The gist of the agreement is that if this country will create and maintain the conditions necessary for multilateral trade in a free exchange market, England will undertake, after a transition period of 3 to 5 years during which exchange controls and bilateral currency arrangements are permitted, to relinquish her controls and join a multilateral exchange system. The agreement, however, carefully states that, even after the 5-year period, the member country shall be the judge of whether the conditions are right for relaxing its controls. (Ibid., 323)
Eccles was no more successful with Ruml than with Sproul. Ruml agreed only that he would stay within the policy statements made by the Board; he said he would state his views on other public issues.
76. Sproul’s Senate Banking Committee testimony is in Senate Committee on Banking and Currency 1945, 301–17. Williams’s is in ibid., 318–34. Eccles tried to prevent the testimony. He told Morgenthau that “he did not think the Banks should be asked to express their views on the Agreements, particularly since at least one of the Banks was opposed” (Board Minutes, February 23, 1945, 4).
Williams argued, also, that the proposed system was more complicated then necessary. He advocated a “key currency” approach, with the dollar and the pound as the key currencies. Once Britain restored convertibility, other countries could fix their exchange rates to one of the key currencies. The main problem at the time was the British transition and the large volume of inconvertible sterling balances left from the war.
Both Sproul and Williams questioned whether the United States should enter the agreement when there was great uncertainty about what Britain and others would do and when, if ever, they would do it.77 White’s statements that adjustment loans might be made with five or ten years’ duration suggested that he too believed the transition would be long and difficult.
Potential dangers are not the same as flaws. Opponents who favored delay faced two major obstacles: the belief that, after the interwar experience, the United States had to show that it would support a multilateral approach and the conviction that the best time to get agreement was now. White did not disagree with many of the criticisms. He argued that reopening the agreement would not produce a better agreement.
Williams’s strongest argument was that in three to five years Britain would not be ready for multilateral trade and the elimination of current account restrictions. He estimated that the British war debt was $12 billion and rising, and that the country faced current account deficits of $1.2 billion to $2 billion a year for many years after the war. These arguments lost some of their persuasive power when the United States later agreed to a $3.75 billion loan to make the transition succeed.78 But Williams was right about the difficulties Britain would have in the postwar period. He erred only in being insufficiently pessimistic about British policy and prospects and the problem of maintaining convertibility. The pound did not become a fully convertible currency until 1979.
77. “A set of vested interests and a network of discriminatory trade and currency practices will have grown up which it may prove difficult to break down” (Senate Committee on Banking and Currency 1945, 323). “The agreement may institutionalize exchange controls” (306). Bankers and others opposed the agreements because they gave away United States gold and supported deficit finance abroad, and because Keynes supported them. The American Bankers Association, and other bank associations, testified in opposition (James 1996, 64–65).
78. The French also borrowed $800 million to help in the transition. This loan came from the Export-Import Bank, so it did not require congressional approval. William McChesney Martin Jr., head of the Export-Import Bank and later chairman of the Board of Governors, opposed the loan. The Treasury insisted, and the loan was made (Black 1991, 56).
Major newspapers supported New York’s position and either opposed the agreement or wanted major changes. Senator Robert A. Taft (Ohio) led the opposition in Congress. Taft saw the World Bank in much the same way as Morgenthau described it to White at the start of negotiations—a new type of deficit finance, an extension of President Roosevelt’s New Deal into a new class of problems to the benefit of other countries (Blum 1967, 429).79
On June 8 the House approved the agreement by a wide margin. Ratification by the Senate was more difficult. The Treasury worked for passage by offering rosy forecasts and minimizing the difficulties of transition from war to peace (ibid., 436). Late in July, the Senate approved the agreement by a two-thirds majority.
The British loan agreement, signed in December 1945, imposed many of the restrictions Williams wanted. After the loan’s ratification in July 1946, Britain agreed to ratify the Bretton Woods Agreement. It agreed to make the pound convertible within a year and relinquished the long transition to convertibility permitted under Bretton Woods. Trade discrimination against the United States had to end by December 1946.80 In return, the United States lent $3.75 billion at 2 percent interest, repayable over fifty years beginning in 1951 and settled lend-lease obligations of approximately $17 billion for about 4 percent of the claim. Since the loan was fixed in nominal value, United States inflation eased repayment; British inflation and devaluation increased the cost.
The Bretton Woods Agreement Act directed the Treasury to pay the $2.75 million subscription to the International Monetary Fund in installments. The Exchange Stabilization Fund contributed $1.8 billion of the profit on the 1934 revaluation of gold. The Treasury paid the remaining $950 million in dollars and non-interest-bearing notes, payable from tax revenues. The $950 million was an ordinary expenditure. To fund the $1.8 billion, the Treasury transferred $1 billion in gold to the IMF and, in February 1947, sold $800 million in gold certificates to the Federal Reserve.81
79. Blum (1967, 427) lists the Wall Street Journal, New York Times, World Telegram, and others as opponents. Morgenthau believed that criticism of the fund was misplaced. The fund would be open only to countries capable of keeping exchange rates stable, and its loans would be only for short-term trade finance. (429). Proponents included the national labor unions, the Independent Bankers Association, and most economists.
80. The fund began operations in March 1946 under the leadership of Camille Gutt, a Belgian. Britain removed restrictions, as promised, in July 1947, followed by the postwar British exchange crisis in August. Under the “scarce currency” clause of the IMF agreement, the British could continue trade discrimination if the fund declared the dollar “scarce.” A main reason for the early postwar discussion of the dollar shortage was to have the dollar declared “scarce.” The clause was never invoked.
Despite the emphasis on trade and avoidance of discrimination in the lend-lease agreement, countries did not adopt a trade agreement at the Bretton Woods Conference. In fact, the British delegation was under orders not to discuss trade policy, so the conference limited its statement to a recommendation favoring cooperation in trade matters. However, the British loan agreement also committed the British to participate in a trade conference. This was a major change from Keynes’s policy of separating trade and payments, then neglecting trade. The conference, held in Havana, Cuba, from December 1947 to March 1948, brought back the conflict between the United States, at the time the proponent of open, multilateral trade, and the British, still attached to preferential arrangements with its empire.
The conference agreed that preferences would end within five years, but the agreement had so many exceptions that the United States Congress would not approve it. The Truman administration withdrew the agreement, and it was never ratified (Presnell 1997, 227). Instead, countries adopted the General Agreement on Tariffs and Trade (GATT), negotiated separately. Originally a transitional arrangement, GATT became the postwar trade organization until it was replaced by the World Trade Organization fifty years later.
The International Bank for Reconstruction and Development (World Bank) created much less controversy at the Bretton Woods Conference. The consensus was that private international lending would remain small after the many loan defaults in the
1930s. The plan was that the World Bank would lend directly and encourage private capital lending by guaranteeing part of the loans. John McCloy, the first governor, thought the bank would concentrate on reconstruction of wartime damage, then close (Dominguez 1993, 377).
The bank started slowly. The Marshall Plan took over much of its original task of reconstruction. By the 1980s, private capital movements had increased. Contrary to the belief under which the bank was organized, most postwar financial problems in developing countries came about because of too much lending, not too little, particularly short-term lending.
81. The Treasury issued $1.75 billion of special non-interest-bearing notes to the IMF, in effect borrowing back and deferring payment of part of its subscription. It then used the $800 million balance obtained from issuing gold certificates to retire $500 million in debt from the reserve banks and $300 million to offset an outflow of gold in January (Fforde 1954, 194). These operations neutralized the effect on the monetary base.
The bank specialized at first in loans to developing countries and technical assistance. Countries soon learned to offer the bank projects with the highest expected return. Although aware that money is fungible, the bank made few efforts to assess its role in financing or learn about the marginal projects that its loans permitted countries to undertake.82
Summary on Postwar Planning
Early Keynesian models based their predictions of postwar depression, and a return to prewar unemployment rates, on estimates of consumer spending. Some market indicators gave a different forecast. For example, measures of risk, such as the spread between Baa and Aaa bonds, fell below 1 percent in 1944 and continued to fall as the yields on riskier bonds declined. By early 1946, the spread was below 0.5 percent, the lowest value reached by the series up to that time. There is no sign in these or similar data of an expected return to depression, unemployment, and bankruptcies.
Investors remained cautious, however. Wars have typically been followed by depressions. Stock prices fell in 1946 as profits declined. For the next five years, capitalization of profits remained low relative to past (or future) experience. Chart 7.4 shows the relation of corporate profits to market capitalization, the inverse of the capitalization rate. The relatively low capitalization rate (high value of the ratio) from 1947 to 1951 suggests that wealth owners did not anticipate continuation of robust profit growth.
In the event, the Keynesian models were inaccurate, the bond market forecasts correct. There was no postwar depression. Instead, the United States had a sharp eight-month recession as war plants closed or converted to peacetime production. The National Bureau of Economic Research dates the peak of wartime expansion to February 1945, two months before the end of the European war and six months before the end of the Asian war. By November the economy began to recover.
Though brief, the recession produced a large drop in output. Strikes for higher wages added to the loss. Industrial production fell 38 percent, but the peak unemployment rate reached only 4.3 percent of the labor force (Zarnowitz and Moore 1986).83
Internationally, the World Bank and the International Monetary Fund did very little to smooth the transition from war to peace (Presnell 1997; Bernstein and Black 1991). As Williams and Sproul had insisted, the fund and the bank could not cope with the transition. After Roosevelt’s death, Morgenthau and White resigned. The new secretary, Fred M. Vinson, recognized that the fund had limited resources. The British loan and, by 1948, the Marshall Plan provided sufficient capital transfer to Western Europe to permit these countries to import both nondurables and the capital equipment needed for reconstruction. The United States operated unilaterally, outside the institutions it had worked to establish.
82. Later the bank broadened its scope to include poverty reduction, environmental concerns, women’s rights, and other projects popular with contemporary political groups in the United States. Keynes had feared that locating the bank in Washington would expose it to pressures from United States domestic politics. James (1996, 72) quotes Keynes’s comment that the United States wanted to move control of international economic policy from Congress to the new institutions where it had a large voice.
83. For 1945 as a whole, production (1992=100) fell from 25.9 to 21.2, a drop of 18 percent. The wartime peak in industrial production came in 1944 and was not surpassed until 1950.
James (1996, 60) summarizes the failure of the Morgenthau-White international economic policy and the substitution of a policy that recognized the reality of American power.
The U.S.S.R. withdrew. In the United Kingdom and the United States bitter conflicts were fought out over the ratification of the Bretton Woods Agreement. The United States adopted more and more a dollar-centered view of the world, more compatible with a different intellectual tradition than that which had led to Bretton Woods. Over the next two decades, the United States often in practice behaved as if a dollar exchange standard had been created in 1944. . . . The United Kingdom clung desperately to the role of the pound sterling as an international currency and, as a consequence, became an obstacle to economic liberalization.84
84. Morgenthau and his aides worked hard and made several concessions to get the USSR to join the International Monetary Fund. Russia did not join until after the collapse of the Soviet Union in the late 1980s.
One of the anomalies of the period is that the American Bankers Association and most large New York banks vigorously opposed the IMF agreement. They could not, and did not, foresee the evolution of the fund. In the 1980s and 1990s, one of the fund’s main tasks was lending to countries experiencing capital outflow to permit them to service debts to large banks in New York and other financial centers.
POSTWAR POLICIES, BELIEFS, AND ACTIONS
Fred M. Vinson left the Treasury after a year to accept appointment to the Supreme Count. His replacement was John W. Snyder, a Missouri banker and friend of President Truman who had served during wartime in several government agencies. Snyder remained secretary until the Eisenhower administration took office in January 1953.
Economic policy remained under the control of the Treasury. On the fiscal side, at the war’s end, government purchases, mainly military spending, declined from $97.3 billion to $29.9 billion in the four quarters ending in second quarter 1946. Tax rates remained close to peak wartime levels. After a short postwar recession the economy grew, so tax receipts stabilized and the budget had a surplus.
After World War I, the budget shifted from a $13 billion deficit in 1919 to a $500 million surplus in 1921. The larger effort in World War II produced both a larger deficit and a larger swing—from a $54 billion deficit in fiscal 1945 to surpluses of $700 million in fiscal 1947 and $8 billion in fiscal 1948. Part of the surplus was used to reduce tax rates in November 1945 and April 1948. The highest income tax rate in World War I was 66.3 percent on an income of $1 million. By 1922 that rate was 55 percent, and a few years later, 24 percent. In World War II the highest rate, 90 percent at $1 million, fell to 84 percent in 1946–47 and 77 percent in 1944–49. Thereafter the rate rose to 87 percent during and after the Korean War.85
Despite pegged interest rates, pent-up demand, and fiscal stimulus from lower tax rates, inflation remained in the 4 to 6 percent range (deflator) through most of 1947 and 1948. By 1949 prices were stable or falling. This is one of the very few times in the postwar years to date that the price level declined.
Treasury operations were a main reason for reduced money growth and lower inflation. The Treasury used the proceeds of the Victory Loan in 1946 and its surpluses in 1947 and 1948 to retire debt.86 Gross public debt reached a local peak at $279.2 billion in February 1946. In the next three years, gross debt declined about 10 percent, $28 billion. Table 7.4 shows the change in the distribution of the debt by type of securities and by ownership.
85. The 1948 act permitted income splitting, so it reduced the rate applicable to many married, high-income taxpayers. The act, passed over President Truman’s veto, increased the standard deduction and reduc
ed rates for all taxpayers by $5 billion, about 11.5 percent of receipts.
One of the Treasury’s aims was to reduce the debt held in the banking system. As the table shows, it succeeded by selling the Victory Loan, consisting of securities ineligible for bank purchase, and by retiring notes and certificates held mainly by banks. The Victory Loan placed nearly $11 billion (net) with nonbank holders.
The administration retired outstanding debt after reducing spending in 1946, 1947, and 1948 and running $13 billion in cash budget surpluses, mainly in the 1947 and 1948 calendar years.87 The surplus, an excess of Treasury receipts over expenditures, reduced the public’s money balances. Using the surplus to retire debt held by the public restored those balances. Reducing debt held by commercial banks increased bank reserves and permitted banks to increase loans. Table 7.5 shows the changes in bank assets during this period. The most deflationary policy retired debt held by the reserve banks. This policy reduced the monetary base and did not restore the public’s money balances.
86. The Victory Loan raised $21 billion between December 1945 and February 1946. Gross public debt declined $20 billion from February through December 1946, so the net effect was to cancel the Victory Loan. As in the text, the reduction was mainly in notes and certificates, held mainly by banks, so the combined effect shifted debt ownership from banks to nonbank holders. The Treasury’s effort to sell bank-ineligible securities was less successful than the text suggests. During the Victory Loan, commercial banks purchased $7 billion in the market, almost all of it from nonbank investors.
A History of the Federal Reserve, Volume 1 Page 91
