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Speech delivered before
IklriL •'•IlinjiLlip.l^^liiFlorida-Southes stern Business. Conference
University of Florida, Gainesville, Florida •
October 20, 1950
MOJET^RY POLICY Al<iD THE INTSBiMIOiJaL ECONOMYFree nations are closely tied together by commercial , nd financial
relations, and the national income of each country depends to a large extent uoon international developments. In order to make full use of its
resources, a nation must exchange products in which it excels for products which are more efficiently produced abroad. It must attract foreign capital if its resources cannot be fully developed with its own
savings'. Similarly, it must send capital abroad if its savings exceed
its own investment needs.
The monetary policy of every free economy must therefore pay serious
attention to the interrelation between domestic and foreign events.
There .-is, however,'a fundamental difference between the domestic and the
international aspects of monetary policy. Within its own borders, every
nation has sovereign control of its system of money and credit, ana the
monetary authorities therefore have a unique position in influencing
domestic economic developments. But sovereign monetary control does not
extend beyond a nation's own borders, and the monetary authorities can
affect happenings abroad only by indirection.
If, for example, the monetary authorities of one country succeed in
curtailing the expansion of domestic credit in order to avoid inflationary developments, this step will directly affect domestic investment and
thereby the size of the national income. The rest of the world, however,
will feel only indirect repercussions; namely, insofar as the change in
national income of the country affected will influence its imports and
exports of commodities and of capital.
International Effects of Monetary Policy
Monetary policy influences the economy primarily through the supply
of credit. This influence can be brought to bear on the entire economy
by changes in the rate of interest and in the liquidity position" of credit institutions and the general public; it can be directed toward individual segments of the economy by selective credit controls.
Changes in interest rates and liquidity.—In times of international ;
security, the currencies of all important nations can be freely exchanged.
In such times, changes in interest rates and liquidity are very important
in determing the international flow of short-term funds. In the present
troubled times it is easy to forget that not so long ago the difference
between short-term interest rates in New York, London, Paris, and Amsterdam was a decisive factor in the distribution of funds among those centers of international finance; it was therefore also an important factor
in the liquidity of the banking systems of the United States, the United
Kingdom, France, and the Netherlands.
Under present conditions it is unlikely that investors would switch
their funds' over night from one country to another in order to get a

slightly higher rate of return on their capital. In most countries capital transfers are subject to the approval of some government agency and,
of even greater importance to their direction, are dictated more by political fears and hopes than by small differences in interest rates. Almost everywhere, people are subject to currency devaluation, capital
levies, or exchange restrictions, not to speak of the danger of war or
revolution. Hence, investors .try'to find a safe ht veil for their funds
even if the interest rate there is substantially below rates prevailing
In times of severe international disturbances, therefore, the influence of changes in .interest rates and'liquidity on the international flow
of -investment funds is limited. In such times', however, both debtor and
creditor countries pay particular attention to balance-of-payment problems, and the influence, of monetary, policy upon the balance of international payments often overshadows its purely domestic effects.
The dollar n a n . — M o s t countries other than the United States are
anxiously watching their current balance of dollar payments. The main
reasons for. this anxiety are twofold: most countries have smaller reserves- than would be necessary in emergencies; they also have an unsatisfied demand for American goods, while the innerican demand for their own 1
products is limited. This situation has become known as the dollar gap}
namely,-'the persistent tendency of many countries to experience a deficit
in their dollar, balance of payments.
Monetary policies can do much to close that gap. ' A chronic deficit
in a country's balance of payments suggests the presence of inflationary
tendencies:, the public has more money to spend than is needed to pay the
existing prices for the goods and services currently produced. By eliminating excess purchasing power, the demand.for foreign goods and services
can be reduced until the international balance is in equilibrium. -But there is a serious obstacle to such a policy: the structure of k country' s economy may be such that before the demand for foreign goods'has
been sufficiently reduced, the demand for domestic goods will fall so
sharply as to bring about a severe recession. For instance, the reduction of purchasing power in a highly industrialized country that depends',
apon imported foodstuffs may lead to serious unemployment .in domestic in1
dustry long, before there, is any appreciable reduction in" food imports.
In such a case,- a more fundamental change in the country' s domestic economic structure, or in its international economic relations may be necesEarly postwar efforts to reduce the dollar gap.—Immediately after
the war, such changes were needed in virtually all countries that had
'suffered severe damage or enemy occupation. . In those years, more reliance was .placed on direct international aid, at first through UiIRRA and
then mainly through ECA, than on the indirect methods of monetary policy.
By 1949, however, the importance of monetary factors had again been universally recognized.. Inflation had been,halted in most of the important
nations,'.but different degrees of inflationary distortions persisted in '
the various countries, especially in those where severe domestic price
m d wage controls had added to the confusion. It Was therefore necessary
to reduce all these inconsistent price and wage levels', so to speak, to a
hew common denominator. It would obviously have been impossible to make
further drastic changes in internal prices and wages so'soon after stabilization and so it was necessary to change the international relations

the various price levels. In other words, it became imperative to alter radically many international exchange rates, the most important of
which was the rate between the dollar ancI the pound sterling.
d oIil§_£lXects_of_ th^er^h^nojj adjustments^ Of 1 2 4 9 . — Y o u know that this
n o i n
September 1949. From that time on, monetary policy has been
able to resume its stabilizing role in international relations. ,.t that
, > Nfcny skeptical observers asserted that prices had lost their .force
to determine the flow of international trade. They were vrqn:.:: the
Price system started to work as well as it ever h; d as soon ag;in
got a chance to do so. Producers in Europe paid 'more attention to their
traditional export markets after the artificial creation of new domestic
Purchasing power had been discontinued and the worst distortions in international i n
price relations had been eliminated. Producers iri 'the' dollar
turn that they could not Maintain their inflated'.export
, sales since the industries in the so-called soft-currency areas were able
to undersell them.

In consequence., two events took place. Our export surplus dropped
e i
h billion dollars in 19/,9 to an annual rate of 1.9 billion'in' the
months of 1 9 5 0 — e reduction by almost two-thirds. The resuiting narrowing of the "dollar gap" made it possible for many countries
to relax their direct controls, and thi«? relaxation in turn increased the
significance of monetary policy.



s t

The, example nf. Germany.—The countries that were most energetic in
applying monetary .measures and in repudiating wartime direct controls
^ r e the most successful in establishing domestic and international staU i t y . For instance, such a policy was responsible for the almost miT
raculous progress achieved in l est*rn Germany.
-Germany suffered more than any other major industrial nation from
one effects of its wartime inflation, sup or ess ed by price and' wege controls of unsurpassed severity. In 19/f8 the German Government,' avainst
the anguished protests pf'the adherents of direct control-, eliminated-"•
Virtually all price controls and rationing and', at the same time, the'- '
^ r m a n central b; nking system used its power firmly to avoid a return to
the over-expansion of money and credit. Within little more than two
years, Germany saw its industrial production rise from less than 50 to
U per cent of prewar and its exports .increase threefold. Between 1°49
^id the first eight months of 1950, its import surplus dropped from 1.1
°Ulion dollars to an annual rate of /+00 million dollars. '
These developments would permit us to view the future of international economic, relations in a very hopeful light if we could assume that
further deterioration of political relations might be avoided.
The problem of convertibility of •currencies.—In the international
postwar monetary policy aims primarily at raking the main currencies of the world again freely convertible into gold and dollars. As
ong as the international economic community cannot make use of exchangeable currencies, international trade is as seriously hampered as our domestic trade would be if we lost our common dollar standard. . Prices oblously cannot ..fulfill their proper economic function in the international economy if it is impossible to tell accurately what a orice expressed
the. seller's currency means in terms, cf the purchaser's currency. For


u .
instance, one pound sterling cannot at present be freely converted into
&2.80 although §2.80 can be freely Converted int6 one pound sterling. As
long as this situation lasts, a commodity priced at one pound sterling
will more readily find a buyer than one priced at ,2.80, even though at
the official rate of exchange the two amounts are the same. The commodity priced at £2.80 can be purchased by'people who have dollars, but not
by those who have sterling, while the commodity priced at one pound ster->.
ling can be bought by holders of either dollars or sterling. Under these
conditions the currency asked in payment for a commodity is often more
important than its price.
For this reason, the reestablishment of international convertibility
of currencies is indispensable to the reestablishment of a free international economy based on the principle of the market mechanism. However,
convertibility can be achieved only when the nondollar countries.can reasonably expect their exports to earn about as many dollars as they need
for buying essential American goods and services. Insofar as the monetary policies of the nondollar nations permit the expansion of exports,
they contribute decisively to progress toward freedom in international
economic relations, and thus to the achievement of one of the prime goals
of our own international policy.
International effects o f U . S . monetary policy.—Our economy is less
dependent than most other economies on monetary conditions in other countries, but monetary developments here often determine economic development abroad. For example, the slight recession here in the first half of
194-9, which made little impression on domestic consumption, considerably
affected the international trade of some foreign countries. In the view
of some observers, it even influenced the timing of the devaluation of
the pound sterling and many other currencies in September 1949. Many
countries have to rely upon vital imports from the United States, and upon their ability to earn the dollars needed for that purpose by means of
exports, a recession that curtails our foreign purchases makes it more
difficult for other countries to buy our foodstuffs, raw materials, and
machinery, upon which their domestic welfare depends. On the other hand,
any serious inflationary development in the United States tends to raise
the prices of our domestic products faster than those of our imports.
thus tends to worsen the terms of trade of foreign countries that need
our products, thereby endangering their economic "stability. For instance,
the rise in U . 3 . prices from 1946 to 1.948 considerably increased the
balance-of-payroents difficulties many foreign countries were already having.
Monetary Policy in the Present Emergency
Developments since the middle of 1950 have clearly sho^-n the impact
of international events on monetary conditions and policy in the United
Before the attack on South Korea, our most difficult postwar financial adjustments appeared to have been made. aow we rust again build up
our defenses against inflation. Rearmament will divert much of our manpower and material resources to the production of goods which, although
vital to our survival, will not be available for purchase by civilian
At the same time, the expanded defense activities will increase the purchasing power of the population. either of these factors

could easily build up serious inflationary pressure. Monetary policy hat
special responsibilities.-, to avoid inflationary disturbances at a time
economic inste oility might seriously impede defense a.n inst grave
Political and str: te^ic ,dangers.
v h e n

Monetary authorities must have regard for the effects of monetary
Policy on"- ti 3' mana^ ement of our lar;. 3 -.ublic debt. The Treasury must
constantly r' fund m turing issues, end it must be prepared to borrow additional money if r- ceipts fall short of Government expenditures, A rise
in rates m, zes these operations more costly, it .is true; but inflation, with its in Teases in prices and wages, would cost the Government far more. More* ver, the effect of inflation on every - ember of the
the >:e eral disturbance created by a drop in the purchasing power of the * at home and abroad, would seriously hamper our
defense effort.
U . S . anti-inflationary policy.—/.s soon at the danger of renewed
inflation became apparen , the President, the Congress, and the monetary
authorities took steps to counteract it.
The Defense Production j>ot mid the executive orders issued by the
President have given the Federal Reserve special powers to combat.inflation in two strategic areas, The Federal Reserve is a- a in' regulating. •
consumer .instalment credit, m d for the first time in its history is
regulating real estate creai\ for new construction'. Restriction of real
estate credit and consumer instalment credit is .intended to dampen the
demand for new homes and for .r ny durable consumer .ftoods and to
ttake way for the diversion of' i trate, ic materials to armament production
without inflation.
Even before passage of the D 'ense Production Act, the discount rate
of the Federal Reserve Banks, uneh, n-^ed since
1946, was raised by
one-fourth of a percentage point In u.L;ust 1950. . iso, the Federal Reserve System, jointly with trie othei agencies entrusted with the regulation of credit institutions, issue-' 1 " o m a i request, that these institutions abstain from any credit expansi>1 that would interfere with the
defense effort. The Federal Reserve Jpen Market Committee is directing
its operation's toward restraint of inflationary forces. The System continues to maintain an orderly market for Government securities, but it
seeks to limit any increase in its holdings cf Government securities and
to offset purchases made in maintaining an orderly market, by sales of
other securities. These sales are to prevent an increase .in bank reserves, which v/ould provide the banks with additional fund3 for multiple
credit expansion. The result of the System's operations has been a moderate rise in short-term interest rates, a development which in itself
tends to discourage the extension of excessive credits.
lilternati.ona 1 re;ercussIons. — T h e recent rapid rise in effective
demand in the United States deeply affected the'international flow of
goods and capital. The drop in our exports and the rise in our imports,
'hich had been going on for some time, has been .ccelerated. In August,
our imports exceeded exports for the first time in 13 years.
Moreover, a number of foreign countries'have begun to take measures
against the international spread of inflation. It is extremely encouraging to note that these measures do not primarily reintroduce .direct .controls, but are concentrating on the .instruments cf monetary policy.


Belgium, Germany, the Netherlands, and Sweden, in particular, have
tightened reserve requirements or .increased discount rates. At least
three of these countries have experienced the harmful results of direct
controls for so many years that they have become convinced of the superiority of monetary policy. Obviously, however, the situation would be
very much confused if the United States itself were compelled to reimpose
direct controls.
Prospects for the future.'—The Federal Reserve System is prepared
to take further action if inflationary tendencies continue. Cuite recently, it has tightened its regulation of consumer instalment credit,
and it has further limited the availability of reserves through its open
market operations. For obvious reasons T. cannot tell you anything about
our plans for the future; however, 1 can give you the assurance that we
shall carefully consider the use of any anti-inflationary weapon in our
i.n inflationary "increase in the supply of money stems chiefly from
two sources: expansion of credit to the public, and expansion of credit
to the Government due to a budget deficit*. The efforts of the Federal
Reserve System serve mainly the purpose of keeping the private credit
situation in hand. The Government budget must be Vept as nearly as possible on a pay-as-we-go basis by means of tax legislation. In addition,
the refunding of maturing Government securities, as well as the flotation
of any new issues that ray become necessary because the yield of increased taxes may lag behind the rise in Government expenditures, should
be so managed that the largest possible share of the debt is sold to the
nonbank public.
Monetary Policy or Direct Controls
Even with all of these deterrents in effect, it would be possible
for private spending to increase further, especially in vie\r of the public's large holdings of liquid assets. It would be equally possible for
our presently planned level of defense expenditures to prove inadequate.
In either eventuality, it would be necessary to impose even stricter monetary and credit controls and to raise our taxes still further. Otherwise, direct controls would have to be imposed.
From the point of view of a free economy, there can be no doubt
that avoiding inflation by monetary and credit controls and increased
taxes is far preferable to suppressing the symptoms of inflation by price
and wage controls and rationing. Such a course, however, will need the
whole-hearted cooperation of the public. Enacting higher taxes and imposing credit restrictions are highly unpopular measures.
too many
people, while applauding anti-inflationary policies affecting the oth^r
fellow, oppose all those that would restrict their own dealings, direct
controls may become unavoidable.
Price controls and rationing tend, at least in the first moment of
their application, to give the impression that they hurt oeople less than
strict credit controls and high taxes: they leave the money income untouched, and preserve the outer appearance of a stable price level, actually, however, they undermine the market mechanism: prices cease to
have economic meaning, money ceases to play its economic function, and
ration points fixed by the Government tend to become the main motors of


economic activity. Such a development would be inconsistent with the
principles of individual initiative on which our economic system is
based, and should be only a last resort during an emergency in order to
protect our system from greater danger.
However, if we can convince the public to support the antiinflationary endecvors of our monetary and fiscal authorities, we can
hope that our economy will bear the burden of the rearmament effort with
out suspending the price mechanism and thus impairing its efficiency.
This burden will be a small price indeed to p:y for the preservation of
our freedom.