CHAPTER 4 Richesse Oblige The Establishment of Convertibility

Harold James
Published Date:
June 1996
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The experience of the late 1940s made apparent how thorny and obstacle-strewn would be the path to a more liberal world economy. The postwar era refuted almost everybody’s expectations. There would be no rapid return to normalcy, and “transition arrangements” would be needed for a long time. But it also soon appeared that fears of a major postwar slump analogous to that after the First World War were ungrounded. In the 1950s, there followed a period of very rapid, and also unusually equally distributed, growth. Liberalization, it seemed was slow; but the world economy was fast, and in the end its growth aided the program of liberalization.

This chapter examines the long debate about currency liberalization, and the hopes and fears that it inspired: the hopes in poorer countries engaged in reconstruction that it might lead to new inflows of funds, and the fears that those funds would limit the scope for national policymaking. The IMF played a crucial part in providing resources, primarily through the stand-by arrangement, to accompany the transition to convertibility. In the case of the major operations involving France and the United Kingdom, this support had an effect in accelerating European convertibility. In the course of this transition, the IMF’s resources were used so much that a discussion began as to their adequacy, and, at the end of the 1950s, the Fund’s quotas were increased.

The inconvertibility of the European currencies with respect to the dollar would remain a constant of the recovery period of the late 1940s and the 1950s. Convertibility in the context of these debates meant the freedom to make currency exchange for nonresidents on current account transactions. The critical part of the Fund Articles of Agreement (Article VIII, Section 2(a)) stated that there should be no restrictions “on the making of payments and transfers for current international transactions.” Tourist expenditure and remittances by emigrants were not included in this freedom. Capital account movements, which had been demonized in the academic discussions, and were feared by the political elites, remained subject to controls such as the requirement of permits or special deposits at central banks until the 1980s in most of the member countries of the IMF.


Despite a general European devaluation in 1949, Europeans were still unable to free imports from the dollar area. In the following decade, intra-European payments were liberalized under the auspices of the European Payments Union and the Organization for European Economic Cooperation (OEEC). Some individual countries might in addition have been able to lift restrictions on dollar payments and did in practice allow a progressive liberalization of trade with the dollar area. Belgium, which had sustained relatively little war damage, had reached this position already by 1952; the IMF judged that Germany could be ready to make the step in 1958, and the Netherlands in 1959. But the existence of a European system, and the high volume of intra-European trade, ensured that the European countries would move as a bloc.

Convertibility, one analyst thought in the mid-1950s, looked like a multinational swimming pool in which only the Canadian, Swiss, and American were moving in the water, while their companions were looking on with trepidation. “The Briton has one foot in the water but does not as yet dare to jump in, if only for the reason that the pool is not yet quite filled with water.… The German, who is already quite wet, stands ready on the springboard and from there instructs others in the art of swimming.… The Frenchman, sitting at some distance from the swimming pool, having only just eaten and not yet digested his meal, cannot enter the pool just now even with a swim belt.”1 How would these timid countries be pushed into the water?

Exchange rates proved a critical issue in the process of moving toward a more liberal international system. Overvalued rates presented a major obstacle, but the attempt to deal with them through the round of devaluations in 1949 had been politically difficult and unpopular. It meant that scarce and expensive but necessary imports became more expensive. For some time, an alternative route to convertibility seemed possible, involving floating, or at least more flexible exchange rates than permitted under the Bretton Woods system. But the major drawback lay in the inflationary potential that such a regime would create in countries with imperfect fiscal discipline.

In these circumstances, the restoration of convertibility depended on the balance of power between the different countries and on fortuitous events that pushed the more reluctant countries to greater openness. The timing of European convertibility depended on a large number of chance factors. In particular, the outbreak of the Suez crisis of 1956 and its consequences made the United Kingdom more willing to abandon its traditional objections; and in France the severe political crisis of 1958 produced a government more willing to accept the stabilization required as a precondition for joining a fixed parity system.

By the end of the 1950s, Germany stood at one extreme, with a powerful surplus position; at the other extreme, Britain found convertibility extremely difficult because of the existence of large balances held in pounds, whose conversion would endanger the British currency. For some time, it appeared that the weakened position of the economy supporting one of the world’s “key currencies” constituted an almost insuperable hindrance in the way of currency convertibility. The United Kingdom and France were pushed into the convertibility pool by political crisis in the wake of Suez. The risks initially appeared great. For a long time in the 1950s, of the two major reserve (“key”) currencies, one—the dollar—seemed to he chronically scarce, while the other—the pound—was in perpetual superabundance. As a result, it was believed, devices had to be invented to prevent the conversion of pounds into dollars. The possibility of convertibility, however, was not simply a product of circumstance and chance. Changing economic conditions, the rise of European productivity, and, above all, the large outflow of U.S. dollars as investment abroad, progressively eroded the scarcity of the dollar, and as a result lessened the risks inherent in the adoption of convertibility.

The Dollar Shortage

The diagnosis of a long-run shortage of the dollar as a consequence of different productive capacities was made on the basis of an observation of interwar trends, but the concept only appeared during the war and was first elaborated systematically in 1943. Soon it became the basis of a highly influential and apparently persuasive analysis. The (never actually utilized) “scarce currency clause” of the IMF Articles of Agreement was often even abbreviated as $¢ rather than as SC. Charles Kindleberger (in 1943) found that the phenomenon depended on “the fact that the rest of the world feels the need for American products in greater value amounts than the United States requires foreign commodities.” In 1945, Alvin Hansen stated, similarly, that “we are always selling to foreigners more than they are able to pay for.” Keynes, who was more skeptical, said that “if in the next five or ten years the dollar turns out to be a scarce currency, seldom will so many people have been right.”2 A violent theoretical debate soon broke out about the existence and the likely duration of the dollar shortage. Some observers assumed that it was little more than a passing phenomenon. Roy Harrod found it “one of the most absurd phrases ever coined … one of the most brazen pieces of collective effrontery that has ever been uttered.”3 Keynes himself seems to have been quite optimistic on the duration issue. He told a group of French officials in 1945 that the dollar was already overvalued and that European capital flight would soon be repatriated to Europe. Fears of a permanent dollar shortage—although for the moment apparently compelling—were misplaced since “the probable seldom happens.”4

The discussion on the permanence of the shortage affected the convertibility debate. At one extreme, the optimists (that is, the skeptics about the dollar shortage), chiefly Roy Harrod and Gottfried Haberler, thought that the problem might easily be overcome by an appropriate adjustment in the deficit countries, in particular by a European devaluation of the kind that took place, belatedly, in 1949, and that in consequence there existed no genuine obstacle to convertibility. At the other extreme, some believers in the dollar shortage were scathing about the efficacity of such a “solution.” Thomas Balogh wrote that it was simply “yet another of those ‘shots in the arm’ which provide a questionable temporary relief for the unbalance in international payments; but in this case … at the cost of the poor both nationally and internationally.”5

In between these radical positions, there were suggestions after 1945 from some of the initial proponents of the shortage thesis, notably Kindleberger, that the problem might be solved, but only over a longer time frame. “The requirement for elimination of the chronic dollar shortage and for making possible convertibility of currencies and multilateral trade is for loans which can be used to meet general deficits created by the excess of domestic investment in the borrowing country.”6 Reconstruction credits could help; but in the end the only hope for an elimination of the problem lay in the financing of higher levels of investment outside the United States, and, as a result, a recovery of worldwide production. These materialized as a result of direct investment and other capital flows in the 1950s: but almost no one had realized or foreseen this solution at the beginning of the decade. Even in 1958, with Europe on the brink of convertibility, and a series of U.S. current account payments deficits, the Danish economist Erik Hoffmeyer concluded that “it cannot be denied that the dollar shortage—whatever causes are assumed—presents the most serious threat to the stability of the present international trade and payments system.”7

Dollar Hegemony

In many modern accounts the immediate postwar period is usually described as the period of “dollar hegemony,” perhaps as an economic analogy to America’s undisputed military hegemony. The fact that the use of the dollar was restricted provided the clearest evidence of the existence of a “dollar shortage.” Until the mid-1950s the pound was the most widely used of all international currencies: in the mid-1950s half of all international transactions were conducted in sterling.8 In addition, since the devaluations of 1931, a payments area had emerged that adopted a common set of exchange controls administered by the United Kingdom. Most of the countries within the sterling area were former British imperial possessions.9 The postwar Labour Party Chancellor of the Exchequer, Sir Stafford Cripps, proudly referred to Britain as being the center of “the largest multilateral trading area in the world, for which [it] acted as banker.”10 Sterling’s dominance as a trading and reserve currency ensured that the sterling problem would be a major obstacle to the establishment of global convertibility.

The fiasco of the lifting of controls in 1947 made clear that Britain represented an immense obstacle to global convertibility, as claims on sterling (“sterling balances”) far exceeded British holdings of gold or dollars, and widespread awareness of this predicament deprived the sterling system of the credibility needed to operate in a multilaterally convertible world. These balances had existed before the war, but had increased greatly as a counterpart to wartime deliveries to Britain of supplies and food, and also manpower, from countries in the sterling area. Many sterling area countries (notably India and Egypt) ran a deficit with the dollar bloc and wanted to use their sterling balances in London to clear this deficit. But Britain could not afford such a liquidation of sterling balances and as a result needed to limit convertibility. Britain’s wartime leader, Winston Churchill, had convinced himself and many others that the sterling balances in large part reflected overcharging by the Dominions for the services performed by the British military in their defense; as a consequence, many British politicians insisted on the justice of a partial cancellation of the balances. Particularly when it became apparent that the Indian subcontinent would soon become independent, they felt that Britain should be paid for the successful wartime defense of India.11 (Indians felt equally strongly that the accumulation of sterling had been imposed on them without their consent and that they had been impoverished as a result of forced wartime deliveries.) It thus became a longstanding requirement for U.K. policy that “adherence to the IMF must not entail any obligations which would damage the essentials of the sterling area system” or any compulsion to pay off the balances in convertible currency.12 After the events of 1947 the path to liberalization appeared infinitely longer, slower, and harder. At the Fund’s Annual Meeting in September 1947 the IMF’s Managing Director Camille Gutt stated that: “A premature attempt to force the acceptance of exchange and trade practices suited for a balanced world economy can do much harm and even endanger the attainment of these objectives.”13 In 1949 the Annual Report of the IMF concluded meekly that “the difficulties of the postwar period are greater than foreseen at the time of the Bretton Woods Conference.”14


The difficulties of 1947 made it clear that a fundamental task of the Fund would be the determination of new exchange parities. In particular, it appeared unclear whether the adoption of a more “realistic” parity would encourage a greater volume of British and European exports, enable these countries to earn dollars, and thus help to close the “dollar gap.” A general reluctance to move in this direction was based on the argument that in conditions of severe supply constraints, downward adjustment of exchange rates would not necessarily promote an increase in exports and an improvement of the trade balance.15 The harsh winter and the food crisis of 1947 had made these constraints worse. In addition, the political and economic uncertainty of Europe fostered a surge of capital flight reminiscent of the nervous movements of the 1930s.16 These flows continued in the era of the Marshall Plan. A New York Times correspondent, Michael Hoffman, later reported that the total volume of U.S. aid to Europe was less than European capital flight (with the implication that the resources of the European Recovery Program (ERP) had been completely squandered).17 Postwar Europe appears as an antecedent for many subsequent occasions on which the extent of capital flight was believed to constitute a major obstacle to stabilization and liberalization and a testimony to the way in which borrowed resources had been squandered. In each case, pessimists argued that a lower exchange rate would not lead to improved export performance because of the existence of alleged structural obstacles, while optimists saw a possibility of quite speedy adjustment. The discussion of the exchange rate produced a ferocious reaction on the part of politicians and consumers who saw their interests as lying with controls and overvaluation and felt threatened by any change in the exchange rate.

Capital flight may reflect political uncertainties, but it may also be a natural and inevitable response to an excessively high exchange rate secured through controls. The makers of Bretton Woods had started with the assumption that they could control the movement of capital. Very rapidly, this proved to be a miscalculation. Once current account transactions were even partially liberalized, trade finance could be used as a conduit for the movement of capital. Importers might pay cash, while exporters might give long-term credit. Such “leads and lags” could effect capital transfers (in this case an outward movement). In the long run, as was eventually recognized, a freeing of the current account would imply a liberalization of the capital account. In the late 1940s, European policymakers were faced with two controversial issues: Did an inappropriate exchange rate contribute to the flight of capital? And how long would supply constraints limit the European capacity to export? The IMF was probably the most vigorous, and hence the most unpopular, proponent of the (correct) view that a change in the exchange rate of European currencies might stimulate an export-led recovery. Its 1948 Annual Report stated that “there are indications … that in some countries the exchange rate is becoming a restraining factor on exports and that it is adding to the difficulty of earning convertible currencies.”18

The Fund’s ability to shape European events was severely limited by the decision of April 5, 1948 not to finance countries participating in the ERP or the Marshall Plan. But the ERP decision did not stand in the way of some extraordinary attempts to influence British policymaking. The key to the continental European position lay in Britain: a British devaluation was needed to clear the way for a general European adjustment. The British Executive Director of the IMF (who had been alone in voting against the resolution on the ERP) reported back very shortly after the Fund’s discussion: “You may be aware that during the debates on the Fund Board on their relations with countries enjoying ERP facilities, we were told behind the scenes that the ban on drawing rights would not apply to the U.K.” He was outraged by the extent of the Fund’s pressure to devalue, even when softened by the hinted promise of access to the Fund resources denied to other participants in the ERP: “If the Fund is going to become an institution which confers no benefits on Members but requires them to carry out impossible obligations besides interfering in all their complex financial arrangements, we should seriously consider suggesting to Washington that the Fund should be put into a state of suspended animation.”19 In June 1948 Gutt proposed a mission to London. Britain responded by objecting to the description of Gutt’s trip as a “mission” as having a “very special meaning which might be described as derogatory.”20

In 1948 there were no immediate balance of payments reasons to press ahead with a British devaluation. Indeed, the Fund’s Research Department was much more hesitant about the desirability of such a move: the British believed that the Director of the Research Department, Edward Bernstein, was arguing that the sterling-dollar rate should be changed only when there was “a clear cut case,” and this would depend on a decision “that latent [British] inflation had diminished to an extent which made it possible to remove controls.”21

In the second quarter of 1949, the British balance of payments deficit became a pressing problem once again as a reaction to a slow own in U.S. growth. The United States, and particularly the Treasury and its representatives in the IMF, pressed for a British devaluation. For them, the temporary British difficulty presented a general European opportunity: the liberalization of European payments depended, they believed, on a general European devaluation, yet none of the European states would be prepared to move before Britain had shown the way.22

Treasury Secretary John W. Snyder concluded that the rapid recovery of European industrial output in 1948 meant that European states no longer faced the supply restrictions that earlier had prevented them from making attempts to regain lost prewar markets. They had used bilateral agreements to shift trade away from intercontinental and toward European markets. Looking forward to the end of the Marshall Plan (whose effects were intended to include a strengthening of European export capacity), he argued that not only would new par values promote European exports, they would also encourage the return of flight capital and the beginning of private capital movements. “In years gone by, the United States Government generally took the position that the rate at which a country bought and sold dollars was primarily its concern. Now, however, when we are contributing billions of dollars to build up the European economies, it becomes a matter of grave direct concern to us insofar as the exchange policies which a country may be pursuing tend to retard its exports or misdirect its trade and increase its Western Hemisphere deficit, and thus indirectly increase its calls upon the United States for assistance.”23 The U.S. Executive Director of the IMF, Frank Southard, threatened that if the Europeans remained recalcitrant, the U.S. Congress would intervene: he explained that one Senator had already introduced a bill cutting Marshall Aid off for countries with an “unrealistic” exchange rate.24

In May 1949, Southard told his British colleague that “the Fund ought to be in a position where it could make positive suggestions to certain countries that their currencies were overvalued by x percent and that exchange and other domestic action should be taken to enable them to reach reasonable equilibrium in their overall balance of payments.” He also circulated a confrontational note about U.S. policy with regard to Fund drawings, in which the United States suggested that a country applying exchange restrictions or current transactions would be considered to be suffering from a fundamental disequilibrium and should not be eligible to make dollar drawings from the Fund except under special circumstances. The British reply was quite abruptly hostile: “I also reminded Southard that the Fund was a negative and not a positive instrument of international exchange policy and that we were not prepared to tolerate interference by the Fund in our affairs. This exercise would therefore probably end in a stalemate, the Fund’s authority diminishing throughout the period, Anglo-American relations probably continuing to diverge.”25 The British devaluation, however, was crucial to the Fund’s view of how a general European realignment might take place. In July, U.S. Treasury experts explained to French officials how France might abandon multiple exchange rates and adopt a unitary rate in the aftermath of a British devaluation.26

In the summer of 1949 Gutt returned, inspired from a visit to a rapidly recovering Europe. This had been, he noted, “the first year in which the question of exports arises.” The immediate postwar constraints no longer applied. “The blunt fact is that European export prices are high relative to U.S. export prices.” Deflation was impossible as a way of achieving European adjustment as it “goes against tenets—or if you like, tendencies—which are today widespread.” In order to bridge the dollar gap, a “flow of capital will be necessary. But to attract this flow of capital one must give the impression to the potential investor—for I think the real capital flow will have more and more to come from private sources and less from official ones—that the recipient country has put its house in order. And for many investors one element, in putting the house in order, would appear to be a currency adjustment.”27 In August 1949 the American Executive Director successfully pressed for a committee in the Fund to examine the situation of international payments.28 The Fund’s position was supported by a number of powerful theoretical expositions on the consequences of devaluation produced by Edward Bernstein—which clearly confused some of the Executive Directors. The French Alternate Executive Director wrote home to say that “we are swimming in econometrics.”29

Almost all British ministers opposed the American and IMF recommendation, as they interpreted the British problem primarily in terms of domestic inflationary pressures, which needed to be counteracted through fiscal economies and further price and wage controls rather than a correction of the exchange rate. They liked to think of an economy still constrained by the exigencies of wartime mobilization. This view was shared by the Chancellor of the Exchequer, Sir Stafford Cripps, as well as by the Bank of England, whose Governor, C.F. Cobbold, put the issue in quite traditional terms: “the two things that would really change the atmosphere in North America would be a real attack on government expenditure and a deferment of further nationalization plans.” In April 1949 Cobbold suggested that the United Kingdom “might consider leaving the IMF” if any attempt was made to put pressure on it by leaking news about the discussion of sterling exchange rates.30 Cripps, in the meantime, attacked those of his economic advisers who favored devaluation as believers in a “free economy” who were closer to American than to British views.31 In the end, a 30 percent devaluation (to a new parity of $2.80) taking effect on September 19, 1949 was adopted in the absence of Cripps and at the pressing of three junior ministers.

Other countries followed the British lead, and continental devaluation led to the establishment of more realistic parities, although France felt strongly that its plans for a small European economic union had been torpedoed by the British action. The sterling area and Scandinavian countries also devalued by 30 percent, France by 22 percent, Germany by 20 percent, and Belgium and Portugal by 13 percent. The rapid growth of European exports showed that the U.S.-IMF view of devaluation had been essentially correct, and that capacity limitations would not stand in the way of a European balance of payments improvement.32

European Payments Union in Practice

The devaluations, however, were not immediately a triumph of the American liberalizing vision. British devaluation was accompanied by new controls on trade and exchange, and there was no relaxation of existing ones, although the IMF tried to argue that the “success” of British devaluation indicated that a lowering of restrictions would be beneficial.33 American policymakers were appalled as it appeared that Britain would become an obstacle to the EPU making the transition to convertibility. At the end of 1950, a sharp dispute broke out at the meetings of the General Agreement on Tariffs and Trade (GATT) in Torquay, when the IMF examined, as was its function under the GATT charter, the justification of quantitative restrictions applied ostensibly for balance of payments reasons in a number of sterling area countries: Australia, Ceylon, Chile, India, New Zealand, Pakistan, South Africa, South Rhodesia, and the United Kingdom. The British government then attacked the IMF’s report as an attempt to dismantle the sterling area.

Though the idea of a European payments mechanism had originally been propounded by the Economic Cooperation Administration (ECA), the Washington-based administrative agency for ERP, and though the State Department was continually concerned with the search for institutional ways of buttressing Europe’s fragile political stability, Washington’s early response to the EPU as eventually realized was quite skeptical. The European version of the EPU at first appeared to the U.S. Treasury and the IMF as a denial of what were seen as the American principles of private initiative, liberal trade policy, competition, and the belief that strength and stability could not be achieved through controls, doles, and relief. In addition, the IMF saw itself as losing another turf battle over the management of the international economy, making the loss of influence implied in the “Marshall Plan decision” more permanent. In 1951 the Fund discussed with the ECA the possibility of a censure of European behavior and a firm call for the relaxation of restrictions and discrimination. But by 1952, there was greater optimism and a quite new language of closer collaboration between the EPU and the IMF.34

There was nothing inevitable in this development of the EPU away from being the American nightmare and toward becoming a means of realizing the dream of progressive liberalization and convertibility. It depended upon a series of decisions, some taken against Washington’s wishes and advice, and upon the pressures exerted on the institutional framework of regional integration by the consequences of economic growth.

The initial optimistic sign came during the first major crisis to affect the EPU, the German payments problem of 1950 that followed the outbreak of the Korean war (June 25, 1950) and a surge of raw material prices. At the same time as import prices rose, the volume of German imports increased as a result of a rapid recovery, made more intense in the wake of a relaxation of German credit controls, that set in with the investment boom accompanying the Korean war.35 The Allied High Commissioner in Germany, John McCloy, in a letter to the German Chancellor Konrad Adenauer, advised the suspension of the liberalization program and the imposition of trade controls. But at the end of October 1950, an EPU delegation composed of the Swedish economist Per Jacobsson from the Bank for International Settlements (BIS) and the Briton Alec Caimcross recommended strongly against this course and in favor of using monetary policy (a discount rate rise) to deal with the German balance of payments. Jacobsson was a committed liberalizer; Cairncross took a more pragmatic stance, but saw in the German situation a “straightforward liquidity crisis in an otherwise healthy economy.”36 Their advice was backed by a special EPU credit of $120 million. This combination of immediate balance of payments assistance with a commitment to progressive liberalization later came to be seen as an extremely attractive precedent for IMF stabilization programs, especially at the end of the 1950s, when Per Jacobsson was in Washington as Managing Director of the IMF. Against the opposition of both the American authorities and Adenauer, the German central bank (then called the Bank deutscher Länder) eventually accepted the EPU recommendation and took the road to economic liberalism. Jacobsson wrote to Roger Auboin, the General Manager of the BIS; “I had one and a half hours with the Americans and I pointed out that there are some very favourable tendencies as regards German trade and added that if liberalisation were discarded by Gennany, people would say that another measure pressed on Europe by the Americans had shown itself unsuitable and impossible (as in 1947 the convertibility of sterling).”37

The Jacobsson-Cairncross course proved to be completely correct, and its success greatly strengthened the impetus to liberalization within the EPU. In retrospect, the experience appeared as an almost ideal model of an adjustment program, in which successful adjustment was followed by impressive growth. Once the process began, liberalization and the lifting of trade controls acquired a momentum of their own.38 Intra-European trade grew very quickly, and the proportion that was liberalized rose from 66 percent in mid-1952 to 81 percent in mid-1954; discrimination against U.S. products also was reduced after 1954.39 But in 1952, despite the growth of production and trade, the original objectives of the IMF seemed as remote as ever. The 1952 Annual Report stated: “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.”40

In 1952, the relationship between the IMF and the EPU improved dramatically, and both sides appeared willing to cooperate. Belgium was the central player in this reconciliation, as the relationship of the EPU with the rest of the world depended heavily on the Belgian payments position. In the early 1950s, Belgium built up a large surplus within the EPU but had a deficit with the dollar countries. In view of this relationship, in 1951–52 the criticisms by Americans and Canadians within the IMF of European arrangements concentrated on Belgium.41 The EPU depended on a credit from the Belgian Treasury, and, in order to cover this, the Belgians proposed to borrow from the IMF and to secure francs from the National Bank in exchange for the borrowed dollars. On February 13, 1952 the principle of the stand-by arrangement, a potential drawing over an agreed period of time, had been laid down.42 The proposed operation looked from the American perspective rather like a technical device to avoid laws on government spending and credit ceilings. The stand-by credit of $50 million agreed by the IMF was renewed until the end of the operation of EPU, bur was only drawn upon in April 1957. (Belgium’s trade balance with the dollar area in fact improved quite quickly by itself after 1952.) In making the application of the standby facility, Belgium promised (in what was the first letter of intent): “Minimum use of restrictions and further progress towards convertibility are permanent objectives of Belgian policy. Assurance from the Fund that adequate assistance will be available if needed would be very helpful in maintaining the determination of Belgium to pursue these policies.”43

The solution that had emerged in the Belgian case almost by chance offered a useful general precedent. The United States proposed IMF standby arrangements in discussions with the United Kingdom, France, and Germany as a means of facilitating the transition to convertibility.44

At this point, with many indications that some countries at least were contemplating convertibility, the IMF and U.S. Treasury position faced a new challenge from a completely opposite approach to international economic relations. Instead of a fixed exchange rate maintained under the surveillance of international regulatory agencies, and apparently inevitably leading to the emergence of balance of payments problems, a floating or free exchange rate would avoid these obvious difficulties. In the discussions preceding Bretton Woods, the fear had been that countries would repeat the experience of the 1930s and engage in competitive devaluation for price advantage in export markets. The problem that became increasingly apparent in the 1950s was a rather different one: the reluctance of countries to devalue (because this increased the price of imports, or because it might appear as political humiliation), the persistence of official overvalued exchange rates, and consequently a need to keep exchange controls. The absence of a fixed parity could avoid this difficulty. There was one striking exception to the long continuation of exchange controls. Maybe it showed that—to take up the analogy of the swimming pool again—it helped in jumping into the world currency system if you could float. In 1950, after a heavy inflow of capital that the Canadians feared would lead to an increase in inflation, Canada had adopted a floating rate. It had not been possible to envisage any new parity that would curb the flows and stabilize monetary development. As a result of the Canadian float, which was viewed from the outside with some suspicion as a very clear violation of the Bretton Woods par value principle, Canada was able to make the transition to external convertibility at a very early stage (in March 1952 Canada accepted Article VIII convertibility under the Fund Articles). The float of the Canadian dollar continued until 1962 and helped to ensure that capital movements had a stabilizing rather than destabilizing effect.45 Those who warned against drawing more general lessons from the success of the Canadian float claimed that this was a situation that was exceptional because of the importance of U.S. Canadian trade and because many consumers assumed that a dollar was a dollar, whether American or Canadian. The Canadian success nevertheless constituted a rather powerful advertisement for the attractions of floating.

Great Britain Is Brought to Heel

In the mid-1950s some European states flirted with floating exchange rates as an answer to the problem of how to deal with capital movements. The most important early proposal (in 1952) came from Britain, and was known as Robot (partly because of the names of its authors, but the title also suggested rather obviously a principle of automaticity). Britain, one author commented, “proposed to subvert the one aspect of Bretton Woods—mutually fixed exchange rates—which had not remained a dead letter.”46 ROBOT envisaged free convertibility of sterling for non-U.K. residents, reopening the gold market, and allowing sterling to float within a wide hand (between $2.40 and $3.20). Its implementation would have “killed” the EPU whose operation depended on fixed parities.47 Eventually the United Kingdom abandoned Robot, in part because Commonwealth countries feared a loss in value of their sterling balances, but also because of the rapid deterioration of the British current account position and the resulting likelihood that floating in practice would mean a rapid sinking of the pound sterling. It seemed unlikely that the $2.40 lower end of the float could be maintained on open markets. But the scheme left a powerful memory, and also an inspiration. As late as 1958, the Governor of the Bank of England while arguing on practical grounds against floating, still added: “It would be prudent to organise monetary policy both at home and abroad, on the probability that something like a unified floating-rate policy is inevitable but to make no attempt to force the pace until it becomes more acceptable to the Western world as a whole.”48 Floating attracted the Bank of England because it would allow greater room for interest rates as an instrument for the control of the domestic U.K. economy.49

One analysis of the British problem that struck at the heart of the British postwar political settlement depicted the balance of payments as weakened by “excessive” investments overseas, and especially in the sterling area. Virtually no controls existed on capital movements to the sterling zone, and governments were happy to see the flow of money being used to maintain the ties of empire. To critics, it appeared that the outflow, which appeared to coincide with Btitain’s payments deficit, represented a British attempt to reassert the nineteenth century role of world banker that it could in reality no longer afford in the changed international economic environment. Postwar Britain, in short, was living above its resources.50 After 1952 the outflow of funds increased: between 1946 and 1964 the total transfer to the sterling area (£2,900 million or $8,120 million) was, as one hostile observer noted, equivalent to the prewar accumulation of British investment over the past one hundred years.51

In the early 1950s, British economic vulnerability led to fierce opposition to the then conventional IMF wisdom of convertibility at fixed parities. One example of the difficulty was provided in 1952 with the first IMF consultations on exchange restrictions (Article XIV consultations). The meetings almost broke down at the beginning because of the strength of the British resistance to convertibility and because of the IMF’s similarly obdurate insistence on its speedy implementation. The Dutch Executive Director, J.W. Beyen, described the IMF’s relation with Britain at this time as “the schoolmaster’s desire to have at least one boy in the class who washed his hands properly.”52 But by the end of 1952 British politicians had become much more sympathetic to the notion of convertibility. The abandonment by Britain of the floating alternative followed from a renewed willingness to make use of the IMF. At the OEEC meeting of the Council of Ministers in March 1953, the British Chancellor of the Exchequer said that “the international institutions should be revivified … particularly the IMF which should come into the international picture as a practical going concern.”53 Governor Cobbold in 1954 emphasized that “agreement on an IMF standby credit would take us further along the road and make reversal of policies more difficult … if we did not take the further step within six months or a year it might well lead to lack of confidence.”54 Britain initiated discussions about a stand-by arrangement, which eventually failed because of U.S. insistence that Britain should abolish all trade discrimination if it were to be allowed to draw on the arrangement. In practice, Britain went some way toward meeting this demand, abolishing the bilateral account status (that is, no longer insisting that another country accept in sterling payments made from another transferable account country, and thus liberalizing the transferability of sterling for trade partners outside the sterling and dollar areas) and removing the distinction between capital and current account transactions. However, despite major concessions on chemical and paper imports, in September 1954 only 55 percent of British imports from the dollar area were free from control (compared with 70 percent from the OEEC area).55

The major obstacle to the introduction of U.K. convertibility backed with an IMF support operation lay in the limited resources of the IMF. At first, the United Kingdom argued that an operation to support sterling could only be viable with an IMF quota increase, which the United States opposed; otherwise it would not be possible to underwrite outstanding sterling balances and maintain Britain’s reserve position. There was thus in reality still a good deal of caution and hesitancy about reintegration in the international economy. In June 1954, the Financial Times quoted British “official circles” as saying that “convertibility is simply not worth having if it is to be achieved at the expense of a contraction, or even a halt in the expansion, of world trade.”56 In 1955 the IMF’s Managing Director again suggested a British drawing from the Fund to smooth the way to convertibility.57 But in August 1955 EPU members signed the European Monetary Agreement, in which the restoration of convertibility was to be undertaken only on the basis of a collective approach by continental Europeans with the British: a provision which in practice delayed implementation yet further.

Floating, which had had some British friends in the early 1950s, also found adherents in Germany (see below), because it seemed to offer a faster path to true convertibility than the par value approach. This was the position taken by the German Economics Minister Ludwig Erhard, who in 1952 called for the complete abolition of foreign exchange control in Europe and added that “if the system of rigidly fixed rates of exchange were maintained, not only would the EPU be doomed, but European integration fail.”58 Liberalization of the currency regime would be the logical sequel to Erhard’s highly successful abolition of domestic price controls. This was a position intellectually close to the academic criticism of fixed exchange rates and the EPU mechanism put forward in 1953 by Milton Friedman.59 In a more subtle form, the German central banker Otmar Emminger in an article in 1957 pointed out that a floating system was in theory compatible with the IMF agreement and that floating had indeed been tolerated in a few cases (Canada and Peru).60

With increasing advocation of floating, and little use of the Fund’s resources, the world economy seemed to be moving to a situation where the Fund was an irrelevance. Sometimes it seemed as if the Fund’s management shared this skepticism. The Fund’s Deputy Managing Director, Merle Cochran, sometimes even boasted about his successes in reducing the number of Fund staff. In April 1956, the Financial Times reported that the IMF looked like a “white elephant.” Its “attempt to encourage member countries to make wider use of its lending facilities seems to have failed.” In early October 1956, Le Monde took up the “white elephant” and “bank without clients” theme. Its only possible usefulness could be in constituting a debating shop that might provide “qualified experts and valuable documentation.”61 These remarks were oddly out of place. At the time they were made, the Governor of the Bank of France had already made an approach to the Managing Director; and within days, France obtained a $262.5 million stand-by arrangement as the worsening political situation in the Middle East produced a new environment for the Fund’s operation.62

It was in the British case that the defeat of the notion of floating was crucial for the development of the whole international financial system. The considerations that eventually pushed Britain away from floating did not arise out of any economic situation but emerged more or less by accident. Political events intruded rather abruptly to push forward the IMF-convertibility approach, despite continuing American opposition to Fund quota increases. It was purely chance that a crisis with major financial implications63 erupted in 1956 in the wake of the Anglo-French attempt to use Israeli soldiers to seize the Suez canal from Egypt. There was no particular economic problem in 1956 in the Anglo-American relationship. For the first ten months of 1956, the United Kingdom had a favorable balance of payments on current account; but in October a drain on reserves started. The United Kingdom needed a stand-by arrangement of unprecedented proportions ($738.5 million), as well as an immediate drawing on the gold and first credit tranches, because of a politically induced run on sterling, and because British politicians had convinced themselves that a major sterling crisis existed. The negotiations took place at a very high political level. Discussing the size of the stand-by operation, Lord Harcourt, the British Economic Secretary in Washington and Executive Director of the IMF, argued that the larger the support fund, the more successful it was likely to be and the less likely it was to be actually used. When the American Executive Director asked the U.S. Treasury Secretary (George Humphrey) about the size of the U.K. request, the latter replied: “You know, Frank, I have always felt that if you are going to do something you have to go all out, so what is the United Kingdom’s quota?” He then agreed to the unprecedentedly large drawing and stand-by arrangement. In the Fund discussions of the U.K. support, it was clear that this operation was only needed because of the extent of the speculative capital movements through “leads and lags.”64

Both the American and the British view of stand-by arrangements was fundamentally changed by the 1956 operation. From the U.S. perspective, larger operations became possible; from the British view, convertibility became the price for assistance. In making his arguments in Washington, Harcourt had tried to put the problem in a longer-term perspective than that of the political crisis arising out of Suez. He spoke of the enormous advances toward convertibility made by the United Kingdom and Western Europe since 1953 and claimed that the British emergency drawing was needed in order to avoid any retreat.

There was no retreat. Britain only drew $561.5 million in 19 6 and made no subsequent drawings in the period of the stand-by arrangement. The arrangement, which had originated as a panic measure, became viewed instead as a way of increasing British reserves in the buildup to convertibility. At the September 1958 IMF meetings in New Delhi, the British Chancellor of the Exchequer spoke about the removal of currency discrimination, and the IMF Managing Director, Per Jacobsson, offered a quota increase rather than a renewal of the unneeded stand-by arrangement as the solution to Britain’s problems.

France: La Grande Nation Stabilizes

The final British move to convertibility came at the end of 1958 as the result of yet another coincidence: a dramatic change in French policy as a result of a new conviction that economic stabilization and convertibility would provide the basis for more settled politics. After it was clear that France would press ahead, the Governor of the Bank of England went to the British cabinet, argued that “the whole question had come to a head,” and Britain followed the French liberalization precedent and adopted convertibility for nonresidents of the sterling area.65 In this way, the final move to European convertibility came about as a result of decisions taken in Paris rather than London.

France had dealt with the par value question in the late 1940s rather differently to Britain. In late 1947, France had proposed to create a separate exchange rate for transactions with dollar countries and with Switzerland in order to increase French exports and pay for dollar imports. The United States opposed the idea and suggested as an alternative a general devaluation with trade discrimination against the weak currency countries of Europe. Both the United States and the United Kingdom insisted on the authority of the Fund to give rulings on cases involving what they held to be the undesirable practice of multiple exchange rates, although the French Executive Director did not believe that a legal basis existed in the Fund’s Articles for such a step.66 When France rejected the U.S. idea and in January 1948 published its new exchange rate regime, France was deemed by the IMF to be operating split exchange rates and was declared ineligible to use the Fund’s resources. (Although, in October 1948, France attempted to unite the rates, the breach with the Fund was not healed until 1954.)67 The clash over exchange rates produced in France a “certain suspicion, even rancor, toward the Anglo-Saxon world and the International Monetary Fund.”68

From the late 1940s, a combination of high levels of investment in order to achieve the ambitious targets set by the Monnet Plan, increasing military expenditure (especially in Indochina), and political instability produced output growth rates unprecedented in French history, but also major monetary and financial dislocations. Unwillingness to deal with the financial aftermath of war and occupation by means of a cancellation of money and bank accounts on the Belgian model left a large French suppressed inflation or monetary overhang. This made France unwilling to take the plunge into the cold waters of currency convertibility. France lived through the first half of the 1950s in a world of exchange control, multiple rates, budgetary deficits, high inflation interrupted by periodic attempts at stabilization, and dramatic swings on the external account. At the end of the Marshall Plan period, as U.S. aid fell away, France ran large deficits (1951–53) and only slowly returned to balance in 1954 and 1955. In 1955 it had a surplus of 132 million EPU units (equivalent to dollars, but subject to exchange control), but in 1956 the old problems returned as a result of increased expenditure arising out of the escalating conflict in Algeria. France’s deficit within the EPU amounted to 653 million units, and for the first three quarters of 1957 of 756 million units. The overall deficit on goods and services was 664 million units in 1956 and 1,181 million units in 1957. From the end of 1955 to the end of 1957, France lost two thirds of its reserves. In July 1956, a domestic stabilization program was only half-heartedly implemented, and by 1957 the IMF was pressing France to accept a more extensive package that would include balance of payments support. In August 1957, France undertook a de facto devaluation by the substitute means of imposing increased import duties that would be directly paid as subsidies to exporters. The main feature of this program was that a substitute devaluation did not require consultations with the IMF.69 The IMF prepared a lengthy paper on French monetary policy, and the Managing Director, Per Jacobsson, conducted intense negotiations in Paris disguised as a private trip to Europe in December 1957. He even occupied an office in the Bank of France.

Stabilization, the Fund concluded, could only be achieved with an effective support operation. “Foreign credits are needed for the time which will elapse until the measures now taken and being taken become effective. It is hoped that the credits will not have to be fully drawn upon—but they must initially be large enough to inspire confidence.”70 The proposals discussed with the French government in late 1957 included detailed plans for the 1958 and 1959 budgets, limiting the legal ceiling on the budget deficit (termed the “impasse”) to F 600 million (the figure in 1957 had been F 1,000 million), as well as a general credit restriction. There should be no net increase in medium-term credits offered by the Bank of France. The first of these measures passed into French law in December 1957. Once this had occurred, the foreign help could be added. In January 1958 a package was announced of $250 million from the EPU, $274 million from the U.S. Export-Import Bank, and $131 million from the IMF (25 percent of France’s quota: a higher amount would have created a precedent). The need for such a mixed bundle of resources demonstrated, as had the discussions on British convertibility, how inadequate were the resources of the Fund in dealing with the problems of currency stabilization as a precursor to convertibility. By 1958, there was widespread agreement that the existing IMF quotas were too low, and in 1959 a general increase came into effect. The French stabilization program from the point of view of the Fund was a major success but one that also demonstrated the need for a larger Fund.

The broader framework also had been, as in the United Kingdom, set by the major political crises of Suez and the Hungarian uprising in late 1956. In France, two additional considerations were critical: the need to move ahead with European integration; and, in addition, the escalating war in Algeria and a resulting fiscal and also political vulnerability.

For some time in the mid-1950s, the European project seemed to have stalled. The “relaunching of Europe” by the foreign ministers of the six member countries of the European Coal and Steel Community at Messina in September 1955 had been followed by protracted and contentious negotiations about the harmonization of labor conditions and welfare conditions within the proposed integrated customs area. But after the political shocks of October and November 1956, the French Prime Minister and the German Chancellor felt that “in view of the magnitude of other recent world events it was absurd to argue about points such as the harmonization of social charges.”71 The urgency of the political problems facing Western Europe propelled its leaders to move ahead rapidly with the creation of the proposed customs area. Monetary stabilization, however, would be an essential precondition for the efficient working of such an area. The European Economic Community (EEC) had barely begun operating (January 1958), and the French stabilization program had barely been implemented, when France was engulfed once more by political instability.

Faced with a mutiny of the army in Algeria, and the threat of a military coup in France, General de Gaulle in May 1958 took power—for the moment as Prime Minister. He appointed as Finance Minister Antoine Pinay, a fiscal conservative who in 1952 had been the author of one of the Fourth Republic’s more successful stabilization efforts, in which budgetary measures had been accompanied by a domestic loan. In June 1958, Pinay launched a new version of this plan: a tax-free loan, with the promise of an amnesty for returned flight capital that might be subscribed. At the time the loan was issued, the economist Jacques Rueff brought Pinay a memorandum couched in apocalyptic terms (“the existence of France is threatened”) and advocating a total liberalization of the Bank of France’s policy. The Bank should not try to impose quantitative credit ceilings but should operate only through changes in discount rates and leave the allocation of credit to the market mechanism. If there were no French stabilization, Rueff believed, there would inevitably be a “new effort at international begging, which would bring, even if it did not fail, humiliation and loss of independence.”72 Rueff convinced Pinay, but the Bank of France opposed a stabilization package.

In the course of 1958, Jacobsson acted as an intermediary between Pinay, the Governor of the Bank of France Wilfrid Baumgartner, and General de Gaulle. Unlike his predecessors as Managing Director, Jacobsson had immense personal charisma and an ability to use his imposing physical presence and imposing personality in the service of institutional self-assertion. Some of the IMF staff later remembered him as a megalomaniac, but there are occasions when an element of megalomania can breathe life into a professional and competent but uncharismatic institution. He saw himself as a diplomat on a global stage pressing for the adoption of economic rationality. Jacobsson’s 1957 proposals, in practice, formed the basis for the radical economic reform program adopted after 1958 by de Gaulle.

Jacobsson took Pinay’s program to the General, spoke about the success of the loan, and then began with the only language de Gaulle really understood: that of power politics. He warned de Gaulle against being concerned only with the pressing issue of Algeria: “No country can gain international esteem if it has not a good currency. That the French franc has not been a strong currency has been very damaging to French prestige in recent years.” He then appealed to the memory of the Emperor Napoleon whose gold franc had survived two revolutions (in 1848 and 1871) and a war (in 1870). “The French are a hard-working and saving people. If they have monetary stability they can stand a great deal of political instability. But after 1919 they had to endure both monetary and political instability and that is too much even for the French.” France in 1958 was threatened by political unrest. “Therefore it will be important to do as Napoleon did—to give France again a strong currency.” Then Jacobsson spoke about the role of international institutions in the world order. The IMF had been created to deal with monetary problems. It was true that it and the World Bank were “dominated by the Americans.” “Of course, the Americans have put up most—almost all—of the money so far—and ought to have influence—and are very decent and helpful. But Europe has already more influence—and will have even more if it can contribute. But to [do] that European countries have to have sound monetary systems.” For an effective French participation in the EEC, Jacobsson said, “a strong French franc was essential.” De Gaulle replied that the Common Market was “probably a good thing. But he added that he does not like supernational structures—he prefers ‘arrangements entre Etats.’”73

The result of the negotiations was a devaluation of the franc and the intoduction of a realisric exchange rare (in reality a regularization of the August 1957 measures), in combination with the implementation of the Jacobsson-Rueff reform proposals. France established, on December 27, 1958, a par value with the IMF for the first time since 1946. In November 1958 Rueff had been summoned to see de Gaulle to advise on economic stabilization. In 1960 a commission under his leadership diagnosed that since 1945 the major obstacle to French economic expansion had been the blocked accounts and manipulated interest rates that followed from the attempt to deal with the postwar monetary overhang.74 De Gaulle’s France had established an identity between liberalization, economic expansion, and the assertion of national power.

French convertibility was supported by the establishment of swap credit lines from European central banks and also by a stand-by credit of $200 million from a private U.S. bank consortium. It was also immediately followed by the entry into effect of the European Monetary Agreement (December 28, 1958), which provided a framework of margins for currency movements, as a successor to the European Payments Union. The European currencies could move within a band of 1.5 percent relative to the U.S. dollar and within 3 percent margins relative to each other.

At this stage, most European countries could have moved to full IMF Article VIII convertibility, rather than maintaining the controls allowed under Article XIV.75 In part, the reluctance came from the argument from the EEC Commission President that Articles 106-108 of the Treaty of Rome conflicted with the nondiscrimination obligations of the IMF’s Article VIII.76 The Europeans were also restrained by a “gentlemen’s agreement” with Britain that all European countries should move to convertibility together.77 Britain was holding out, partly in the hope familiar from the Bretton Woods negotiations, of obtaining an effective Article VII of the Fund Agreement (the “scarce currency clause”) to tackle the problem of the dollar scarcity. A crucial 1959 report on monetary policy had called for the commitment of the IMF to use Article VII before any British acceptance of sterling convertibility could be contemplated. “We think that before accepting the obligations of Article VIII the United Kingdom should seek to obtain the agreement of her fellow-members of the International Monetary Fund that the Fund’s approval for the use of discriminatory measures should not be withheld in conditions in which there is a persistent and substantial movement of gold and foreign exchange to a single country or group of countries.”78 Unlike in the 1940s, when only the United States could have been the target for such action, by 1958 some European countries—in particular Germany—were attracting “persistent and substantial” exchange inflows. For the moment, the European transition to convertibility remained incomplete.

A Model for Imitation

With the French stabilization in place, it rapidly became apparent to many policymakers that currency liberalization and stabilization offered a way to a better future. Probably the most extraordinary and surprising of all the European liberalizations at the end of the decade occurred in Spain. The Nationalist regime of General Francisco Franco, which had been victorious in the Civil War of the 1930s, committed itself to traditional, anti-urban values and to a regimented nationalist corporatism. It had tried to cut Spain off from the world economy and “international capitalism” and dependence. Spain survived into the 1950s as a relic of the attempts at autarkic planning characteristic of the 1930s, to which the spirit of Bretton Woods had stood in fundamental antagonism. In fact, import licenses on machine tools, fuels, and fertilizers produced a slow strangulation of the Spanish economy. Industrial wages declined—in accordance with the ideological preferences of the regime. But even agricultural production stagnated.

By the late 1950s, it had become clear to many Spaniards that economic nationalism was unsustainable. The combination of high rates of inflation, produced by unlimited central bank discounting of government debt, with government regulation of pay in accordance with the principles of corporatism, provoked major unrest in the industrial centers of Catalonia and the Basque country. At the same time, some policymakers, notably in the Bank of Spain and the Ministry of Commerce, began to argue against the idea of Spanish difference and a peculiar Spanish economic policy.79 They wanted to use the possibility of Spanish membership in international institutions as a way of securing and supporting a fundamental reform. Spain became an associate member of the OEEC, and in 1958 joined the IMF and the World Bank.

The missions sent in the process of the membership negotiations emphasized the need to suppress unnecessary restrictions, regulation, and interventions, and to improve productivity by engaging in competition on the world market. On June 25, 1959, Franco received Per Jacobsson and Hans Karl von Mangoldt, the General Manager of the European Monetary Agreement; both men persuaded him of the benefits of convertibility and the devaluation of the peseta to a realistic rate.80 In a television interview, Jacobsson explained that membership of the Fund provided additional reserves, which would protect against the need to combat balance of payments by means of “severe and damaging import restrictions.” But he also explained that sometimes deep-seated problems required “a fundamental stabilization program … to restore the balance of the economy.” His formulation of how Spain might be helped has a surprisingly modern tone. “I must emphasize that such programs can only succeed if there is the will to succeed in the countries themselves. The Fund has always found people in these countries who know-very well what needs to be done. The Fund does not impose conditions on countries; they themselves freely have come to the conclusion that the measures they arrange to take—even when they are sometimes harsh—are in the best interests of their own countries.”81

At the end of June, the Spanish government presented the IMF and the OEEC with a memorandum in which it set out the basis of a stabilization plan: “the time has come to redirect economic policy in order to place the Spanish economy in line with the countries of the Western world, and to free it from the interventions inherited from the past which do not correspond to the needs of the present situation.” Public sector expenditure would be limited; government securities would no longer automatically be treated as collateral by the central bank; commercial credit would be limited; and a more liberal trade and payments regime instituted.82

With the help of an IMF drawing and an additional stand-by arrangement, the National Stabilization Plan was launched one month later.83 Spain joined the European Monetary Agreement and provided a first list of liberalized imports, mostly foodstuffs and other raw materials, covering over half of Spain’s foreign trade. By 1961, almost all barriers had been lifted. In addition, foreign investment was permitted up to 50 percent of the capital of a Spanish company (and in some cases even higher). The reform initially produced a distinct economic and social cost. Some industries suffered heavily from the initial effects of foreign competition.84 In 1960 real GNP fell by 0.5 percent. But then a great boom began. In 1961 real GNP rose by 3.7 percent, and in 1962 by 7.0 percent. As the economy grew, it drew in large volumes of imports (especially engineering goods and machine tools); but the resulting trade deficit was paid through large investment inflows. Most observers consider the 1960s the date of “the true industrialization of Spain.”85

Economic success of a spectacular variety also in the longer run generated an increased pressure for political liberalization in the wake of the economic reforms. One economist in 1969 expressed very eloquently the new mood created by successful structural adjustment: “The last third of the twentieth century will be extremely difficult for any country which does not accept the rhythms of rapid technological and social change and the rational criticism and democracy that make them possible.… The future of economic development in Spain will depend on our ability to force the retreat of conservative forces.” The experience of 1959 left a profound impact, and helped to shape the course of the reforms and adjustment pursued after General Franco’s death.86 It also provided a very effective model of liberalization for other countries, especially outside Europe.

German Surpluses

For France and Spain, stabilization and the restoration of national prestige had been closely associated. In large part, those responsible for managing these economies saw a German model as holding out a powerfully attractive precedent. Germany had joined the IMF in August 1952 and came to regard it as an institution that could help to recast Germany’s position in the international system. In return, the new German economic strength implied international obligations and responsibilities. As the IMF’s Managing Director put it, “Richesse oblige.”87

In the course of the 1950s, the early payments crisis of 1950–51 receded quickly into a distant memory. Germany built up a very strong balance of payments position. The current balance rose from DM 2,301 million in 1951 to DM 5,998 million in 1958. The turnaround in the trade account was even more dramatic.88 Germany’s surplus within the EPU made it into the pioneer of liberalization. It occurred within the setting of an international multilateral order, which provided a helpful instrument in overcoming the opposition of domestic interest groups to liberalization: for instance in 1957, when an IMF report for the GATT asked Germany to lift quotas on imports (since these were not conformable with the GATT charter).89 As implemented, the trade liberalization occurred within a European framework. The greatest European institutional reform of the 1950s, the creatio of the EEC in 1958, involved a mixture of liberalization and the distortion of trade flows. Liberalization, because of the reductions of internal tariffs between the six member countries. Distortion, for Germany, because the mechanism for setting a common external tariff involved the averaging of national tariffs and thus frequently meant an increase of German (and Dutch and Belgian) rates. Distortion, above all because of the failure of German and (to a lesser extent) British hopes of a larger free trade area. The result of the French search for a way of preserving French national power involved currency stabilization, but also a smaller Europe. As a result, the European Free Trade Association of the seven (Austria, Denmark, Norway, Portugal, Sweden, Switzerland, and the United Kingdom) developed separately from the EEC. Europe, it was said at the time, was at sixes and sevens.

Trade liberalization did not affect the rising trend of German trade and current account surpluses, and the emergence of a payments problem. Should Germany adjust to its surpluses and through which method? The strength of the German economy also attracted capital inflows, which German policy tried to limit as much as possible on the grounds that such inflows would produce inflationary consequences, or that they would lead to pressure for an upward valuation of the deutsche mark, or that they would just prove internationally embarrassing if left as reserves. In the IMF Executive Board, the U.K. Executive Director demanded that the Annual Report criticize countries with “extreme surpluses” for not relaxing their credit policy, but the Managing Director assured the Germans that he would never agree to any formulation that surplus countries should adopt a “consciously inflationary policy.” By the beginning of the next decade, the U.S. administration was beginning to interpret the German surpluses as a threat to the U.S. position: “a sustained accumulation of gold and other international reserves by any one country is disruptive to the international community.”90 The German Central Bank Council repeatedly debated ways of making it less attractive to take long-term capital into Germany, and insisted that the Economics Ministry delete passages from a report for the OEEC referring to the possibility of Germany borrowing abroad.91 One of the major incentives to liberalize controls on capital in 1957 was the hope that this step would encourage a larger outflow of funds from Germany and in this way stabilize Germany’s payments position, and allow a sustainable current account surplus without the accumulation of excessive reserves.

Capital inflows and trade surpluses raised the question of appropriate exchange rate policy. The German case came to provide a vivid example of the difficulties involved in altering an exchange rate in the par value system. There had been devaluations in the framework of the Bretton Woods fixed parity system, but so far, no revaluations. Revaluation might seem an appropriate path for adjustment by a surplus country, but it was an option that invariably encountered massive domestic resistance. Major interest groups representing business and labor in exporting industries believed they would he hurt. And the process of selecting a new parity involved almost impossible political choices.

The first major German debate occurred at the end of 1956 in the wake of the Suez crisis. In 1957 a large German surplus on goods and services (DM 7,637 million) was accompanied by a major inflow: DM 260 million as private capital transfers and DM 1,753 million registered as net errors and omissions.92 Much of the inflow represented speculative and flight capital movements out of France. Could these inflows be controlled? The alternative of floating with an effective (but not fixed or predetermined) revaluation was defended passionately in the newly constituted central bank (Bundesbank) by one of the members of the Council, Otmar Emminger, but his opinion at the time attracted little support. In November 1956, he had written that “in order to preserve the internal stability of the currency, the revaluation of the deutsche mark will sooner or later be unavoidable” and suggested as alternatives either a revaluation at some rate less than 10 percent or floating within a 6 percent band.93 In August 1957, as the German surpluses continued, the German government held discussions with the Bundesbank President, Karl Blessing (who was opposed to Emminger’s notions), and then reached a resolution that no alteration of the external value of the deutsche mark was required.94

The Managing Director of the IMF, Per Jacobsson, called Emminger “very ambitious but not yet very wise.”95 He was not “very wise” chiefly because he wanted to ignore the complex domestic politics of exchange rate discussions in a country with a chronic payments surplus. By the beginning of the new decade, Germany found itself in the position that the wartime planners had foreseen for the United States: of running apparently permanent surpluses and thus in practice managing what might well be termed a “scarce currency.”

At the end of 1960, the pace of German capital inflows had resumed, and the issue of an alteration of the par value became politically acute once again. The economy was growing at a very fast rate (real GDP in that year grew at an amazing 16 percent), and a revaluation appeared as an attractive way of slowing down both an unsustainable growth and the wage and cost pressures that it produced. While in 1956–57, the major source of the currency inflows had been European, after 1960 they came from across the Atlantic Ocean. As the U.S. presidential election approach d, Germans feared that an attack of American nerves would lead to major movements out of the dollar.96

Once more, the principal proponent of a change in parity was Emminger. Since the major problem of the deutsche mark at first appeared to be the likelihood of speculative inflows, Emminger suggested leaving the pat value unaltered, but allowing movement within a broader range than the 1 percent of Bretton Woods as a way of increasing the risks to speculators.97 On this occasion he had the support of the economic liberals in the government around Ludwig Erhard’s Economics Ministry. Within Germany, on the other hand, a change in the mark parity was resisted by agricultural producers, who were frightened of the consequences for the price structures established by the new EEC, and by the major industries, concerned with a loss of competitiveness on their export markets. The opponents of revaluation were also supported by the commercial banks associated with export manufacturers,98 the President of the Bundesbank, Karl Blessing, and the Federal Chancellor, Konrad Adenauer. On October 18, 1960, Adenauer told the Bundesbank’s President that the German government “categorically” rejected any alteration of the deutsche mark parity.99

The view from the IMF in Washington supported the conservative approach to parity alteration. Jacobsson’s argument was that the alterations that Emminger and Erhard were talking about (around 6 percent revaluation) were too small to affect the payments position and would only encourage new speculative inflows anticipating a second revaluation. And, in any case, it was better not to interfere with the par value system. A larger amount—for instance, 15 percent—might solve the external problem but would infuriate the German farmers and undermine the government. An alternative to changing the parity was, Jacobsson told Blessing in a letter, for both the government and the private sector to increase foreign assistance.100 The U.S. government also pressed Germany to solve its payments problem by increasing its development aid. It pointed out that the American deficit “arises wholly from its commitments and actions in the common defense of the Free World”; and argued that “a sustained accumulation of gold and other international reserves by any one country is disruptive to the international community.”101 The German ministers resisted and resented this advice, because they believed that the United States had its own foreign policy reasons for pushing development spending and because they thought that the German public would not accept increased outlays abroad while domestic road building projects were being cut back because of budget restraints.102

Erhard responded to domestic criticism and to the foreign pressure with a public polemic against the Bundesbank and its policy of high interest rates. The high rates applied to brake the domestic expansion had only increased the pace of capital inflows. In February 1961 he said that “We owe to the Bundesbank and Herr Blessing the fact that we have these surpluses and that we have to pay this much” and told Emminger that he was ready to resign if his plans were frustrated.103 In the end, Erhard’s pressure convinced the German cabinet on March 3, 1961 to vote for a “small” revaluation of 5 percent, and by law it was the German government and not the Bundesbank that determined German exchange rate policy.

In the February discussions, Bundesbank President Karl Blessing had also threatened to resign—if a majority of the Bundesbank Central Council would vote in favor of the revaluation—and blamed “excessive activism by the government in all areas (social payments, defense, public investment)” for Germany’s problems.104 He changed his mind in March because, as he told the Bundesbank Council, the only alternative to a German revaluation, an American dollar devaluation against gold, had been rejected by the Kennedy administration; and a multilateral discussion of new parities within the framework of the Organization for Economic Cooperation and Development (OECD) would be impossible, as the news would leak and unleash wild speculative movements. “I believe,” Erhard said, “that it is an act of international solidarity to take this measure.”105 The United States soon became convinced that any such change in the price of gold would be futile, as all the other countries would respond by devaluing by the same amount (see Chapter 8).

From the point of view of what was desirable internationally, this solution made little sense. The Director of the IMF’s Research Department, Jacques Polak, still held to the view that the appropriate rate should be at least 10 percent, and preferably 15 percent. The U.S. Executive Director stated that the change would be of “no use” if it were less than 8 percent. Jacobsson replied that there had been too many cabinet meetings in Bonn over revaluation for the Fund to intervene in the debate over the rate: “to attempt to alter whatever decision they had come to would be a vain attempt.”

There had been no international discussion at all of appropriate exchange rate policy in the event of German changes, either in the OECD or at the IMF. Nevertheless, in March 1961 at the insistence of the Dutch Finance Minister Jelle Zijlstra, following the German revaluation the Netherlands also revalued, at the same rate. The official Bundesbank declaration blamed the decision on the failure of the U.S. administration to contemplate a multilateral alteration of parities, on international speculators, on German unions and the pay increases they demanded, and on the government’s objection to the Bundesbank proposal of credit restrictions.106

The rate chosen was indeed too low to deter speculators who saw another parity change as possible or even likely. In September 1961, the Financial Times for instance wrote: “It is hard to see how the eventual re-emergence of an overall German surplus capable of causing great concern to other countries can be avoided unless the March revaluation is carried further.”107 At the BIS in the summer of 1961, Jacobsson denied that there would be any more changes in exchange rates, or in the 1 percent margins within which currencies were permitted to move in the Bretton Woods formula. “I happen to know that in all the major financial centres the monetary authorities are determined to maintain existing parities.”108

The German revaluation had for the moment corrected a disequilibrium in international payments that justified the famous but undefinable term of the IMF’s Articles of Agreement, “fundamental.” But alterations in parities were themselves destabilizing in that they encouraged new capital flows in anticipation of new alterations. And the result of the liberalization of exchange controls was in any case the encouragement of a substantially greater volume of capital movements than in the pre-liberalized environment of the 1950s.

The Liberalization of the Japanese Economy

Japan moved to current account convertibility slightly later than the majority of European states. Initially policymakers felt hesitant, because such a transition might endanger the high-growth strategy pursued in the 1950s, sometimes known as seisan fukko setsu or “reconstruction through production.” The possibility of the Ministry of International Trade and Industry (MITI) using administrative controls on foreign exchange meant that external balance of payments constraints might be largely ignored in a drive for higher output levels. An IMF document later spoke of the Japanese “predilection for maximising growth rates rather than concern with the balance of payments or business fluctuations.” Even so, the constraints asserted themselves. After record growth, Japan ran a large trade deficit in 1956 and 1957, and in 1957 a balance of payments deficit of ¥ 211 billion. Faced by a drain of reserves, it negotiated a stand-by arrangement with the IMF, and drew $125 million. The negotiation was accompanied by an exhortation to stabilize growth. Per Jacobsson told the Japanese Executive Director that the government should not only tighten credit conditions but run a budget surplus during a period of very fast expansion. “It should,” he said, “be remembered that an oversized budget, even if fully balanced, might do considerable harm to an economy at a time of a pronounced boom.”109

In addition, there had always been a Japanese alternative to the high-growth tradition. This view asserted the importance of stability oriented policies, and regarded the growth of the 1950s as only possible because of the prior stabilization and currency reform imposed in 1949 as part of the “Dodge line.”

In the early 1960s, Prime Minister Ikeda Hayato followed the European turn to greater trade liberalization and combined it with the adoption of a ten-year income doubling plan. The United States and the IMF repeatedly pressed for faster liberalization, as well as a greater commitment to anti-inflationary policy. Ikeda initially suggested that Japan should “liberalize” (remove from administrative control of foreign exchange allocation) 80 percent of its imports; the IMF suggested 95 percent, then agreed on 90 percent. In the Article XIV consultations held in November 1962, the Japanese representatives frequently referred back directly to the Prime Minister and spoke of the political difficulties involved. For instance, the coal mining unions objected to the inclusion of heavy oil in the liberalization, as greater energy imports would undermine their bargaining position. Foreign Ministry officials spoke of “waging a war” against MITl’s demand to resist the freeing of trade. The background to these discussions was the Japanese fear that the 1950s recovery had merely been a catch-up after wartime devastation and that their economy would soon revert to lower growth rates, despite all the political promises of income doubling. The difficulties appeared augmented by the experience of a renewed balance of payments crisis in early 1961, which had required the negotiation of an IMF stand-by arrangement. In the end, however, the Japanese officials agreed to continue the liberalization. The IMF report emphasized that “the staff team impressed on the Japanese authorities that it was in Japan’s best interests to liberalize; exposing domestic industry to external competition was calculated to improve productivity and efficiency and thus accelerate growth rather than retard it. If more imports were allowed in, more exports would become possible.”110 The Fund staff set out a vision according to which Japan could continue on a high-growth course only through a dramatic expansion in exports. On February 6, 1963, this advice was repeated in the course of a discussion by the IMF Executive Board, and Japan replied that it would apply on April 1, 1964, to become an Article VIII member of the Fund. In short, Japanese policymakers accepted the argument that liberalization would strengthen rather than weaken the export economy, and the proportion of Japan’s national income that was exported indeed increased dramatically over the subsequent decade.

It had been the prospect of increased capital movements, as well as of expanding export opportunities, that provided the spur to the introduction of convertibility in many different countries, perhaps most obviously of all in Europe in the cases of France and Spain. At first the vigorous economic growth of the 1950s had produced balance of payments problems, and a new dependence on IMF assistance. The IMF provided the additional reserves required to undertake the process of trade liberalization. Without them, the relaxation of restrictions would have produced immediately impossible balance of payments constraints. One of the major achievements of the IMF was the massive provision of resources that allowed at the end of the 1950s the establishment of a liberal and open international economy. The final European moves to widespread external convertibility (that is, convertibility for nonresidents) occurred in 1958, after a vigorous boom in late 1956 and 1957, which created payments problems in a number of fast-growing countries which socked in imports and then required IMF stand-by arrangements: Bolivia, Brazil, Chile, Colombia, Cuba, France, Honduras, India, Japan, the Netherlands, Nicaragua, Peru, and South Africa. The requirement of large drawings under stand-by arrangements during the transition to convertibility meant that, far from being an irrelevance, as so many British and French commentators had asserted in the mid-1950s, the IMF became a vital source of support. In order to provide such assistance, it required enlarged resources. In 1959, the quotas of all members were raised by 50 percent; and, in addition, there were special increases for Canada, Germany, and Japan, reflecting their increasingly powerful economic performance. The IMF could supply the reserves required by the expansion of the global economy and of world trade by creating additional “conditional liquidity”—allowing members to draw from the Fund on the basis of their quota position. As long as quotas continued to be increased in line with the expansion of world trade, the IMF saw no problem in the world supply of reserves.111

After the strains imposed by rapid global expansion, recession provided a relief. In 1958, the U.S. trade balance shifted adversely, and the United Kingdom ended discrimination on imports from the dollar area for a wide range of previously restricted goods. In the next international surge of growth, the reason that payments problems appeared on the whole much less universally—and that as a result there were few impediments to liberalization—lay in the large deficits of the United States and the relief that they afforded to the position of other countries. This offered another alternative, but less satisfactory, solution to the reserve problem.

At the end of 1959, 14 Western European countries had made their currencies externally convertible. There was pressure from Germany to move toward full current account convertibility, and for the European countries to move as a bloc. In 1961, 9 European states and Peru accepted the Article VIII obligations of the IMF. More generally, by 1961 two thirds of the Fund’s members allowed nonresidents to transfer freely to other nonresidents currency acquired from current transactions. On the other hand, most developing countries believed that some measure of exchange restriction was an inevitable and essential part of the development process.112

Over the course of the 1950s, the dollar shortage, which had often been treated as if it were a permanent phenomenon caused by an intrinsic superiority of American capitalism, came to an end. At first the major alleviating factor was U.S. military spending abroad, but after the mid-1950s this was increasingly supplemented by private capital transfers. This development startled most observers: in the late 1940s Marshall Plan administrators had tried, but very frequently failed, to interest American business in guarantees for European investment. After 1956, however, the stream of U.S. participations took off. In that year, U.S. direct investment overseas and long-term capital outflows exceeded for the first time since the Second World War official grants and capital flows (Figure 4-1).

Figure 4-1.United States: Balance of Payments

(in billions of U.S. dollars)

Source: United States, Economic Report of the President, various issues.

Robert Triffin later commented in another context that “history teaches us … that the most crucial reforms of the international monetary systems as well as of national monetary systems, have already been determined, with very rare exceptions, by the private sector of the economy rather than by the governments and their bureaucracies.”113 This was the case with the private flows of the 1950s, which created a powerful incentive to undertake convertibility, but the resources to sustain national reserves during this transition were supplied by the IMF. It is possible in the late 1950s to detect a new attitude to capital movement, a change from the pronounced hostility of the Bretton Woods era. The 1952 IMF Annual Report had stated: “Balance of payments adjustments are also made more difficult by the virtual absence of any effective private international long-term capital market.”114 As capital flows developed, they became not a problem and a source of destabilization, but a way of making adjustments within the framework of growth.

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