I The World Economic Situation
- International Monetary Fund
- Published Date:
- September 1952
At the time of the foundation of the Fund, it was envisaged that, after the destruction and dislocation caused by World War II had been repaired, a balanced pattern of multilateral world trade and payments would emerge in which the general support of restrictive and discriminatory policies would no longer be needed. Seven years have now elapsed since the war, and more than five years since the Fund began operations. During these years there have been a remarkable growth in production and one widespread adjustment of exchange rates. The attainment of a stable international equilibrium, however, still eludes large parts of the world, and there has been little secure or sustained progress toward the Fund objectives of unimpeded multilateral trade and the general convertibility of currencies.
During the last seven years, balance of payments difficulties have been continuous or recurrent, and most countries have either been unable to make substantial progress toward freer international trade, or have had to reverse from time to time some of the steps taken in that direction. The difficulties at any given point of time can nearly always be represented as being, at least in part, the result of some special temporary disturbing factors. These special factors can, indeed, never safely be neglected. The frequent recurrence of balance of payments difficulties suggests, however, that an explanation of the difficulties should be sought in terms of more fundamental and pervasive influences that to some extent have affected almost all countries.
The first critical situation arising out of the postwar payments disequilibrium occurred in the summer of 1947, and was associated with the short-lived resumption of sterling convertibility. It was temporarily resolved by the U.S. interim aid program and the Marshall Plan, which permitted the European countries to proceed with the restoration of their economies much more rapidly than would otherwise have been possible. Their recovery was in most cases substantial, but, as the most urgent reconstruction and pent-up consumer and producer demands were satisfied, a second exchange crisis began to develop. Its first symptoms were seen in a tendency for some European exporters to find themselves priced out of dollar markets. The par values agreed in 1946 and 1947 were at first quite compatible with a rapid recovery of exports, because unsatisfied demands for exports were so large. As the urgency of many of these demands declined, however, it became apparent in many countries that inflation was adding to the competitive difficulties of exporters. The emergence of a buyers’ market was hastened by a moderate downturn in economic activity in the United States early in 1949, and the exports of many countries began to lag. With a decline of confidence in certain key currencies, this resulted in the widespread devaluations of September 1949. A substantial improvement in the international reserves of many countries followed. This was due in part to the reversal of earlier speculative positions in regard to payments and orders and to a running down of stocks, but there was also a significant strengthening of the underlying balance of payments situation. In many countries restrictions were relaxed and some progress was made toward convertibility.
Before there had been time for the full effects of the devaluations of September 1949 to be worked out, fighting broke out in Korea in June 1950 and initiated a series of new developments to which balances of payments had to be adjusted. The immediate, and partly speculative, reactions to the outbreak of hostilities were followed by a readjustment or correction phase. The increased demands arising from stockpiling and rearmament raised prices, national income, and world trade to higher levels. It might have been expected that the increased demand for raw materials would, after some adjustments, lead to a new equilibrium, with the terms of trade and exchange reserves of the countries concerned somewhat more favorable than before June 1950. The reserve positions of many countries were, indeed, strengthened, but this trend ceased with the subsequent decline in commodity prices, which reversed part of the initial improvement in the terms of trade of raw material producers. The old troubles then reappeared. There were widespread balance of payments difficulties, reserves declined, and the earlier movement toward freer trade was to some extent reversed. While conditions in individual countries in the first half of 1952 vary widely, the reappearance of these difficulties provides a strong indication that the earlier efforts to restore a new world equilibrium had failed to get to the root of the matter.
A proper understanding of the fundamental causes responsible for the recurrent external disequilibria in recent years is not possible without reference to the domestic fiscal and monetary policies pursued by various governments. These policies have permitted continuous inflationary pressures, and the connection between domestic inflation and balance of payments difficulties has become increasingly evident. Since the end of World War II the pressure of demand for consumption and investment goods and services has, for a wide variety of reasons, been allowed to pass beyond the limits set by the resources available. The efforts to translate into reality the widespread desire for economic security and betterment, or, in some countries, to check the deterioration of standards realized in the past, have been an important factor in this situation. More recently, rearmament programs have made further demands upon the limited supplies of resources. Sometimes an inflationary situation has been produced that was clearly recognizable. Sometimes the effects of inflationary pressures have been temporarily concealed by devices such as price controls and subsidies. Without the aid given since the end of the war by various countries, and especially by the United States, inflation would probably have been more severe, and the development of production would have been retarded. But even when temporarily held in check, the inflationary pressures have always been ready to re-emerge and to upset such uneasy monetary equilibrium as may have been established.
In their efforts to satisfy the competing claims of divergent social and economic objectives, many countries have adopted economic and monetary policies which have meant that they were attempting to live beyond their means. Any such attempt is bound sooner or later to be frustrated, but if this is not clearly understood, or if for social or political reasons governments feel it impossible to act in accordance with a correct understanding of the situation, the necessary adaptations of domestic policies to current changes in the balance of payments are not quickly or adequately made. Measures which it is feared will be unpopular are either not taken at all or taken only after long delay and then not pushed far enough. In the meantime, the continuance of inflation makes it difficult to recognize and respond to any structural changes that may be taking place. When there is excessive demand for all resources, the incentives to undertake the transfers of productive resources that may be necessary if long-term external equilibrium is to be established are seriously weakened. Continuous inflationary pressures and balance of payments problems are bound to make it increasingly difficult to ensure the maintenance of supplies of essential raw materials, and therefore of steady levels of employment.
While the recurrence of balance of payments difficulties is to be explained mainly in terms of the inflationary pressures generated by diverse conflicting claims on limited resources, other factors also have had a significant influence. The magnitude and range of U.S. production and productivity have placed that country in a position of predominance in the world economy and of comparative self-sufficiency. This situation demands difficult adjustments, in both the rest of the world and the United States, that are still far from complete. Agricultural protection in Europe and the United States still creates difficulties for some countries, and the other protective policies maintained in the United States, despite its great competitive power, also continue to embarrass other countries.
The industrialization of some of the raw material producing countries, which was already under way before World War II and was further accelerated in response to the wartime disruption of trade connections, also calls for adjustments in the world economy, and particularly in the industrialized countries of Europe. Overseas industrialization means, on the one hand, diminished demand for the products of some European industries, while, on the other hand, it provides an expanded market for exports of all kinds of capital equipment. In recent years the industrializing countries have increasingly turned to dollar sources of supply to satisfy their demands for these capital goods. It has thus become difficult for the older industrialized countries to meet their dollar area deficits by export surpluses to raw material producing countries with a dollar surplus.
An aggravating factor in the recurrent balance of payments crises of the postwar years is the inadequacy of international reserves available to monetary authorities outside the United States. Although the gold and dollar holdings of countries other than the United States have risen to some extent since 1938, the increase has not been in proportion to the expansion of world trade, and their value in real terms has been actually reduced by inflation. These trends, combined with the abnormally wide swings in balances of payments, have often produced situations in which reserves have appeared to be dangerously low. The attainment of any particular level or ratio of reserves is not by itself a guarantee against balance of payments crises; nevertheless, a more adequate cushion against balance of payments disturbances is clearly desirable so that more time may be available to make the necessary readjustments.
The significance of inadequate reserves has also been greatly enhanced by the fact that the disruption in the 1930’s of the private international short-term capital market has not been repaired. Instead of private capital movements helping to minimize the use of official reserves, in a great number of countries the whole burden of adjustment to balance of payments fluctuations has had to be borne by central banks and governments. Balance of payments adjustments are also made more difficult by the virtual absence of any effective private international long-term capital market.
Postwar economic developments have further been affected by the international political developments which have proved much less satisfactory than was envisaged at the end of the war. The decline in East-West European trade is partly responsible for the deterioration in the terms of trade of Western Europe, which has been cut off from the raw material and foodstuffs supplies of Eastern Europe. Similar difficulties have arisen in the Far East. Political tensions have led to a general feeling of insecurity which, combined with the growing sensitiveness to risks of economic insecurity, has induced disturbing short-term capital movements that greatly complicate the tasks of monetary policy. In the last few years, the conflict in Korea and increased political tension generally have necessitated rearmament which tends further to disrupt international prices, intensify inflationary pressures, and impose on countries increased burdens of adjustment.
Finally, the recurrence of balance of payments difficulties must also be attributed, in part, to a certain lack of effective cooperation between various countries. In the last analysis, the success of any international endeavor must depend on the degree of cooperation and coordination among countries. Progress toward a balanced pattern of international exchange would be more rapid if countries were to cooperate more effectively, for example, to ensure careful consideration of the interests of other countries if restrictive measures have to be taken, and in the stockpiling of scarce materials.
In the situation that has been described above, the steps taken by the Fund to facilitate the utilization of its resources by members, as described in Chapter II, have particular significance as fulfilling in part the need of members for a second line of reserves. The solution of members’ problems requires, however, more than a strengthening of their reserves. For each country it will have to be found in the acceptance of appropriate domestic monetary and fiscal policies that are in accord with that country’s balance of payments position. The Fund has an important role in helping its members to adopt such policies. Moreover, by watching developments and by providing a forum for an exchange of views between its members, the Fund can seek to increase the degree of coordination among them. There are some forces, such as the growing international tension, over which the Fund can have little, if any, influence. The adoption of effective balance of payments policies is still often impeded by domestic political forces. The difficulties that have been responsible for the recurrent exchange crises are not, however, irremediable. Indeed, within the past year, there has been increasing recognition of the fundamental weaknesses underlying external imbalance and a growing determination to come to grips with them.
While the Fund’s main task is international—to seek a system of multilateral trade and payments—the purposes for which it was formed can be reached only if effective domestic measures are taken by its members. Whatever its cause, domestic inflation has been at the root of many recent international difficulties, and as long as it continues a satisfactory and stable system of international trade and payments will be impossible. Inflation has had much to do with one serious danger to international trade—the maintenance under conditions of peace of the division of the world into separate currency areas that had followed the war. Such a division cannot last without the support of a network of administrative controls applied both to the external trade of countries and to their internal economies. The economic relations of countries are too pervasive to be confined for long within a complicated network of this kind, unless the controls are extended to many of their major activities. The choice before us is to end inflation, or to move further toward a kind of world which is the antithesis of the world the Fund was formed to serve. In such a world, even the present weakened structure of international trade and payments is more likely to deteriorate than to improve.
Initial Reactions to the Korean Outbreak
U.S. imports, which even before the outbreak of fighting in Korea were rising, showed a further prompt and vigorous increase after the conflict began; this increase dominated the first phase of the reactions to the Korean outbreak through the first quarter of 1951. The value of U.S. imports in the third quarter of 1950 exceeded that of the second quarter by $470 million, or about 25 per cent, and there were further increases of $260 million in the fourth quarter of 1950 and $380 million in the first quarter of 1951. During the first few months after the beginning of hostilities, foodstuffs (e.g., sugar) accounted for a more than proportionate share in this expansion of U.S. imports, but emphasis soon shifted to industrial raw materials. Remembering the wartime shortages and fearing a rise in prices, consumers, producers, and the U.S. Government sharply increased their demands. In the third quarter of 1950, the principal effect of these increases was to raise the volume of imports; subsequently, their principal effect was to raise import prices. In both the fourth quarter of 1950, when the value of U.S. imports rose by 11 per cent, and the first quarter of 1951, when their value rose by 14 per cent, the increase in import volume was only around 3 per cent.
In the industrial countries of Western Europe, the movements of retail sales indicated a similar upward surge in demand in the third quarter of 1950. The value of their imports, however, did not increase until the fourth quarter (Germany and Switzerland were notable exceptions), and continued to rise through the second quarter of 1951. The expansion of European imports in general lagged behind that in the United States by one quarter. As a consequence, in contrast to the United States, Germany, and Switzerland, which had been able to obtain some of their additional imports at prices closer to the level of June 1950, most countries of Western Europe increased their purchases substantially only after prices had advanced. An important impediment to the expansion of European imports was probably the administrative delays in relaxing controls and the fact that the general public was at first less influenced in Europe than in the United States by the outbreak in Korea. The upsurge in retail buying in Western Europe in fact lagged about two months behind that in the United States.
The increased imports demanded by the industrial countries were obtained principally from the primary producing countries. The Latin American republics felt this impact particularly strongly in the third quarter of 1950, when the exports of the group as a whole increased by the equivalent of US$350 million, to $1,820 million. The countries of the outer sterling area were affected most in the last quarter of 1950 and the first quarter of 1951, when their exports increased by $640 million and $560 million, respectively, from $2,000 million in the third quarter of 1950. The exchange reserves of the sterling area and of many Latin American countries accordingly increased; subsequent liberalization of trade controls and fears of scarcity led, however, to increased imports and a decline in reserves. In general, this increase in imports lagged about a quarter behind the increase in their exports, Latin American imports as a whole beginning to increase sharply in the fourth quarter of 1950, while the sharp increase in the imports of the outer sterling area got under way in the first quarter of 1951.
Already by the end of the first quarter of 1951, the untenable levels reached by many raw material prices indicated the possibility of an exchange crisis. The price of Australian wool (greasy), for example, had risen from an average of US$0.68 per pound in the first six months of 1950 to $1.89 in March 1951. The prices of several other commodities—e.g., tin, rubber, Egyptian cotton, jute, cordage fibers—doubled, or almost doubled, during this period, and the prices of U.S. and U.K. imports of primary commodities as a whole rose by about 50 per cent. It was in this situation that the U.S. Government took steps to become the sole buyer for the country of rubber at the end of 1950 and of tin in March 1951, and later reduced its stockpile purchases of these two commodities and of wool. Further uncertainties were injected into the market for import goods in general by the U.S. Government’s general price regulation of January 26, 1951. Finally, U.S. consumer demand also began to show signs of falling off, the seasonally adjusted index of retail sales reaching a peak in January. The first quarter of 1951 thus marked the end of the initial reaction to the outbreak of fighting in Korea. By the second quarter, U.S. imports had turned down and the decline in commodity prices had begun.
Commodity Price Movements
The decline in U.S. imports, mainly of raw materials, which was moderate in the second quarter of 1951, was more substantial in the third quarter, when imports fell by about $500 million, to $2,510 million, and there was a further moderate decline in the fourth quarter of the year. A similar decline in the imports of the OEEC countries lagged a quarter behind that in the United States. U.K. imports, however, continued to increase through the third quarter of 1951.
The decline in import demand brought about a sharp reduction in many raw material prices; the extent of this reduction is illustrated by the movement of the index of wholesale prices of eleven primary commodities imported into the United States (Table 1). For many commodities the price decreases were much sharper, as shown in Table II. By early 1952 many prices, although still higher than in June 1950, were substantially below their level in the spring of 1951. For some commodities, the March-September 1951 decline proved to be excessive, and since then their prices have recovered a little. For others, however, for which a brisk demand was maintained, such as copper, lead and zinc, the price trend continued to be upward.
Averages of daily index of U.S. Department of Labor, Bureau of Labor Statistics
Averages of daily index of U.S. Department of Labor, Bureau of Labor Statistics
|Copra (Philippines, 100 lbs.)||7.97||11.48||6.97||4.20||(Apr)|
|Egyptian cotton (Ashmouni, 100 lbs.)||52.60||82.001||43.90||48.60||(May)|
|Jute (Pakistan, short tons)||193.00||413.002||266.00||270.00||(Mar)|
|Wool, greasy (Australia, 100 1bs.)||68.00||188.70||59.70||54.20||(Mar)|
|Tin (Malaya, 100 lbs.)||72.40||181.401||109.80||119.10||(Mar)|
|Rubber (Malaya, 100 lbs.)||21.00||73.502||51.40||35.80||(Apr)|
Most of the reduction in the import demand of the industrial countries affected first the primary producing areas. The exports of the outer sterling area stopped increasing in the second quarter of 1951 and fell sharply, by $880 million, in the third quater, when Latin American exports also fell off. The decline appeared to have been arrested in the fourth quarter of 1951, but, combined with the increases in the imports of these countries, it caused a sharp deterioration of their trade balance. The trade balance (f.o.b.) of the Latin American republics deteriorated by about $150 million in the second quarter of 1951 and by $210 million in the third, while that of the outer sterling area worsened by $340 million in the second quarter and by $1,010 million in the third. The trade balances of many countries deteriorated further in the fourth quarter because of the continued upswing in their imports. By that time, indeed, they had worsened in most countries to the point where the reserves that had increased during the boom were being drawn down; for some countries, e.g., Australia, the decrease was at a very rapid rate.
Balance of Payments Developments
The outflow of gold from the United States that had begun in 1950 lost its momentum in May 1951, when U.S. reserves were $21,861 million, and a substantial inflow began in August. By May 1952, U.S. gold holdings amounted to $23,502 million. The net deficit1 of foreign countries as a whole with the United States, covering not only goods and services but also private capital movements and certain other transactions, amounted in 1951 to $3,156 million, against $265 million in 1950 and $5,348 million in 1949. This deficit was financed not only by movements of reserves but also by substantial grants and loans.
The changes in 1951 of the balance of payments of various areas with the United States and the deterioration that occurred, especially in the second half of the year, are summarized in Table III. Some countries were particularly affected by sudden cuts in U.S. purchases of their staple exports, and the deterioration was substantial for most areas. The surplus of most of the OEEC dependencies (both sterling and other), however, increased.
|Other OEEC countries||—799||—1,498||—167||—253||—455||—357||—433||—367|
|Rest of sterling area||173||—156||89||74||91||—82||—239||—155|
|Latin American republics||—167||—541||—91||299||—168||—384||—288||—48|
|Unadjusted total 1||162||—2,117||53||226||—447||—865||—1,031||—481|
|Errors and omissions 2||—156||—594||90||—93||—244||—173||—84||—270|
|Other adjustments 3||—271||—445||—86||—103||—41||—118||—183||....|
|Adjusted total 4||—265||—3,156||57||30||—732||—1,156||—1,298||—751|
The regional figures represent the net balance on account of goods and services, unilateral transfers except economic aid, and U. S. capital movements, except ECA loans.
Assumed to be largely private capital movements.
Adjustments made to include certain noncompensatory official financing transactions, e.g., import prepayments and developmental loans, and to exclude a few minor compensatory transactions.
Surplus or deficit (—) as measured by compensatory official financing.
The regional figures represent the net balance on account of goods and services, unilateral transfers except economic aid, and U. S. capital movements, except ECA loans.
Assumed to be largely private capital movements.
Adjustments made to include certain noncompensatory official financing transactions, e.g., import prepayments and developmental loans, and to exclude a few minor compensatory transactions.
Surplus or deficit (—) as measured by compensatory official financing.
Throughout the postwar period, U.S. Government grants and loans have been a factor of outstanding importance in the reconstruction and balance of payments developments of many countries, especially in Western Europe. The knowledge that this financial aid would be reduced was something to be taken into account in determining policy in 1951. Although ECA aid tapered off in that year, U.S. Government grants and loans (net) to foreign countries, including both military and economic aid, amounted to $4,594 million, somewhat more than the 1950 total of $4,207 million. Military grants increased from $580 million to $1,460 million, whereas economic grants fell off from $3,460 million to $2,970 million. Although most of the military as well as of the economic aid continued to go to the OEEC countries, the total grants extended to them declined slightly.
The balance of payments of the United Kingdom deteriorated seriously during 1951, not only with the United States but also with the EPU area. Although the balance with the rest of the sterling area improved, from a deficit of £13 million in the first half of the year to a surplus of £116 million in the second half, this improvement was insufficient to offset the worsening vis-à-vis other areas, and the 1950 surplus of £255 million was followed in 1951 by a deficit of £756 million. For the year as a whole, the outstanding feature was the widening of the trade deficit, as the value of exports increased by 22 per cent while the value of imports rose 47 per cent. In the second half of the year, there was a sharp drop in the surplus on account of services, partly because of the stoppage of Iranian oil sales. Britain’s balance of payments deficit with the non-sterling area rose from £204 million in the first half of the year to £655 million in the second half. Gold and dollar holdings, after rising moderately to $3,867 million at the end of June 1951, fell in the next four quarters by $2,182 million; at the end of June 1952, they were $1,685 million, about the same as at the end of 1949. In real terms, gold and dollar holdings at the end of June 1952 were below the 1949 level.
The downward movement of reserves, indeed, gives an exaggerated picture of the real deterioration in the external position of the United Kingdom. In a time of uncertainty there was an inducement for importers in the United Kingdom to accelerate the dollar payments that they had to make, and for the importers of U.K. goods abroad to delay the settlement of their obligations. These changes in the timing of payments, the so-called “leads and lags,” were an important factor in reducing reserves. Any subsequent reversal of such short-term movements must be taken into account in interpreting later movements of reserves. One reason for emphasizing the importance of reserves is precisely the protection that they afford against the effects of temporary adverse changes of this kind.
The deterioration of the U.K. balance of payments was also the result of more fundamental changes in its economic position. For example, according to calculations in which c.i.f. import prices are used, its terms of trade in 1951 were 11 per cent below those of 1950; the actual decline must have been less, because freight charges increased. The most important factor, however, was undoubtedly the increase of 16 per cent in import volume, which in part may have been the result of the rebuilding of stocks that had been allowed to run down in 1950, and is to be compared with an increase of 3 per cent in the volume of exports (Table IV).
With a view to checking the deterioration of its balance of payments, import restrictions were intensified in the United Kingdom. Most other countries in the sterling area also took similar action in the early months of 1952.
In the first half of 1951, the sterling liabilities of the United Kingdom to all countries increased by £425 million, to £4,168 million, and were then as high as they had ever been. By the end of the year they had fallen back to £3,807 million, not much above the level of £3,743 million at the beginning of the year. This movement was accounted for largely by changes in liabilities to other sterling area countries. These increased from £2,732 million at the beginning of the year to £3,100 million at the end of June, and then fell off to £2,789 million by the end of the year. There were considerable variations in the records of individual countries, but the sterling balances of the United Kingdom’s dependent territories as a whole tended to increase throughout this period.
Further evidence of the inbalance in world trade is afforded by developments in the European Payments Union, whose members clear through its machinery not only their own transactions with other members, but also most of the transactions of their associated monetary areas. Until May 1951 the sterling area had a surplus in EPU, but subsequently it had deficits which reached a peak of $236 million in October. Although the monthly deficit has declined since then, the United Kingdom by the end of May 1952 had exceeded its quota, and reached the stage of 100 per cent gold settlement. Substantial invisible and capital transactions appear to have affected the EPU position of the sterling area, but an examination of the trade returns of the United Kingdom with continental OEEC countries, and of the latter with the rest of the sterling area, suggests that U.K. trade was a more important factor in the reversal of the sterling area’s EPU position than was the trade of the other sterling area countries. The trade deficit of the United Kingdom increased, and the trade surplus of the other sterling countries decreased, the increase in the deficit, however, being substantially greater than the decrease in the surplus.
The balance of payments position of the next largest member of EPU, France, also deteriorated sharply in 1951. The over-all deficit of the franc area, which in 1950 had been $217 million, increased to about $1,000 million in 1951, almost entirely on account of goods and services. The terms of trade deteriorated by 9 per cent. The increase in the volume of exports (19 per cent) was only slightly greater than the increase in the volume of imports; the export surplus with the overseas territories increased moderately; and the trade deficit with other countries grew substantially. Although the monthly deficit in EPU decreased in March 1952, France was by that time in the 60 per cent gold settlement tranche of its quota.
The general balance of payments positions of a number of other EPU members improved. For example, the over-all deficit of the Netherlands decreased from the equivalent of $358 million in 1950 to $119 million in 1951; Belgium’s 1950 deficit of $301 million was followed by a surplus of about $145 million in 1951; and Western Germany, which had a deficit of $653 million in 1950, had a small surplus in 1951.
The two largest members of EPU have been its heaviest debtors and three members, Belgium, Italy, and Portugal, have credit positions in excess of their quotas, requiring special arrangements for gold settlements. These are symptoms of the disequilibrium which has from time to time threatened a drain on the liquid resources of the Union. Some of the trade liberalization progress of EPU has been lost in an effort to reduce these payments difficulties. Free imports from other EPU countries were temporarily suspended by France and severely limited by the United Kingdom. Some creditors (especially Belgium) also introduced specific controls designed to reduce their monthly surpluses. These measures, taken together, may help temporarily to suppress the payments disequilibrium within Europe, but at the cost of retrogression in the field of liberalization.
Latin America’s trade position with the United States shifted from a surplus in the first quarter of 1951 to a large deficit in the third and fourth quarters. An inflow of U.S. capital and of dollars received from exports to other countries maintained Latin America’s reserves at a level in September 1951 which was still above that at the end of 1950; but they were declining sharply in the third quarter, and fell further in the fourth quarter. The Latin American republics as a whole continued to run a modest trade surplus with the OEEC countries until the fourth quarter of 1951. The terms of trade of Latin America as a whole are down from the level of early 1951, but may still be above the level of the first half of 1950. Canada’s over-all surplus fell from Can$642 million in 1950 to about Can$240 million in 1951, less than a quarter of the decline being accounted for by a worsening of the goods and services balance.
Continuance of Inflationary Pressures
Balance of payments developments since the outbreak of hostilities in Korea in June 1950 afford another illustration of the inevitably close relationship between balance of payments difficulties and inflationary pressures. It was impossible immediately after hostilities began to predict confidently the course of events. In fact speculative purchases, the increased cost of imports, and the expansion of military outlays produced, in a situation where there were already inflationary potentialities, a mixture of cost and income inflation in both industrial and primary producing countries. The fact that steps were not taken in time to minimize these inflationary forces and to neutralize their impact was the outstanding element in the reversal after the middle of 1951 of the favorable balance of payments position that had developed earlier in many countries.
The commodity boom of 1950 might have been kept within bounds if there had been a more widespread and prompt use of monetary policies and more effective coordination among countries in government stockpiling. This would have reduced the inflationary pressures felt during the first phase of the Korean war and would have smoothed the transition to rearmament economies. The increase in defense expenditures would have required in any case a reduction of the proportion of national expenditures directed toward civilian goods, and it was particularly desirable that any further complications through wide swings in terms of trade and speculative buying should have been avoided. Some changes in the terms of trade and in the balance of payments positions of raw material producing countries may well have been inevitable; but if it had been possible to moderate the inflationary impact of these changes, the subsequent sharp reversal in international reserves would have been limited.
In some countries, indeed, considerable progress has been made in recent months in the fight against inflation. Uncontrolled inflation has not yet altogether ceased to be a danger, but the threat today is generally not so great as it was a year ago. Even, however, where internal stability has been temporarily attained, the measures taken have often been insufficient to ensure that it will be permanent. The main test of stabilization policy will come when rearmament expenditures reach their maximum.
During the first few months of the Korean war, the upsurge of speculative demand and the consequent increases in the prices of imported raw materials led in most industrial countries to a sharp expansion in bank credit. This expansion was slowed down after March 1951 by the decline in raw material prices, the tightening of credit and money market conditions, and stronger consumer resistance in reaction to the earlier spate of buying. In the United States, for example, commercial bank loans to business and individuals, which had increased by 21 per cent during the nine months ended March 1951, increased further during the subsequent nine months (April 1951-December 1951) by only 6 per cent. There was a similar slowing down in the rate of bank credit expansion in other countries, including Canada, the Netherlands, Italy, Switzerland, and Western Germany. This relaxation of inflationary pressures in industrial countries can also be seen in the movements of their cost of living indices during these two periods. The U.S. cost of living index, which had increased by 8 per cent from June 1950 to March 1951, rose by less than 3 per cent between March 1951 and December 1951, and declined slightly in the first quarter of 1952. Cost of living increases have similarly slowed down in most of Western Europe, particularly where an effective monetary policy had been adopted, as in the Netherlands, Belgium, Denmark, Finland, and Italy.
The tendency toward a reduction of inflationary pressures in the latter part of 1951, was, however, less obvious in some other industrial countries, including the United Kingdom and France. In the United Kingdom, commercial bank credit to business and individuals continued to expand until October 1951, when it was 15 per cent higher than a year before. The continuance of inflationary pressures in the United Kingdom at a time when they were diminishing elsewhere can be traced in part to its greater dependence on imported food and raw materials, to its efforts to rebuild the stocks which had been allowed to run down when prices first began to rise, and to the speed and magnitude of its rearmament effort. A high level of reconstruction and investment has also continued to be an important factor. The difficulties of the United Kingdom were, moreover, prolonged by the delay in making adequate use of the weapons of monetary control. Throughout the postwar period, commercial banks in the United Kingdom have been subject to a form of selective credit control, and since 1948 there has been a tendency for interest rates to rise gradually. But the decisive break from cheap money policy came only in November 1951, when the discount rate of the Bank of England was raised, for the first time since 1939, from 2 to 2.5 per cent. In March 1952 the discount rate was raised further, to 4 per cent. In the meantime, the liquidity of the banking system was also reduced by funding a part of the floating debt. The consequent change in the financial climate of the country slowed down the expansion of bank credit to a considerable extent in the first quarter of 1952. It did much to restore confidence in sterling and to reverse the outflow of capital.
In France in the first part of 1951, political circumstances hampered the adoption of fiscal and monetary measures firm enough to check inflation, when military expenditures and a large investment program are taken into account. France has maintained elaborate quantitative restrictions on credit, and the discount rate of the Bank of France, which had been reduced prior to the outbreak of hostilities in Korea, was raised in October 1951 to 3 per cent, and in November to 4 per cent. The Government’s finance program announced early in 1952 proposed to reduce some noninvestment expenditures, and to link investment outlays more closely to the borrowings available from genuine savings.
Inflationary developments in the raw material producing countries have followed a slightly different pattern. In some of them, e.g., Egypt, Venezuela, Costa Rica, and the Dominican Republic, the growth of the money supply during the nine months ended March 30, 1951 was moderate. In most of them, however, the money supply increased rapidly in response to the improvement in their foreign exchange positions. This expansion was checked sharply after March 1951, when raw material prices began to decline and import controls were liberalized. During the last nine months of the year, the money supply actually declined in India, Ceylon, the Philippine Republic, and Uruguay. In most of the other raw material producing countries, with the exception of a few such as Chile, the increase was quite moderate in comparison with the earlier period. In Australia the growth in the money supply ceased after April 1951. Australian imports, however, rose sharply during the last nine months of 1951, and there was a large trade deficit which would have resulted in a contraction of the money supply, if there had not been an increase of 18 per cent in bank advances, the greater part of which was used to finance temporarily heavy stocks of imported goods.
The spectacular increases in the money supply during the first phase of the reaction to the Korean war were not, however, entirely a consequence of external factors; in many raw material producing countries there was also a speculative wave of demand fed by an expansion of bank credit. The boom in raw material prices, indeed, made it possible for many underdeveloped countries to raise extraordinary revenues through higher export duties which had been intended as an anti-inflationary measure, or by multiple currency practices. Countries such as Ceylon, India, and Indonesia were thus able to reduce their budget deficits, and some of them were for some time able to a greater extent than before to finance developmental projects from current revenue. But the decline in export receipts during the latter part of 1951 has in some countries raised again the problem of financing capital expenditure by normal taxes and genuine savings. In order to maintain exports at satisfactory levels in the face of declining raw material prices, export duties have been reduced, and budget deficits of uncomfortable proportions have begun to reappear.
The foreign exchange reserves accumulated in the first phase of the Korean war enabled many countries during the readjustment phase to counteract the inflationist impact of re-emergent budget deficits by increasing imports. But this remedy against domestically generated inflationary pressures involved a deficit on current external account and could be applied for only a short time. It is now, however, coming to be more generally realized that financial stability is an essential element in schemes for rapid economic progress. The difficulties of a country with limited administrative resources in collecting taxes and utilizing domestic resources have sometimes been exaggerated; recent experience in some countries, such as the Philippine Republic, has shown that much can be achieved by improving tax collections. At the same time, if the development of these countries is not to be unduly retarded, an expansion of the flow of long-term international capital is required. This objective will not be attained without the active cooperation of both the countries receiving capital and those supplying it. Despite setbacks in certain areas, there have been some indications in recent months of willingness to adopt policies to attract investments to underdeveloped countries.
In India the bank rate was increased in November 1951 from 3 to 3.5 per cent, and there was a partial withdrawal of support for government bonds. At the same time domestic production had increased considerably during the year, while foreign demand for jute and cotton had slackened. Some stringency in the money market followed in the early months of 1952, which forced a general dishoarding of commodities, and there was a sharp fall in the wholesale price level in March 1952. Since that time prices have recovered a little. Australia, which in 1951-52 budgeted for a substantial surplus, has a system of quantitative credit controls, but interest rates have not been a major instrument of monetary policy. The strain of rapid development and the regulation of wages in accordance with movements of the cost of living meant a continuous rise in the cost of living in Australia during 1951, even after the prices of raw materials had begun to decline.
During the first year of the Korean war, defense expenditures did not increase sharply except in the United States and, because of military operations in Indo-China, in France. In the United States these expenditures were roughly $26 billion in the fiscal year ended June 1951, and about $47 billion in the fiscal year ended June 1952, when they were covered largely by higher tax yields. For fiscal 1952-53 the expenditures are estimated at some $60-65 billion and a sizable deficit is expected. The intensification of the conflict in Indo-China led to a substantial increase in military expenditures in France prior to the outbreak of hostilities in Korea; a further increase in 1951 brought total military expenditures in that year, in money terms, to more than twice the 1949 level.
In some countries, such as Yugoslavia and Turkey, defense expenditures have been maintained at the high level that had been reached earlier. They have increased in the United Kingdom where, during the fiscal year 1952-53, they are expected to total approximately £1,500 million (against £750 million in 1949-50). Over the period 1949-51, defense expenditures have increased substantially in other European countries. This intensification of rearmament efforts has not led so far to any serious imbalance in government budgets except in France, but defense expenditure is still expanding, and the stresses and strains of this expansion are widely felt. Some countries have had to revise downward their immediate plans for rearmament expenditure, and the need for further U.S. military and economic assistance has been pressed more strongly than was envisaged a year ago.
As pointed out above, the instruments of monetary policy have been used more widely during the past year, particularly in the industrial countries of Europe and North America, to cope with the resurgence of inflationary pressures; interest rates have been raised, and quantitative and qualitative controls over credit have been more extensively applied. Fiscal policy has also been adapted in some countries with a view to checking inflation. To some extent, direct controls, relaxed before June 1950, have been imposed. The movement toward direct controls is not widespread, however, and recent extensions have affected mainly raw material allocations, foreign trade, and wages.
Among the fiscal measures adopted in the last year, the reduction of subsidies on consumption in countries such as India, the Netherlands, and the United Kingdom is noteworthy. In order to avoid increases in the cost of living and in wages, subsidies have often been used to offset the effects of increased costs upon prices. Recently, however, there has been a tendency to cut these subsidies substantially. The immediate anti-inflationary significance of these decisions has sometimes been small, because of counterbalancing tax concessions and the wage adjustments that might be made. Nevertheless, these changes, in addition to being significant as a move toward the restoration of an effectively working price mechanism, serve to emphasize the basic need in all anti-inflationary efforts. Whether inflationary pressures are generated by an effort to use more resources than are in fact available—in response, for example, to rearmament or development demands, or to changes in the terms of trade—the central problem is to persuade people to accept the inevitable cuts in real consumption and in investment for civilian production. This requires that money wages and money profits should not be increased in an effort to compensate for higher taxation or higher costs of materials and consumer goods. The realization of this objective demands high standards of public responsibility and willingness to accept a plan for distributing the sacrifices that are unavoidable.
Some of the more significant increases in bank discount rates since June 1950 are shown in Table V. In Belgium the rate was first raised to 3.75 per cent, but later reduced to the pre-Korean level of 3.25 per cent; in Finland, after an increase to 7.75 per cent, the rate was returned to 5.75 per cent; and the rate in the Netherlands, after being raised from 2.5 per cent to 4 per cent, was subsequently reduced to 3.5 per cent. In Yugoslavia, where interest rates formerly played only a nominal role in the economy, the National Bank of Yugoslavia has established, as part of the process of reorganizing the Yugoslav economy on a market basis, a series of rates averaging around 4.5 per cent. In several countries the rate has not been changed, e.g., Italy (4 per cent), Norway (2.5 per cent), and Switzerland (1.5 per cent). Nor, except in India, Bolivia, and Chile, has there been any widespread tendency to raise discount rates in Asia or Latin America.
|June 30, 1950||April 30, 1952|
In addition, several countries have allowed long-term rates on government bonds to fluctuate more freely. Even where the policy of supporting government bond markets has not been completely abandoned, there has been an orderly withdrawal of support, and the market yield on government bonds in many countries has consequently increased. During the two years ended April 1952, the yield on long-term government bonds increased by about
The general effect of restrictive credit policies has been to curtail speculative investment, mainly in inventories, and to dissipate inflationary expectations. Once these objectives are achieved, it may be possible to relax credit restrictions to some extent. If unemployment should rise to a level regarded as unacceptable, some relaxation of credit might become inevitable.
The tendency toward easing credit in order to meet the changing requirements of the situation is already evident in some countries. Early in April 1952, credit controls were lifted in the Netherlands, and the reduction of bank rates in Belgium, Finland, and the Netherlands has already been mentioned. In the United States and Canada some of the selective credit controls and informal credit restrictions imposed on commercial banks have also been relaxed or withdrawn in recent months. In some countries steps have been taken to prevent higher interest rates from unduly retarding housing construction.
For a variety of reasons unemployment remains comparatively high in some countries of Western Europe, such as Belgium, Denmark, Western Germany, and Italy; in certain other countries, including the Netherlands and the United Kingdom, it has increased in recent months from previous low levels. There has been no tendency toward greater unemployment in the United States, where average unemployment, as a percentage of the total labor force, declined from 5 per cent in 1950 to 3 per cent in 1951, and was smaller in the first quarter of 1952 than in the corresponding period of 1951 (3.2 per cent against 3.8 per cent). To some extent, increases in unemployment have been due to the temporary resistance of consumers after a spate of buying, or to causes requiring some reallocation of productive resources. Thus, the recession in the clothing and textile industries of the United Kingdom, the Netherlands, and Western Germany is explained in part by the revival or building up of textile industries in other countries and the overstocking of earlier months. In some countries, the intensification of import restrictions elsewhere has also been a cause of unemployment. The unemployment trend in Western Europe needs to be seriously watched, if only because it might weaken the resolve to reduce inflationary forces and might give a cumulative turn to the recent restrictive international trade measures. While certain types of chronic unemployment may require joint international action, steps have already been taken independently in some countries to counteract the recent tendency toward unemployment. For example, an extension of public works is proposed in the Netherlands, and military orders are being more swiftly directed to the depressed industries in, for example, the United Kingdom and the Netherlands. The line of demarcation between inflation and deflation is necessarily a matter for delicate judgment. It has yet to be seen whether the unemployment that has appeared calls for anti-deflationary policies or whether it is the result of the cessation of inflationary pressures and of the shifts in production which must accompany the attainment and maintenance of internal stability and external solvency.
International Payments Prospects
The readjustment of the payments disequilibrium between the dollar and non-dollar areas was being made easier in the early part of 1952 by the re-entry of the United States into the market for certain key commodities and by the foreign financing program of the U.S. Government. There were also some favorable developments that pointed to a more fundamental solution of the payments problem. The more general use of monetary and fiscal measures to keep effective demand within the limits of availabilities suggests a better understanding in many countries of the real nature of the problem.
With inflationary pressures still active in many countries, however, such balance of payments improvements as have been recorded recently have been achieved to a large extent at the cost of further trade and exchange restrictions and the additional distortion of trade that these restrictions are likely to involve. By reducing the supply of goods, these restrictions indeed will strengthen the forces of inflation. As rearmament expenditures increase, the supply of goods on the home market may be further restricted. The effects of political developments upon the level and timing of rearmament expenditures inject into the situation a further element of uncertainty. Demands for wage increases may upset the precarious balance between demand and supply and thus generate fresh inflation. Finally, there are still some important divergences between prices in dollar and nondollar markets, which distort the normal course of international trade, impede the attainment of competitive prices, and threaten to complicate the present pattern of exchange rates.
Summary and Conclusion
It is a melancholy fact that seven years after the end of the war the Fund has to report that international payments are still far from having attained a state of balance and that exchange difficulties and exchange restrictions are again, over large parts of the trading world, the order of the day.
In the years immediately after the war, disequilibrium in the world exchange markets was inevitable. The task confronting all countries at that time was primarily to restore and modernize production facilities after a long war which had caused great destruction, had altered prewar debtor-creditor relations, and had prevented normal capital investment. At the same time consumers were eager to replace their old, worn-out durable goods and purchase other consumers’ goods which for so many years had been in short supply. Without substantial balance of payments deficits, many countries would have found it impossible to restore production rapidly and to make good consumption deficiencies. These deficits were partly covered by large-scale aid from abroad.
During the past few years, however, the restoration of production facilities has resulted in a volume of output—particularly of industrial output—throughout the world substantially higher than prewar levels. In spite of this, balance of payments pressures have never been entirely absent in many countries, and though the pressures have on occasion been relieved by singularly favorable circumstances—such as very high export prices—exchange difficulties have never been far from the surface, and any adverse change in circumstances has threatened to cause them to emerge in the form of a fresh exchange crisis.
It has been argued above that a basic reason for the persistence of these balance of payments problems so long after the restoration of production is that certain countries—and they constitute a large part of the world—have followed policies aimed at achieving higher levels of consumption and investment than could be covered out of the real resources available. The result has been a situation of inflationary pressure throughout the world that in certain countries has been aggravated by the emergence of a new important claimant on resources in the form of rearmament. The inflationary pressure has not been uniform; some countries have taken more effective and timely anti-inflationary action than others; some have disposed of much greater reserves of productive capacity than others and so have been able to satisfy out of their own resources the growing demands of consumption, investment, and government, including rearmament expenditures. Inflationary pressures have tended to spill across the frontiers. They have created excessive demands for imports and reduced the quantities of goods available for export to parts of the world less subject to inflationary strains.
In this situation the use of exchange restrictions and quantitative import controls, frequently of a discriminatory nature, has seemed inevitable to many countries; and during the past year there has been a tendency to extend and intensify these restrictions and controls. Even where the long-term consequences of the measures adopted were clearly understood, the need for immediate action to deal with a critical situation has made it difficult to give adequate attention to them. In consequence, the treatment of exchange problems has frequently been symptomatic rather than radical: it has been aimed at the outward manifestations of balance of payments pressure rather than at its causes.
Restrictions and prohibitions and discriminations inevitably exert a strong influence on the structure of production and on the allocation of resources. The direction which they give to production and to the allocation of resources is not always determined by considerations which might be relevant in a system of rational “planning”: it is often accidental, dependent as it is on the selection of goods as proper objects of import restrictions and discrimination. Goods considered by the authorities to be relatively less essential tend to be a favored object of import restrictions. In countries dealing with their balances of payments problems in this way, an incentive is thus given to the production of goods of this kind. At the same time, there is no adequate incentive to increase, or even maintain, the production of certain basic foodstuffs and raw materials, the shortages of which are an important factor perpetuating international disequilibrium. Attempts to meet payments problems by relying on the shelter of import restrictions or on the assistance afforded by other countries’ import discriminations are likely, over a period of time, to lead to a more wasteful and inefficient allocation of resources and make the countries relying on these methods less, rather than more, capable of dealing effectively with their international payments problems.
The undesirable long-run consequences of exchange and import restrictions are often well known to the authorities of the countries applying them. Their continued use reflects in part the great difficulties that are felt to lie in the way of eliminating the basic inflationary causes of balance of payments deficits. Attempts to deal with inflation encounter resistance on the part of those who fear that such attempts must result in a spiral of deflation with all its evil consequences in the form of unemployment and loss of production. No one, however, would wish to initiate a spiral of deflation, and it cannot be assumed that a well considered program for controlling inflation will necessarily have this effect.
The countries which, through their membership in the Fund, have subscribed to the objectives of expansion and balanced growth of international trade and currency convertibility have other economic objectives as well, such as a high level of employment, economic development or economic stability, high or minimum standards of living. In the short run for particular countries there may be difficulty in reconciling the claims of all these objectives. In such circumstances it is the function of the Fund to provide a forum for discussion. The judgment is embodied in the Fund Agreement that the balanced growth of international trade, with the highest degree of multilateralism, currency convertibility, and currency stability, will itself be of major assistance in helping countries to attain their other basic economic objectives. It is the duty of the Fund constantly to remind countries of the weakening effects on the world economic structure of the mere symptomatic treatment of exchange difficulties, and to urge them to give careful consideration to the question whether the policies they adopt set up incentives that lead, over a period of time, in the direction of international balance, or in the opposite direction.
In the last resort, the maintenance of monetary stability depends upon the policies adopted by the domestic monetary authorities. In relation to every sector of economic policy, it is indeed the duty of all countries to recognize their mutual responsibility for each other’s welfare, and for many purposes it is important to distinguish between inflation imposed by external forces and inflation that has been generated domestically. The distinction can, however, easily be pushed too far, if it encourages the belief that the external causes of inflation are always predominant, that individual governments are therefore helpless to deal with an inflationary situation, and everything must wait for decisions to be taken by other more powerful governments abroad. Even when external conditions are most unfavorable, there is much that can be achieved by domestic measures.
The task of restoring a balanced system of international settlements that will function without periodic breakdowns is indeed formidable, even under the most favorable circumstances. To urge that, with this objective in view, more serious attention must be paid to the importance of monetary and fiscal policy in no way detracts from the overriding importance of maintaining and raising the level of world output. The fruits of postwar investment are now becoming available in increasing volume, but the world is still confronted with urgent production problems. There have been profound shifts of economic power as between different countries since before the war. New products have emerged and new demands developed. The old multilateral patterns of international settlement have been disturbed and new, more stable patterns have not yet replaced the old. International payments equilibrium would be brought much nearer if, for example, the output of raw materials such as coal, and of foodstuffs such as wheat, could be expanded on an economic basis so that the need for dollar imports of these commodities would be reduced. The protective stimulus that restrictions give to the production of less essential goods and services has indeed been one of the factors that have caused the production of basic foodstuffs to lag behind the world’s requirements.
This situation is one that calls for the most efficient possible allocation of resources on the part of all countries, for a very high degree of competitive strength, and for the maximum degree of flexibility in national economies in making the inevitable adjustments to changing circumstances, such, for example, as the reviving productive capacity of Germany and Japan. In making these adjustments each country should have regard to its trading position with all others as well, of course, as to its competitive position at home, and it should not allow an excessive preoccupation with any single market to deflect it from seeking to make its adjustments on the widest possible basis.
The efficient allocation of the world’s resources also requires that continuous attention should be given to the problems of economic development. Wisely planned development will strengthen the balance of payments of countries whose natural resources have hitherto been neglected. The use of inflationary means of finance to promote development, however, often creates balance of payments difficulties, and even the development that it produces sometimes turns out to be disappointing. The underdeveloped countries need themselves to undertake measures that would assure for development some flow of resources from their own savings. No comprehensive program of development is possible, however, unless there is a larger flow of foreign capital to the underdeveloped countries than has been the practice in recent years.
If, in this Report, great stress has been laid on the maintenance of internal monetary stability, it is because, in the judgment of the Fund, the balance of payments difficulties of the past couple of years have been due mainly to the attempt of many countries to do more by way of consumption, investment, and government expenditure than could be managed with the resources available to them. But it is obvious that the task of reestablishing a healthy pattern of international payments must be undertaken as much by the countries that achieve persistent surpluses in their balance of international payments as by the deficit countries. Obstacles placed by the surplus countries on imports, whether in the form of increased tariffs, import quotas and prohibitions, customs administration, or in any other way, may frustrate even the most strenuous efforts of the deficit countries to achieve international balance without resorting to restrictions. For this reason, the Fund expresses its earnest conviction that all countries in a strong balance of payments position should take all practicable means of reducing barriers to international trade as their most effective contribution to the restoration of a balanced world economy.
Except where otherwise indicated, the balance of payments surplus or deficit as used in this section is measured by compensatory official financing (see Table III)