Full text of Economic Review (Federal Reserve Bank of San Francisco) : July 1961

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L IB R A R r

AUG22 195)
ID A H O

A L A SK A

FEDERAL

RESERVE

T

TWELFTH

BANK

FEDERAL

OF

SAN

RESERVE

FRANCISCO

DISTRICT

W A S H IN G T O N

Review of Business Conditions

page 130

The Search For Certainty In An Uncertain World
PART II:

UTAH

The International Adjustment Process:
the Gold Standard and After

.

.

.

. page 137

Adjustment Under the Gold Standard
The Flight from the Gold Standard
OREGON

C A L IF O R N IA



The Pound Sterling Standard
The Dollar Standard
Summary

M

'
ARIZO N A

N EVADA

Review of Business Conditions
recovery in the national econom y was
tran sfo rm ed in M ay and Ju n e into eco­
nom ic expansion. G ross national p ro d u ct, in
real term s, is estim ated to have increased
above its p rio r peak. Industrial pro d u ctio n in
June m ade w idespread gains w hich w ere well
in excess of those seasonally expected, so th a t
physical p roduction is now approxim ately at
the pre-recession peak level. C ivilian em ploy­
m ent and nonfarm em ploym ent rose to record
levels in June, and the average pay rates and
w ork w eek of factory w orkers also rose. D e­
spite these w idespread im provem ents, the end­
ing of the school year resulted in an unusually
large nu m b er of new en tran ts to the labor
force so th a t the nu m b er of unem ployed rose
about seasonally to 5.6 m illion and the un em ­
ploym ent rate of 6.8 percent rem ained within
the range established over the past six m onths.
A lthough personal incom e has risen steadily
to new highs, retail trade continues below the
levels of the spring and fall of last year. The
m oderate behavior of consum ers has been re­
flected in the continued sidewise m ovem ent of
prices and in a m ore sober tone in the stock
and com m odity m arkets. T he principal forces
at w ork in the revival of business activity so
far have been a cessation of inventory c u t­
backs and increases in consum er and G o v ern ­
m ent spending, w ith sup p o rt from stable
levels of new construction and net exports.
T he m oney m arkets have continued rela­
tively easy, reflecting com fortable bank re­
serve positions and the absence of strong
loan dem and. A t city banks, loans in June
responded m oderately to co rp o rate tax and
dividend needs, b u t holdings of U nited States
G overnm ent securities expanded sharply. The
June increase in b an k credit brought loans at
city banks to a level about $870 m illion below
the first of the y ear and investm ents to $ 2.2
billion above the year-end level. T he to tal
credit expansion at city banks of $1.4 billion
com pares with declines at this tim e in m ost
he

T

130




recent years. D espite the rise in b an k credit,
the seasonally adjusted m oney supply in June
show ed no change, and for the first six m onths
of the year rose at an annual rate of only 2
percent. O ne explanation of the difference in
behavior betw een bank credit and dem and d e­
posits is afforded by the behavior of tim e d e­
posits w hich increased ab o u t $ 5 00 m illion in
June, on a seasonally adjusted basis, to bring
the rise since the end of 1960 to about $4.5
billion. This increase, at an an nual rate of 12
percent, is m uch faster than in m ost o th er
postw ar years.
In co n trast with the m odest dem an d for
bank loans in June, co rp o rate security issues
continued very large, and new b o nd offerings
by state and local governm ents w ere at a rec­
ord level. H igh-grade bond yields responded
by increasing in Ju n e to the highest levels of
the year, while sh o rt-term interest rates co n ­
tinued to fluctuate aro u n d the level estab ­
lished over the past six m onths. In Ju n e, and
particularly in July, cu rren t and prospective
T reasury needs fo r new funds and the sched­
uled m aturities of o u tstan d in g issues also d e­
pressed the interm ediate and longer term c a p ­
ital m arkets. Judging from the second q u arte r
gold and d ollar figures, the deficit in the U nited
States balance of paym ents has risen slightly
from the first q u a rte r to an annual rate of
about $1.5 billion.

Unemployment remains high
The level of unem ploym ent in the D istrict
rem ained high in M ay, but the typically heavy
increase in June was less th an in m ost previ­
ous years. C ontinued signs of recovery in the
D istrict labor m ark et occurred in M ay and
also in June, according to p relim inary data.
In the Pacific C oast States, to tal civilian em ­
ploym ent expanded slightly m ore th a n sea­
sonally in M ay and June. T he increase of
3 3 7 ,4 0 0 persons from A pril pushed total civil­
ian em ploym ent in those states to a record

July 1961

MONTHLY REVIEW

high of alm ost 8 m illion persons in June. P re­
lim inary d ata indicate th a t Tw elfth D istrict
nonfarm em ploym ent also expanded in June
as well as in M ay.
T he addition of 72,3 0 0 wage and salary
w orkers swelled D istrict non farm payrolls to
7.1 million in M ay. T he rise was greater
th an seasonal and, as expected, m ore th an
com pensated fo r the disappointingly small in ­
crease in A pril th at was due to a labor dispute.
B etter than seasonal expansion occurred in all
m ajor industry categories except m ining, co n ­
struction, and tran sp o rtatio n . E m ploym ent
gains were sharpest in the m anufacture of
durables because of the term in atio n of strikes
in m achinery and fab ricated m etals industries.
A ircraft was the only h ard goods industry th a t
m oved counter to the tren d as increased h ir­
ing by Boeing in Seattle was outw eighed by
layoffs am ong Southern C alifornia firms. A l­
though the size of layoffs during the past few
m onths generally has been sm aller th an it
was in the sam e p eriod of 1960, the M ay
em ploym ent decline in the L os A ngeles-Long
B each area resulted in the displacem ent of
aircraft by electrical m achinery (w hich in ­
cludes electronics) as the largest em ployer
am ong m anufacturing industries in th a t area.
This reflects the fundam ental change in m ili­
tary defense p rocu rem en t during recent years.
Seasonal declines dom inated the em ploym ent
picture in nondurables m anufacturing, but
continued gains in M ay o ccu rred in printing
and publishing and in m iscellaneous non­
durables (chem icals, petroleum , ru b b er, and
leather p ro d u c ts). M an u factu rin g industries
showing higher em ploym ent th a n a year ago
were electrical m achinery, p rinting and p u b ­
lishing, and shipbuilding.
The average length of th e factory w ork­
w eek in the Twelfth D istrict again rose by a
little m ore th an usual in M ay, m oving from
a seasonally adjusted 39.7 in A pril to 39.8
hours in M ay. This was the second consecu­
tive m onth this year th at average weekly hours
equaled year-ago levels.



A v e r a g e w o rk w e e k in District
m a n u fa c tu rin g has risen steadily
since February
A v e r a g e W ee k ly H our s

40 .0 r

J

F

M

A

M

J

J

A

S

O

N

D

Note: Data are adjusted for seasonal variation.
Source: State departments of employment.

D espite the lengthening of the w orkw eek
and a grow ing level of em ploym ent, total
unem ploym ent in the Pacific C oast States re­
m ained high in M ay, falling by 15,400 w ork­
ers from A pril to 5 7 6 ,0 0 0 — a little less than
the expected seasonal decrease. O n a season­
ally adjusted basis, the unem ploym ent rate
went from 7.4 percent in A pril to 7.5 percent
in M ay. T he en tran ce of a som ew hat larger
num ber of new jobseekers into the labor force
and a persistently high level of long-term u n ­
em ploym ent accounted fo r the failure of the
unem ploym ent rate to decline. The slow re­
sponse of unem ploym ent to the im provem ent
in econom ic activity reflects a characteristic
tendency of em ployers at the end of recessions
to increase hours and reduce layoffs before
engaging in heavy rehiring.
A heavy influx of new jobseekers into the
lab o r force in June increased unem ploym ent
in the Pacific C oast States by 30,500 to a
total of 606,400 w orkers, the highest level
for June in the postw ar period. H ow ever, the
increase was som ew hat sm aller th an usual
for June, and consequently the seasonally ad­
justed rate of unem ploym ent as a percent of
the labor force fell from 7.5 in M ay to 7.2 in

FEDERAL

RESERVE

BANK

June. T he n u m b er of m ajo r la b o r m ark et
areas in the D istrict having substantial u n em ­
ploym ent (6 p ercen t o r m o re ), how ever, re­
m ained unchanged, although th e n atio n al list
of such areas declined by 8 in June. T en o f the
15 m ajor in d u strial areas in the D istrict con­
tinued in th e la b o r surplus category, w hereas
nationally the p ro p o rtio n was 88 o u t of 150.
W enatchee, W ashington an d O xnard, C ali­
fo rn ia w ere added to th e list of sm aller areas
of substantial unem ploym ent, bringing this
to tal to 18. A s in M ay, half of these 18 areas
w ere also designated as areas of “p ersisten t”
labor surplus.
A greater th a n seasonal expansion in D is­
trict em ploym ent th ro u g h m id-July is sug­
gested by em ployer hiring schedules. F ro m
m id-M ay to m id-July, according to reports of
local state em ploym ent offices, these hiring
schedules p o in t to a seasonal expansion of
em ploym ent in co nstruction and food p ro c ­
essing, w ith som e additional n onseasonal gains
in p rim ary an d fab ricated m etals, electrical
m a c h in e r y , o rd n a n c e , a n d s h ip b u ild in g ,
m ostly concen trated in the Los A ngeles-Long
B each, San F ran cisco -O ak lan d , an d San Jose
areas. F u rth e r sizable cutbacks are expected
in the civilian and m ilitary aircraft industry of
L os A ngeles-L ong B each, b u t as in M ay these
are not expected to be large enough to o v er­
shadow the an ticip ated n onseasonal gains in
several o th er industries.

OF

SAN

FRANCISCO

increased contracts fo r streets an d highw ays,
continuing the tren d observed in recen t re­
ports. N o nresidential co n tracts, on the o th e r
hand, fell slightly below M ay 1960, reflecting
declines in aw ards fo r m an u factu rin g and edu­
cational and science buildings. T he decline in
the la tte r category m ay have been m ore in the
n atu re of an erratic m ovem ent, how ever, since
contracts fo r these buildings have been h o ld ­
ing up so fa r this y ear an d th ere is no reaso n
to expect a decline. T he sam e general p a tte rn
of change in co n stru ctio n aw ards is evident
nationally.
D istrict F H A applications fo r m ortgage in ­
surance on new housing failed to p ick up in
A pril, the m ost recent m o n th available, al­
though they d id increase m ore th a n seasonally
fo r the entire n atio n in M ay. D istrict applica­
tions fo r F H A -m o rtg ag e insurance on existing
hom es continued to increase. F o r th e first four
m onths of this year, th e re have been over
three-fourths again as m any of these applica­
tions com pared w ith the sam e p erio d in 1960.
D istrict savings and lo an associations have
been increasing th eir m ortgage investm ents
m ore rapidly th a n in 1960, an d this is likely
to continue as th eir m ortgage lo an co m m it­
m ents in M ay w ere substantially above the
sam e d ate last year. T h e flow o f savings into
these associations continues at a rate exceed­
ing la st y e a r’s pace.

Lumber and plywood markets

District construction up in M ay

steady in June

T otal con stru ctio n in the D istrict, as m eas­
ured by the value o f co n stru ctio n contracts,
am ounted to $658 m illion in M ay or 8 percent
above the sam e m onth last year. D istrict resi­
dential contracts w ere 13 p ercen t above M ay
1960, reflecting increased contracts fo r bo th
single and m u lti-fam ily units. A w ards for
h e a v y e n g in e e r in g c o n s tr u c tio n w e re a ls o
above last y ear ( 1 2 p erce n t) because of in ­
creased con tracts fo r b o th public w orks and
utilities construction. T he form er was due to

A fter easing in A pril an d M ay follow ing an
early spring upsurge, new o rd ers fo r D ouglas
fir leveled off in the first half of Ju n e acco rd ­
ing to p relim inary reports and, in fact, rose
slightly d uring th e la tter p a rt of the m onth.
F ir p ro d u ctio n in Ju n e was ap p aren tly kept
in check, falling slightly below th e level of
new orders. H ow ever, this level o f o u tp u t was
still above shipm ents, w ith th e resu lt th a t in ­
ventories increased slightly. Prices, w hich h ad
declined slightly to w ard th e en d of M ay, w ere




July 1961

M ONTHLY REVIEW

steady during the first two w eeks of June. P re­
lim inary reports on w estern pine new orders
in June suggest th at they were approxim ately
the sam e as in M ay. W estern pine o u tp u t was
apparently also held below new orders and
slightly below pine shipm ents, with the latter
resulting in a fu rth er decline in pine inven­
tories. P ine o u tp u t through the end of June
is estim ated to be 15 p ercen t below th a t of
the corresponding period in 1960. Plyw ood
prices on the on e-q u arter inch sanded p anel­
ing, w hich had been p ushed up to $68 p er
1,000 square feet at the end of M ay, rem ained
at this $68 level thro u g h o u t the m onth of June.
D istrict lum ber m arkets are beginning to
feel the im pact of certain international devel­
opm ents. O ne of these is the recent increase
in J a p a n ’s purchases of tim b er from U nited
States G overnm ent-ow ned land (F ed eral tim ­
b e r), a dem and increase which is reported to
have pushed up the price of this tim ber. This
is having repercussions on dom estic mills,
since m ost of them depend on buying F ederal
tim ber o r logs for at least a p art of th eir raw
m aterials. T he decline in the value of the C a­
nadian dollar vis-a-vis the U nited States d o l­
lar has also created some uncertainty in the
D istrict lum ber m arket. B rtish C olum bia mills
turn out the sam e types of lum ber as do D is­
trict mills, and they both sell in the sam e m a r­
ket. T he decline in the C an ad ian do llar gives
C anadian mills a slightly w ider profit m argin
from sales in the A m erican m arket and th e re­
fore could encourage some price cutting by
these C anadian mills and th eir m ore inten­
sive cultivation of o u r m arkets.

Steel production enters seasonal slump
T h e D is tric t ste e l p r o d u c tio n in d e x in ­
creased steadily from the low of 111 (1 9 4 7 -4 9
equals 100) in Jan u ary of this year to 191 in
M ay. The output in M ay was higher than any
m onth since the first two m onths of last year.
H ow ever, production during June, as indi­
cated by weekly rates for the W estern States ,1
1 T w e l f t h D i s t r i c t a n d C o lo ra do.




retreated slightly from the high M ay rates.
T he weekly index (b ased on 1 9 5 7 -5 9 ), which
ranged betw een 121 and 128 during M ay,
varied betw een 119 and 124 during June. T he
average of Ju n e weekly rates fo r the W estern
States of 121 contrasts with an average of only
108 for national steel production and reflects
the fact that recovery of steel production has
been m uch m ore rapid in the W est. F o r the
first week of July, the D istrict index was 110
and the national index was 95.5. Some official
price cuts on several kinds and grades of steel
products occurred during June following re ­
ports of price shading by sm aller com panies
com peting fo r larger m arket shares in order
to operate at higher rates of capacity.
C urrently, the earlier autom obile m odel
changeover this y ear and usual vacation sh u t­
downs are affecting bo th steel and copper. In
addition, the dem and for copper was affected
by a potential strike against a m ajor mine p ro ­
ducer which did not develop. M ay shipm ents
of fabricated co p p er products in term s of cop­
per content were the highest for any m onth in
16 years. H ow ever, w hen the strike did not
m aterialize, dem and for fab ricated products
— and in turn for refined— eased during June.

Retail sales erratic
Sales of G ro u p I retail sto res 1 in the D istrict
during M ay rose 6 percent from A pril and
approached the dollar volum e of sales a year
earlier. O n a trading day basis, how ever, sales
by G ro u p 1 stores eased from both the previ­
ous m onth and a y ear ago as did departm ent
s to r e s a le s . B u t d e p a r t m e n t s to r e s a le s
strengthened in June and were 6 percent above
a year ago. New passenger car registrations in
C alifornia in M ay increased by 9 percent over
A pril and were only 2 percent u nder the n um ­
ber registered in M ay 1960. H ow ever, on a
daily average basis (registration day b a sis),
the decline from a year ago was 6 percent. F o r
'Scores of firms o p e r a t i n g 1-10 scores a t th e tim e o f t h e 1958
C e n s u s o f B u sin e s s. P r io r to D e c e m b e r I 9 6 0 , sto re s in th is
ca t e g o r y w e re c la ss if ie d o n th e basis o f th e 1954 C e n s u s .

133

FEDERAL

RESERVE

BANK

District retail sa le s h a v e b e h a v e d
e rra tic a lly compared with year ago

1961

Note: Data plotted are adjusted to a trading day basis and show
percentage changes from corresponding months of 1960.
Source: Bureau of the Census and Federal Reserve Bank of San
Francisco.

the first five m onths of 1961, to tal reg istra­
tions w ere 16 p ercen t behind those during the
com parable perio d of 1960.

Farm receipts slump in April
R eturns to D istrict farm ers fro m m a rk e t­
ings in A pril dro p p ed 10 p ercen t from A pril
of 1960 as cro p receipts declined sharply. A
reduction was not unexpected because vege­
table prices w ere unusually high last year.
H ow ever, receipts in A pril were even below
the dollar volum e received in M arch. This is
the first y e a r since 1953 th a t a reduction in
cash receipts has occurred from M arch to
A pril. F o r the first fo u r m onths of th e year,
receipts from m arketings were slightly below
those received during the com parable p eri­
od of 1960. N ationally, receipts w ere up 7
percent for the sam e four-m o n th period.

134

Som e of th e uncertainty concerning the
farm lab o r situation in C alifornia has been
rem oved as a m ajo r u n io n ’s organizing efforts
am ong C alifornia farm w orkers have been
halted. H ow ever, oth er lim ited union activity
in C alifornia agriculture continues.




OF

SAN

FRANCISCO

Tax borrowing boosts loan volume
in June
T o tal loans ad ju sted 1 and investm ents of
D istrict w eekly rep o rtin g m em b er b anks in ­
creased over $300 m illion in the la st three
weeks of June. T he loan increase of $100
m illion was largely due to tax borrow ing at
m id-m onth by business firms an d increased
use of b an k credit by n o n b an k financial in sti­
tutions th a t custom arily reso rt to b a n k accom ­
m odations around tax p aym ent dates as h o ld ­
ers of th eir open m ark et p a p e r allow it to
run off. Business firms b o rrow ed only h alf as
m uch as in the corresponding p erio d last year,
but borrow ing by sales finance com panies was
heavier. T he increase in investm ents during
this period was reflected in larg er holdings of
both U nited States G o v ern m en t securities and
o th er securities. W eekly rep o rtin g b anks w ere
allocated relatively sm all am ounts of the new
strip T reasu ry bills in m id-June b u t bought
additional bills in the secondary m arkets.
N et additions w ere also m ade to holdings of
T reasury bonds of over 5-year m aturity. T he
2 XA percent bonds m atu rin g in Ju n e 1962 and
the 2 Vi p ercen t bonds callable in Ju n e 1962
1 Total loans less valuation reserves and loans to domestic com­
mercial banks.

District fa rm cash receipts
d e clin e d in April
M i l l i o n s of D o ll a r s

Source; United States Department of Agriculture.

v

MONTHLY REVIEW

July 1961

d ropped into the w ithin 1 -year m aturity range
and accounted for a large p art of the increase
in holdings in this m aturity category. D em and
deposits adjusted declined in the last three
weeks of June, but time deposits continued to
rise as savings offset declines in deposit ho ld ­
ings of foreign banks and official institutions
and of states and political subdivisions. In
contrast to recent m onths, D istrict banks were
net purchasers of F ederal funds in the period
June 7-28 as tem p o rary tightness developed
in the reserve positions of some banks.

Second quarter shows gains in loans,
investments, and deposits
A brief survey of the position of D istrict
weekly reporting m em ber banks at the end of
June discloses that loans adjusted and invest­
m ents were alm ost $850 million above the
end of the first quarter. This was $300 million

m ore than the increase in the second q u arter
last year. H owever, only 10 percent of the
gain in 1961. was accounted fo r by loans,
while last y ear loans were responsible fo r 95
percent of the increase. This difference in per­
form ance is fu rth er brought out by the fact
that the level of loans adjusted at the end of
June 1961 was still below th at at year-end,
w hereas there was over a $500 m illion in­
crease in the first six m onths of 1960.
The accom panying table illustrates the d i­
verse m ovem ents of loan categories in the
second qu arter of 1961 and of 1960. This year
business loans showed only a nom inal in­
crease for the q u arter as dem and for bank
credit by the m etal products industry and
oth er m anufacturing and m ining firms, by
public utilities, and by trade firms failed to
develop in the sam e m agnitude as last year.
The only category to show particu lar strength

C H A N G E S IN S E L E C T E D B A LA N C E S H E E T ITE M S OF T W E L F T H D IS T R IC T
W E E K L Y R E P O R TIN G M EM BER B AN KS
(millions of dollars)
19b0

1961

ASSETS:
Loans adjusted1 and investments
Loans adjusted’
Commercial and industrial
Real estate
Nonbank financial institutions
For purchasing and
carrying securities
Other

First
Quarter

Second
Quarter

First 6
Months

First
Quarter

Second
Quarter

First 6
Months

— 339
— IS 8
— 52
— 52
— 90

+ 841
+ 84
+
2
+ 47
+ 11

+ 502
— 74
— 50
—
5
79

— 1,018
—
19
+
33
—
22
—
24

+ 551
+ 526
+ 279
— 69
+ 96

— 467
+ 507
+ 312
— 91
+ 72

—
+

f
98

—
—

11
39

—
+

+ 13
+ 214

+ 576
+ 474
— 52
+ 165

19
26
998
891
160
166

—
6
+ 188

757
660
288
259

+
+
—
—
—
—

+
+
+
+

24
61
31
34

—
—
—
—

974
830
129
132

93
68
22
38

—
+
—
—

295
276
549
145

12
59

Total investments
Total U. S. securities
Treasury bills
tertiticates
Notes and bonds
Within 1 year
1 to 5 years
After S years
Other securities

— 181
— 186
— 340
_ _ 94

+
+
+
+

+ 321
— 45
— 28
+
5

+ 452
— 512
+ 172
+ 97

+
—
+
+

773
557
144
102

—
+
—
—

202
208
571
107

—
+
+
—

LIABILITIES:
Demand deposits adjusted
Total time deposits

— 365
— 144

— 28
+ 562

— 393
+ 418

—
-

728
451

— 264
+ 260

_______________

1 Exclusive of loans to domestic commercial banks and after deduction of valuation reserves; individual loan items are shown gross.
Source: Federal Reserve Bank of San Francisco.




— 992
— 191
135

FEDERAL

RESERVE

BANK

during the q u arte r was real estate loans, a
reversal o f last y e a r’s trend. T he volum e of
consum er borow ing, as reflected in the “o th er
loan category” in the table, is distorted due to
the inclusion of loans of over $200 million
m ade to a n atio n al retail firm in the first
q u arte r and of repaym ents of about half th at
am ount m ade in the second qu arter. If ad ju st­
m ents are m ade to exclude these loans, co n ­
sum er borrow ing w ould show an increase of
about $60 m illion in the second q u arte r this
year instead of a decline.
T he absence of loan pressure, the grow th
in total deposits, and the continued ease in
b an k reserve positions during the second
q u a rte r led D istrict weekly reporting m em ber
banks to m ake a net increase of over $750
m illion in investm ents. As can be noted in the
accom panying table, m ost of the gain was
concentrated in short-term U nited States G ov­
ernm ent securities, although additions were
also m ade to holdings in the over 5-year m a­
turity range. T h e second q u arte r of 1961
contrasts sharply w ith th a t of last y ear w hen
weekly reporting banks added only $24 m il­
lion to th eir investm ent portfolios and d e­
creased th eir holdings of T reasury notes and
bonds of un d er one-year m aturity. The in ­
crease in investm ents represents som e rebuild­
ing of the liquidity of D istrict banks, although
their loan to deposit ratios are still high rela­
tive to m ost of th e postw ar period. This factor,
com bined w ith expectations of a pickup in
business and consequently in loan dem and,
has restrained banks from aggressively seek­
ing to expand th eir loan portfolios by either
lengthening lo an m aturities significantly o r by
low ering sh o rter term interest charges. In fact,

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as is noted below, interest rates o n business
loans have tended to rise.
D em and deposits show ed a no m inal in­
crease in the second q u arte r while to tal tim e
deposits increased over $550 m illion, m ore
than twice the increase in the second q u arte r
of last year. C o m putation o f in terest on sav­
ings accounts on a daily basis ap p ears to be
m aking such deposits increasingly attractive.

Higher rates on short-term business
borrowing
B usiness firms th a t b o rro w ed sh ort-term
funds from Twelfth D istrict ban k s in Ju n e
p aid a slightly higher average rate of interest
th an in M arch, according to the latest q u a r­
terly interest rate survey con d u cted by the
F ed eral R eserve B ank of San F rancisco. W hile
the increase was n o t large, it rep resented a
reversal of the tren d in the preceding three
qu arters tow ard low er borrow ing costs. The
average unw eighted interest rate on sh o rt­
term loans (those m aturing in one year o r
less) m ade during the p eriod Ju n e 1-15 was
5.36 percent, an increase o f 8 basis points
from the 5.28 percent rate prevailing in M arch
and 4 basis points above the average rate in
D ecem ber 1960. T he d o llar volum e of loans
carrying the cu rren t prim e rate of 4 Vi p e r­
cent d ropped from 33 p ercen t in the M arch
survey p eriod to 28 p ercen t in Ju n e. T here
was also an upw ard shift in the p ercentage of
the do llar volum e of loans m ade at rates over
5 p ercen t and over 6 percent. T he average
rate on business loans of ov er one y ear was
5.51 p ercen t in June, dow n from th e average
rate in M arch b u t still above the 5,28 percent
rate prevailing in D ecem b er 1960.

The Search for Certainty in
An Uncertain World
P art II
THE INTERNATIONAL ADJUSTMENT PROCESS:
THE GOLD STANDARD AND AFTER
ADJUSTMENT UNDER THE
GOLD STANDARD
first article 1 in this series dealt with
the function of gold as backing for the do­
mestic m onetary issue. T he m an n er o r m etal
in which each co u n try defined its currency
would be of little consequence if each co u n ­
try were a self-contained econom ic unit. But
because the nations of the w orld exchange
goods with each other and because trade be­
tween any two countries is rarely exactly in
balance, it is im perative th a t there be some
com m on basis for transacting business and
m aking paym ents. T rad e betw een New Y ork
and M ontreal, for exam ple, represents a m ore
com plex paym ents problem than trade be­
tween New Y ork and San F rancisco because
different m onetary units are em ployed. The
exporter wishes to be paid in his ow n cu r­
rency, and the im p o rter wishes to pay in his,
so th a t in international transactions a com ­
m on denom inator is useful. T h at com m on
denom inator has long been gold. T he follow ­
ing discussion traces the role of gold in the
international paym ents m echanism from the
h e y d a y o f th e “ c la s s ic a l” g o ld s ta n d a r d
through the rise of the key currencies— the
pound sterling and the U nited States dollar.
M em bership in the com m unity of nations
which w ere a p arty to the international gold
standard was easily obtained. T h ere were
two principal requirem ents: First, th at gold
should serve as the stan d ard of value for the
p a r tic u la r n a tio n , a n d , s e c o n d , th a t th e
he

T

1M o n th ly Review, Federal Reserve Bank of San Francisco,
May 1961.




treasury o r central bank should stand ready
to buy and sell gold a t a fixed price and p er­
mit the free im port and ex p o rt of gold. The
first of these requirem ents is a purely internal
m atter for it m erely specifies th at all form s of
dom estic m oney, w hether coins, currency, or
dem and deposits, shall be kept at p ar with
gold and with one another.
The second requirem ent of the gold stan d ­
ard was w hat gave it its in tern atio n al c h a r­
acter. N ations w ere tied together by virtue of
the fact that they defined their currencies in
term s of gold and w ere willing to buy o r sell
gold and perm it the im port o r export of gold
w ithout restriction. T he am ount of gold in
the various currencies determ ined the ex­
change ratios of those currencies as long as
convertibility was perm itted. Since the gold
co n ten t of the currencies of the gold standard
nations rem ained relatively constant, a sys­
tem of fixed exchange rates together with
the free m ovem ent of gold across national
borders was the m echanism through which
the adjustm ents to any im balance in a coun­
try ’s paym ents were supposed to take place
under the international gold standard.
T he o p eratio n of the adjustm ent m ech­
anism m ight best be exam ined by looking at
two countries, one of which has a deficit in
its balance of paym ents with the other, and
following the course of adjustm ent in the
respective countries. It should be em phasized
th at the adjustm ent is necessitated by an im ­
balance in the external accounts rath er than
by gold flows, which serve m erely as one
m eans of restoring a balance.

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FEDERAL

RESERVE

BANK

Adjustments to a payments deficit
may operate through prices
and interest rates
F o r purposes of exposition, assum e th a t
one of the countries on the gold stan d ard
experiences a tem p o rary deficit in its in ter­
n ational accounts. A fam iliar exam ple is a
crop failure and the need to im port food­
stuffs. L et us assum e th a t this results in a
net im port balance. (T h is is m ore correctly
a deficit in the balance of trade rath e r than
in the balance of paym ents, but it serves to
illustrate the process of ad ju stm en t.) T he net
im port balance m ay be settled in several
w ays: By draw ing upon existing short-term
claim s held ab ro ad , through borrow ing of
the foreign currencies needed, o r through the
w illingness o f foreigners to accept paym ent
in the form of b an k balances in the debtor
country. A fu rth er m eans of settling a deficit,
and the m ost relevant to o u r subject, is the
shipm ent of gold.
W hen the adjustm ent m echanism un d er the
international gold stan d ard was first studied,
it was thought to o p erate prim arily through
c h a n g e s in p ric e s, in te r e s t ra te s , a n d th e
m oney supply in bo th the d eb to r and creditor
countries. This explanation cam e to be asso­
ciated with w hat is popularly called the “clas­
sical” gold standard. As gold is sent abroad,
the dom estic m oney supply shrinks since the

138




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b u y er’s deposits fall when checks are w ritten
to p u rch ase gold. T h ere is an equivalent re­
duction in bank reserves as com m ercial banks
either reduce their own holdings of gold w hen
this is perm itted or reduce th eir claim s upon
the central bank (th a t is, their reserves) to
pay for the gold. U n d er a fractional reserve
system , the gold loss forces a reduction in
overall deposits by a m ultiple of the gold lost
if the banking system is o perating w ithout
excess reserves. This is done through a reduc­
tion in outstanding bank loans and invest­
ments.
As the m oney supply in the deficit country
is reduced, prices are supposed to fall since
the sam e am ount of business m ust be tra n s­
acted with a sm aller stock of m oney. A d e­
cline in the level of dom estic prices relative
to foreign prices tends to discourage buying
abroad. O n the o th er hand, the low er price
level in the deficit country will m ake it a m ore
attractive place for foreigners to buy goods.
T h e cost stru ctu re of the country losing gold
will also tend to fall since the deflation occa­
sioned by the gold loss may also push dow n
wage rates, fu rth er im proving the com petitive
advantage of the deficit co u n try in both its
ow n and in foreign m arkets. A s ex p o rts ex­
pand and im ports decrease because of the
changes in prices, the co u n try ’s receipts and
paym ents are brought into closer balance.
A t th e sa m e tim e , th e g o ld o u tflo w is
supposed to com pel banks to liquidate their
loans and investm ents because of the pressure
placed on their reserves. Security prices will
be depressed by sales from the b an k s’ p o rt­
folios, and b an k loans will be h ard er to o b ­
tain. In terest rates in general will tend to rise,
discouraging new investm ent in p lan t and
equipm ent. T he reduced levels of p roduction
and em ploym ent w hich stem from the d e­
creased availability of credit and from higher
in te r e s t r a te s w ill h e lp to p u s h d o w n th e
prices of finished goods and labor. T h e net

July 1961

MONTHLY REVIEW

effect of the gold loss in the deficit country
is thus deflationary, despite some offset aris­
ing from larger purchases in the deficit co u n ­
try by both nationals and foreigners as prices
decline.
In the surplus country, on the o th er hand,
changes in the opposite direction are su p ­
posed to occur. A s gold flows into the co u n ­
try, the m oney supply increases and prices
tend to rise. H igher dom estic prices reduce
the attractiveness of the goods of the surplus
country to foreigners b u t m ake th at country
a better m arket; as a consequence, exports
tend to fall and im ports increase. Interest
rates tend to decline, encouraging business­
m en to lay in greater stocks of inventories,
not only because interest rates are falling and
it is easier to obtain b an k accom m odation
but also because prices are rising and busi­
nessm en wish to build their inventories in
advance of rising prices. E x p an sio n ary influ­
ences therefore em erge in the surplus coun­
try.

Central banks played a positive
role under the international
gold standard
W ithin the fram ew ork of th e international
gold standard, central banks w ere assigned
a m ore positive role th an sim ply the passive
act of exchanging gold for currency. T he cen­
tral bank was supposed to act according to
the “ rules of the gam e,” a series of m easures
intended to reinforce the basic adjustm ent
forces. T he principal action was either to
raise o r low er the central b a n k ’s discount rate
depending upon w hether the co u n try was los­
ing o r gaining gold. A n increase in the dis­
count rate in the face of a gold outflow was
designed to p ro tect the central b an k ’s gold
reserve, the ultim ate cover for the dom estic
currency and deposits. T he increase in the
r a te w o u ld a t tr a c t s h o rt-te rm fu n d s fro m
abroad and thereb y gold, o r slow the rate of
gold loss. This m easure w ould reinforce the



restrictive effect on interest rates and price
levels of com m ercial b an k adjustm ents. T he
B ank of E ngland discovered th a t quick ac­
tion in raising the b an k rate could stem the
gold outflow quite rapidly, and there is even
an instance recorded in which an ou tb ound
shipm ent of gold was taken off a ship in the
h arb o r upon the news th a t the b an k rate had
been raised. A higher bank rate also encour­
aged com m ercial banks to reduce their in­
debtedness to the central bank.
T he im pact of changes in a co u n try ’s gold
stock could also be intensified by the use of
open m arket operations. A sale of securities
by the central bank in the open m arket in the
case of a gold outflow w ould reduce further
the reserves of the banking system, while the
purchase of securities by the central bank
w hen gold was flowing into the country would
supply additional reserves. O th er m ethods
th a t were used by central banks to facilitate
the adjustm ent process un d er the in terna­
tional gold stan d ard included borrow ing from
the m arket and m oral suasion. A s a rule of
thum b, the “rules of the gam e” dictated that
the dom estic assets of the central bank should
m ove in the sam e direction as its holdings of
in ternational assets, chiefly gold.

Changes in income important
in adjustment process
U n d e r th e in te r n a tio n a l g o ld s ta n d a rd
m echanism , as literally interpreted, a great
deal of gold m ight have been expected to flow
back and forth betw een countries in settle­
m ent of deficits. H ow ever, the physical m ove­
m ent of gold was surprisingly small. O ne rea­
son was the influence of the differentials in
interest rates upon sh ort-term capital flows.
Short-term balances are particularly sensitive
to differences in retu rn on alternative invest­
m ents. F o r exam ple, if gold threatens to or
actually flows o u t of New Y ork to L ondon
to cover a U nited States deficit, the resultant
rise in interest rates in N ew Y ork and their

139

FEDERAL

RESERVE

BANK

decline in L o n d o n will induce a p ro m p t flow
of short-term funds from L o n d o n to New
Y ork as investors shift balances to take ad­
vantage of the higher returns in N ew Y ork.
T hese balances, of course, will flow w here
possible to th a t investm ent giving the m ost
favorable yield only under conditions of com ­
plete confidence in m aintenance of converti­
bility at stable exchange rates.
T he m ore fu n d am en tal reason why gold
m ovem ents w ere m inim ized, how ever, was
the fact th a t the adjustm ent process did not
op erate exclusively through changes in prices
and interest rates. T he original explanation
of the gold stan d ard m echanism u n d er stable
exchange rates assum ed conditions of full
em ploym ent and price and wage flexibility,
w hich necessarily placed m uch of the b urden
of adjustm en t on prices. U n d er conditions
m ore closely approxim ating reality, w here
there m ay be less th an full em ploym ent and
price and w age inflexibilities, a fundam ental
source of adju stm en t arises from changes in
incom e and em ploym ent resulting from a
surplus or deficit in trade. In the case of an
ex p o rt surplus, the incom e of exporters will
rise, and total dom estic incom e eventually
increases by som e am ount in excess of the
ex p o rt su rp lu s .1 Some p o rtion of the increase
in incom e, in addition, will tend to be spent
on im ports (dep en d in g on the p ro p o rtio n of
the additional incom e th a t consum ers are in­
clined to spend on such g o o d s), helping to
close the gap in the balance of paym ents. If
wages are inflexible, p a rt of the adjustm ent
m ay take the form of a reduction in em ploy­
m ent. C onversely, a deficit in the balance of
paym ents will bring ab o u t a decline in the
level of dom estic incom e m ore than p ro p o r­
tional to the am ount of the deficit, im ports
will d ro p off, and the balance of paym ents
will be brough t into ad ju stm en t at som e low er
level of incom e.

140

* I n a d d i t i o n t o th e in i t i a l rise in i n c o m e g e n e r a t e d by t h e e x p o r t
s u r p l u s , t o t a l d o m e s t i c i n c o m e in s u c c e e d i n g p e r i o d s w i l l be
b o o s t e d b y successivc* r o u n d s o f s p e n d i n g i n d u c e d by t h e inc re as e in i n c o m e .




OF

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A lthough it is possible to visualize the a d ­
ju stm ent process as taking place prim arily
through the incom e effects of a surplus or
deficit in the balance of paym ents, incom e
effects in teract with price, wage, and interest
rate effects. Incom e effects induce price and
wage changes, while price and wage m ove­
m ents in turn induce changes in incom e. T he
following table sum m arizes the effects of a
deficit o r surplus in the balance of paym ents
upon gold flows and other econom ic indi­
cators.
In deficit
country

Gold Flow
Money Supply
Bank Reserves
In te re s t Rates
Prices
Income
Em ploym ent
Wages

Out
Down
Down
Up
Down
Down
Down
Down

In surplus
country

In
Up
Up
Down
Up
Up
Up
Up

The actual workings of the gold
standard did not alw ays follow
the theoretical explanation
In describing the o p eratio n of the gold
s ta n d a r d m e c h a n is m as a m e a n s o f s e tt le ­
m ent, the w ord “ au to m atic” should be used
advisedly. As we have indicated, the gold
stan d ard m echanism p rio r to W orld W ar I
w o rk e d m o st s a tis f a c to r ily w h e n c e n tr a l
banks generally observed the “ rules of the
gam e.” T he im m ediate goal of central bank
policy, how ever, was the m aintenance of con­
vertibility rath er th a n econom ic grow th and
stability of prices. A nu m b er of central banks
also em ployed oth er m ethods to facilitate the
necessary adjustm ents, such as sm all changes
in the official selling price for gold to influ­
ence the m ovem ent of short-term funds or
gold o r as an alternative to discount rate
changes, official operatio n s in the foreign ex­
change m arkets, and borrow ing from foreign
com m ercial banks, foreign governm ents, or
from their own governm ents to o b tain foreign
exchange. T here was also som e cooperative

July 1961

MONTHLY REVIEW

action am ong central banks, such as direct
borrow ing from o th er central banks, dis­
counting of foreign bills (fo r exam ple, ster­
ling b ills), and, on occasion, shipm ent of gold
to foreign m arkets. C o o p eratio n betw een cen­
tral banks, how ever, was n o t a com m on fea­
ture of the p re -1 9 1 4 gold stan d ard .

the U nited K ingdom and the po u n d sterling
provided the econom ic and financial strength
around which the system revolved, and that
the rate of change in prices, incom e, and busi­
ness activity in the various countries was quite
closely synchronized.

Several studies have suggested th at the
gold standard did not function in the m anner
neatly described by the theory. T he m ajority
of central banks did raise their discount rates
when their gold stock or o th er external re­
serves declined b u t w ere less inclined to lower
their rates w hen their international assets
increased. T heir dom estic incom e-earning as­
sets did not always m ove in the sam e direc­
tion as their international assets, although
this lack of parallelism m ay be due partly
to statistical w eaknesses in the d ata, partly
to some autom atic offsets, and partly to
cyclical influences .1 D iscount rates, m ore­
over, were of varying effectiveness in affect­
ing other m oney m arket rates— being m ore
effective for G reat B ritain— o r the in tern a­
tional flow of sh ort-term funds. G old losses
and higher discount rates, in addition, were
a less depressing influence on incom e and
em ploym ent than m ight have been expected
from the theoretical description because of
the long-run expansionary grow th forces that
prevailed during this period.

THE FLIGHT FROM THE GOLD
STANDARD

Since adjustm ents u n d er the international
gold standard did not always take place in
the m anner described by the theory, w hat
w as r e s p o n s ib le fo r its re la tiv e ly s m o o th
operation? Short-term capital m ovem ents in
response to interest rate differentials and
fairly dependable longer term capital flows
contributed to the m aintenance of balance.
B ut m ore im portant was the fact th a t the
exchange rate stru ctu re reflected fairly accu­
rately the existing price and cost relationships
betw een the principal trading nations, that
' Arthur I. Bloomfield, M onetary Policy Under the International
G old Standard: 1880-1914 (Federal Reserve Bank of New
Y ork).




A lthough the gold stan d ard was an excel­
lent m eans of settling international tran sac­
tions, it was not able to w ithstand the shocks
of wide swings in prices and the level of eco­
n o m ic activ ity o r th e p o litic al d isru p tio n s
born of a general w ar. D uring W orld W ar I,
the U nited States was the only m ajor belliger­
ent nation that rem ained on anything th a t re­
sem bled the classical gold standard. G reat
B ritain left the gold stan d ard for all practical
purposes for alm ost a decade, returning to it
in the m id -1 9 2 0 ’s. F rance also found itself
unable to adhere to the requisites of the full
gold standard and left it during the w ar, to
return to it after G reat B ritain. As in the case
of previous w ars, nations found th at if they
were to continue to sell gold they would soon
exhaust their m onetary stock, so unrestricted
transactions in gold were suspended. In times
of war, im ports generally run ahead of ex­
ports as nations divert their productive ca­
pacity tow ard producing w ar m aterials and
away from the usual exports th at provide
foreign exchange. B etw een 1929 and 1936
nearly all of the m ajor nations th at had faith­
fully observed the two prerequisites of the
gold s ta n d a rd — d efin itio n o f th e d o m estic
currency in term s of gold and unlim ited p u r­
chases and sales of gold at fixed prices— left
th e gold s ta n d a rd , som e te m p o ra rily and
others perm anently.

Conditions had changed
after World W ar I
T he reasons for the final breakdow n of the
international gold stan d ard during the w orld­

FEDERAL

142

RESERVE

BANK

wide depression th a t started in 1929 were
m any and com pelling. Som e, b u t by no m eans
all, of the factors involved m ight be laid at
the d o o r of the depression. O ne of the p rin ­
cipal factors was the change in the patterns
and practices of trad e and finance from those
th a t h ad prevailed before W orld W ar I.
W here trade h ad been relatively free in the
earlier period, it was now encum bered with
high and rising tariff b arriers. T h e Sm ootH aw ley tariff en acted by the U nited States
in 1931 is a case in point. N o t only did this
m easure raise A m erican duties to all-tim e
highs, b u t it pro v o k ed sim ilar responses from
o th er nations. Tariffs played a p a rt in the
breakdow n of the gold stan d ard insofar as
they acted to lim it m ultilateral trade. The
raising of b arriers to trad e through tariff re­
strictions n arro w ed the trading area an d co n ­
sequently reduced th e ability of countries to
balance o u t deficits against surpluses from
o th er nations.
A n o th er facto r was the shrinkage in in ter­
national lending tow ard the end of the dec­
ade, particularly by the U nited States, but
also by G reat B ritain in some m easure. T he
decline in intern atio n al lending helped to h as­
ten the dow nfall of the gold stan d ard on an in ­
tern atio n al basis because it lim ited the ability
of som e nations to close the gap in th eir b al­
ance of paym ents. T he place of the U nited
States as an in tern atio n al len d er was quite
different fro m th a t of G reat B ritain, which
had held this position p rio r to the w ar. W here
B ritain was a n et lender and a n et im porter,
its financial and service transactions offsetting
its im ports of goods on balance, th e U nited
States was b o th a net lender and a net ex­
p orter. T h e fact th a t E u ro p ean countries were
doubly debto rs to the U nited States, both on
capital account and to pay for the excess of
their im ports from the U nited States, m ade it
increasingly difficult for them to m eet their
obligations to this country. T h en there was
the m a tter of the w ar debts and rep aratio n s




OF

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paym ents. These dem ands for paym ent bore
no relation to the existing p attern s of trade
and of paym ent for cu rren t com m ercial tran s­
actions.
T he rules of the gam e were not always fol­
low ed by central banks. T he F ed eral R eserve
System in the U nited States n eu tralized the
effects of a heavy influx of gold from 1920 to
1924. It was thought th a t such funds w ere
m erely transient and th at, if an expansion
were to be encouraged on the basis of these
funds, it m ust be follow ed by a deflation as
the funds were w ithdraw n. Sim ilarly, the B ank
of E ngland and, to som e extent, th e B ank of
F ran ce follow ed a practice of offsetting gold
flows after 1925. It was con ten d ed , m o re­
over, th at the pound was overvalued by B rit­
ain w hen it retu rn ed to the full gold stan d ard
at the pre-W orld W ar I p arity, while F ran ce
undervalued the franc after 1926. T hese ac­
tions h ad the effect of w eakening the p ro c ­
esses of adjustm ent to shifts in trad e relations
w ith o th e r c o u n trie s. T h e se d e v e lo p m e n ts
w ere fu rth er sym ptom s of a m ovem ent aw ay
fro m a w o rld eco n o m y to w a rd in c re a sin g
concern with the dom estic econom y.
F ro m 1929 to 1931, th e ad ju stm ent to the
depression to o k the form o f deflation and, to
a certain extent, exchange d epreciation. T he
first phase of the in tern atio n al crisis w as felt
m ost keenly by countries w hich w ere p rim ary
producers of raw m aterials. T he prices of raw
m aterials typically fall fu rth er and faster in
a depression th an do the prices of finished
goods, and such countries w ere particularly
affected by the decline in w orld prices. Such
countries as A ustralia, w hich was dependent
upon wool as a source of foreign exchange,
and the South A m erican countries, such as
A rgentina, B razil, o r B olivia, w hich depended
upon w heat and beef, o r coffee, o r tin for their
foreign exchange, found them selves at a se­
vere disadvantage as the w orld prices of the
goods in w hich they trad ed fell sharply in
relation to the prices of the m an u factu red

July 1961

MONTHLY REVIEW

goods w hich they w ished to purchase. T he
decline in intern atio n al lending and the heavy
pressure upon the prices of the goods which
they exported m ade it necessary for these
prim ary producers to m ake some adjustm ent
to the situation.
C ountries w hich are principally producers
of raw m aterials are usually heavily d epend­
ent upon their exports as a source of incom e.
W hen w orld prices of these com m odities fall
relative to the prices of m an u factu red goods,
these countries find them selves at a consider­
able disadvantage vis-a-vis countries w hich
are exporters of finished goods. If the prim ary
producing countries w ere to m ain tain the
existing exchange rates in term s of the gold
c o n te n t of th e ir cu rre n c y , th e y w o u ld be
bound to experience trouble. A s their prices
fall relative to prices in the countries from
w hich they im port finished goods, there will
be a tendency for them to have a deficit on
external account, except in the unlikely case
w here the fall in the prices of their exports is
com pensated by a rise in the physical volum e
of these exports. If countries exporting p ri­
m ary p ro d u c ts d e p re c ia te th e ir c u rre n c ie s
(th a t is, reduce the gold c o n te n t), they may
reduce their im ports and thus reduce the rate
of their gold loss. In practice, these countries
did depreciate their currencies as an altern a­
tive to drastic deflation. B ut, in spite of the
depreciation in the currencies of these p ri­
m ary producers, there was no basic change in
the gold stan d ard until the spring of 1931.
T he break in the stan d ard cam e from an en ­
tirely different q uarter.

Capital flight contributed
to financial crisis in 1931
The financial crisis of 1931 cam e, not from
one of the m ajor pow ers, b u t from A ustria.
T he leading ban k in A ustria, the C redit A nstalt, had been in difficulty for some time, and
the announcem en t th a t the governm ent in­
tended to reorganize it was the signal for a
run on the bank. T he loss of confidence in




the largest b an k in A u stria led foreigners to
question the safety of their funds in the coun­
try. A large scale w ithdraw al of foreign bal­
ances then ensued, both from A u stria and
other central E u ro p ean countries. T he G er­
m a n b a n k in g s y ste m w as n o t in h e re n tly
strong since it was dep en d en t to a very con­
siderable extent u p o n short-term borrow ing
from abroad, and foreign deposits accounted
for 45 p ercen t of total deposits by 1928.
Political and econom ic difficulties at hom e,
com pounded by the failure of a large G erm an
textile com bine and the failure of the D arm sta d te r B ank, w hich was associated with it,
led to a b an k p anic in G erm any and a conse­
q u en t loss of confidence and w ithdraw al of
funds by foreigners.
T he pressure then shifted to E ngland,
which h ad experienced no such difficulties
with its banking system , b u t w hich h ad large
balances which w ere now frozen in A ustria
and G erm any. In spite of su p p o rt by the F e d ­
eral R eserve and the B ank of F ran ce, the
B ritish G overnm ent found it necessary on
Septem ber 21, 1931 to suspend the responsi­
bility of the B ank of E ngland to sell gold. The
decision of E n gland to leave the gold stand­
ard was at least as m uch of a blow to the gold
stan d ard as it was to sterling: T he prestige
of sterling was only a little less th an that of
gold itself. A t th e tim e, a le ad in g B ritish
econom ist q uipped th at sterling d id n ’t “leave
gold, b u t gold left sterling.” T he m assive ef­
fo rt to offset the depression by international
financial cooperation thus cam e to an end.

Domestic considerations forced
the United States off gold
By way of co n trast, although $338 million
in gold flowed o u t of the U nited States in
1931-1933 as the gold exchange standard col­
lapsed abroad, it was the dom estic situation
w hich took the U nited States off the fullbodied gold standard. T he depression of 1929
touched all of the industrial countries of the
w orld, b u t it visited the U nited States with

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BANK

the greatest severity. W holesale prices fell by
alm ost a th ird betw een 1929 and 1932 while
national incom e declined by half. A ccom ­
panying the business depression was a virtual
collapse of the banking system . As values d e­
clined, the banks, w hich were heavily co m ­
m itted to real estate loans, were unable to real­
ize upon these loans and becam e increasingly
illiquid. B anks failed at a rap id rate betw een
1929 and 1933, and in the latter year the n a ­
tional governm ent closed all ban k s for a brief
period pending a d eterm ination of th eir sol­
vency.
O ne of the aims of national policy in 1933
was to reflate the price level— and presu m ­
ably thereby econom ic activity— to the level
th a t had ob tain ed p rio r to the depression. It
w as thought in som e q u arters th a t this could
be accom plished by cutting the value of the
dollar, th a t is, raising the price of gold in
term s of dollars. T h e price of gold was cut
free from its old price of $20.67 p er ounce,
and the price was determ ined on a daily basis
fo r a n u m ber of m onths before it was finally
fixed at $35 p er ounce in 1934, a devaluation
of 41 p ercent from the old price. A t the sam e
tim e, exports of gold w ere tem porarily sus­
pended, and individuals w ere forbidden to
hold gold.




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SAN

FRANCISCO

A fter th e U nited States left the fo rm al gold
stan d ard for a m ore m odified form , the n a ­
tions adhering to the gold stan d ard dw indled
to a group of six: F ran ce, the N etherlands,
Ita ly , B elgium , S w itz e rla n d , an d P o la n d ,
which u n d er the leadership of F ran ce consti­
tu ted the “ gold bloc.” T he central banks of
these gold bloc nations co o p erated to check
speculation in their currencies. T h u s, after
1933 the w orld was divided into th ree p rin ci­
pal currency groups: T h ere was the sterling
area w hich was cu t free from gold, the dollar
w hich was tied to gold, and the gold bloc
w hose co n stituent nations still retain ed the
trappings of the old in tern atio n al gold stan d ­
ard. T he gold bloc was a short-lived affair
and dissolved in 1936 w hen F ran ce, Sw itzer­
la n d , an d th e N e th e rla n d s d e v a lu e d th e ir
currencies.
W hen the gold bloc ceased to exist in Sep­
tem ber 1936, the T rip artite A greem ent be­
tw een the U nited States, G reat B ritain, and
F ra n c e w as sig n ed , p led g in g a v o id a n c e of
exchange rate fluctuations and com petitive
exchange depreciation. T h e A greem ent was
strengthened in O cto b er by agreem ent of the
m em bers to sell each o th er gold at a fixed
price g uaranteed for at least 24 hours, which
tended to give greater stability to the stru c­
tu re of exchange rates and p erm itted the v ari­
o u s e x ch a n g e sta b iliz a tio n f u n d s 1 th e n in
o p eratio n to be m ore effective.
By the fall of 1936, the p rin cip al w orld
currencies had been bro u g h t into closer align­
m ent. Sterling, w hich h ad been overvalued
w hen brought back onto the gold stan d ard in
1925, was being m aintained at a som ew hat
low er level by the actions of th e B ritish ex1The purpose of an exchange stabilization fund invites expla­
nation. When a country has left the international gold stand­
ard, there is no tie to the value of other currencies other than
the demand for and the supply of the currency of the country
in question in its international relations. In an effort to pro­
vide some degree of stability to the value of the currency in
relation to that of other currencies, the stabilization fund w ill
enter the foreign exchange market, making the specific cur­
rency available when it rises to a premium and buying it to
provide strength when the demand for it is slack. In this
manner the stabilization fund endeavors to maintain the in­
ternational value of its currency at a given level. It might be
noted that in this case the fund offsets rather than reinforces
the domestic effects of foreign developments.

July 1961

MONTHLY REVIEW

change stabilization fund; the dollar rem ained
at the rate established by the 1934 devalua­
tion; and the F rench franc had been devalued
in 1936. A num ber of other countries cam e
into the agreem ent: T he N etherlands, B el­
gium , and S w itzerlan d . T h is a rra n g e m e n t
provided for a significant degree of co o p era­
tio n b etw een s ta b iliz a tio n fu n d s an d su c­
c e e d e d in a c h ie v in g re la tiv e s ta b ility of
exchange rates. W ith the o u tb reak of W orld
W ar LI, the T ripartite A greem ent ceased to
be operative.

THE POUND STERLING STANDARD
T he breakup of the international gold
standard did not spell the en d of international
trade, but it did m ake it m uch m ore cu m b er­
some. T he old relationships betw een cu rren ­
cies an d gold w ere gone. O b sta c le s w ere
ra ise d to the c o n v e rtib ility o f c u rre n c ie s
through the im position of trad e restrictions
and of exchange controls in some countries.
Exchange controls were im posed either to
restrain the export of capital o r to restrict
m erchandise im ports. T he im m ediate objec­
tive of such restrictions was to rem edy an
im balance, generally a deficit, in the balance
of paym ents. T he varieties of controls were
m any and ingenious. A nu m b er of countries,
chiefly in South A m erica, h ad m ultiple ex­
change ra te s, g ra n tin g the m o st fa v o ra b le
term s to exports which they wished to en­
courage or to im ports which w ere deem ed to
have the highest priority. A rrangem ents were
arrived at betw een countries w herein all pay­
m ents for exports and im ports w ould be co n ­
d u c te d th ro u g h som e g o v e rn m e n t agency,
generally the central bank. But all such agree­
m ents had one thing in com m on; they treated
the sym ptom s of the problem rather than the
basic causes. M arkets were lim ited, and the
gains that m ight have been realized from a
m ore efficient use of resources were lost.
A fter gold ceased to be the universal c u r­
rency, attention was directed to the individual




currencies. T h ere cam e to be certain m oneys
that were considered to be “ key” currencies.
C hief am ong these w ere the pound sterling
and the dollar. The pre-em inence of these
currencies lay in the fact th a t L ondon and
N ew Y ork were the principal m oney centers
of the w orld. Subsequent to the b reakup of
the international gold stan d ard , each of these
currencies cam e to acquire some of the luster
th a t had lately belonged to gold by serving as
in tern atio n al m eans of paym ent and as in ter­
national reserves.
The gold stan d ard was, in fact, the British
(th a t is, pound sterling) stan d ard from late
in the seventeenth century until the outbreak
of W orld W ar I. T he p o u n d sterling was in
its greatest ascendancy during the period
1870 to 1914 w hen it was unrivaled as the
m ost im portant currency in in ternational
finance. It was the L ondon-centered system
of international finance based upon British
predom inance in international trad e which
b reathed life into the p re-W orld W ar I form
of the gold standard.

Sterling reached a crisis
in World W ar I
In W orld W ar I, the ex trao rd in ary w arinduced changes in the flow of international
trad e and the reversal in the distribution of
credit illum inated the dependence of the gold
stan d ard upon the u n in terru p ted perform ance
of L ondon as m iddlem an in international fi­
nance and the unsuitability of gold as the
balancing factor in in ternational paym ents
in a tim e of disorganized credit. P rior to the
war, L ondon had been able in time of crisis
to con tract her total foreign obligations and
to realize som e of her foreign assets. T here
were two sets of circum stances th at enabled
B ritain to do this for they w orked to offset
one another in her balance of paym ents. B rit­
ain was a large net lender at long term , chiefly
to n o n -E u ro p ean countries. In a time of crisis
lo n g -term le n d in g w ould d eclin e, an d this

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w ould w ork in the direction of a surplus. A t
the sam e tim e, B ritain ’s exports w ould fall
m uch m ore th an her im ports, w hich were
chiefly foodstuffs, and this w ould act to push
the balance of paym ents tow ard a deficit. Y et
a n o th e r c h a ra c te ris tic o f B r ita in ’s p o sitio n
was her facility to shift to short-term lending
during a crisis, m aking up for the decline in
her long-term lending ab ro ad at these times.
T h e se c o u n te rm e a s u re s w ere c a rrie d o u t
w ithout creating a shock to the m oney and
capital m arkets, w ithout interfering w ith in­
ternational trad e and paym ents, and w ithout
le ssen in g th e a v a ila b ility o f ste rlin g as a
m edium of w orld paym ent.
T h e distinctive ch aracteristic o f the crisis
of 1914 was th at fo r the first tim e the flow of
sterling credit was halted, and the City of
L ondon was forced to suspend its o peration
as m iddlem an in in ternational finance. In the
norm al course of affairs L ondon served as a
clearing center, and as sterling credits were
received from investm ents abroad o r sales
of m erchandise or services, such as insurance
o r shipping, banks and financial houses used
these to offset sterling paym ents fo r im ports,
services, and interest and dividends on British
securities ow ned by foreigners. T he advent

146




OF

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of w ar d isrupted this com plex b u t sm oothly
functioning system of clearing.
A lthough B ritain rem ained on the gold
stan d ard in the strictest legal sense during
W orld W ar I, for all p ractical purposes it left
gold. T here was no form al suspension o f spe­
cie paym ents, b u t a n u m b er of legal m eas­
ures, adm inistrative p ro ced u res, and private
practices accom plished the sam e end. In the
dom estic sphere, the Peel A ct, w hich since
1844 required the B ank of E ngland to secure
increases in the currency above the fiduciary
issue by an equal value of gold, w as sus­
p ended. T he G overnm ent did n o t refuse to
redeem notes in gold upon presentation but
effectively discouraged the dem and for gold
through a policy of inquiring quite closely
into the purposes for w hich the gold w as d e­
sired . In 1 9 1 6 th e m a jo r leg al re s tric tio n
placed upon gold was a proh ib ition against
the m elting dow n of gold coin. T h ere w ere no
restrictions against the im p o rtatio n of gold,
but all gold p ro d u ced in E m p ire countries
and later all gold from o th er sources was p u r­
chased by the B ank of E ngland. O n the ex­
p o rt side, the principal facto r restraining the
outflow of gold was the voluntary restrain t
upon transactions in the free m ark et in gold.
W ith the great strain upon exchange rates
created by w ar finance, it was significant of
th e c o n te m p o ra ry p o sitio n of th e U n ite d
States and of the role of B ritain as peacetim e
and w artim e financier th a t the sterling-dollar
rate was the key rate to be m aintained. If the
sterling-dollar rate rem ained stable, this of­
fered a b road base upon which to stabilize
o th er exchange rates. T he p o u n d depreciated
a fte r th e w ar s ta rte d b e c a u se o f u n p re c e ­
d ented im port dem ands for w ar m aterials but
w as pegged at $ 4 .7 6 T7ff from 1915 until the
end of the w ar through large foreign credits
o b tained chiefly from the U nited States and
through sales of A m erican securities by the
B ritish G overnm ent. T he security sales were
incidentally a m ajor elem ent in transform ing

July 1961

MONTHLY REVIEW

the U nited States into a cred ito r nation. A t
th e sam e tim e , B r ita in g r a n te d c r e d its to
F ran ce to support the franc.

Problems confronted sterling
after World W ar I
The afterm ath of a m ajor w ar is typically
c h a ra c te riz e d by tw o p rin c ip a l eco n o m ic
problem s. T he internal p roblem is inflation,
and the external problem is th at of finding,
and adjusting to, an ap p ro p riate exchange
rate. D espite strong w artim e efforts to sup­
po rt the exchanges, there developed a fan­
like dispersion of exchange rates aro u n d the
sterling-dollar par, w hich did not reflect the
m ovem ent of price levels in the various coun­
tries.
B ritain’s position was m ade m ore delicate
by the fact that large balances had been built
up in L ondon during the w ar by the D om in­
ions and by neutrals, who did not wish to
repatriate these funds at the existing disad­
vantageous m arket rates of exchange, and by
ow ners of flight capital. T he existence of these
large and potentially volatile balances placed
obstacles to a return to the international gold
standard at the conclusion of the w ar, but,
even m ore im portan t, significant changes had
occurred in the institutional fram ew ork com ­
pared w ith th a t of the prew ar gold standard.
Even before W orld W ar I, B ritain ’s share
in w orld trade had begun to dim inish due to
increased foreign com petition in shipping and
in the export of textiles and iron and steel
goods; the w ar accelerated the decline in
B ritain ’s relative trading position. T he de­
m ands of w ar finance had exacted a heavy
toll from B ritain ’s resources, and h er creditor
position was reduced by ab o u t one-q u arter
during the period 1914 to 1920. B ritain ’s
position in international finance also was sig­
nificantly changed in oth er respects from p re ­
war. T he dom inant role of the pound sterling
bill of exchange (th e “ bill on L o n d o n ” ) be­
fore 1914 was perm anently m odified by two




w artim e developm ents: ( a ) the grow th of
new m ethods of finance, nam ely, the tele­
graphic transfer of funds and the use of bank
advances and (b ) the rise in im portance of
the dollar bill of exchange issued in New
Y ork.
T he unquestioned position of L ondon as
the center of international finance was al­
tered by the strong underlying force of the
m o v e m en t o f w a rtim e m e rc h a n d ise tra d e .
The basic pull of L o n d o n over the exchanges
was w eakened, and N ew Y o rk was raised to
the position of a pow erful com petitor to L o n ­
don in in ternational finance. As a conse­
quence, B ritain was forced to a ttract foreign
b a la n c e s th ro u g h d e p o sit a d v a n ta g e s; she
could no longer com m and them as the sole
center of finance.
D espite the change in B ritain ’s relative
position in international trade and finance
and despite the postw ar difficulties facing all
the form er belligerents, there was w idespread
support in B ritain and in o th er countries for
a retu rn to the prew ar in tern atio n al gold
standard as soon as feasible. T he support for
a retu rn to the gold stan d ard was based upon
its long and relatively successful o peration
p rio r to W orld W ar I and upon an u n d er­
estim ation of the fundam ental changes which
had occurred in its institutional setting. G reat
B ritain returned to the gold stan d ard in M ay
1925, w ith the pound sterling at its prew ar
parity. T he high level of unem ploym ent which
B rita in suffered su b se q u e n tly in th e la te
1920’s — in o rd er to m aintain the exchange
r a te — led to the w idely-held view th a t the
pound had, in fact, been overvalued in its
resto ratio n to prew ar parity.
By 1928 m ost of the nations of the w orld
had retu rn ed to the gold standard. In m any
cases, the stan d ard to w hich they returned
was the gold exchange stan d ard under which
countries w ere perm itted to co u n t as their
legal reserves funds held in other countries
which were on the gold standard. T hus, while

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BANK

eco n o m izin g on g o ld, th e gold ex ch an g e
stan d ard served to encourage the accum ula­
tion of sh ort-term funds in the depositary
countries. Since B ritain m aintained a rela­
tively high B an k rate in defense of sterling,
fu n d s flow ed in to L o n d o n , an d B rita in ’s
s h o rt-te rm in d e b te d n e ss to fo reig n e rs w as
m u c h la rg e r th a n its s h o r t- te r m c re d its
ab ro ad . T h e in herent volatility of these sh o rt­
term funds, how ever, created a potential d an ­
ger to the banking and m onetary system of
the depositary co u n try since they could be
easily w ithdraw n. T he w orld-w ide depression
touched off by the A m erican stock m arket
crash in 1929 and the m ovem ent of sh o rt­
term funds, occasioned by the international
b anking panic, succeeded in forcing B ritain
off the gold stan d ard by S eptem ber 1931.

The sterling area w as
organized in 1931

14g

G reat B ritain was the first m ajor nation to
abandon the gold stan d ard in the depression
of the 1930’s. In doing so, she chose to p u r­
sue a m onetary and dom estic policy geared
m ore closely to internal developm ents, de­
spite her stake in international trad e. This
move was followed by the organization of the
sterling area in 1931 as a defensive m echa­
nism in in tern atio n al trad e and paym ents.
Its princip al characteristics w ere the link to
sterling as an international currency and the
coordinated exchange rate and im port policy
usually follow ed by all m em ber countries. A
num ber of countries chose to join the sterling
area, w hich m eant th a t they chose to link
their currencies to the p o u n d sterling rath er
th an to gold, and m ost or all of these co u n ­
tries’ m on etary reserves w ere held in L ondon
in sterling balances o r o th er liquid assets.
H ow ever, unlike the gold standard, the p a ri­
ties of m em ber currencies w ere n o t rigidly
fixed w ith respect to sterling b u t were al­
low ed to fluctuate som ew hat in response to
national interest.




OF

SAN

FRANCISCO

T h e m em bers of the 1931 sterling area
included G reat B ritain, E ire, In d ia, B ritish
colonies and m an d ated territories, Iraq , Iran,
E gypt, Portugal, the Scandinavian countries,
and the D om inions except C anada. C an ad a
never becam e a m em ber of the sterling area
because of her close econom ic relations w ith
the U nited States. M ost, b u t n o t all, m em bers
of the sterling area w ere m em bers of the
British E m pire. O ne of the m ajor advantages
afforded to m em bers was the im p o rtan ce of
the U nited K ingdom m arket fo r exports of
foodstuffs and raw m aterials from m em ber
countries. If th eir currencies w ere tied to
gold, the sterling price of th eir principal ex­
p o rt com m odities w ould have risen as ster­
ling depreciated, and dem and in th eir largest
m ark et w ould have been adversely affected.
In addition, m any countries in the sterling
area ow ed large debts to B ritain and to other
m em bers w hich could be settled m ost con­
veniently through the m edium of sterling.
T hen, too, there was the prestige th a t sterling
still com m anded in the in tern atio n al financial
w orld. A d ditional reasons encouraging the
tie-in with sterling included the preference
system , which was adopted fo r in tra-E m p ire
trade, and the negotiation of b ilateral trade
agreem ents with oth er countries and the fact
th at B ritish industrial activity fell off m uch
less than th a t of the U nited States during the
period 1929-1932. A m erican im ports con­
sisted m ainly of industrial raw m aterials and
hence were m ore subject to cyclical variation.
B ecause the B ritish E m pire co n stituted the
largest single com m ercial and m onetary sys­
tem in the w orld and the sterling area in ­
cluded m ore than on e-th ird of the w o rld ’s
po p u latio n , the sterling area form ed a very
large m ultilateral trading system . T he pound
sterling was bo th a m eans of in ternational
settlem ent and a m edium for reserves w ithin
the area; it served also as backing for dom es­
tic currency and for oth er central bank lia­
bilities.

July 1961

MONTHLY REVIEW

The sterling area changed in
character after World W ar II
W orld W ar I I m ark ed a change in both
the m em bership and ch aracter of the sterling
area. T he m em bership becam e m ore exclu­
sively British and now includes the British
C om m onw ealth (ex cep t C a n a d a ), the Irish
R epublic, British T ru st T errito ries, British
protectorates and p rotected states, B urm a,
Iceland, Jo rd an , Libya, South A frica, and
South W est A frica.
In character, the sterling area becam e m ore
tightly knit, with closer m onetary co o p era­
tion internally and a m ore form al coordi­
nated policy tow ard the rest of the w orld. T he
basic elem ents of the prew ar system , how ­
ever, were retained. M em ber currencies co n ­
tinued to be m aintained at a stable exchange
ra te w ith the p o u n d sterlin g , an d official
m onetary reserves continued to be held in
L ondon. In addition, the sterling area coun­
tries developed a system of exchange control
beginning in 1939 generally p attern ed after

and co o rd in ated w ith th a t of B ritain and
agreed to pool th eir non-sterling exchange
and gold in L ondon, m aking it possible to
centrally direct the use of these resources in
the conduct of the w ar. This arrangem ent
p erm itted exchange tran sactio n s w ithin the
sterling area to rem ain relatively free of con­
trol, while m em bers could still buy dollars
w ith sterling to m ake essential purchases.
B ritish exchange co n tro l during the w ar
developed gradually into a tight control. A t
th e sam e tim e, B rita in b o rro w e d h eavily
overseas to finance the w ar and by 1946 had
a c c u m u la te d s h o rt-te rm sterlin g liab ilitie s
am ounting to £ .3 ,5 0 0 million. A fter W orld
W ar II, B ritish exchange control continued
un d er a classification of accounts based upon
co u n try of residence of the account-holder;
each of the principal classifications of ster­
ling accounts had its ow n convertibility ch ar­
acteristics, and ap p ro v al for use of sterling
holdings was based upon the residence of the
payee as well as the residence of the account-

M e m b e rs of the ste rlin g a re a in the early postwar period

Source: T he Sterling Area: An American Analysis, Special Mission to the United Kingdom, Economic Cooperation Administration (London
1951).




149

FEDERAL

RESERVE

BANK

holder. A ccounts held by residents of the
sterling area w ere term ed “ resident sterling,”
and regulations perm itted freedom of in tra­
resident acco u n t transfers, including capital
transfers. T ran sfers to nonresident accounts,
how ever, required approval by the govern­
m ent of the acco u n t-h o ld er’s country. Ster­
ling accounts held by residents of certain
E uropean countries were term ed “ tran sfer­
able sterling” and were freely transferable
am ong countries in this group and to resident
accounts, but capital tran sactio n s and tran s­
actions with the do llar area w ere excluded.
Britain could n o t afford to provide exports
for all existing external claim s to sterling at
once when she herself sorely needed im ports,
b u t th e tra n s fe ra b le ste rlin g classificatio n
represented a lim ited effort to regain the fo r­
m er place of sterling as a m edium of w orld
paym ents.
A lth o u g h B r ita in ’s d o lla r deficit b efo re
W orld W ar II was greater than after the w ar,
the prew ar system of free m ultilateral trade
accom m odated the dollar deficit, w hereas the
disorganized state of w orld trade and p ay ­
m ents in the im m ediate postw ar period could
not. T h ere was free m ultilateral trad e within
the postw ar sterling area, b u t trad e and pay­
m ents with the outside w orld were restricted.
N evertheless, as B ritain recovered from the
effects of the w ar, she succeeded in gradually
liberalizing the use of sterling. In D ecem ber
1958 sterling becam e fully convertible for
nonresidents fo r cu rren t trad e and service
transactions.

THE DOLLAR STANDARD

150

B ecause of its large area, diversity of n a tu ­
ral resources, and developed econom ic activ­
ity, the U nited States of 1914 was the closest
co u n terp art of the L ondon-centered British
com plex of trad e and paym ents. Long before
W orld W ar I, New Y ork had becom e the
clearing cen ter for tran sactio n s betw een diffe re n t p a rts o f th e c o u n try . T h is w as th e




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c e n te r fo r a rra n g in g fo r th e ex ch a n g e of
m anufactured goods for agricultural p ro d ­
ucts and the distribution of im ported goods,
as well as the en trep o t cen ter for exports.
L oans, deposits, and financial tran sactions
w ere co n centrated in New Y ork, an d the c o r­
resp o n d en t banking system p erm itted settle­
m ent of interior tran sactio n s through the New
Y ork clearing house.
B efore W orld W ar I, the facilities required
of an international m oney m ark et w ere not
provided by New Y ork alone, but in co o p era­
tion with L ondon; for exam ple, the credit
facilities required by the cotton trad e of the
South utilized both the New Y ork and L o n ­
don facilities. T h e New Y o rk -L o n d o n con­
n e c tio n w as th e c h a n n e l th r o u g h w h ic h
long-term capital was attracted to the U nited
States and through w hich A m erican funds
found profitable em ploym ent. T h e L ondon
m ark et enjoyed the advantage of traditional
usage and of an efficient com plex of financial
facilities. W orld W ar I provided the o p p o r­
tunity for N ew Y ork to em erge as a pow erful
international m oney m arket. T he w ar caused
the U nited States to becom e a cred ito r in the
long-term area and also co n tributed to the
provision by New Y ork of the sh ort-term
financing required by A m erican trad e and to
the establishm ent of an A m erican foreign
banking system.
The New Y ork acceptance m arket grew
rapidly during the w ar, and by 1917 the vol­
um e of acceptances outstanding am ounted to
$1 billion, of which tw o-thirds was draw n
to finance foreign trad e. In tern atio n al bank
balances in New Y ork rose, influenced by the
key role played by advances from the U nited
States T reasu ry in financing the w ar after
A m erican entry and by capital flight from
E u ro p e. New sources of financing acceptance
credit and a new distribution of international
bank deposits had com e into being. D uring
the war, the New Y ork Stock E xchange also

July 1961

MONTHLY REVIEW

gained im portance in the distribution of in ­
ternational securities.
The w artim e tran sfo rm atio n of New Y ork
into an international m oney m ark et occurred
because the U nited States was the only m ajor
country on the gold standard, had im pressive
c re d it reserv es, an d re p re s e n te d im m ense
real wealth. H ow ever, New Y o rk yet lacked
the international confidence which L ondon
had earned over its long period of o peration,
and New Y ork lacked certain facilities re ­
lated to com m odities, shipping, and foreign
exchange w hich were available in London.
Private capital exports from the U nited
States becam e prom inent in the 1920's; how ­
ever, they had an unsatisfactory ch aracter
because insufficient attention was given to the
repaym ent prospects of the borrow er (p a r­
ticularly in the case of bond flotations) and
because they were irregular in volum e, as
shown in the table below, thus exerting an
unstabilizing effect upon the w orld econom y.
T he 1930’s proved a difficult period; fol­
lowing the collapse of the New Y ork stock
m arket in 1929, the U nited States ex p eri­
enced a severe d e p re s s io n an d a b an k in g
panic. T he depression becam e w orld-w ide,
and international trade greatly contracted. In
A pril 1933, the A m erican dollar was allowed
to depreciate in term s of gold, and the U nited
States has been on a lim ited gold bullion
standard since passage of the G old Reserve
A ct of 1934. W ithin the next several years
there occurred a very large inflow of gold to
the U nited States due to unsettled exchange
conditions and political conditions abroad.

The dollar shortage after
World W ar II
T hroughout the postw ar period and right
up to the presen t tim e, attention has been
focused on the dollar. T h ere have been two
distinct phases to this problem . In the early
postw ar period, nations which had been dev-




NET PR IV A T E A M E R IC A N C A P IT A L EXPO RTS,
LO NG -TERM A N D SH O R T-T ER M
(millions of dollars)
Year

Year
1923

— 33

1927

695

1924

517

1928

944

1925

621

1929

306

1926

181

1930

739

Source: Department of Commerce,

astated by w ar w anted to purchase goods
from the U nited States but did not have either
the exports o r accum ulated gold and dollar
holdings to cover the needed im ports. M ore
recently, the m ajor trading nations have been
building up their gold and dollar balances
(especially g o ld ), as shown by the large p ay­
m ents deficits recorded by the U nited States
in 1958-60, in preference to spending them
on U nited States goods and services.
T he U nited States was a m ajor supplier
of finance and m aterial for the conduct of
W orld W ar II, an d A m e ric a n p ro d u c tiv e
capacity and the dollar em erged from the w ar
in very strong positions. The U nited States
was alm ost the only m ajor industrial nation
am ong the belligerents which did not suffer
severe dam age to its industrial plant. C onse­
q u en tly , th e W estern E u ro p ea n c o u n trie s,
which had been ravaged by the w ar, turned
to the U nited States for the goods and serv­
ices necessary to rebuild th eir industrial plant.
T able 1 illustrates the gap betw een U nited
States exports of goods and services and im­
ports in the years im m ediately following the
war. U nited States im ports from the rest of
the w orld provided only p art of the dollars
to pay for exports from this country. A s the
E u ro p e a n e co n o m ies re c o v e re d an d th e ir
currencies were brought into closer alignm ent
w ith p rev ailin g c o st an d p rice s tru c tu re s
through the devaluations of Septem ber 1949
and as the K orean w ar stim ulated U nited
States im ports, the surplus of U nited States
e x p o rts o v er im p o rts b eg an to d eclin e in
1950.

FEDERAL

RESERVE

BANK

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I
S E L E C T E D IT E M S FROM T H E U N IT E D S T A T E S
B A LA N C E O F P A Y M E N T S , 1946-1960
T

a ble

(billions of dollars)
Exports of
goods and
services

Imports of
goods and
services

Surplus on
goods and
services

Net U .S .
capital
exports

U. S. gold
sales or
purchases (— )

Increase in
foreign holdings
of dollars

1946

14.7

7.0

7.7

6.7

-

0.6

-

0.6

1947

19.7

8.2

11.5

7.9

-

2.9

-

1.7

1948

16.8

10.3

6.4

6.6

-

1.5

0.5

1949

15.9

9.7

6.1

6.7

-

0.2

*

1950

13.9

12.1

1.8

5.4

1.7

1.9

1951

18.9

15.1

3.7

4.5

*

0.4

1952

18.1

15.8

2.3

3.9

0.4

1.5

1953

17.1

16.6

0.4

2.8

1.2

0.9

1954

17.9

16.1

1.9

3.5

0.3

1.2

1955

20.0

17.9

2.1

3.7

*

1.1

-

1956

23.7

19.8

3.9

5.5

-

0.3

1.3

1957

26.7

20.9

5.8

6.1

-

0.8

0.3

1958

23.3

21.1

2,3

6.1

2.3

1,2

1959

23.7

23.5

0.2

4.3

0.7

2.9

1960

27.3

23.3

4.0

7.3

1.7

2.2

*Less than $100 million
Source: Department of Commerce.

152

T h e trad e balance, how ever, was only p art
of the picture. In the early postw ar period,
the dollar deficit was m et by grants o r loans
from the U nited States G overnm ent o r by a
decline in th e international assets of oth er
countries, prim arily gold. F rom 1946 through
1949, $5.2 billion in gold flowed into the
U nited States. B ut a substantial p a rt of the
deficit was m et by the extension of econom ic
aid and loans by the U nited States G o v ern ­
m ent. In this w ay the U nited States provided
th e d o lla r e x c h a n g e th a t w as n e e d e d to
finance its ex p o rt balance. This m eans of set­
tlem ent was n o t unique since B ritain had
followed a sim ilar policy in earlier years of
financing its ex p o rts by lending ab ro ad to the
im porter nations. T h e only difference is that
in the 1946-50 case grants were used to a
greater exten t than loans. T he requirem ents
of postw ar reconstruction and the fact th at
the U nited States em erged intact and even
stronger econom ically than before the w ar
w ere thus in stru m en tal in elevating the U nited




States dollar to its position of prom inence as
a key currency.

The supply of dollars
increases in 1958-60
A fter the critical phase of the do llar sh o rt­
age had passed by 1950 o r th ereabouts, the
dollar continued to be highly regarded as a
m eans of paym ent and in tern atio n al reserve
currency, as evidenced by the steady build-up
in fo reig n d o lla r b a la n c e s in th e U n ite d
States. F rom $6 billion in 1946 foreign short­
term dollar holdings in the U nited States rose
to $21 billion by the end of I9 6 0 . Beginning
in 1958, how ever, the U nited States started
to incur large deficits in its balance of p ay ­
m ents, and foreigners took a large p a rt of
their dollar gains in the form of gold. N ever­
theless, claim s of foreigners against dollars
increased by $6.4 billion during the three
years 1958-60 (excluding the U nited States
subscription to the In tern atio n al M onetary
F u n d ). T he experience of 1958-60 seem ed

July 1961

MONTHLY REVIEW

to indicate th a t n o t only had the dollar sh o rt­
age ended but th a t there m ight be a surplus
of dollars available fo r in ternational p ay ­
m ents and external reserves. P a rt of the less­
ening in the dem and for dollars was due to
the econom ic recovery of W estern E u ro p e
and Ja p a n and g reater freedom in in tern a­
tional paym ents consequent upon the in tro ­
duction of nonresident convertibility at the
end of 1958— goals w hich the U nited States
su p p o rted .1 P a rt of the enlarged deficits was
due to special, n o n recu rren t circum stances.
T he sharp rise in the U nited States p ay ­
m ents deficit and its m aintenance at high
levels, together with an accelerated rate of
gold losses, led to speculation against the
dollar in the latter p a rt of 1960. It was ru ­
m ored th a t the U nited States w ould be forced
to devalue the dollar because of the pressures
against it. T he low er level of interest rates in
the U nited States relative to other nations
also e n c o u ra g e d th e m o v e m en t o f fu n d s
abroad. Steps taken by the U nited States to
bring its paym ents into closer balance and
the cooperation of other countries helped to
w eather the crisis of confidence since the un­
derlying position of the U nited States was
still strong. T he dollar thus continues to be
widely accepted as the leading international
currency.

International cooperation
after World W ar II
A fter W orld W ar II, the do llar increased
in im portance relative to gold and sterling
as an in tern atio n al currency. Since the end
of the w ar, the functions perform ed by the
dollar, the pou n d sterling, and gold have
been supplem ented by the creation of two
international agencies w hich w ere conceived
in the course of w artim e discussions con­
cerned w ith exchange stability and future
balance of paym ents problem s. These agen'For a discussion of the United States balance of payments in
recent years, see "Our Balance of Payments in Perspective,”
M o n th ly R eview, Federal Reserve Bank of San Francisco, Au­
gust I960.




c ie s — th e I n te r n a tio n a l M o n e ta r y F u n d
(IM F ) and the In tern atio n al B ank for R e­
c o n s tru c tio n an d D e v e lo p m e n t (o fte n r e ­
ferred to as the W orld B a n k )— w ere set up
at the B retton W oods C onference in 1944.
T h ese in te rn a tio n a l ag en cies, m e n tio n ed
briefly here, will be discussed in som ew hat
greater detail in a subsequent article in this
series.
T he In tern atio n al M o netary F u n d was de­
signed to p rom ote and m aintain a p attern of
exchange rates sufficiently stable to encour­
age w orld trad e and investm ent and at the
sam e tim e sufficiently flexible to perm it the
orderly adjustm ent of exchange rates in o rd er
to deal with a fu n d am en tal balance of p ay­
m ents im balance. T o ensure stability of ex­
change rates, signatory nations are required
to m aintain their currencies w ithin 1 percent
of a given parity. T o tide them over tem po­
rary paym ents difficulties, the IM F m akes
available to m em ber n ations short-term as­
sistance from its pool of gold and currencies
subscribed by m em bers. O n the o th er hand,
th e F u n d A r tic le s p e r m it c h a n g e s in e x ­
change rate p arities to co rrect a fundam ental
p a y m e n ts im b a la n c e . T h is flexibility w as
built into the A greem ent to avoid the com ­
petitive devaluations th a t had plagued w orld
trad e and paym ents in the 1930’s. T h e F u n d
also provides a forum fo r in ternational con­
sultation on balance of paym ents problem s.
T he In tern atio n al B ank for R econstruction
and D evelopm ent in tu rn was established to
help m eet the need for long-term investm ent
capital in the w ar-devastated countries and
in the less econom ically advanced areas of
the w orld. T he prim ary lending role of the
B ank is supplem entary to private in terna­
tional investm ent and to dom estic investm ent,
while its principal function is to increase the
p ro d u c tiv e c a p a c ity of b o rro w in g n atio n s
over the long haul and thus enable them to
ex p an d exports and earn foreign exchange.
T w o auxiliary agencies of the W orld B ank

153

FEDERAL

RESERVE

BANK

have been created recently: Tn 1956, the In ­
ternational F in an ce C o rp o ratio n specializing
in equity-type investm ents and in 1960 the
In tern atio n al D evelopm ent A ssociation for
long-term lending on easier term s. B oth the
F u n d and the B ank carry o u t som e of the
functions borne prim arily by the p o u n d ster­
ling and the do llar before W orld W ar II.
In addition to these w orld-w ide in tern a­
tional financial agencies, sm aller regional a r­
ra n g e m e n ts a p p e a re d a fte r th e w ar. T h e
E u ro p ean Paym ents U nion ( E P U ) , for ex­
am ple, w as fo rm ed in Septem ber 1950 by
the M arshall P lan countries and o p erated as
a m echanism for the regional, m ultilateral
s e ttle m e n t o f c u rre n t acc o u n ts am o n g its
m em bers, w ith facilities for extending credit.
T h e E P U was an essential elem ent in the
restoration of m ultilateral trade in E urope
until nonresident currency convertibility was
achieved in D ecem ber 1958. T he E uropean
E conom ic C om m unity (the C om m on M a r­
k et) and sim ilar regional groupings have also
set up, o r p lan to set up, institutions on a
sm aller scale to provide long-term financing
and facilities fo r consultation am ong m em ­
bers.

SUMMARY

154

A n exam ination of the functioning of the
gold stan d ard indicates th a t it served very
well in the p ast as a m eans of effecting settle­
m ents in in tern atio n al trad e when the basic
c o n d itio n s o f in te rn a tio n a l re la tio n s w ere
stable, b u t it was m uch less satisfactory when
conditions w ere undergoing severe change.
F ew countries left the gold stan d ard in times
of peace and prosperity, while m any left it in
tim es of w ar and econom ic turm oil. T he p rin ­
cipal advantage of the gold stan d ard was that
it p ro v id e d a s tru c tu re of stab le (in d e e d ,
rigid) exchange rates. Such a system of rela­
tionships betw een the international values of
currencies actively encouraged trad e betw een
nations because it elim inated m uch of the u n ­
certainty th a t w ould have been p resent if the




OF

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th read of gold did n o t ru n through the fabric
of currencies of the principal trad in g nations.
This very quality of certain ty and changeless­
ness was also the chief w eakness of the in ter­
national gold standard. A ll nations do not
grow at the sam e rate o r p ro sp er at the sam e
tim e. If, under the gold stan d ard , one or a
few countries w ere experiencing difficulties
in their balance of paym ents, assistance in the
form of loans m ight be o b tain ed from other
n a tio n s , w h ile th e u n d e rly in g a d ju s tm e n ts
were carried through. B ut w hen w ithin the
space of three decades the w orld underw ent
tw o general w ars and a depression of m ajor
p ro p o rtio n s , th e n a tio n s w h ich w ere e c o ­
nom ically strong w ere affected as well.
T he existence of a causal relationship b e­
tw een adherence to th e in tern ational gold
s ta n d a rd an d g en era l e co n o m ic w ell-b e in g
am ong nations has never been proved. T h ere
is no assurance th a t general p ro sp erity w ould
prevail if the nations of the w orld w ere to
retu rn to the gold standard, although the gold
stan d ard nourished against a b ack g ro u n d of
general pro sp erity in the 1870-1914 period.
A f te r W o rld W ar I, th e r e w e re d r a s tic
changes in the political an d econom ic align­
m ent of nations and in the econom ic struc­
ture of trad e betw een nations th a t m ade the
successful o p eratio n of the in tern ational gold
stan d ard as it was reconstituted im possible.
E ven if the conditions necessary to its suc­
cessful operatio n had been restored, the ac­
ceptance of price stability and high levels of
em ploym ent as goals of n ational policy p re ­
sents a fundam ental conflict with the req u ire­
m ents of the international gold standard.
T he gold stan d ard was a m eans for bring­
ing ab o u t the adjustm ent necessary to m eet
a balance of paym ents disturbance. A lthough
the “ rules of the gam e” have a disarm ing
sim plicity about them , they im plied m uch
about the environm ent in which they w ere
operative. They im plied a high degree of re­

July 1961

MONTHLY REVIEW

sponsiveness in the dom estic econom y to an
im balance in the foreign accounts and a will­
ingness of the m onetary authorities to rein­
force the needed adjustm ents. A lthough it
was seldom if ever stated in discussion of the
operation of the international gold standard,
a high degree of flexibility in the price and
cost structure of the p articip an t nations was
quite necessary. In recent years prices have
been highly resistant to dow nw ard ad ju st­
ment, thus hindering the adjustm ent called
for under the gold stan d ard in a country
having a deficit in its balance of paym ents.
Follow ing W orld W ar I, m oreover, nations
becam e increasingly reluctant to subordinate
dom estic econom ic policies to the require­
m en ts of the in te rn a tio n a l gold sta n d a rd .
Seem ing conflicts between international and
dom estic considerations were resolved in fa­
vor of the hom e econom y. T he problem s of
full em ploym ent and levels of prices and
wages were divorced insofar as possible from
the balance of paym ents and from develop­
m ents in other countries. T hus, the adjust­
m ent m echanism of the gold stan d ard was




not perm itted to function in its custom ary
fashion.
In reviewing the process of international
adjustm ent over the past th ree-q u arters of a
century, one is struck by the degree o f m an­
agem ent th at was necessary even under the
“ auto m atic” gold standard. A fter the b reak ­
down of the gold standard, m anagem ent and
international cooperation carried much of the
burden of achieving the goals of balance of
p a y m e n ts a d ju s tm e n t th a t w ere d e e m e d
desirable under the gold standard. T h e em ­
phasis, how ever, shifted to the actions of
governm ents and central banks to influence
the flow of gold, rath er than as a reflex to the
gold flow.
T he next article in this series will consider
the cu rren t role of gold, the dollar, and in­
te rn a tio n a l ag en cies in in te rn a tio n a l p ay ­
m ents and discuss the general problem of the
adequacy of international liquidity and some
o f the proposals advanced to increase such
liquidity. T he final article in this series will
exam ine the flow of gold ab o u t the w orld in
recent years and its p resent ow nership p at­
tern.

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BANKING AND CREDIT STATISTICS AND BU SIN E SS IN D EX ES— TWELFTH DISTRICT 1
(In d exes: 1947-1949 = 100. D ollar am ounts in m illions of dollars)
Condition items of all member banks2’ 7

Bank rates
Bank debits
index
31 cities1’ 6

Demand
deposits
adjusted3

Total
time
deposits

495
720
1,450
6,463
6,619
6,639
7,942
7,239
6,452
6,619
8,003
6,673
6,964

1,234
951
1,983
9,937
10,520
10,515
11,196
11,864
12,169
11,870
12,729
13,375
13,060

1,790
1,609
2,267
6,777
7,502
7,997
8,699
9,120
9,424
10,679
12,077
12,452
13,034

42
18
30
132
140
150
153
173
190
204
209
237
253

17,131
16,895
17,142
16,923
16,958
16,898
17,139

5,738
5,967
6,303
6,339
6,626
6,697
6,964

12,298
12,608
12,579
12,575
12,848
12,907
13,060

12,277
12,253
12,454
12,547
12,628
12,616
13,034

255
260
249
253
263
248
258

16,751
17,525
17,517
17,637
17,632
17,578

6,984
6,991
6,916
7,436
7,393
7,571

13,010
12,750
12,860
13,222
12,865
12,935

13,121
13,639
13,754
13,999
14,289
14,371

255
257
274
267
265
269

Year
and
Month

Loans
and
discounts

1929
1933
1939
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960

2,239
1,486
1,967
7,866
8,839
9,220
9,418
11,124
12,613
13,178
13,812
16,537
17,139

1960
June
July
August
September
October
November
December
1961
January
February
March
April
M ay
June

U.S.

Gov’t
securities

Total
nonagri­
cultural
employ­
ment

short-term
business
loans8' 7

3^66
3.95
4.14
4.09
4.10
4.50
4.97
4.88
5.36
5.62
5.73
5.53
5.50

5 48
5.50

Industrial production (physical volume)5
Year
and
month

Steel1

1929
1933
1939
1950
1951
1952
1953
1954
1955
1956
1957
1958
1959
1960

95
40
71
114
113
115
116
115
122
120
106
107
116
110

87
52
67
98
106
107
109
106
106
105
101
94
92
91

78
50
63
103
112
116
122
119
124
129
132
124
130
134

55
27
56
112
128
124
131
133
145
156
149
158
174
161

24
125
146
139
158
128
154
163
172
142
138
154

103
17
80
115
116
115
113
103
120
131
130
116
99
129

29
26
40
120
136
145
162
172
192
209
224
229
252
271

190
110
163
92
186
171
141
133
166
201
231
176
188
241p

1960
M ay
June
July
A ugust
September
October
November
December

115
110
108
109
106
103
100
99

91
91
91
90
90
91
91
91

136
132
138
138
136
131
135
137

167
170
149
164
143
159
155
151

164
158
133r
125
131
127
129
133

144
142
123
121
141
144
141
137

271
270
270
275
279
275
276
274

1961
January
February
M arch
April
M ay

101
101
103
112
110

91
91
92
92
92

134
134
131
135
143

159
176
178
168
169

111
152
162
172
191

139
134
137
137

277
276

Refined

Cement

Dep't
store
sales
(value!6

Retail
food
prices

it a

'60
112
118
121
120
127
134
139
138
146
150r

‘57
121
130
137
134
143
154
160
155
166
166r

102
52
77
lOlr
100
100
96
104
104
96
89
94r
88r

150
loOr
150r
150r
150r
150r
150r

166
164r
164r
164r
164r
163r
163r

85
86 r
82 r
86r
85 r
85 r
87 r

153
159
155
155
160
152
159

125
126
125
126
126
126
127

151r
151r
151r
151r
151
152p

162r
162r
163r
162r
163
164p

84 r
83r
83r
88r
81
85

154
164
160
164
153
162p

127
127
127
127
127

Exports
Electric
power

Copper7

Crude

Car­
loadings
(number)5

30
18
31
112
120
122
122
132
141
140
143
157
156

64
42
47
113
115
113
113
112
114
118
123
123
125

Waterborne Foreign Trade Index7’ »• 10

Petroleum1
Lumber

Total
mf'g
employ­
ment

Total

Imports

Dry Cargo

Tanker

150

247

107
80
194
201
138
141
178
261
308
212
223
305p

243
108
175
130
145
123
149
117
123
123
138
149p

251
243
193
227
250
244
220
271

330
288
257
280
3 t7
347
306
338

139
180
102
153
113
97
97
175

235

318

118

Total

124
72
95
144
162
204
314
268
314
459
582
564
686
808p

Dry Cargo

128

Tanker

7

97
145
140
141
163
166
187
201
216
221
263
269p

57
103
733
1,836
4,239
2,912
3,614
7,180
10,109
9,504
11,699
14,209p

771
872
681
1,025
885
779
826
1,046

289
294
263
261
284
238
254
245

13,341
15,944
11,565
20,948
16,550
9,240
15,744
21,919

779

218

15,394

1 Adjusted for seasonal variation, except where indicated. E xcept for banking and credit and department store statistics, all indexes are based upon
data from outside sources, as follows: lumber, National Lumber M anufacturers1 Association, W est Coast Lumberman’s Association, and Western
Pine Association; petroleum, cement, and copper, U.S. Bureau of Mines; steel, U.S. D epartm ent of Commerce and American Iron and Steel Institute;
electric power. Federal Power Commission; nonagricultural and manufacturing em ploym ent, U.S. Bureau of Labor S tatistics and cooperating state
agencies; retail food prices, U.S. Bureau of Labor Statistics; carloadings, various railroads and railroad associations; and foreign trade, U.S. Departm ent
of Commerce.
* Annual figures are as of end of year, m onthly figures as of last W ednesday in month.
3 Dem and deposits, excluding
interbank and U.S. Governm ent deposits, less cash item s in process of collection. M onthly data partly estim ated.
* D ebits to total deposits
except interbank prior to 1942. D ebits to demand deposits except U.S. Government and interbank deposits from 1942.
4 D aily average.
6 Average rates on loans made in five major cities, weighted by loan size category.
7 N ot adjusted for seasonal variation.
8 Los Angeles,
San Francisco, and Seattle indexes combined.
8 Commercial cargo only, in physical volume, for the Pacific Coast custom s districts plus Alaska
and Hawaii; starting with July I960, "special category” exports are excluded because of security reasons.
10 Alaska and Hawaii are included
in indexes beginning in 1950.
p— PreEminary.
r— Revised.

156