Huge Amounts of Short-Term Capital were beginning to flow freely across national boundaries from one monetary center to another by early in 1968.1 In the course of 1969 these flows of funds, together with other economic circumstances, precipitated changes in the par values of two major currencies—the French franc and the deutsche mark.
Prelude to Devaluation of Franc
The difficulties that preceded the devaluation of the French franc in August 1969 began late in May 1968. Social unrest, starting among university students, touched off widespread strikes throughout France. At their height these “events,” as the French authorities preferred to call them, involved 10 million workers, about half the labor force. They were responsible for a loss of output estimated at 2 per cent of the gross national product for 1968. The potential effects on France’s international competitive position of the wage agreement concluded to settle the strikes were of even greater concern, however. This agreement involved an increase in hourly wage rates of over 11 per cent and a shortening of the workweek.
These difficulties, which were compounded by the flight of vast amounts of capital, notably into deutsche mark, prompted the French authorities, in June 1968, to make a gold tranche drawing from the Fund. But if the immediate outlook for the franc was dim, the reverse was true for the deutsche mark. The Federal Republic of Germany had been running surpluses both on trade and on current account since the late 1950s, and many suggestions, including some from highly placed monetary officials in other industrial countries, were being made that the deutsche mark ought to be revalued. Talk of this kind began to produce recurrent rumors, usually near the weekend, that a revaluation was intended. The resulting speculation swelled the capital inflows that were already prompted by the trade surplus. Rumors of an impending revaluation of the deutsche mark persisted throughout most of 1968 despite repeated announcements by the German authorities that the par value of their currency would not be changed.
After settlement of the strikes, the French authorities took steps to minimize the pressure on prices from the loss of output and higher wage costs. Since excess capacity existed in the economy, they hoped to expand output and enhance labor productivity and, therefore, adopted expansionary fiscal and monetary policies. To help control the impact of these policies on the balance of payments, they tightened price controls and introduced temporary restrictions on imports and on certain external payments and subsidies for exports. To curb outbound capital movements, they imposed exchange controls.
Before these policies could be tested, capital flight, especially into deutsche mark, again confronted the French authorities. Beginning late in August 1968 there were, once more, expectations in exchange markets that the franc would be devalued, especially as labor costs in France continued to rise, or that the deutsche mark might be revalued, as the Federal Republic of Germany’s trade surplus grew even larger, or that both of these exchange rates might be changed. To revive confidence in the franc, the French authorities, in September 1968, reversed the steps taken earlier. They restricted credit, and in a bold gamble abolished exchange controls. These measures did not work, however, and in November 1968 there was a fresh wave of international currency speculation. With no exchange controls as an impediment, the flow of funds from francs into deutsche mark reached unprecedented proportions. On November 20, 1968 the major European exchange markets were forced to close. By the end of November, France’s official exchange reserves had dipped to $4.0 billion, from $6.9 billion at the end of April 1968. This use of $2.9 billion of reserves included the utilization by France of its gold and super gold tranche positions in the Fund. In addition, France drew on the $1.3 billion short-term borrowing facilities that had been made available by foreign monetary authorities.
Meeting at Bonn
Already in September 1968 monetary officials in the United States and in several European countries were finding France’s heavy reserve losses worrisome. The large imbalances in the payments positions of France and the Federal Republic of Germany appeared to be chronic, and considerable disagreement and uncertainty existed about how these imbalances would be reduced or eliminated. Monetary officials in the United Kingdom and the United States, fearful of the effects of a devaluation of the franc or of the devaluation of any European currency on the competitive positions of sterling and the dollar, were especially concerned that the franc might be devalued.
Consequently, when the exchange crisis of November 1968 that has been described in the preceding section arose, Mr. Schiller, Minister of the Economy of the Federal Republic of Germany, who was then Chairman of the Ministers and Governors of the Group of Ten, called an emergency meeting of that Group, mainly at the urging of Mr. Fowler, Secretary of the U.S. Treasury, who was in the Federal Republic of Germany at the time. The Ministers and Governors of the Group of Ten met in Bonn on November 20–22, 1968. Mr. Schweitzer, who was traveling in Africa at the time, interrupted his trip and flew from Abidjan to Bonn on November 20. So urgent was the conference that, when Mr. Schweitzer’s commercial flight was delayed by bad weather in France, a special plane was chartered for him. He arrived in Bonn very late on the first day of the meeting. Staff representatives had attended the sessions that day.
The Bonn meeting centered primarily on what measures ought to be taken and by whom. Major attention was directed to the need for, and the possibility of, revaluation of the deutsche mark and devaluation of the French franc. At the opening of the meeting, the authorities of the Federal Republic of Germany stated their view that, as appropriate balance of payments measures were being considered, emphasis ought to be placed on basic comparisons of relative prices and costs in different countries and not on speculative activity in currencies. They described a number of measures, mainly changes in the border taxes, which the Federal Republic of Germany had introduced earlier, to reduce the trade surplus and the imposition of restrictions on banking transactions to ward off speculative capital inflows. They also explained that the Cabinet had just agreed upon these measures and was sending them to the Bundestag for approval.
Most other officials of the Group of Ten, including Mr. Fowler, viewing the continuing large overall surpluses of the Federal Republic of Germany as the heart of the problem of international imbalance, took the position that the measures being planned were inadequate and that the deutsche mark ought to be revalued. Many officials were not convinced that the par value of the French franc needed to be changed and were ready to consider financial support for the franc, including aid to France through the Fund without burdensome conditions. In arguing for a revaluation of the deutsche mark, they cited the need for measures that affected all of the Federal Republic of Germany’s balance of payments, and not mainly trade, and the need to calm the recurrent speculation that the deutsche mark would be revalued. Some of them argued pointedly that Germany had a “fundamental disequilibrium” and that it ought to be handled by means other than manipulation of border taxes.
In reply, the officials of the Federal Republic of Germany strongly defended their measures and opposed revaluation. Border taxes fitted in with the Bretton Woods philosophy of fixed exchange rates. Moreover, they went to the crux of the country’s surplus problem because there was a surplus on trade account but a deficit on services. They stressed that the expected reduction of the trade surplus by one third during the course of the next year was a great sacrifice for the country; any further reduction would be intolerable. Revaluation of the deutsche mark alone, in any magnitude considered reasonable, would not, they argued rather pointedly, resolve the payments problems of other countries, a conclusion, they believed, that was warranted by the experience with the revaluation of the deutsche mark in 1961. Instead they suggested that, once the SDR facility had been activated, a conference be called to consider a realignment of all major currencies, “not excluding the dollar.” Furthermore, they intimated that much of the speculation against the deutsche mark might be officially inspired.
The discussions were tense. Some officials suggested possible magnitudes for the currency changes they considered necessary. Mention was made of a 4 per cent revaluation of the deutsche mark, since the changes in border taxes were equivalent to about that magnitude of revaluation. A 15 per cent devaluation of the franc was indicated by the French representatives as the amount France would require if the Federal Republic of Germany could not go beyond 4 per cent. Others cautioned against the need for so large a devaluation of the franc.
Mr. Schweitzer counseled against the proposal for a future conference to re-examine currency values. He was apprehensive about the speculation that the prospect of such a conference might provoke. He laid emphasis on the fact that it was the position of only two currencies that raised a problem. Regarding devaluation of the franc, it would be better to delay action until one could estimate the magnitude of any fundamental disequilibrium. A number of Ministers supported Mr. Schweitzer’s position on the inadvisability of a future conference to consider a general realignment of currencies.
Mr. Guido Carli, Governor of the Bank of Italy, suggested a recycling of capital flows through the bis, and the Governors of central banks then met separately to consider a credit package for France and Mr. Carli’s proposal. The Ministers of the six eec countries likewise met separately to consider the exchange rates of their countries.
The conference ended without agreement on adjustment of the exchange rate for either the deutsche mark or the French franc. Instead, it was understood that the Federal Republic of Germany would go ahead with the measures that had been announced. These were a temporary export tax and an import subsidy, which were expected to have effects equivalent to a revaluation of between 3 and 4 per cent. In addition, to forestall capital inflows, certain short-term transactions of domestic banks with nonresidents would be restricted and the reserve requirements in respect of any increases in foreign deposits with domestic banks would be raised to 100 per cent. France would take “appropriate measures” to restore confidence in the franc and could receive short-term credits of up to $2 billion from other central banks and the bis. The communiqué of the Ministers and Governors of the Group of Ten following their meeting in Bonn further observed that France had nearly another $1 billion of drawing rights in the Fund.
Despite the secrecy of the proceedings, there were many newspaper accounts. In Mr. Schweitzer’s oral report to the Executive Board immediately after the meeting, he clarified two points that had been prominently discussed in the press. First, he said that at no time had the French authorities at the meeting announced an intention to devalue; it was always perfectly clear that they reserved for their Government the choice between no devaluation or a devaluation of a very limited amount. Second, he informed the Board that the stand-by credits arranged for France by the central banks of the other countries of the Group of Ten were not subject to conditions.
On November 23, 1968, the day after the Bonn meeting ended, President de Gaulle stated that the par value of the French franc would be maintained unchanged. Having ruled out devaluation, the French Government adopted a number of restrictive economic and financial measures. Government expenditures were reduced and indirect taxes were increased so as to cut the budget deficit for 1969 nearly in half. Ceilings were imposed on commercial bank lending, and interest rates were raised. Exchange controls were reintroduced.
These actions were expected to lead to a reduction in import demand and thereby in the external trade deficit, encouraging, in turn, a reflux of capital. Within days after the Bonn meeting, members of the Fund staff arrived in Paris for discussions in connection with the 1968 Article VIII consultation. In its report of these discussions, the staff stated that the actions taken had had immediate effect. Speculation had been quickly stemmed, the franc’s value in exchange markets had been strengthened, and there had been a marked reflux of funds to France.
The favorable effect of the measures taken at the end of 1968 proved, however, to be short-lived. The deficit on the French current account for the first half of 1969 was greater than ever.
Decision to Devalue the Franc
In the first week of May 1969 there were again extremely large flows of funds into the Federal Republic of Germany. Mr. Schweitzer noted that the situation of the French franc had not worsened in the last few weeks—in spite of a referendum that had led to the resignation of President de Gaulle—that the position of sterling had now become favorable, and that the flow of short-term funds into Germany vastly exceeded the aggregate flow out of France and the United Kingdom, and he considered the problem as centering on the Federal Republic of Germany. He cabled the authorities of that member urging them to take “prompt, courageous, and effective action” to avoid serious consequences for the international monetary system and for many other members.
At their regular monthly meeting in Basle, a few days later, the Central Bank Governors of the Group of Ten and Switzerland examined these latest developments. Mr. Blessing, President of the Deutsche Bundesbank, read a message of May 9, 1969 from the Federal Chancellor in which he stated categorically that the decision of the Government to maintain the par value of the deutsche mark would not be altered. The Government took a number of other measures, including several restrictions on foreign deposits, to induce a recycling of speculative capital, and a large proportion of the funds that had come in earlier did leave shortly thereafter.
The French authorities announced another series of monetary restraints. Existing quantitative restrictions on bank credit were extended beyond mid-1969 and tightened, and the minimum requirements for hire purchase were made much stricter. In mid-July the new Government of President Georges Pompidou took more anti-inflationary steps, including freezing the funds previously allocated to a large number of public investment programs. Despite all these measures, the drain on reserves continued. By the end of July they were down to $3.6 billion, barely half of what they had been 16 months earlier, and official short-term debts of some $2.3 billion had been incurred.
In a cable from Mr. Giscard d’Estaing, the Minister of Economy and Finance, to Mr. Schweitzer on Saturday, August 9, 1969, the Government of France requested the Fund’s concurrence in a change in the par value of the franc. The par value of the franc was stated in terms of gold and was to be altered from 0.180 gram of fine gold per franc to 0.160 gram, a devaluation of 11.11 per cent. This was the figure that had been calculated earlier by the staff of the Fund and that had been generally accepted at the Bonn meeting as the appropriate magnitude of devaluation for the franc. The new par value was to enter into effect on Sunday, August 10, 1969, at 8:00 p.m., Paris time (3:00 p.m., Washington time). This devaluation, from 4.93706 francs per U.S. dollar to 5.55418 francs per U.S. dollar, was the first change in the par value of the French franc since December 1958, when President de Gaulle, as one of his first acts after taking office, had devalued the franc.
Although France had had balance of payments troubles for at least a year, the decision of the French authorities to devalue the franc took most monetary officials by surprise. Less than nine months before, President de Gaulle had definitively refused to devalue the franc. In the interim, President Pompidou had succeeded President de Gaulle, but the French monetary authorities had continued to rely on internal policies and exchange controls to rectify France’s external deficits.
The Fund’s Deliberations on Franc Devaluation
At least from early in 1968 the Fund staff had held the view that, following the remarkable increase in output, productivity, and exports after the devaluation of 1958, there had been, since about 1963, a gradual weakening of France’s international competitive position. Admittedly, France’s exports were large and had continued to increase. The evidence of a lessening in the country’s economic strength lay rather in the reduced rate of growth of the domestic economy, the smaller external surpluses, and the growing penetration of imported goods into domestic markets, especially after the liberalization of trade within the eec. Mr. Plescoff had taken issue with this assessment, contending that France’s economic difficulties were more current and were primarily associated with the events of May–June 1968.
In August 1969, when the staff evaluated the proposed devaluation of the franc, it again cited these longer-run trends. But its explanation of the need for devaluation was based on developments in France’s situation in the previous year. In the second half of 1968, domestic costs and prices had risen more than had originally been foreseen, while some of France’s main competitors, particularly the Federal Republic of Germany, had succeeded in holding down unit labor costs. Moreover, the cutback in domestic demand required to eliminate the current account deficit in the balance of payments and to restore confidence in the franc at the existing rate of exchange would have to be excessively large and would probably lead to a very substantial increase in unemployment. Devaluation was, therefore, a necessary element in the resolution of this basic conflict between the goals of full employment and external equilibrium.
The Executive Board met on Sunday morning, August 10, 1969. Mr. Plescoff justified the devaluation in terms of the fundamental disequilibrium that had now developed in the French economy. The expansion of costs, prices, and domestic demand in the previous several months had been such that it could no longer be expected that the current account of the balance of payments would soon recover. Continuation of the current account deficit at the level then existing would rapidly deplete France’s exchange reserves, increasing the vulnerability of the franc to any fresh waves of currency speculation. The only alternative to devaluation was “ruthless deflation.” That policy not only would have grave social consequences but would compromise investment undertakings and efforts to modernize productive capacity. Such investment and modernization were essential to the restoration and maintenance of France’s competitive position in foreign markets.
Mr. Plescoff stressed that the degree of the proposed devaluation had been carefully adjusted to what was essential to correct existing disparities between unit production costs in France and those abroad. The proposed devaluation was thus limited strictly to correcting the past. The French authorities were also taking many related measures. Investment spending in the 1969 budget had been frozen at F 4 billion. The budget for 1970 would be balanced. There would be stringently enforced credit ceilings.
The Executive Directors readily agreed that the French balance of payments was experiencing a fundamental disequilibrium. The effects on domestic employment and output of the severe measures that would have been necessary to restore external payments equilibrium at the existing par value would be too adverse. Miss Fuenfgelt (Federal Republic of Germany) reported that the German authorities welcomed the devaluation of the franc as an important step toward a better international equilibrium.
The secrecy and the timing of the French action were, however, the subject of some comment. The authorities had made a quick and unexpected move to devalue over a holiday weekend. They had made a public announcement prior to the Executive Board’s formal consideration of the proposed change in par value. The Executive Directors recognized that this timing had avoided any further speculation in exchange markets, but they very much regretted that, prior to the Fund’s concurrence, the French Government had already publicly announced the devaluation. Mr. Dale explained that it was only because of the unique circumstances of the French situation that he would not object more formally. Those circumstances, he made clear, were that, after the discussions in Bonn in November 1968 and the international consultative discussions on the French economy since that time, the French authorities rightly had every reason to assume that a devaluation of the amount proposed would be approved by the international community. However, members should not assume that any par value change they might propose would necessarily receive the Fund’s concurrence. Mr. Maude, stating that there was a strong presumption that the country in question was best placed to judge the appropriate moment for changing its par value, nonetheless regretted the French authorities’ announcement prior to the Fund’s concurrence.
The Executive Board then took a decision concurring in the change in the par value of the French franc.
Effective at the same time were corresponding changes in the par values for the separate currencies in France’s nonmetropolitan areas. These were the franc of French Guiana, Guadeloupe, and Martinique; the CFA franc of the Comoro Islands, Réunion, and St. Pierre and Miquelon; and the CFP franc of French Polynesia, New Caledonia, and the Wallis and Futuna Islands. The par value of the Djibouti franc of the territory of the Afars and the Issas (formerly French Somaliland) and that of the CFP franc of the New Hebrides remained unchanged.
French Franc Area Alters Its Rates
At the meeting of the Executive Board on Sunday morning, August 10, Mr. Yaméogo (Upper Volta) announced that the countries linked to the French Treasury by an operations account would also wish to change the rates of exchange for their currencies, effective simultaneously with the change in the rate for the French franc, so that trading the next day could take place at the new exchange rates. He was not ready to have the Executive Board consider these currency changes until after the Conference of Ministers of Finance of the Franc Area met in Paris later that afternoon (Washington time).
Accordingly, the Executive Directors reassembled on Sunday evening, August 10, to take action on the changes in the exchange rates for 14 other members: Cameroon, the Central African Republic, Chad, the People’s Republic of the Congo, Dahomey, Gabon, Ivory Coast, the Malagasy Republic, Mali, Mauritania, Niger, Senegal, Togo, and Upper Volta. These members had not yet established par values.
Cameroon, the Central African Republic, Chad, the People’s Republic of the Congo, and Gabon, all of which used the CFA franc issued by their common central bank, the Central Bank of Equatorial African States and Cameroon (bceaec), requested the Fund to agree to a change in the rate of exchange for the CFA franc, from CFAF 246.853 per U.S. dollar to CFAF 277.710 per U.S. dollar. This change represented a devaluation of 11.11 per cent, the same as for the French franc, and kept the relationship between the CFA franc and the French franc at CFAF 1 = F 0.02. Dahomey, Ivory Coast, Mauritania, Niger, Senegal, Togo, and Upper Volta requested the Executive Board’s agreement for a similar change in the exchange rate for the CFA franc issued by their common central bank, the Central Bank of West African States (bceao).
The Malagasy Republic requested the Executive Board to agree to a change in the official rate of exchange for its currency, the Malagasy franc. The rate of exchange and the change were the same as for the CFA franc, that is, from FMG 246.853 per U.S. dollar to FMG 277.710 per U.S. dollar, a devaluation of 11.11 per cent.
Mali also requested approval of an 11.11 per cent depreciation in the rate for the Mali franc, from MF 493.706 per U.S. dollar to MF 555.419 per U.S. dollar. This depreciation was the second for Mali during the years 1966–71. On May 5, 1967, as part of the process of rejoining the West African Monetary Union and to realign Mali’s prices with those of the other countries in the Union, the Malian authorities had, with the Fund’s agreement, devalued the Mali franc by 50 per cent.
The staff paper explained that changes in exchange rates for members in the French franc area were necessary to help them avoid serious economic and financial difficulties should their exchange rates deviate from that of the French franc. At the Executive Board meeting, Mr. Yaméogo, on behalf of these members except Mali, and Mr. Omwony (Kenya), on behalf of Mali, elaborated the point, saying that the complete freedom of transfer for both current and capital transactions that existed between countries in the French franc area, and the free interconvertibility of their currencies, had many advantages for the French franc area. Moreover, these countries conducted some 40–60 per cent of their foreign trade with France, and their principal source of foreign aid, both financial and technical and public and private, was France. Any change in the par value of the French franc without a corresponding change in the exchange rates for the CFA, Malagasy, and Mali francs would seriously disrupt external trade and financial transactions. Mr. Plescoff added his support to the proposed changes in these exchange rates.
With relatively little discussion, the Executive Board assented.
Other members in the French franc area, including Algeria, Morocco, and Tunisia, that did not have an operations account with the French Treasury did not devalue their currencies.
Sequel to Devaluation of Franc
Shortly after the devaluation of the French franc, the Fund approved a one-year stand-by arrangement for France, the details of which, and the subsequent rapid turnaround in France’s economy, have been reported in Chapter 18. The economic adjustments in the aftermath of the devaluation took place without much loss of output, and the French authorities maintained a system of surveillance which moderated the rise in prices. France’s balance on current account moved from a deficit of $1.7 billion in 1969 to a surplus of $0.5 billion in 1970, and there was an overall balance of payments surplus of $2 billion in 1970, in contrast to a deficit of over $1 billion in 1969. At the end of 1970 net official reserves were about three times as large as at the time of the devaluation.
In 1971 France’s balance of payments improved further, showing both current account gains and increases in capital inflows. The surplus on current account reached $1.2 billion; the overall balance showed a surplus of $3.4 billion. In 1971, too, the rate of economic growth continued to be strong. It was well above that of other eec countries and of the United States and the United Kingdom and, indeed, was matched among major countries only by that of Canada and of Japan.
Deutsche Mark Is Revalued
Within weeks of the franc devaluation came still another crisis: the future of the deutsche mark had become one of the main issues in the general elections to be held in the Federal Republic of Germany on September 28, 1969. On Monday, September 29, the day after the elections, the German monetary authorities, having closed their exchange markets on the previous Thursday and Friday to halt another rush into deutsche mark, informed the Managing Director that they would not ensure that rates for exchange transactions involving the deutsche mark within their territory would be confined to the limits hitherto observed. This floating of the deutsche mark was intended to ward off further speculative capital inflows.
The Managing Director had been alerted over the weekend that this action was likely. The General Counsel was concerned about the implications for the member’s legal position under the Articles of Agreement—specifically, that the member would not be taking appropriate measures to permit within its territory exchange transactions only within the prescribed margins, as required by Article IV, Section 4 (b)—and about the implications for the legal obligations of other members with regard to the exchange rates at which transactions between their respective currencies and the deutsche mark would take place. There had been two precedents for the action now proposed by the Federal Republic of Germany—the action of France in 1948 and that of Canada in 1950. However, the General Counsel stressed that, notwithstanding these precedents, the basic applicable provision was Article IV, Section 4 (a), under which members must “collaborate with the Fund to promote exchange stability, to maintain orderly exchange arrangements with other members, and to avoid competitive exchange alterations.” It was for the Fund to specify what it regarded as appropriate collaboration.2 Because of the General Counsel’s concern, precise words were supplied to Mr. Schleiminger (Federal Republic of Germany), who cabled them to his authorities. The communication received by the Fund on Monday morning was in the language suggested. After advising the Managing Director that they had decided that they would not ensure that rates for exchange transactions involving the deutsche mark within their territory would be confined to the limits hitherto observed, the authorities of the Federal Republic of Germany assured him that they would maintain close contact with the Fund and would in the future, as they had in the past, collaborate with it fully in accordance with the Articles of Agreement.
When the notification arrived, Mr. Schweitzer was already on the platform at the Sheraton-Park Hotel ready to deliver his opening address to the Governors at the 1969 Annual Meeting. Because of foreknowledge of the action by the Federal Republic of Germany, the staff was able at the last minute to draft an insert to Mr. Schweitzer’s speech. Thus it was Mr. Schweitzer who first informed the world of the floating of the deutsche mark.3
When the Executive Directors met late in the day on September 29 to consider the notification from the member, they expressed anxiety for the par value system. But Mr. Schleiminger stressed the temporary nature of the step, and other Executive Directors recognized that allowing the deutsche mark to float was about the only action that could be taken in the circumstances. The Executive Board’s decision noted the intention of the member to collaborate with the Fund and “to resume the maintenance of the limits around par at the earliest opportunity.” The Fund was to remain in close consultation with the member for the latter purpose.
When the foreign exchange markets were reopened in the Federal Republic of Germany on September 30, 1969, the Deutsche Bundesbank had suspended its intervention in the exchange market at the former maximum and minimum rates. The spot rate for the deutsche mark against the dollar gradually appreciated.
The floating rate was short-lived, however. Less than four weeks later, on Friday morning, October 24, 1969, in a telex communication from the President of the Deutsche Bundesbank to the Managing Director, the Government of the Federal Republic of Germany requested the Fund’s concurrence in a change in the par value of the deutsche mark from 25 U.S. cents per deutsche mark to 27.3224 U.S. cents per deutsche mark, to be effective on Sunday, October 26, 1969, at midnight, Bonn time (6:00 p.m., Washington time). The proposed change represented a revaluation of the deutsche mark of 9.29 per cent and, according to the communication, was needed to correct a fundamental disequilibrium.
Fund’s Considerations
The staff and the Executive Directors had been following closely developments in the economy of the Federal Republic of Germany through the various exchange crises of 1968 and 1969, and, in fact, at approximately the time of the May 1969 decision not to revalue, the Executive Directors had been considering the staff’s report on the 1968 Article VIII consultation. The report explained that, following a recession in 1966/67, exports had become buoyant and domestic investment had surged, and the resulting economic upswing had been more rapid and comprehensive than either the authorities or the Fund staff had forecast. During 1968 and 1969 the gross national product in real terms had been rising by 7–8 per cent a year, compared with a goal of 4 per cent. By the middle of 1969, unemployment had dropped to 0.7 per cent of the labor force, a postwar minimum. The one major bottleneck that had been feared once full employment had been restored, a general shortage of labor, had not appeared because of an ample supply of foreign labor: of the total labor force of 21.5 million in mid-1969, as many as 1.4 million had been foreign workers, a postwar peak.
The external trade surplus in 1968 had followed an already large surplus in 1967, which had come about because of depressed domestic demand. The monetary authorities had assured the staff that this enlarged surplus had been contrary to their expectations and to their policy. The economic expansion had been achieved with less strain on price stability than they had thought possible. Moreover, the small rise in prices in the Federal Republic of Germany had coincided with large price rises in other industrial countries. The authorities had not welcomed the extraordinary capital inflows, which enhanced bank liquidity and posed a serious threat to domestic stability. They had been trying to reconcile the objectives of full employment with equilibrium in the balance of payments, but had been reluctant to reverse their policy of monetary ease. This policy fitted in with their medium-term objective of promoting greater domestic orientation in the economy and reducing its excessive export orientation.
The Executive Directors had recognized the dilemma confronting the member. As Mr. Palamenghi-Crispi (Italy) had phrased it, the authorities had been “torn between the ghosts of inflation and the unpopularity of revaluation.” The Directors had praised the high standards of international monetary cooperation and sense of international responsibility demonstrated by the German authorities in past years, with pointed reference to the fiscal measures taken to dampen the boom, the financing made available to countries that had suffered reserve losses owing to flights into deutsche mark, and the large amounts of development aid.
Against this background, the staff interpreted the decision of October 1969 to revalue as meaning that the authorities of the Federal Republic of Germany regarded the large current account surpluses and the persistent short-term capital inflows of 1968 and the first nine months of 1969 as incompatible with the preservation of internal balance. Production was now close to effective capacity and domestic prices were rising faster than before. Wages were also increasing, and greater proportions of rising incomes were going into consumption. The staff agreed that the events leading to the floating of the deutsche mark on September 29, 1969 had demonstrated that, at the prevailing exchange rate, reasonable price stability and sustainable balance of payments equilibrium, including an appropriate volume of capital exports, could no longer be realized simultaneously.
The Executive Board met on Friday afternoon, October 24, 1969, just hours after the communication was received, to consider the proposed revaluation. Mr. Schleiminger explained that, in determining the new rate for the deutsche mark, the authorities had not only followed the rate in the free market but had aimed at achieving a balance of payments that would, on the one hand, remedy the excessive current surpluses and yet, on the other hand, leave room for long-term capital exports, especially foreign aid. Mr. Plescoff said that he was under personal instructions from the French Minister of Economy and Finance to express the complete support of the French Government for the proposal, and he commended the authorities of the Federal Republic of Germany for their quick response to the wish the Executive Board had expressed on September 29, 1969, when the par value of the deutsche mark had been suspended, that the member revert to a fixed par value as soon as possible.
Mr. Dale expressed his appreciation for the speed, courage, and sense of international responsibility with which the Government had acted. He congratulated the authorities on the farsightedness shown in choosing the new rate; it involved a greater appreciation than had been considered probable by outsiders, at least until very recently. Other Executive Directors also welcomed the proposal. Mr. Kafka (Brazil) congratulated the authorities on being “good citizens of the international financial community.” He hoped that the resulting reduction in the payments surplus and therefore in the supply of long-term capital would not lessen the capital flow to developing countries. Mr. Kharmawan (Indonesia) believed that the Executive Directors should be grateful for this bold step; it ought to facilitate international equilibrium. He, too, hoped that the reduction in the outflow of capital would not affect the developing countries. Both Mr. Kafka and Mr. Kharmawan also expressed the thought that the change in par value might provide an opportunity for all aid-giving countries to consider the untying of aid.
After this discussion, the Executive Board took a decision expressing the Fund’s concurrence in the new par value of 27.3224 U.S. cents per deutsche mark.
Upon revaluation, the authorities of the Federal Republic of Germany reversed a number of earlier measures to curtail the current account surplus or to fend off excessive inward movements of foreign capital. The previous year’s border tax adjustments were suspended, and the special reserve requirements in respect of bank liabilities to foreigners were removed.
Netherlands and Belgian Par Values Unchanged
On Monday morning, October 27, 1969, following the revaluation of the deutsche mark, Mr. de Vries (Netherlands) informed the Executive Board that the Netherlands Government, which had revalued along with the Federal Republic of Germany in 1961, had decided on this occasion to maintain the par value of the guilder unchanged. Mr. Roelandts (Belgium) said that the Belgian authorities would reach a decision on the par value of the Belgian franc following the meeting of the Council of Ministers of the European Communities then going on in Luxembourg. In accordance with that decision, Belgium also maintained its par value unchanged.
Difficulties After Revaluation of Deutsche Mark
When the staff returned to Bonn and Frankfurt some four months later in connection with the 1969 Article VIII consultation, they regarded the decision to revalue the deutsche mark as a material contribution to improving the relationships among the exchange rates of the major currencies. So did the Executive Directors. In the last quarter of 1969, speculative positions had been reversed and large amounts of capital had left the Federal Republic of Germany. As noted in Chapter 17, the member had made a super gold tranche drawing of $540 million from the Fund on November 24, 1969 to meet the capital outflow.
It continued to be difficult and even hazardous to predict the course of the economy of the Federal Republic of Germany. By the beginning of 1970 it was clear that the targets of stabilization policy had been missed by a rather wide margin. Internal inflationary forces had been underestimated and, despite the revaluation, prices and wages continued to rise rapidly. By the end of 1970 domestic prices had risen more sharply than in any year since the Korean war. On the other hand, unusually rapid gains in living standards were taking place, and real wages had increased by 13 per cent.
After revaluation, imports rose sharply. However, the country continued to run a surplus on trade account, which came to about $5.5 billion in 1970. There had been an improvement in the terms of trade. Also, exports were in a very strong competitive position, both because of the substantial investment in industry that had taken place and because consumer prices in the country’s main trading partners were rising even more rapidly than they were at home. The current account surplus, nonetheless, declined, from $2.7 billion in 1969 to $1.7 billion in 1970, because the revaluation had a significant effect on the balance of services and transfers. Expenditure on foreign travel, which had increased sharply during the 1950s and 1960s and had become a relatively important component in the overall balance of payments, had a high price elasticity and rose markedly, while receipts from tourism dropped.4 There was also a sizable increase in the remittances abroad of foreign workers. Accordingly, the deficit on net services and transfers rose from $2.4 billion in 1969 to $4.2 billion in 1970.
In the first quarter of 1970, there began to be very large inflows of foreign funds, including more than $4 billion of short-term borrowing by domestic enterprises and an increase of $2 billion in the liabilities of commercial banks. The net short-term capital inflow of banks and enterprises in 1970 more than accounted for the increase in official reserves, which was in excess of $6 billion.
The authorities, wondering whether their decision to revalue had been “too little and too late” and whether, instead of the usual expansionary measures that accompany revaluation, they should have enacted a stabilization program earlier, took a number of restrictive monetary, fiscal, and incomes policy measures to cool off the overheated economy. They viewed these measures as at least partly self-defeating, however: the tightening of monetary policies and the raising of interest rates, which in the past had been effective, now induced domestic enterprises to borrow abroad and foreign depositors to seek haven in domestic banks. Capital inflows became greater than ever. The situation, they thought, showed up the constraints on effective national economic policy that resulted from the growing internationalization of Western economies, including the web of interconnections among financial institutions within Europe and between Europe and North America.
This inflationary domestic situation, together with an external surplus, continued through the first several months of 1971 and, as will be seen in Chapter 25 below, on May 9, 1971, the authorities of the Federal Republic of Germany again informed the Fund that they could not maintain exchange rates within the required margins around the par value of the deutsche mark.5
After August 15, 1971, Article IV, Section 4 (a), became the primary legal basis for the Fund’s activities in connection with exchange rates.
Opening Address by the Managing Director, Summary Proceedings, 1969, p. 10.
For an econometric analysis of the effect of the revaluation on tourist expenditures, see Jacques R. Artus, “The Effect of Revaluation on the Foreign Travel Balance of Germany,” Staff Papers, Vol. 17 (1970), pp. 602–19.