ing their aims. They wanted to return, eventually, to a reformed gold standard, but they were not ready to commit to such a move. They wanted to retain the right to devalue if necessary. Within that framework, they welcomed cooperation. Morgenthau was pleased by these conditions. He suggested further discussions between the two treasuries, avoiding the central banks (Blum 1959, 142–43).
The French elections of May 1936 accelerated the conversation. A coalition of leftist parties, known as the Popular Front and including the Communist Party, came to power under the leadership of a Socialist, Leon Blum. Their platform did not put forward a clear monetary program. The Socialists were willing to consider devaluation, but the Communists opposed (Kindleberger 1986, 252). Morgenthau favored devaluation of the franc by 15 percent but opposed a French gold embargo. Several of his advisers were willing to accept a 25 percent devaluation (Harrison Papers, file 2012.6, June 9, 1936).
The British used the market disturbance resulting from French strikes, the election, and concerns about devaluation to request authority to purchase gold directly from the United States Treasury. Morgenthau, as usual, took the issue to Roosevelt, who objected. But Morgenthau managed to convince the president of the importance of a French devaluation followed by stabilization of the pound, franc, and dollar. The next day Roosevelt agreed to let Morgenthau sound out the British on a program to let the franc devalue by 25 percent without any retaliation by the United States or Britain (Blum 1959, 145–47).
France was the stumbling block. In a pattern later followed by socialist governments in Chile, France, Peru, and elsewhere, Blum and his finance minister, Vincent Auriol, believed they could raise wages and reduce the workweek to forty hours without devaluing. To add to their mistakes, they allowed firms to borrow from the Bank of France at a 3 percent interest rate to cover the additional employment costs. The government guaranteed the loans.
The program increased costs and raised prices. In the Blum government’s first year, French wholesale prices rose 47 percent. Blum and Auriol had pledged to maintain the franc’s gold parity, but they left room for an adjustment in its value as part of an international agreement. In fact, they had few choices. Faced with a continuing loss of gold, they could devalue or resort to exchange controls. Morgenthau’s offer of assistance, and his use of sanctions against Germany, convinced the new government that a cooperative agreement was possible.253 They sent a special representative to meet Morgenthau to discuss international monetary relations.254
253. Germany used currency manipulation—discounts of the mark for purchases in Germany, export subsidies, and other policies—to expand exports. The Treasury claimed these actions violated the 1930 Tariff Act, so they required retaliation. The State Department objected, but the solicitor general found for the Treasury. Roosevelt agreed. On June 4, the United States ordered countervailing duties (Blum 1959, 149–53).
The Tripartite Agreement
To remain on the gold standard, France and the gold bloc had followed deflationary policies in 1934–35. By the summer of 1935, French wholesale prices were 51 percent of their 1929 average. The policy would have worked had it been followed long enough, but the cost was high, and the policy had become unpopular. There were two problems. First, devaluation of the dollar and the increased United States gold price drained gold from France. Second, as a consequence of continued deflation, the gold bloc countries faced increasing unemployment or lower wages at a time of recovery in Britain, Germany, and the United States.255
Beginning in summer 1935, repeated efforts to deflate by balancing the budget, reducing wages and pensions, and other means failed to stop inflation. Chart 6.7 shows that French prices began to rise absolutely and relative to prices abroad. Eichengreen (1992, 367–74) describes the response; successive governments blamed the unbalanced budget. They promised to do better.256 If fiscal stringency did not work, many said, the answer was more stringency.
In the year before the Blum government took office, French wholesale prices rose 15 percent. By September 1936 the French price level was back to 67 percent of the 1929 average. This compares with 86 percent and 78 percent for the United States and Britain. In August, before the franc devaluation, the real dollar-franc exchange rate was 4.8 cents, about 20 percent above the 1929 rate.
The Blum government hesitated to act. The final push came after renewed weakness of the franc against the dollar and the pound in August 1936. The French wanted the dollar and pound to remain fixed if they devalued the franc, and they wanted an agreement to return to the gold standard. Neither the United States nor Britain would agree to fix rates permanently. Roosevelt, Morgenthau knew, would not agree to return to the gold standard.
254. Governor Montagu Norman usually took his vacation in Maine. In June 1936 he expressed interest in coming to Washington during July to confer with Morgenthau and Eccles. Morgenthau talked to Roosevelt, who was concerned that, since no agreement was contemplated, the press would decide that the meeting had failed to reach agreement. Part of the concern may have been an unwillingness to have a policy “failure” so close to the presidential election (Harrison Papers, Conversations with Other Officers of the Bank of England, file 3117.4, June 29, 1936).
255. Eichengreen (1992, 357–74) gives a good account of the problems within the gold bloc. Even before the Popular Front, a French government had tried reflation instead of deflation. As noted in the text, French prices began to rise in 1935 before the election.
256. Eichengreen (1992, 367) notes that in 1935 France lost 20 percent of its gold reserves, the Netherlands 25 percent, and Switzerland 40 percent.
The French government’s position was weak. It had paid out more than one-fourth of its gold stock in nine months and counted on devaluation to provide enough profit on its remaining gold to balance its budget. Morgenthau offered only a general agreement to avoid retaliation following a French devaluation. He did not mention the gold standard. The British response was similar. The final agreement accepted the main points of the United States statement, although each government used its own wording.257 The agreement provided funding for a French stabilization fund from half the proceeds of the devaluation. Each country agreed to stabilize exchange rates, one day at a time, by announcing in the morning the price at which it would exchange its currency for gold at the end of the day.258 The British did not insist that the United States agree to sell gold to stabilization funds, but it did agree to do so on October 12. Belgium, the Netherlands, and Switzerland chose to comply with the agreement. Switzerland and the Netherlands devalued by 28 percent and 20 percent, respectively. Italy also devalued by an additional 33 percent to bring its devaluation to 40 percent since the United States devaluation in 1934.
257. The Blum government hesitated to state that it would devalue the franc. It preferred to float the franc but in the end agreed to a devaluation of 25 percent to 34.3 percent with the pound at $5.00 ± 0.10. Roosevelt insisted the pound must be above $4.86 as the United States election approached. Blum (1959, 160–73) gives the details of the discussion and negotiation. The British did not mention $4.86 and did not agree to keep the pound fixed, but they agreed not to force devaluation.
258. The Bank for International Settlements called the arrangement a daily gold settlement system.
Morgenthau did not mention the agreement to Eccles or the Federal Reserve until it was final. Like Roosevelt, he wanted to put governments, not bankers, in charge of monetary policy. The Tripartite Agreement was another step in that program. Unlike the 1920s, when Strong and the New York bank ran international monetary policy, the Treasury was now in charge.259
Morgenthau was euphoric about the outcome. He believed the agreement was a major step toward peace, economic stability, and prosperity. The Treasury staff shared his enthusiasm, as is common among those who have participated in a long and difficult negotiation.260 Major newspapers lauded the agreement (Blum 1959, 173; Eichengreen 1992, 380). Harrison was cautious. He probably expressed the view of those wh
o wanted to restore the gold standard when he told Morgenthau that “a stabilization fund to keep the franc within a 10 percent range only added one more flexible exchange [rate]” (Harrison Papers, file 2012.6, September 25, 1936).
In fact, the agreement was more symbolic than substantive. The franc and some of the currencies allied in the former gold bloc devalued their nominal exchange rates by 15 percent to 30 percent of their 1929 values. The dollar and the pound remained close to their predepression nominal parity. Britain and the United States agreed not to respond immediately to the French devaluation, a modest sign of cooperation.
One measure of the agreement is the effect on exchange rates. Table 6.7 shows estimates of exchange rates adjusted for changes in wholesale price levels, a measure of so-called real exchange rates, at selected dates. The top row shows bilateral real exchange rates before the start of the Great Depression. Rows 2 and 3 show these rates after the 1931 British devaluation and the 1934 United States devaluation. Row 4 follows the Tripartite Agreement.
Devaluation restored the 1929 real franc exchange rate for the dollar and devalued the real rate for the pound by 3 percent. What a cumbersome and costly way to correct the misalignment of exchange rates after the restoration of the gold standard in the 1920s!261
259. Eccles’s book does not mention the agreement. Harrison was informed and acted as an adviser to Morgenthau, but he could not talk to Eccles or Ransom. When the countries reached an agreement, he called the principal New York bankers, at Morgenthau’s request, to ask that they avoid speculating against the three currencies.
260. The Bank of England was enthusiastic also, judging from correspondence between H. A. Siepmann at the bank and Allan Sproul at New York. These men exchanged personal letters, sharing views and information. Siepmann’s letter dated October 27, 1936, for example, is sixteen pages of handwritten comments that end by noting that he did not inform the bank’s governor of their correspondence (Sproul Papers, Bank of England, November 6, 1936).
The adjustment that the agreement made possible did not produce stability. Chart 6.7 shows that between September 1936 and the start of the United States recession in June 1937, French prices continued to rise relative to United States and British prices; the franc depreciated in real value against the dollar and the pound.
After the Agreement
Harrison telephoned to ask for cooperation from the major bankers on Friday evening, after agreement was reached. Apparently they did not all relay the message to their traders. On Saturday morning the pound began to sink, falling from $5.02 to $4.91. The proximate reason was an order from the Russian State Bank to Chase National Bank to sell £1.2 million for dollars. Morgenthau viewed this as an attempt to subvert his agreement: “He was not going to have the Reds or Communists ruining this program” (Harrison Papers, file 2012.6, September 26, 1936, 9). He ordered Harrison to buy the pounds immediately for the Exchange Stabilization Fund, and he threatened to announce publicly that “the Reds were making an attack on the pound in order to draw it down and spoil the program” (10).262
The agreement did not specify who could buy or sell gold at the Treasury. Morgenthau tried to clarify the issue at a press conference in October, but he misstated the policy. By limiting transactions to governments only, he was more restrictive than he intended, but he would not issue a corrected statement until after the November election (Harrison Papers, file 2012.6, October 13, 1936). Finally, on November 24 the Treasury announced that it would sell gold to treasuries or fiscal agents acting for treasuries (including stabilization funds) that would sell gold to the United States. This statement relaxed the restriction on the Treasury to deal only with gold standard countries, in effect since January 1934. Britain, France, Switzerland, the Netherlands, and Belgium became trading partners.
261. The agreement has always had greatest appeal to proponents of currency stabilization policies. See, for example, Kindleberger 1986, 258–59, or Eichengreen 1992, 381–82. See chart 6.1 (above) for more detail on real exchange rates.
262. When Morgenthau called the Chase to get permission to announce the transaction, he learned that the total was £1.2 million, of which £300,000 had been sold on the thin Saturday market before the Exchange Stabilization Fund intervened. After Morgenthau made the announcement, with Roosevelt’s permission, at a Saturday press conference, Winthrop Aldrich, president of Chase, informed him that the transaction was a commercial transaction by the Russians to obtain dollars to repay a loan to Sweden. Morgenthau did not dispute the explanation but remained skeptical (Blum 1959, 173–74). And he was happy to show that the bankers, not the government, were doing business with the Russians.
In 1937 the French began to respond to German rearmament by increasing military spending. The increased spending added to the burden of the Popular Front’s social programs and the devaluation. By February the franc was under pressure, falling against the dollar and the pound. Harrison began conversations with the British about stabilization of exchange rates, and the Treasury began intergovernment discussions. At $2.5 billion, French gold holdings were at the lowest level since the 1931 British devaluation. The French suggested that the United States buy $5 million to $10 million worth of francs but not convert them into gold until after the summer tourist season. Morgenthau was shocked. The suggestion “made him break out in a cold sweat” (Blum 1959, 456). The loan would probably have violated the Johnson Act, passed in 1934, prohibiting loans to any foreign government that had defaulted on its war debt.
The French thought they would have to impose exchange controls, violating the Tripartite Agreement. At Neville Chamberlain’s urging, bankers arranged a private loan to France, so the agreement continued. The Blum government survived (ibid.).263
By March 1937 the franc was under pressure again. The French wanted to arrange a defense loan, payable in dollars, francs, and pounds. The announcement created a storm in Washington, and Morgenthau had to testify that the Treasury viewed the loan as a violation of the Johnson Act, hence illegal (Harrison Papers, file 1610.1, March 8 and 9, 1937; Blum 1959, 461–62).
So it continued, with intermittent disturbances followed by brief periods of calm. Again, as in 1927–29, the main problem was never mentioned: exchange rates were misaligned and, as charts 6.1 and 6.7 show, inconsistent with the relative movements of wholesale prices in the principal countries.
Rumors spread in April that, to slow gold flows, the United States planned to revalue the dollar against gold. Gold flowed to the United States from private speculators and the exchange stabilization funds of smaller countries (Kindleberger 1986, 265). The franc weakened again in nominal and real terms. On April 9 President Roosevelt denied any knowledge of a plan to change the gold price. The franc continued to weaken, but the rate of decline slowed temporarily (Harrison Papers, file 2012.7, April 10, 1937).
263. Both the United States and Britain wanted the Blum government to survive. Both saw Blum as the strongest antifascist likely to form a government. Morgenthau and Roosevelt also liked his social policies (Blum 1959, 456–57).
The Blum government fell in June 1937. The new government promptly devalued the franc by 15 percent but agreed to hold the new range, 3.80 to 3.96 cents, and not seek a competitive devaluation. It wanted only to offset the costs to French industry of the Blum government’s social legislation.
Morgenthau accepted the devaluation as within the Tripartite Agreement because the French avoided new controls and announced a buying and selling rate at which they would sell gold. He was able to persuade the British to agree also, although they privately warned the French to avoid a further devaluation (Blum 1959, 478).
For the next year, several French governments, plans, and discussions produced no result. To save the remnants of the agreement, Morgenthau offered to let the French use “temporary” exchange controls (ibid., 500). In May 1938 France again devalued the nominal exchange rate to 175 francs to the pound and 2.8 cents per franc. The more critical real exchange rate was now 3.6 cen
ts per franc, about 12 percent lower than at the start of the agreement. The British did not want to accept the new parity, but they feared even more ending the Tripartite Agreement while facing the prospect of war to stop German and Italian expansionist actions.
Discussions continued about how to use the agreement as a political measure to strengthen the democratic governments. For practical purposes, the agreement ended before the May 1938 devaluation. After Munich, in September 1938, preparations for war increased in Britain and France. Both currencies fell against the dollar in nominal and real terms. The United States continued to regard the agreement as in effect.
What Was Achieved?
Proponents of international cooperation point out that exchange rate variability declined after the agreement. Eichengreen (1992, 382) shows that afterward monthly exchange rates were more stable in leading countries (except France).
This is a modest benefit to put beside the economic cost. The agreement could work only if the new nominal exchange rates were (close to) full equilibrium rates, consistent with stable real exchange rates. Differences in price levels and in economic policies leave little doubt that this was not so. Within six months the real dollar-pound exchange changed by 6 percent.
Try as they did, Morgenthau and Chamberlain could not make cooperation produce stability. The British insisted that the agreement was limited to daily, or short-term, exchange rates and a pledge to avoid using devaluation to improve relative positions.264 That meant uncertainty about future exchange rates remained. Countries remained free to pursue policies that would result in devaluation. Indeed, the French were engaged in such policies at the time. Instead of criticizing the policies as inconsistent with the agreement, Morgenthau and Roosevelt praised and encouraged them as a French version of Roosevelt’s New Deal.
A History of the Federal Reserve, Volume 1 Page 79
