The Incubus of Exchange Control

May 31, 1948

The National Advisory Council, composed of Cabinet-level officials headed by Secretary Snyder, reminds Marshall-Plan countries that their exchange rates “will require adjustment.” Paul Hoffman, head of the ECA, thinks it “quite obvious that there should be more realistic rates of exchange.”

It is gratifying to have at last this official recognition of exchange realities, even though the NAC still fails to draw some of the most important logical conclusions from this recognition.

The British pound is the key example. It was pointed out in this column on May 10 how exchange control with an overvalued pound systematically encourages imports, discourages exports, and brings a chronic trade deficit, which the United States is then called upon to make up. If the pound were allowed to decline to its free-market value the result, it is true, would be a substantial increase in Britain’s internal price level. For in terms of pounds imports would cost more. And British consumers (in the absence of watertight allocations) would be forced to pay higher prices to hold their share of goods at home against the increased price in pounds obtainable for exports.

But the only way that Britain in the long run could avoid this result is by an internal deflation. This could be brought about by slashing government expenditures, particularly on capital projects and on food subsidies, by increasing the purchase tax, by abandoning the infra-low interest rate policy, and by warning British labor that it must keep its wage rates low enough to meet world competition at a $4 rate for sterling. One has merely to cite these conditions to recognize how improbable they are politically under the present Labor government.

The British Government, in short, has a choice of free foreign-exchange markets, of official devaluation, or of rigorous internal deflation: and it is unwilling to embrace any one. This “forces” it to impose direct import controls. But as the Canadian economist Donald B. Marsh points out, it has “a basic predilection for controls combined with a policy that, by deepening the crisis, makes the removal of controls unthinkable.” As he adds: “In a country as dependent as Great Britain on external trade, exchange control provides the ultimate in governmental control of private business. Whether exercised or not, the government’s power under exchange control is literally the power of life and death over firms and industries dependent upon imports.”

The British bureaucrats are convinced that the only cure for the trade deficit is a great overall increase in British production. All that is really needed, however, is a change in the internal structure of consumption and production sufficient to correct the trade balance. This task is not herculean. What is involved is a total annual trade deficit officially estimated at £250,000,000. This is less than 3 percent of Britain’s present national income. It could be corrected either by raising British production 3 percent (less than the actual increase of 1947 over 1946) or by lowering British consumption 3 percent.

But analysis shows that instead of devoting the resources released by the cessation of the war to export production, these have been chiefly reabsorbed by other activities. And it is government controls that have prevented readjustment. Only when free exchange rates and free prices are reestablished will imports and domestic output readjust themselves to the proportions necessary to cure the trade deficit.

As long as other currencies also remain overvalued and inconvertible, it is true, the British cannot correct their balance of payments by sales to “soft-currency areas.” But British and above all American leadership could get the leading countries of the world simultaneously to abandon the whole vicious Schachtian network of exchange control. It is fantastic for America to be draining its resources in order to subsidize and prolong a totalitarian device that disintegrates and strangles international trade, makes free enterprise impossible, retards European recovery, and intensifies and perpetuates the very “dollar shortage” that it pretends to cure.