The Gold Rush
KENEN, PETER B.
The President-elect must restore faith in the American dollar quickly, and beyond this he must begin searching for a solution to a cruel economic dilemma THE GOLD RUSH By Peter B. Kenen THE FINAL...
...Third, and more important than these interest-induced movements, we have also seen outright speculation against the dollar since mid-October...
...United States gold holdings are still larger than American banking liabilities to the rest of the world...
...New gold production cannot satisfy the demand for reserves if the major holders of reserves insist upon keeping most of their cash assets in the form of gold...
...In effect, American firms operating abroad get an interest-free loan from the Federal Government...
...The President-elect must restore faith in the American dollar quickly, and beyond this he must begin searching for a solution to a cruel economic dilemma THE GOLD RUSH By Peter B. Kenen THE FINAL WEEKS of the recent campaign produced the usual forecasts of sweeping policy changes in the event of a Democratic victory...
...The foreign banks and businesses that are the initial recipients of the dollars we supply when we buy things abroad passed those dollars along to the foreign-exchange markets...
...It is inadequate because an increase of our interest rates, within feasible limits, will not suffice to bring back dollars that have fled into gold in anticipation of a higher gold price...
...First, we must note that the payments deficit has itself widened in recent months because of a change in the relationship between American and foreign interest rates...
...The new Administration must scan the financial horizon, even as it struggles to allay the world's doubts about the dollar...
...They thereby tended to depress the price of the dollar in terms of other currencies...
...But in recent weeks, as in 1958, foreigners have preferred to send their funds to Europe, where they can obtain higher interest rates...
...The Bank of England has actually done this sort of thing before, notably in 1958...
...If our prices were lower than they actually are, our exports would probably be larger and our imports smaller...
...At the end of 1950, our gold stock was 3.2 times as large as our short-term debt to other countries, and almost 5.9 times as large as our debt to foreign governments...
...It would rupture the strategic connection between the dollar and gold...
...gold price offers a solution to our payments problem—that it could stimulate our exports and could curtail our imports...
...We, too, are guilty of restricting agricultural imports and of manipulating farm prices, but our sins pale by comparison with those of West Germany and some other European countries...
...Still, our balance of payments could benefit from West Germany's participation, for some of the money lent by Germany might be spent on American exports, just as some of our credits are eventually spent on German goods...
...We can, for example, offer foreign governments an exchange-rate guarantee, a promise that in case of a change in the dollar price of gold...
...Triffin has suggested that the International Monetary Fund be transformed into an international central bank, empowered to create a new species of money that would serve national reserve needs...
...We may soon be unable to honor our commitments to the defense of the free world and to the development of the new nations...
...gold stock...
...This shift alone accounts for nearly half our gold loss since 1957...
...Austria, Belgium, Germany, Italy, the Netherlands, Portugal, Switzerland and Japan have all built up their gold holdings faster than their currency reserves...
...To be sure, this is not an immediate danger, but it is surely better to forestall trouble than to improvise when the crisis is upon us...
...It could have acted as a broker, connecting the European speculators with the Treasury...
...And the stock of dollar assets cannot be expanded, as a substitute for gold, without eventually impairing the U.S...
...The payments deficit was noticeably smaller than in 1958 or 1959, and the gold outflow dropped to a very low annual rate in the first six months of 1960...
...If recent trends are long continued, the world may soon face a serious gold shortage...
...In many instances, incidentally, American industry has long been at a cost disadvantage, but we have just recently become conscious of our handicap because European industry is at last able to exploit its opportunities...
...It is impractical because our own economy is in need of monetary stimulation...
...Others have complained that the foreign aid program and our military spending abroad are larger than we can afford and are therefore robbing us of gold...
...One increase in the gold price, moreover, would be taken to presage others, so that foreign governments could not be persuaded to hold dollars thereafter...
...Since the end of June, foreign governments and central banks have swapped $988 million of dollar balances for U.S...
...In short, an increase in the gold price would impair the quality of the American dollar as a reserve medium, damaging those countries that now hold dollars and making it much more difficult to enlarge world reserves in the years ahead...
...The most recent unemployment figures are ominous evidence that we are entering yet another recession...
...This, however, brought foreign governments into the foreign-exchange markets, because they are committed to buy dollars whenever the price of the dollar falls in terms of foreign currencies and to sell dollars when the price of the dollar rises...
...The world's key currency—the American dollar—has been under suspicion since 1958, when the United States balance of payments slid into yawning deficit...
...HOW, THEN, can we explain the sudden recrudescence of speculation and gold losses in summer and autumn of 1960...
...Were these funds brought home year by year, our balance of payments would surely be considerably strengthened...
...Kennedy must not allow a renascence of American protectionism, dignified by a concern about the payments deficit...
...Several observers have suggested that we have "priced ourselves out of world markets," and have then hastened to blame their favorite villains for this terrible condition...
...cannot cut back its aid effort when West Germany joins in the battle against economic backwardness: the combined contribution of the industrial countries must be increased in the next decade...
...By the same token, cuts in foreign aid, private foreign investment and overseas military spending could make it easier for us to live within our income from exports...
...Lastly, there is evidence in the official statistics that the major countries have been increasing their gold holdings instead of their foreign-exchange balances...
...The Federal Reserve System, custodian of the key Treasury bill rate, has moved slowly and cautiously, but has allowed an unmistakable easing of credit conditions...
...income taxes by reinvesting profits abroad instead of bringing them back to the United States...
...In fact, our 1958 gold loss was the largest in our history, totalling $2.3 billion...
...With the introduction of the American compact car, the revival of business in Europe and a boom in jet-aircraft exports, our trade balance has improved markedly...
...Thus, the total of official reserves has increased much faster than would have been possible had gold alone been acceptable...
...Each camp, as usual, is partly right, but neither has explained the whole problem...
...The next Administration cannot plan to curb American private investment abroad, nor should it make drastic cuts in Government aid and lending...
...But such an increase would also do irreparable damage to the world's monetary system...
...An analogous guarantee is now in force in Western Europe and could be extended to the American dollar...
...The usual prescription to make the dollar attractive is to increase American interest rates...
...payments deficit widened suddenly in 1958, enlarging the annual outflow of dollars from a trickle to a flood, In 1955–57, our annual payments deficit had averaged just $0.4 billion...
...In 1958, by contrast, the private demand for additional dollar assets dropped below 10 per cent of the new supply...
...But reason does not always prevail where gold is involved...
...drive us into peril in another year...
...In 1959 and early 1960, the new net private accumulation of dollar balances rose again toward its 1956–57 rate...
...But whatever the cause, the scramble for gold snowballed rapidly as the London gold price rose...
...The demand for bullion was soon swollen by orders from those who hoped to make a quick profit during the boom...
...The new Administration should also give sympathetic attention to recent proposals for reform of the International Monetary Fund, especially to the scheme proposed by Professor Robert Triffin of Yale, in his challenging study, Gold and the Dollar Crisis...
...And in a frantic-scramble for gold, private speculators have driven the London gold price as high as $40 an ounce, $5 higher than the price charged by the Treasury for the gold it sells to foreign governments...
...In 1958, our troops and their families spent some $877 million in other countries...
...It could have sold gold from its own stock, then replenished its holdings by buying gold from the U.S...
...Second, foreign banks and corporations have shown a reluctance to hold additional dollars...
...The central banks that have been buying gold are, of course, bringing closer the very crisis they fear: a rupture of the link between the dollar and gold...
...Under present arrangements, the overseas subsidiaries of American firms can postpone paying U.S...
...Consequently, most of the dollars we have been supplying through our deficit have again been passing into official hands...
...This huge gap in our balance of payments has provoked a flurry of theorizing in the United States...
...we have not "priced ourselves out of world markets...
...Had these countries kept their gold holdings at a constant fraction of their total reserves, our gold losses through June 1960 might have been $2 billion smaller than they actually were...
...What is worse, a further decline in our reserve position would give dangerous credibility to the perennial rumors that we are going to raise our official dollar price for gold...
...The Bank of England had the power to keep the London gold price near our own official price of $35 an ounce...
...While we may be able to limp along with the present financial arrangements, we must eventually cope with a cruel dilemma...
...It now gives signs of enlarging its aid effort, but should be asked to do still more...
...But summer and autumn of 1960 have turned that suspicion into outright alarm, and we may soon be witness to an actual run on the dollar...
...But for most of the postwar period those claims were small in relation to our own cash balance, that is, in relation to the Treasury's gold stock...
...liabilities relative to the Treasury's gold stock...
...Private sales of dollars for sterling, for example, have concentrated additional dollars in the hands of the Bank of England...
...The U.S...
...But there are some things we can do to make the dollar more attractive...
...We must not impose new import restrictions or raise tariffs, Rather, the next President must put the United States in the forefront of a new assault on trade barriers, At the next session of Congress, or in 1962, he must ask for an overhaul of the Trade Agreements Act to give him extensive bargaining powers...
...The 1959 steel strike crippled our steel exports and increased our steel imports before and during the strike...
...Treasury with the dollars thus acquired...
...Kennedy must also make new efforts to enlist West Germany and other countries in the work of development financing and must insist that those countries refrain from "tying" their aid to their exports...
...Countries may someday have to impose trade controls to combat payments difficulties, just as they did after World War II...
...If, on the other hand, reserves do not grow, we may face a different sort of financial problem...
...After 1957, however, the international position of the American dollar began to deteriorate...
...The new Administration should also strive to hold down spending by American troops abroad...
...an expansion of dollar balances would enlarge U.S...
...The Kennedy Administration will have to act quickly if it is to halt erosion of the financial arrangements underlying international commerce and investment...
...But our prices have not increased more rapidly than those of our competitors...
...Some would say that an increase in the U.S...
...In 1956–57, they absorbed more than half of the additional dollars we made available by way of our payments deficit (see chart...
...As I have indicated, the long-run costs to the free world would be enormous, and the gains on the balance of payments would be small...
...gold stock was 1.7 times as large as our total short-term debt, and 2.9 times as large as our debt to foreign governments...
...This tax concession was designed to encourage construction of additional plants abroad...
...In 1959, our gold loss was smaller, but the payments deficit itself was larger than in 1958...
...We do not yet have data on the size of this capital outflow, but it has been large enough to attract much attention in the financial press...
...Such a guarantee would make the dollar as good as gold from the standpoint of foreign central banks, and might thereby help to stem their relentless drift toward gold...
...Here the opportunities are limited, but have not been exhausted...
...His proposal is assuredly open to technical criticism, but his premises seem unassailable...
...But it seems to have stood aloof during the October boom—some say at the behest of the American Government, which was apparently loath to see the Bank of England give private speculators indirect access to the U.S...
...We were able to exercise the banker's prerogative: to acquire earning assets by "creating" deposit balances in the name of those supplying the assets...
...But the British have a strong preference for gold over dollars, and have swapped their additional dollars for additional gold...
...currency, has left most Americans at a loss to understand exactly what is happening...
...To complicate matters, those governments that have been gaining dollars are the ones that usually hold gold rather than dollars...
...With this reduction of American interest rates, American corporations have been sending cash to London and other financial centers, where they are buying short-term securities...
...In many cases, however, it merely seems to encourage an accumulation of cash assets in foreign financial centers...
...Like any bank, of course, we had to be ready to meet our depositors' claims on us...
...He will need these powers to deal with the Common Market countries and the European Free Trade Area...
...Exports soared to record levels in the first half of 1960, and imports levelled out near their 1959 peaks...
...The United States was the most liquid bank in history...
...Germany, with larger gold and foreign-exchange reserves than Britain and France combined, makes a smaller contribution to the development of low-income countries than any other major country...
...But he must work to reduce the costs of our contribution, as they appear on the balance of payments...
...The nervous ones in Europe and elsewhere, who always run for gold when the future clouds, have been buying gold in London and other foreign centers, They may have started to do so when they began to anticipate a Democratic victory in the United States and, like the moneyed everywhere, thought that this would mean inflation in America and an increase in our payments deficit...
...the growth of dollar balances accounted for more than half that increase...
...That deficit was actually too small from the standpoint of other countries, for the foreign demand for new dollars to hold was larger than our deficit, and foreigners sold us gold to acquire additional dollar balances...
...He must ask our allies, especially West Germany, to carry a larger share of the North Atlantic Treaty Organization's joint construction costs, the costs of building missile bases in Western Europe and the costs of maintaining American ground troops abroad...
...they have grown in number and conviction during recent weeks...
...This remedy, however, is inadequate and impractical...
...The postwar growth of foreign dollar balances—official and private —has been advantageous to the United States...
...SO MUCH FOR diagnosis, Now for therapy, Consider, first, the immediate task that faces the Kennedy Administration—the job of bringing our balance of payments under control, It need not strive to eliminate the deficit, but must reduce it to a sustainable rate, to one that furnishes just enough dollars to the rest of the world to match the foreigners' demand for extra dollar assets...
...Finally, the next Administration should urge Europe to modify its farm policies...
...The U.S...
...Kennedy is indeed in an unenviable position...
...President Kennedy should not try to cut back our contribution to the defense of the free world...
...The American balance of payments would benefit hugely from a reduction of Europe's barriers to United States agricultural exports...
...Because other countries wanted dollars to hold, we were able to buy more from them than we were selling —more goods, more services and more earning assets...
...The U.S...
...But too few pre-election prophecies drew attention to that dimension of national policy which most urgently requires a radical change...
...Interest rates here have been falling since the beginning of 1960...
...But Congress should be asked to revise a part of our tax code applying to foreign investment...
...This drift into gold may have accelerated in the last two months, although certain of the major central banks have shown remarkable restraint...
...Detroit was too slow in entering the small-car market and we were flooded with automobile imports...
...The United States must also work to solve the long-run problem that confronts it—to make the dollar more attractive as a reserve medium...
...For we must swap tariff concessions with Europe to reduce discrimination against American exports and to dismantle the tariff wall being built across Western Europe...
...Treasury gold...
...In 1958, our deficit reached $3.5 billion and we began to lose gold...
...Finally, the popular explanations of our predicament neglect the constellation of temporary difficulties that beset our foreign trade in 1958–59...
...The present reserve media, gold, the dollar and sterling, cannot be made to supply the reserves required for another decade of expansion in international trade...
...New gold production has not been large enough to satisfy reserve needs...
...Even in 1957, after a huge increase in our banking liabilities, the U.S...
...DEMAND FOR DOLLAR BALANCES (Annual averages in millions of dollars) 1956–57 1958 1959 1960 (first half) Dollars Supplied by the US Deficit $834 $3,287 $2,557 $1,996 Increase of Private Dollar Balances 478 252 1,108 926 Increase of Official Gold and Dollar Balances 356 3,035 1,449 1,050 Increase of Official Dollar Balances 482 748 480 854 Official Gold Purchases from the US —126 2,287 969 196 Increase of Private Dollar Balances as a Percentage of Total Dollars Supplied 58% 8% 43% 47% Increase of Official Dollar Balances as a Percentage of Official Gold and Dollars 135% 25% 33% 81% Source: Federal Reserve Bulletin...
...If the price of gold were suddenly increased, the countries that hold dollars would be penalized, and those that hold gold would be rewarded...
...reserve position...
...they will be reimbursed for the losses they suffer on the dollars they hold...
...Here Peter B. Kenen, Assistant Professor of Economics at Columbia University and author of the recently published Giant Among Nations, explains why the gold rush is on, how serious it is and what President-elect John F. Kennedy can do about it...
...Because the Treasury's gold price has tied the dollar to gold in the postwar period, foreign governments and central banks have been willing to hold dollars in lieu of Gold, From 1949 through 1957, foreign official holdings of gold and foreign exchange rose by $9.4 billion...
...Europe suffered a business setback milder than our recession, but still severe enough to hurt our coal and cotton sales...
...It has allowed this country to run a deficit in its transactions with the rest of the world...
...payments deficit resurrected those rumors in 1958...
...These outlays might decline if our Armed Forces were offered incentives to deposit part of their pay in banks back home, and if they were denied tax-free access to European luxury goods at the post exchanges...
...For the needs of the dollar as an international currency and those of our own economy have contrary implications for monetary policy...
...This increase of reserves, it should be added, has fueled Europe's recent progress toward convertibility and freer trade...
...But cuts in these outlays would also reduce our income from exports, since much of what we lend to other countries or invest in plant and equipment abroad is actually spent on American products...
...Thus, foreign governments took up most of the dollars supplied by our payments deficit in 1958...
...And while there is much to be said for emphasizing fiscal policy in the battle against recessions—certainly for using it much more intensively than did the Eisenhower Administration—easier money may be essential to full recovery...
...we are still able to pay off our creditors, should they ask us to do so, Our safety margin, however, has narrowed rapidly in the last few years, so that a prolongation of our payments deficit and gold losses may The foreign demand for gold in place of dollars, which is spotlighting the lack of faith abroad in U.S...
Vol. 43 • November 1960 • No. 45
