The Struggle for Stability
Boom conditions continued throughout 1956, sustained by an undercurrent of private business investment sufficiently strong to compensate for such weaknesses as appeared in some individual sectors. Any apprehensions which might have been entertained in the early months of the year that the upward trend of business was soon to be reversed were thus shown to be without foundation. Nearly everywhere the intensity of the demand for capital increased, accompanied by a great volume of economic activity which, with only brief interruptions, has continued throughout the entire postwar period. Many of the economic and financial problems of that period have had their origin in this great demand for capital, and the means taken to satisfy it, which have not always been desirable or effective and have sometimes endangered balance of payments equilibrium and internal monetary stability.
In the years immediately following World War II, the most urgent problem was that of rebuilding the economies that had been devastated during the war. Even when economic life had not been subjected to widespread physical destruction, the maintenance of existing assets had often had to be neglected, and for some time production in Western Europe and the Far East was even less than it had been before the war. In the countries of these regions the resources which could be made available in the form of savings were not adequate to provide all the capital needed to raise production within a reasonable period to a more satisfactory level. For many of these countries the gap was filled by generous aid from abroad—and thus the foundations were laid for continued dynamic development, such as has never before been seen after any great war.
Even after reconstruction in most sectors was completed, there was a further great expansion of activity, and the effort to raise the output of goods and services well above prewar levels brought with it a continued pressing need for capital. In 1956 industrial production in Western Europe was about 75 per cent greater than before the war; during the three preceding years, it had been growing at an average annual rate of about 8 per cent. This large and growing volume of production would not have been possible without substantial increases in business investment, which expanded to a level considerably higher than that of the depressed years of the 1930’s. In the United Kingdom, for instance, gross fixed capital formation has been nearly 50 per cent greater than immediately before World War II; and in most other Western European countries there was also a substantial expansion. In the United States, postwar private domestic investment has risen even more, to around three times the prewar volume.
The causes of the continued pressing demand for capital are complex. New inventions have led not only to the introduction of new techniques in production, but to an almost complete transformation in the methods of manufacturing in many branches of industry; there have also been important changes in the methods used in agriculture and in certain other sectors of primary production. An outstanding feature in the development of recent years has been the persistent spirit of optimism which has characterized the business world in the planning of new industrial investment. The growth in population, which has also expanded the labor force, has been another factor of great importance. In 1956 the population of Western Europe was about 15 per cent, and the labor force about 20 per cent, greater than before the war. The population and the total labor force of the United States at the end of 1956 were nearly 30 per cent greater than in 1938. To the great capital requirements for expanding industrial and agricultural production and for power, transport, and communication facilities, there has been added an insistent demand for increased public and private investment in social services and amenities. Investment in housing is far greater than before the war, not only because of the increase in population, but also because of higher housing standards. And large amounts of capital are being used for investment in hospitals, schools, and public roads and buildings. Moreover, there is no indication that in the industrial countries as a whole the intensity of these demands is diminishing.
In the less developed countries, the urgency of the need for capital is no less conspicuous than in the highly industrialized countries, when account is taken of the volume of investment required to raise the current low standard of living of a large and often rapidly growing population. It is, indeed, this low level of income which often makes it so hard in these countries to obtain from the domestic economy an adequate flow of savings. At the same time, the pressure for capital in North America and Europe adds to the difficulties of attracting foreign investment on a strictly business basis. Moreover, in some countries, restrictions on the remittance of profits and amortization, associated with recurring exchange difficulties and other uncertainties, make private foreign investment appear to be a hazardous business. The less developed countries have come increasingly to look for the satisfaction of their capital demands to loans and grants from other governments, to long-term loans from the International Bank for Reconstruction and Development, or to short-term or medium-term credit from the suppliers of their capital imports.
The rate of saving in most countries has kept up very well in the postwar period, and has often exceeded previous records, even in relation to the increased national income. It is not surprising, however, that with such vast claims as have been made upon the national product the supply of capital has been unable to grow as rapidly as would be necessary if all the demands for investment were to be satisfied. Attempts to meet such deficiencies by the creation of bank credit result in a persistent inflation, with rising prices and with risks of recurring difficulties in the balance of payments, which, in their turn, encourage the use of restrictions, discrimination, and other undesirable exchange policies. In 1956 indeed there was no further significant extension of restrictions, but the inflation which has been generated in many parts of the world in the way described above is still a problem of the first importance.
On the other hand, it is noteworthy that in some European countries, and especially in those which within a single generation had passed through two periods of unbounded inflation, the public was so determined to avoid any similar experience that it was willing to support, even in the years immediately following the war, very harsh measures which circumscribed the issue of new money and thus checked the rise of prices. But in a number of other countries—and they probably formed the majority—the prevailing mood at the end of the war was different. Influenced by the memories of the devastating depression of the 1930’s, public opinion in those countries fought shy of any policies that might be thought to carry with them a risk of widespread unemployment. It has, however, gradually come to be understood that the desire to avoid another depression is not by itself an adequate guide for policy in the postwar world. The depression which so many had prophesied for the postwar decade has not materialized; this experience has made it easier to take a more balanced view of the proper relations between monetary stability and the maintenance of high and stable levels of employment, and in these countries, too, there is increasing understanding of the disruptive effects of inflation.
Once the Korean boom had been effectively checked, and those sensitive commodity prices which had been most affected by the boom had fallen to a level some 10 per cent above that prevailing before the outbreak of the conflict, the general level of commodity prices in many countries—in Europe, in the Americas, in Asia, and in Australia and Africa—remained relatively stable for some three to four years. The excessive liquidity which had been generated during the war had by that time been almost fully absorbed so that more normal relations had been established between the money supply and gross national product.
The reason for the interruption in 1955 and 1956 of this period of stability is to be found in the reappearance of those economic trends which are typical of a peacetime boom. This, together with a rising level of earnings and an often expanding volume of government expenditure—due as a rule less to armaments than to other purposes, and frequently to economic development—produced a state of affairs in which overspending in relation to available resources was an outstanding characteristic.
The measures taken to cope with the resulting inflationary pressures were sometimes inadequate, or they were not applied sufficiently early to provide the checks on overspending which were needed; most countries have been embarrassed by rising prices and some also by growing balance of payments difficulties. World trade continued to expand, and until well into the second half of 1956 the changes in gold and foreign exchange reserves were broadly a continuation of the trend of previous years.
Boom conditions still prevailed in the second half of 1956 when the Suez Canal crisis introduced a new disturbing element. A good test of the firmness and soundness of any economy is the way in which it reacts to crisis conditions. Judged by this criterion, the behavior of many countries in the face of the strains and stresses of the 1956–57 disturbance was generally encouraging. There was evidence of much more basic strength than could have been expected a few years earlier. Difficult internal adjustments were made with considerable success, and it proved possible—in some cases with assistance from the Fund—to absorb the shock imposed by temporary balance of payments disequilibrium without any significant tendency to revive the restrictive practices which had been gradually relaxed or abolished during the last ten years. It is, therefore, reasonable to expect that, despite the tribulations of the past year, the movement toward the re-establishment of a fully multilateral world trading system will at no distant date again acquire increased momentum.
The experience of the past year also justifies the expectation that the Fund will be able to play an effective part in this movement. The great expansion in the volume of its financial transactions, which is recorded in detail later in this Report, has shown both that the Fund can act promptly and efficiently when its members have a need for such financial support as it is in accordance with the principles of the Fund to supply, and that its members in general are able to associate the financial backing of the Fund with such effective monetary and fiscal policies as they themselves are prepared to adopt in order to ensure or restore balance of payments equilibrium.
In all countries the maintenance or re-establishment of internal stability continues to be an essential condition for the attainment both of this and of other legitimate economic objectives. Inflationary pressures are commonly associated today with balance of payments deficits; they are often the result of efforts to push forward too rapidly with economic development. The concern which is widely felt for progress and development must command general approval. But if development is to proceed smoothly, positive steps are needed to encourage an increase in savings and the most effective use of savings in production. For this purpose, the elimination of the risks of inflation by effective credit and fiscal policies has particular importance, since savings can be expected to respond to the protection which monetary stability would ensure for any amounts saved. If inflationary development finance leads to substantial drawings upon monetary reserves, the rate of expansion will indeed have to be at least temporarily reduced in many cases. To limit this reduction, and if possible to make more capital available for domestic needs—and in some countries also for foreign investment—it will be necessary in many countries to reduce the share of the national income devoted to current government expenditure, and to accept a slower rate of increase in private consumption.
In quite a number of countries today there is great unwillingness to accept higher interest rates. It should be understood, however, that in an economy free from inflation, and with institutional facilities adequate to ensure the conversion of savings into investment, current interest rates will tend to be a true indicator of the degree of scarcity of capital—a scarcity which is now more pronounced than it was in the low interest period of the 1930’s. With the relative scarcity value of capital thus truly measured by the level of interest rates, the available supplies of capital would tend to be invested in closer conformity with basic economic criteria.
Attention has been drawn in earlier Annual Reports to other long-range factors which hamper the efforts of many countries to establish a strong balance of payments position. To emphasize the importance of monetary stability is not to be taken as implying that these influences have lost any of their importance. Last year, there were again several countries with difficult balance of payments problems that originated in the chronic instability of the prices of some primary products. No satisfactory means has yet been discovered for solving the problems of the accumulation of agricultural surpluses, which are largely the result of the widely practiced policies of subsidizing agricultural production, and the disposal of which tends as a rule to affect adversely the current and prospective foreign exchange earnings of a number of countries. Progress is also slow in building effective machinery for lowering tariff barriers and removing other impediments to trade that still seriously limit the earning capacity of the exporters of many countries.
In this connection, reference must also be made to another circumstance to which attention has been drawn in earlier Annual Reports, namely, the responsibility not only of deficit countries but also of surplus countries to contribute to the maintenance of general monetary equilibrium. The domestic financial policies of countries with large and persistent surpluses in their balances of payments will also necessarily have an effect upon the economies of other countries. It is proper that account should be taken of the whole resulting complex situation. Therefore, countries in a strong surplus position, whilst applying such anti-inflationary policies as are appropriate to their circumstances, should seek not to apply them in such a way as to make it more difficult for other countries to correct their positions. They should, accordingly, pay special attention to the contribution which they can make to the removal of both their own difficulties and those of other countries through such measures as the reduction of trade barriers and the encouragement of capital exports. In this latter connection, the expenditure of the U.S. Government outside the United States has been an equilibrating factor of first-rate importance. But while the true evaluation of the economic and monetary trends of recent years cannot be made without due weight being given to its useful effects, it would be rash to take for granted its indefinite continuance on the scale of recent years.
The speed of the movement which may reasonably be expected toward a sound multilateral trading system depends to an important extent on all the considerations which determine the availability of capital, as well as on the progress made in solving the other problems briefly noted above, but none of these problems should be regarded as a pretext for delaying the adoption of the indispensable policy measures for which, within each country, the responsibility rests with the government and the central bank.
Balance of Payments Trends in 1956
During the three years between the end of 1952, when the Korean crisis had, for all practical purposes, spent its force, and the end of 1955, the official gold and dollar reserves of countries outside the United States steadily increased, though at a gradually declining rate, which moved from $2.45 billion in 1953 to $1.43 billion in 1955. These annual increases were fairly widely distributed among individual countries. In 1956, the net addition to the gold and dollar holdings of countries outside the United States was $1.5 billion, but this was to a considerable extent a result of the support given to certain countries by access to the Fund’s resources. Only a small number of countries added substantially to their reserves in 1956, and without the support given by the Fund, the distribution of the increase would have been still more lopsided.
The U.S. merchandise trade surplus with the rest of the world, which had increased steadily from $1.3 billion in 1953 to $2.7 billion in 1955, increased further in 1956 to $4.5 billion. On the other hand, there was a continued expansion of U.S. Government spending abroad, and net exports of U.S. private capital increased from $1.2 billion in 1955 to $3 billion in 1956. These were important factors in the maintenance of international balance, the net result of these and other transactions being that about $550 million accrued to official holders in other countries from their transactions with the United States, compared with more than $1 billion in 1955. During the year the gold holdings of the United States increased by $306 million. These holdings had declined in each of the three preceding years, and most of the increase in 1956 was accounted for by purchases of gold from the Fund, which amounted to $200 million.
The net increase in 1956 of about $1.5 billion in the official gold and dollar reserves of countries outside the United States was the combined result of several causes, of which three stand out as having special significance. The value of gold production for all countries, except the U.S.S.R., Mainland China, and other countries closely associated with them—for which statistics are not available—is estimated to have been about $985 million in 1956. Much of this gold was used for industrial or hoarding purposes, but, including some sales of gold by the U.S.S.R., the total amount of new gold which was added to monetary reserves in 1956 in countries other than the United States was about $350 million. A net amount of some $580 million was obtained from the Fund, and these two items, together with the $550 million which became available to other countries from their transactions with the United States, account for the increase in the gold and dollar reserves of countries outside the United States.
The increase in the gold and dollar reserves of the Federal Republic of Germany in 1956 was about $1 billion, a figure which greatly exceeded the aggregate net amount accruing in that year to the reserves of the industrial countries of Europe. By the end of 1956, West German reserves of gold, dollars, and other currencies amounted to $4.3 billion, a situation which was the result of a large trade surplus and of leads and lags in making current payments. A fuller analysis of the causes of the persistent increase in West German reserves, which has gone on practically without interruption since 1952, and which has of course affected the payments positions of other countries, will be found in other sections of this Report. Here it may be pointed out that the accumulation of such reserves forms part of a country’s investment. In this particular instance, the savings of the West German economy involved in this increase in reserves are broadly related to the net national savings of public authorities partly resulting from the fact that defense appropriations were not actually spent but were accumulated with the central bank.
Reserve developments in other countries varied widely, in response both to shifting external market conditions and to fluctuations in the relative intensity of domestic and external demand. The Suez Canal conflict added to the dollar commitments of a number of countries, and reduced the foreign exchange earnings of the oil producing countries in the Middle East. In general, however, its effects upon world trading conditions were less serious than had been expected. Its most important economic consequences were the stimulus which it gave to the movement of short-term funds, and in particular the crisis of confidence, which put pressure on the sterling exchange rate and led to the U.K. drawing and stand-by arrangement with the Fund. The current account surplus of the United Kingdom for 1956 as a whole was £233 million, but there was a considerable outflow of short-term capital in the second half, and particularly in the fourth quarter, of the year. After drawing $561.5 million from the Fund, U.K. gold and dollar reserves at the end of 1956 were practically the same as they had been at the beginning of the year.
In France, there was a large current account deficit in 1956 and reserves declined by nearly $800 million. Under the conditions of a pronounced boom, industry continued to expand at a rapid rate during the year; at the same time, an increasing part of the private savings of the economy was absorbed by expanding government expenditure that was not covered by corresponding increases in government revenue, so that other activities, including house construction, had to be financed to a larger extent by recourse to bank credit. Part of the decline in French reserves was the result of leads and lags in current payments and of increases in the exchange holdings of banks.
While the reserve movements of the three European countries just mentioned attracted most attention during 1956, changes in the reserve positions of several other countries were also of importance. In Europe there were considerable declines in the reserves of Finland and the Netherlands, and both countries had to face the problem of taking appropriate remedial steps. Austria was able to register a gain in reserves, profiting from the introduction in 1955–56 of rather far-reaching measures of fiscal and credit policy.
In other continents, also, the movements of reserves—as reflected in balance of payments positions—varied widely in both magnitude and direction. The variations were closely connected with differences in the rate of expansion, with the degree of success attained in keeping inflationary forces under control, and with the effects of movements of staple export prices. While in many countries the stimulus given by the government continued to be an important factor in economic expansion, the permeating influence of the world-wide boom was an overriding factor that made itself felt everywhere. Thus in India, alongside the government expenditure under the Five Year Plan, there was also a considerable increase in private investment in 1956, which contributed to the mounting import figures. The Indian current deficit in 1956 exceeded $400 million, and early in 1957 India was given access to the Fund’s resources to the extent of $200 million. In Japan, under the strain of an intense industrial expansion, mainly on private account, the payments surplus which had been realized in 1955 dwindled in the course of 1956 and was followed by a deficit in early 1957. In Canada, too, private investment has been the most active factor of expansion; the possibility of developing natural resources and setting up new industries attracted a considerable flow of foreign capital to Canada, which more than offset the deterioration on current account.
Among the other countries whose reserves continued to increase, or whose balance of payments positions showed substantial improvement in 1956, are Argentina, Australia, Mexico, and Venezuela. Notwithstanding the burdens imposed by efforts to reconstruct its economy and improve its trading position, the current account deficit of Argentina was smaller than in 1955, though there were still considerable difficulties to be overcome. Australia, with its policy of rapid development and continuous large-scale immigration, is particularly susceptible to balance of payments pressures. But in contrast to 1955, when there was a large deficit, Australia had in 1956 a balance of payments surplus of $117 million, as the result of favorable export market conditions and of the application of monetary and fiscal measures which made possible the relaxation of some import restrictions. In Venezuela, with its steadily expanding oil exports and considerable direct investment of U.S. capital, there was again a substantial increase in exchange reserves. Mexico, too, strengthened its reserve position; under the influence of the measures taken during the previous two years, domestic savings rose, there was a substantial inflow of foreign capital, and production increased.
Progress Toward the Fund’s Objectives
Although there are still important unsolved problems in the fields of public policy with which the Fund is particularly concerned, considerable progress has been made in dealing with these issues. The authorities responsible for determining policy have become increasingly aware of the importance of monetary stability as part of the primary objectives which they wish to pursue. They realize more and more that economic expansion with a high level of employment cannot for long be achieved if it is not sustained by confidence in the monetary unit and developed under a price and cost system which is free from artificial distortions impairing the production and distribution of goods and services. The public itself is also now more concerned with the danger of inflation, and shows greater willingness to accept the consequences of the policies which are necessary if monetary stability is to be ensured. The adoption of policies of monetary restraint, however, sometimes encounters opposition, particularly in those sectors of the economy likely to be most immediately affected, and a high degree of understanding is required if these policies are to obtain the broad public support that is needed.
While for some time after the war it was rather widely believed that many of the so-called classical methods of credit policy—for example, those relating to changes in interest rates—no longer had the same range of application as before, it is now generally recognized that, even in these respects, the experience of the past has useful lessons to offer. However, institutions and practices which have once served admirably are certain to require adjustment and adaptation from time to time if, as is very likely to be the case, the background out of which they originally grew has in the meantime undergone important changes. It is a matter for satisfaction that in several countries the intention has been announced of undertaking thorough investigations of the workings of the credit system in the modern world, with a view to a more systematic exposition of basic principles in the light of the experience of recent years. Even if the results that will thus be obtained will be immediately applicable only to the countries in which the investigations have taken place, such an exposition will no doubt also prove useful from a more general point of view.
Much of the Fund’s practical work consists in the adaptation of general policies and principles to the varying circumstances and requirements of its members. By the ever closer contact that is developing between the Fund and its members, much experience has been gathered, which it is hoped will contribute to the gradual solution of monetary and exchange problems. In the state of tension characteristic of the boom conditions in which many countries find themselves today, there is some hesitation about entering into formal undertakings which the authorities fear might limit their freedom of action in the international financial field. At the same time, the increased attention given to the monetary aspects of current problems, both by the authorities and by the general public, gives ground for confidence that monetary stability will be more effectively preserved than in the past, and that a steady movement toward a fully multilateral system of international payments will be maintained.