Convertibility vs. Control

February 9, 1953

British Government officials are said to have a plan to make the pound sterling freely convertible with the American dollar. The aim is laudable; but there are grounds for grave misgivings concerning the method that may be proposed to achieve it.

One step is indispensable. Britain must abandon exchange control. It must let the sterling rate go free. It must stop forbidding people to exchange pounds for dollars on any terms they can agree upon. The way to restore currency convertibility, in short, is simply to permit it.

Hitherto British officials have been frightened by the mere mention of convertibility. They cannot forget the quick collapse of the effort to make sterling convertible in the summer of 1947. But they still misinterpret the result. Britain was drained of dollar and gold reserves in those few weeks, not because the government had made sterling convertible, but because it had done so on the basis of a fantastically false conversion rate with the dollar. On Sept. 18, 1949, British officials at last admitted that the pound had been grossly overvalued. They slashed the official rate overnight from $4.03 to $2.80. But they failed to recognize even then that the only “realistic” rate for the pound is a free-market rate.

One would like to think that the subject is better understood now. Yet typical of the confusion which still exists even at the highest levels of British economic thought is the article by Prof. Lionel Robbins in the January issue of Lloyds Bank Review of London. This article makes some very sound points in an admirable way. It recognizes the weaknesses of “imperial preference.” It exposes the fallacies of the argument, seriously put forward by influential British and other European writers on economics, that productivity in the United States is so much greater than in England or elsewhere that trade equilibrium is impossible without a permanent aid program. As Professor Robbins points out: “The great principle of the division of labor is founded on just such differences; if there were no differences in productivity there would be no advantage in trade.”

But when it comes to the central issue Prof. Robbins still puts the cart before the horse. He is still opposed to currency convertibility through free exchange rates, the indispensable requirement for full convertibility. “I am yet to be convinced,” he writes, “that the dilemma is escapable that, when the general financial position is strong, free rates are usually unnecessary and that, when it is weak, they are apt to be a source of appalling danger.”

The real “dilemma” is in fact the reverse of this. When the general financial position of a country is strong, a pegged rate for its currency is unnecessary; and when it is weak, a pegged rate is an appalling danger. A pegged rate for the pound, higher than what a free market rate would be, necessarily brings a “dollar shortage.” It creates a chronic excess of imports over exports. It diverts production into the wrong channels, by reducing the relative incentives to export. It encourages the continuance of internal inflation. A pegged rate destroys the pressure-gauge readings by which everyone could measure the extent of inflation and the changes in world confidence in the currency. You cannot tell the real condition of the patient if the thermometer is pegged at 98.6 degrees or the exchange rate at $2.80.

There is no historic justification for Professor Robbins’s fears of a free or “floating” rate for the pound. Convertibility of the paper pound was maintained in a fluctuating market over the period from 1931 to 1939. Canada’s return to a “floating” dollar has been followed by a rise, not a fall, in the quotation for its currency.

Of course, a “floating” rate, one can hope, would be merely transitional to an eventual return to a gold standard. But Professor Robbins does not even hint at this last possibility. American taxpayers should not be called upon to contribute another dollar to the maintenance of exchange control in Britain or anywhere else.