Where We Are Going

August 27, 1962

The dollar is the world’s anchor currency. Nearly every other monetary unit is tied to it. It is difficult to estimate what the domestic and world repercussions would be if the dollar went off gold or were devalued.

Yet what is the outcome likely to be if our government continues the policies it has pursued, not only since Mr. Kennedy took office, but practically since the end of World War II?

In 1958, to go no further back, we had a deficit in our balance of payments of $3.5 billion. In 1959 this deficit was $3.7 billion; in 1960, $3.9 billion; in 1961, $2.5 billion. In the first half of the present year the deficit ran at an annual rate of $1.5 billion.

This decline in the annual rate has been hailed by some commentators as very reassuring. But they forgot that the deficit is cumulative. Since the beginning of 1958 it has totaled $15 billion, and is still increasing.

So we continue to lose gold while foreign claims against our remaining supply of it continue to grow. At the end of 1957 our stock of gold amounted to $22.8 billion, and our total short-term liabilities to foreigners (including international institutions) to $15.2 billion. Today the relation is reversed. Our short-term liabilities to foreigners now total $23.5 billion while our gold stock is down to $16.1 billion. In brief, our gold stock is already less than the total direct and indirect short-term foreign claims against it. True, our government is pledged to pay gold only against “official” foreign or international claims. But even these now reach $15.1 billion.

IF WE LOSE MORE GOLD

What is likely to happen if a deficit in the balance of payments, even at the present reduced rate, continues? Against present note and deposit liabilities of $47.4 billion, the Federal Reserve System is required to hold a gold reserve of 25 percent, i.e., of $11.8 billion. This means that we now hold “free” gold reserves of only $4.3 billion. What will happen if foreigners continue to ask for gold and even this narrow margin shrinks?

It is possible that foreign central banks, worried by the diminution of our “free” gold supply, may become nervous and precipitate a run. Fearful of this, the Kennedy Administration may renew its support of the proposal to abolish the 25 percent gold reserve requirement so as to “free” our entire gold stock for withdrawal. It is doubtful, however, that such a step (which would obviously shake domestic confidence in the dollar) would in fact reassure foreign holders; it might itself precipitate a run.

If the export of gold were suspended, nothing could prevent a violent drop of the dollar on the foreign-exchange markets. If an overnight devaluation of the dollar were announced—say by raising the price of gold from $35 to $70 an ounce—the step would be almost automatically followed by an equal devaluation of other currencies. This would probably be the signal for a new world inflation. But it would not cure our balance-of-payments problem—unless we stopped inflating faster than other countries.

STOP THE INFLATION

Our balance-of-payments deficit, and the dwindling confidence in the dollar, are both consequences of the same cause—inflation. Because it raises our costs and prices, inflation makes this a better market to sell to and a poorer one to buy from. Our cheap-money policy makes it less attractive for foreigners to lend or invest here and more attractive for Americans to lend or invest abroad.

The indispensable step in any cure is to halt our inflation. This means that we must allow our interest rates to go up, stop expanding credit and printing money, slash government spending, and balance our budget.

The proposals in Mr. Kennedy’s television address of Aug. 13 were nearly all in the opposite direction. Of the six bills that he wants enacted immediately, one is a tax credit for new investment (which would be good considered in isolation), but four of the other five—for increased public works, “youth employment,” longer unemployment benefits, and education subsidies—involve still more Federal spending. They would increase the prospective deficit. Their enactment would further undermine confidence in the dollar.