As American deficits continued to mount, doubts were raised whether the huge amounts of US dollars held abroad could be converted into gold. By 1960, foreign claims on the dollar amounted to $20 billion, while the American gold hoard was only $19 billion. The Kennedy Administration, obsessed with the nation’s image abroad and committed to the restoration of pre-Sputnik American prestige, grew fearful of a run on Fort Knox. Maintaining a “sound dollar” and avoiding a currency crisis became high priorities for the government. Among other measures Kennedy imposed an “interest equalization tax” on US purchases of foreign securities, adopted “Buy America” policies for defense purchases, and maintained high interest rates to encourage US capital to stay at home and discourage it from seeking opportunities abroad. The Administration accepted limitations on domestic growth and employment for the sake of balance of payments rectitude.
Had it not been for the Vietnam war, the American deficit would probably have disappeared, leaving the dollar “strong” but the world economy short on reserves. But as it happened, American military expenditures abroad and the booming, import-happy economy at home sent the deficit to new heights in the mid-Sixties. Vietnam accounted for an $11 billion drain on the US balance of payments from 1965 through 1968—$6 billion in direct military expenditures and $5 billion in extra imports and reduced exports resulting from the fact that the economy was being run at a faster tempo during the war than Congressional conservatism had ever permitted during peacetime.1 In addition, direct investment abroad by US corporations exceeded foreign companies’ investments in the United States by $8 billion during the same period. Thus the United States would probably have had a substantial payments surplus if it had either stayed out of Vietnam or severely constricted corporate investment overseas.
The Johnson Administration, of course, did neither. It did extend some of its predecessor’s policies, adding some new controls on capital outflow, but for the most part it chose to ignore the balance of payments. Its own objectives, Vietnam escalation and home-front prosperity, took precedence over its fear of international financial embarrassment.
The result was the long-expected “crisis” on gold convertibility. Speculators and merchants rushed to dump their dollars for gold, and in March, 1968, the world’s central banks had to suspend their gold payments to private parties. America still remained pledged to redeem a foreign government’s dollar holdings with gold, but this clearly had become a Catch-22 promise, valid only until put to a real test. Any substantial run on the dollar would have forced the United States to stop converting dollars to gold.
The crisis came and went, leaving the United States with a continuing deficit, billions owed in foreign debts, and the most prosperous economy in its history. Soon economists and officials began to wonder whether the situation was really as perilous—or immoral—as orthodox economists suggested. Theorists began formulating a “benign neglect” policy toward the balance of payments. The United States, they argued, had no special responsibility to stanch its payments flow. Other nations, if they wished, could move to reverse their accumulation of dollars. They could pass laws to restrict new American investment or they could raise the value of their currencies, thus discouraging exports to the US and encouraging imports. But if they failed to do these things, America need not slow down her economy, or sacrifice her national programs, for the sake of international good citizenship.
This policy became influential in the Nixon Administration; but to the Europeans, it represented the summit of arrogance. Heedless of balance of payments constraints, America had financed the foreign currency needs of her military expansion in Asia and corporate expansion in both Europe and Asia (e.g., in Korea) simply by spending dollars and letting others accumulate them. Because of the dollar’s role as an international reserve currency, the Europeans complained, there was no effective limit on this process. Americans could buy abroad with overvalued dollars and expect foreign governments to hoard these pieces of paper, as if international finance were a giant Monopoly game with the US as banker. Without ever having asserted the right—and certainly without having been granted it—the United States had managed to get an indefinite free ride from the world’s other trading nations.
A special source of grievance for many Europeans was the use of America’s deficit to finance her investments in European industry. “Fifteen years from now,” wrote Jean-Jacques Servan-Schreiber in the late Sixties, “it is quite possible that the world’s third greatest industrial power, just after the United States and Russia, will not be Europe, but American industry in Europe.” Between 1964 and 1970, American investment in Europe totaled $21 billion.
The European complaint against our “benign neglect” policy has merit, as far as it goes. Had Europe shown any interest in stemming the flow of dollars by revising exchange rates, the United States would have had some moral obligation to cooperate. Indeed, we would have had little choice. Since the US doesn’t have enough gold to redeem the dollars held abroad, the Europeans could at any time have forced us to abandon the parity and let the dollar “float” to a new, lower level. But in fact, the European governments, like the Japanese, kowtowed to their exporters and resisted devaluation of the dollar. In these countries auto, steel, textile, and other manufacturers of exports wield even more power than their counterparts do in the United States.
Similarly, if the Europeans had proposed a revamping of the world monetary system to eliminate the privileged reserve status of the dollar, we would have had little right to object. Our de facto ability to make unlimited purchases of goods with dollars cannot be defended in principle. But as it happens, it has been the United States that has pushed proposals to increase the amount of international reserves that are not tied to the dollar, and the Europeans that have dragged their feet.
For years the French have had their own proposal: to topple the almighty dollar by restoring the reign of gold as the major world reserve currency. But this can hardly be called a reform. Raising the exchange value of gold would temporarily increase world reserves—each nation’s gold stock would be worth more in goods and national currencies—but it would have no impact at all on the basic problem of allowing countries to solve payment imbalances without crippling their domestic economies. In effect, increasing the price of gold would transfer the American reserve privilege to the major owners of gold—Middle Eastern sheiks, European speculators, and South African businessmen. While other European countries are less committed than France to the myth of gold, the prospect for a consensus on real reform measures is remote.
In view of the European attitude, an American attempt to force devaluation makes no sense as an act of international duty. Rather, it is an act of devotion, reinforcing the tradition that national prosperity and autonomy should be sacrificed to bankers’ ideology.
National autonomy, of course, is not always put to worthy uses. The dollar’s privileged position in world finance has made it easier to fuel the war in Vietnam. Stringent adherence to the orthodox rules would have limited our power to achieve all of our objectives, including the most deplorable ones. But it is not military adventures that the Nixon Administration intends to jettison. What Nixon has mainly accomplished by his devaluation of the dollar is a transfer of wealth from American consumers to citizens in foreign countries and to high-priced American manufacturers.
The European response to Nixon’s going it alone is uncertain. American mercantilism will strike a chord of recognition in the European financial community whose economic instincts are remarkably similar to John Connally’s. Should Nixon succeed in generating payments surpluses, some nations would have to accept debtor status. But the Europeans are not likely to sacrifice strong currencies to the American ego. They may retaliate by devaluating their own currencies, by erecting additional tariff barriers against American goods, or by subsidizing their exporters in order to regain access to the American market.
A trade war with Europe would have no serious impact on United States consumers, thanks to the near self-sufficiency of the North American economy. Damage in Europe would be more noticeable if exporters lost their substantial share of the $50 billion American import market, but the setback would not be disastrous. On both sides of the Atlantic, of course, a number of industries would be subject to very serious losses. From the view of American soybean farmers the Japanese market is more than a minor portion of national income.
A more notable cost would be intangible political losses in our relations with Europe and Japan. It is easy to write off the myth of the Atlantic Community as only a successful public relations job. European governments are presumably devoted to realpolitik, to maintaining workable relations with the US, and will not permit a breakdown to extend much beyond some nastiness in financial negotiations. But diplomatic progress on such questions as European disarmament, a European security settlement, and cooperative aid to underdeveloped countries could be retarded. In the coming months, there will be negotiations on the international monetary situation. One grim possibility is that a new system of rigidly fixed exchanges will emerge. Once more countries with unfavorable balances of payments will be pressured to shrink their economies and suffer unemployment.
A more sanguine possibility is that the tactic of floating the dollar might lead to the permanent abandonment of fixed exchange rates. It would in that case have served as a back door to the solution of the world’s real balance of payments problem: the rigidity with which the postwar regime of fixed exchange rates, like the old gold standard, has required countries to sacrifice domestic prosperity to international balance. Britain suffered years of privation to safeguard the value of the pound until Harold Wilson, like Nixon, decided he could treat devaluation as a mark of success. But even with the best of leadership, fixed exchange rates constantly pose a choice between austerity and crisis.
Floating rates, by letting the value of a country’s currency be determined largely by the market place, would allow more scope for domestic economic policy. A British government that wanted to reduce unemployment could pump up the economy without great worry about the trade accounts. As imports rose, the pound would indeed fall—but without a crisis or an international confrontation. Floating exchange rates certainly would not be an answer to all of Britain’s economic problems, but they would give its government greater leeway to pursue an aggressive growth policy. For this reason, more flexibility in international exchange has long been advocated by economic scholars. But until a few months ago, the combined opposition of Europe’s traditionalist bankers and its self-interested, politically powerful exporters prevented any European country from letting its currency float upward against the dollar.
Nixon’s moves may have disarmed that opposition. He may have inadvertently convinced America’s trading partners that competing with the US on mercantilist grounds is impractical. If the President of the US wants to exclude Volkswagens and Fiats from American markets, one way or the other he can do it. A prolonged period of floating, even without an explicit international agreement to float, could make clear the futility of nations competing to build up surpluses by overvaluing their exchange rates. But this may be wishful thinking in the narrow world of international finance which has never put a premium on rationality.
Rationality was not, of course, the theme of Nixon’s New Economic Policy, in either its domestic or its international editions. Its intent and effect were emotional and political. A single speech was supposed to reverse the Administration’s “game plan” for inflation, explain how the economy could be revived by cutting the budget, gloss over a regressive tax program, and win applause by devaluing the dollar. The method was dramaturgy, not logic. Its immediate political success testifies to our national belief that decisive action, regardless of its nature, will cure economic crises. With luck, the belief can be self-justifying, and the President’s belligerent and regressive moves may by their boldness alone produce some benefits. But no amount of showmanship will yield any permanent progress against the unemployment, maldistribution, and misuse of resources which now make a mockery of America’s trillion-dollar economy.
See Leonard Dudley and Peter Passell, "U.S. Balance of Payments and the War in Vietnam," Review of Economics and Statistics, November, 1968.↩
See Leonard Dudley and Peter Passell, “U.S. Balance of Payments and the War in Vietnam,” Review of Economics and Statistics, November, 1968.↩