Money Meltdown

Judy Shelton

• Publisher: Free Press
• Year: 2009
• eBook ISBN: 9781439188460
• Topic: History
• Subtopic: World History
• Index: History

In this analysis, Shelton calls for a unified international monetary regime—a new Bretton Woods—to lay the foundation for worldwide stability and prosperity in the post-Cold War era. Despite worldwide rhetoric about free trade and the global economy, the leading economic powers have done little to address the most insidious form of protectionism—the inherently unstable international monetary system. In outlining steps toward a new world monetary structure, Judy Shelton elevates the needs of individual producers—who actually create wealth in the global economy—over the programmes of governments.

1. The Legacy of Bretton Woods

Even as World War II raged, two economists, John Maynard Keynes and Harry Dexter White, directed their considerable intellectual prowess toward a single momentous objective: How to structure a new world economic order based on international cooperation. The crux of the challenge was to set up a global monetary system to serve the needs of a postwar world recovering from devastation. Given that the outcome of the war was not yet assured, the timing for such an endeavor was both hopeful and fateful. Allied forces would land in Normandy on June 6, 1944, less than four weeks before the opening day of the international monetary conference at Bretton Woods, New Hampshire.

Keynes, a British subject, was already a legend at the time he was tapped to lay out designs for a postwar financial system. He had written The General Theory of Employment, Interest and Money in 1936. Sweeping in its philosophical implications, the General Theory was a tirade against laissez-faire economic principles and a pitch for activist fiscal policy on the part of governments. Keynes advocated massive public spending programs to counteract down-turns in the economy, which were caused, he contended, by insufficient demand for goods and services by households and businesses. Keynes’s solution to private sector inadequacies was economic intervention by government.

White, an American expert on international finance with degrees from Columbia, Stanford, and Harvard, had his own ideas for structuring a postwar monetary order. White was a firm believer that stable domestic and international prices were a prerequisite for economic order and that stable exchange rates among national currencies were necessary to promote foreign trade and global prosperity. White wanted to reduce the ability of individual governments to impose exchange controls and other barriers that inhibited trade. Instead, he envisioned an international banking institution charged with the authority to stabilize exchange rates so as to encourage the most productive use of international capital.

Both Keynes and White were drawn to the idea of establishing supranational agencies to manage economic and financial affairs at the global level. National sovereignty would be partially surrendered to these organizations for the sake of achieving the greater good of stable international exchange rates. While Keynes wanted to ensure that individual governments could manipulate their own domestic economies in accordance with his theories about fiscal activism, he recognized the importance of orderly global arrangements to stimulate international trade. White’s main concern was to prevent the chaotic consequences of multiple currencies growing at different rates and to avoid the harmful effects of competitive depreciations. As a monetary expert at the U.S. Treasury, he had assisted several Latin American countries to establish formal currency stabilization arrangements with the United States.

Both men also favored the idea of a universal currency of sorts, a global monetary unit that would transcend the vagaries of individual national monies. Keynes wanted to call his international currency “bancor” (derived from the French words for bank and gold) and use it as a bookkeeping money for the purpose of settling international balances. Bancor would be defined in terms of gold, but the conversion rate would not necessarily remain unalterably fixed. Countries would be able to obtain bancor in exchange for gold; they would not be able to obtain gold in exchange for bancor.

White’s concept of an international currency, which he christened “unitas,” was more definitively linked to gold. As a global monetary unit of account, the unitas would consist of 137 1/7 grains of fine gold (equal to ten dollars). White proposed to set up an international fund consisting of gold, national currencies, and other securities that could be used to stabilize monetary relations among contributing countries. The value of each nation’s currency would be established in terms of unitas, and the accounts of the fund would likewise be kept and published in terms of unitas.

Despite their mutual admiration for global institutions and the notion of a world currency, Keynes and White did not always get along well personally. This friction was due in some measure to differences in their respective British and American cultural backgrounds. Keynes accused White of writing in “Cherokee” as opposed to his own “Christian English.” He complained that White was “over-bearing” and did not have “the faintest conception of how to behave or observe the rules of civilized intercourse.” For his part, White found Keynes insufferably arrogant and referred to him sarcastically as “your Royal Highness.”¹

Still, personality clashes between the two primary architects of the Bretton Woods system did not preclude them from working closely together to lay the foundation for the postwar international economic order. Both Keynes and White were motivated by a humanitarian desire to prevent the kind of financial stresses and economic dislocations that might lead to future wars. Both believed that it was possible to shape the world through sheer human determination and intellectual effort. By establishing global monetary mechanisms and organizations, imposing in their power and resources, they sought to create optimal conditions for achieving world prosperity and world peace.

In short, Keynes and White were convinced that international economic cooperation would provide a new foundation of hope for a world all too prone to violence. “If we can continue,” Keynes observed, “this nightmare will be over. The brotherhood of man will have become more than a phrase.”²

KEYNES’S VISION

Finely honed during his student days at Cambridge, Keynes’s combination of brilliance, charm, and cynical wit greatly enhanced his ability to communicate ideas. He had a tremendous talent for turning scholarly insights into logical arguments; these in turn provided the basis for public policy initiatives. Although Keynes seemed to possess an innate sense of elitism and preferred to socialize with more sophisticated members of society, he took great pains to express his views in terms that made sense to common people. For example, propounding his theory that a dwindling economy should spend its way out of recession, he wrote in The Listener:

When anyone cuts down expenditure, whether as an individual or a town council or a Government Department, next morning someone for sure finds that his income has been cut off, and that is not the end of the story. The fellow who wakes up to find that his income is reduced or that he is thrown out of work … is compelled in his turn to cut down his expenditure, whether he wants to or not…. Once the rot has started, it is most difficult to stop.³

Unlike some scholars, Keynes was not at all reluctant to dispense his economic views outside the halls of academe. He often submitted articles to popular magazines such as Redbook or opinion weeklies such as The New Republic; indeed, between 1919 and 1938 he wrote fifty-three pieces for the The New Republic.⁴ Whether he was dashing off newsy observations for general consumption or crafting articles with scholarly rigor for the prestigious Economic Journal, which he edited for over three decades, Keynes managed to calibrate the tone of his text to his intended audience. He appealed directly to his readers’ sensibilities, carefully geared his message to what he deemed the appropriate level of intellect, and always strived to persuade as he informed.

Keynes’s ability to move easily from professorial jargon to everyday language figured keenly in his efforts to influence politicians and shape public policy. When political leaders ignored his recommendations—for example, concerning excessive German reparations after World War I—Keynes retaliated by writing polemical essays and arranging for their immediate publication. He could be brutal in his indictments of the world’s most powerful leaders, and he did not hesitate to charge them with lack of foresight or intelligence. For Keynes, human values were more compelling than sterile economic analyses; they provided the starting point for resolving the world’s most pressing problems. By starting literary backfires of vehement public opinion, Keynes ensured that his views received attention at the highest political levels.

In contrast to his impressive mental powers, Keynes considered himself physically unattractive, an opinion that apparently was justified. According to an assistant master at Eton, where Keynes received his early education, he was “distinctly ugly at first sight, with lips projecting and seeming to push up the well-formed nose and strong brows in slightly simian fashion.”⁵ But Keynes did not let his shortcomings in this area dampen his appreciation for beautiful objects and intensely personal relationships. In keeping with the philosophy of the Bloomsbury set, an elite group of gifted intellectuals with whom he associated, Keynes affirmed that one’s primary goals in life should be “love, the creation and enjoyment of aesthetic experience, and the pursuit of knowledge.”⁶ Keynes was homosexual, which posed little problem to the anti-Victorian Bloomsbury group; at age forty-two, however, he married the Russian ballerina Lydia Lopokova.

Although Keynes was devoted to the cultured world of art and theater, he departed sharply from the attitude of his Bloomsbury compatriots in a most significant way: he did not share their disdain for the world of action. On the contrary, Keynes’s interpretation of aesthetic achievement was actively to utilize his vibrant intellect to improve the human condition. He saw himself as a unique individual who could change the course of economic thought, a catalyst poised at the center of “one of those uncommon junctures of human affairs where we can be saved by the solution of an intellectual problem, and in no other way.”⁷

Transcending Orthodoxy

Keynes had respect for the classical body of economic knowledge to which he had been exposed at Cambridge; he was particularly influenced by the teachings of his mentor, Alfred Marshall. He absorbed the arguments and mathematical formulas that framed such fundamental works as Marshall’s Principles of Economics and used them as the basis of his own intellectual foundation for explaining how the world works.

But Keynes had the unique ability to go beyond the elegant equations and verbiage, to grasp the essence of the argument, and to discover some new twist, some new insight that would enliven the theoretical text into a directive for human action. Even as he was back at Cambridge teaching economics, following a brief stint in government after graduation, Keynes was beginning to venture beyond the classical tradition in his interpretation of real world relationships. Describing Keynes’s first major book, Indian Currency and Finance, biographer Roy Harrod wrote:

It is the work of a theorist, giving practical application to those esoteric monetary principles which Marshall had expounded and Keynes was explaining in Cambridge classrooms, and at the same time it showed an outstanding gift for penetrating the secrets of how institutions actually work.⁸

Why did Keynes choose to write about the Indian currency situation? It was his first opportunity to apply scholarly analysis to real world circumstances. After leaving Cambridge, Keynes did not get the position he was seeking when he applied to work for the government; he had wanted to receive an appointment at the Treasury but instead was assigned to the India Office in London. On its own merits, the job was not particularly challenging for Keynes. Among his early tasks was to make shipping arrangements for ten young bulls to Bombay.⁹ But even if Keynes found the administrative duties somewhat tedious, he was intrigued by India’s developing monetary and financial system. He observed that, as it was moving toward establishing a traditional gold standard, India was in the meantime operating according to a hybrid system where paper claims on gold were redeemed for export purposes but were not part of the nation’s internal currency mechanism. Keynes decided that this “gold-exchange standard” was better than a full-fledged gold standard because it permitted India to link its paper currency to sterling without having to engage in “the needless accumulation of the precious metals.”¹⁰

Keynes thought that paper money was not only much more efficient than gold coin but was also more flexible, allowing the volume of currency to be temporarily expanded to accommodate seasonal demands of trade. Rather than having every nation maintain reserves in gold to back its currency, Keynes believed it made more sense for India and other countries to guarantee convertibility of their money into sterling, which functioned as an international currency, and keep reserves in London in the form of sterling balances on which they were paid interest. Keynes advocated the use of “a cheap local currency artificially maintained at par with the international currency or standard of value (whatever that may ultimately turn out to be)” as an attractive alternative to the gold standard and “the ideal currency of the future.”¹¹

With the advent of World War I, Keynes left Cambridge once more and went back into government service. This time he made it to the Treasury where he had ample opportunity to turn his attention to the political side of financial and economic questions. Indeed, by the end of the war his talents in analyzing policy options and writing position papers had propelled him to the top ranks of the department and provided him a strong forum for influencing government decisions. When Keynes, then aged thirty-five, was sent to the peace conference in Versailles following the armistice, he was designated senior representative of the Treasury and was authorized to represent the views of the chancellor of the Exchequer.

At the conference, Keynes was appalled at what he considered the excessively punitive financial measures that were being assessed against Germany. He was upset that the leaders of the Allied nations—President Woodrow Wilson of the United States, French Premier Georges Clemenceau, British Prime Minister Lloyd George, and Italian Premier Vittoria Orlando—seemed unable to comprehend that in demanding such high reparations from their defeated and humiliated enemy, they were destroying Germany’s ability to regenerate and become economically productive in the future. Keynes observed:

The entrepreneur and the inventor will not contrive, the trader and the shopkeeper will not save, the labourer will not toil, if the fruits of their industry are set aside, not for the benefit of their children, their old age, their pride, or their position, but for the enjoyment of a foreign conqueror.¹²

Keynes felt that Germany’s ill-fated future would end up having negative repercussions for its neighbors and the entire region; rather than destroying the German economy, Keynes asserted, the Allied leaders should be endeavoring to restore it as a safeguard against political instability throughout the whole of Europe. The remedies offered by Keynes were much less harsh toward Germany and much more oriented toward rebuilding Europe’s economy. Keynes proposed to (1) set reparations within Germany’s capacity to pay, (2) waive the United Kingdom’s claim on such reparations and cancel interallied war indebtedness, and (3) provide an international loan to meet Europe’s immediate requirements for reconstruction funds. But to no avail. According to Keynes:

The Council of Four paid no attention to these issues, being preoccupied with others—Clemenceau to crush the economic life of his enemy, Lloyd George to do a deal and bring home something which would pass muster for a week, the President to do nothing that was not just and right. It is an extraordinary fact that the fundamental economic problem of a Europe starving and disintegrating before their eyes was the one question in which it was impossible to arouse the interest of the Four. Reparation was their main excursion into the economic field, and they settled it as a problem of theology, of politics, of electoral chicane, from every point of view except that of the economic future of the states whose destiny they were handling.¹³

Keynes resigned his Treasury position in June 1919 to protest the accepted terms of the treaty and within months churned out a scathingly critical book, The Economic Consequences of the Peace. It created an international sensation, broke book sale records in England and the United States, and elevated Keynes to new heights of recognition in public policy circles.

Ensconced at Cambridge once again after the war, Keynes continued to ponder and lecture, accumulating the insights and arguments that would ultimately find their way into The General Theory of Employment, Interest and Money. Keynes was not satisfied with prevailing explanations of the factors leading to economic depression, nor did he accept orthodox prescriptions calling for patience and perseverance as the price of economic recovery. Keynes instead sought to mesh his own theories about the relationship among key financial variables with his proposals for government-directed stimulation of the economy. He felt certain that there was a fundamental error in the traditional economic literature, which stipulated that demand equals supply in a self-regulating capitalist economic system and that savings and investment are perfectly equilibrated by the rate of interest. He was not willing to totally dismiss the classical approach, but he was intent on discovering what his predecessors had overlooked in their zeal to pursue theory at the expense of reality. “A large part of the established body of economic doctrine I cannot but accept as broadly correct,” Keynes wrote. “For me, therefore, it is impossible to rest until I can put ...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Contents
• Introduction: Losing the Dream
• 1. The Legacy of Bretton Woods
• 2. The Fall from Grace
• 3. The World on Edge
• 4. Theory Versus Reality
• 5. The Solid Choice
• 6. Agenda for a New Bretton Woods
• Epilogue: The Sanctity of Sound Money
• Notes
• Acknowledgments
• Index