Dr. Zijlstra’s A Series of Unfortunate Monetary Events
On this webpage you can read a selection of translated and English writings of the late Dutch central banker, President of the Bank for International Settlements, renowned Dutch economic scholar, former minister of Economic Affairs, minister of Finance, Prime Minister, and last but not least, member of the European Advisory Board on Economic and Monetary Integration (since August 1991), Dr. Jelle Zijlstra (1918-2001). Also a minister of State after his active career, Jelle Zijlstra was one of the Netherlands’ finest Statesmen.
What Jelle Zijlstra shares in his analyses will be (entirely) new for some, while for others it underlines what they have explained years ago, and that others do nowadays. Either way, Zijlstra’s unique and lucid clarification of the monetary events as they occurred during his time in office is one of which I think, we can be in awe of.
I translated three passages from “Gematigd Monetarisme” (1985), or “Moderate Monetarism”. This book is a bundle of his fourteen analyses as published in the annual reports of DNB from 1967 to 1980. Beside these three translations, I also translated the whole section from his 1992 autobiography, “Per slot van rekening“, about which I wrote last year, “Gold as the Monetary Cosmos’ Sun”.
Starting with 1967, I translated his account of the problems with which Zijlstra was confronted while he became President of De Nederlandsche Bank and the Bank of International Settlements. Then his account of events of 1971 and a passage from 1978. Along with two retrieved transcripts of two English lectures that Zijlstra gave in 1974 and in 1981, this selection provides a historic account on the evolution of the international monetary framework as written by Zijlstra in 1967, 1971, 1974, 1978, 1981, and at last, 1992.
The first lecture, “Reflections on international economic and monetary problems“, is a retrieved transcript of Zijlstra’s lecture delivered to the Zürcher Volkswirtschaftliche Gesellschaft on Wednesday, March 13 1974, in Zürich. This lecture is a literal translation of Zijlstra’s 1973 analysis as published in DNB’s annual report. This analysis contains some real eye-openers in my opinion. The second lecture is one Zijlstra held on Sunday, September 27, 1981 for the Per Jacobsson Foundation in Washington and is titled, “Central banking with the benefit of hindsight“. This lecture reflects on the disparity between theoretical ideas on monetary affairs and real world monetary problems.
Translating the selected texts was time consuming and not easy. Notwithstanding, I feel confident that my efforts have generated a readable text, one that reflects Zijlstra’s precise choice for words accurately. Notwithstanding, if any errors were made, I appreciate it very much if you forward these to me. The Dutch language cannot always be translated to English literally, therefore words in between squared brackets […] reflect editorial choices. Words in between parentheses (…) are Zijlstra’s own and reflect his use of parentheses. Also, I feel that I should note that I spend much time examining my use of English words that can be translated in more than one way. Hereby the objective was to prevent exaggerations all together. Zijlstra’s exposition of monetary problems is a series of tragic events in and by itself, yet his exact phrasing, despite it is formal, old-fashioned and ultimately erudite, it remained neutral conscientiously throughout.
As noted, I am no expert translator; I hold a Master’s degree in international economics and economic geography. This explains my interest in his work. Also, in 1974 Zijlstra noted: “I hope that one day somebody will write the history of the monetary role of gold and also of the various views held on that role, particularly those expressed since the early 1960s.” To sum up my motive to translate Zijlstra’s analyses with a question: Why not help Zijlstra posthumously, and allow him to tell this story himself, albeit now through the Internet and in English?
My role is thus one of a very humble translator as well as an admirer of his analytical skills, and one of an economist who recognizes the gravity and the importance of Zijlstra’s wish. In this regard, I consider my efforts a great honour that was well worth my time. Unemployment – ironically – helped a great deal too.
Although I have my thoughts on Zijlstra’s series of analyses in connection with the financial and ultimately, the international monetary crisis we witness today, I decided to publish these texts without any further commenting. Notwithstanding, I invite anyone interested to reflect on Zijlstra’s analyses to do so. I have intentions to share my thoughts, however not here and now. There is one element I did add here and that concerns the title for these English Zijlstra-analyses: “Dr. Zijlstra’s A Series of Unfortunate Monetary Events“. I think Dr. Zijlstra would have appreciated the wit as much as I hope you will too.
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1967: A Prelude to Monetary Change
From Jelle Zijlstra’s book “Moderate Monetarism”, a translation of pages 50-62 covering Zijlstra’s views of the events preceding the collapse of Bretton Woods, his account on the London Gold Pool and the devaluation of pound sterling. On a note aside, Zijlstra’s complete 1967 analysis in the annual report of De Nederlandsche Bank starts on page 33 and focuses on domestic financial issues; it ends on page 62.
In respect to the international context, the reporting year has been rich considering the events. One could say that after the end of World War II, during a long period, important successes were achieved in regard to freeing up international trade and payments; one almost could say these were spectacular. Discontinuance of quantitative restrictions to trade, lowering import duties, discontinuance of ever more restrictions in regard to payments, crowned with the restoration of external convertibility of the most important currencies, they all contributed to growth of production and global trade that in almost all respects contrasted the period between the two world wars. Then, after all, difficulties already started to show up on the horizon in 1925 that ultimately led to the collapse in the 1930s. As opposed to those sad developments, the world after 1945 witnessed an at least 20-year period of increasing international cooperation in [regard to] flows of trade and payments without which economic growth, and its consequent rise of wealth, would have not been conceivable.
However, the last years it became clear that it was no longer sure we could count on such a fortunate development. Problems loom up for which solutions [within a reasonably short time frame] have to be found.
In the first place, the already yearlong discussion on the question if shortages of international liquidity loomed – that is, reserves held by central banks – have led to the currently generally [accepted] insight it is time to come to a deliberate creation of reserves to complement [existing] reserves, that – in multiple forms – are part of the official reserves of monetary authorities, [and that now] have to be faced.
After four years of studies and negotiations whereby mainly the Group of Ten had a leading role – in the last phase closely cooperating with the International Monetary Fund – it was in the annual meeting of the IMF in Rio de Janeiro during the week of 25 to 30 September 1967 that a preliminary decision was taken for the creation of new, unconditional extension of drawing rights on the IMF.
Secondly, [in] the last years it has been established that the so-called reserve countries, namely Great Britain and the United States, face great difficulties, albeit that the nature and scope of the problems [in question] are by no means identical in both countries. Anyway, for years both countries struggle with persistent balance of payment deficits. These difficulties have led to a devaluation of the pound sterling in Great Britain on November 18, 1967. However, it proved that the devaluation called forth new problems that for the time being have been concluded with the decision taken in Washington on March 17 1968 in regard to suspending interventions on the gold market in London.
The two mentioned problems, namely the necessity to deliberate reserve creation and the balance of payment deficits in both countries are partially related. After all, albeit it that on one hand balance of payment deficits are inconceivable without the implemented domestic policies in both countries, [while] on the other hand it cannot possibly be seen how, without a reasonable solution for the question of complementing existing reserves through deliberate creation, the problems of the reserve currency countries can be solved [so that it is beneficiary to] the entire international monetary framework in a way that is orderly and satisfactory.
Now, the decision in Rio de Janeiro in regard to special drawing rights is of a far reaching meaning. In this resolution, [there is this phrasing] talking about the arrangement: ‘… to meet the need, as and when it arises, for a supplement to existing reserve assets … ‘. The system gives every participating country the unconditional right to use the drawing rights, albeit according to certain rules. Chiefly, this system will constitute to the right to convert the drawing rights in currencies.
Currently it is clear that this new portion of currency reserves is fundamentally different from the current reserves typically held by central banks. The gold reserves held for monetary purposes was only until recently depending on the gold production – and thus mainly by the profitability of gold mines – as well as the demand by private parties including pure speculative demand. After the decision taken in Washington on March 17 1968, everything that one can claim with a particular degree of certainty in this matter, is that the monetary gold reserves will no longer decrease, assuming that all central banks stick to the rules of Washington, and that it is not considered necessary to buy gold for monetary objectives. The size of the total gold reserves for the time being has with this [decision] become frozen.
Further, reserves of central banks consist partially of dollars and (in some countries) pound sterling. The creation of these reserve [assets] depends on balance of payment deficits of these reserve currency countries. These dollars and pounds sterling are, besides being used by central banks for reserve purposes, in economic life generally also used for transactions. Partially because a transition between these two zones is in principle relatively easy, it must be said that the amount of the dollars and pounds used for monetary purposes, can be subject to great variations. There is however a significant decreasing willingness to hold pounds sterling as medium of reserve. In regard to the dollar, it seems that this threshold is also gradually approaching.
At last, in this context the claims on the IMF in the so called super gold tranche must be mentioned, which can be received through conditional withdrawals. Multiplications of the total amount of reserves assets that thus come into existence will however be [retired] after a country that is withdrawing, repays in due course.
The special drawing rights as foreseen in the agreement of Rio de Janeiro differ from each of the mentioned components of reserves in one or more respects. They are created through decisions [taken] by the IMF whereby the assessed demand for increasing the total amount of reserves will be the foundation for a periodically to be created amount of these drawing rights. Secondly, these created amounts of reserves are to be a permanent addition to official international reserves. And at last, these special drawing rights are exclusively intended to function as a means of settlement among monetary authorities. Summed up: the new drawing right shall be created in a rational manner, is intended as a permanent complement [of reserves], and is exclusively intended for international means of settlement.
It speaks almost for itself, [but] this new medium of reserve, certainly in its [introductory] phase, should be used cautiously; in the decision of Rio de Janeiro, rules that the IMF has to apply were indeed foreseen [as to] guarantee an orderly use. The main stipulations may be mentioned here. In the first place, the new drawing rights can only be used for balance of payment deficits. Using [drawing rights] exclusively intended for altering the reserve components is not permitted. In this regard, it is important that in general, it should be more pursued – although this is not a formal instruction – that there is a certain harmonisation of proportions in the possession of drawing rights and other components of [currency] reserves. It is clear that such a behavioural [instruction] is more than anything else benefited by giving this new component of reserves the quality of a full-fledged reserve like the other reserves, especially in regard to gold. Secondly, there is a so called creditor limit. No country is obligated to hold more drawing rights than three times its cumulative allotment. At last, there is [a] reimbursement or repayment duty. For the initial five years, it is currently formulated that each participant must hold on average, 30% of its net accumulated average allotment during this period.
An extensive discussion took place on this last stipulation. Mainly, the French persistently insisted strongly that this new drawing right was regarded not as ‘money’, but as ‘credit’. The reimbursement duty in this line of reasoning is a logical consequence of the credit nature of this new facility. Also in case one holds a different point of view on the nature and character of this new special drawing right, one can however be in favour of such a duty of repayment – certainly in its initial phase – both in promotion of the credibility of this new medium of reserve as well as [a means] for liquidity of the whole system. In the long run, a more enforcing application of the mentioned harmonisation rule can [help establish] a most effective rule of the repayment duty.
Now that the creation of special drawing rights has come within reach of practical application, it is of the utmost importance to realize fully what this new application is and what it is not. Before everything, one needs to realize that it will take years before the international monetary framework clearly and tangibly undergo the influence of the new system. Firstly, the framework must be shaped into Law [as to] allow legislative approval. At the conference held by the Group of Ten on March 29 and 30 1968 in Stockholm, the needed agreement was established; although France did not come to terms with it. Before parliamentary procedures in a sufficient number of countries are finished, a year will probably have passed. Probably, it will take 1968 entirely. After that, the decision shall have to be taken on the size of the creation, and the length of the term for which this decision applies (the so called activation). In this regard, the voting procedure demands a (weighed) majority of 85%. These decisions should be founded on considerations in regard to the need of the new reserve instrument, thereby relating the necessity to decrease the balance of payment deficits of currency reserve countries, especially the United States. At last, after a sufficient quantum of drawing rights has come into circulation, only then its influence on the functioning of the international monetary framework can be assessed. All together, one must think of year-end 1970 in the earliest. From this, it inevitably arises that it may not be expected of the new drawing rights that they help solve the current problems that need to be addressed in the immediate future.
May it be expected for the future, somewhat further down the road, that the new reserve component complements the current reserves and especially gold, and even partially replacing it; in enthusiastic [intellectual] reflections on this new system it is at times claimed that according to deliberate and rational considerations the myth (sometimes it is also referred to as tyranny) of gold shall be replaced. This however is a misconception. Certainly, for the distant future one must hope for an international monetary framework that is built up likewise rationally and able to function as a money framework within any orderly states. Special drawing rights however, like they are currently foreseen, can only function because of the link between it and gold; this link is enfolded by the stipulation that the unit of account in which the special drawing rights are expressed is equal to 0.888671 grams of gold. Without a fixed price of monetary gold, the special drawing rights as they were conceptualized as a system in Rio de Janeiro, are [indeed] inconceivable. The claim that is argued once in a while, that these drawing rights will lead to a demonetisation of gold [cannot be maintained]; on the contrary, such a demonetisation of gold would be the end of the special drawing rights [as they currently, are in character proposed]. If it is desired to make this new framework a success, then [all] have to do [their] best to have gold maintain its important role in the international monetary framework. A full replacement of gold by deliberately created reserve [assets] assumes political stability in the world and a general trust in a global authority of the issuing institution, of which one (unfortunately) must say, that will require substantial time [that we must await]. Because of this, the currently foreseen drawing rights shall remain for a long time being, a complementing [one] and thus cannot be [considered] a full replacement of gold.
The resolution of Rio de Janeiro got hardly through to the world and a dramatic event called forth all attention. On November 18, pound sterling devalued with 14.3%. For a long time and with an increasing degree, the balance of payments of the United Kingdom was in a weak position. In 1964, the pound sterling was only saved because of a quick reaction of the main central banks who [came to the rescue] with £3 billion. Since then the situation actually deteriorated gradually; the multiple forms of credit extension to the United Kingdom increased gradually further. While in the spring of 1967 it seemed that, also because of domestic policy measures, things turned around, in autumn of the reporting year [read: 1968] it soon became clear that the current parity of pound sterling had become unsustainable; in November devaluation was inevitable. It can be questioned in hindsight, if it had not been better to come to this decision earlier. After all, it was already clear before 1967, that the United Kingdom was gradually sliding off to a fundamental disequilibrium, [one] that makes a balance of payments equilibrium and full employment incompatible, and since it is possible of being granted permission by the IMF for correcting the exchange rate. The causes for sliding off – like always – was a combination of income inflation, expenditure inflation and monetary inflation. Firstly, incomes rose faster in the United Kingdom than productivity, a development that was from time to time instigated by blasts of expenditure inflation and was not even stopped [after installed] limitations to expenditures. A persisting continuance of monetary inflation allowed creating a beneficial environment for both forms of inflation mentioned here.
That despite this the [British] Government resisted a devaluation of the currency for a long time can be understood already. Firstly, one must not act too readily [and] change the exchange rate. The struggle for maintaining the parity must be undertaken until it is firmly established that the fundamental disequilibrium cannot be overcome other than by changing the exchange rate. One could also conclude and say this differently [and that is] that in such a situation a policy that pursues a restoration of the balance of payments equilibrium must in an increasing degree prevail over the goals of employment and growth. With that it becomes also clear where the limitations of policies are that want to overcome a fundamental disequilibrium without a change in the exchange rate.
That it is better to try to postpone an exchange rate correction for a long time is [a consequence of] the consideration that a too readily abandonment of the struggle can lead to anticipations in regard to further exchange rate corrections that would make domestic policies aiming at stability an illusionary [mission]. But beside this general consideration, there was another special consideration for the United Kingdom. There was and there is the question of sterling-balances, the sterling deposits that are partially – as reserves – held by central banks, and partially – as transaction money – held and used outside England by banks and companies. [While] a correction of the exchange rate will be able to clean up the balance of payments through the current account by the influencing of the relation of [financial] means and expenditures, the influence [of this correction] on the sterling-balances held abroad could [very] well be the opposite. Whatever this all may be, the devaluation had become inevitable and in November 1967 a new situation came into existence.
With the devaluation of sterling, there was a remarkable valuable and intense consultation beforehand. For the first time in history of international monetary relations, the percentage of devaluation was largely established as a fruit of preceding consultation. A percentage of devaluation that is perceived as too low revives expectations of further devaluation by which the new rate can again be exposed to speculative attacks. However, when – partially on this basis – the percentage of devaluation is chosen too high, the chance increases to that degree so that more countries will follow, whereby beneficial effects that may be expected from [such] a devaluation will be nullified. It is rewarding that this time intense and confidential consultations reduced these dangers to the smallest possible proportions.
Whilst, with the devaluation of sterling unrest has not receded. Especially the London gold market endured strong pressures. For a proper understanding one must realize that the in 1961 introduced intervention policy supported by a number of important countries (forming the so called gold pool) [worked] through the London gold market [and] opened the possibility to transfer central bank gold to the private sector. The objective was to limit unrest-provoking gold price increases on the free market (this price reached heights in 1960 of $40.50). Through deliberate intervention, the price of gold for non-monetary purposes would be linked to the official price of gold. During a cycle of years, this intervention was not accompanied with substantial losses chargeable to monetary reserves. In the meanwhile, it did however become clear that increasing private demand would absorb an ever-larger part of annual gold production. The official gold price [that] had not been raised since January 1934 stimulated private demand (jewelery, industrial applications etc.) while it also put a brake on production. Calculations showed that – unless there was a fundamental change in this tendency – the entire annual production would become necessary to still private demand in the course of the 1970s. The emerging currency unrest in 1967 did however create a new demand, namely a purely speculative demand. After the devaluation of sterling, there were very substantial gold losses chargeable to monetary reserves on that account in both November and December. While it initially appeared in January and February 1968 that rest in this regard had returned, by March losses became that substantial that on insistence of the United States, the most important contributor to the gold pool, to temporary close the London gold market on March 15. The hastily convened conference in Washington (after France [withdrew from the gold pool] since July 1967) of seven gold pool countries, decided to stop the intervention all together, whereby the pre-1960 likewise situation of the gold market was restored.
The size of the mentioned gold losses has been especially substantial for the United States. After clearing the losses made during the month March, the American monetary gold reserves amounted to a net value of a little less than $10 billion.
While the decision taken in Washington ended the [speculative] assessment of the monetary gold reserves, in different areas the unrest remained. The program that the Government of the United Kingdom announced after the devaluation proved insufficient to restore confidence in sterling appropriately. First, the government program announced on March 19, touched the core of the problem. The standard of living of the population was too high and had to be reduced as to let it only increase in a very slow pace thereafter. After all, this is the only possibility to effectively restore competitiveness on foreign markets sufficiently. By the whole [body] of far-reaching budgetary measures, as well as measures in regard to income and price policy, it was hoped to achieve this result. This courageous program is by itself certainly sufficient to restore the balance between means and expenditures of the United Kingdom itself, and even to have it turn around in a surplus that is necessary in a long cycle of years for repayments of debt and a restoration of reserves. Outstanding sterling balances remain however, also when one justifiably regards the program intended for this of great importance, a substantial problem, both for the United Kingdom itself as well as for the stability of the entire international monetary framework. One of the most important tasks in the near future thereby is to find more permanent solutions for this so important question.
American Balance of Payments
Beside the events of sterling and gold, also – and in an increasing degree – the other reserve currency, namely the dollar, called forth attention. In 1967 the American balance of payment deficit again increased and indeed to $3.6 billion. While the increasing deficit of the balance of payments of the United States was initially caused in the last years as a fruit of monetary inflation leading to a substantial deficit on the whole of capital accounts of the balance of payments, in  also the balance of trade was deteriorating without by any doubt a forceful, persistent [and] increasing expenditure-inflation in the sense that the surplus on the current account was decreasing. This expenditure inflation was caused by higher Defence expenditures that were not adequately met by increased taxes. Also this expenditure inflation [was a source for] causing income inflation that – after having been maintained stable over years in an almost admirable manner – was now indeed becoming clear. The program for improving the balance of payments position announced by the President of the United States around New Year, can indeed contribute to a restoration. In the first place, in the program [itself] the President points to earlier announced tax proposals. He deems these – very correctly – necessary for a fundamental restoration of the equilibrium. Beside this, [the program] consists of a range of measures that can lead to an improvement of the balance of payments [to the tune] of $3 billion. Half of this sum must be achieved by restricting capital movements with foreign countries, [a measure] that by itself can only provide some comfort temporarily.
Accepting the mentioned tax program is a necessary condition, not only for a restoration of balance of payments equilibrium in the United States, but also for the stability of the international monetary framework in general. After all, the willingness to hold dollars, whether by central banks, or by private parties, can no longer be burdened by allowing dollars to flow continuously out of the United States. When this is not [turned around] within a reasonable course of time, dollar-balances held by central banks will under the circumstances increase too strongly. Especially, this amount could grow to a dubious amount in case non-official holders turn to their central banks and offer dollars for conversion in local currencies. Moreover, such a move for conversion could have a very distorting effect on the Euro-dollar market, which has developed its own character and has to some degree become indispensable. Firstly, there is the possibility that these dollars will be held permanently by central banks. This would imply in so far a particular country would accept a dollar-standard for its own monetary policy. This could lead to an undesirable situation. Especially when this line of conduct is followed by the main central banks, [then] in general, the gold exchange standard would be replaced by a dollar standard, with which the possibility of having one’s own monetary and financial policies would become ever more narrow because this would become almost entirely dependent on the policies as they are pursued by the United States. The second possibility is that dollar balances are in a substantial degree offered in the United States for conversion. It is clear that this would again give rise to a gold problem. It is not necessary to mention all possible results of such a situation; [most probably and] in an increasingly degree, implementing restrictions to international payments and with that, probably also international trade would very well be an endpoint to this.
From the above, it should be clear that it is of great and urgent importance to readily restore the American balance of payments. It would nevertheless be incorrect to hold the United States exclusively accountable for this. Countries with a surplus on their balance of payments are jointly accountable as well. With an important surplus on the current account, and in case this is accompanied by a somewhat voluminous unemployment, it is necessary [to pursue] a policy to improve the capacity utilization of production [in order to] decrease the surplus of the current account. Since this situation has occurred in several surplus nations, the United States is [thus not] alone in its responsibility for their balance of payments equilibrium.
This does not mean however – as said [before] – there is not an essential task for [the United States]. It is perhaps good to call into memory in this context, as mentioned before [in this annual report, and] in regard to both domestic issues in the Netherlands and several issues in the United Kingdom, [where it became clear] that overcoming income inflation and expenditure inflation are important. When several forms of inflation are not sufficiently overcome, [then] unfavourable consequences in regard of a proper functioning of the international monetary framework cannot be held off, certainly not when it concerns countries with key currencies. Yet especially income policies (whereby one must think not in the last place of keeping incomes within the limits of labour-productivity) and spending policies (whereby it is mainly about budgetary politics) are entirely or partially political matters. It is necessary to understand that a proper functioning of the international monetary framework is not only a matter of system and technique, but is to an important extent also conditioned by political circumstances and political relations within the main countries. Mistakes in domestic policies may never be accounted to the international monetary framework; vice versa, the international monetary framework may never be used to allow or facilitate said problems.
After the decision in Washington whereby the price of gold for non-monetary gold was decontrolled, the question was raised how long such a two-tiered price for gold could last. It is better to rephrase this question more generally: in what way can the gold exchange standard be based on a gold price of $35, which proved a great service to the economic development in the world after the war, also remain the foundation for a properly functioning international monetary framework in the future? Which improvements must, and can be made; which conditions have to be met.
In regard to several problems related to these problems – as mentioned here before – important measures have been taken in the reported year, as well as in 1968. From the previous, it also becomes clear that important questions still await solutions. In case these solutions are reached within not all too long time, then there is reason to look forward to the future with confidence.
The gold exchange standard, like we know it today, will have to be gradually changed however. The key currencies as a part of reserves shall decrease in significance; the creation of new reserve [assets] like special drawing rights, can foresee in this. Also, the significance of gold, in a quantitative sense, will probably become slimmer. During a long cycle of years, the significance of gold as the core of the gold exchange standard in a qualitative sense will however remain. After all, it seems that the parts of reserves – other than gold – will remain linked to gold in some way or another, like this also will be the case with special drawing rights. By a careful policy, such a link between increasing amounts of other parts of reserves to a, in relative terms, falling gold-part of reserves, must be accomplished. It is clear that arranging the harmonisation of the proportions in which the various countries hold certain reserve [assets] must be considered indispensable.
Whether a monetary framework without gold – in the long-term – can replace a more rationally functioning gold exchange standard is a question of a much more far stretching meaning. This shall be only possible if and in so far peace and security in the world allows this, thereby including an almost supranational role of the International Monetary Fund. An eventual removal of gold from the international monetary framework is – again – not in first instance a matter of system and technique, but of – this time international – political relations.
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1971: End of an Era
From Jelle Zijlstra’s book “Moderate Monetarism”, a translation of page 155-163 covering his personal account of the events preceding the collapse of Bretton Woods and those thereafter. Zijlstra’s 1971 analysis starts on page 145 and starts out focusing on domestic financial issues; it ends on page 163.
End of an Era
The measures made public by President Nixon on August 15 1971 mark the end of an era. The freedom of international trade and payments (on basis of fixed parities), personified by GATT and the IMF and that, to an important degree, was accomplished in the twenty five years after World War II, has protected the world from disasters like in the 1930s. It was a first large-scale attempt to what later became referred to as economic integration. After all, acceptance of free trade and free payments enforce the necessity in national policies to properly take into account the demands that unhindered preservation of these freedoms put forward. ‘Beggar-my-neighbour policies’ from the past were abandoned on principle; perhaps this is the ultimate characterisation of this post-war framework.
Especially during the second half of the 1960s, tensions arose in the international monetary system. Initially it seemed that only imbalances in certain countries – beside the United States of America – led to individual adjustments of parities, but eventually it became clear there was something wrong with the system. For a proper understanding one must be keenly conscious of the central role of the dollar in the postwar framework. Supported on the [sheer size] of the American economy – which becomes obvious from the fact that in the early 1950s the American national income was equal to half of the global income – the dollar had a dominating role. As trade currency, as reserve currency and as intervention currency the dollar was pivotal to the system. Formally other currencies were tied to gold, materially however to the dollar. The relatively decreasing dominance of the American economy, [and] the undermining of the strength of the dollar as a result of a deterioration in the American balance of payments in the 1960s, have led to difficulties for the dollar and as a result of this, [to a collapse of] the whole of the international monetary framework. When President Nixon on August 15 1971 postponed the convertibility of the dollar, as a result, also the functioning of the IMF was postponed. The task we currently are confronted with is no more and no less to put forward foundations on which – again for twenty to twenty five years – the international monetary framework can be build.
Reforming the International Monetary Framework
Reforming the international monetary framework will prove to be a difficult and time-consuming task. Before everything, it is necessary in the first year and a half to two years after the events of 15 August 1971 to see the American balance of payments restore its balance after the exchange rate adjustment has run its course without running into an accident. To the problems of this intermediary period some further attention should be given, before the most important aspects of a general reform of the system can be considered.
The question if the size of adjustments in exchange rates, agreed to in Washington on December 18 1971, suffice, is of utmost importance. The American authorities had initially postulated a £13 billion bending in the current account in order to support a genuine sustainable balance of payments. Translated in terms of exchange rate, this implies an adjustment in regard to the foremost currencies of 15% (on basis of May 1970). The Washington Agreement led to a change in value of the dollar in regard to those currencies and also on basis of May 1970, of about 11%. If this suffices has to be awaited; anyway in first instance it appeared this amount suggested by the Americans was too large. One must never forget the problems with answering the question which exchange rate adjustment is necessary and sufficient for a restoration of the balance in the balance of payments with the margins of uncertainty being great. An adjustment in exchange rate must of course within a wide range be accurate. But beside this, it is about the willingness of the authorities to defend this new exchange rate, not merely by maintaining the foreign exchange market on the basis of intervention points belonging to the new exchange rate, but foremost all, by policies that substantiate the support for this rate. Put differently, it is not about the question whether the new [exchange] rates are mathematically correct, but whether countries want to base their policies in support of new and sustainable rates. It is at least very desirable, that the form of the new exchange rates – the so called [central] exchange rates (‘informal parities’) – as initially adopted, are as speedily as possible be transformed into formal parities as this is stipulated in the Statutes of the IMF. Immediate execution of the agreed to ratification of the United States Congress of the new agreed gold price of the dollar is urgently necessary.
Before and while the American balance of payments will have achieved a genuinely sustainable balance, there are especially short capital movements that can disrupt and undermine an initiated restoration of trust; also here an important problem for the intermediary period is found. In this regard central banks ought to be exceptionally reticent in placing dollars in the Eurodollar market. Therefore there should be sufficient facilities that allow investing dollars held by central banks within the United States. One possibility is to open dollar accounts in the United States with SDR’s as collateral and a reduced interest rate for dollar holding central banks. An open-market policy whereby the Bank for International Settlements could play a role, can contribute to the transfer of dollars from the Eurodollar market to the United States. Consequently, limitations on short capital movements probably are inevitable. Hereby one has to think of restrictions imposed on lending on the Eurodollar market. Finally, it is very desirable that monetary policies are partially aimed at regulation of short capital movements. Divergences in monetary policies that may result from [countries] that almost solely aim for national policy objectives are important factors for giving rise to, or accelerate short capital movements.
Beside the problem of short-term capital movements, also the problem of convertibility shall have to be dealt with during this intermediary period. The dollar is currently inconvertible. The monetary authorities in the United States do not possess by approximation sufficient assets (‘ultimate assets’) to restore convertibility completely, let alone partially. In the reformed internationally monetary framework, the convertibility must be restored in one way or another; fixed parities without convertibility are unacceptable. During the intermediary period, further steps have to be taken to promote a restoration of convertibility in regard to the new international framework as much as possible. A restoration of the so called small convertibility on behalf of a full functioning of the IMF as much as possible, especially where it concerns redemptions that have to be paid back by debtors nations to the IMF, does not have to be forestalled because it only requires a well intended willingness of all relevant parties. The full convertibility can be prepared by agreements between the countries, belonging to the Group of Ten. The essence of these agreements may allow a possible restriction on the employment of dollars from the current reserves in case of a deficit towards the United States, with additional arrangements between countries (other than the United States), aimed at a certain harmonisation of the dollar component of their reserves. Hereby, the US could be able from the outset to earn gross reserves from their surpluses, which would promote a speedy restoration of convertibility. It is about breaking a vicious circle. So long as confidence in the dollar is not sufficiently re-established, resorting to these kind of measures will not be favored [by countries]. Without such agreements it is hard to see how the confidence can be restored. That is why in the intermediary term it is also necessary to start with speedy consultations in regard to a reformed international monetary framework with a certain priority given to the issue of convertibility. Only if legitimate perspectives exist, the problems of the intermediate period can be addressed and solved.
With the reform of the international monetary framework it must be recognized [by all] that fixed parities should again be the foundation on which the framework is based. It is currently too early to elaborate into more details how the future framework will be. An examination of the most important point can however be considered in place.
In the old framework, as said, the dollar had a central role. One could speak of an asymmetry between the dollar on the one hand, and other currencies on the other hand. In the new framework this asymmetry will largely disappear. How much the dollar will remain the most important currency, [the dollar] should, under the authority of the IMF, be treated on an equal footing as the other currencies. After all, it has become clear that the existence of reserve currencies can cause de-stability. Essential is that the meaning of national currencies as parts of reserves of central banks must be forced back as much as possible, while also the emergence of new reserve currencies must be prevented. Only in this way, creation and management of international liquidities can be rationally accomplished. A more specific clarification of this idea has in the meanwhile become far from simple. Of the current official reserves, dollar claims on the United States, per last known date, of $48,8 billion, can be reduced in various ways. First, with a return in confidence in the dollar, on basis of the Washington Agreement, a certain, not unsubstantial part, will flow back to the USA. Beside this, there should be more room for voluntary bilateral consolidation-agreements. Another option that has been mentioned here above is to transfer current dollar deposits to a special account with the American authorities against a low interest rate and a SDR guarantee. At last; recently, suggestions have been made to the IMF for convertibility of current dollar balances into SDRs that have to be specially created. The problems that such a conversion would bring along must not be underestimated; the whole of the SDR framework would therefore likely have to be fundamentally altered, while on the other hand the circulation of SDRs in such a way can undermine the confidence in this new reserve asset in a way like it happened with the dollar. Besides, difficulties with interest rates and redemption emerge.
Further, the question of flexible exchange rates will have to be dealt with. The Washington Agreement foresees a (temporary) wider margin of 2,25% in regard to intervention-currencies. It is likely that a margin of this order of magnitude will be implemented in the final framework. Whether a possibility beside this is created for easier adjustments of parities, is a disputed point. Undoubtedly it was considered in the past for too long whether to change parities. It is however not unlikely that recent events of the past years have contributed to the willingness with structural imbalance-disruptions not to wait too long with adjusting parities. Anyway, in this regard there is a profound difference with the past. Then one could assume the parity of the dollar could not be fixed. This aspect of the asymmetry of the dollar in the system led to revaluations elsewhere when the dollar got itself in a situation of fundamental imbalance. For the future it can thus be expected that parity adjustments will be more reasonably be both devaluations and revaluations.
The convertibility must again become an essential part of the framework; convertibility is the explicit sanction to an insufficient willingness to adjustment, this is to pursue national policies that contradict with the terms that international cooperation demand. Certainly, the convertibility – eventually – will have to be different from what it has been. Previously, convertibility was a right of each creditor nation to ask for redemption in gold any second. The new convertibility will have to be managed by the IMF. The Fund should take the position of the debtor nation (whereby mostly the US, assuming the dollar will remain an important degree an intervention-currency) as the creditor nation into consideration, thereby closely monitoring the configuration of their reserve assets, in order to stipulate in which asset (SDR’s, gold, Fund-deposit) conversion must happen. The IMF could hereby strive for a gradual harmonisation of the configuration of assets. Put differently, the unrestricted right of a nation to convert into gold shall have to be replaced by a right on conversion under the supervision of the IMF.
With the revision of the system there will have to be a reflection on the role of gold. Gold is in the current framework the unit of account (numéraire) by which even the SDR is defined. There is a strong tendency to give the SDR this role. At first instance nothing changes thereby. The new unit of account is only the reciproque of the older. Materially, only a change would occur after the current relations are adjusted. The switch of the numéraire thereby would only have any meaning when it is thereby expressed that changing said relations can no longer be ruled out. Apart from that, it would be unwise to assume that gold has arrived at its first stage of demonetisation. Recent events have rather strengthened the role of gold than weakened it. The willingness of monetary authorities to sell gold was significantly less than their willingness to buy gold.
The attempts to come to a new international monetary framework will prove to be to no avail, when two (closely related) conditions are not met. First, the political willingness should be in place to adjust national policies to meet the preconditions that international monetary cooperation necessitates. Second, there must be willingness to give the IMF the authority that it will need to perform these more burdensome tasks, so that it can carry these out satisfactorily. It must not longer be possible that the Fund is paralyzed by the actions of member countries. The new policy demands a strong IMF; member states must want this and implement this.
Snake in the Tunnel
Because of events in May of the reporting year , the decision by the members of the Board of Ministers of the EEG who met previously in February where they decided in principle to make preparations for the first step to a monetary union, had became uncertain. On May 5 1971, the official intervention on exchange markets of Germany, Switzerland, the Netherlands, Austria and Belgium were postponed. It meant that within the EEG serious problems emerged, especially with agricultural policies. The Board of Ministers of the EEG, who met on 8 and 9 May 1971, could, given the circumstances, do no other than accept the facts. Directly thereafter, the Swiss franc revalued and the Austrian Shilling; in Germany and the Netherlands the exchange markets reopened under a regime of floating exchange rates. In several countries new restrictions were implemented on incoming capital or existing restrictions were tightened. The calm on foreign exchange markets did however not return and on August 15 1971 the American measures decided the end of a monetary framework based on fixed parities. At the end of August, of all the important currencies only the French franc (for the better part of their balance of trade) maintained its old parity.
On August 23 1971, the Benelux-countries took a far-reaching decision. They agreed to committing themselves to maintain exchange-differentials of maximally 1,5% on both sides of their old parities (one calculated on the basis of the old gold parity) [and do so] through interventions in terms of their own currencies. This decision was also of importance because the Benelux-countries hereby (again) set the example that, in context of a wider (EEG) relation, could be followed by others. The [Benelux] agreement in this regard went further than what had been agreed to by the Board of Ministers of the EEG in February. Then it was only decided in regard to the exchange rate differential with the dollar to narrow this margin from 0,75% to 0,6%. This created an “inner band” of 1,2% and “outer band” of 1,5%. A wider inner band would demand a conscious decision by the monetary authorities. Intervention would only be done in terms of dollars.
The Benelux-agreement introduced beside intervention in terms of dollars, intervention in terms of each other’s currencies. The maximum differential is not managed in terms of dollars, but in terms of guilders and francs. Dollar interventions could initially be omitted, because the agreement started with floating rates against the dollar, while authorities saw no reason to influence the dollar intentionally. When the Washington Agreement was in place, new mandatory intervention points in regard to the dollar were determined, namely 2,25%.
By the decision of the Board of 6/7 March 1972, all EEG currencies will by 1 July 1972 have the same system like the Benelux-countries that adopted this in December . The maximum rate differential of EEG currencies however will be 2,25%, with an explicit addition to narrow this to 1,5% as soon as possible. Also here, an inner and outer band thus exists. The room for maneuvering and the movements within the inner band is however much greater than it was in the system foreseen in February 1971. The analogy has thereby changed [somewhat]; one now speaks of a “snake” in the “tunnel”. The objective is, certainly initially, to decide the place of the snake in the tunnel through joint operations in each of the five financial centers of the Community currencies, as to restrict the movements of the currencies against each other to a maximum of 2.25%.
The Benelux-agreement, despite its short existence, has already generated valuable insights and operational experiences. In the first weeks a debt of Belgium to the Netherlands came into existence, that after having reached a maximum of Fl. 460 million [guilders] was partially redeemed in gold and partially through the market. It became clear that consultations on monetary policies became very desirable; it is then not a surprise that lower discounts after the agreement of Belgium and the Netherlands that have since then been implemented are the result of [very] close consultations. Consultations on dollar policies took place as well.
Bringing into practice what the monetary agreement between the EEG countries, with whom four [EEG] candidate countries have already joined, and whereby other European counties shall participate in, will give rise to similar problems. In regard to redemptions of debt positions more and more arrangements were made. The configuration of the reserves of a debtor country will decide on the asset used for redemption. This formula in itself will, in the longer term, lead to a harmonisation of the configuration of the reserves of the member-countries.
However, this monetary agreement brings the EEG in a decisive phase. The decision of the Dutch Cabinet of February 1971 was of a much-limited order; it was a first experimental step. The far-reaching events on the international monetary stage have forced the EEG countries to take the first steps on a path that hardly allows a return. The narrowing of margins, in the manner currently foreseen, brings along the necessity to harmonise monetary policies and with that, also the basic ideas of financial politics. The EEG will burn the ships behind them, but after August 15 1971, it has no longer any other choice. Certainly, the Community may not forget for any moment, her increasing monetary strength may not undermine, but contrary to that, must provide further support to come to a renewed and effective international monetary framework.
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1974: Reflections on International Economic and Monetary Problems
The below text is a transcript of Zijlstra’s lecture delivered to the Zürcher Volkswirtschaftliche Gesellschaft on Wednesday, 13th March 1974, in Zürich. This transcript is identical to his Dutch analysis as published in the annual report of DNB of 1974.
Had no oil crisis occurred, a talk such as this would have been easy to plan. I would have begun by running over the series of events which ultimately led to the virtual end of the Bretton Woods system in March 1973, when shortly after the 10 percent devaluation of the American dollar there was a general change-over to a system of floating exchange rates, albeit with a European island of fixed parities known as the snake arrangement. The end of the old international monetary system may perhaps even be dated back to the suspension of the convertibility of the dollar by President Nixon on 15th August 1971. But in any case, between 15th August 1971 and March 1973 it was still possible to hope that a new system could be built up on that part of the old system which had remained intact and which was based on fixed parities between a number of important currencies, even though the feature of convertibility that is vital to this system in the long run might initially have been lacking.
Carrying on from there – still assuming there had been no oil crisis – I should then certainly have looked in some detail at the progress made in the discussions of the Committee of Twenty which has been given the task of drawing up plans for a reform of the international monetary system.
And at the end of my talk I would most definitely have focused attention on the world-wide inflation rampant at the present time and urged that everything in our power be done to bring this pernicious state of affairs to an end.
The far-reaching developments in the closing months of 1973 – and more specifically the two-fold increase in the price of oil and its monetary consequences – compel me to adopt a completely different scheme.
I propose – and this time the oil crisis will be brought into the picture – to discuss in turn the following matters:
(a) the problems involved in international monetary reform;
(b) European monetary co-operation;
(c) the position of the American dollar;
(d) higher oil prices and their consequences.
There can be no doubt that the oil crisis has important implications for the prospects of reform of the international monetary system. At first the aim was seemingly to devise an entirely new system worked out down to the details, which was to be ready in broad outline by 31st July 1974 at the latest. In the uncertain conditions now prevailing, this is certainly out of the question. Even in the absence of an oil crisis that might well have been the case, because an international monetary system needs to be flexible and adaptable with a limited number of fundamental rules. After all, as time goes by new problems are bound to emerge, and these will have to be resolved by the International Monetary Fund on the basis of those rules. This was the position from 1944 onwards and it will continue to be so in the future. There are really only three basic rules:
(i) fixed parities;
(ii) convertibility; and
(iii) timely adjustment.
In point of fact, these three rules can be summed up in the single precept that a system resting on these foundations constitutes for all member countries an essential limiting condition for the conduct of their own national policies. This serves, as it were, to keep national policies in line with the requirements that are essential to the proper functioning of the system as a whole. In addition to this, I assume that the SDR will be the numéraire of the new system; from time to time it will be necessary to ascertain, on the basis of objective criteria, whether new SDRs need to be created to meet an impending shortage of international liquidity.
If I expect the SDR to be the basis of the new system, it stands to reason that I expect gold to have a different role from that assigned to it by the present Articles of Agreement of the IMF. To that extent I do not, therefore, expect a remonetisation of gold, but that by no means implies a demonetisation of the metal. However, we should perhaps not spend too much time playing with such words as remonetisation and demonetisation. For what is really the true issue? The more than spectacular events in the gold market compel us to give the gold problem very serious attention. I hope that one day somebody will write the history of the monetary role of gold and also of the various views held on that role, particularly those expressed since the early 1960s. I will, however, quote two examples to illustrate the degree of confusion that has been possible on this subject. After the Washington Agreement of March 1968 – recently terminated, as you know – which was viewed by some simply as the end of the working of the gold pool, and by others (mistakenly, to my mind) as the beginning of a deliberate demonetisation of gold, discussions started on the question of the application of the Articles of Agreement, which, after all, provide that gold may be purchased at the official price. These discussions led to an agreement between the United States and South Africa, the substance of which was also embodied in an agreement between South Africa and the IMF. The result was that South Africa was provided with what amounted to a guaranteed floor price for its gold – namely, the official gold price. In return, South Africa accepted certain obligations, particularly an undertaking to supply its current new gold production regularly to the free gold market. In fact, the whole matter was bound up in rather a complicated set of balance-of payments conditions.
While the discussions were going on I heard highly intelligent people maintain in all seriousness that it was wrong to give South Africa this guarantee because the price of gold on the free market was certain to fall below the official price. At that time (1968) even a price of US $ 20 was on some people’s lips. Another idea that seems somewhat farfetched today was that of selling gold to the IMF in exchange for SDRs on the basis of the official gold price, even when the price in the free market was already far higher than the official price.
Whatever we may think of such opinions, they are things of the past. Like many other fanciful notions, they have been swept away by the fierce tide of events. What we have to do now is look at the issue realistically and with open minds and consider in what way gold may contribute as efficiently as possible to resolving the many complicated monetary problems facing us. I do not see gold returning to its function as the pivot of the international monetary system in the way it has functioned over the past twenty-five years. That would mean having to maintain an official gold price in the IMF Articles of Agreement. The official price itself would, moreover, have to be increased drastically. I do not expect this to happen; nor am I in favour of such a step. There is now a broad measure of agreement that the SDR should serve as the basis of the new system. From this the conclusion may be drawn that central banks holding gold should be free in principle to use their gold as they think fit, that is buy and sell gold in the free market – perhaps regulating the price a little through a new-style gold pool – or, if necessary, use it in settlements between one another. In this latter context one might think in particular of regional groupings like the EEC. However that may be, it is to be regretted that up to now so little attention has been devoted to these matters by the Committee of Twenty, for that is the body where such problems should first of all be dealt with. At all events, the taboos surrounding gold are gradually breaking down; the time has come for solutions to be found.
I may perhaps pass on now to what may be regarded as the heart of the international monetary system: fixed parities, even if with more flexible adjustment procedures than hitherto. Without fixed parities, which are adjustable in accordance with certain definite procedures, it is impossible to conceive of an orderly international monetary system in the long run. Fixed parities form the foundation for the formulation of balance-of-payments objectives, and thus also for discussions on the compatibility or incompatibility of these objectives. They enable conclusions to be drawn about the financing of balance of-payments deficits: whether – where they are assumed to be temporary – they can be financed by means of IMF credit facilities, or whether they stem from fundamental disequilibria and can only be corrected by a change in parity. Only with a system of fixed parities is it possible to calculate the international liquidity needs both of individual countries and of the system as a whole. In short, no coherent policy is possible and there can be no consistency in balance of-payments objectives without fixed parities. This was the essence of the old Bretton Woods system and this must again be the essence of a new monetary system, at any rate in so far as countries are still prepared to accept some degree of subordination of their national policies to the demands of an international system working, in the longer run, for the good of all.
I feel that it is important to spell out these points quite explicitly, even though they are perhaps self-evident. Sometimes I get the impression that it is not always and not everywhere understood what is really at issue. If we were to abandon the basic rules I have just described, we should find ourselves in a completely new situation, which would have very little, or nothing in common with the one the founding fathers of Bretton Woods had in mind. It is true that even without this hard nucleus there would still be room for international discussions, and perhaps also for an International Monetary Fund as a centre for consultations on what is acceptable behaviour and what is not. But these discussions would necessarily only lead to conclusions that were not binding. It is also to be feared that if the international monetary system is allowed to wither, the other cornerstone of the post-war economic and financial structure – an orderly international trading system – will also be put in jeopardy.
The architects of Bretton Woods and of the GATT were profoundly conscious of the disasters of the 1930s and what had brought them to pass. I cannot resist adding that the 1930s provide the most graphic example of an economy without growth going hand in hand with a very high level of unemployment. I mention these things to remind you of the wise maxim that it is necessary to know history in order to prevent it from repeating itself.
I come now to my second subject – the state of monetary co-operation in Europe, and more particularly within the EEC. How did matters stand on the eve of the energy crisis? As you know, the member countries of the EEC have decided to create gradually an economic and monetary union, to be completed by 1st January 1980. One of the most important features of this plan consists of two closely related policy aims. The first is that fluctuations between any two EEC currencies in the foreign exchange markets should be contained within set limits, with the maximum spread around parity being put initially at 2.25 percent. In the course of time the margins – which are to be maintained by means of interventions in Community currencies – would be gradually narrowed until by about 1980 they would have been completely eliminated and one single European currency would have been ushered in. The second is that concurrently with this process there would be a pooling of central-bank reserves so that, again by 1980, the European central bank – or, if you prefer it, a European ‘Federal Reserve System’ – would have been created, having at its disposal the pooled reserves of the member countries. The snake venture, which opened with considerable political enthusiasm, has not so far been free of difficulties. On 23rd June 1972 the United Kingdom had to withdraw from it, and on 12th February 1973 Italy also backed out. These developments show quite clearly that without a sufficient degree of harmonisation and co-ordination of economic and monetary policies the road to full economic and monetary union cannot be travelled together. France, too, was recently forced to the conclusion that, particularly because of the uncertain situation since the oil crisis, it could no longer adhere to the rules of the snake arrangement.
What is the position now? The remaining countries have decided to continue with the snake arrangement. This group now consists of Germany, Belgium, Luxemburg, the Netherlands and Denmark, as EEC members, and of Sweden and Norway. These last two countries are not members of the EEC. They have joined in the afore-mentioned monetary agreement without participating in the European Monetary Co-operation Fund or in the mutual support arrangements agreed upon by the EEC countries.
The question may be asked what purpose such an arrangement still serves. It should first be said that this monetary agreement can contribute towards restoring and pushing ahead the movement towards economic and monetary union within the Community. The preserved agreement might be viewed primarily as a kind of platform offering countries that have withdrawn – only temporarily, it is to be hoped – from the snake arrangement the opportunity to return. But there is another important point. The former fixed parities have disappeared as pillars of the international monetary system. It is of paramount importance that in a world of floating rates a certain pattern of exchange rates be formed that not only contains an element of stability but also provides a starting-point for a return in due course to an orderly international monetary system, which – as already explained – will have to be based once more on a closely related system of fixed parities of at least the major currencies.
I should like to add one concluding remark, which serves as something of a link between the two subjects I have dealt with so far. I feel sure that in a reformed monetary system there will inevitably be a certain amount of splitting into groups. Perhaps it would be better to speak of categories of countries rather than groups, in order to avoid negative associations. Traditionally the world has tended to be divided into rich and poor countries. The rich countries have been primarily – though not exclusively – identified with the Group of Ten, that is those countries which in 1962 expressed readiness to provide funds to the GAB, a supplementary financing facility for the IMF. In the course of the discussions that have been taking place on reform of the international monetary system it was becoming clear that as far as, for instance, convertibility, adjustment and the maintenance of parities were concerned not all countries could be treated alike. After the drastic rise in oil prices, it has become quite evident that a third category has come into being. This is made up of those oil-producing countries which in the years ahead will find themselves unable to invest a large part of their oil earnings in their own national economies and will consequently experience a huge expansion of their reserves, with all the problems that this involves. There are thus three categories discernible now, which will have to be taken into account in reforming the international monetary system:
(a) the countries of the Group of Ten together with those countries which in the context of the current problems are to be regarded as belonging to this group;
(b) the oil-producing countries with heavy reserve accumulation;
(c) the non-oil-producing developing countries (in cases where it is not possible for them to improve their economic position sufficiently of their own accord through other primary products at their disposal).
With regard to these three categories, the following may be added. The first group will have to form the nucleus as regards obligations concerning fixed parities, convertibility and adjustment. I should not be surprised if, as discussions on this subject continue, the conclusion were arrived at that this group of countries should come to some sort of snake arrangement with procedures closely akin to those of the European snake. However, the maximum permissible spread between any two currencies in the market would have to be wider than the 2.25 percent under the European arrangement. The compatibility of these two elements does not present any problems. In Europe we already have a combination of the Benelux agreement – the ‘worm’ as it is sometimes called in the current jargon – with a spread of 1.5 percent and the wider arrangement with a band of 2.25 percent. Such a set-up would also offer a solution to the notorious problem of symmetrical intervention in the exchange markets.
As far as the second group is concerned, special arrangements will be necessary concerning the composition of reserves – arrangements which will have to be acceptable to the countries concerned and also fit in with the new system one is aiming to bring about.
The countries within the third group cannot have many obligations imposed upon them. It is they who should have first call on adequate aid. Into this design would also fit the ideas worked out by the IMF on the institution of a new GAB, with funds coming in particular from countries in the second group, thus enabling a special facility to be created for those countries which are in danger of running into insurmountable difficulties because of the oil crisis.
Since President Nixon suspended the convertibility of the dollar on 15th August 1971, the dollar has undergone three important falls in value. A formal devaluation of 7.89 percent took place in December 1971 under the Smithsonian Agreement, which together with simultaneous revaluations of other currencies meant an average devaluation of the dollar of 9 percent. On 12th February 1973 the dollar was again devalued, this time by 10 percent, and when on 19th March the leading currencies were allowed to float, the dollar depreciated further on the exchanges with its value falling again by up to about 10 percent against leading currencies. After this a turn-round occurred, however, which even before the oil crisis had practically recouped this latter depreciation. There are good reasons why this should have happened. The Smithsonian Agreement and the 10 percent devaluation in 1973 must certainly be regarded as sufficient to turn the US balance of payments round from deficit to substantial surplus. It is true that this took some time to come about, but adjustments on that kind of scale do take time; the turn-round in the US trade balance was assured. The oil crisis in itself is bound to lead to a further strengthening of the position of the dollar, since a considerable proportion of oil payments are made in dollars and there will thus be an extra demand for dollars for these transactions. That this has not yet made itself clearly felt is due to the fact that the large oil payments have yet to get under way. All things considered, it is now beginning to look as though the dollar is on the way to regaining the position in the international payments system which it had to relinquish in the 1960s.
I regard this development as being of the utmost importance for the reform of the international monetary system. A system like this can only be designed and made to function on the basis of a certain balance between countries in the position of debtors and countries in the position of creditors. Deficit countries are in favour of as much international liquidity as possible, want loans to be as large and as straightforward as possible, and wish to be secured against competitive non-revaluations. Surplus countries are more cautious about the creation of liquidity, they want clear-cut terms for loans they provide, and they are very much afraid of competitive devaluations. At Bretton Woods these two philosophies were personified in the representatives of the United Kingdom and the United States, Keynes and White respectively. They clashed, they came to compromises, and in so doing became the most important architects of the new system. In the current discussions on reform of the system one of the major difficulties has been the initial predominance of the debtor-country philosophy. I expect the recovery of the dollar to lead to a better balance between the points of view of debtor and creditor countries, and feel sure that thereby the chances of arriving at an acceptable new system will be greatly enhanced.
I shall now turn to the oil crisis itself and its economic and financial repercussions. The facts are well-known. The increases in the price of crude oil – assuming they remain unchanged (and I feel that the probability of a reduction is rather greater than the opposite) – will add $ 60–65 billion to the gross income of the oil-producing countries. Two adjustments need to be made to this figure to give a broad idea of the size of the net amounts with which we are due to be confronted. The first adjustment is for increases in imports. Some countries will soon spend much of their increased oil income on imported goods, but this will not be possible in the short run for some other countries. At the same time, it is to be assumed that the very sharp increases in oil prices will, once they have been fully passed on in the oil-consuming countries, lead to a cut-back in the use of oil. After allowing for these two factors, we are left for the moment with an amount of between $ 40 billion and $ 50 billion, expressed at an annual rate. It has been calculated that of this amount about $10 billion will fall onto the shoulders of the developing countries and the balance of $ 30 billion to $ 40 billion will have to be borne by the other countries. With regard to this latter group of countries, a distinction can be made between those countries which, as a result of this deterioration in the current account of their balance of payments, will show a deficit (or will increase their existing deficit), and those which, because of the surpluses they recorded in 1973, will be approximately in balance. This latter group includes, for example, the United States, Canada, Germany, the Netherlands and Belgium.
The increase in oil prices, which came so unexpectedly and was so unprecedented in scale, has given rise to two problems for the world economy:
(a) a problem of real resources;
(b) a financial/monetary problem.
The higher oil prices mean potentially that real resources are transferred from oil-consumers to oil-producers. This can be described as a redistribution of the real income of the world. In other words, we, the oil-consuming countries, must part with more goods in exchange for our oil imports, i.e. we are suffering a massive deterioration in our terms of trade. This, in itself, need not necessarily give rise to any problems. There is a danger of a problem arising, however, if and to the extent that the oil-producing countries, or some of them, cannot or cannot yet take in these extra imports because the absorptive capacity of their national economies cannot be adjusted in the short run to the scale of the money inflow resulting from the higher prices. It is important to get this point quite clear from the start, because it is this discrepancy between additional income and additional expenditure that gives rise to the specific problems I shall now briefly examine.
For the sake of simplicity I shall assume that this temporary non-spending is not, or is only very slightly, offset by long-term capital investments. As time goes by, such investments will certainly be made on an increasing scale, but for the time being the amount involved will be fairly small. For that matter, in the somewhat longer run expenditure will also increase on account of additional imports. The discrepancy to which I was referring is basically, therefore, only temporary. As I said, there are two aspects involved: a real resources aspect and a financial/monetary one. The temporary non-spending by the oil producing countries of their additional income means that the oil-consuming countries – also temporarily – must not cut down their expenditure to the level that the deterioration in the terms of trade resulting from the higher oil prices would in itself call forth. If they were to do so, this could mean a deflationary impulse for the whole world.
Application of this analysis to the policy actually conducted by any one country naturally requires caution. If – to take one example – a country was already suffering from serious overspending immediately before the oil crisis, it cannot use these arguments in order to avoid taking the necessary measures to put its economy on a sounder footing. More generally, a distinction has to be drawn between oil deficits and surpluses and non-oil deficits and surpluses. What I have said refers solely to oil deficits and surpluses.
Furthermore, the way in which this cut-back in spending due to the oil deficit is temporarily avoided is of prime importance. This rather unusual adjustment process – or to be more precise, non-adjustment process – must take place, as far as possible, at the stage of secondary, and not primary, income allocation. The question is how the non-reduction of real expenditure is to be attained. If this were to be done at the level of normally negotiated wage increases, with increases consequently being agreed to which were not adjusted for the deterioration in the terms of trade, a fresh and very strong impetus would be given to wage and price inflation – to cost-push inflation. The right way therefore is to adjust the normal wage increases for the deterioration in the terms of trade, but then to pull the net real increase gained by wage-earners up again by tax adjustments and changes in social insurance contributions paid out of wages. In this way it would be possible, in principle, to avoid the undesirable reduction in expenditure without fanning the flames of wage and price inflation. I say ‘in principle’ because there are many technical problems involved in carrying through such a policy which will certainly differ from country to country. To give just one example: the Treasury of one country will have less difficulty in financing the effects of this proposed policy than will the Treasury of another country. On the fundamentals, however, there is no room for disagreement.
These questions concerning the reallocation of real resources, both at national and at international level, have their counterparts in the financial and monetary sphere. The unspent part of the oil earnings that accrue will initially take the form of an accumulation of liquidity with the oil-producing countries – after all, the liquid funds have to be somewhere. This creates what can be described as a very large-scale recycling problem – recycling being called for because the accumulation of liquidity is mirrored by financing requirements on the part of the oil-consuming countries, at least in so far as they pursue the course I have just been advocating and keep expenditure for the time being at its existing level.
I do not propose to go into details of the various conceivable forms that this recycling could take. By way of summary, the possible recycling mechanisms might be listed as follows:
(a) the International Monetary Fund;
(b) the United States money market;
(c) the banks operating in the Euro-dollar market;
(d) (in all modesty) the Bank for International Settlements.
To this a few remarks may be added. First of all, it is clear that this recycling question contains within it a transformation problem: the transformation of short-term funds into long-term investments. This is so because the need for these funds stems from the fact that for the time being the oil-consuming countries will – as described earlier – be maintaining their expenditure at its existing level and thus face a financing problem that cannot be met adequately by means of short-term funds.
With regard to the International Monetary Fund, let me merely say that the Managing Director of the Fund has taken a laudable initiative, but that the main thing just now is to see that sufficient funds flow from the oil-producing countries to organise what might be called a second GAB.
As to the United States money market, a point worth noting is that the recent lifting of restrictions on outflows of capital from the United States is conducive to recycling. Nevertheless, the bulk of the transformation problem will fall onto the shoulders of the banks operating in the Euro-dollar market.
As far as the Bank for International Settlements is concerned, I will not do more than say that we are following and studying the relevant problems most carefully. If there is scope for action on the part of the BIS, and if it is deemed desirable, the Bank will be prepared to play its part.
I should like to conclude this brief consideration of the oil-price increase and its implications by returning to a point I made earlier about fixed and floating exchange rates.
If the analysis I have just presented is correct, it is of even greater importance than before that on balance-of-payments objectives and their compatibility. I have already pointed out that it would be quite wrong to try to make good the oil losses in the short run. If it attempted to do that, a country would only pass its problem on to other oil-consuming countries. Now, a meaningful discussion of balance-of-payments objectives and their compatibility presupposes the maintenance of a certain pattern of exchange rate relationships and thus, where rates are floating, a certain intervention policy on the part of national monetary authorities. For the moment, a formal return to fixed parities as they existed under the old system is impossible. But it is possible, and even necessary, for international consultations to be held on what could be, in a more general sense, a consistent pattern of exchange rates for the leading currencies, in order to open the way for meaningful discussion of the compatibility or incompatibility of balance-of-payments objectives in the very difficult period we now have ahead of us.
My time is running short. But I do not want to conclude without referring for a moment to the problem of inflation. Both in scale and in international spread, inflation has grown to unprecedented proportions. Immediately before the oil crisis the situation was already such that prices were rising in the major industrial countries at a rate of 7 or 8 percent or more. There can be no doubt at all that even without the oil crisis inflation would have continued moving in the direction of double figures. After the steep increase in oil prices it is now to be feared that the number of countries with inflation rates of 10 percent or more in 1974 will be quite large. In countries recording a price rise of less than l0 percent the authorities will probably regard this as a notable achievement and cite it as proof of the success of their policies.
Yet it must surely be possible to bring this senseless development to a halt. And in this context ‘senseless’ is the right word. For no one who obtains a wage increase of 14 percent with prices going up by 10 percent is better off – or worse off – than he would be with wages rising by 8 percent and prices by 4 percent. After all, what counts are real wages, or, taking into account taxes and social insurance contributions, net disposable real wages. Discussion on income distribution should consequently focus far more than hitherto on the distribution of real national income, as reflected for individuals and groups of individuals in net real income. If there is general agreement on that score, it is in everybody’s interest that these real figures should be accompanied by as small a purely nominal increase as possible.
Summing up, I would say that on the eve of the oil crisis the main features of the international monetary scene were these.
(1) Discussions on international monetary reform were making little headway. There was already reason to doubt the possibility of having a definite reform plan ready and approved by the agreed target date of 31st July 1974.
(2) The dollar was beginning to show a rapid recovery, which was making for a more balanced situation and in itself improved the prospects for a successful monetary reform.
(3) Monetary co-operation within the EEC was at a low ebb. The key date of 1st January 1980, the target date set for the attainment of full economic and monetary union, was looking distinctly optimistic.
(4) Inflation was gathering alarming speed.
After the oil crisis most problems have become even more difficult to solve. It is my belief, however, that the direct consequences of the oil crisis can be mastered, provided the problems are properly judged and tackled energetically. After all, as far as their price increases are concerned, even the oil-producing countries have to cut their coats according to the cloth afforded them by the free-market economy.
Fundamentally, therefore, it is not the oil crisis but the depreciation of money at its present intensity that constitutes the most serious problem. This threatens to have socially disruptive effects, which may have drastic consequences. Runaway inflation invariably leads ultimately to a dictatorship. A democracy is not able to bear an unlimited degree of monetary depreciation. But since my speech was not devoted specifically to inflation, I shall not go into this subject in any further detail. The only thing I will say is that I honestly feel that the problem of fighting inflation, of combating the depreciation of money, is not receiving from the politicians the priority it demands.
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1978: “Defective Functioning International Monetary Framework”
A translation from Jelle Zijlstra, “Moderated Monetarism”, pages 275-279. Zijlstra’s 1978 analysis starts on page 273 and ends on page 288.
An autonomous wobbly factor in the world economy is the defective functioning of the international monetary framework. Since 1973 de facto, and currently, after the revision of the IMF statutes, also de jure, the world has to cope with a framework of floating exchange rates — not as some theoreticians wish and expect one of free and only market determined exchange rates — but one of floating exchange rates influenced by ad hoc interventions by the monetary authorities on the basis of considerations [given by] the moment. Beside this, the American balance of payments, more broadly the American monetary policy flooded the world with billions of dollars, so that drastic consequences for exchange rates could not have been [prevented]. The American dollar has also in these last years lost a substantial amount of its external value; viz. the [Dutch] guilder this loss amounted to 7% and in 1978 another 12%. Who at the end of the sixties would have foretold that the dollar in regard to the guilder would have become less valuable than before World War I — when the exchange rate was about f 2,50 — one would have been stared at compassionately. In regard to the German mark and the Swiss franc and the yen, the loss of external value of the dollar these last years was even greater than in regard to the guilder. Notwithstanding, the depreciation of the dollar as a weighted average against all currencies was considerably less, but this [can] for a large part [be explained] by the misfortunes of the two most important trade-partners of the United States, namely Canada and Mexico, something that can be considered a sober comfort.
On the causes for the depreciation of the dollar there has been much said and written. On this, a couple of broad points may be given attention to. Of course, a [prolonged and] deficient balance of payments has consequences for the exchange rate, certainly when deficits are voluminous and persistent. But while correction mechanisms normally kick in, this functions for a reserve currency nation not any differently. When a country has problems of deficits on its balance of payments, there are two fundamental limits to this process. There has to be sufficient internal liquidity for conversion of the offered foreign currencies, and the national currency reserves must be sufficient to supply the asked foreign currencies. In the United States, balance of payments deficits are in first instance financed through attaining dollars by non-American holders, whether private or official holders, or both. So long they hold these accumulated dollars because they trust the stability of its value, there are no problems yet. However, they create a potential source of disruptions. After all, a threat to the value of the dollar is not only enfolded in current account deficits, but also in the dollars accumulated from the deficits from the past. Especially the non-official dollar holders, the private holders can become worried. When they decide to sell (mostly with central banks as buyers against their own wishes), the exchange rate declines as a function of distrust, rather than as a function of the size of the deficit on the balance of payments in the running term. The scope of these phenomena can be established by looking at the amounts of dollars in the hands of non-Americans, including the investments of central banks. They increased in 1977 and 1978 all together with $90 billion (they increased from almost $160 billion to $250 billion), of which more than $65 billion found their way to monetary authorities. The problem of trust becomes extraordinary bigger by the existence of the Eurodollar market where dollar liabilities can be transformed in any currency at any moment if the holders wish so. This masse de manoeuvre is extremely significant; the meant dollar deposits outside the United States, within the Group of Ten amounted to $360 billion at the end of September, when one would include interbank deposits; and $230 billion without these interbank deposits. At last, one also has to consider investments with a dollar risk in a more general sense — for example equity portfolios — where in times of exchange unrest, cover can be found.
Against this background, the American program to accomplish a certain stability of the dollar on the foreign exchange markets must be seen as positive. Announced on November 1, this consists predominantly from an arsenal of resources to acquire strong currencies for the purpose of being able to intervene on the markets. It concerns a total of $30 billion, consisting of lines of credit for short and mid terms, as well as the employment of own reserves such as gold and SDR’s. It is good a thing to see that, after the insistence from many sides to the American authorities, an ear eventually was lend to. Beside a policy aimed at decreasing the balance of payments deficit, this intervention was the necessary oil on the waves of distrust. The initial success of this policy could justify a cautious optimism.
On the causes of the American balance of payments deficits, there are still a few other points to be made. This deficit consists not only or even predominantly from a deficit on the current account. Of the earlier mentioned $90 billion, two thirds were due to an outflow of dollars through the balance of payments, only a third emerged from a current account deficit. That this deficit on the current account could be presented as a result of oil-imports is an incorrect representation of affairs. This follows already, from a comparison with several other countries; Japan produces no oil and has a big surplus on its balance of payments, [and] the same applies to Switzerland and West Germany. The Netherlands has a significant energy production with natural gas reserves and notwithstanding, [we] accomplished successfully to create a balance of payments deficit. A balance of payments deficit (the same applies to a surplus) can principally never be explained from having been caused by only one component of the balance of payments. There must always be more general causes that determine the net position of payments received and paid for [to foreign parties] with which one will always find a monetary crux.
A deficit on the current account is a representation of national overconsumption that, in a certain way, is accompanied by monetary finance of one or several domestic [economic] sectors. This can be compensated through a positive balance of payments or can be increased through a negative balance of payments. Direct credit extensions by banks to non-residents are a special case among these [aspects]. In the United States, this component is very substantial: 1977 and 1978 together showed in this regard a creation of dollars of around $45 billion, thus practically almost half of the total dollar creation went through the balance of payments. The monetary policy in the United States could impossibly have been restrictive. This also follows from the development in interest rates by the way. The nominal interest rates for longer terms are, corrected for inflation, zero or negative. Even if at first sight the rate of expansion of the total money supply seems modest, a correction must be pursued. As it happens, the largest part of outgoing dollars have found their way to foreign central banks. These dollars are to a large extent invested so that they disappear from the registered money supply that thereby has become essentially [under-reflecte]. The conclusion must be that decreasing the American balance of payments deficit [can only result] from the implementation of restrictive monetary policies.
Earlier a point was made about the functioning of the Eurodollar market, namely with the explanation of the tendency of the dollar to depreciate on the foreign exchange markets. Recently, the discussion on this market, [or] more broadly defined, the Euro foreign exchange markets, was revived. Calls for some form of regulation of this market can again be heard, after it initially was stupefied when this market fulfilled an important role with sluicing back the oil revenues in the international payments circuit. With this question of regulation, one must discern macro-economic and micro-economic aspects. Banks that have subsidiaries or side offices in other nations, do not, in every instance, have to follow domestic rules [and regulations] in regard to solidity, in their offices elsewhere. Increasingly, awareness that this does not suffices, grows. The supervision on parent banking companies, through consolidation requirements, should be stretched in order to reach beyond national borders.
Beside this, there is the macro-economic aspect. When monetary authorities want to restrict extending credits in order to manage domestic circulation, this of course, is limited to domestic residents. Credit supply to non-residents remains unaddressed. Here, credit supply is possible outside of the control of monetary authorities, unless capital inflows in countries from where [dollar] loans are contracted can be sufficiently impeded. These possibilities would also exist without the institutionalized Euro foreign exchange markets, but it is clear that their presence has increased the volume of these transactions exceptionally. If with this an uncontrollable inflationary potential is created, a question then emerges. The answer cannot be simply given while it should first become clear if the result is a net creation of credit, [or] put differently, whether there would have been an even net credit expansion without this market. Whatever is the case, the discussions about the desirability and possibility of regulations of the Euro foreign exchange markets are intensified. Technically, this is a very complex problem. Under any circumstances, it may never be forgotten that from a monetary perspective, the objective of interest should be on the credit extensions to non-residents, in whatever currency of denomination.
At last, there is an additional question with and surrounding the dollar after the events of these last years. The international monetary framework is de facto more then ever based on the dollar. Practically speaking, we live under a dollar standard. This means that the fortunes of the dollar, its erosion of value and its instability, also feed back on the functioning of the framework. In and outside the United States the awareness grows that “something differently” is needed. One can say that a solution in first instance is found with the implementation of SDR’s in 1967. But the success of this alternative to the dollar as the pivot of this international monetary framework has thus far only proved itself limited. Especially, so long the SDR cannot be freely exchanged on markets — currently it only functions as means of settlements among central banks and in first instance only allows for settlement of deficits — its emergence is stuck. The broad basis of trust that must be met for such an emergence of [the status of] the SDR is apparently not there. One could also think of solutions whereby other currencies could support the dollar by adopting the function of acting as reserve currency to a certain degree. This will not be simple. The question of repairing the intensive cooperation of the countries of the G10 (along with Switzerland), that led astray during those turbulent times in the first years of the 1970s, would then however return to the agenda again. It should come down to a systematic categorization of and institutionalization of ad hoc arrangements that has been agreed to in this year of annual reporting [read: 1979] to support the dollar, without continuing to extend an unlimited monetary credit to the United States. It has not come that far yet, however. The conclusion cannot be any otherwise than that we will have to work with a relatively deficiently functioning international money-system. Thereby, pragmatic solutions will have to be pursued to accomplish more stability on the international foreign exchange markets. That a substantial decrease in the American level of inflation is an absolutely necessary condition for this will by now not necessitate any further elaboration.
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1981: “Central Banking with the Benefit of Hindsight”
Below is the lecture held by Dr. Zijlstra for the Per Jacobsson Foundation in Washington on Sunday, September 27, 1981. The Per Jacobsson Foundation has published all the lectures held since its inception in 1964 on its website and I am happy to send forward an invitation to look at their collection of lectures.
It is well-nigh indisputable that the present time is far from easy for central banks and their governors. Not only must they do their work under more difficult circumstances but they are also subject to a degree of public and political interest, which does nothing to ease their burden, let alone make it pleasurable.
My intention in this talk is to discuss this subject against a background of nearly fifteen years’ experience as president of the Netherlands Bank and of a similar period as president of that remarkable institution, the Bank for International Settlements at Basle. But first allow me to give you some details of my career before I entered central banking; as you will see, this may be useful for a proper understanding of some of the points I wish to make.
After completing my university studies, I was appointed in 1948 as professor of economics at the Free University of Amsterdam. During my studies I had observed that the academic world in general had little sympathy for central banks. Even now, this is often the case. I could give colourful examples of what I mean, but shall refrain from during doing so, not wishing to damage the reputation of the persons concerned. However I cannot possibly resist the temptation to give one example. It is from a recent interview with Professor Galbraith. ‘The people who man the central banks are nice men, and in our case one woman; well spoken, well tailored and of good personal hygiene. I would be kind to them and keep them in business in a minor way, but I would not for a moment rely on them. One of the mysteries of monetary policy in the U.S. has always been how one becomes an expert in it. You can have a man in high political position in Washington, who has difficulty balancing his checkbook and keeping within his family budget. But one day the President appoints him to the Federal Reserve Board and all of a sudden he is a monetary wizard. That is a form of magic that I have long admired.
Well, I don’t want to be too harsh on those people, but I certainly don’t want to rely on them for the management of anything so complex as the modern economy. To some extent the tension that exists between economics in an academic context and the actual policy pursued by the central bank is natural and understandable. After all, on the one hand we have the builders of abstract models who are not confronted daily with real problems, and on the other hand we have those persons whose over-full diaries sometimes prevent them from reflecting on the fundamental relationships which could provide solutions to some problems in the longer term. I have had experience of both these worlds. In retrospect I am somewhat amazed at the carefree way in which the young professor of yore told his students how central banks should behave, In my present position I have been surprised several times by the unworldly suggestions which are occasionally directed at central banks by academics.
In 1952 I became a member of the Dutch Cabinet: first as Minister of Economic Affairs, and later, until 1963, as Minister of Finance. In this latter function I naturally learned much about the Central Bank. There are specific areas of friction between the Minister of Finance and the president of the Central Bank, which are not the result of theory versus practice, but are a consequence of the division of powers between the monetary authorities; these powers are vested in part in the Ministry of Finance and in part in the Central Bank. I am assuming now that the Central Bank is to a certain extent independent of the government, whether de jure or de facto (or both). By this I mean that it has its own powers either based on statute or on the authority it has in the eyes of the public. It is clear and also inevitable that differences of opinion will arise from time to time which may lead to open conflicts and which have in practice also done so. In saying this I am not thinking of The Netherlands because in that country such a situation has not yet occurred. As Minister of Finance I realized at an early stage that my office would benefit most by achieving the best possible relationship with the Central Bank, with full recognition of its powers and authority. After all, the finance minister is badgered from all sides by the ministers of the spending departments, who will always conspire to spend more money than is justified by a sound financial policy. In this struggle he is inevitably alone and consequently lonely. If the relationship is good, his best ally is the central bank. A government is sorely tempted to try to solve its problems by resorting to so-called monetary financing, but without the active cooperation of the central bank this is possible only for a short period and within narrow limits. Therefore in the world in which we live, with its deep-seated inflationary tendencies, there is an immense need for a close alliance between these two parties. I felt this at the time and I acted accordingly. It also made me bold enough, when the roles were reversed in 1967, to try and impress this philosophy upon successive ministers of finance.
I joined the Netherlands Bank in 1967, a year in which the serious problems which would give rise to grave concern at the central bank were already apparent.
I intend this afternoon to examine – looking back and sometimes ahead – three problems, which have engaged us so fully in past years and which also confront us in the future:
1. the exchange rate system;
2. international reserves;
3. monetary policy in theory and practice.
First, we shall take a look at the exchange rate system. In the 1960s the existing international monetary system was subjected to increasing pressure. Fixed exchange rates, which could only be changed when there was a so-called fundamental disequilibrium, proved to be insufficiently flexible in the increasingly more severe financial climate. Nor was this all. The Bretton Woods system was based on the principle of maintaining or restoring equilibrium on the current accounts of the balances of payments. Movements of capital were given no or only slight attention because it was assumed that they were relatively unimportant or that they would not really disturb balance of payments equilibrium. If need be, restrictions could and should be placed on capital movements. Last but not least the 1960s saw a growing disequilibrium in international payments, this consequent on the deficit on the United States’ balance of payments. The dollar became overvalued and the United States found it increasingly difficult to meet its obligations to convert the dollar (into gold). It is my firm conviction that a devaluation of the dollar combined with a substantial increase in the price of gold (as provided for in Article IV of the then Articles of Agreement of the IMF) would have meant a real improvement of the situation. The stability of the international monetary system would have been considerably strengthened. As a result it would not have been necessary to conclude, too early, that the Bretton Woods sytem could not be maintained, as was done in 1973 on the eve of the great oil crisis. In other words, the shock of the oil crisis would have come up against a much more stable system. This does not mean that a system of fixed exchange rates would have been stable enough, even if it had been strengthened by the two measures I mentioned above, to survive this shock. But the resulting chaos would have been significantly less.
The discussions about the best system of exchange rates will probably never lead to a definitive answer. Too much depends on the actual time and place. There is a time to peg and a time to float. However, a closer analysis is called for. In my speech to the Annual Meeting of the BIS in June of this year I said: ‘Obviously, there is no question of going back to a par value system on a worldwide basis – to mention only two obstacles, the OPEC surplus and the dispersion of inflation rates rule it out. But, if the domestic price of money is not to be disregarded, why should its external price be? Or, to put it another way, what would happen if we were to disregard both for any prolonged period? We cannot safely adopt as a principle that exchange rates should be left to their own devices. The exchange rate is too important a macroeconomic variable to be relegated to the position of a residual item in the way that the money supply was in some countries until not so long ago. We have therefore to pursue a middle course between the Bretton Woods sytem of fixed exchange rates and a hands-off policy in the exchange market.’ But it will not be easy to find the middle course. I hope that in the turmoil of rapidly changing conditions which seriously hamper the realization of any new exchange rate system, it will be possible at any rate to achieve a greater degree of consistency of views and policies. Let me give an example. After a period of what was succinctly, but not entirely accurately, termed ‘benign neglect,’ the American authorities changed direction sharply in 1978. President Carter announced a massive support operation for the steadily weakening dollar. As this happened fairly recently I need not go into the details. At present the policy is again one of nonintervention on principle and the value of the dollar has risen very sharply. Should we speak of an asymmetrical policy? Intervention when the dollar weakens, nonintervention when it strengthens? Or, expressed in slightly malicious terms, does the philosophy behind the policy depend on the circumstances? How should others respond?
My own answer is a paraphrase of Walter Bagehot: ‘rates of exchange will not manage themselves,’ or ‘rates of exchange are too important to be left alone.’ The principle contained in that answer is explicitly recognised in the Bretton Wood type arrangements, which exist within the European Monetary System for fixed but adjustable rates of exchange, with narrow margins of permitted market fluctuations, between the currencies of the participating countries. These arrangements have, in my view, provided a useful zone of relative exchange rate stability in Europe and I very much hope that they will continue to do so. For that to be possible two main conditions will have to be fulfilled: first, there must be sufficient harmonization of economic policies within the EMS to allow a reasonable degree of exchange rate stability; and secondly, changes in exchange rates, when these become necessary, must be made more promptly than was sometimes the case in the Bretton Woods system. To sum up what I believe about the application of my exchange rate philosophy under our current arrangements I would say the following: we need sufficient management of floating rates to avoid movements of currencies that are erratic or completely unrelated to fundamentals; and we also need, within the EMS system, sufficient flexibility to maintain a realistic structure of rates between participating currencies.
Central banks play very difficult roles under different exchange rate systems. Our life was relatively simple under the Bretton Woods system of fixed parities. The rates were fixed or they were changed by government decision, often on the advice of the central bank. Within the Group of Ten and Switzerland, our activities at the time were especially the organization of support for currencies under threat. Our friend Charles Coombs was the ideal salesman in such support credits. How shocked and sad we are today that he is no longer amidst us.
Yes, we were experts at gathering millions in a very short time. In this respect some of you will remember the slightly chaotic Group of Ten conference of Bonn in 1968: ministers who were unable to reach agreement about anything far into the night, and central bankers who in a single hour succeeded in organizing large-scale support operations for the pound sterling and the French franc. For the rest the central bankers were ignored. It is a pity that there are no newsreels showing the frustrated and irritated central bank governors roaming through the rooms and passages.
Under a system of floating rates, especially one of ‘clean floating,’ the task of the central bank is also easy. The work is done by Mr. Market. However, I fear that it is not as simple as that, as I shall show when I discuss monetary policy. The control of the monetary supply, the levels of the exchange rates and of interest rates influence each other in such a way that one cannot afford to ignore any one of them. We are willy-nilly caught up in a triangle with the points called money supply, exchange rates and interest rates. The life of a central banker has truly become more difficult.
In the period I am discussing, it was not only exchange rates but also the problem of international reserves, which played a major role. It will be remembered that the Bretton Woods system, besides providing fixed exchange rates based on gold parities, was also a system in which the ultimate reserve asset was gold. It is true that in practice it was mainly the dollar, which constituted the actual reserve asset but, owing to its convertibility, the link with gold was defined. In August 1971 all this came to an end. The second amendment of the Articles of Agreement of the International Monetary Fund, which became effective in 1978, settled the problem in a basically different manner. Gold and reserve currencies would gradually have to make way for the SDR. How far have we progressed in that direction? At present the principal gold-holding central banks refuse to give more than a moment’s thought to parting with their gold reserves and thus effect a de facto demonetization, either by selling gold in the market against foreign exchange or by placing it in a – not yet existing – substitution account within the IMF against the receipt of SDRs. The dollar has remained the most important reserve currency, although some room has had to be made for other currencies, such as the Deutsche mark and the Swiss franc. Their joint role as reserve currencies has not been reduced in favour of the SDR, as provided for by the Articles of Agreement of the IMF. What has happened to gold? During the period described here, gold was often at the centre of attention. It would be interesting to repeat here in detail the many different statements about gold made at the various international meetings since 1971. I shall refrain from doing so, but I should like to touch briefly upon those aspects of the history of monetary gold which would seem to be significant for future developments. It all started at that remarkable gathering of the governors of the central banks of the Group of Ten and Switzerland in Washington on March 16-17th, 1968, which led to the end of the gold pool. Present were the governors of the central banks participating in the gold pool, viz., those of Belgium, Germany, Italy, The Netherlands, Switzerland, the United Kingdom and the United States. The IMF was represented by Pierre-Paul Schweitzer, the BIS by Gabriel Ferras and Milton Gilbert. Also present was Fred Deming, Under-Secretary of the United States’ Treasury. The result was a two-tier system, providing for a separate development of the gold price in the free market as distinct from a fixed price for monetary gold, then $35 per troy ounce. The communiqué of that meeting included the following sentence: ‘They no longer feel it necessary to buy from the market.’ During the meeting this sentence had been the subject of heated discussion. Some of the participants, including myself, opposed it, as we felt it could be interpreted as an undertaking that the central banks would never again make market purchases of gold. Thus the combined holdings of monetary gold would have to be regarded as fixed, serving merely as an instrument of settlement among the monetary authorities. Newly produced gold could then be sold on the free market only. The counterargument which was advanced stressed that the sentence could be most useful as it would have a calming effect on price movements in the free market and would, hence, check speculation. It was this argument which finally swayed the opponents. However, no sooner had the communiqué been issued than the first interpretation was widely accepted. Yes, indeed, so it was stated, the central banks had decided never again to buy gold from the market. Interested parties and especially the U.S. authorities kept a close watch to check whether the central banks adhered strictly to this supposed undertaking.
All this is now far behind us. Step by step, not always painlessly, the freedom of central banks to effect transactions in gold, whether among themselves or in the free market, has been restored. The present Articles of Agreement of the IMF merely forbid a new official gold price. How times have changed may be illustrated by the example of the monetary mobilization of part of the gold holdings of the central banks participating in the European Monetary System. How times have changed is also illustrated by the Act signed by President Carter on October 7th, 1980 approving an increase in the U.S. quota in the IMF and including the provision that the Secretary of the Treasury shall establish and chair a commission which shall conduct a study to assess and make recommendations with regard to the policy of the U.S. government concerning the role of gold in domestic and international monetary systems, and shall transmit to the Congress a report containing its Findings and recommendations not later than one year after the date of enactment of this Act. At least gold is no longer a dirty word. Nevertheless, the present position cannot be termed satisfactory. The central banks of the principal countries hold vast reserves of gold. The Netherlands Bank, for instance, has gold holdings which, at current market prices, account for 66% of its total reserves. It is most frustrating that, sales in the market against foreign exchange apart, there is no systematic manner in which this reserve component can be used. I feel that it is necessary for us, within the Group of Ten and Switzerland, to consider ways to regulate the price of gold, admittedly within fairly broad limits, so as to create conditions permitting gold sales and purchases between central banks as an instrument for a more rational management and development of their reserves. On the occasion of the annual meeting of the IMF in Belgrade in 1979 this was brought up, but regrettably insufficient agreement could be reached to make even a modest start with regulating the gold price in the free market. It is my firm conviction that relatively small-scale interventions, though not forestalling the subsequent explosion of the gold price, would at least have reduced it to more manageable proportions. Now that the turbulent emotions seem to have subsided, we would be wise to reflect anew and without prejudice on these subjects.
Finally, I should like to give some attention to the SDR, the pivot of a new international monetary system. All of us are supposed to want the new system and are thus under a moral obligation to further its realization to the best of our ability. However, those talking part in the many discussions which are devoted to the SDR do not, in my opinion, always evince an adequate insight into the problems we will face if the SDR is actually to become the pivot of a new international monetary system. Such a new system requires that two conditions be met. First, greater exchange rate stability is essential. If exchange rates are left to be dictated by market forces, reserves are basically unnecessary. In the fullness of time the SDR will have to be the fullfledged instrument of settlement. If no settlements take place, or if this is done erratically or unsystematically, there is no need for a fundamental instrument of settlement. Second, and in connection with the first condition, convertibility will have to be restored. In an orderly international monetary system, in which the SDR is given the role formerly played by gold, major currencies, including the dollar, must be convertible into SDRs. Whoever truly wishes to make the SDR the pivot of a reformed international monetary systems, and shall transmit to the Congress a report containing its others and perhaps even himself.
All this is not of course feasible at present, so that the role of the SDR will continue to be a marginal one for some time to come, even though its significance as a unit of account is on the increase. This also means that there will be no substitution account in the near future and that the allocation of SDRs will have to remain limited.
We now come to my third subject, viz. monetary policy in theory and practice. When, in 1967, I entered the world of central bankers, monetarism had not yet become a political slogan. Of course, Milton Friedman was not unknown. His monumental work A Monetary History of the United States was rightly renowned, and not only in academic circles. His lecture in 1970 on The Monetary Counterrevolution was an exceedingly lucid exposition of what is now termed monetarism. But is was only as a result of the inflationary waves of the 1970s that monetarism broke out of the confines of the world of the professors and spilled over into politics. Ministers of finance, heads of government and even heads of state must cudgel their weary brains over the secrets of M1 to Mx, over the monetary base and the money multiplier.
In passing, it is interesting to note that something comparable happened to Keynesianism, which was widely taught as an economic theory at all universities after 1936 but did not become the basis of the economic and financial policy of nearly all the important countries until after the end of the Second World War.
In examining the many problems involved here, it is necessary to be aware of the fact that monetarism like Keynesianism has many variations and nuances. Some stylization, perhaps even simplification, is necessary to provide, in the short time at my disposal, a type-casting of what I should like to term the typical monetarist. My typical monetarist’s creed has three articles:
(a) a politicoeconomic or in other words an ideological one;
(b) an analytical one; and
(c) one on the techniques of monetary policy.
I shall examine each of these briefly. Our monetarist is convinced that the public sector is relatively unstable and that the private sector is relatively stable. The instability of the public sector is related to the fact that it is much to large in most countries, that politicians frequently make irrational decisions, based on insufficient knowledge of complex social and financial problems, whereas private sector behaviour is in principle ruled by rational expectations and rational reactions to the impulses from the market economy.
In the typical monetarist’s analysis, the control of the money supply is both necessary and sufficient for an effective macroeconomic control of the national economy. Naturally, this instrument may not be perfect but is by far the most efficient instrument we have at our disposal.
Finally, in order to control the money supply, the use of the so-called monetary base is necessary and sufficient. It makes it possible to control the money supply continuously and with the required precision.
To a central banker, these three points vary in importance and each carries a different weight: the view one takes of the relative stability or instability of the public and the private sector is often rooted in the individual’s economic philosophy. Phrased differently, this view is ideologically flavoured. My own opinion is that a great deal depends on the concrete circumstances of time and place. In the 1930a the private sector was undoubtedly comparatively unstable and it is not surprising, then, that traditional Keynesianism is based on the relative instability of the private sector, which needs to be corrected by government measures; consequently, this line of argument assumes a relatively stable public sector, which must support the shaky private sector and save it from collapsing. In present times, this is no longer quite so. In many countries the public sector is overburdened and in danger of being crushed by a multitude of tasks and responsibilities. As a result, the possibilities of using the public sector to stabilize the entire economy have become substantially fewer. An added factor is that in the postwar years the private sector has shown a high degree of resilience, even in the face of heavy external shocks. Ideological bias aside, the purely pragmatic conclusion is warranted that the balance between stability and instability within, respectively, the public and the private sectors has shown a distinct shift since the 1930s.
The second article of the typical monetarist’s creed brings us closer to the central banker’s job. We are concerned here with analysis, leading to the thesis that for controlling the economy as far as possible the monetary policy instrument is both necessary and sufficient. All other instruments, fiscal policy in particular, are erratic and have a procyclical and, hence, destabilizing effect. In this view, wage and price policies are doomed to fail.
It is solely the control of the money supply by the monetary authorities, in the form of inflexible monetary expansion targets published in advance, which is capable of stabilizing the private sector and of preventing or eliminating inflation. This is demonstrated with the aid of that famous equation MV = PT. In the longer term, the volume of transactions (T) is governed by nonmonetary factors, the velocity of circulation (V) is, likewise in the somewhat longer term, stable, so that the level of prices (P) varies in proportion to changes in the money supply (M). If governments are sensible enough to keep or reduce the growth of the public sector within acceptable limits, adequate macroeconomic control of the economy is feasible. This line of reasoning is further strengthened by the theory of rational expectations. Those in charge of the public sector, the politicians, often act irrationally and unpredictably.
Those taking part in the economic process in the private sector are guided by rational expectations, especially as regards inflation. They have learned to see through the money illusion. Firm standards for the growth of the money supply aimed at preventing or eliminating inflation dissipate inflationary expectations and thus constitute, by themselves, an essential contribution to the fight against inflation.
As to this major issue in past and present discussions, I should like to give a brief outline of my own views before we come to the technique of monetary policy.
In my opinion, as an instrument for adequately guiding the economy, control of the money supply is necessary but not sufficient. Fiscal policy plus wage and price developments cannot be dispended with or ignored. In theory, but in theory alone, it can be maintained that control of the money supply is sufficient. Any borrowing requirement can be covered by non-monetary means, provided that one is prepared to accept any interest rate level and may degree of crowding out of private investment. Any discrepancy between wages and productivity can always be eliminated by sufficient stagnation of output and employment. But, let me repeat, this is pure theory. There is a size of the borrowing requirement and there is a degree of discrepancy between productivity and nominal wages which simply precludes any possibility of conducting an effective monetary policy. The reverse is, of course, also true.
The foregoing can also be phrased in a different fashion. Monetary policy, fiscal policy and wage movements commensurate with productivity are each other’s constraints. In this framework, an effective monetary policy aimed at controlling the money supply is necessary but not sufficient. Finally, in addition to the ideological and the analytical problems, there remains the technique of monetary control, which is one of the most relevant issues for central bankers. In the reasoning of our monetarist, the money supply can be adequately controlled by controlling the monetary base, which consists of the banks’ credit balances with the central bank and the banknotes held by the public. Both these items appear on the liabilities side of the central bank’s balance sheet and both can therefore be controlled by the central bank. This possibility of control flows from the assumed predictability and stability of the money multiplier, which relates the money supply to the counterbalancing reserves held by the banks with the central bank. It is furthermore assumed that there is a workable definition of the money supply. In the monetary literature we often come across the term of narrow money, M1, consisting of banknotes and demand deposits. But its use is not strictly necessary. In various measures of the money supply are distinguished (M1a , M1b, M2, M 3 …… Mx), each with its individual money multiplier. In the United Kingdom a relatively broad definition of the money supply is employed, M3, which also includes savings deposits with the banks. Before going on let me briefly summarize the various elements of the monetarist creed.
Our true-blue monetarist believes:
(a) that the central bank is able to control the monetary base;
(b) that the money supply is thus controlled through a stable money multiplier;
(c) that the level of prices is thus controlled assuming a stable velocity of circulation;
(d) that the private sector is thus adequately stabilized;
(e) that, if the size of the public sector is kept within certain limits, a reasonable degree of macroeconomic control is thereby ensured.
The many discussions about monetarism centre not least on the techniques used. They have become political issues and have even made their way to the lofty heights of the summit meetings of the political leaders of the world. Do not we, central bankers, at times stand somewhat helplessly on the sidelines? Have the central bankers among themselves come to a consensus as to the best, the most adequate monetary techniques? Let me briefly dwell upon this point.
It would appear to me that there is at any rate a large measure of agreement about one important aspect. Monetary policy is, by its very nature, a policy as to quantity. In the past many central banks pursued a policy directed towards one or more interest rates so as to achieve or maintain a certain interest rate level. The resulting money supply was accepted as a dependent variable. It is clear that such a policy cannot be expected of produce that money supply which must be considered proper from the point of view of the stability of the economy and of the maintenance of the value of money.
This does not mean that in pursuing a policy aimed at controlling the money supply, interest rates can be neglected; I come to that later on. The question now before us is this: in what manner can the money supply be controlled by the central bank and what are the pros and cons involved?
The customary variants of a policy aimed at controlling the money supply fall, roughly speaking, into two main categories, viz. direct and indirect methods. Under the direct method, some sort of ceiling is imposed upon the activities of the banking system so as to ensure that money-creating lending operations remain within the limits set. Not all central banks have the powers to do this. In The Netherlands and in France, for instance, the central banks have, and are currently exercising, these powers. Under the indirect method, the central bank seeks to control the money supply by controlling other variables which are assumed to bear a sufficiently fixed relationship to the money supply. Here the interest rate level is of major significance as an essential part of the transmission mechanism which maintains or restores the relationship. The so-called monetary base method is the principal example of the techniques in question. You will allow me to analyse briefly the most frequently used monetary technique with the aid of the variant employed in The Netherlands. In my country we have had at our disposal for many years the instrument of credit ceilings known in French as encadrement du crédit. If the expansion of the money supply threatens to assume unduly large proportions, the Netherlands Bank can impose restrictions on the volume of lending by the banking system. In the past, this power was exercised repeatedly; the last restrictions were imposed as of 1977. They were suspended recently, as the banks’ lending had remained below the prescribed ceiling for a sufficiently long period. The system works as follows: a certain maximum percentage increase is fixed for the total assets of the banking system, except for short-term paper issued by the public authorities (an exception which may be cancelled in the future). However, long-term funds raised or received by the banks or, in other words, genuine savings, may be used for lending without restriction. The room allowed for the expansion of lending is thus increased by the amount of such long-term funds. Expressed differently, lending by the banking system is restricted to the extent that it is money-creating, and is not restricted to the extent that it is financed from long-term funds. The result is that any demand for credit over and above the volume allowable from a monetary point of view is shifted to the capital market, and may thus push up capital market rates. Experience has shown that the monetary instrument employed by the Netherlands Bank results in fairly effective control of the money supply and is attended by a distinct effect on long-term interest rates.
An additional instrument of the central bank in The Netherlands is aimed at controlling the liquidity of the banks – money market policy. Whereas for other central banks this is the instrument for attempting to control the money supply, this is not the case in The Netherlands. The Netherlands Bank controls the liquidity of the banking system in such a manner that short term interest rates are in normal proportion to long-term rates, due attention being given to the exchange rate. This policy is implemented with the aid of semipermanent borrowing quotas available to the banks, complemented, where necessary, by an open-market policy. This means that, in exceptional circumstances only and especially in the event of heavy speculation against the guilder, a tightening of money market policy will cause short-term interest rates to rise temporarily to well above capital market rates.
Put differently, the basic monetary policy designed to control the money supply effects this control on a medium-term basis, influences long-term interest rates and thus also, of course, contributes to achieving overall equilibrium on the balance of payments. The money market policy is a short-term and complementary one; it avoids major fluctuations in short-term interest rates whenever possible and, hence, also tries to prevent exchange rate movements which are not a reflection of the underlying position and development of the balance of payments.
Does this technique of monetary policy merely have advantages and no drawbacks? It has one major drawback. The allowable credit expansion for each individual bank must be based on figures from the past. If credit restrictions of this kind are continued for too long, they tend to have stifling effects on competition, counter to the fundamentals of the market economy. Consequently, a number of years of such restrictions must be followed by a sufficient number of years without them. It will be clear that in times of persistent inflation, as we are witnessing now, such a break is far from easy to effect.
The monetary policy now being pursued in the United States aims at controlling the money supply by regulating the liquidity of the banking system. I need not go into details about the precise technique used. Let me just say that it is based on an assumed stability of the relationships between the various components of the money supply (M1, M2……………Mx) and their respective required reserves. This cannot but lead, as it has proved to do in practice, to wide fluctuations in short-term interest rates and at times to very large differences between short-term and long-term rates. This may also cause substantial exchange rate movements. Recently, this monetary policy has been subjected to severe criticism. To a certain extent, this is understandable. A monetary policy which gives rise to prime rates of 20% at a rate of inflation of around 10%, which pushes up the exchange rate to a level far out of line with the underlying balance-of-payments position, and which thus has serious dislocating effects internationally, simply asks to be called into question, apart even from the preoccupation with weekly money supply figures which it calls forth and the destabilizing expectations thus arising with regard to interest rates in the money and capital markets (in this context, Alexander Lamfalussy uses the term pig-cycle effect, known from economic theory). I find it hard to believe that this technique of monetary policy is the best conceivable one. Yet, this criticism needs to be qualified. The fact that in the United States the fight against inflation is waged with consistency and a strong sense of purpose deserves our warm approval. It is only with regard to the monetary techniques used that doubt is possible, but even this doubt must be seen against the background of the frequent failure of the critics to suggest suitable alternatives.
I outlined these two types of monetary policy to illustrate the point that, as far as the question of the optimum policy for an effective control of the money supply is concerned, we as central bankers unfortunately have to speak of unfinished business. I also encountered this in the circle of the countries participating in the EMS. A multitude of instruments, differing from one country to the next, makes a harmonization of policies extremely difficult. However, here we are in an area at the heart of central banking. In this very area we are under criticism from political and academic quarters, and increasingly so in my opinion. In the future, we shall have to intensify our discussions on this subject, for instance in Basle, so as to reach greater clarity on this issue, if only to save our hides.
Let me conclude this lecture. After the Second World War, the central banker’s life was, comparatively speaking, fairly simple. Fixed rates of exchange, the absence of inflation or at most a very low rate of inflation, small public sector deficits in many countries and often trade unions open to reason: under such conditions, controlling the money supply is a relatively simple matter. However, somewhere in the mid-1960s and in subsequent years, many of these comfortable certainties disappeared, the storm broke and we have not emerged unscathed. We are now facing the formidable challenge to regain in the last two decades of this century some of what we lost on our way. By trial and error we will have to find our route. Where should it lead? To renewed stability of exchange rates, and to the breaking of the backbone of inflation also through an appropriate monetary policy. The central banks are faced with a difficult task. In performing that task, they will not invariably receive support from the world of politics and politicians. In his brilliant Per Jacobsson lecture of 1977, Arthur Burns was candid on this subject; after complaining that the government is so often busy ‘to enlarge the flow of benefits to the population at large, or to this or that group,’ he described why it was so difficult politically for the Federal Reserve System to keep the money supply under control: ‘If the Federal Reserve then sought to create a monetary environment that fell seriously short of accommodating the upward pressures on prices that were being released or reinforced by governmental action, severe difficulties could be quickly produced in the economy. Not only that, the Federal Reserve would be frustrating the will of Congress to which it was responsible – a Congress that was intent on providing additional services to the electorate and on assuring that jobs and incomes were maintained, particularly in the short run.’
No, life is not going to be easy for central bankers in the last two decades of the twentieth century. But however difficult it may prove to be, we central bankers should remain intent on what I see as our primary task – irrespective of the many differences in our statutory positions – to be the guardians of the integrity of money, the integrity of money so dear to Per Jacobsson, in whose honour this lecture was given.
* * *
1992: Gold as the Monetary Cosmos’ Sun
From Zijlstra’s 1992 autobiography “Per slot van rekening”, or “Final Settlement, a translation of pages 219-237 in which Zijlstra reflects on the unfortunate monetary events once more and shares his thoughts on the road to a European monetary union. I decided to recycle the title of my earlier article, for indeed, as Zijlstra eloquently explains: gold is the monetary cosmos’ sun.
Before I continue with the functioning of DNB in national economic affairs, I call for attention for international aspects of the work of the bank during the years of my Presidency [of DNB]. As I summarized earlier, it hasn’t been an easy period in that regard. The orderly system of fixed parities with which the post-war international framework started, lasted to the early 1970s. Thereafter, we stumbled from conference to conference, from communiqué to communiqué. It eventually ended almost systemless. Firstly the last years have brought some order again, mainly because of the monetary cohesion within the EEG countries that seemingly can evolve into a true monetary union with its own currency unit. With that, the [international] field [of currencies] will become neater because it would then only revolve around three leading currencies, the American dollar, the Japanese yen, and the European unit (the ecu), although also then the dollar would have a dominant role. This will remain so until there emerges a truly global monetary framework with a sufficient degree of firmness between the three mentioned currencies. The other, strictly theoretical, possibility is a world-central bank to which monetary policies in the most important countries must be subordinated.
When I commenced in 1967 the framework of fixed exchange rates was based on gold. Each important currency was defined as equal to a specific amount of gold with following from this normal, fixed exchange rates.
When in a country things went wrong, because of extravagancies in government budgeting, because of escalating wages, because of excessive growth of money supply or like it almost always was, because of a combination of these three adversities, then the gold content of such a currency could no longer be maintained and a currency [then] had to be devalued. The currency unit would become equal to a lesser amount of gold and lost as a consequence value in regard to all other currencies. In the economic literary works it is described at length that and why such an operation can contribute to a recovery of the equilibrium of such a country. A currency devaluation was considered a defeat for a country, a testimonium paupertatis for a country. One could not pursue such a step [under Bretton Woods] just like that, such a step had to be examined by the International Monetary Fund, the guardian of the framework. And one could receive permission only when a country was profoundly [on the wrong track]. Only a situation that could be characterised as a fundamental imbalance was allowed repaired; temporary, via other measures repairable accidents, not. It was an orderly system, a sort of planetary universe with a convertible dollar in gold as the sun. All other currencies circled around it. This view is not completely apt because the planets in our solar system are in an everlasting position, while in the currency framework their positions can be altered through re- or devaluation. However, it remains an appealing comparison because it projects a view of an orderly cosmos that provides certainty to its participants, certainty that is uppermost important for international trade and payments.
But change was in the air. In 1961 something peculiar had already happened. Germany and the Netherlands changed their parities, not because they had performed badly but because the opposite held true. Most countries surrounding [Germany and the Netherlands] displayed in a greater or lesser degree, the collection of misfortunes as mentioned earlier, and then one must, as a relatively healthy nation, decide wisely. You can be sucked into a wrong direction under fixed parities, or you can choose to change the value of your currency, but upwards – a revaluation – whereby you neutralize the dangers that are coming from outside. You ‘put a bit more gold in your currency then’ and that [currency] becomes more valuable in regard with all others. Summarizing: it is about the choice between ‘adjustment’ inflation, or revaluation. Germany decided to revalue the German deutschemark on March 3, 1961 with 5 percent; we decided as mentioned previously to follow. To my regret, then and still, Germany did not revalue more; I would have defended a revaluation of 10 percent zealously if Germany had done so.
At first, it seemed as if everything had remained the same but this was only appearance. The taboo that parities were to remain the same unless the balance could only be restored through devaluation was broken. Now, revaluation was accepted as an instrument of policy.
I shall describe several much telling events on the way from monetary cosmos to the monetary chaos whereby emphasis is given to the manner in which these events were experienced in the Netherlands, how these played out in the functioning of politics and which role the [Dutch central] Bank had with these.
It is perhaps nice to get into the role of gold and its meaning in the time before the monetary cosmos collapsed into more chaotic conditions. Throughout centuries gold was a protection against [natural] disasters, arbitrariness, and persecution. The high density of gold and its high intrinsic value mean that it is easy to hide or easily taken with you fleeing. Because natural production levels hardly allow overproduction with substantial depreciating values as result; because it does not rust and, once produced, never perishes, excessive scarcity can never occur. That’s why gold developed its image of solidity, stability, and reliability. Beside, there is of course this romantic semblance that has always accompanied gold because it is beautiful and thereby is identified with precious jewelry, important monarchs and pretty ladies. Gold coins then have been used over the centuries as means of exchange in primitive currency frameworks and were later, with the development of paper money, seen as a reliable basis. In the heydey of the gold standard one could take a banknote to the central bank and — if you would like that — get gold in return. The famous Englishman Bernard Shaw once said one has the choice between the natural stability of gold and the natural stability of honesty and intelligence of government. And he was of the opinion this choice was not hard.
The intrinsic value of gold along with its romantic image has until the 1960s dominated the international monetary framework. It was perhaps a bit irrational anchor however a stable anchor. Eventually, this changed, not because old-fashioned understandings had been replaced by more modern, but because the United States of America found the role of the dollar threatened by gold. So long the dollar and gold, like a Siamese twin were linked to one another, the international monetary framework could be supported, [and] there was no problem. From the 1960s onwards however, there emerged a scissor like movement. Confidence in the dollar was waning, and the confidence in gold grew. Because of the Vietnam war, the US budget deficit got that much out of balance that the US balance of payments [went into deficit]. The outer world saw a stream of dollars flowing its way (a country with a balance of payments deficit sees its currency flowing abroad) and under [the Bretton Woods] system, foreign central banks could convert those dollars in the United States in gold. American gold reserves declined and Washington was displeased with that. A good solution would have been to drastically raise the price of gold. Since it was extraordinarily peculiar that in the post-World War II world, in which everything became more than three to four times more expensive than in the 1930s, the price of gold remained the same. Actually, two things had to be done. The official gold price in all currencies had to be raised (‘their gold content had to be reduced’) and, beside this, the official dollar price of gold had to be raised extra, to allow the dollar to devalue against all other currencies. However, the Americans found this idea like swearing in a cathedral. Because, by that, the dollar would in regard to gold become second, and the American ideal was and is to have the dollar central in its role on the economic stage. As a consequence, there was only one exit and that was cutting the tie between the dollar and gold. That would eventually happen in August 1971 when President Nixon announced that the dollar was no longer convertible into gold. After increasing American pressure, step-by-step, the actual convertibility of dollars in gold was curtailed until it was formally ended.
An important step on this road was the creation of a whole new international monetary instrument, the SDR (Special Drawing Rights). This is about an inventive construction whereby ‘something’ is created out of ‘nothing’. The International Monetary Fund would — through precise administrative procedures — create rights on the fund, with which central banks can settle their payments among each other. Those rights would — according to certain measurements — be credited to the members of the fund. The idea behind this was that it was expected that in due time there would be too little gold (I am inclined to say: what do you expect with such an artificially maintained, much too low gold price) to serve as ‘international means of settlement’. The International Monetary Fund would ‘create’ a new international currency like a big bank could create money in a country as previously described. This new phenomenon was enthusiastically welcomed when it saw the light in 1967. In intellectual fantasies, a new international monetary framework had already emerged, a new cosmos with the SDR as sun. The idea was that the International Monetary Fund would, from time to time, assess how much demand there was for new, to be created SDRs. After consent of the highest executive body of the IMF, the Executive Board could decide to create and distribute among the member countries. To what would the SDR in value be equal? At first, that value was expressed in gold, later, it was construed as a basket of a number of currencies [which] determined the value of the new instrument. Nowadays, we do not hear much of it. At first, it appeared as if the foremost Americans were enthusiastic proponents of this new international monetary instrument, but this proved to be pretense. They welcomed the SDR to move gold even further away. As soon as gold was removed as a central point in the international monetary framework, their love for the SDR disappeared. The SDR has become a piece for a museum.
But in case there is no complete international means of settlement, no gold, no SDR, wherein should central banks settle? The logical end-piece of this development was giving up on fixed parities [to gold]. The currencies are currently exchanged on international markets. The resulting prices bring supply and demand in balance and there is no way of settling. No more cosmos, no sun with planets: All currencies are formally equal. One can buy and sell them on international currency markets.
It may be so that in the formal sense of currencies one can say that all are equal, but that in reality it proves that some are more equal than others. The dollar is back as the material core of the international financial and monetary arrangements. That the countries of the EEG have begun constructing their own monetary cosmos, I have mentioned already.
Of course, I experienced these affairs intensely from close by. In the time of fixed parities, first globally and later within the EEG, a change of parities (revaluation or devaluation) was a decision to be taken by the Cabinet whereby, according to Dutch Law, the Dutch central bank must give a written advice. In annual meetings of the IMF in Washington (or once every three years elsewhere), meetings of the so called interim committee of the IMF two times a year, during meetings in relation to the EEG, and last but not least with my beloved Bank for International Settlements in Basle, the BIS (I return to this later), I was intensively involved with these affairs, sometimes with Ministers of Finance, sometimes with central bank presidents among one another.
In 1968, in Bonn [then the capital of West Germany] there was a conference of Ministers of Finance and presidents of central banks of the Group of Ten countries. It should be obvious: the international monetary world consists of groups and [little] groups [of countries]. This group, the core of the richer countries of the IMF was formed in 1961 to provide extra financial means to the IMF in case this would prove necessary, meaning above the more or less periodic contributions [to the Fund]. In the 1960s and 1970s, this club was materially the executive body of the IMF, which with its large number of members was hardly able to come to decisions without efficacious preparations within a smaller club. The Group of Ten still exists — also here the Law of conserving what exists applies — but the work has been largely taken over by the Group of Seven (United States, Japan, England, Germany, France, Italy and Canada) with its core a sort of group of three, the United States, Japan and Germany, that in my experience essentially determine [the outcome]. The Group of Ten included, beside the seven countries already mentioned; the Netherlands, Belgium and Sweden. Switzerland was more or less an associated member while without membership of the United Nations it could also not be a member of the IMF.
In November 1968 the Group of Ten met in a nervous hurry. There were great tensions on foreign exchange markets. The exchange rate of weaker countries such as England and France were under pressure. Germany had pursued a pseudo-revaluation through a known trick, namely imposing an export tax and tax exemptions on imported goods, together about some 4 percent. The singular duo Strauss and Schiller, respectively the German minister of Finance and of Economic Affairs, chaired the conference. Both were highly intelligible; Strauss proved to be a rough character and Schiller a fine [professional] economist with a strong assertiveness. They were part of the grosse Koalition (a broad base as we would say in Dutch) of Christian Democrats and Socialists under the management of Chancellor Kiesinger. They were not particularly fond of each other, which was visibly noticeable. The objective of the conference was to get Germany to revalue and France to devalue. I must say that the presidents of central banks of the Group of Ten had met during the weekend before the conference in Basle, and had discussed the matter coolly. They had concluded that Germany could revalue with at least the mentioned 4 percent, but rather more, and that France had to devalue to such a level that together with the German revaluation a difference was created of at least 10 percent.
The temperature at the conference increased soon, mainly because of the way the two chairmen operated. There were frequent interruptions, the chairmen ran regularly to microphones and cameras to comment on their heroic deeds. At some point, the clenched energy of minister Schiller was focused on the President of the Bank of International Settlements, thus on me. With a stern tone he told he had heard the gentlemen central bank presidents had discussed changes of parities in Basle and even mentioned percentages. He wanted to know from me what this was about. It was clear he was of the opinion it was not the place for central bank presidents to deal with questions that were reserved for ministers of Finance. “I want”, he said, “a clear answer: yes or no.” Now, I was hardly a year and half President in Basle (later more on this), so it was a tough moment. The room was filled with silence and I felt very much alone. I said to him in my best English and as coolly as I could that there are never any communications about ‘Basle’ and that the ministers of Finance would have to find answers with their own respective central bank presidents. “Thus, I can tell you”, I said, “no answer”. Charles Coombs, a top executive of the Federal Reserve Bank in New York and as such, an important figure with the American delegation, later wrote in his memoirs about my answer to Schiller: “He politely told him to go to hell” (1). To my fortunate surprise Schiller backed down. The conference got chaotic the second day and some amazing scenes happened. At some point, the ministers wanted to discuss matters among themselves and sent high and lower clerks out of the room and even the central bank presidents. That had never happened before and we were, to just say this, upset. Wondrous scenes kept [dominating] the conference. The French minister of Finance Ortoli experienced really tough days. He went from the conference table to the telephone, to contact Paris, and back again but still was not receiving permission to agree with a devaluation of the French franc. His face was not all too happy already and started to look like the famous movie comedian Fernandel in his difficult moments. The only positive that came out of the conference came from the central banks. There was a need to coordinate emergency credit facilities for the currencies under threat as is normal under those circumstances. Because of my position in Basle, I had to coordinate the effort and I took pleasure in the fact my colleagues central bankers had within an hour arranged two billion dollar. When we were invited back in the conference room after said unfortunate episode, I was able to present this to the presidium. The conference ended on Friday November 22 with a hollow communiqué. Nothing had been decided in regard to exchange rates. Everybody expected that France would devalue that weekend eventually but that did not happen. General De Gaulle seized the opportunity to declare majestically Non against such a dishonest devaluation of the French franc. Not long thereafter it eventually did happen: a French devaluation and a German revaluation. The year 1971 was in respect of the international monetary field of decisive meaning. I explained already how President Nixon in August had cut the link to gold in a rather rude manner. The dollar was no longer convertible in gold. The world from outside the United States had to put their houses in order first. May that year however, the American minister of Finance John Connally on an international monetary conference in München had told the world out loud (one of the renowned international conferences of the American Banking Association) literary and figuratively that everybody had to know: “We are not going to devalue the dollar” and “we are not going to change the price of gold.” Essentially, he repeated the permanent American point of view. The world had to adapt. The dollar, our currency, your problem, is one of the many expressions one could hear in regard to this. A different description about the fluctuations of the dollar on exchange markets did also become famous. The Americans considered this benign neglect. The duo Nixon-Connally loved a dramatic appearance and so the thunder struck from the Sinai upon us, in this instance Camp David, where decisions were taken. Nixon saw to it that these were accompanied with a communiqué [formulated] in a light snoring prose of which only he seemed to have known its secrets.
From one day to another the whole, thoroughly construed post-war monetary framework, that had functioned terrifically for so long consummately, was blown up. After 1971 one thing after another happened in this respect. Through several, deemed important conferences, [advisory] commissions and learned reports, an endpoint like we can see today was eventually clear. Convertibility in gold gone; fixed exchange rates gone; the SDR, a functionless curiosity. Only a strong monetary Europe – but this still has to happen – could, [along] with a strong Yen provide for a counterbalance. There is one thing left, to conclude this part that I have to get of my chest. The old framework did not collapse because it had intrinsic deficiencies that prevented it from functioning like it did for twenty years after the war. It was thrown over board by the United States at the moment that the discipline it demanded to participating countries was knocking on America’s door. An American senator once asked whether it was truly believed that those backroom boys, with whom he meant the International Monetary Fund, would enforce the American Congress. The United States has done the world unimaginable great services. In two world wars they showed determination and willingness to take sacrifices and truly not only in money, as this recently was proved yet again with the Gulf War. We owe our freedom to this country. However, in regard to the international monetary framework, there is room for serious criticism. Perhaps we should just accept this. Personally, I would agree with this.
After the dramatic events of August 1971 about which I wrote before, several things had to happen. In the beginning, it was expected that a new system based on fixed parities had to be agreed to. Nixon had, beside the postponement of dollar convertibility in gold, [more things ready]. He introduced an extra tax of 10 percent on all imported goods and declared that one or two things still had to happen to agricultural subsidies abroad. He also complained about too large American contributions to Defense spending by Allied nations.
How would the new exchange rates be established? How would you go at it: determine new parities for all currencies simultaneously? And who could start these negotiations without prejudices? Nobody would open his mouth without knowing what others would do. A conference about this could start and end with great silence. During the annual meeting the Fund in Washington in 1971 my American colleague Burns asked me if I wanted to perform the function of what he called ‘an honest broker’. He already had arranged for the approval of his colleagues. I would have had to visit the capitals of the Group of Ten countries in great secrecy; there they would have to inform me of their deepest thoughts in regard to desirable new exchange rates. With this knowledge I would then have to write a report that would provide the foundation for negotiations.
Although Burns had told me that also Treasurer Connally agreed with this approach, later it appeared this was only partially the case. Anyway, I said yes, whereby Burns stressed [that I should] not forget other problems such as agricultural subsidies and Defense burdens. I [traveled all by myself] because every official support that I would bring along would only increase the risk of leaking, as Burns suggested. I traveled to London, to Bonn, to Washington, to Montreal. The Japanese I met in Paris and my remaining counterparts in their capitals. In every city I sat alone with the minister of Finance, the central bank president and two or three public servants. I told my story and they explained their point of view. I made notes and in the evening I would work out these notes, [madness]. On my way to Bonn I almost crashed. I flew with a private jet, sort of a double-engine sports airplane. It was beastly weather and during landing it almost went wrong.
That is how I wrote my story: about exchange rates, about Defense burdens and about agricultural policies. In hindsight I could have spared myself of my efforts of agricultural subsidies and Defense spending; [they] were only interested in exchange rates. My document was never published and I think of it too long-winded and too specialist to add this to this chapter, even if only appendix. The conference where decisions had to be taken was held in December 1971. The result has become known as the Smithsonian Agreement because the meeting was held at the Smithsonian Institute. If I believe that my report successfully contributed then this is founded on a thoughtful note Burns wrote to me: “(…) More particularly, I believe that your discussions and your paper established a firm lower limit for the degree of exchange rate realignment. (…) Without the crystallizing of positions that you helped to bring about, it is difficult to imagine that the progress at Rome and Washington occurred“. Dr. Emminger, later president of the Deutsche Bundesbank, wrote about this and mentioned my report as one of the foundations of the Washington conference (2). He emphasized aspects slightly differently, namely by stating his own part in the preparatory work, “durch ein vertrauliches Gutachten von Jelle Zijlstra, dem Präsident der BIZ und der Niederlandischen Notenbank, ergänzt wurde” [in English: was supplemented by a confidential report written by Jelle Zijlstra, the President of the BIS and the Dutch Central Bank]. Connally and the man who handled these affairs for him, Undersecretary Paul Volcker, were less enthusiastic. They wanted to do it all by themselves and found my report an inconvenient complication. I found it appeasing to ascertain that the end result of the Washington conference hardly differed from what I propositioned. The dollar devalued only a bit more than I proposed in my report and in regard to mutual proportions of other currencies the differences were minimal.
To me, what made the Presidency of the Dutch Central Bank so special, was the combination with the function of President of the Bank of International Settlements in Basle. This Bank was founded in 1930 and was to be in charge of arranging the reparation payments between the victors and losers of World War I. Shareholders were victors and losers, as well as nations as Czechoslovakia and Yugoslavia, Estonia, Latvia and Lithuania that emerged. The Bank was governed by a board of commissioners (Board of Governors) wherein the so called founding fathers had two seats, the United States, Japan, Germany, France, England, Italy and Belgium. Three nations were invited to join the group. It concerned the neutral countries of World War I that were considered financially sufficiently solid because they had based their currencies on gold: Switzerland, Sweden and the Netherlands. They each received one seat and they had to be reassigned each three years, something that since 1930 has been done consistently. On site, there is a board that governs the bank on a daily basis. The bank also has a President who also presides the board of directors. This function was especially important because the President is the true boss, not only in the Dutch sense of President-Commissioner, but also what we refer to as President-Director. Albeit he delegates the executive work as much as possible to the local board, yet he is responsible. My predecessor Holtrop was since his inauguration with the Dutch Central Bank in 1946 member of the Board, was appointed President in 1958 and since then reappointed repeatedly until his resignation in 1967. After my accession to office in Amsterdam, he visited me and said: “I have something to tell you of which I am not sure whether to congratulate you or have to feel sorry for. Count on it that with my resignation in June (then his term ended) you will be appointed as my successor, that is, if you want it.” I was certainly not happy with it, although it is a position that [later] proved to be of utmost importance. Why then was I not delighted? In the first place, I was of the opinion I had to learn the métier of banking in Amsterdam before I could be working uninhibitedly among colleagues who were all known for their utmost competencies, people like Carli from Italy, O’Brien from England, Blessing from Germany, McChesney Martin from the United States and many others. Moreover, I feared to have to act as a parachutist again. Their new president would come from outside, not from within. It appeared indeed that some colleagues had more or less expected that they were promoted to this higher bliss. Enfin, I was [appointed], on the proposal of the French governor Brunet and I was appointed, as the statutes prescribe, for three years. Since then I was reappointed every three years. My departure from Basle coincided with my departure from the Dutch Central Bank in December 1981.
The monthly meetings in Basle, group around the formal board meetings that are held on Tuesday mornings, where the actual banking affairs are handled. As it happens, the bank has evolved in ‘the bank of central banks’, that holds parts of reserves that are deposited there with which the bank in Basle can arrange its business further with. With this, the bank evolved beyond its original objective. When the reparation payments were settled, or said better, had become distinct, the bank remained a place of meetings for the leaders of central banks. After the war [read: WWII] the bank blossomed into an international banking institution of size. The bank thereby has substantial income. The balance and its profit-and-loss account are ascertained each year on the annual shareholder meeting, an event that is yearly highlighted with publicity, if only because its president gives his speech in which the bank shares its vision on the global monetary problems.
But around these formal monthly meetings there are at least two other important meetings. The central bank presidents of the Group of Ten also meet monthly. Because the complete group, that is including the ministers of Finance, only meets if there is an immediate cause, these meetings in Basle are of great importance. Also over these meetings I have presided these years. In my time, when fixed exchange rates still existed, these meetings were extra important because here decisions were regularly made to extent credit to countries with a weak currency, to prevent devaluations or sometimes to guide one. Those transactions by central bank to central banks were very substantial in size. We arranged these by ourselves; parliaments were not involved and ministers only in background in case and to the degree in which central bank president wanted or had to arrange this with the minister of Finance. In the Netherlands the Bank is completely autonomous. Of course I informed the minister during the weekly lunches, but the Bank took decisions.
In 1976 there was yet another case with the pound sterling. On the Friday before Pentecost I called my British colleague Richardson around four and told him – if he wanted so – I was willing to take the initiative to organize a supportive intervention amounting to five billion dollar, a sizable amount at that time. It was intuitive that I took the initiative on that moment. Richardson was pleasantly surprised and entrusted me saying that he had similar thoughts, that he hadn’t come to a definitive decision yet but that he, having heard me, also was of the opinion that now was [the time for it to be done]. With my hat of BIS-president I started with a series of lengthy telephone calls. First there was a need to establish the proportion between the United States and the other countries of the Group of Ten. I thought of two billion for the United States and three billion for the rest, based on the sort of allotments we used in these particular matters.
The pound sterling had fallen by 15% in three months time on foreign exchange markets. In England, the situation was particularly tense. Harold Wilson unexpectedly stepped down as Prime Minister on March 16 and was succeeded by James Callaghan. The colourful Dennis Healey, minister of Finance, was having a difficult time. Low productivity, fast increasing wages, government finance in serious disarray and excessive money creation; it was truly bad. My telephone calls with my colleagues resulted in indeed (except for the United States) around three billion. This did not prove easy because with the weekend of Pentecost ahead and the gentlemen for a part were at their destinations of Holiday. Especially finding my French colleague Clappier, who was somewhere in the Rivièra, was hard. My German colleague Klasen found the amount I suggested [for Germany] somewhat too high. “But,” he said, “if you say this is necessary then it will be correct.” I found this a clear illustration of the high degree of trust that existed between the central bank presidents in Basle. The Americans made more difficulties. In the first place, they found – as always – that it was they who must have taken the initiative, but the position of the BIS was such that they did not dare to follow through and to say no on the basis of that, but beside, they found that conditions had to be met because “the spending spree of the Labour government had to be curtailed.” The credit should thus not last longer than six months because if the English would by then not have put the house in order then they had to go to the IMF and have themselves put under wardship of that institution. On a note of clarification, formally these kinds of central bank credit extensions last no longer than three months. They can more or less be renewed automatically, but remain to be meant as temporary bridge loans. Mostly, such lines of credit are in dollars or in the currency of the creditor country. England did not really get out of difficulties but the substantial BIS-credit provided for a much welcome breathing space.
The Bank in Basle operates with minimal publicity. The press is only admitted to the annual meeting, around the monthly meetings, communiqués are almost never provided for. An important side effect is that if there is a communiqué, it can be known something really important is at hand. We used a sort of standard jargon with little variations. If there had been yet another wild mess on foreign exchange markets and we had brought about a return to equilibrium by the measures of which I described you one here before, then the presidents did not run to the microphones or cameras, that were absent anyway since the press knew it did not make any difference. The standard communiqué started off something like this: “The governors” (like central bank presidents are referred to in English), “discussed recent events (…). They are satisfied that (…).” A loose translation: “We discussed the problems and are confident that we …”. And then a short clarification followed on what we had solved, or had prevented, or had accomplished. The psychological effect of such unemotional statement was often remarkable.
From the above it also becomes clear how important it is that the presidents of the BIS preside over a longer timespan. After a couple of years of having been in function I was somewhat a Mr. BIS internationally. That is why it is to regret that recently it was decided in Basle to take turns for the presidency, and thus for three years. This undermines the inward and outside authority. The directorship of the bank locally consisted and consists from real heavy weights and if the boss is replaced every three years then it must have influence in the manner in which the bank is managed, and certainly in the firmness of the grip of the president on the board in Basle.
During the meetings in Basle, also meetings of the Comité des Governors of the EEG-countries took place. At that time, this was predominantly some sort of group talk. Attempts to come to a more effective coordination of monetary policy did not come a long way. In this regard, it is [to be seen] how the road to a European central bank is traveled. It is [to be expected] that this process evolves step by step by the means of strengthening the authority by which the meaning of the Comité des Gouvernors, probably under a new, somewhat more impressive name will increase.
The dinner on the first full meeting day was renowned, the evening before the formal board meeting. There, important problems were discussed forthright and sometimes [harsh opinions were given] about each other’s policies and about monetary authorities – read: ministers – who were not present. More than one important decision on international monetary matters were prepared at this dinner that always was held in Hotel Euler where the food and drinks were of more excellent quality as in most restaurants in Basle.
Especially in the beginning when I was still an ‘amateur’ in the profession, I learned a great deal of my colleagues back then. With three of them I held close relations with the big advantage of being able to fall back on them when I had to make a tough decision. We formed a sort of gang of four that functioned as an informal directorship that from time to time had a not unimportant influence on the international monetary arena. Arthur Burns, a born Austrian but who emigrated on a young age with his parents to the United States, was a true learned scholar, and author of impressive [economic] literature of which I remember some from my time as a student. Already before he accepted his position at the Federal Reserve Board he had had an important career as professor. He was advisor to several American (republican) presidents. [He was] an indefatigable worker who, when I was a pensioner for a while, in his seventies became the American Ambassador in Bonn. One of the great aspects of Americans remains that they appoint competent people regardless of their age. (One has to appreciate that I do not mean this as a complaint.) I have never seen Burns heated. He was [a tower of strength], a monument of scholarship and wisdom. Karl Klasen, the aristocratic banker from Hamburg, was not an expert in the secrets of monetary theory but a leader who emanated authority. At last, Olivier Wormser, the Governor de la Banque de France, one of the super intelligent people that the French grandes école, a sort of top university, delivered continuously. (On a note beside: when shall we in the Netherlands have the courage to establish a couple of such top universities, where one can only enter after having done comparable exams and that delivers [students] after strict and persistent selection to society?) Wormser was director-general for foreign economic relations on the French ministry of Foreign Affairs before the era of Charles De Gaulle, when Cabinets lasted for three to six months. [France] was practically governed by high officials of the renowned high French quality; Wormser was one of the most important among them. Because of the political situation it was not possible to do business with the French on international monetary conferences. They had to say no unremittingly, put forward reserves and apply all sorts of difficult tactics. When I met him in Basle, he told me: “You look at me so suspiciously and I understand it. You consider me as an impossible man. But the position of my country was constantly impossible. [By now, you shall see I turn out better than you expected]. That proved to be correct.
The collaboration within our group of four was made easier through a high degree of consensus on fundamental questions. I believe we were somewhat conservatives. Now, that can indeed be understood. Countries where the central bank president is only slightly a radical new modernist, should – if this was possible – be put under wardship. Burns once told about himself: “I am a Neanderthal conservative“. It was not that bad with the others but we did understand each other very well indeed. Who manages other people’s money should, within reasonable boundaries, be conservative.
When I [stepped down] at year end 1981 in Amsterdam as well as in Basle I realized that I would miss the latter city most. Of my farewell, I like to share an anecdote. Back then I was already somewhat critical about that new international money, created out of thin air, the SDR. I thought the American love for that was suspicious. I suspected that they wanted to push gold away, only to later have this new toy abandoned [as a museum piece]. Paul Volcker, who had succeeded Burns as chairman of the Board in Washington, presented me with a specimen of the SDR, that is, a fictitious specimen, because in concreto, the SDR never existed as a real bank note. His gift became a lasting memory of the feelings on both sides: It will never be something, respectively; it may never be something with the SDR.
I spoke about the IMF several times, that most important institution, once destined to supervise the effective functioning of the international monetary framework, and to put forward rules for the monetary behavior of member states; possibly the beginning of a global central bank. It ultimately did not come this far. In our world of free, market driven exchange rates, the IMF is only a ghost of what it once was. The annual meetings, once of utmost importance, captivating and often rewarding, have subsided into almost folkloristic meetings. My first annual meeting was in 1959 in Vienna just before I became minister of Finance. Dr. Holtrop was still President of the Dutch central bank. He gave there one of his renowned speeches. The number of member states of the IMF then was still limited; we were able to really discuss matters. My memories on the many annual meetings of the IMF that I witnessed as Bank-president increasingly narrow down to the enormous Sheraton Park Hotel in Washington; a conference room with several thousands representatives and special guests, listening to countless speeches, or partially listening since the texts were provided simultaneously. After the first speakers on the first day (the big nations) nobody was [interested any longer]. People were visibly longing for lunch and in the afternoon it was a dead-alive business. In the late afternoon, gigantic limousines came on and off for the joys of the meeting: the cocktail-party’s, [and] consequently, dinners. Of the expenditures of such a meeting it would be possible to soothe a significant part of the destitution of a poor country. In so far formal decisions had to be taken they were largely hatched upfront. Communiqués were, except for points and commas, arranged beforehand. The IMF has ended up in a situation of slumber from which it can only awaken if there is chance for restoring the international monetary order. This view is however not unfair, then yet incomplete. The International Monetary Fund has since the two oil-crises in an increasing degree taken upon it a very important task, namely as relief worker for poor countries, among other by taking supervision over attempts to find solutions for the often sky-high debts of these countries. The ‘state of slumber’ relates to original role of the IMF as global monetary institution.
Gradually, the meetings of the EEG became much more interesting. After the European Coal and Steel Community with its meetings, the center of gravity shifted, albeit for the board of ministers from Luxembourg to Brussels. The ministers of Finance of the EG had from the start on the desire to keep closer relations, if only to have partners in misfortune, beset by spendthrift colleagues. They have formed, beside their regular formal meetings of the board of ministers in Brussels, their own informal private chat that took place in the presiding country. In this group, central bank president were also allowed to speak so that I have witnessed in the course of several years a great number of these meetings. These consultations became more and more intensive; the increasing disorder in the international monetary area forced a closer European collaboration in order to establish a particular stability, appropriate with the gradually more intensive economic union. After several attempts with varying degrees of success to link the various European currencies by fixed parities that within limited boundaries could fluctuate (among insiders known as ‘the snake in the tunnel, the snake outside the tunnel’ or, as interesting Benelux variation, ‘the worm’), eventually [and] on the initiative of the Chancellor of Germany Helmut Schmidt and the French President Giscard d’Estaing the EMS was established, the European Monetary System. Both politicians, who got along well with each other, if only because they could speak English reasonably well with each other, put their proposal in July 1978 on the table. Here, a political fait accompli was put on the table. Suspicious and skeptic as these institutional organisations are, they at first were at their wits’ end. There was a pooling of a part of the national currency reserves and it was foreseen that substantial [and] mutual credit extensions would be made by central banks, two matters where a sound central bank is not enthusiastic about.
The negotiations that in the course of 1978 led to [an] agreement, gave these two matters fundamental enhancements. Extension of credit remained within the bounds of decency. The currency reserves were not ‘pooled’. Twenty percent of the reserves would be lend to the new [and] to be founded European Monetary Fund that thereby become able to ease the mutual and in this system necessary credit extensions, technically. The core of this system was, like under the Bretton Woods system, based on fixed exchange rates between the national currencies. The value of each currency – the so called central exchange rate  – was established through a ‘basket’ in which each of the currencies was represented with a specific share. In regard to bilateral central exchange rates a maximum 2.25 percent margin is allowed.
The term that was contrived was a find: the ECU is the French word for daalder, an earlier Dutch currency, in German Thaler, [and] also reads as an acronym in English: European Currency Unit. Like in the former international monetary framework exchange rates have to be maintained through intervention of the participating central banks. If this eventually proves impossible, then fixed exchange rates – central exchange rates – have to be adjusted.
This system worked beyond expectations; in regard to financial and monetary central bank policies it worked disciplinary. A country must defend the exchange rate of its currency as long as possible with all instruments of national policy at its disposal. Only after it really cannot last longer, then an exchange adjustment can be resorted to. This necessitates intense international consultations. If parities have to be altered, a meeting of ministers of Finance and central bank presidents is warranted. When the real monetary union is founded, with a central bank and a European currency, the EMS will have brought invaluable preparatory work. For the present central banks, the emergence of EMU will bring about thorough consequences. Their most important task, controlling the money supply, shall move to a European level. The central banks will possibly maintain to have an executive task for such policies, but no more than that. A strong European currency shall give the conversation on international monetary stability a whole new turn. The dollar, the yen and ecu can give the world back the basis of stability, that in 1971 after ending the Bretton Woods system by president Nixon, was lost. The most important task for the new European central bank, beside the control of the money supply, will be the external monetary policy. For the present central banks only executive tasks will remain.
(1) Ch. A. Coombs, The arena of international finance, Wiley & Sons, New York, 1976, p. 184.
(2) O. Emminger, D-Mark, Dollar, Währungskrisen, Deutsche Anstaltsverslag, Stuttgart, 1978, p. 201.
* * *
Jelle Zijlstra (1974), “Reflections on international economic and monetary problems“, a retrieved transcript of Zijlstra’s lecture delivered to the Zürcher Volkswirtschaftliche Gesellschaft on Wednesday, March 13 1974, in Zürich.
Jelle Zijlstra (1981), “Central banking with the benefit of hindsight“, a transcript of the lecture held by Dr. Zijlstra for the Per Jacobsson Foundation in Washington on Sunday, September 27, 1981.
Jelle Zijlstra (1985), “Gematigd Monetarisme“, H.E. Stenfert Kroesse BV (Leiden); ISBN: 90-207-1382-5.
Jelle Zijlstra (1992), “Per slot van rekening“, Uitgeverij Contact (Amsterdam), fifth Edition; ISBN: 90-254-0181-3.
 Zijlstra uses a Dutch figure of speech, namely “uit zijn voegen geraken”. This figure of speech refers to “the cement” holding the bricks of buildings together, which after breaking apart leaves a house uninhabitable. Figuratively, this figure of speech thus refers to the collapse of Bretton Woods.
 The exact word Zijlstra uses is ‘spilkoersen‘. If translated too literally, it says “pivotal exchange rates”. Given the context, he refers to the agreed targeted exchange rate, above and under which the exchange rate can fluctuate: a central exchange rate.
 In Dutch, “het lenen” can refer to both lending and borrowing. In this instance, the phrasing suggests that since dollars can be borrowed on the Eurodollar market, “imposing restrictions” refers to restrictions placed on lending by banks rather than setting limitations to the capacity in which borrowing parties from within the euro area are able to borrow dollars. Obviously, this is a technicality, albeit one that should be taken into consideration because of diverging consequences. My interpretation in this regard is not necessarily the correct one, but since Zijlstra is explaining the problem of dollar excesses and what to do with these dollars: go figure.
 The exact wording is slightly different from Fund-deposit. In Dutch, Zijlstra writes “Fondspositie” and this, of course, can be translated with “a position held at the Fund”. However, to stress the difference with SDR’s, I translated it this way.
 Benelux stands short for the formal and official cooperation between Belgium, the Netherlands and Luxembourg.
 Guilders refer to the Dutch currency, the franc in this instance, to the Belgian currency.
 Zijlstra uses the word “flatteren” here, and in the context of accounting, this can only – at least according to my dictionary – be translated with “cooking [the books]”. In my opinion, this translation would not reflect the way in which Zijlstra opted for this word; not generally and also not how Zijlstra applies this figure of speech here. The wording is a very polite way of saying that the true dollar supply is understated so that the appearance is too flattering, and thus “under-reflected” in regard to the true nature of the monetary situation. “Look flattered” in context of accounting can alternatively be translated with a way in which the “sin” of window-dressing is (politely) emphasized.
 De Haagsche Post,p. 28, August 15th, 1981; interviewer was Maarten Huygen.
 Zijlstra uses a Dutch saying — “op sterk water zetten” — that I believe cannot be translated to English. Basically, this saying refers to the method of preserving dead animals in formaldehyde as they are shown in museums and biology classrooms. Zijlstra’s use in the context here implies that he recognized early on the USA only wanted the SDR as a tactic to have everybody move away from gold and thus welcoming the SDR, knowing full well it would be dead on arrival.
 Like in footnote 2; in Dutch, the term is spilkoers.
These notes are not in any way meant as an investment advice or a solicitation for such an advice. Like all writings on my website, they are exclusively intended for educational purposes. Readers should do their own research and make up their minds what to do with their (life) savings. I have done so as well; I am long physical gold (and a “tiny bit” of silver) exclusively.
2 Replies to “The Zijlstra Notes”
Zijlstra was niet de radicale vrijemarktdenker als de neoliberaal Ludwig von Mises. Hij bevorderde een meer gematigde variant: een Europees liberalisme waarin marktwerking en ondernemerschap centraal stonden, maar dat ook plaats bood aan daadkrachtig ingrijpen en effectieve ordening door de overheid. In deze theorie tendeert de markt niet automatisch naar een optimale balans, maar heeft correctie nodig. Het is interessant na te gaan welke overeenkomsten beide economen hadden. Een ervan was de overtuiging dat de goudstandaard noodzakelijk was in de huidige economie: in een economie met een goudstandaard zorgt de marktwerking voor de continuïteit van de koopkracht van goud.
Persoonlijk denk ik dat met de afschaffing van de goudstandaard, het geld zijn zekerheid heeft verloren (JP Morgan): “Gold is money. Everything else is credit”. Een moderne versie (van een goede vriend): “Gold was money then, is money now and will be money after all the crypto is hacked (or nationalised by Govts who will impose conversion to central bank issued digital currency).”. In tijden van oorlog (zoals nu) wordt de waarde van goud duidelijk: goud blijft bestaan. Ook als de computers uitgaan.