Making Currencies Convertible

February 2, 1953

Exchange control is a totalitarian device which until the outbreak of the second world war was confined to Communist Russia and to Nazi Germany. The democracies fighting Hitler themselves adopted exchange control, imitating Schacht’s techniques, after they became involved in the war. But no responsible statesman in the democracies suggested at the time that exchange control was anything but a war-emergency measure. In fact, though a necessary and inherent part of a totalitarian economy, it is completely incompatible with a free one. Yet England and nearly all the continental countries have retained exchange control since the war. It is the chief cause of their so-called “dollar shortage,” of their “international payments difficulties,” of their chronic excess of imports over exports, of “currency inconvertibility.”

Exchange control is a form of price fixing applied to money itself. The government of a country attempts to fix by fiat the rate at which its citizens are allowed to buy or sell its paper currency in terms of other currencies. This is only another way of saying that the government of a country under exchange control attempts to fix the price at which the currencies of all other countries are allowed to be bought or sold in terms of its own.

The consequences are like the consequences of price fixing in any other field. If the price of meat is arbitrarily fixed by an OPS below what it would bring in a free market, the consumption of—or demand for—meat increases, the supply coming to market diminishes, and there is very soon a “meat shortage.” So the next steps are consumer rationing, slaughter-hour licensing, processing quotas, and so on. In the field of currency, similarly, if the British pound is arbitrarily fixed at a price of $2.80 when the market thinks it is worth only $2.63, there is a “dollar shortage” because dollars are underpriced. Then dollars must be rationed through the imposition of import quotas, and international trade is put under an incredibly complicated system of licensing and controls.

This regiments and strangles an economy far more seriously than any other form of control. Through a system of import licenses and quotas, a government can fix the exact amount of raw material that a given industry or individual firm may use. In that way it can freeze an industry or a firm at any size it wants. It can exercise life-and-death powers over every business or firm that depends on imports. It can indirectly freeze the whole economy and get the entire business community accustomed to lack of freedom, lack of initiative, and lack of incentive. But it can never basically cure the “dollar shortage” that its exchange control has itself created.

Ever since the Bretton Woods agreements of 1944, a bare handful of writers, including myself, carried on a rather lonely battle against exchange control. A terrific crack in the system came in September of 1949; but instead of a return to free markets, there were worldwide devaluations of currencies unparalleled in history. Today the battle against exchange control is no longer forlorn. The turn of the tide may be dated from Dec. 14, 1951, when Canada completely abandoned exchange control. The immediate flow of funds and investment into Canada instead of out, and the rise of the Canadian dollar against the American dollar, was the opposite of the consequence usually feared by those who are afraid to abandon exchange control in their own countries.

The argument against exchange control has now received powerful support in the January letter of the National City Bank of New York. The bank points out that $38,000,000,000 of American postwar aid to foreign countries has not cured their dollar shortage. It doubts that the fantastic proposal of The London Economist for an additional $35,000,000,000 contribution from us would cure it. It points out that free convertibility of the paper pound was successfully maintained in a fluctuating market over the period 1931–39. And it insists bluntly that the way to get convertibility is to let the free market do the job. “The way to make currencies convertible is to make them convertible.”