Financial Cold War. James A. Fok
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no doubt that Keynes’ theories were founded on Britain's particular economic circumstances at the time. Nevertheless, it became clear that the rigidity of the gold standard was a major underlying contributor to the worldwide breakdown in trade and economic hardship of the 1930s. The need to maintain fixed exchange rates forced central banks to raise interest rates to prevent outflows of gold just as economic demand was already shrinking. Due to the nature of fractional reserve banking systems,22 the impact of withdrawals of gold was magnified through the reduction in banks’ capacity to lend. In turn, this caused asset prices to tumble, which led to loan defaults that further compounded economic weakness. As panic set in, scenes of depositors queued up outside banks to withdraw their savings became commonplace. Some 9,000 banks in the US failed during the 1930s.23
Via the transmission mechanisms of international trade and investment, economic problems in one country spread to others and prosperity declined globally. Even countries that had run large trade surpluses suffered. France had maintained strong exports by keeping the franc undervalued, but the Banque de France incurred huge losses on its sterling balances when Britain was forced to devalue the pound in 1931.
Keynes was convinced that the global monetary order needed to be radically reformed. Instead of society adjusting to the requirements of the gold standard, he believed that it was monetary policy that needed to adapt to the natural tendencies of society. In his vision, there needed to be a more flexible mechanism of international exchange rates to allow for periodic adjustments in response to imbalances in trade or capital flows, and the role of the barbarous relic in monetary policy needed to be gradually phased out. And this is precisely the plan that he drew up.
Two Competing Plans
Hitler's invasion of Poland in September 1939 precipitated the commencement of WW2 in Europe. Even before America was drawn into the war by the Japanese attack on Pearl Harbour in December 1941, it was already entangled via the Lend-Lease programme, through which it was providing material and financial support to a cash-strapped Britain. Churchill described America's Lend-Lease programme as a ‘most unsordid act’,24 but it was also one of calculated self-interest since, if Britain were to be defeated by Germany, the US would be left standing alone against a fascist-controlled Europe. For Britain, however, it meant it would face a costly debt to the US after the war.
Keynes returned to the Treasury as an unpaid advisor to the Chancellor of the Exchequer after WW2 started. By this time, he was becoming a part of the establishment that he had previously derided. He was elected to the Court of the Bank of England in 1941 and then ennobled as Baron Keynes of Tilton the following year. Understanding the implications of his country's financial position and the need to plan ahead for its changed circumstances after the war, he began work in August 1941 on a plan for a new post-war global monetary order.
Anxious to avoid a repeat of the policy mistakes of the 1920s and 1930s, his plan sought to replicate the stability of the gold standard within a more flexible framework. There were two key elements to his proposal.
First, there was to be a new global reserve currency created, which he called Bancor (French for ‘bank gold’). Bancor was to have a fixed exchange rate against all members’ currencies and gold, but it was provided that countries with persistent balance of payments deficits would be subject to automatic devaluations, while countries running persistent surpluses would be subject to upwards adjustments of their exchange rates. This created a ‘pegged but adjustable’ currency system that enabled changes in countries’ relative balance of payments to be reflected in their exchange rates over time.25
Second, it involved setting up a new global central bank that he called the International Clearing Bank (ICB), which would take on the role of issuing Bancor. Central banks were to buy and sell their own currencies among themselves through a system of debits and credits in their ICB ‘clearing accounts’, with the ICB providing overdraft facilities to cover any temporary balance of payments shortfalls.26 This would avoid the chronic shortage of gold reserves that wrought global financial instability in the interwar years. Although Keynes had accommodated gold within the system in recognition of its historic monetary role, it was provided that the ICB could issue new Bancors in exchange for gold, but that there would only be one-way convertibility, thereby gradually withdrawing gold from its monetary role over time.
Almost in parallel, Harry White had begun work on a competing plan, the first draft of which was completed in March 1942. Though they had worked independently and, initially, without either of them knowing that the other was even working on such a plan, the contours of White's proposal were remarkably similar to Keynes’. However, the White plan also reflected key American interests. Among these were the opening up of international markets for US exports and the elevation of the dollar to become the global unit of exchange.27
The White plan continued to place gold at the centre of the monetary system, alongside dollars. Each currency was to be fixed to the dollar, which was in turn fixed to gold. Currency devaluations under this system were to be rare and would entail significant penalties on the devaluing country. He also provided for two new agencies: a United and Associated Nations Stabilisation Fund (later to become the International Monetary Fund (IMF)) and a Bank for Reconstruction and Development of the United and Associated Nations (later to become the World Bank). The Fund, like Keynes’ ICB, would allow members to buy currency to cover balance of payments shortfalls, but only against adequate collateral in the form of gold or other currencies. Compared with the Keynes plan, therefore, the White plan provided for a far more rigid system of global exchange rates. The mechanism for temporary liquidity support was also far less flexible than the one Keynes had proposed.
White's continued adherence to gold at the centre of the system was, in part, because he simply did not believe that the world was ready to accept that the dollar could play the global role he envisioned without the backing of gold.28 However, the fact that the US held two-thirds of the global reserves of monetary gold also gave it an incentive to ensure that its monetary value was protected. America's large gold holdings at that time nevertheless legitimised the dollar to be ‘as good as gold’ and, by setting all other currencies’ exchange rates by reference to the dollar, the dollar's role at the centre of the global monetary system would be cemented.
White's plan also reflected America's position as a large balance of payments surplus country at that time. Keynes’ proposal would have made surplus nations unsecured creditors to deficit countries that made use of the ICB's liquidity support facility. This was unacceptable to the Americans, as was Keynes’ proposal that countries running persistent large surpluses be subject to automatic upwards revaluations of their currencies, since this would have served to penalise the US. This may seem ironic in light of fierce American criticism of China's large trade surpluses in recent years.
The change in US circumstances was something that Jacob Viner actually foresaw in a July 1943 letter to Keynes, in which he wrote: ‘The expectation that the US will be alone or almost alone as a creditor is plausible for the first period’ but ‘Over the long pull … I think that the US is as likely to be short as to be long of foreign short-term funds.29
Keynes’ plan equally reflected British interests. In light of Britain's strained economic circumstances, it was not realistic for sterling to play the central role as a global reserve currency that it had before. However, Keynes was opposed to the idea that another national currency should do so. Beyond the question of national interests, there was simply a fundamental conflict between the role of a national central