Why Europe Is in a Mess

June 9, 1947

NAZISM was defeated in war. Hjalmar Schacht, the Nazi economic wizard, is in jail. But when Schacht and his surviving comrades survey the world today, they must feel consoled. Intellectually Schachtism has conquered Europe. The system of price control, wage control, profit control, interest control, exchange control, foreign-trade control, bilateral treaties, rations, priorities, allocations, quotas, with a special license required for almost every move, and with a mounting currency inflation hidden and repressed by these devices—this is Schachtism. And this is the system which nearly every country in Europe has now embraced. If it does not repudiate outright the free-market and free-price system, it regards that system as a luxury that it may be able to afford after its recovery has already been achieved.

The central economic problem of the world today is Europe, and the central economic problem of Europe is Germany. Yet in Germany the looting, the “level of industry” plan, the combination of a chaotic currency with legal prices and wages far below what a free market would bring, destroy production and all incentives. In misdirected efforts to prevent Germany from again becoming a menace to the world we have made it a burden to the world.

It should be possible to prevent it from becoming either—by permanent supervision, by forbidding war production, by permitting full peace production, by setting up a stable currency, by abolishing the whole system of price and wage control, allocations and licenses, by imposing reparations up to the point where they do not endanger output or disrupt world economy, and finally, by forcing on Germany entire freedom of trade with other nations.

This last policy, the opposite of Hitlerian autarchy, would make Germany heavily dependent on imports at the same time as it would increase world efficiency. To protectionists and government planners and socialists, it should be pointed out that from their point of view it ought to be the worst of punishments to deprive Germany of protection and planning and socialism.

It is precisely because Germany exhibits a bankrupt Schachtism in extreme form that it is so instructive an example. But elsewhere the same disease is illustrated in milder forms. Let us take a sort of composite photograph, and call it Ruritania. The situation in Ruritania will be found to apply with only minor modifications to most of the countries of Europe.

Ruritania’s budget is unbalanced. Heavy sums are being spent on armaments, 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 is 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. The policy also increases the inflationary pressure, the volume of money and bank credit, and ultimately the government’s general expenditures; but about this nothing is said by government spokesmen.

But if the government is creating inflation, it is determined to prevent the unpopular consequences of this inflation. It blames all price rises, not on its own inflationary policies, but on the greed and rapacity of producers and sellers. It fixes ceiling prices on everything. Holding down prices to arbitrary levels of course 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. Necessities are underproduced; luxuries are overproduced; there are universal complaints of “labor shortage.”

Where inadequate profit margins discourage or prevent production, and where prices fixed below the market over encourage consumption, an attempt is made to correct the situation by rationing, arbitrary priorities, and allocations. The shortages brought about by bad price control are treated as inescapable and inherent. As all output is interdependent, production all around is slowed down to that of the item in shortest supply, whether coal or timber or “labor.”

Price control economically necessitates wage control; but wage control in turn politically necessitates price control; and no one knows how or where to break out of the circle.

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 consequence of this is that the volume of money is kept in excess of the total volume of goods at 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 get them as cheap as possible. It can do this by keeping its official exchange rate arbitrarily high and making it a crime to buy or sell its currency below this rate. This makes foreign goods cheap in terms of its own currency; but it also makes its own export 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 obligation 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 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 set aside for export.

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 necessity products. 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. An internally dictated economy would break down immediately 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 the foreign political policy of the moment. But none of this makes for peaceful, free, or stable world trade.

Once we in America have recognized the real nature of the European disease, it should be clear that we have been applying the wrong remedies. Between July 1, 1945, and July 1, 1947, it is estimated, the United States will have contributed abroad nearly $817,000,000,000 in cash and goods. In general, we have been pouring these gifts and loans into Europe without conditions, or with wholly inadequate conditions. It is not surprising that we have achieved such small results from such huge sums, and that the crisis grows worse instead of better.

The operations of the Export-Import Bank have drifted insensibly from commercial loans to political loans, and then to thinly disguised relief. The managers of the International Fund have next to no power to insist on internal fiscal or economic reforms before they grant their credits. The $25,000,000 credit recently granted to France, for example, will be used to keep the franc far above its real purchasing power, and at a level which encourages imports and discourages exports. This will merely prolong the unbalance of French trade and create a need for still more loans.

Such a use of the resources of the Fund not only fails to do good but actually does harm. The International Bank has at least the power to refuse loans unless the borrower is “in position to meet its obligations.” But it also lacks clear power to insist on reforms.

It is now contended in Administration and other circles not only that we must make further huge loans to Europe, with equally inadequate conditions, but that there is no use dealing with this matter on a “patchwork, one-at-a-time” basis. We must treat Europe, we are told, on a “Continental plan,” and lend it as a unit one huge sum.

This is much as if a banker were to call all his applicants for loans into a single mass meeting and say: “Listen, it’s just too much trouble to deal with each of you separately, to find out just how much each of you really needs, and whether your individual plans, past record, and present business methods are such as to give reasonable assurance that the money will be properly used and has a good prospect of being repaid. I’ve only got a limited amount of money anyhow, so I’m turning it over to you fellows in a lump and you can divide it among yourselves.”

The real need is the exact opposite of this. Instead of this whole-lump approach, what is needed is a far more careful and critical examination than we have yet been willing to make, of the particular problem of each country and the precise merits of each application for aid. No loan should be granted except in exchange for far-reaching reforms that would really make it possible for the loan to achieve its purpose. Among reforms on which lenders should insist are balanced budgets, a termination of inflationary policies and of exchange controls, and reasonable restoration of external and internal freedom of trade.

After the first world war two types of loans, as W. Randolph Burgess recently pointed out in London, were especially effective—the Central Bank stabilization loans and the League loans. They were effective because each was preceded by a thorough review of the position and program of the borrowing country. The loans were accompanied by expert aid and supervision. The granting of the credit thus became itself an assurance to the world that an effective program had been adopted. Big results were obtained with moderate means.

All this underlines the need of returning the business of international lending as soon as possible to private hands. There could still be an important role for the International Bank while such a shift to private hands was going on. It could stand ready to take the unsold balance of any loan it approved, provided private investors had already subscribed to a certain percentage of it. In this way the Bank would make only loans that had met some test of the market. It would not place itself in the position of imposing conditions, but would merely be a bond buyer.

Certainly it would add to clarity of purpose and better international relations all around if from now on relief were clearly relief, politics were clearly politics, and loans were really loans.