The Board’s reaction was generally positive and supportive of the original bill. Woodlief Thomas, assistant director of research at the Board, read the bill as an attempt to “legislate the Keynes-Eccles-Hansen-Beveridge theory of economic stabilization” (Memo Thomas to Ransom, Board of Governors File, box 198, February 12 and 4, 1945). Thomas saw enactment of a particular economic theory as a danger, but the act did not do that. The bill, he said, was “a statement of goals, not an outline of policies” (ibid.).
50. For a contrary view, see Keyserling 1972. According to Keyserling, the act allowed economic planning but was not carried out because of the unwillingness of government (and Keynesian economists) to propose income redistribution.
51. Forecasters’ failure to foresee rapid postwar recovery instead of a return to high unemployment did not strengthen their case. See Stein 1990, 202. On the inaccuracy of economic forecasts, see Meltzer 1987.
52. The Reagan administration considered abolishing the council because of differences between one of its chairmen and other presidential advisers over budget deficits. Since the council was authorized in the Employment Act, demission required legislation. The administration chose not to raise the issue.
Eccles had favored countercyclical use of fiscal policy since the early 1930s. He came to Washington early in the New Deal to promote that policy. In a letter to Senator Robert Wagner, he accepted the objectives of the bill but emphasized the primary role of the private sector in providing employment. He urged Wagner to substitute for full employment “maintaining economic stability at as high a level of employment and production as can be continuously maintained” (Eccles to Wagner, Board of Governors File, box 198, June 16, 1945). Although he discussed the Federal Reserve, he did not mention monetary policy as a tool for reaching the objectives of the act.
Neglect of monetary policy was not an oversight. The conventional view among economists at the time was that monetary policy had, at most, modest effects on output and prices.53 These beliefs justified the passive monetary policy that the System chose mainly for political reasons. When conventional views changed in later years, the Federal Reserve accepted major responsibility for moderating recessions and controlling inflation.
International Plans
Planning for postwar international monetary cooperation began before the United States entered the war. Section 7 of the lend-lease agreement, under which Britain and others obtained military supplies and equipment “on credit,” provided that the United States could waive postwar repayment if the British agreed to eliminate trade “discrimination” and reduce tariffs. Discrimination was not further defined, but the objectives it expressed included elimination of the prewar system of imperial preference that bound Britain to its empire and favored British exports.
Avoidance of bilateral agreements and imperial preference was a major goal of the State Department. Secretary of State Cordell Hull favored a multilateral system centered on “most favored nation” clauses that gave each signatory the lowest tariff rate agreed with any other country. The British accepted section 7 out of wartime desperation. They did not like it (Presnell 1997).
53. This position dominated research at the time. See Villard 1948 and Ackley 1961, and for a Federal Reserve view see Thomas 1941. For a contrary view see Friedman 1956 and Warburton 1966. Assigning a more powerful influence to monetary policy would have required the Federal Reserve to accept more responsibility for the Great Depression, but it would have moderated, or even prevented, the Great Inflation after 1965.
In the course of negotiations leading to the lend-lease agreement, Keynes broadened the terms of reference to include finance and exchange rates. The two treasuries then took the lead in negotiations, shifting emphasis from trade issues to finance. By September 1941 Keynes had developed a proposal for an international clearing union that could create a currency for member central banks to use in settling payments imbalances. After adjustment, Keynes’s proposal became the British government proposal in April 1943, when formal bilateral discussions began.
Keynes (1924) had developed the basic analysis much earlier. Each country acting alone can achieve either stable prices or a fixed exchange rate but not both. To achieve both, there must be international cooperation or agreement. The gold standard is one type of agreement; each country accepts the rules of the standard, defining currency value in grams of gold, agreeing to buy and sell gold at a fixed price, and allowing money and prices to rise or fall with gold movements. If member countries followed these rules, exchange rates would remain fixed and inflation or deflation would be limited to changes around the world price level, the latter set by world demand for and output of gold. Large productivity shocks might disrupt countries’ efforts to maintain employment and stable prices, but prices and output would eventually adjust as required by the fixed exchange rate.
The rules, however, required procyclical policies—allowing gold inflows to inflate the economy during expansions and to accept contraction, unemployment, and deflation when gold flowed out. With the growth of industrialization, labor unions, and the spread of the voting franchise, voters and governments were less willing to follow such rules in the 1920s. Many proposals to eliminate or reduce procyclicality had been made, but none had been adopted.54
In December, a week after the United States entered the war, Morgenthau asked Harry Dexter White to “prepare a memorandum on the establishment of an inter-Allied stabilization fund” as the basis for postwar international monetary arrangements (Blum 1967, 228–29).55 Morgenthau’s diary suggests that, although the United States had insisted on title 7, he had no more than a vague idea about expanding the prewar Tripartite Agreement to avoid competitive devaluation.56
54. Chapter 4 discusses attempts in the United States to enact Irving Fisher’s proposal for a “compensated” gold dollar and to establish domestic price stability as the principal policy goal.
55. White was director of monetary research and later assistant secretary of the treasury. The United States proposal that became the basis of the International Monetary Fund is often referred to as the White plan. Keynes’s plan called for a clearing union to adjust current account balances of debtors and creditors. White envisaged a permanent fund that could lend to debtor countries. White’s version was the basis of the Bretton Woods Agreement.
The British were particularly interested in preventing a return of their interwar problem, when efforts to expand their economy by lowering interest rates were followed by a current account deficit and an outflow of gold that reduced the money stock and forced contraction and deflation.57 White, and others at the United States Treasury, also favored a more flexible system. He too proposed a middle way between fixed and fluctuating rates with rules for lending and borrowing. Exchange rates would be fixed but adjustable; countries with a balance of payments surplus (like the United States in the 1920s) would lend to countries with deficits (like Britain in the 1920s). Unlike Keynes’s plan, the new international institution could not create money.
The plan envisaged that deficit countries would not be forced to contract and deflate for balance of payments purposes. They would maintain imports from the rest of the world instead of reducing purchases and spreading contraction. To enforce lending, member countries agreed to impose costs on surplus countries that would neither expand imports nor lend to countries in deficit. Thus deficit and surplus countries alike would benefit from increased flexibility.58 Both Keynes and White limited their proposals to financing trade and current account deficits. To the extent that they considered lending and borrowing on capital account, it was the responsibility of the proposed International Bank for Reconstruction and Development, later called the World Bank.59
56. Blum (1967, 228) speaks of “a kind of New Deal for a New World” and avoiding past difficulties caused by “private bankers, pursuing selfish ends” (229). Gardner 1956 is a comprehensive history of the origins of the fund. Several papers in Bordo and Eichengreen 1993 are a useful supplement.
I limit my discussion principally to Treasury and Federal Reserve responses and actions. Keynes visited the United States in fall 1941 and possibly discussed his plan informally before White began work.
57. Keynes’s dislike of the classical gold standard and what he called laissez-faire was no longer heretical in Britain by the 1940s. The established view was that the maldistribution of gold had made the system untenable. The accepted conclusion was that Britain should manage domestic policy to maintain full employment (Ikenberry 1993; Presnell 1997). Fluctuating rates were anathema to bankers and policymakers. An influential study by Nurkse (1944) concluded that fluctuating exchange rates caused destabilizing speculation in exchange rates and the prices of traded commodities. Nurkse’s argument and evidence were later successfully challenged by Friedman (1953), but Nurkse’s view remains widely held by bankers and governments.
58. This benefit could be achieved if all fluctuations were temporary, or cyclical, so that members could borrow in recessions and repay in recoveries, but the authors did not specify how to distinguish cyclical or temporary changes from permanent changes. Countries were allowed to devalue up to 10 percent without approval by the fund, and by more than 10 percent with prior approval. Devaluation was to be used to adjust to a “fundamental” disequilibrium. The fund was never able to define “fundamental” or to enforce the requirement that countries could not devalue by more than 10 percent without agreement.
Countries could pursue the domestic policies of their choice, a main British aim and another major departure from classical gold standard rules. Countries could correct policy errors by changing the exchange rate, with the consent of the new agency, the International Monetary Fund. The fund would also prevent multiple currency practices, discriminatory bilateral arrangements, and competitive devaluations. Eventually countries would maintain current account convertibility, a main aim of the United States.
Many in the banking community and the Federal Reserve wanted to return to the gold standard. White dismissed these proposals: “There isn’t the slightest chance of getting other countries to return to the gold standard” (White to the Board and Reserve Bank Presidents, Minutes, FOMC, March 2, 1945, 20). The only chance for agreement was to combine stability of exchange rates with the flexibility to change them with the fund’s approval. Other countries would agree to this mixture of stability and flexibility if it was part of an agreement that gave each country some assurance that it could borrow in an emergency: “We must give them time to balance their payments in such a way that they will not hurt the rest of the world” (25). Adjustment might take two, three, five, or even ten years.
The Reserve Board began to consider the Keynes and White plans in May–June 1943. Their first concern was the amount of new bank reserves that the United States would have to create. To eliminate all restrictions on current account financing, as Keynes proposed, required an expansion of $25 billion to $30 billion of United States base money. An expansion of this magnitude would double the amount of base money then outstanding. Board members wanted either power to control the domestic effect of such a large increase or a limit on the size of the increase (Board Minutes, May 29 and June 1, 1943). The Board also favored a provision, suggested by the Canadian representatives, that if the amount of foreign exchange balances at the fund increased beyond a preset limit, the member would gain voting power (ibid., June 1, 1943, 4). This would permit a surplus country to eventually limit borrowing and expansion of its money stock. The British would not accept this proposal. They remembered the policies of surplus countries (the United States and France) in the 1920s and did not intend to repeat the experience.
59. White explained to the Federal Reserve Board that the World Bank would be responsible for capital transfers. “Many of the loans will be risky and there will be some losses. That is one of the reasons why we insisted that the Bank be an international bank rather than to take the risks by ourselves. We felt that the benefits would be world-wide and that other countries should bear part of the risk” (White to the Board and Reserve Bank Presidents, Board Minutes, March 2, 1945, 17). The Bank was also expected to remove the impediment to economic development arising because risk-averse private lenders restricted lending to developing countries or charged excessive risk premiums. Although no evidence was presented, this conclusion was widely held.
As the plan developed, the Board’s discussion of substantive issues ceased. Board staff participated actively in meetings organized by the Treasury, but few of the issues they raised came before the Board. The Board never considered the merits of alternative proposals and objections to the plan by leading bankers and the New York reserve bank.
The Board’s consideration of the proposals that became the Bretton Woods Agreement is remarkable for the failure to discuss substance. This was not its initial intention. On March 7, 1944, Governor Menc S. Szymczak proposed that the Board approve the joint statement of a committee of international experts provided the Board would participate in the selection and control of the United States representative to the fund (Board Minutes, March 7, 1944, 1).60 The Board did not act. The following day the Federal Advisory Council, meeting with the Board, supported the principle of exchange rate stabilization under an international agency but mentioned no details. A week later, Szymczak asked whether the Board wanted to suggest changes in the plan.61 There was “general agreement . . . that if a plan were to come into existence it would not be possible for the Board to propose any fundamental changes” (Board Minutes, March 13, 1944, 2). The only decision was that a majority of the Board wanted “a voice in the selection of the American member of the board of directors” (3). “Reference was made to the fact that discussion of the plan up to this point had been strictly on a staff level and that none of the interested heads of agencies of the Government had in any way committed himself to what had been done” (4). The Board agreed to wait and not take a position until other agencies did. It instructed Goldenweiser, one of the Board’s representatives at the technical discussions, to say that the Board’s representatives did not speak for the Board.
60. Menc S. Szymczak, who served from 1933 to 1961, was a professor of business administration at DePaul University in Chicago when he was appointed to the Board. He had been active in Chicago area banking and had served also as comptroller of the city of Chicago. He was the Board’s expert on international economics and participated in some of the Treasury meetings preparatory to the Bretton Woods Conference. Later he served as director in charge of rehabilitation of the German economy, on leave from the Board. His long service is explained by appointment to a twelve-year term in 1936 followed by a fourteen-year term beginning in 1948. He resigned six months before his term expired (Katz 1992).
61. Before the meeting, each of the members received a copy of the Joint Statement of Experts, a synthesis of the Keynes and White plans, and a statement of the positions taken by the Board’s staff in the discussions.
This was either subterfuge or myopia. The Treasury was moving rapidly toward agreement on the plan. Morgenthau called a meeting in mid-April to discuss next steps. Eccles reported to the Board that Morgenthau had asked whether the Board would make a commitment to the plan. Eccles said no, the discussions had been at the staff level, and “it was understood that no commitments had been made or were expected at this time. I said it had been my understanding that the principals would meet and consider the report of the technicians, after which there would be an opportunity to discuss the matter, and that no such meeting had been called” (Board Minutes, April 18, 1944, 2). White, who was present, did not agree. The conference “would not go outside of the statement of principles” (1).62 The Board hesitated, neither endorsing nor opposing the plan.63 Instead it adopted a statement saying that “no governments are committed by action of the technicians. It now becomes necessary for the executive branch of the Government to consider the proposal of the technical experts and to determine what course of action in this matter should be undertaken and ultimately wh
at program should be recommended to Congress” (Board Minutes, April 24, 1944, 2). The Board voted five to one to approve the statement. McKee abstained because he said the statement had no value.
Late in May the president announced an international conference to begin July 1 at Bretton Woods, New Hampshire. Governor Szymczak told the Board that, on June 15, technical experts from twelve countries would meet to prepare the conference agenda. Eccles, who was not present at the Board meeting, had agreed to be a member of the United States delegation. Some of the Board’s staff would serve as members of the conference staff.64
The Board members agreed that the main issue they faced was how the Board wished to counsel Eccles as their representative (Board Minutes, May 31, 1944, 3). Governor McKee asked for a meeting with the reserve bank presidents to hear objections from President Sproul and to discuss the plans “point by point” (3).
The meeting was held on June 6, but the “point by point” discussion did not occur. The main reason was that Eccles was now a member of the United States delegation, and the conference was only a few weeks away. Eccles did not attend the meeting; it was chaired by Vice Chairman Ransom, who opened the meeting by limiting discussion “to the question of how to make the international fund serve the best interests of this country, including the Federal Reserve System, rather than the question whether the international fund should be created or some other mechanism devised” (Board Minutes, June 6, 1944, 2–3). This limitation prevented Williams and Sproul from proposing an alternative. Governor Szymczak proposed removing additional topics from discussion. The meeting should discuss issues that had not yet been decided at the technical level, how the proposed arrangement would affect the United States economy and Federal Reserve operations, and how to raise the United States contribution to the fund. This was opposite to the position he had taken a few months earlier.
A History of the Federal Reserve, Volume 1 Page 89
