The World Monetary Earthquake

October 3, 1949

Within a single week 25 nations have deliberately slashed the values of their currencies. Nothing quite comparable with this has ever happened before in the history of the world.

This world monetary earthquake will carry many lessons. It ought to destroy forever the superstitious modern faith in the wisdom of governmental economic planners and monetary managers. This sudden and violent reversal proves that the monetary bureaucrats did not understand what they were doing in the preceding five years. Unfortunately it gives no good ground for supposing that they understand what they are doing now.

This column has been insisting for years, with perhaps tiresome reiteration, on the evil consequences of overvalued currencies. On Dec. 18, 1946, the International Monetary Fund contended that the trade deficits of European countries “would not be appreciably narrowed by changes in their currency parities.” I wrote in Newsweek of March 3, 1947: “It is precisely because their currencies are ridiculously overvalued that the imports of these countries are overencouraged and their export industries cannot get started.” In the issue of Sept. 8, 1947, as well as in my book Will Dollars Save the World? I wrote: “Nearly every currency in the world (with a few exceptions like the Swiss franc) is overvalued in terms of the dollar. It is precisely this overvaluation which brings about the so-called dollar scarcity.”

Yet until Sept. 18 of this year the European bureaucrats continued to insist that their currencies were not overvalued and that even if they were this had nothing to do, or negligibly little to do, with their trade deficits and the “dollar shortage” that they continued to blame on America. And the tragedy was that former Secretary of State Marshall, the President, and Congress, completely misunderstanding the real situation, accepted this European theory and poured billions of the American taxpayers’ dollars into the hands of European governments to finance the trade deficits that they themselves were bringing about by their socialism and exchange controls with overvalued currencies.

In time the managers of the Monetary Fund learned half the lesson. They recognized that most European currencies were overvalued. They recognized that this overvaluation was a real factor in causing the so-called “dollar shortage” and unbalancing and choking world trade. But they proposed the wrong cure.

They did not ask for the simple abolition of exchange controls. (Their own organization in its very origin was tied up with the maintenance of exchange controls.) They proposed instead that official currency valuations be made “realistic.” But the only “realistic” currency valuation (as long as a currency is not made freely convertible into a definite weight of gold) is the valuation that a free market would place upon it. Free-market rates are the only rates that keep demand and supply constantly in balance. They are the only rates that permit full and free convertibility of paper currencies into each other at all times.

Sir Stafford Cripps fought to the last against the idea that the rate of the pound had anything to do with the deepening British crisis. Trying to look and talk as much like God as possible, he dismissed all such contentions with celestial disdain. But at the eleventh hour he underwent an intellectual conversion that was almost appallingly complete. We “must try and create conditions,” he said, “in which the sterling area is not prevented from earning the dollars we need. This change in the rate of exchange is one of those conditions and the most important one” (my italics). And on the theory that what’s worth doing is worth overdoing, he slashed the par value of the pound overnight from $4.03 to $2.80.

There are strong reasons (which space does not permit me to spell out at this time) for concluding that the new pound parity he adopted was well below what the real free-market level of widely usable sterling was or would have been on the day he made the change. What he did, in other words, was not merely to adjust the pound to its market value as of Sept. 18 but to make a real devaluation.

The first consequence was to let loose a world scramble for competitive devaluation far beyond anything witnessed in the ’30s. Most nations fixed new rates lower than their existing real price and cost levels called for. These countries, therefore, will now undergo still another epidemic of suppressed inflation. Their internal prices and living costs will start to soar. Unions will strike for higher wages. And if the past (or Sir Stafford’s Sept. 18 talk) is any guide, the governments will try to combat this by more internal price-fixing and rationing, continued or increased food subsidies, unbalanced budgets, and wage fixing.

In this country, on the contrary, the tendency will be to drag down our price level somewhat by lowering the dollar price of imported commodities and forcing reductions in the dollar price of export commodities. This will increase our problems at a time when the unions are pressing for a wage increase in the camouflaged form of insurance-pension benefits.

It will be necessary to reexamine our whole foreign economic policy in the light of the new exchange rates. Marshall-Plan aid with overvalued European currencies was largely futile; Marshall-Plan aid with undervalued European currencies should be unnecessary. In fact, we may soon witness the reversal of the world flow of gold. For the first time since 1933 (if we omit the war years 1944 and 1945) gold may move away from, instead of toward, our shores.

But getting rid of overvalued currencies, even in the wrong way, is nonetheless a tremendous gain. The chief barrier that has held up a two-way flow of world trade in the last five years has at last been broken. The chief excuses for maintaining the strangling worldwide network of trade restrictions and controls have at last been destroyed. Were it not for the echoes of the atomic explosion in Russia, the outlook for world economic freedom would at last be brighter.

The best British comment I have read since the devaluation comes from The London Daily Express: “Let every foreign country pay what it thinks the pound is worth. . . . But the socialists will never consent to free the pound. It would mean abandonment of their system of controls. . . . If you set money free you set the people free.”