15. MONETARY CONTRADICTIONS BETWEEN THE EEC AND THE USA IN THE EARLY 1970s. BREAKDOWN OF THE BRETTON WOODS SYSTEM
The devaluation of the French franc and the revaluation of the West German mark in the second half of 1969 intensified contradictions both within the European Economic Community and between the Six and the United States. The sharp divergence of currency rates within the EEC endangered the common agricultural market based on single prices. It became more difficult to maintain a stable correlation of the currencies of the Common Market countries to the US dollar.
At the threshold of the 1970s an economic recession began in the United States, its financial difficulties mounted and the balance of payments deteriorated, increasing the influx of dollars into world currency circulation.
Inflation spread further in the United Stales as in other capitalist countries. Inflation processes in individual countries merged into general inflation in the capitalist world. A considerable part in this development was played by the mounting influx of dollars into world circulation.
Exchange rates fluctuated widely, and in order to maintain their currencies in a definite relation to the dollar, countries had to buy dollars for their national currency and accumulate them in their exchange reserves on an increasing scale, correspondingly expanding money circulation in the United States, Japan and other countries. This raised the rate of the dollar and reduced the rates of national currencies but not for long. This is how the United States, together with dollars, exported inflation to other capitalist countries. In view of this situation a number of countries increasingly pressed the United States to put an end to its balance-of-payments deficit and to the method of covering it by introducing dollars into world circulation and the exchange reserves of other countries.
To eliminate the unfavourable balance of payments, the United States would have to do away with its main causes: the excessive expenditure of foreign currency abroad along Pentagon channels and the wide outflow of American capital abroad. This required a radical change of the country's monetary and financial system.
In view of the economic recession the United States could not consistently implement anti-inflation measures, although at the end of the 1960s the spread of inflation assumed a threatening scale. The steps to restrain inflation by credit restrictions taken in 1969 and the first half of 1970, proved to be abortive. More then that, some of the measures supposedly designed to ``normalise'' the monetary system facilitated the spread of inflation. This applies specifically to the so-called Special Drawing Rights (SDR). The SDR system was set up within the framework of the International Monetary Fund early in 1970, at first in an amount exceeding $ 3,400 million. In the next two years this sum went up to $ 9,500 million. SDRs, also called "paper gold", were widely published as a prototype of an artificial international currency. But they began to play the part of additional liquid assets, which promoted inflation. Like book-keeping entries in respective accounts, SDRs arise out of the real international circulation process. Real trade and other settlements between countries are made in convertible currencies by private corporations and banks. Their foreign exchange receipts land in central banks through conversion in national currencies of the respective countries. Thus, the money stock in circulation of a country increases on account of the issue of notes by the central banks. The central banks make settlements among themselves in SDRs, which [...text missing]
While prior to the second half of the 1960s the introduction of dollars in world circulation was justified on the grounds that growing world trade needed liquid assets, the financial shocks at the end of the 1960s demonstrated that the point was not the shortage of liquidity. Exchange rates fluctuated widely, and in order to maintain their currencies in a definite relation to the dollar, countries had to buy dollars for their national currency and accumulate them in their exchange reserves on an increasing scale, correspondingly remain in their accounts for a long time. The use of SDRs is inevitably accompanied by the appearance of additional bank notes in national currencies. And since the sum of SDRs is steadily mounting, the money stock grows respectively. From this it follows that the accumulation of SDRs, like dollars, promotes inflation. Such in general outline is how the operation of the SDR system stimulates inflation.
As for the concrete procedure of SDR circulation, it is simply the voluntary mutual crediting of IMF member countries which have joined the Special Drawing Right account (not all member countries have done so).
Depending on a country's quota in the IMF and its economic potential, it is allocated a sum of SDRs which can be disposed of by the given country or its central bank. This is the limit of mutual crediting. The new international medium of payment cannot be utilised as ordinary money on current accounts or/and trade transactions of private corporations or persons. The biggest sums of SDRs naturally are allocated to highly developed countries which have the largest quotas in the IMF.
When some countries use SDRs for settlements of their adverse balance of payments, the original SDRs sum on their accounts is reduced; at the same time the accounts of other countries accepting the SDRs are correspondingly increased. The percentage of decrease of the SDR sum is an indicator of the intensity of the system's operation. The four-year experience of the system shows that the use of SDRs is of a limited, artificial nature. Nevertheless, since the beginning of the 1970s US financial circles have been the chief SDR votaries.
It is not by chance that the SDR unit, which has no special name, was made equal in gold content to the dollar. It was to serve as a symbol of the dollar's stability. When the system was introduced, Washington sharply changed its tight money policy.
In the last quarter of 1970 and the first quarter of 1971 this was clearly displayed in a number of reductions of the discount rate by the Federal Reserve System, which extended bank credit and lowered its cost. From November 13, 1970 to January 18, 1971 the discount rate was lowered four times and brought down from 6 to 5 per cent, while in other West European countries and Japan it was higher and, consequently, the return on capital was greater. Because of this the influx of American capital to these countries in the form of dollars continued on a growing scale.
Difficulties in the sphere of monetary relations in 1971 were accompanied by greater crisis phenomena in the capitalist world and stiffer competition. In the report of the GPSU Central Committee to the 24th Party Congress (March 1971) Leonid Brezhnev stated: "Even the most developed capitalist states are not free from grave economic upheavals. The USA, for instance, has been floundering in one of its economic crises for almost two years now. The last few years have also been marked by a grave crisis in the capitalist monetary and financial system. The simultaneous growth of inflation and unemployment has become a permanent feature. There are now almost eight million unemployed in the developed capitalist countries.''1 It was further noted in the Report that "...the main centres of imperialist rivalry have become clearly visible: these are the USA, Western Europe (especially the Six Common Market countries) and Japan. The economic and political competitive struggle between them has been growing ever more acute.''2
In May 1971 a panic swept through many money markets in the capitalist countries. It assumed the form of a flight from the US dollar which literally flooded the markets. Many central and big private banks temporarily refused to accept dollars and to engage in operations with them. Some banks temporarily closed down, waiting for the situation to clear up. As the crisis grew deeper the demand for, and the price of, gold rose. Dollar holders, especially private banks, were anxious to convert their dollars, if not into gold, at least into more stable currencies, specifically West German marks and Japanese yen. The usual speculative mainsprings came into action. They were based on the expectation that sooner or later the currencies of the FRG and Japan would be revalued, while the dollar would be devalued.
The calculations of speculators fitted into the following approximate scheme. If one were to keep dollars up to their devaluation, say, by 10 per cent, this would mean a loss of $ 10,000 per $ 1,000,000. If, on the other hand, the dollars were to be converted into stabler currencies one would not only prevent a loss of $ 10,000 but even gain $ 10,000 from the expected revaluation.
In this connection the central banks of the FRG and Japan became the main centres of concentration of US dollars. The influx of dollars also increased to one extent or another in the exchange reserves of other capitalist countries. Thus, the total official sum of foreign exchange in the reserves of capitalist countries, which amounted to $ 32,200 million at the end of the first quarter of 1970, climbed to $ 44,500 million at the end of the 'year, to $ 49,400 million at the end of the first quarter of 1971 and to $55,500 million at the end of the first half of that year.3
Gold and Exchange Reserves of the Federal Republic of Germany and Japan (million US dollars)
first quarter, fourth quarter 1970, first quarter, second quarter, September, October 19714
Gold / Foreign exchange
Federal Republic of Germany 4,081 3,980 3,977 4,046 4,077 4,077 /
6,286 8,455 10,392 11,199 11,380 11,589
Japan 530 532 539 641 679 679 / 2,423 3,188 4,285 6,238 11,939 12,653
Source: International Financial Statistics, December 1971 pp. 21, 23.
The table shows that, although the movement of the foreign exchange reserves of the FRG and Japan differed, the result was the same: excessive accumulation of dollars not dictated by the requirements of current balance settlements. Japan found herself in a worse position because, relying on the stability of the dollar, she did not accumulate a sufficient gold stock, as was done by financial circles of the FRG and other West European industrial countries, which at the end of the first half of 1971 had at their disposal gold valued at $ 17,800 million, or considerably more than the United States ($ 10,500 million).
At the beginning of May 1971 some European countries were compelled to allow the free floating of the rates of their currencies in relation to the dollar under the influence of supply and demand.
This was one of the measures designed to protect the reserves of central banks from the excessive influx of dollars. But this measure–floating rates–completely upset the usual currency relations regulated by IMF rules (prevention of the upward or downward fluctuation of rates in relation to the dollar by more than one per cent). The Federal Republic of Germany was the first to take this path on May 9, although the free floating of its currency in relation to the dollar ran counter to the Common Market countries line of maintaining minimal fluctuations between the rates of their currencies. The example of the FRG was followed by the Netherlands, and this disorganised currency relations within the Common Market.
The Governments of Austria and Switzerland, countries which do not belong to the EEC, officially revalued their currencies: the Austrian schilling by 5 per cent and the Swiss franc by 7 per cent. Thus, the system of regulating currency rates, with the dollar serving as the standard, practically stopped functioning. The currency rates of most countries of the capitalist world began to climb upwards.
The threat of imminent monetary chaos alarmed international financial and banking circles. The sudden massive shifting of capital from country to country became particularly dangerous. Under these conditions guidance of the monatary system by the IMF, like the maintenance of the fluctuation of currency rates upwards or downwards within the bounds of one per cent in relation to the dollar, bscame impossible.
US financial circles took no measures whatsoever to maintain the rate of the dollar. They expected that a depressed dollar would help to increase exports and reduce imports, resulting in a more favourable trade balance, which is the backbone of the country's balance of payments. In 1971, for the first time since 1898, the balance of trade became unfavourable to the tune of some $ 2,700 million. Let us recall that in the first half of the 1960s the favourable balance of trade exceeded $ 5,400 million" annually on average. The sharp deterioration of the trade balance in 1971 could not but affect US monetary policy. It is largely this factor that explains the exceptional measures in US monetary, financial and trade policy in 1971.
In his radio speech of August 15, 1971 President Nixon announced measures which sharply altered not only US financial and economic policy but also monetary and financial relations in the capitalist world as a whole. The USA announced its refusal to convert dollars into gold at a time when world circulation and the exchange reserves of other countries were clogged with dollars. It also introduced a 10-per cent import surcharge. This measure was regarded as a big step towards protectionism. The US Administration also introduced a wage freeze, tax privileges on capital invested in expanding production, and so on. All these measures were designed to improve the competitive ability of American goods.