I The World Economy in 1958-59
- International Monetary Fund
- Published Date:
- September 1959
The year that ended on April 30, 1959 stands out not only because of the marked changes which occurred in general business activity and in the international flow of funds, but also because important steps were taken to consolidate the monetary improvements achieved since the war and to strengthen the financial structure of the world economy. Outstanding events were the sharp upswing of industrial production in the United States, together with indications of renewed expansion in other industrial countries; the increase of more than $3.5 billion in the gold and foreign exchange reserves of Western European countries; the adoption in December 1958 of external convertibility by 14 European countries and the complementary steps taken by 15 other countries to adjust their exchange controls to the new conditions thus established; and the proposal made at New Delhi in October 1958, and the agreements subsequently reached, to expand the financial resources of the Fund and the Bank.
On the other hand, the experience of many of the primary producing countries was much less satisfactory. The decline in the prices of many primary products, which had begun in 1956, continued into 1958; and there was a reduction in the earning capacity of most of these countries, which created further difficulties in their payments positions and acted as a brake upon their economic development. They have had to deal with some difficult problems over the year; it is the more to their credit that so many of them have taken steps to withstand inflationary pressures, and in some cases to introduce and carry out comprehensive stabilization programs. There has been a growing recognition of the importance of orderly monetary conditions, and of the distortions of economic activity and the dissipation of resources which occur when such conditions are absent. As the expansion of activity is resumed in the industrial countries, and world trade expands, the less developed countries may expect substantial gains from their continued efforts toward stabilization and development.
The significance of the events of the past year is most evident when viewed against the background of the fears that were widely entertained early in 1958. The recession in the United States was still deepening, and raw material prices continued to decline. In the other industrial countries, output had slowed down as the boom lost its momentum and determined efforts had been made to eradicate inflationary tendencies. Evidence that the decline in economic activity in the United States had been arrested and reversed by mid-1958 was, therefore, noted with great relief, as were also the indications of some expansion in other industrial countries after the earlier adjustments had been made. Moreover, balance of payments developments in the United States during the recession and the subsequent recovery were such as to assist many other countries. While U.S. exports declined, partly because of the disappearance of the exceptional demands of late 1956 and early 1957, U.S. imports and investments abroad were well maintained. The result was that most other industrial countries, far from experiencing payments difficulties, were able to add substantially to their reserves.
Like its two predecessors, the third postwar recession was of short duration. Modern industrial countries appear to have developed strong powers of resistance to the downward thrust of the business cycle. The effects of certain “built-in stabilizers” help to ensure that consumer disposable income will be well maintained, even when business inventories and outlay on plant and equipment undergo substantial reductions. In the postwar period, moreover, there has been a strong urge toward systematic innovation based upon the allocation of substantial resources to research, which, by ensuring a rate of fixed investment less vulnerable to temporary setbacks, has reduced the severity of recessions and given strength to the recovery and expansion periods of the cycle. These longer run factors were supplemented by the authorities with appropriate policies in successive phases of the business cycle. Thus, once inflation had abated, monetary policies in a number of countries shifted from a position of credit restraint to one of ease and greater liquidity, in order to mitigate the decline and to encourage recovery. The lowering of interest rates and the increase of liquidity in the United States and Germany not only induced expansion at home and an increased volume of imports from the rest of the world, but also encouraged the flow of capital abroad—all of which was helpful in facilitating adjustments elsewhere. In the United States, the downward movement of interest rates was reversed in mid-1958, as business recovery got under way; in Germany, the downward trend persisted through the early part of 1959. Government expenditure increased in various directions in many countries, although large-scale public works programs played little part in fiscal policy. Since revenue tended to decline, deficits appeared, which under the circumstances of the recession helped to sustain economic activity.
Recovery in the United States was assisted by a large increase in liquidity. During 1958, the banking system as a whole increased its domestic assets by about $17 billion. This increase in domestic assets was associated with increases in the money supply and time deposits of $13 billion, or about 7 percent, with an outflow of gold and increases in official dollar balances of $3 billion, and with a rise in the banks’ capital accounts. But unlike the pattern of many recessions in the past, prices and costs did not decline. For an effective stimulus to recovery, therefore, greater reliance was placed on the creation of liquidity.
The decision taken by 14 Western European countries at the turn of the year to establish nonresident convertibility was perhaps the most notable step since the end of World War II toward the establishment of a truly multilateral system of payments, in accordance with the objectives of the Fund, and it was warmly welcomed by the Fund. This decision was the result of a remarkable cooperative effort. While it may be regarded as the culmination of the developments that occurred during 1958, it became possible in fact only because of the steady strengthening of the European economies that had taken place in the preceding years.
This strengthening was the result of a variety of factors. Aid from the United States was of great importance in the early years, helping in the task of reconstruction. Then, with production expanding, cautious credit and fiscal policies became increasingly effective in eliminating the overstrain in European economies. By and large, these countries had, by 1958, rid themselves of inflationary pressures which had endangered their currency positions throughout much of the postwar period; in most of them, the relation between money supply and gross national product, for instance, had been brought back to more normal proportions. Increased economic and financial strength was also shown by improved payments positions and the accumulation of reserves, which was particularly rapid in 1958. In the years 1956-58, financial assistance from the Fund had been an important factor in helping to overcome emergencies and strained positions, and the steps to enlarge the Fund’s resources, which were initiated at its Annual Meeting in New Delhi in October 1958, gave increased confidence that the Fund would continue to be able to reinforce reserves.
The exchange rates quoted in the free markets for the “transferable” currencies of certain Western European countries had for some time before the decision to establish nonresident convertibility differed from parity by only a slight margin. However, this did not mean that the decision was no more than the formal recognition of an already existing situation. It had in fact a much deeper significance. It meant, in the first place, the unification of exchange markets, with proper cross rates naturally emerging from arbitrage operations, and the disappearance, at least for current payments, of the often disturbing element of separate quotations for “transferable” and other types of these currencies. Another consequence of the adoption of nonresident convertibility was the termination of the European Payments Union, which had provided for settlements at par rates between central banks and made available to its members a system of automatic financing—25 percent of monthly net balances had been settled by credits to and from the Union. The elimination of central bank financing from current settlements could safely be undertaken, not only because of the improvement in reserves and in balance of payments positions, but also because there could be greater confidence than in earlier postwar years in the effective working of the international banking system. The ordinary channels of financing are supported by the possibility of obtaining ad hoc credits from the European Fund set up under the European Monetary Agreement, which had been worked out in 1955 to replace the European Payments Union, and, of course, also by the possibility of using the resources of the International Monetary Fund.
Nonresident convertibility was not limited to countries in Europe; 15 other countries, most of which are closely related as members of a monetary area to one or another of the European countries, also adjusted their exchange controls to the new conditions. But other countries also benefited, for they are now able more freely to use their holdings of the currencies which were made convertible for nonresidents. By far the largest part of world trade is now carried on in convertible currencies, so that exporting countries are in general free to use the proceeds from their exports anywhere in the world. This development is also of both psychological and technical importance for countries applying multiple rate practices, and an increased willingness to discard such practices in favor of unitary rates can already be seen.
Finally, while nonresident convertibility by itself does not necessarily produce a reduction of trade restrictions, it has important repercussions upon trade relations. Now that the proceeds of exports can, as a rule, be transferred freely into other currencies, the road has been opened to the elimination of discrimination in trade and payments practiced on balance of payments grounds. That improvement in reserves and in balance of payments positions which made possible the move to nonresident convertibility itself also facilitated a greater freedom of trade. It was, therefore, natural that the move should be associated in some countries with a further liberalization of trade, and it is to be expected that countries will be able to make further progress along these lines. The Fund intends to continue its study of the remaining restrictions—and especially the remaining discriminatory restrictions—and in the meantime, it is urging its members to eliminate discrimination as rapidly as is feasible.
Exchange developments in Western Europe in the first half of 1959 were distinctly favorable, thus providing further confirmation of the fact that these countries have on the whole attained a balanced position internally and increased strength in relation to other countries and continents. This gain in strength is the more remarkable since it has occurred at a time of continuing international political tensions, which fortunately have had little effect on economic activity or on the movements of funds.
If inflation does not at present pose the acute problem for the industrial countries that it did some years ago, this is due primarily to determined action on the part of the authorities to keep it in check. The comparative stability of the price level of finished goods in most industrial countries during the past year, however, has been due to some extent to the fall in prices of imported raw materials, and the threat of inflation has by no means passed. As it becomes clear that the recession has been overcome, increasing care will have to be taken to maintain by appropriate policies internal stability and the external value of the currency. The need for positive policies is all the greater because in many countries there is still a lingering expectation of inflation, nourished by years of rising prices and their failure to fall during the recession in North America. Such a situation may well require a clear demonstration by the authorities that no further inflation will be allowed.
In analyzing recent world balance of payments developments, account must also still be taken of the part played by U.S. Government payments abroad, which in 1958 amounted to $5.8 billion. However, the acceptance of convertibility by a large part of the trading world provides clear evidence of a conspicuous change in the unique position occupied by the U.S. dollar since the end of World War II. Underlying this change were tendencies toward the development of competitive world markets for both goods and capital. Part of the recent improvement in the balances of payments of industrial countries in Europe and of Japan, compared especially with the U.S. position, was associated with the return to more normal competitive conditions in the world markets for manufactures. The advantage which U.S. exporters and, to a much smaller extent, U.K. and Belgian exporters enjoyed in these markets in the early postwar years has been gradually eliminated by the recovery of productive capacity and efficiency in other industrial countries. For some years these tendencies had not produced their full effect, as insistent domestic demand pressing against still limited capacity kept export supplies down; but as boom pressures were eased, a setting was created in which the full competitive capacity was increasingly realized. This new competitive position was reflected both in a large increase in U.S. imports from the other industrial countries and in some reduction in the share of the United States in world exports of manufactures. Despite these changes, however, this share was still somewhat greater in 1958 than it had been in prewar years.
With the reconstruction of their economies virtually completed, industrial countries can play a more active role in providing capital, both private and official, for the development of the less industrialized countries. The improvements which led to nonresident convertibility have set the stage for a gradual increase in the freedom of capital to move across national boundaries, and the rise in interest rates in the United States since the middle of 1958, contrasted with the decline in rates in Europe, has increased the relative attractiveness of European money and capital markets to foreign borrowers.
The significance of Western Europe for the world economy is further indicated by the fact that its imports of raw materials and foodstuffs from the less developed countries are nearly twice those of the United States. Business fluctuations in Europe thus have an autonomous influence on the earning capacity of the primary producing countries, and this influence has been felt increasingly in recent years.
In these circumstances, close attention is being paid to the development of the European Economic Community, the first practical measures of which came into force on January 1, 1959. In this association, six Fund members in Europe (Belgium, France, Germany, Italy, Luxembourg, and the Netherlands) have begun the gradual abolition of the trade barriers between themselves and the coordination of their financial, fiscal, and social policies, with a view to achieving a higher level of output and welfare in each of the six countries. When the first reductions of trade barriers between these countries became effective from the beginning of 1959, arrangements were also made whereby some part of the benefit of the reductions was extended to other participants in the General Agreement on Tariffs and Trade. Discussions are taking place about further similar arrangements in the future, but the solutions that may be found cannot yet be foreseen. The treaty establishing the Community contains provisions for financial cooperation between the six countries, and the monetary framework for this cooperation was set when the six members established nonresident convertibility just before the Community began to operate.
Increased general confidence has resulted from the fact that the recession in the United States has, as on two previous occasions in the postwar period, been overcome quickly, and with limited untoward effects upon the rest of the world. The virtually irrevocable character of the movement toward convertibility of the various European and other currencies and the strengthening of reserves—of primary reserves in Europe, and of secondary reserves everywhere as a result of the expected enlargement of the resources of the Fund—have set the stage for a further steady expansion of multilateral world trade.
Notwithstanding these encouraging developments, careful attention has to be given to the other, far less satisfactory, aspects of the world economy presented by the general situation of the primary producing countries. From 1954 to 1958, the terms of trade of these countries taken as a group have deteriorated every year, the decline for the entire period being of the order of 12 percent. The decline in the prices of primary products has been more than a cyclical development. In any single year, the interplay of short-run factors affecting either supply or demand, such as business conditions in the United States or Europe, the trading policies of countries in the Soviet bloc, weather conditions, plant diseases, strikes, etc., tend to produce divergent movements in the prices of primary products. But over the last decade as a whole, the prices of many raw materials and foodstuffs have been affected by a gradual but substantial increase in their supply, while demand has been weakened by the increased use of synthetic substitutes and by technical changes that have gradually reduced the raw material content of some finished products. As a consequence, while the renewed expansion of world industrial production has benefited the prices of some primary products, it has not led to any appreciable general increase.
These broad commodity price developments have had an unfavorable effect upon the setting in which the less developed countries have to plan their economic development, and they have increased the difficulties both of achieving a satisfactory rate of growth and of dealing with inflationary pressures. The less developed countries do not indeed have to face their problems unaided, for funds from abroad have been made available—and are likely to continue to be available, especially where stable monetary conditions have created an environment that is favorable both to domestic capital formation and to the inflow of foreign capital. In the circumstances of today, the importance of such financial support has become even greater than before. Satisfactory domestic policies can be more confidently applied when supported by an adequate inflow of international capital.
Even with long-term loans and grants from abroad, the adjustment of economic and financial policy to the magnitude of the foreign exchange receipts that is realistically to be expected presents serious difficulties for many of the less developed countries. For some of them their problems are aggravated by mounting charges for the service of short-term and medium-term indebtedness contracted in recent years. The enlargement of resources and their effective use necessitate many difficult decisions in relation not only to development policies, but also especially to fiscal and monetary questions. If these decisions are evaded, inflation will take its course, and will not only distort the allocation of resources, but before very long is likely also to reduce the amounts available for productive investment. The experience of the last decade has brought most governments to the conviction that continued inflation is not conducive to sustained development, and that only by making the hard choices before them can they steer their countries through the present difficulties in the expectation of reaching a more satisfactory situation in the future.
In dealing with these questions, a considerable number of the less developed countries have sought close cooperation with the Fund. Further discussion of this question will be found in the last section of Chapter III. The Fund has provided technical assistance to some of them; it has also made its resources available to ease the immediate impact of the adjustments that have to be made. At the same time, the adoption of measures leading to a sound monetary situation makes it easier for the countries concerned to arrange for long-term funds for economic development.
Indeed, the more developed countries can be helpful to the less developed countries in a number of ways, and it is, moreover, directly in their own interest to do so. By maintaining a high level of domestic activity, they can exercise a favorable influence on the export earnings of these countries. They can further affect these earnings by the manner in which they order their policies with regard to their own primary producers. In this respect, industrial countries have often shown an unfortunate tendency to give far greater weight to the interests of small groups of domestic producers than to the interests either of the large body of primary producers abroad or of consumers at home. Restrictions on imports of primary products by the more developed countries, or exports of surplus stocks without proper safeguards, have unfavorable effects on the export earnings of countries elsewhere that are heavily dependent on the sale of the commodities in question. In addition to paying greater attention to the impact of their trade policies on other countries, the developed countries, as already indicated, can assist, and have assisted, the less developed countries by making available official capital and by stimulating the flow of private capital, insofar as this flow depends on them rather than on the policies of the countries in need of investment funds from abroad. The short- and medium-term capital that has been available to some countries does not provide an adequate foundation for economic development, and during the past year several interesting initiatives have been taken to increase the flow of official capital on a more assured basis.
The improvement in the reserve positions of many industrial countries is reflected in the Fund’s financial activities during the past year; repurchases—some of them earlier than was required—were twice as large as drawings. However, the total of drawings, $263.5 million, was substantial; and the total amount outstanding on April 30, 1959 under stand-by arrangements, newly concluded or renewed, was $1,132.8 million. Most of the drawings were made by less developed countries. The volume of transactions in 1958-59 was smaller than in the two preceding years, when the total was dominated by a few large transactions which gave valuable support to several currencies, and in particular to sterling, the French franc, the guilder, the yen, and the Indian rupee. While there were no comparable critical conditions in this last year to cause such large demands on the Fund’s resources, there were 20 countries to which the Fund sold currencies or with which standby arrangements were made or renewed.
At the end of April 1959, the Fund held $2.5 billion in gold and U.S. dollars, but of this only $1.4 billion was uncommitted, compared with uncommitted funds of $3.5 billion at the end of September 1956—before the recent active period began. To ensure that the Fund would be in a position to meet the demands which might properly be made upon it, action was initiated at the Annual Meeting in New Delhi for a substantial increase in the Fund’s resources. As explained later in this Report, the initiative taken in New Delhi seems likely to lead to that result. The governments have almost unanimously approved the Executive Directors’ Report, Enlargement of Fund Resources, and a number of them have already informed the Fund of their consent to the proposed increases in their quotas and have made the additional payments to the Fund.
The significance of this increase in the Fund’s resources is not to be measured only by the extent to which these new resources are drawn upon. A stand-by arrangement that is not followed by use of the Fund’s resources is as important as a stand-by under which a drawing has been made; and in the same way, the increase in the Fund’s resources may still have great importance, even if for some time to come drawings on the Fund do not reach substantial amounts. The essential objective is, above all, the creation of a feeling of confidence among Fund members that, even if the reserves directly under their control are considered not adequate to meet every eventuality, they can safely make their decisions with respect to the freedom of payments and trade without having to pay undue regard to such temporary balance of payments difficulties as may from time to time occur.