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Statement by

Arthur F. Barns

Chairman, Board of Governors of the Federal Reserve System

before the

Subcommittee on International Economics

of the

Joint Economic Committee

June 27, 1973

I am pleased to appear before this Committee to comment
on recent developments in foreign exchange markets and their
In assessing the exchange-rate arrangements that have
prevailed since mid-March of this year, it is useful to recall a few
historical facts.

Starting in the mid- 1 960' s, the balance of payments

of the United States deteriorated with only minor interruptions. A
trade surplus per year averaging more than $5 billion in the mid19601 s vanished by 1969, and was converted to a deficit at an
annual rate of over $3 billion by the second quarter of 1971.
For a time, particularly during 1968 and 1969, capital inflows
offset the decline in the trade balance and kept the official settlements balance from reflecting the underlying deterioration. By
the late spring of 1971, however, the growing weakness of our
balance of payments was already widely recognized. A little later,
a massive movement of dollars into foreign currencies finally
forced the United States in August 1971 to suspend the convertibility
of the dollar into gold and other reserve assets.
The actions taken by the United States that August culminated in a realignment of the par values of major currencies at

the Smithsonian meeting in December of 1971, No quick improvement of our trade position was anticipated in view of the lags with
which exchange-rate changes affect international trade, and also
because our economy was advancing with some rapidity at a time
when the economies of our trading partners were generally sluggish.
In fact, our foreign trade performance during 1972 turned out to be
much poorer than had been expected, with the trade deficit soaring
to about $7 billion.

By early February of this year, after some

renewed disturbances in exchange markets, foreign governmental
authorities agreed with our conclusion that the Smithsonian
realignment had not gone far enough and that a further devaluation
of the dollar was needed to restore equilibrium in international
This second realignment of currency parities was agreed
to on February 12, In contrast to the Smithsonian realignment,
under which virtually all countries established new par values
for their currencies, Italy and Japan now chose to float their
currencies, thus joining the Canadian dollar, British pound,
and Swiss franc - - all of which were already floating,
Once faith in a national currency is shaken, the process
of rebuilding confidence is never an easy matter.

The monetary

authorities of the leading countries were confident that the exchangerate pattern established on February 12 was realistic and that it
would in time restore equilibrium in world payments.


less, the dollar once more came under severe pressure in late
February and early March.

Countries still committed to main-

taining par values for their currencies were therefore forced
once again to purchase large amounts of dollars in the course
of their intervention, and then ultimately to close their exchange
The disorder that prevailed in currency markets during
this crisis period prompted international discussions that resulted
in a further extension of floating among the major currencies.
Most countries within the European Economic Community - West Germany, France, the Netherlands, Belgium, Luxembourg.,
and Denmark - - chose, however, to maintain exchange rates
among their own currencies within narrow margins, but to permit
them to fluctuate more or less freely against the dollar.


European bloc was soon joined formally by Sweden and Norway
and informally by Austria.
After the mid-March Paris meeting of finance ministers
and central bank governors, exchange markets reopened.



the next few days the volume of activity was light, and exchange
rates moved within a rather narrow range.

Over the following

weeks, markets continued to be calm as the volume of trading moved
closer to normal levels.

Fluctuations in market exchange rates

differed little from those that had normally prevailed under the
previous regime of fixed parities.

In fact, the dollar did not move

outside the range of 2-1/4 per cent on either side of the central
rates established in the February-March period.

Thus, during

April and early May, the average dollar price of 10 major
currencies (those of Japan, Canada, and 8 European nations)
appeared to have stabilized at a level some 19 per cent above the
exchange parities that prevailed in the spring of 1970 - - that is,
prior to the Canadian float and the subsequent currency realignments.
In mid-May, however, the relative calm that characterized
exchange markets during the preceding weeks ended abruptly.
Movements of exchange rates became larger, and the dollar began
to decline sharply further against the major European currencies.
Over the six-week period from May 9 to June 20, the dollar price
of the mark, the French franc, and the Swiss franc rose by 10,
7, and 6 per cent, respectively.

The average appreciation during

this period of the ten major currencies previously mentioned was

smaller - - about 4-1/2 per cent; the main reasons being that
the dollar price of sterling rose little, while the Japanese and
Canadian currencies remained quite stable, and the price of the
Italian lira actually declined.
The causes of the widespread further depreciation of
the dollar in this recent six-week period have been discussed

I doubt if they can be identified with any great
My own impression is that the most important

factor was the accumulating evidence that the moderate success
which the United States had achieved in curbing inflation during
1972 was eroding.

Other factors undoubtedly played their role - -

among them, the tightening of monetary policies abroad, the
new restrictive fiscal policy in Germany, the spread of
uncertainty abroad about the ability of our government to handle
economic problems effectively, and wild rumors that another
devaluation of the dollar was contemplated.

Not least important,

there was a sharp speculative run-up in the market price of
gold, which reflected, and in turn generated, a growing distrust
of currencies generally.

This development was bound to focus

particularly on the dollar, in view of the world-wide fears
caused by the sudden discovery that its stability could no longer
be taken for granted.

There may be some economists who view the recent
decline in the international value of the dollar with satisfaction.
I am not one of them.

When a currency depreciates, a nation's

effort to curb inflation becomes more difficult.

For in such a

case, the prices of imported goods rise, and their rise is
transmitted to domestic substitutes as well as to finished
products based on imported raw materials.

Meanwhile, exports

are stimulated; and if direct controls are simultaneously being
applied to domestic prices, as is now the case with us, some
troublesome shortages may develop in domestic commodity

In contrast to the earlier devaluations, which were

needed to restore equilibrium to our international transactions,
the May-June depreciation is unfortunate.

It certainly cannot

be justified on any realistic evaluation of international price
levels or underlying economic trends.
Nor is that all.

To the extent that excessive depreciation

of the dollar should persist, the United States would in time
develop an undesirably large trade surplus.

In other words,

we would then be transferring real resources on cheap terms
to the rest of the world instead of putting them to use here at

Such a development, besides being senseless from our

viewpoint, could cause difficulties for other countries, most
of which depend far more on foreign trade than does the United

Still another consideration to bear in mind is that per-

sistent depreciation of our currency would in time undermine
confidence in the dollar's role as a transactions currency, and
thereby weaken the international role of our highly developed
financial system.
Although the decline in the international value of the
dollar since mid-May is unwarranted by the condition of our
economy or our balance of payments, there has as yet been no
intervention by our government in the exchange markets.


who are selling the dollar short - - whether out of a desire for
safety or quick profits - - will probably be punished
by the market itself.

In any event, the central banks of the

leading countries will not remain aloof indefinitely.
is being watched closely*

The situation

As agreed at the March 16 meeting in

Paris, we and the monetary authorities of other countries stand
prepared to intervene to facilitate the maintenance of orderly
conditions in exchange markets.
Under present circumstances, with many financial,
commercial, and political issues still unresolved among the

nations of the world, the present exchange-rate arrangements - which I hope will involve little central bank intervention - - are
bound to continue.

These arrangements have their advantages.

The impact on exchange markets of speculative purchases and
sales of currencies can be reflected in rate movements that
are eventually self-limiting.

In recent weeks, we have in fact

been able to avoid the crisis atmosphere that would have
emerged if the monetary authorities were still committed to
maintaining a particular set of exchange rates through unlimited
official intervention.

There has been no need to close exchange

markets to shut off massive international movements of funds.
In addition, several countries have found that the present floating
arrangements enable them to keep a firmer grasp on the
expansion of their money supply and domestic indebtedness.
Limited experience is always an ambiguous teacher, but
it can still generate strong opinions.

Many of our businessmen

and bankers now view floating exchange rates as a desirable
development, or at least as necessary or entirely acceptable
in current circumstances.

Many regard the uncertainty

associated with these arrangements as inconsequential, or as no

more serious in their business calculations than other sources
of price or cost variation.

Many believe that a return to a par

value system will bring further episodic crises or new controls
that would impede world commerce more than floating exchange

These attitudes contrast dramatically with the views

held by most businessmen and financiers only a few years ago.
Even some of my central bank colleagues - - who traditionally,
as you know, have been the staunchest defenders of fixed exchange
rates - - now seem to be accepting floating exchange rates with
Thus, there is fairly broad agreement - - among businessmen, bankers, and political leaders - - that the present exchange rate arrangements have been helpful or at least tolerable.
Thoughtful and prudent men recognize, however, that the present
arrangements have not been in operation very long, and.I believe
that not a few of the businessmen and bankers who were enthusiastic
about floating exchange rates in April have developed doubts since

Any judgments of the future based on recent experience

must therefore be quite tentative.
For the longer run, thinking of a reformed international
monetary system, I remain skeptical about the desirability of a
general system of floating exchange rates.

I hold this view even


though I recognize the usefulness of floating rates in particular
situations, such as the present.

Some reasons for my skepticism

are as follows:
First, in my judgment, the floating exchange-rate system
which has figured so heavily in academic discussions is a dream
that will continue to elude us.

Even for a country with as low a

ratio of international trade to GNP as that of the United States,
the repercussions of exchange-rate changes on the domestic
economy can be substantial**

Under a floating exchange-rate

system, governments are always apt to be subject to political
pressure by business, agricultural, and labor interests for
protection against large movements of exchange rates - - which
may mean new controls or central bank intervention or both.
So-called "clean11 floating is not a politically viable arrangement
over the long run.
Second, a system of floating exchange rates may lead to
political friction and competitive national economic policies.
From time to time, suspicions will be generated that this or
that country has been manipulating its exchange rate at the
expense of the interests of its trading partners.

In such an

atmosphere, whether for defensive or retaliatory reasons,
governments may impose controls on capital flows or on current



It is true, of course, that suspicion and political

friction may be present under any type of exchange-rate regime.
And we know from experience that governments often imposed
controls on international transactions when they were trying to
defend fixed exchange rates that were unrealistic.


I fear that such problems would be greater with widespread
permanent floating of the major currencies.
Third, the uncertainties associated with floating exchange
rates may lead in time to some erosion of international trade,
particularly in the case of equipment purchases that require longterm financing and when profit margins are slim.

These un-

certainties may also weaken private foreign investment - especially in long-term bond issues.
Fourth, exchange-rate fluctuations under a floating regime
may add further to the difficulties that some governments- already
have in carrying out suitable fiscal and monetary policies.


is danger, for example, that a temporary exchange-rate depreciation
will get translated into permanent price-level increases through
upward revisions of nominal wages.

Moreover, floating exchange

rates may themselves become a tool of business-cycle policy, and
thereby lead at times to neglect of appropriate domestic policies.


While I have such misgivings about floating exchange rates
as the basis for a reformed international monetary system, I realize
that international rules may be developed to minimize their undesirable effects.

In any event, I do not approach the question

of long-run reform in a dogmatic frame of mind.

The objective

of the negotiations currently under way should be to adopt that
set of institutional arrangements which, in the balanced judgment
of financial experts, is most likely to promote the orderly expansion
of international economic transactions among countries - - each of
which will be pursuing the goals of high employment, improvement
in productivity, and general price stability.

The exchange-rate

regime is not an end in itself.
I also recognize that the Bretton Woods arrangements,
despite their great contribution to the international economy of
the post-war period, failed to achieve timely adjustments of
exchange rates.

In the future, exchange parities must not be

allowed to become so rigid or unrealistic.

Many changes take

place in the world economy - - for example, in national rates of
growth in productivity - - that require some change in currency

Furthermore, while we all hope that at least the major

countries will pursue sound, noninflationary policies in the future,


we know that mistakes will at times be made.

These mistakes,

too, may modify the pattern of exchange rates that is appropriate
for maintaining balance of payments equilibrium*

Hence, I fully

endorse the objective of developing an exchange-rate regime that
will be more flexible than the Bretton Woods system.
The approach of our government to international monetary
reform was outlined by Secretary Shultz last September in his
address at the IMF meetings, and is embodied in the U.S. proposals to the Committee of Twenty.

This approach assumes that

in the new international monetary system most nations will maintain established parities for their exchange rates.

A similar

view was expressed by the Committee of Twenty in the communique
issued at the close of their meeting this March.

The communique

stated that exchange rates must be a matter for international concern
and consultation; that in the reformed system the exchange-rate
regime should be based on. -cable but adjustable par values; but
that floating rates could provide a useful technique in particular
The U«S. approach to international monetary reform does
not envision a par value regime of the Bretton Woods character.
The U.S. proposals provide for rather prompt corrective actions,


including par value changes where they are deemed appropriate.
The proposals recognize, moreover, that a realistic framework
for a reformed international monetary system must permit a
country to float its currency for a temporary «- and possibly
for a prolonged - - period.

In the latter case, however, inter-

nationally accepted rules of behavior would still need to be
Under the U.S. plan, movements in a nation's reserves
are assigned a central role in establishing the need for corrective

We do not, however, propose a system of automatic

responses to reserve movements.

On the contrary, each

country would retain a substantial degree of freedom in choosing
the corrective measures that appear most appropriate in its
An essential feature of the U.S. plan is that it would
evenhandedly encourage adjustments by countries whose reserves
were out of line, whether on the high or low side.

The plan

would operate on a principle analogous to that of workmen's
compensation and no-fault accident insurance; in other words,
remedial action would be expected of a country whose reserves
either rose excessively or declined excessively, without attempting
to allocate blame or fix responsibility for the remedial action
on a "guilty11 party.


Before concluding, I would like to comment briefly on
the prospects for the U.S. balance of payments.

For I believe

that, as a result of the exchange-rate realignments of 1970-71
and early 1973, the outlook for our balance of payments has
greatly improved.

Altogether, by April of this year the dollar

had been effectively devalued against other currencies by about
16 per cent since mid-1970, and by substantially more than that
against some of our strongest competitors such as Japan and

This is a large adjustment, and it has substantially

improved the international competitiveness of U.S. goods.
The exchange-rate changes of recent years are already
beginning to have perceptible effects on both our exports and
our imports.

So far this year, there has been a marked improve-

ment in the trade balance.

The trade deficit in the period from

March through May, the latest three months for which data are
available, was at an annual rate of about $1.3 billion, compared
to $6. 8 billion for 1972 as a whole,

Much of this recent improve-

ment reflects a bulge in agricultural exports which is likely to
prove temporary, so that the underlying gain is not as large as
the raw figures suggest.

We should be prepared for some

temporary setback during the months ahead.
been solid gains.

But there have

The value of nonagricultural exports in the


March-May period was 18 per cent larger than it had been six
months earlier.

New foreign orders for machinery in the first

quarter of this year were 16 per cent higher than in the third
quarter of last year.

Meanwhile, the growth of total imports

appears to have moderated, although a sharp spurt did occur
in May - - probably a result in large

part of the recent rise in

the prices of imported foods and raw materials.
Later this year and in 1974, we may expect to see further
gains in our foreign trade balance, not only because of the
cumulating effects of our strengthened competitive position, but
also because business cycle conditions are likely to change in
our favor*

The growth of real output in the United States has

begun to slow to a more moderate and sustainable rate, which
should dampen the growth of our imports.

On the other hand,

economic activity abroad, which is the main determinant of our
exports, is continuing to expand at a vigorous pace.

The improve-

ment in our trade balance this year is therefore likely to gather
momentum in 1974 and 1975, by which time we should be
experiencing a sizable trade surplus for the first time since
the late 1960rs.
The improvement in the trade balance may well be
accompanied by some improvement in other international


transactions - - particularly capital movements.

With the dollar

so much cheaper than it was two or three years ago, foreign
investors are likely to develop a greater interest in acquiring
American assets - - business firms, real estate, or securities.
There are already numerous indications of such a widening
foreign interest.

On the other hand, the higher prices that

Americans must now pay for foreign currencies tend to diminish
their incentive to build plants abroad or to acquire foreign
This favorable outlook for the U. S. balance of trade and
payments is, of course, contingent upon containing domestic
inflationary pressures.

I am greatly troubled by the high rates

of inflation that we have experienced in recent months. No
exchange-rate regime or international monetary system can
work well if the major industrial nations, particularly the
United States, fail to gain better control over inflation than
we have as yet achieved.
A stable dollar is vital to the well-being of American
workers and consumers.

It is also essential to the continuing

progress of our domestic and foreign business, to a healthier
investment climate in our country, and to the maintenance of


our international political standing.

I therefore hope that this

influential Committee, while immediately concerned with the
problem of floating currencies, will keep in mind the overriding importance of restoring stability to the domestic
purchasing power of the dollar.