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Speech by Darryl R. Francis, President
Federal Reserve Bank of St Louis
at a Rotary Inter City Meeting
Webster Groves YMCA, Webster Groves, Mo.
July 12, 1968
The United States is currently twice blessed with serious
international economic problems. O e problem is a weak balance of .
payments, and the other is a weak international monetary mechanism.
The balance of payments problem stems from the domestic inflationary
pressures that have developed in the last three years. The United States
is not unique with respect to this problem which any country can expect
to face if it attempts, through public policy, to force economic growth
beyond productive capacity. This eventually produces serious Inflation.
However, the other international economic problem we presently face
is, in many ways, unique. It is the growing and obvious weakness in the
international monetary mechanism. The United States is the architect
of that mechanism, and \he dollar is its major bulwark.
Many people tend to confuse these two problems, suggesting
solutions to our international economic problem without specifying
which problem the solution is designed to correct Although these
two problems arc interrelated, they are not the same and cannot
be dealt with by the same methods. Once we realize these are two
diseases; we can consider appropriate remedies for each. In my opinion,
the remedies suggested in the President's January 1st message to correct
the balance of payments problem can not be effective. • The only successful

remedy for that problem is restrictive monetary and fiscal policies at home.
With respect to the problem of a weak International monetary mechanism,
the best solution is for the United States to ultimately eliminate gold from
the process. The action taken on Mrh

1 to suspend gold sales to private

markets was a step in the right direction, but it may not have been enough.
The Special Drawing Rights once again enunciated at the Stockholm meeting
at the end of March is a further step forward if they can be activated in time
and in sufficient volume.
Now that 1 have given you my recommendations, \ will build
a factual and analytical structure which I believe justifies these conclusions.
Balance of Payments Problem
There are essentially two ways to correct a balance of payments
deficit: through direct controls on internatlonal transactions which
force people to reduce their spending, or through monetary and fiscal
policy and the price mechanism which induces people to reduce their
spending by changes in the environment of the market place. We seem
to have chosen the direct control alternative, which 1 consider unfortunate,
unworkable, and, most important, an abridgment of personal choice.
The President's January 1st call for administrative controls to correct the
United States Balance of Payments problem affects all segments of the
American public. Businessmen can no longer invest in foreign countries
as freely. Bankers can no longer make foreign loans as freely. Government
officials must conduct international affairs more on the criteria of the foreign
exchange cost and less on the c r i t e r i a

of general national


The use of direct administrative controls to correct economic
problems has been used widely in other countries, but we have traditionally
used economic tools to correct economic problems. The use of administrative
controls represents a break with our traditional way of dealing with economic
Reviewing past experiences with such controls may provide
insights into its possible success for the future.
On two recent occasions the United States has attempted to
use administrative controls to improve the balance of payments. The
Interest Equalization Tax of 1963 was designed to discourage investment
in foreign stocks and bonds by raising the effective costs of such purchases.
The Voluntary Program of 1965 covered a much broader range of capital
movements than the Interest Equalization Tax, including corporate direct
investments and foreign bank loans. Each of these programs was preceded
by a sharp deterioration in the United States balance of payments.
Furthermore each was followed by a temporary improvement with a
reduction in the capita! outflow in the particular segments of the balance
of payments at which they were directed. However, other components
of the balance of payments sprang additional leaks, and the overall payments
position was not permanently improved. Neither of these programs could
be considered successful.
The explanation of this lack of success is that administrative
actions to solve economic problems run counter to the narrow selfinterest of those who are affected. They have substantial incentives

-4to devise methods to avoid controls. As pointed out in the Wall Street
Journal, they prefer that the problem would be corrected In the marketplace,
not at a legislative level. The discipline of the marketplace cannot be evaded
or avoided, but legal restriction often can. Evasion of the !law is difficult

penalties mild. Legal avoidance of the intent of the law by discovering and
utilizing "loopholes" in the administrative regulations Is even more popular.
Inevitably, the authorities in charge cf the program implement more
restrictive enforcement methods to prevent Illegal evasion, and propose
more comprehensive controls to prevent legal avoidance. This has been
the experience of many foreign countries and seems to be what we are doing.
The logical outcome of such a progressive movement is to plug
all conceivable loopholes and introduce the most severe penalties for
those who break the rules. The end result is a complete, comprehensive
and restrictive set of foreign trade and capital controls which is so
complex and unwieldy that It is a serious impediment to domestic growth
and an efficient distribution of resources. As Gabriel Hauge, President
of the Manufacturers Hanover Trust and past Chief Economic Adviser to
President Eisenhower, observed (at a meeting of the American Chamber
of Commerce in London), 'The resort to controls of one sort or another to
deal with a problem that has its roots deep in the nation's economy is
likely to be increasingly ineffective as time goes on . . . "

-5Thus, I am rather pessimistic about the success of the January 1st
program. Although more comprehensive and more restrictive than our
earlier balance of payments programs of 1963 and 1955, It is still far from
being a complete set of trade and capital controls.
An administrative program carried to its extreme, might temporarily
alleviate the symptoms of our balance of payments problem. The political
cost in the form of loss of freedom of choice and the economic cost in
the form of misallocation of resources which comes from distorting
the price mechanism, would be substantial. ! question whether we
should or would be willing to pay such a high price for solving a problem
in a segment of our economy which represents only five per cent of our
national income.
I think it would be wiser if we attacked the prime cause of our
present balance of payments problem, the serious domestic inflationary
pressures which have developed since 1964, with economic tools. The
sharp deterioration of our balance of trade surplus, the strongest
segment of our overall balance of payments, is due almost exclusively to
domestic inflation. Mot only will the resolute use of monetary and
fiscal tools to restrain total demand strengthen the balance of payments,
but it will also be conducive to stable and non-inflationary growth in the
domestic economy. The recent tax increase and spending cut are moves in
the right direction.
International Monetary Mechanism P r o b l e m
Putting our domestic house in order, however, is only half of
the job. The other half is to strengthen the international financial

-6mechanism, which has become increasingly and obviously incapable
of meeting the long-term needs of world trade and capita! movements.
The present mechanism as established at Bretton Woods in 1944, largely
under the auspices of the United States, is designed to generate a form
of international money. This money is needed to meet the needs of
world trade and finance, just as domestic money is needed to meet the
needs of domestic trade and finance. Unlike domestic money, there
is no international central bank to supervise the growth in international
money. The mechanism has been allowed to run more or less on its own.
International money is composed of monetary gold stocks,
automatic drawing rights on the International Monetary Fund, and
non-resident holdings of British pound sterling and United States dollars.
These various components of the international money supply must be freely
convertible between one another at a fixed price if they are to be considered
equally valuable. Holders must be able to shift from dollars to gold
to sterling without loss, just as in the domestic economy money holders
can shift between currency and demand deposits without loss.
The weakness in the international financial mechanism is the
growing fear in some quarters that this free convertibility at fixed prices
will not continue in the future. There are numerous cases where such
expectations have hurt the domestic economy. Consider the runs on
United States banks in the early 1930s. They represented an attempt
by people to shift their money holdings out of deposits and into currency,

-7because of fear that deposits would lose their convertibility. The
short-term solution of the run on the banks in the early 1930's
was a one-week holiday, and the long-term solution was the development of deposit insurance which, in effect, guaranteed deposits up
to a certain amount. The integrity of cur domestic monetary
mechanism was restored by these actions and has not been seriously
questioned since.
The sterling devaluation in November 1967 was a shock to
the international financial mechanism, because one of the component
currencies of the international money supply thereby lost value relative
to the other components. Confidence in the mechanism was shaken,
precipitating a movement into the component of the international money
stock which was expected to be of greater value. This is the underlying
reason for the gold rush in the London market. The short-term solution
of the run on the London gold market was to give that market a two-week
holiday. The long-term solution that has been proposed is to attempt to wall
off the private market for gold from the official market for gold.
The two-price, or two-market system for gold has been accomplished
by the United States and the other members of the gold pool refusing to
buy or sell gold to private persons. In addition, the United States as the
only country in the world which has freely bought and sold gold to other
governments, will suspend gold sales to any government which buys or
sells gold to the private market. This restriction applies to Governments
buying gold from their own gold producers. It will have a major effect on

-8South Africa which will now have to sell its newly mined gold in the private
These regulations, if successful, will freeze the stocks of gold
held by governments at their preserve level. New supplies of gold
presumably would all go into non-monetary use. The purpose is to
separate the demand for gold as a commodity from the demand for
gold as a component of the international money supply.' The uniqueness
of gold is that it has been simultaneously a commodity and also a
component of the international money supply. By attempting to
separate the commodity demand for cold from the monetary demand for
gold, it is hoped that private speculation in gold will have no more
effect on the international monetary system than private speculation
in any other commodity.
A two-price system for gold will be successful only as long
as the commodity market and the monetary market for gold can be
kept separate. That in turn depends primarily on two factors.
First is that the monetary demand for gold will not grow in the future.
Second is that the commodity price of gold will not be significantly
higher than the monetary price of gold. If the first condition does
not hold, then the monetary demand for gold will pull gold from the
commodity market. If the second condition does not hold, \he
commodity demand for gold will pull cold from the monetary stocks.

-9The natural forces of the marketplace would tend to increase the demand for monetary gold stocks. Surplus countries would
desire to have some of their Increased reserves in the form of gold.
On the other hand, deficitcountries would most likely prefer to reduce
the non-cold portion of their reserves. Such developments would imply
that the United States must still continue to act as the residual source
of gold supplies to central banks. Unfortunately, after the massive
gold losses from December through A/larch of this year, the United States
is in a rather weak position to play that role. Our gold stocks stood
at $10.4 billion as of the end of June. The United States could probably
meet the gold needs of the smaller countries, but not of the larger
countries. Thus, if the monetary demand for gold is to be kept from
rising, it will be necessary for the major countries of the world to
individually and collectively refrain from purchasing gold from the United
States. The only conceivable incentive these governments would have to
cooperate with us in this way would be their reluctance to see the present
international monetary system, based on a fixed official price of gold,
disappear. It is ironic that to preserve the gold exchange standard most
of the major countries of the world must be prepared not to exchange
A second way in which this system could break down is for the
commodity price of gold to rise significantly above the official monetary
price of gold. If the commodity price of gold were, for example, $70 an ounce,.

-10it is quite likely that imaginative profit-minded speculators would manage
to find some method of acquiring monetary stocks of gold which are
officially priced at $35 an ounce from some central banks.
What could cause the commodity price of gold to rise significantly
above $35 an ounce? As with a y commodity, that would depend on the
supply and demand for gold. The major source of new gold supplies is
South Africa, which provided something like 70 per cent of new gold
supplies in the last decade. South African gold production increased
from 370 tons in 1956 to 950 tons in 1966 due entirely to the discovery
and exploitation of major new gold-mining regions. In 1967 these new
mines supplied 83 per cent of South Africa's annual output. It is
estimated that at the $35 an ounce price, South Africa's gold production
cannot increase above its present level, and will probably decline
somewhat in the next few years. Thus, a substantial price increase
would be needed to Increase new supplies of gold coming onto the market
in excess of the present level of $1.5 billion per annum.
With respect to the other side of the market, there are two
components to the commodity demand for gold. The first component is
the commercial, industrial, and artistic demands. These have grown
in the postwar period at a steady ratebecauseof the rise in real incomes
and the rise in general price level. They took approximately one-half
of the world's gold production in 1967. The second non-monetary demand
for gold consists of those gold purchases which cannot be specifically

identified with the first demand and are assumed to be largely speculative
in nature. It is this speculative demand for gold which has shown the
sharpest variations from year to year.
As with speculation in any commodity, gold speculation is
based on the expectations of buying a a low price and selling at a higher
price. Most speculation was based on the expectation that the United States
•.would unilaterally increase the price of gold. Now that the United States,
in agreement with the other active gold pool countries, has instead
suspended gold sales to the private market, private speculation will be
more risky. There are likely to be greater variations in the commodity
price or .gold and no guarantee that the price cannot go below $35 an ounce.
Therefore, some persons who might otherwise have speculated In gold
will withdraw from the market.
The sharp decline in the volume of activity in the private gold
markets after the March !7th announcement of suspension of sales by
the gold pool countries is due to speculators who are obviously waiting
to see what further action the central bankers will take. If the central
bankers of the major countries refrain from purchasing gold from the
United States and agree to activate an alternative form of international
reserve asset to supplement the frozen monetary stocks of gold, then
the monetary price of gold could remain unchanged at $35 an ounce.
Under these circumstances, speculation with respect to a rise in the
monetary price of gold would probably decline. Given that the nonspeculative demand for gold is only one-half of new production at the

- 1 2
price of $35 an ounce, it is possible that the commodity price of gold In
the future might be below $35 an ounce.
The key to a viable International monetary mechanism is to
prevent the commodity d m n
e ad
mny supply.

The t o price

for gold from affecting our international

for gold is a step in that direction.

Whether it is a sufficient step will depend upon the degree of cooperation
among the major governments of the world. Generally, such cooperation
is hard to achieve because governments, like persons, so often see
the narrow, short-term disadvantages of cooperation in a stronger light
than the wider, long-term advantages. People tend to highly discount
both the risks and the benefits associated with actions to affect the
future. It generally takes a period of crisis to force people and countries
to subordinate their short-term interests to achieve some long-term
An analogy may be drawn from the Cuban missile crisis of 1962.
Prior to that event no effective policy efforts had been made towards
nuclear disarmament or arms control although a considerable amount of
intellectual effort had gone into analyzing the substantive issues. That
crisis led the United States and the Soviet Union to the brink of a
nuclear war. The horrors of such a possibility became very real in the
minds of policy makers on both sides. After that event a substantial
amount of progress was made..

-13 years and realistic economic solutions are available. What are required
are policy level decisions to go ahead. If the panic which surrounded
the gold speculation during the Ides of March created the crisis atmosphere
in the minds of the world's central bankers to go ahead with a change in
policy, then this will have been the most beneficial monetary development
in the past twenty years.
Perhaps these expectations of cooperation by the world's major
central banks are too optimistic. They may still insist on making purchases
from our gold stock and refuse to activate a paper gold in sufficient
quantity. That lack of cooperation is not apparent now and hopefully will
not develop, but it is worthwhile to investigate alternatives in the event
of a breakdown of the present high level of international cooperation. If
such a breakdown were to become apparent, private speculation of an
increase in the monetary price of gold would probably force up the
commodity price of gold, and the United States would be forced to take
unilateral action to correct the problem. There are only two solutions
which the United States can unilaterally choose. One is to raise the
price of gold, and the other is to withdraw completely from the gold market
by suspending sales to foreign central banks as well as to foreign private
persons. I do not under any circumstance favor raising the price of gold.
It would perpetuate that "barbarous metal" in international monetary
use. We have quite rightly broken the link between gold and our domestic
money. We should also break the link between gold and international
money. The supply of money, neither international nor domestic, should
not be dependent over the longer run upon the accidents of supply and demand
in the marketplace for just one commodity.

-14In the event the paper gold proposal should break down, I favor
the United States unilaterally abandoning Its promise to buy and sell
gold at the fixed price of $35 an ounce. Unpegging from gold does not
mean that the United States dollar would automatically be devalued.
Devaluation is a chance in the price of the dollar relative to other
currencies, not relative to gold. To see whetherthe dollar would, in
fact, be devalued, one must consider the possible reactions of foreign
countries to the unpegging of gold. There are two: first, they could
continue pegging the value of their currencies to the dollar. If their
currencies were pegged to the dollar at the present exchange rate, the
dollar would not be devalued in any meaningful sense. Second, they
could peg their currencies to gold, i nwhich case the international
value of the dollar with respect to other currencies which are tied
to gold would fluctuate. This action Is unlikely because no other
country would likely be willing to assume the heavy responsibilities
of maintaining the gold standard. They would eventually face the same
dilemma presently faced by the United States. In addition, they would
be reluctant to see their currencies fluctuate with respect to the dollar.
This would upset the trading practices of their exporters and importers
with the United States which accounts for about 20 per cent of the world's
trade. On balance, therefore, it is most likely that foreign countries
would continue to peg their currencies to the dollar, even without the
present gold backing.
If the dollar is likely to continue to be held by foreigners, even
in the absence of gold backing, why the reluctance of United States

officials to unpeg gold? Because of the repeated commitment of the United
States to maintain a fixed price of gold at $35 perounce. The United
States could handle this issue by agreeing to compensate those foreign
governments which have held dollars rather than purchasing gold
because we asked them to do so. Such compensation would consist of
allowing certain friendly central banks to turn In their green chips for
gold chips if they desire at the rate of $35 per ounce of gold.
Some observers are fearful that if we unilaterally suspend gold
sales to foreign central banks, the rest of the world, especially European
countries, would not accept new dollarholdings. They feel that the
option to purchase gold is necessary to induce foreigners to accept dollars.
To prevent dollars from flooding into their country when they had balance
of payments surpluses, these countries would impose various types of
exchange controls. Let's assume for a moment that is the case. We would
still be better off than we are now. At present, the United States is
imposing exchange controls on its citizens i n order to reduce our balance
of payments deficit in the expectation that this will increase confidence
in the dollar and reduce purchases from our gold stock. If we suspend
gold sales, the pressures on the United States to maintain or expand these
exchange controls would be reduced. I believe it is better to face the
possibility of the Europeans imposing controls on United States citizens
than the certainty of the United States imposing controls on United States

- 16.In any event, the possibility of the Europeans imposing exchange
controls is small. First, this would be the only time in history that
a country has imposed exchange controls to reduce a surplus in its
balance of payments rather than to reduce a deficit. Second, and more
important, if the only issue is providing the Europeans with another
alternative to holding dollars, there are techniques new available through
Special Drawing Rights of the International Monetary fund which could
be activated to syphon off undesired dollar balances held by European
central banks.
I mentioned before that actions to solve important problems
usually must take place in an atmosphere of crisis so that the narrow
parochial interests of the participants is subordinated to their collective
long-term interests. If the gold crisis of early March did not create a
sufficiently strong crisis atmosphere in the minds of the world's
central bankers, an action by the United States to suspend gold sales to
central bankers probably wouId.
An international financial mechanism based on dollars and
Special Drawing Rights would be superior to one based on dollars and gold.
Unlike gold, Special Drawing Rights can be expanded with the growth in
trade and are not dependent upon the accidents of new gold discoveries
for their supply. We need an international money based on paper and
confidence just as we have domestic money based on paper and confidence.

-17Basically, the value of our currency is supported by our production of
goods and services and its purchasing power is dependent on our
willingness to inject rational a d responsible judgment into our
budgetary and monetary management.