MONETARY POLICY

Waikato Independent, Volume XLIV, Issue 6076, 14 July 1947, Page 3

MONETARY POLICY

I GOLD STANDARD SHOULD A FREE MARKET BE RESTORED? (By a Special Correspondent of The Times, London) The recent decisions of Egypt and India to link their currencies with the dollar rather than with sterling have no immediate practical importance. So long as the parity between sterling j and the dollar remains fixed it is indifferent whether the link is expressed in terms of the dollar or of sterling. The International Monetary Fund required all parities to be fixed in terms of gold or of the dollar as representing a fixed quantity of gold, so that there was really ; no option. The exaggerated emphasis given to these decisions may be regarded as a political gesture intended to placate nationalist sentiment in these countries.

But there is, in fact, more to it than this. Both these countries acquired large sterling balances during the war and now there is growing uncertainty as to the real value of these balances. Further, although both countries have been treated fairly over the allotments of dollars made to them from the sterling, area pool, the restrictions on dollar purchases have inevitably been attributed by malicious critics to the selfish manipulations of the British control. Finally, both countries are still "gold minded." They believe that their currencies will be strengthened if they are attached to the currency which is most fully backed by gold and most chosely linked to gold.

Black Market Rates

There is a good deal of muddled thinking in these arguments, but there is also a basis of sound economic reasoning. Sterling assets, which are- not freely convertible, cannot be a satisfactory medium for the reserves of other currencies. Exchange controls cannot be fully effective outside the country which imposes them. Elsewhere there is always a free market of some sort, with rates substantially different from the official rates. Above all, the tendency in this country to insist that currency management should be directed by reference to full employment and cheap, money, rather than to stability of exchange or the maintenance of the gold parity, tends to accentuate an apprehension that the link with sterling may involve serious losses in terms of gold or gold currencies.

The position of sterling is, of course, far from being exceptional. Most of the European currencies are in a far worse position. All of them are .being controlled at "official" parities, and all of them are being fteely dealt in at varying ratios of depreciation. They have all to face a readjustment of parity; the difficulty is to find an effective basis on which to calculate that parity. A remedy would be to revert to a free exchange system, under which the various currencies and gold would be convertible at economic rates. It .is one of the objects of the International Monetary Fund to assist in reestablishing such a system. The task will not be easy. At present it is difficult to know where to begin. In accepting the various parities declared by the member Governments, for

their currencies, the fund indicated that many of these parities must be regarded as artificial. The fund has not, however, indicated a similar scepticism about the most important of all the factors on which currencies are based, that is, the price fixed for gold. Gold is taken at the official price in the United States—3s dollars an ounces—and the currencies of all the member States are linked to gold at this price.

The price of 35 dollars an ounce is the price at which the United States is prepared to accept gold. But the United States does, not sell gold freely at this price; it is normally provided only to Central Banks. The official i price does not represent a free market price. At present there is no completely free gold market in the world. There are, however,, relatively free markets in India and in the Middle East, and in these markets gold is dealt in at prices varying from 60 dollars to 90 dollars an ounce. In other countries free dealings are illegal, but, in fact, substantial amounts are dealt in on the so-called black markets at approximately the same price. ( Nor is there anything extraordinary in gold fetching this price; the prices of most other commodities have risen in the same ratio. The value of gold alone is officially pegged; at about one half of the price which the public is prepared to pay for it, legally or illegally.

What is the advantage of this system? The price of 35 dollars an ounce was the pries of gold before the war, anc|. although all other commodity prices have changed gold is theoretically maintained at its before-war value. In other words, the effect of Government controls is to depress the value bf gold artificially in relation to other commodities. As gold is the standard measure of all values and particularly of international exchange transactions, it is desirable that ,its price should be fixed in relation' to the principal currencies; but to assess the real value of any currenpies a free gold market would have to be re-established, where gold could be bought and 'sold without restrictions, so that its value could be genuinely fixed, instead of being artificially pegged. The Level of Prices No doubt there are political advantages in disguising the depreciation of currencies resulting from war-time inflation. But is the public so easily deceived? The best that can be said for the present system is that it is too early yet to decide at what level prices will eventually settle down. Until something like the normal production and interchange of goods can .be restored, the basis of a.new equilibrium cannot be determined with any degree of accuracy.

There is force in this argument, though there is also a danger that it will lead to the maintenance of artificial prices much too long. The effect of pegging the price of gold at the before-war figure, while the prices of other commodities including the price of equipment and supplies, for the gold-mining industry—have risen far above that level, is to make gold mining less and less profitable, with a consequent diminution of gold output. Under the old gold standard, the output of the gold mines directly affected business activity throughout the world. Unless their yield could keep pace with the Increase of production, a fall of prices and a general depression ensued. This was one of the factors which led to the great depression of 1930.

Since then, the- technique of monetary management has been developed and the volume of credit is no longer so directly related to gold holdings as it was when most countries maintained gold reserves in a fixed percentage to their note circulation and to the deposits in their banking systems. Nevertheless, the output of gold etill has. a substantial influence on the credit system' and a reduction in the output of gold will tend to cause restriction of credit and deflation of prices. In other words, the pegging of the price of gold, by discouraging output, may go far to neutralise the benefits of the more elastic methods of credit control which have been developed since 1920.

It may be hoped that the authorities of the International Monetary Fund will tackle the question as soon as practicable. Under the Bretton Woods agreement, they have the power to decide upon a general revaluation of currencies in terms of gold. Probably no step would do more to facilitate a restoration of exchange stability. The authorities of the fund will, however, have an extremely difficult task if they attempt to revalue gold without the existence of any truly free gold market. They might attempt it by periodical 10 per cent readjustments, in the hope that by trial and error a rate would eventually be found which corresponded with equilibrium" But errors may prove costly and bring discredit on the whole system. It would be more preferable either for the fund itself or for one of its principal member States to restore a free market..

When the free market price for gold can be ascertained, the various currencies will have to be readjusted to that price at the appropriate parity. It is not the linking of a currency with gold that is dangerous. Indeed, only by such a link can the public be safeguarded against the illusion that perpetual prosperity- can be attained by perpetual inflation. The important thing is that the currency should be linked to gold at the appropriate parity. Here, again, it may be necessary for a period to adopt provisional parities, which could be revised as circumstances require and the International Monetary Fund could fulfil a very important task in advising what, these parities should be.