The Future of the Dollar; H. Hazlitt

Mr. Hazlitt is the well-known economist, col umnist, editor, lecturer and author of numer ous books, including What You Should Know About Inflation which is available in paper back from the Foundation for Economic Edu cation at 95 cents. This article is from a paper delivered at a regional meeting of the Mont Pelerin Society in Guatemala, September 4, 1973. HENRY HAZLITT Dollar ut because some American essmen and some par lia iWere thought to have a prejudice in favor of seemed prudent to com and to set up something oked almost like a gold ard - a thinly gold-plated s andard. So, through ~n Interna tional Monetary Fund .(IMF), a sort of world central bank, every other currency was to be pegged at a fixed rate to the Almighty Dollar. Each nation, after fixing an official parity for its currency unit, pledged itself to maintain that parity by buying or selling dollars. The dollar alone was to be convertible into gold, at the fixed rate of $35 an ounce. But unlike as in the past, not everybody who held dollars was to be allowed to convert them on demand into gold; that privilege was reserved to na tional central banks or other of ficial institutions.

Thus, everything seemed to be neatly taken care of. When every other currency was tied to the dol lar at a fixed rate, they were all necessarily tied to each other at fixed rates. Only one currency was 39 40 THE FREEMAN January tied to the dreadful discipline of gold, and even that in a very limited way. Gold was "econo mized" as never hefore. It was now the servant, no longer the master. Automatic Credit In addition, the Bretton Woods agreements provided that if any nation or central bank got into trouble, it was entitled to auto matic credit from the Fund, no questions asked. Thus, not only released from a strict gold standard, but tempted to imprudence, individual nations felt free to expand their _paper money and credit supply to meet their own so-called domestic "needs." The politicians and the monetary mana'gers in practically every country were infected with a Keynesian or inflationary ideol ogy. They rationalized budget defi cits and continuous monetary and credi t expansion as necessary to maintain "full employment" and "economic growth." As a conse quence, there were soon wholesale devaluations. The IMF has pub lished hundreds of thousands of statistics; but the single figure of how many devaluations there were between the opening of the Fund and August 15, 1971, when the dollar itself became officially in convertible into gold, the IMF has never published.

There were certainly hundreds of devaluations. To my knowledge, practically every currency in the Fund, with the exception of the dollar, was devalued at least once. The record of the British pound was much better than that, say, of the French franc, but the pound itself, which had already been de valued from $4.86 to $4.03 when it entered the IMF, was devalued again from $4.03 to $2.80 in Sep tember 1949 (an action that touched off 25 more devaluations of other currencies within a single week), and devalued still again from $2.80 to $2.40 in November, 1967. Devaluation, let us remember, is an act of national bankruptcy. It is a partial repudiation, a gov ernment welching on part of its domestic and foreign obligations. Yet, by repetition by all the best countries, devaluation acquired a sort of respectability .. It became not a swindle, but a "monetary technique." Until the dollar went off gold in August 1971 and was devalued in December, we heard incessantly how "successful" the Bretton Woods system had proved.

During the early part of this pe riod, however, the world suffered from what everybody called a "shortage of dollars." The London Economist, among others, even solemnly argued that there was now a permanent "shortage of dol1974 THE FUTURE OF THE DOLLAR 41 lars." Americans thought so too. Our monetary managers seemed completely unaware of the tre mendous responsibility we had as sumed when we allowed the dollar to become the standard and the anchor for all the other currencies of the world. Our money managers never dreamed that it was possible to create an excess of dollars. They issued and poured out dollars and sent them abroad in foreign aid. Total disbursements to foreign na tions, in the fiscal years 1946 through 1971, came to $138 bil lion. The total net interest paid on what the United States borrowed to give away these funds amounted in the same period to $74 billion, bringing the grand total through the 26-year period to $213 billion.

This amount was sufficient in it self to account for the total of our Federal deficits in the 1946-1972 period. The $213 billion foreign aid total exceeds by $73 billion even the $140 billion increase in our gross national debt during the same years. Foreign aid was also sufficient in itself to account for all our balance-oi-payments defi cits up to 1970. 'nternal'nllation We created a good deal of this money through internal inflation. From January 1946 to August 8, 1973, the money supply, as meas ured by currency in the hands of the public plus demand bank deposits, increased from $102 bil lion to $264 billion, an increase of $162 billion, or of 159 per cent. In the same period the money supply as measured by currency plus both demand and time deposits in creased from $132 billion to $549 billion, an increase of $417 billion, or 316 per cent. Because of what our monetary authorities believed was the neces sity of keeping this enormous in flation going, they adopted one ex pedient after another. In 1963, blaming the deficit in our balance of payments on private American investment abroad, they put a penalty tax on purchases of for eign securities. In 1965 they re moved the legal requirement to keep a gold reserve of 25 per cent against Federal Reserve notes.

They resorted to a "two-tier" gold system. Next they invented Spe cial Drawing Rights, or "paper gold." But all to no avail. On Aug ust 15, 1971, they officially aban doned gold convertibility. They de valued the dollar by about 8 per cent in December, 1971. They de valued it again, by 10 per cent more, on February 15, 1973. Exported Inflation Before we bring this dismal his tory any further down to date, let us pause to examine some of the chief fallacies prevailing among 42 THE FREEMAN January the world's journalists, politicians, and monetary managers that have brought us to our present crisis. Because we were sending so many of our dollars abroad, the real seriousness of our own infla tion was hidden both from our of ficials and from the American pub lic. We contended that foreign in flations were greater than our own, because their official price in dexes were going up more than ours were. What we overlooked what most Americans still over look - is that we were exporting part of our inflation and that for eign countries were importing it.

This happened in two ways. One was through our foreign aid. We were shipping billions of dollars abroad. Part of these were being spent in the countries that re ceived them, raising the'ir price level but not ours. The other way in which we exported inflation was through the IMF system. Under that system, foreign central banks bought our dollars to use them as part of their reserves. But in addi tion, under the rules of the IMF system, central banks were obliged to buy dollars, whether they wanted them or not, to keep their own currencies from going above parity in the foreign exchange market. The result is that foreign central banks and official institu tions today hold some 71 billion of our dollars. These dollars will eventually come home to buy our goods or make investments here. When they do, their return will have an in flationary effect in the United States. Our domestic money supply will be increased even if our Fed eral Reserve authorities do noth ing to increase it.

Balance of Payments The meaning of the "deficit" in our balance of payments has been grossly misunderstood. It has not been in itself the real· disease, but a symptom of that disease. The real question Americans should have asked themselves is not what consequences the deficits in the balance of payments caused, but what caused the deficits. I have just given part of the answer - our huge foreign aid over the last 27 years, and the obligation of for eign central banks under the Bret ton Woods agreements to buy dol lars. But the foreign central banks had to buy dollars because dollars had become overvalued at their official rate. Th~.y became over valued because the U.S. was inflat ing faster than some other coun tries. After the United States formally suspended gold payments, and after the dollar was twice de valued, foreign banks no longer felt an obligation to buy dollars. The dollar fell to its market rate, 1974 THE FUTURE OF THE DOLLAR 43 and as one consequence we again have a monthly excess of exports.

The economists who had all along been demanding the restoration of free ...market exchange rates were right. Now that the dollar is no longer even nominally convertible into gold there is no longer any excuse for governments to try to peg their paper currency units to each other at arbitrarily fixed rates. The IMF system ought to be abandoned. The International Monetary Fund itself ought to be liquidated. Paper currencies should be allowed to "float" - that is, peo ple should be allowed to exchange them at their market rates. But it is profoundly wrong to assume, as many economists and laymen unfortunately now do, that daily and hourly fluctuating mar ket rates for currencies will be alone sufficient to solve the multi tudinous problems of foreign com merce. On the contrary, these wildly fluctuating rates create a serious impediment to interna tional trade, travel and investment. They force importers,exporters, travelers, bankers, and investors either to become unwilling specu lators or to resort to bothersome and costly hedging operations.

With 125 national currencies rep resented in the IMF, there are some 7,750 changing cross-rates to keep track of, and twice as many if you state each cross-rate both ways. With a gold standard gone, with the dollar standard gone, there is no longer a single ac cepted unit in which all of these rates can be stated. Some Gain - Some Loss It is a great gain when curren cies can be exchanged at their true market rates. Since this has happened the American trade bal ance has improved. In the second quarter of 1973, for example, there was again a surplus of exports. In July, 1973, American exports in dollar terms were the highest for any single month on record. But it is one thing to allow trade to improve by abandoning arbitrary pegs on foreign-exchange rates; it is quite another thing for a coun try to seek to increase its exports at the expense of its neighbors by deliberate devaluation. Yet this is what the United States govern ment has very foolishly done.

In early August, 1973, Freder ick B. Dent, the U. S. Secretary of Commerce, assured the Ameri can public that the devaluations of the dollar had provided the nation with a "bright opportunity." "Without question," he added, "the most important factor in the im proving trade trend is the com bination of the two devaluations." In fact, the U. S. Department of Commerce placed an advertisement in the issue of Time of July 2, and 44 THE FREEMAN January in other magazines, declaring that to the .U. S. exporter the devalued dollar means "vastly improved prospects," that it would help him to capture "a bigger share of over sea markets," and that it was up to him to "start putting the de valued dollar to work." The basic fallacy in this eu phoric picture is that it looks only at the short-run consequences of devaluation and even at these only as they affect a small segment of the population.

It is true that the first effect of a devaluation, if it is confined to a single country, is to stimulate that country's exports. Foreigners can buy that country's products cheaper in terms of their own money. Thus, as the Department of Commerce's ad correctly pointed out: "For instance, an American product for which a West German importer paid 1000 deutsche mark only 18 months ago would now cost him as little as 770 marks. Or about 23 per cent less than before." So the American exporter stands to sell more goods abroad at the same price in dollars, or the same volume of goods in higher prices in dollars, or something in be tween, depending on whether his product is competitive or a quasi monopoly. So far, so good. But U. S. ex ports amount to only 41j2 per cent of the gross national product. Now let us enlarge our view. If the dollar is devalued, say, by a weighted average of 25 per cent in terms of other currencies, some thing else happens ~ven on the first day after devaluation. The prices of all American imports go up by that percentage (or more pre cisely, by its converse). Every American consumer has to pay more, directly or indirectly, for meat, coffee, cocoa, sugar, metals, newsprint, petroleum, foreign cars, or whatever. Even the American exporter, as a consumer, has to pay more, and also more for his im ported raw _materials. So the im mediate effect of a devaluation is to force the consumers of the de valuing nation to work harder to obtain a smaller consumption than otherwise of imported goods and services. Is it really a national gain for the American people to sell their own goods for less and buy foreign goods for more?

The belief that devaluation is a blessing, because it temporarily en ables us to sell more and forces us to buy less, stems' from the old mercantilist fallacy that looked at international trade only from the standpoint of sellers. It was one of the primary achievements of the classical economists to explode this fallacy. As John Stuart Mill said: The only direct advantage of foreign commerce consists in the imports. A 1974 THE FUTURE OF THE DOLLAR 45 country obtains things which it either could not have produced at all, or which it must have produced at a greater expense of capital and labor than .the cost of the thing which it exports to pay for them ... The vulgar theory disregards this benefit, and deems the advantage of commerce to reside in the exports: as if not what a country obtains, but what it parts with, by its .. foreign trade, was supposed to constitute the gain to it. Long-Run Effects So far I have considered only the immediate effects of a devaluation.

Now let us look at the longer effects. The devaluation or depre ciation of a currency soon leads to a rise of the internal price level. The prices of imported goods, as I have just pointed out, have a cor responding rise immediately. The demand for exports rises, and therefore the prices of export goods rise. This rise of prices leads to increased borrowing by manu facturers and others to stock the same volume of raw materials and other inventories. This leads to an expansion of money and credit which soon makes other prices rise. (Often, of course, the causa tion is the other way round: an expansion of a country's currency and a consequent rise of its inter nal price level will soon be reflected in a fall of its currency quotation in the foreign exchange market.) In brief, internal prices soon ad just to the foreign-exchange quo tation of the currency, or vice versa. We can see more clearly how this must take place if we look at a freely transportable international commodity like wheat, copper, or silver. Let us say, for example, that copper is 50 cents a pound in New York when the deutsche mark in the foreign exchange market is 25 cents. Then purchases, sales, and arbitrage transactions will have brought it about that the price of copper in Munich is four times as high in marks as in dol lars plus costs of transportation.

Suppose the dollar is devalued or depreciated so that the mark now exchanges for 40 cents. Then, assuming that the price of copper in terms of marks does not change (and though I have been specifically mentioning marks, dollars, and copper I intend this as a hypo thetical and not a realistic illus tration), purchases, sales, and arbitrage transactions will now bring it about that the price of copper in New York will have to rise 60 per cent in terms of dol lars. To bring this new adjustment about, more copper will flow from the U. S. to Germany. But after this temporary stimulus to Amer ican export, the new price adj ust ment will bring it about that, other 46 THE FREEMAN January things being equal, the relative amount of copper exported may be no different than before the deval uation. A Brief Period of Transition I have been speaking of interna tional commodities, traded on the speculative exchanges, and easily and quickly transportable. In these commodities the international price adjustments will take place in a few days or weeks. The price adjustments of most other goods will, of course, take place more slowly. The main point to keep in mind is that there is a constant tendency for the internal purchas ing power of a currency to adj ust to its foreign-exchange value and vice versa. In other words, there is a constant tendency for the internal prices in a country to adjust to the changing foreign exchange value of its currency and vice versa. Though our mod ern monetary managers and sec retaries of commerce seem to know nothing about this, the purchasing power theory of the exchanges was first explained a century and a half ago by Ricardo.

In other words, the alleged for eign trade "advantages" of .a de valuation last for merely a brief transitional period. Depending on specific conditions, that period may stretch over more than a year or less than twenty-four hours. It tends to become shorter and shorter for any given country as depreciation of its currency con tinues or devaluations are re peated. Internal currency depreci ation usually lags behind external depreciation, but the lag tends to diminish. Statistical studies have been made of the relationships of the internal and external purchasing power of a currency under extreme conditions - for instance, the Ger man mark during the 1919-1923 inflation. (See The Economics of Inflation, by Constantino Bresci ani-Turroni, 1937.) It would not be too hard for any competent statistician, with the help of a copy of International Financial Statistics, published monthly by the IMF, to put together revealing comparisons of foreign-exchange rates and internal prices for any country that publishes reasonably honest wholesale or consumers price indexes.

It is instructive to recall, inci dentally, that at the height of the German hyperinflation, which eventually brought the mark to one-trillionth of its former value, monthly exports, measured in ton nages, fell to less than half of what they had previously been, while the tonnage of imports doubled or tripled. In brief, the pursuit of a more "favorable" balance of payments, 1974 THE FUTURE OF THE DOLLAR 47 or a trade "advantage," through depreciation or devaluation of one's own currency, is the pursuit of a will-o-the-wisp. Any gain of exports it brings to the devaluat ing nation is temporary and tran sient, and is paid for at an exces sive cost - an internal price rise and all the economic distortions and social discontent and unrest this brings about. The usual criticism of currency devaluati.on is that it will provoke reprisals; that other countries will try the same thing, and the world may be plunged into competitive devaluations and trade wars. This objection is, of course, both a valid and a major one. But what I have been trying to emphasize here is a point that few of our monetary managers have grasped - that even if there is no retaliation, devalu ation as a deliberate policy pur sued for the sake of a foreign trade gain is self-defeating and stupid.

The two American devaluations, for example, were monumental blunders. If the world's monetary managers can be brought to learn this one lesson, the economic and political gain will be immense. Remedial Measures What steps should be taken to halt the present world inflation and return the world to sound money? The immediate steps are simple and can be briefly stated. The United States - and for that matter every country - should forthwith allow its citizens to buy, sell, and make contracts in gold. This would be immediately fol lowed by free. gold markets, which would daily measure the real de preciation in each paper currency. Gold would immediately become a de facto world currency, whether "monetized" or not. The metal it self would not necessarily change hands with each transaction, but gold would become the unit of ac count in which prices would be stated. Exporters would be insured against the depreciation of the currencies in which they were being paid.

The second (and preferably simultaneous) step can· be stated more briefly still. Every nation should refrain from further in crease in its paper money and bank credit supply. For the United States a special measure would also be needed. A hundred billion dollars or more are held by foreign central banks and foreign citizens. Most of these are no longer wanted. They danger ously overhang the market, and constantly threaten to bring sud den and sharp declines in the dollar. The U. S. government must do two things. It must follow mone tary policies that will assure for eign dollar holders that they are 48 THE FREEMAN Januar'y not holding an asset that is likely. to depreciate still further but, on the contrary, one that is likely to keep its value or even to appre ciate a little. Secondly, the U. S. government should volunteer to fund the dollar overhang. It could do this by offering foreign central banks interest-bearing long-term obligations for their liquid dollar holdings - say, bonds that would .be repayable and retirable, princi pal and interest, in equal install ments over a period of twenty-five or thirty years. It should prefer ably negotiate with each country separately, and should guarantee its bonds by making principal and interest repayable, at the option of the central bank holding them, in either the face value of the dol lars or in the currency of the country holding them, at the same ratio to the dollar as of the market rate on the day the agreement was reached. Thus, the Bank of Japan would be paid off, at its option on any payment date, either in dollars or in yen; the Bundesbank either in dollars or in marks; and so on.

Ricardo's Recommendations of a Full Gold Standard Of course, the world should eventually return to a full gold standard. A gold standard is needed now for the same reason that David Ricardo gave for it in 1817: Though it (paper money) has no in· trinsic value, yet, by limiting its quantity, its value in exchange is as great as an equal denomination of coin, or of bullion in that coin .... Experience, however, shows that neither a State nor a bank ever have had the unrestricted power of issu ing paper money without abusing that power; in all States, therefore, the issue of paper money ought to be under some check and control; and none seems so proper for that purpose as that of subjecting the issuers of paper money to the obli gation of paying their notes either in gold coin or bullion. A return to gold will involve some difficult but not insuperable problems, which we shall not at tempt to discuss in detail here.

The main immediate requirement is that individual countries stop increasing their paper money supplies .. But my topic here is the future of the dollar - not what it ought to be, but what it is likely to be. And I am obliged to say that the outlook for the dollar - or, for that matter, of national currencies any where - is hardly bright. The world's currencies will be what the world's politicians and b.ureaucrats make them. And the world's polit cians and bureaucrats are still dominated everywhere by an in flationary ideology. Whatever they say publicly, whatever fair assur ances they give, they still have a 1974 THE FUTURE OF' THE DOLLAR 49 mania for inflation, domestic and international. They are convinced that inflation is necessary to main tain "full employment" and to con tinue "economic growth." They will probably continue to "fight" inflation only with false remedies, like "income policies" and price controls.

The International Monetary Fund is the central world factory of inflation. Nearly all the national bureaucrats in charge of it are de termined to continue it. Having destroyed the remnants of the gold standard by printing too much paper money, they now propose to substitute Special Drawing Rights, or SDR's, for gold - in other words, they propose to print more international paper money to serve as the "reserves" behind still more issues of national paper monies. The first international step toward sound money, to repeat, would be to abolish the IMF entirely. In August, 1973, the present American Secretary of the Trea sury, George P. Schultz, named fourteen men as members of a new advisory committee on reform of the international monetary system. These included three former Trea sury secretaries, all of whom pur sued the very monetary policies that brought the United States and the world to its present crisis. The whole list of men in this committee included only two professional economists. I don't want to attack individuals, but to my knowledge not a single man appointed to the new panel believes in the gold standard, has ever advocated its restoration, or has ever spoken out in clear and unequivocal terms even against the chronic increase in paper money issues. But the climate of opinion is now such in the United States that I must con fess I would find myself hard put to it to name as many as fourteen qualified Americans who could be counted on to recommend a sound international monetary reform.

The truth is that everybody is afraid of a return to sound money. Nobody in power wants to give up inflation altogether because he fears its abandonment would be followed by a recession. It's true that if we stopped inflation forth with we might have a recession, for much the same reasons as a heroin addict, deprived of his drug, might suffer agonizing with drawal symptoms. But such a re cession, even if it came, would be a very minor and transient evil compared with the catastrophe toward which the world is now ~un~n~ , FREE PARKING... GARY NORTH SpaceNot Available "You can't get something for noth ing," is about as safe a slogan as one could invent. Sometimes we get what turns out to be nothing for something, although we hadn't ori ginally planned it that way. But sometimes "nothing" turns out to be something, and all kinds of problems appear if we fail to put a price tag on it. One of these "nothings" is space.