Chapter III. The Policies of “Ruritania”

GERMANY is the outstanding case of a demoralized production imposed by stupid controls from without. We come now to countries which have disorganized and prevented production by unintelligent government interference from within. To keep from making this story too repetitive, by discussing the remarkably similar interventions of each government in turn, it will be more convenient to present a sort of composite photograph of the situation in a single country, which we shall call Ruritania. The situation in Ruritania will be found to apply, with only minor modifications, to most of the countries of Europe. While Belgium and Switzerland, for example, have freer economies than those in this composite picture, other nations are subject to even more extensive dictation.

Ruritania’s budget is unbalanced. Heavy sums are being spent on armaments, on subsidies to nationalized industries running a deficit, on food subsidies, and on increasing pensions, family allowances, and other forms of social security—but obviously, the government points out, none of these expenditures can be reduced. Tax rates have been kept up or increased on the higher incomes. A capital levy has been added. Further nationalization and socialization are discussed. Sales taxes on luxuries, with one or two exceptions, have been reduced.

It is surely not the finance minister’s fault if these arrangements are not bringing in more revenue. Meanwhile the volume of money in circulation has risen enormously and is still rising. The government, however, is holding down interest rates so that it can borrow cheaper and encourage business borrowing. This policy, however, also increases the inflationary pressure. In fact, artificially low interest rates cannot be achieved except by increasing the volume of money and bank credit; and the volume of money and credit are increased by maintaining a government deficit. But about this nothing is said by government spokesmen.

Yet though the government is itself creating the inflation, it is alarmed by the unpopular consequences of this inflation. It blames all price rises, not on its own inflationary policies, but on “speculators” and “hoarders,” and on the greed and rapacity of producers and sellers. It fixes ceiling prices on everything. This dislocates all profit margins. But as goods are produced in accordance with relative profit margins, there is a huge misdirection and waste of capital and labor. It is necessities that are controlled most. It is their prices that are usually held lowest in relation to production cost. It is necessities which are strictly rationed. The inflationary purchasing power hedged off from necessities expends itself on luxuries which are uncontrolled. Necessities are therefore underproduced. Luxuries are overproduced. While labor is diverted by this process to luxury lines there are universal complaints of “labor shortage.”

As inadequate profit margins paralyze production, and as artificial price bargains stimulate consumption, an attempt is made to correct the result by rationing, command priorities, and dictated allocations. The shortages brought about by price control are treated as inescapable and inherent. But as all output is interdependent, production all around is slowed down to that of the item in shortest supply.

On its foreign trade Ruritania imposes controls made necessary by, and in turn necessitating, its internal controls. The country has an inflation and wishes to conceal it. It does this internally by price fixing. But one result of this is that monetary purchasing power is kept in excess of the total value of goods as measured in official prices. This produces the “inflationary gap”—i.e., the amount of money or money incomes with no outlet.

If imports are allowed to come in freely, all this excess money (as Sweden discovered) will be used to buy them. Yet Ruritania wants imports of raw materials and machinery, and wants to buy them as cheaply as possible. It attempts to do this by keeping the official exchange rate of its currency arbitrarily high and by making it a crime to buy or sell its currency below this rate. This makes Ruritania’s own goods extremely if not prohibitively expensive in terms of foreign currencies. The high rate for its currency, in short, encourages imports and discourages exports. It is also likely to make the American traveler feel that he is being swindled by the compulsion to convert his dollars at the official exchange rate, and so provokes resentment and discourages tourism.

Ruritania tries to cure all this, not by allowing its paper currency to seek its natural supply-and-demand level, but by refusing to permit any import to come in except by special license. It orders manufacturers to set aside specified goods for export and forbids its own citizens to buy at any price the goods so set aside.

The result of refusing to permit its own citizens to buy “luxury” imports with their own money, however, is to hurt the luxury export trade of all other countries. Yet each European country has its own luxury exports which it is eager to push to get dollars or other exchange to buy necessary imports. France has its wines and brandies, perfumes and laces. Holland has its tulip bulbs and fancy cheeses. Switzerland has its embroideries and resort hotels. Each argues that it is unsound and unrealistic to expect people in these trades to turn to other work. Their capital and long-acquired skills are irrevocably invested in what they are doing. It is often a way of life inherited from their fathers and grandfathers. To force them into other lines would involve huge losses and radically dislocate the whole national structure of production. So each country tries to force other countries to take its luxury exports while refusing to take theirs.

The stalemate is broken by bilateral trade treaties in which each country forces its neighbor to take some of its luxuries along with its necessary products. In return it also agrees to take luxuries along with necessities. These treaties, however, do not merely leave matters where they would have been under freedom of trade. Both necessities and luxuries are exchanged against each other at artificial prices, which do not have to meet world competition. Each country is forced to take, not the goods that its consumers want, and in the proportions that they want them, but the luxuries that its neighbor is most eager to get rid of.

Bilateralism is politically popular because its basic principle, “Buy where you sell,” is easier to understand than free multilateralism. It is obviously imitated from Schacht and Hitler, who in turn revived a mercantilist fallacy centuries old. “The sneaking arts of underling tradesmen,” wrote Adam Smith in condemning it, “are thus erected into political maxims for the conduct of a great empire; for it is the most underling tradesmen only who make it a rule to employ chiefly their own customers.”

Bilateralism is a necessary part of a “planned”—that is to say, a dictated—economy. The internal restrictions of a dictated economy would break down at once if it permitted free international trade. Internal and external controls necessitate each other. Bilateralism is ideal for government “planners,” because it permits them to say just how much of this or that shall be sold or bought, and to or from just what country. This enables them to keep their hands on all the strings of business, to retain life-and-death control over particular industries, and to throw trade this way or that in accordance with their foreign political policy of the moment. But none of this makes either for domestic prosperity or for peaceful, free or stable world trade.

EFFECTS OF OVERVALUED CURRENCIES

SEVERAL important conclusions emerge from this brief survey. The common assumption, as we have already noted, is that the existing economic difficulties of Europe are in the main the consequence of the destruction and dislocations of war. But the foregoing survey should be enough to show that, on the contrary, the main obstacles to European recovery are the present economic policies followed by the governments of Europe.

When a currency is overvalued (to consider the harmful effects of merely one governmental control) it produces a chronic surplus of imports over exports. The overvaluation of a nation’s currency makes imports cheaper than they would otherwise be in terms of that currency. This naturally encourages people in that nation to increase their purchases of imports. The overvaluation of the currency tends, on the other hand, to make the prices of that nation’s exports high in terms of other currencies. This discourages other countries from buying.

Suppose, for example, that a French brandy sells in Paris for 1,200 francs a bottle. The black-market rate for the franc is about 280 to the dollar as this is being written. Let us assume that in a free market the franc would sell a little higher—say about 240 to the dollar. At such a rate the brandy could be bought for $5 a bottle in American money. But the official rate for the French franc, which the American importer is now forced to pay, is 119 to the dollar. This means that the brandy must cost him more than $10 a bottle. The arbitrary exchange rate enforced by the French police raises the price as much as would a 100 per cent American import duty (on top of the duty that we actually impose). And this applies to every French import to this country. Is it surprising, apart from any other factor, that France is exporting so relatively little to us?

In the same way, if we look at the problem from the other side, a typewriter that costs $100 in the United States would cost a French buyer, if he had to pay 240 francs for the dollar, 24,000 francs. But as he is able, thanks to exchange control and American loans, to get the dollar for only 119 francs, the typewriter costs him less than 12,000 francs. And this applies to every American import to France. Is it surprising that Frenchmen should want to buy a great deal from us?

Because the overvaluation of the franc makes French goods expensive in terms of dollars, the would-be French exporter may have to reduce his price in terms of francs if he is to meet the competition of other sellers, foreign or American, in the American market. Yet he may see no reason for doing this, because he can realize a larger margin of profit on his domestic sales. And inflation at home, by causing a rise in domestic money incomes, will cause a rising home demand for goods which otherwise would be exported. As if all these discouragements to exports were not enough, the French government does not allow the French exporter to keep the dollars he has made from his export sales or to convert them freely. He must turn 90 per cent of his dollar proceeds over to the government. And he must turn them over at the official rate.

It is hardly surprising, in the face of such regulations, that in most European countries there is a chronic excess of imports over exports. It is hardly surprising that these countries now buy more than they sell. This trade deficit does not prove, however, as Secretary Marshall’s Harvard speech and the report of the sixteen nations assume, that Europe’s “requirements” are this much greater than “her present ability to pay.” It was not primarily brought about by the destructions of war. This chronic excess of imports is being brought about, on the contrary, by Europe’s own governmental policies. It is being financed today mainly by American governmental loans. It will continue as long as those loans continue, and as long as the internal policies responsible for it continue.