A History of Money and Banking in the United States: The Colonial Era to World War II

by Murray N. Rothbard

  After negotiating during 1943 and into the spring of 1944, the United States and Britain hammered out a compromise of the White and Keynes plans in April 1944. The compromise was adopted by a world economic conference in July at Bretton Woods, New Hampshire; it was Bretton Woods that was to provide the monetary framework for the postwar world.61

  The compromise established an International Monetary Fund (IMF) as the stabilization mechanism; its total funds were fixed at $8.8 billion, far closer to the White than to the Keynes prescriptions. Its balance of IMF international control as against domestic autonomy lay between the White and Keynes plans, leaving the whole problem highly fuzzy. On the one hand, national access to the fund was not to be automatic; but on the other, the fund could no longer require corrective domestic economic policies of its members. On the question of exchange rates, the Americans yielded to the British insistence on allowing room for domestic inflation even at the expense of stable exchange rates. The compromise provided that each country could be free to make a 10-percent change in its exchange rate, and that larger changes could be made to correct “fundamental disequilibria”; in short, that a chronically deficit country could devalue its currency rather than check its own inflation. Furthermore, the U.S. yielded again in allowing creditor countries to suffer by permitting deficit countries to impose exchange controls on “scarce currencies.” This meant in effect that the major European countries, whose currencies would be fixed at existing highly overvalued rates in relation to the dollar, would thus be permitted to enter the IMF with chronically overvalued currencies and then impose exchange controls on “scarce,” undervalued dollars. But despite these extensive concessions, there was no “bancor”; the dollar, fixed at $35 per gold ounce was now to be firmly established as the key currency base of a new world monetary order. Besides, for the dollar to be undervalued and other major currencies to be overvalued greatly spurs American exports, which was one of the basic aims of the entire operation. U.S. Ambassador to Britain John G. Winant recorded the perceptive hostility to the Bretton Woods Agreement by the majority of the directors of the Bank of England; for these men saw “that if the plan is adopted financial control will leave London and sterling exchange will be replaced by dollar exchange.”62

  The proposed International Monetary Fund ran into a storm of conservative opposition in the United States, from the opposite pole of the hostility of the British nationalists. The American attack on the IMF was essentially launched by two major groups: conservative Eastern bankers and Midwestern isolationists. Among the bankers, the American Bankers Association (ABA) attacked the unsound and inflationary policy of allowing debtor countries to control access to international funds; and W. Randolph Burgess, president of the ABA, denounced the provision for debtor rationing of “scarce currencies” as an “abomination.” The New York Times urged rejection of the IMF, and proposed making loans to Britain in exchange for the abolition of exchange controls and quantitative restrictions on imports. Another bankers’ group came up with a “key currency” proposal as a substitute for Bretton Woods. This key currency plan was proposed by economist John H. Williams, vice president of the Federal Reserve Bank of New York, and was endorsed by Leon Fraser, president of the First National Bank of New York, and by Winthrop W. Aldrich, head of the Chase National Bank. It envisioned a bilateral pound-dollar stabilization, fueled by a large transitional American loan, or even grant, to Great Britain. Thus, the key-currency people were ready to abandon temporarily not only the classical gold standard but even an international monetary order, and to stay temporarily in a modified version of the world of the 1930s.63

  The Midwestern isolationist critics of the IMF were led by Senator Robert A. Taft (R-Ohio), who charged that, while the bulk of the valuable hard money placed in the fund would be American dollars, the dollars would be subject to international control by the fund authorities, and therefore by the debtor countries. The debtor countries could then still continue exchange controls and sterling bloc practices. Here Taft failed to realize that formal and informal structures in the Bretton Woods design would ensure effective United States control of both the IMF and the International Bank.64

  The administration countered the critics of Bretton Woods with a massive propaganda campaign, which was able to drive the agreement through Congress by mid-July 1945. It emphasized that the U.S. government would have effective control, at least of its own representatives in the fund. It played up—in what proved to be gross exaggeration—the favorable aspects of the various ambiguous provisions: insisting that debtor access to the fund would not be automatic, that exchange controls would be removed, and that exchange rates would be stabilized. It pushed heavily the vague idea that the fund was crucial to postwar international cooperation to keep the peace. Particularly interesting was the argument of Will Clayton and others that Bretton Woods would facilitate the general commercial policy of eliminating trade discrimination and barriers against American exports. This argument was put particularly baldly by Treasury Secretary Morgenthau in a speech to Detroit industrialists. Morgenthau promised that the Bretton Woods agreement would lead to a world trade freed from exchange controls and depreciated currencies, and that this would greatly increase the exports of American automobiles. Since the fund would begin operations the following year by accepting the existing grossly overvalued currency parities that most of the nations insisted upon, this meant that Morgenthau might have known whereof he spoke. For if other currencies are overvalued and the dollar undervalued, American exports are indeed encouraged and subsidized.65

  It is perhaps understandable, then, that not only the major farm, labor, and New Deal liberal organizations pushed for Bretton Woods, but that the large majority of industrial and financial interests also approved the agreement and urged its passage in Congress. American approval in mid-1945 was followed, after lengthy soul-searching, by the approval of Great Britain at the end of the year. By the end of its existence, therefore, the second New Deal had established the triumphant dollar as the base of a new international monetary order.66 The dollar had displaced the pound, and within a general political framework in which the American empire had replaced the British. Looking forward perceptively to the postwar world in January 1945, Lamar Fleming, Jr., president of Anderson, Clayton and Company, wrote to his longtime colleague Will Clayton that the “British empire and British international influence is a myth already.” The United States would soon become the British protector against the emerging Russian land mass, prophesied Fleming, and this would mean “the absorption into [the] American empire of the parts of the British Empire which we will be willing to accept.”67 As the New Deal came to a close, the triumphant United States stood ready to reap its fruits on a worldwide scale.

  EPILOGUE

  The Bretton Woods agreement established the framework for the international monetary system down to the early 1970s. A new and more restricted international dollar-gold exchange standard had replaced the collapsed dollar-pound–gold-exchange standard of the 1920s. During the early postwar years, the system worked quite successfully within its own terms, and the American banking community completely abandoned its opposition.68 With European currencies inflated and overvalued, and European economies exhausted, the undervalued dollar was the strongest and “hardest” of world currencies, a world “dollar shortage” prevailed, and the dollar could base itself upon the vast stock of gold in the United States, much of which had fled from war and devastation abroad. But in the early 1950s, the world economic balance began slowly but emphatically to change. For while the United States, influenced by Keynesian economics, proceeded blithely to inflate the dollar, seemingly relieved of the limits imposed by the classical gold standard, several European countries began to move in the opposite direction. Under the revived influence of conservative, free-market, and hard-money-oriented economists in such countries as West Germany, France, Italy, and Switzerland, these newly recovered countries began to achieve prosperity with far less inflated currencie
s. Hence these currencies became ever stronger and “harder” while the dollar became softer and increasingly inflated.69

  The continuing inflation of the dollar began to have two important consequences: (1) the dollar was increasingly overvalued in relation to gold; and (2) the dollar was also increasingly overvalued in relation to the West German mark, the French and Swiss francs, the Japanese yen, and other hard-money currencies. The result was a chronic and continuing deficit in the American balance of payments, beginning in the early 1950s and persisting ever since. The consequence of the chronic deficit was a continuing outflow of gold abroad and a heavy piling up of dollar claims in the central banks of the hard-money countries. Since 1960 the foreign short-term claims to American gold have therefore become increasingly greater than the U.S. gold supply. In short, just as inflation in England and the United States during the 1920s led finally to the breakdown of the international monetary order, so has inflation in the postwar key country, the United States, led to increasing strains and fissures in the triumphant dollar-order of the post–World War II world. It has become increasingly evident that an ever more inflated and overvalued dollar cannot continue as the permanently secure base of the world monetary system, and therefore that this ever more strained and insecure system cannot long continue in anything like its present form.

  In fact, the postwar system has already been changed considerably, in an ultimately futile attempt to preserve its basic features. In the spring of 1968, a severe monetary run on the dollar by Europeans redeeming dollar claims led to two major changes. One was the partial abandonment of the fixed $35-perounce gold price. Instead, a two-price, or “two-tier,” gold price system was established. The dollar and gold were allowed to find their own level in the free gold markets of the world, with the United States no longer standing ready to support the dollar in the gold market at $35 an ounce. On the other hand, $35 still continued as the supposedly eternally fixed price for the world central banks, who were pledged not to sell gold in the world market. Keynesian economists were convinced that with the dollar and gold severed on the world market, the price of gold would then fall in the freely fluctuating market. The reverse, however, has occurred, since the world market continued to have more faith in the soundness and the relative hardness of gold than in the increasingly inflated dollar.

  The second change was the creation in 1969 of Special Drawing Rights (SDRs), a new form of “paper gold,” of newly created paper which can supplement gold as an international currency reserve behind each currency. While this indeed put more backing behind the dollar, the quantity of SDRs has been too limited to make an appreciable difference to a world economy that trusts the dollar less with each passing year.

  These two minor repairs, however, failed to change the fundamental overvaluation of the ever more inflated dollar. In the spring of 1971, a new monetary crisis finally led to a massive revaluation of the hard currencies. If the United States stubbornly refused to lose face by raising the price of gold or by otherwise devaluing the dollar down to its genuine value in the world market, then the harder currencies, such as West Germany, Switzerland, and the Netherlands, found themselves reluctantly forced to raise the value of their currencies. Their alternatives—a massive calling upon the United States to redeem in gold and thereby the smashing of the façade of dollar redemption in gold—was too much of a political break with the U.S. for these nations to contemplate. For the United States, to preserve the façade of gold redemption at $35, had been using intense political pressure on its creditors to retain their dollar balances and not to redeem them in gold. By the late 1960s, General Charles de Gaulle, under the influence of classical gold-standard advocate Jacques Rueff, was apparently preparing to make just such a challenge—to break the dollar standard as a move toward restoring the classical gold standard in France and much of the rest of Europe. But the French domestic troubles in the spring of 1968 ended that dream at least temporarily, as France was forced to inflate the franc for a time in order to pay the overall wage increase it had agreed upon under the threat of the general strike.

  Despite these hasty repairs, it is becoming increasingly evident that they are makeshift stopgaps, and that a series of more aggravated crises will shake the international monetary order until a fundamental change is made. A hard-money policy in the United States that put an end to inflation and increased the soundness of the dollar might sustain the current system, but this is so politically remote as to hardly be a likely prognosis.

  There are several possible monetary systems that might replace the present deteriorating order. The new system desired by the Keynesian economists and by the American government would be a massive extension of “paper gold” to demonetize gold completely and replace it with a new monetary unit (such as the Keynesian “bancor”) and a paper currency issued by a new world reserve bank. If this were achieved, then the new American-dominated world reserve bank would be able to inflate any currencies indefinitely, and allow inflating currencies to pay for any and all deficits ad infinitum. While such a scheme, embodied in the Triffin Plan, the Bernstein Plan, and others, is now the American dream, it has met determined opposition by the hard-money countries, and it remains doubtful that the United States will be able to force these countries to go along with the plan.

  The other logical alternative is the Rueff Plan, of returning to the classical gold standard after a massive increase in the world price of gold. But this too is unlikely, especially over powerful American opposition. Barring acceptance of a new world currency, the Americans would be content to keep inflating and simply force the hard-money countries to keep appreciating their exchange rates, but again it is doubtful that German, French, Swiss, and other exporters will be content to keep crippling themselves in order to subsidize dollar inflation. Perhaps the most likely prognosis is the formation of a new hard-money European currency bloc, which might eventually be strong enough to challenge the dollar, politically as well as economically. In that case, the dollar standard will probably fall apart, and we may see a return to the currency blocs of the 1930s, with the European bloc this time on a harder and quasi-gold basis. It is at least possible that the future will see gold and the hard European currencies at last dethrone the triumphant but increasingly uneasy dollar.

  Notes

  Introduction

  1For good discussions of praxeology, see Ludwig von Mises, Human Action: A Treatise on Economics, Scholar’s Edition (Auburn, Ala.: Mises Institute, 1998), pp. 1–71; Murray N. Rothbard, The Logic of Action I: Method, Money, and the Austrian School (Cheltenham, U.K.: Edward Elgar, 1997), pp. 28–77; and Hans-Hermann Hoppe, Economic Science and the Austrian Method (Auburn, Ala.: Mises Institute, 1995).

  2Douglass C. North, Growth and Welfare in the American Past: A New Economic History (Englewood Cliffs, N.J.: Prentice-Hall, 1966), pp. 1–2 (emphasis in original).

  3Robert William Fogel, “The New Economic History: Its Findings and Methods,” in The Reinterpretation of American History, Robert William Fogel and Stanley L. Engerman, eds. (New York: Harper and Row, 1971), p. 7.

  4Murray N. Rothbard, America’s Great Depression, 5th ed. (Auburn, Ala.: Mises Institute, 2000).

  5As Rothbard has written of Theory and History, the book in which Mises gives this method its most detailed exposition, this work “has made remarkably little impact, and has rarely been cited even by the young economists of the recent Austrian revival. It remains by far the most neglected masterwork of Mises.” Murray N. Rothbard, Preface to Ludwig von Mises’s Theory and History: An Interpretation of Social and Economic Evolution, 2nd ed. (Auburn, Ala.: Mises Institute, 1985), p. xi.

  6Ibid., pp. 224–25.

  7Ibid., p. 187.

  8Ludwig von Mises, The Ultimate Foundation of Economic Science: An Essay on Method, 2nd ed. (Kansas City, Mo.: Sheed Andrews and McMeel, 1978), p. 45.

  9It is true that in deriving theorems that apply to the specific conditions characterizing human action in our world, a few additional facts o
f a lesser degree of generality are inserted into the deductive chain of reasoning. These include the facts that there exists a variety of natural resources, that human labor is differentiated, and that leisure is valued as a consumer’s good. See Mises, Human Action; Rothbard, The Logic of Action I; and Hoppe, Economic Science and the Austrian Method.

  10Mises, Theory and History, p. 298.

  11Ibid., p. 310.

  12Some economists would date this inflation from 1965 to 1979, but the precise dates do not matter for our present purposes. See, for example, Thomas Mayer, Monetary Policy and the Great Inflation in the United States: The Federal Reserve and the Failure of Macroeconomic Policy (Northampton, Mass.: Edward Elgar, 1999).

  13Mises, Human Action, p. 50.

  14Mises, Theory and History, p. 309.

  15Ibid., p. 301.

  16John Kenneth Galbraith, The New Industrial State (New York: New American Library, 1967), pp. 189–207, 256–70.

  17Mises, Theory and History, p. 301.

  18Ibid., p. 265.

  19As Mises puts it, “Understanding aims at anticipating future conditions as far as they depend on human ideas, valuations, and actions.” Mises, Ultimate Foundation, p. 49.

  20Mises, Theory and History, p. 320.

  21Mises, Ultimate Foundation, p. 48.

  22Mises, Theory and History, p. 265.

  23Ibid., p. 266.

  24Ibid., p. 272.

  25Ibid., pp. 272, 274.

  26Ibid., p. 313.

  27Ibid.

  28Mises, Ultimate Foundation, p. 50.

  29Ibid.

  30Mises, Theory and History, pp. 306–08, 313–14.

  31Ibid., p. 219.

  32Mises, Human Action, p. 56.

  33Ibid.

  34Murray N. Rothbard, “Economic Determinism, Ideology, and The American Revolution,” The Libertarian Forum 6 (November 1974): 4.