The Balance of Power and the Balance of Payments

2007

Long before the phrase "balance of payments" was widely known in our country many people were familiar with the concept in international relations of balance-of-power. The whole phrase "balance of power" seems to suggest a seesaw with a great power sitting at each end and some of the smaller powers throwing their weight first one way and then the other as circumstances change. The balance-of-power, however, might better be likened to a large disk supported in the center by a pivot with its circumference ringed with all the elements which go into maintaining a nation's position. The chips that a nation places on the edge of this disk to tip it one way or the other have been the subject of study by this committee. They include, among others, moral force, military power and the geographic location of these forces in relation to other forces. What I am suggesting today is that the deficit in the American international balance-of-payments is now a weight on this disk which is influencing our relationships with the rest of the world.

In relating the soundness of the dollar to American power, I want to make it clear at the outset that history teaches that no war has ever been lost solely because the defeated power ran out of money or mismanaged its internal finances. If a sound currency were a prerequisite for victory, the American Revolution would never have been won and Nazi Germany would have been defeated much sooner. It is interesting that I can find no reference in the Federalist Papers to the importance of a sound currency in the national scheme of things, and if you review one of the oldest diplomatic handbooks of skulduggery, "The Prince" by Machiavelli, you will fail to find any strong statements about the importance of maintaining a solid currency. Indeed, it was not until 1863 in our own country that the National Bank Act and subsequent legislation forced out of circulation all notes excepting those issued by national banks. The point to remember, therefore, is that a country living in isolation can often survive with a bad currency, but a world power, like the United States, whose internal money is the reserve currency of the world, must inevitably be subject to different pressures and limitations. A bad currency, which is often the mirror image of a balance-of-payments deficit, is capable over a period of time of reducing a great power to a nation without influence in the world. The Spanish historian Salvador de Madariaga traced the decline of Spain as one of the world's most important powers to the importation of Peruvian gold which started a cycle of inflation that eventually broke up the greatest colonial power in the world. There are few instances in history where cause and effect can be sharply delineated with certainty, but there is no doubt that runaway inflation has been a major factor in many cases of declining political power.

John Stuart Mill wrote about money that: "It is a machine for doing quickly and commodiously, what would be done, though less quickly and commodiously, without it: and like many other kinds of machinery, it only exerts a distinct and independent influence of its own when it gets out of order." "Perfectly true," says Professor Milton Friedman. "Yet also somewhat misleading, unless we recognize that there is hardly a contrivance man possesses which can do more damage to a society when it goes amiss." If the United States dollar were permitted to deteriorate through extraordinarily large doses of credit expansion and thus assure a growing and continuous deficit in our balance of payments, this would have at least two major effects on the world balance of power: 1) It could in the end destroy the savings flow that builds our industrial plant and with it the main power base of our foreign policy. 2) Concurrently with our internal deterioration, the present gold exchange standard, which is anchored to a sound dollar, would be in danger of breaking down. Should this breakdown occur, the cohesive character of world economics made possible by the enormous growth in international trade and investment would be seriously undermined.

A look at the international record is instructive. In July, 1944, the Allied Nations sat down at Bretton Woods and put together the framework for a world payments mechanism built around the International Monetary Fund. It worked, and worked so well, that since 1949 it has financed an increase of more than $100 billion in Free World exports. In the process we largely freed ourselves from the shackles of economic nationalism that arose out of the debris of world-wide economic collapse in the early 1930s.

The wealth of the world has grown enormously. A number of countries once again can afford to hold vast amounts of gold. The system of international payments based as it is to a great extent on dollars and sterling is under sharp attack and there are uneasy rumblings of wanting to return to the exchange controls of the Thirties.

While recurring crises in sterling, and particularly the one last November, are major factors contributing to the rather pessimistic view some hold for the future of the present payments arrangements, we will center our remarks largely on the difficulties of the dollar.

The arithmetic of our balance-of-payments deficit is becoming familiar to many people who never gave it a thought until recently. Since 1949 the U.S. has incurred a deficit in its balance-of-payments every year but one. That was 1957. A statistical snapshot of that period shows that the cumulative deficit through last year totaled about $34 billion. It was financed largely by $9 billion of gold sales and an increase of $22 billion of liquid dollar liabilities to foreigners, both private and official.

Gold losses from the United States accelerated after 1959 and in the past six years our deficit on the so-called regular basis has ranged between $3 and $4 billion a year. The changes in accounting recommended by the Bernstein Committee would reduce last year's figure about one half. The deficit on any basis was serious enough so that various ad hoc measures have been undertaken to bring about equilibrium.

For years our balance-of-payments deficit was largely the concern of economists who regarded it as something of a technical problem. Traditionally, we regarded balance-of-payments problems as something that happened to other countries and had no real meaning for us except as an academic exercise. More recently, our deficit has moved from a classroom discussion to a position of some importance as a limiting factor upon the power of the United States to pursue its world-wide objectives and meet its responsibilities. Growing awareness of this new limitation has helped inspire a greater sense of urgency in finding a lasting solution. The global side effects of our balance-of-payments deficit are many and are increasing. 1 ) The specter of a breakdown in our international payments mechanism has tended to feed this world neurosis which could influence important economic decision making. 2) As a great power in a divided world we must assume political postures in our national interest which inevitably displease some of our allies. The France of De Gaulle has been outspoken in this regard. Our failure to bring our balance-of-payments into equilibrium has not been overlooked by that country as one means of giving weight to its differences with the United States--a kind of gold rattling diplomacy. 3) Should the deficit in our international payments continue unabated and at an accelerated rate, leading ultimately to devaluation of the dollar and collapse of the present payments mechanism, the political unity of the Free World in facing up to the Communist challenge could be seriously imperiled. 4) The difference between having a surplus or trying to finance a deficit must find reflection in our national posture. In the last few years we have had to ask our friends not to convert their dollars to gold and, additionally, to set up short term credits to ward off gold losses. To be in this position cannot be said to improve our political bargaining position in the world. 5) The less developed countries are asking with increasing frequency: Will your aid continue? Can you afford the Alliance for Progress?

The international political impact of our balance-of-payments problem has increased significantly over the past year so that it can no longer be regarded merely as a bookkeeping problem. In early January, when one of the most serious sterling crises of the postwar period was scarcely five weeks old, the French announced intentions to step up their conversion of dollars into gold. They did and in the first quarter of this year French gold purchases from the U.S. totaled about $450 million.

Many Americans are prone to scold General De Gaulle for what seems to be his bad manners in attacking a financial weak spot in the very country that had so much to do with helping his own achieve financial recovery and strength. I have no such inclination. We should learn a lesson from this experience. The difficulties we are now passing through with France are not by any means peculiar to that country or these times: they are evident elsewhere and could emerge to the French proportions.

The General is clear on the significance of linking national financial power to political power. France's differences with the leadership of the United States have many roots. Whatever the causes may be, the point is that the French have added their excess dollar holdings to their arsenal of arguments. Failure to give sufficient weight to the possible effects of our balance-of-payments deficit on political postures was a serious omission in our international financial policies during the past four years. What I have in mind particularly is the reliance on cooperative arrangements between central banks, foreign currency swaps, informal cooperation between the United States and foreign central banks in providing stability to the London gold market and the sale of special U.S. Treasury issues to foreign governments. There is no doubt that the spirit of cooperation embodied in these arrangements made possible the $3 billion rescue package for sterling last November. But even then, France, one of the major players in this team-work, went into the game half-heartedly.

The pressures of dollar and sterling difficulties are giving rise to a growing chorus of demands that urgent steps be undertaken to make changes in our international payments mechanism. The Group of Ten has been studying possible steps during the past two years. Whatever changes may be made in world payments arrangements, we must not overlook the lesson that the payments machinery must be insulated as much as possible from the political power plays in the community of nations. Long before we reach international agreement on changes in our international machinery, we must recognize the extent to which a weak dollar would fail to carry its weight on our balance-of-power disk.

As a nation we are concerned about the image created abroad by our open efforts to achieve social equilibrium between white and Negro citizens. It is also important that we recognize the extent to which our image as an effective Free World leader is influenced by our success or failure to achieve balance-of-payments equilibrium.

The dollar, hungrily sought by nations of the world in the aftermath of World War II and long regarded as better than gold, has recently picked up some of the stigma of controls that has long been identified with other currencies of the world. Two years ago we imposed a tax on borrowings by foreigners in the traditionally free U.S. capital market. More recently this tax was extended to bank loans, and the President has asked Congress to extend it for two years beyond its expiration date of December 31, 1965. Furthermore, this year, in response to a sudden deepening of our deficit in the final quarter of last year, the Administration asked businessmen voluntarily to restrict their investing and lending abroad. In part, this move was a response to the growing complaints in a few foreign countries that Americans were too competitive, too aggressive, in acquiring business interests there. The voluntary program, in its initial stages, seems to be working and working well. Dollars are draining out of markets abroad and while this may satisfy some countries abroad, notably France and Germany, others are becoming unhappy about the relatively sudden difficulties in getting all the dollars they need. Among these are Australia, Japan and some of the Scandinavian countries. Here too the balance-of-payments problem moves quickly from the Treasury Department to the State Department. The political overtones make a solution to the deficit more imperative than ever.

For many years we offered advice, first to Europe, then to our neighbors to the south, on how to stop the currency printing presses and so curb their balance-of-payments deficit. We have sought to enunciate the simple accounting principle in the balance sheet of central banks that when domestic assets in the form of government securities or loans to commercial banks go up, this increase is often offset by a reduction of gold and foreign currency holdings or, in other words, a deficit in the balance of payments. This is not an economic theory--it is arithmetic. Each nation, including our own, starts out on the premise that its deficit in the balance-of-payments is unique. It is due to low coffee prices, unfavorable terms of trade, capital flight, too much tourist expenditure, or too much foreign aid. Only after a protracted period do we ever get down to a concerted attack on the basic source of the deficit.

Before attacking the root cause, nations sometimes go down the dark road of exchange control despite the fact that exchange control has a perfect record of failure in curing balance-of-payments deficits anywhere in the world. The secondary political consequences of exchange control are even more important than their primary economic impact. Like our experiment with prohibition, exchange controls are not effective and encourage the worst criminal elements to circumvent them and erode our moral base. The British, for example, by limiting money made available to their citizens for foreign travel to a few dollars a day, effectively stopped an entire generation from seeing and thus learning about the world. Never in history has the penalty been so great for failure to understand the aspirations of the people of the world; yet the U. S., where the need is critical, seriously considered a tax on foreign travel which would have hindered the teachers of your children and mine from the kind of learning that only travel can bring. Controls breed more controls because it is impossible to write down the permutations and combinations of a free economy. Controls breed centralization of power which erodes freedom. For all of these reasons and many more--not the least of which is that they don't work--controls are the wrong way to solve our problem. They would vitiate our position of leadership by jamming up the wheels of the most efficient economic machine ever constructed.

The magnitude of our problem is great, but it is well within our capacity to solve through the intelligent application of the resources at our command, including the use of classical monetary and fiscal policies. This nation pays about $50 billion a year in sterile manufacture of military might as the necessary price of freedom. It is not unreasonable to believe that we would pay a far smaller price to maintain the integrity of our money lest we dissipate through this medium the leverage we need in the world to maintain our freedom.

The essence of successful policy is a highly developed sense of perspective. Those among us who would dismiss a deficit in our balance-of-payments as an inconsequential amount when measured against our over-all economy would be as wrong as those who overstate the danger to the point of talking about the collapse of the American power base. If the ancient axiom that we should negotiate from strength has any validity, it is clear that in the year 1965 one important element in that power base is a strong United States dollar. The relative importance of maintaining a sound dollar has grown enormously as America changed its posture from that of isolation to involvement in the world. The stakes are no longer only the stability of the American economy, but must include the enormous interest we have in preventing the breakdown of the whole Free World's monetary structure.

 
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  • The document was created from the speech, "The Balance of Power and the Balance of Payments," written by Walter B. Wriston for the U.S. Senate Subcommittee on National Security and International Operations on 13 May 1965. The original speech is located in MS134.001.001.00025.
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