion dollars before the German foreign exchange markets were temporarily closed to prepare for the new steps to be taken.

Of course, not all, not even the greater part of these huge movements of funds were transactions of private speculators in the true sense of the word. The bulk of it arose out of changes in the terms of payments of companies, the so-called leads and lags induced by the expectation of a parity change. But whatever their underlying cause, these massive short-term capital inflows created an artificial liquidity situation in Germany--you might call it a "fool's paradise"--and thereby severely jeopardized the possibilities of the Central Bank to act against the mounting pressures of a more and more overheated economy. This, indeed, was the main reason why our Central Bank was in favour of a revaluation all along.

As to the international repercussions of these speculative movements of funds I think it is fair to say that Germany did a lot to mitigate them. Not only did the Central Bank embark on substantial swap operations--now referred to under the term of "recycling", a policy to which I shall refer again later but it also encouraged the leading issuing banks to intensify their efforts to place foreign DM bonds in the German capital market. Also on this subject, which should be of interest to you who have among others profited from this situation, I shall have something more to say later on. But in spite of these short-term and long-term capital exports, which led to an unprecedented volume of capital outflow in the German balance of payments in 1969, severe effects on the reserve and liquidity positions of some other European countries could not be avoided. I would like to mention in passing that the reverse movement which we presently face in our German banking system, an outflow of speculative funds in the order of more than 5 billion dollars within the few weeks after revaluation, is equally embarrassing and even more painful for us. It has, inter alia, completely blocked for the time being our possibilities to place DM issues of foreign borrowers on our capital market.

We are all aware that the almost unmanageable potential of speculative waves in our days is due mainly to the existence of the Eurodollar market, the size of which is now estimated at some 35-40 billion dollars. It is not surprising therefore that for some observers this huge market of freely convertible funds, which is not subject to any control by Central Banks or government authorities, has become the villain in the play of international monetary affairs. Indeed, many other difficulties can easily be attributed to its existence: Central Banks find it much harder to control the volume and the price of credit today, when not only banks but also industry can borrow directly from this market. American banks have demonstrated this most conspicuously during the last year when they mobilized through their European branches some 8 billion dollars, increasing their total liabilities to their foreign branches to more than 15 billion dollars. And at present, for the first time due to the parallel moves against inflation in the important countries, the Eurodollar market has become extremely tight and interest rates of up to 13 % are paid for short-term money. The risk can, of course, not be excluded that some shortterm borrower who has--against the golden rule of banking--lent this Euromoney on long term can neither renew nor repay his credit and that such a weak spot could endanger the whole edifice of the Eurodollar market. And again, quite understandably at first sight, the critics point to the villain.

Personally, I do not share this view. While recognizing fully the problems just described--some of which might be eased by making this market more transparent--I believe that the Eurodollar market has also brought great advantages to world trade and payments. Some commentator has called it recently a "lubricant for world trade", a well coined phrase in my opinion. Without this free international money market the risk of severe recession might be much greater in our countries if for one reason or the other a real "credit crunch" occurs which completely upsets investment plans. It might also be said that in the absence of speculative tendencies the Eurodollar pool works as an enormous equilibrating basin making the need for reserve movements much smaller.

But whether liked or not liked, the Eurodollar market exists and will continue to exist in my opinion. One could even apply the old saying: if it did not exist, it ought to be invented. As a market it is neither devil nor angel, it is the operators on this market who bear the responsibility for not threatening but easing the work of our monetary system.

Certain conclusions must be drawn in my view from the fact that we shall have to live with the Eurodollar market. The most important one seems to me that co-operation between monetary authorities must be even closer than before. As I already said, there are two types of such co-operation: the "crisis preventing co-operation" and the "crisis management". The former is more important--and more difficult. It requires not only the adoption of more or less identical standards for the outer limits of tolerance for price increases but also a clear determination and power to act if monetary stability thus defined is endangered. International monetary cooperation also means that the repercussions of domestic policy measures on other countries must constantly be kept in mind and that, therefore, policies affecting others should be devised in consultation with these countries as it is foreseen in the International Monetary Fund or in our more recent European institutions.

It needs hardly be said that this type of co-operation or rather co-ordination, sometimes referred to as the adjustment problem, is far from being satisfactory in our present world and even our European efforts to achieve these aims between the six member countries of EEC have so far not yielded encouraging results--as has been demonstrated by the growing disparity between the French franc and the D-Mark. Thus, we cannot expect that our present monetary system, even with the undisputable strengthening it has been given by the introduction of the Special Drawing Rights reflected among other things in the fall of the free gold price--will be free from speculation and currency crises in the future.

It is all the more reassuring that the second type of cooperation, as explained above, works very well. This cooperation consists mainly of the close daily contacts of the Central Banks and the utilization of a network of swap agreements as well as the private channels of the Eurodollar market; it is co-operation not by long meetings but by telephone. This co-operation for which the Bank for International Settlements in Basle plays a pivotal role has been developed and "tested" in the various crises of the pound sterling, and I have already mentioned its relative success preventing a collapse of the whole system--in the German case. As long as this co-operation is not mistakenly considered as the whole task of international co-operation, it can be praised without hesitation.

Now there have been proposals to make this system of reshuffling speculative funds back into the country of origin, of recycling, as the more glamorous term goes, more or less automatic. You will remember, last year there was some talk of placing a binding obligation on Central Banks, perhaps those of the Group of Ten, immediately to redirect speculative inflows of money and capital regardless of the amount involved to the country or countries they came from. (This idea is sometimes referred to as the Carli Plan.) I do not believe that an automatic process of this kind would be practicable. In purely technical terms it would be difficult to determine in each individual case what should be regarded as a speculative inflow. But there are, in my view, more important reservations on policy grounds. Automatic recycling could seriously reduce the will to fight inflationary pressures in a given country when any threat of losing reserves is abolished. We have also seen in the German case that recycling can be self-defeating under certain circumstances. What developed in late spring of 1969 could be called a self-financing carousel. The German Central Bank induced the commercial banks through favourable swap rates to invest their liquidity in the Eurodollar market. But from there, given the speculative tendencies, the money immediately returned to Germany. With automatic recycling nothing would have been gained in such a situation. I, therefore, believe that it should be left to the Central Banks to judge in what direction and to what extent recycling appears appropriate in the given circumstances.

Another conclusion to be drawn from the existence of the Eurodollar market is that interest rates are now much more closely interdependent internationally than before. The market acts as a turn-table, furthering the transfer of movements in interest rates from one country to another. Yet, the impact of countries is, of course, not equal. The development of the past year has clearly shown what a dominant role the United States now plays in interest rate developments throughout the developed world. Before such an audience I scarcely need to go into details.

This does not mean that it would be justifiable to blame the United States for the internationally high rates. They are rather one of the results of world-wide efforts--very evident also in your country--to control inflation and of the accompanying phenomenon that in most countries the Central Banks have to bear the main burden of stabilization policy and are not sufficiently supported by fiscal policy. As the present high interest rates all over the world are thus nothing but a symptom of our difficulties to maintain or re-establish economic and monetary stability, I do not believe one would achieve much by demanding a concerted international effort, as once agreed upon in Chequers, to force down interest rates. It is only when efforts of stabilization have produced clearly recognizable and adequate results in all greater countries and mainly in the United States that it will make sense to talk about harmonization of downward movements of interest rates.

In many quarters the developments of the last few years and particularly in 1969 have been interpreted as proving that our exchange rate system is too rigid and that greater flexibility should be allowed. It is argued that the obvious impossibility of co-ordinating national policies (as I have suggested) and of agreeing on common standards of price stability and incomes policies leaves no other way open. For my taste, this conclusion is drawn too quickly. I believe that a better observance of the rules of the Bretton Woods system as it has been in force up to now would render superfluous a great deal of the alleged needs for drastic reforms. It must be emphasized that this system which is based on fixed exchange rates does not imply a concept that these should never be changed. On the contrary, changes of parity should be enacted without long hesitation when fundamental disequilibria in the balance of payments have become apparent. The difficulty is, of course, as we have seen in the German case, to reach agreement in a given moment on whether a fundamental disequilibrium is prevalent. But much would be gained already if changes in parities, and particularly devaluations, would not be considered any more as questions of national prestige. The Bretton Woods system could then be operated quite flexibly and there would not even be a great gulf to some of the crawling peg proposals. I have to admit, however, that this might not be fully realistic.

Meanwhile some adherents of the theory of flexible rates have maintained that the German experiment of temporarily floating rates can be taken as proof that such a system would work. Market forces would bring the rate smoothly to a new and "right" level while trade and payments would continue as usual. In my view such a conclusion is not permissible. The rate for the D-Mark was flexible only in a very limited sense from September 28 to October 26; in fact, the Central Bank was constantly in the market during these weeks and influenced the rate by its interventions. Furthermore, everyone knew that the period of quasi-flexibility could only be an interlude and would soon be replaced by the fixing of a new parity. For all these reasons the recent German experience, while providing perhaps a valid model for changing from one parity to the other, says very little about the workability and suitability of a flexible exchange rate system.

In this country you have a much greater experience with exchange rate flexibility and it would therefore mean carrying coals to Newcastle should I try to lecture here on this subject. But I doubt whether even your experience allows us to draw conclusions for a system in which not just one or two but all major currencies with the likely exception of the US dollar would be operated on a flexible basis. Thus, I think we will all await with interest the expert studies presently under way. I would not be surprised if a modest widening of the margins of fluctuations finds the greatest support by the governments.

Whatever advantages systems of more flexible or flexible rates might have I fear they have one great disadvantage: they are solutions of disintegration and of resignation with respect to the undeniable difficulties of achieving better international co-operation and co-ordination of economic and monetary policies. They are more or less elegant attempts to evade this obligation and regain the liberty to pursue policies geared mainly to national interests. I cannot bring myself to accept this philosophy of international economic relations and I am old-fashioned--or idealistic enough to want to make further efforts to obtain better international adjustment of national economic policies.

There is one other field of truly international experience to which I want to switch now in concluding my remarks: the international capital market, twin brother, as we might call it, of the Eurodollar market. Despite grave monetary crises international bond issues have been almost as high in 1969 as in the record year 1968--4 billion dollars as against 4.7 billion dollars--the decline being only due to the diminishing attractiveness of convertible issues of American companies. I am tempted to repeat here my phrases when talking about the Eurodollar market: the international capital market exists and will continue to exist. If it did not exist, it ought to be invented. As you know, this market, mostly called Eurobond market--although it is by no means a European capital market--has not developed out of an integration and harmonization of national capital markets but rather the reverse: it has come into appearance as an imaginative counter-move of free investment bankers from both sides of the Atlantic against the regrettable protectionistic sheltering of national capital markets almost everywhere, be it for balance of payments or other reasons. It is spread over various market places, such as Zurich, Frankfurt, London, and it has no controlling or supervising authority. It is a truly free market.

I need not tell you here in Canada which advantages this market has brought to the world economy, what effects the partial closing of the New York capital market would have had on many countries without the existence of this "cushion". And I want to stress only with one sentence our satisfaction as Europeans to have been able for the last two years to export capital on a net basis to the United States in rather substantial amounts, thereby helping our great Atlantic partner in its balance of payments difficulties who has given support to Europe so generously for many years after the war.

What are the lessons we can learn from this market, what are the "secrets" of its success, what are its limitations and handicaps? Obviously, the recipe for its success has been freedom and flexibility. No government steered or supervised market could have reacted so quickly to dramatically changing circumstances. There have been constant shifts of emphasis from one currency to the other, from one type of issue to the other. In 1969 the D-Mark had temporarily to replace the dollar as the leading currency; in 1970 the dollar has again taken the lead as the DM-market has been severely struck by the effects of the revaluation. In 1968 dollar-denominated convertible bonds of American companies became a particularly attractive feature of the market; in 1969, with the unstable situation of Wall Street, there was a return to straight bonds and towards the end of the year dollar warrant issues of some big German companies became the front runner of the market. All this has been effected without any severe disturbance or even interruption of the issuing business.

There have, however, been some periods of overloading and ensuing "indigestion". Like a healthy living organism, the market has overcome these periods rather quickly and without adverse after-effects. But the lesson should be learned that this free market cannot flourish without a certain amount of self-discipline. In my view this self-discipline, or call it feeling of responsibility, must be exerted mainly by the issuing banks, but also by borrowers. Of course, competition between issuing houses is and must be a life element of this market but if I look at the excitement with which at the end of each year the lists of the top five, ten or twenty in the business are compiled and awaited I cannot avoid a feeling that too many elements of a horse race or football league mentality have come into the picture and that perhaps standards of selectivity have been lowered too much, necessary time intervals between issues shortened too much for the sake of big figures in the various lists and, of course, profits.

On the side of the borrowers, there have also been "sinners", but mostly they have got their "punishment" rather quickly. Two European countries rushed into this market after long periods of hesitation at the end of 1968 and the beginning of 1969 and tried to mobilize for some of their Governments entities too much in too short a time; the result was in both cases a rather poor reception of the later issues and an unwillingness of the market to take more of the same kind. Other countries, such as for instance Japan, have proven that by a more regular and more moderate approach to the market greater amounts can be mobilized over time and a higher standing on the market be reached.

If I should say a word on Canadian borrowing in the international bond market, particularly in D-Mark, it must first be stated that the complete independence of the Provinces in their foreign issue transactions unavoidably complicates the self-discipline problem. If one Province borrows abroad why should the other, even if it has not the same market standing, not try to do so at the same time? Undoubtedly this implies the risk of overloading the market and there have been some comments in this direction. I certainly cannot judge whether there is a possibility of coordination between the Provinces. Given this situation one must say that by and large things have gone remarkably well with Canadian Provinces in our market which is certainly due to the knowledge of the investing public of the strength and the potential of the Canadian economy. This holds particularly true for the Province in which I have the privilege to speak today. As a member of the managing bank for Ontario, I am very pleased to tell you the issues of this Province have all been successful.

One other great problem of the present international capital market should be mentioned: the market is not yet sufficiently broad so far as currencies and placing possibilities are concerned. Although the US-dollar, in spite of the continuing balance of payments difficulties of the United States, has developed a universally accepted reputation as the leading issue currency and the D-Mark and the Swiss franc are also well received internationally, it could only strengthen the market if other currencies such as the Pound sterling or the French franc would return to the scene which presupposes, of course, an opening of their capital markets. I mention only in passing that in the longer run all these currencies might be replaced by a strong European reserve and issue currency. Looking at a future time, I could also imagine the Japanese yen becoming a currency for international issues.

As to the possibilities of placement it is obvious that the seclusion of such markets as Britain or Italy narrows the potential of the whole international market and involves the risk of an over saturation of available markets for placement such as Germany or Switzerland. It is therefore reassuring that markets in Belgium and France seem to become more receptive these days thereby compensating for the present weakness of the German market.

But there can be no doubt that the crucial problem is the American, the New York capital market. It would be an illusion to believe that European capital markets can in the longer run, apart from satisfying all European needs, provide the bulk of the funds for foreign--including American investment in the rest of the world. A stable and powerful international capital market which is a prerequisite for the further growth of our economies and particularly the great international or multinational corporations requires a reopening of the American capital market.

Let me conclude with a vote of confidence in our present international monetary system and the expression of my hope that the attained freedom of transactions in goods, services and capital will be increased rather than diminished in the future and international co-operation be improved on all levels.

Dr. Guth was thanked on behalf of The Empire Club by Mr. R. Bredin Stapells.