Henry Hazlitt, noted economist, author, editor, reviewer and columnist, is well known to readers of the New York Times, Newsweek, The Freeman, Barron’s, Human Events and many others. The most recent of his numerous books is The Inflation Crisis, and How to Resolve
So asserts the title of an article in the May issue of PHP. PHP is a monthly magazine published in Tokyo, by a dominantly Japanese editorial staff. It is in English, however, and aimed at a worldwide audience. The title initials stand for "Peace, Happiness and Prosperity." The author of the article is Konosuke Matsushita, founder of the international electric and home appliance industry, Matsushita Electric.
The hope that Mr. Matsushita expresses is one that has been voiced by reformers for more than a century. His arguments for it are persuasive. He refers to the wild fluctuations in international exchange rates in the last few years. He points out that at the beginning of 1977 it took 290 yen to buy a dollar, but by the end of the year only 240. He reminds his readers that in December 1971 The Group of Ten countries met in Washington to set up a new international currency system, known as the "Smithsonian" agreement, hailed at the time as "the most important monetary agreement in history"—and that it broke down in a year or so.
After that the world entered a "floating currency" era. But this means that every day the exchange rate of every national currency fluctuates in terms of every other. It means that no one can foresee what any given currency will be worth in terms of any other a year from now, or even tomorrow. And so it means that every man engaged in import or export trade, or in any international business whatever, is forced to some extent to become a gambler. Deploring all this, Mr. Matsushita concludes:
We need to integrate the wide variety of currencies we have now. In other words, I suggest we agree on the use of one currency that will be common in all the countries of the world. . . . I am fully aware of the numerous problems that would be involved, such as national pride, differences in economic level and so on. However, if we want to continue our community life on this planet, we’re going to have to integrate our currencies at the earliest possible date. . . .
I suggest the United Nations or the International Monetary Fund take up the problem, seek to overcome the difficulties which lie in the way by eliciting the cooperation, effort and wisdom of every country, and therefore achieve an integration of the world’s currencies for the peace, happiness and prosperity of the world.
I find Mr. Matsushita’s article encouraging in one respect but disheartening in others. It is encouraging as a sign that leading international businessmen are beginning to call for an end to the present intolerable chaos in the foreign exchange market, and are willing to set aside national prejudices to achieve a return to order. But it is disheartening as a sign that these businessmen—probably the majority of them—still do not understand the basic causes or suspect the basic cure for the world currency chaos.
Balance of Payments
Mr. Matsushita seems to think that the basic cause of the changes in the yen dollar and other exchange rates was changes in the "balance of payments" between individual nations. He does not seem to realize that these wide fluctuations in the balance of payments were themselves in large part the result of different rates of inflation within the respective countries, and consequent shifts in the relationships between internal and external prices. His article nowhere mentions the enormous increase in the paper money issuance of individual countries. And it nowhere mentions gold.
The truth is that the world once did have a common currency, in everything but name. It had such a currency roughly from the last third of the Nineteenth Century to 1914. It was known as the gold standard.
The majority of leading currencies were tied together not because they were tied to each other but because each of them was tied to gold. Each was directly convertible on demand into a specified weight of gold. The British pound was worth $4.86 because it was convertible into 4.86 times the weight of gold that the dollar was. The French franc was worth approximately 19.3 cents for similar reason.
True, as an international system this had a few shortcomings. It would have been far simpler and made calculation easier if each national currency had been made convertible into precisely the same weight of gold, or at least into a round relationship to other currencies—if, for example, the British pound had been convertible into exactly five times the weight of gold as the dollar, the dollar into exactly five times the weight of gold as the franc, and so on.
Fractional Reserve Gold Standard
A more serious shortcoming, however, is that the various national currencies were not on a full gold standard but only on what is known as a fractional reserve system. That is, the gold reserve they were obliged to keep was not equal to the full amount of their outstanding paper currency, but only to a fraction of it. And as time went on, and individual countries experienced no excessive runs on their gold supply, they yielded to the temptation to increase their credit and currency issues more and more. Their gold reserves, in consequence, tended to become a constantly smaller and more hazardous fraction of their credit and currency issue.
The fractional reserve gold standard, moreover, even while it was preserved, suffered from a chronic defect. In good times, one country after another was tempted to expand its volume of money and credit. But when one country expanded faster than its neighbors, its internal prices increased relative to theirs. It became a better place to sell to and a poorer place to buy from. Its balance of trade (or payments) became "unfavorable." Its currency went to a discount on the foreign exchange market; and if that discount passed "the gold point," the country began to lose gold. To stop the outflow, it had to raise its interest rates and contract its issuance of credit and currency. It was this that caused the recurring business cycles, the alternation of boom and bust, that were considered by its critics to be inherent in capitalism itself.
Even the fractional gold standard was abandoned in Europe in 1914. The belligerents feared to lose their precious gold reserves, and in any case they wanted to be free to expand their currency and credit.
Gold Exchange Standard
When the war was over the world went back, not to the old gold standard, but to a "gold exchange" standard. This was something quite different. The gold exchange standard meant that the majority of countries, instead of keeping their currencies directly convertible into gold, kept them convertible only into some "key currency"—for example, the British pound or the American dollar—which was supposed to be directly convertible into gold.
As formalized at Bretton Woods in 1944, the gold exchange standard became still more attenuated. The other participating countries agreed only to keep their currencies pegged to the American dollar; the dollar alone was convertible into gold. But even then, dollars were not, as formerly, convertible by anybody who held them, but only by foreign central banks.
The effect of this relaxation of discipline, combined with the growth of the Keynesian ideology, was increasing and almost universal inflation. The American monetary managers, under successive Administrations, did not seem to have the slightest realization of the weight of responsibility they had assumed in agreeing to make the dollar the anchor currency for the world. They continued to inflate until, when other countries finally became more importunate in their demand for actual gold, President Nixon officially suspended gold payments on August 15, 1971.
A profound irony in Mr. Matsushita’s proposals is that he wants to turn over the problem of curing the world’s currency ills to the International Monetary Fund. But the International Monetary Fund is the problem. It was set up at Bretton Woods, chiefly under the leadership of Lord Keynes of England and Harry Dexter White of the United States, to make inflation and devaluation easier, smoother, and respectable. Instead of letting each country suffer the full consequences of its own inflation, the IMF used the stronger currencies to support the weaker. The long run effect was only to weaken the stronger currencies. One of the Bretton Woods’ objectives from the beginning was to "phase gold out of the system." One of the first steps in any real currency reform would be to dismantle the IMF.
Mr. Matsushita forgets that the meeting that drafted the Smithsonian agreement, to which he refers, came only three months after the United States suspended gold payments; that the Smithsonian agreement was thought necessary because of this suspension; and that it broke down so soon because gold convertibility was not restored. There is simply no substitute for gold convertibility.
No international organization can wave a magic wand, or draft a magic formula, that will bring a sound "world" currency. Each nation must bear full responsibility for its own currency. It can make it sound only by making it convertible into gold. And it can make and keep it convertible only by strictly and constantly limiting the quantity of that currency.
Because of the dismal recent record of practically all countries in swindling their own citizens, the return to an honest convertible currency may now be difficult and remote. Individual nations can begin by strictly limiting any further expansion of their credit and currency issue. Meanwhile they can grant the right to their own citizens to coin gold privately and even to issue gold certificates against their coins.
When governments are ready themselves to return to a gold standard, it would be well if this time they kept a 100 per cent gold reserve behind their paper currency and so removed the expansionary temptations of a fractional reserve system. And it would be an excellent thing, also, if their new currency unit were fixed as a definite round weight of gold, say a gram, and were called simply a gold gram—instead of a dollar, franc, mark, peso or what not—and if at least the leading countries could agree on the same gold weight for their unit. Then the world would really have, for all practical purposes, the "single" and common currency that Mr. Matsushita would so much like to see.