INTERNATIONAL ECONOMICS

The past two decades have seen the building of a closely knit international economy. Remarkable growth in international commerce has gone hand in hand with sustained prosperity; each has contributed to the other. At times, deep and obvious strains in the international monetary system have imperiled this progress, but these difficulties have been weathered without a serious setback in economic growth or world trade.

The world economy emerged from the Second World War in a gravely weakened state with many countries suffering severely from war damage. However, the recuperative strength of the Western European nations, assisted by U.S. aid, resulted in rapid economic recovery.

The fruits of unprecedented prosperity are still not being fully shared by nations in Africa, Asia, the Middle East, and Latin America. The future growth of these nations must be built primarily on the skills, intelligence, and labor of their citizens. However, the developed countries can facilitate the process by providing technical assistance, public and private capital and access to markets.

During the 1950's, the increasingly prosperous countries of Western Europe liberalized trade and capital movements substantially. Meanwhile U.S. capital moved in to promote economic growth abroad and contributed to expansion of world monetary reserves, and in turn helped the expansion of world trade.

The growth of world trade and income continued and accelerated during the 1960's. But there have been periodic monetary disturbances. U.S. balance of payments deficits have continued to date, except for 1969. Important problems remain. Recent financial disturbances have emphasized the need for further evolution to insure that the system can continue to support growing world trade and prosperity.

The President's report to the Congress of February 1972 reflects the following pertaining to international economics:

"The year 1971 marked a turning point in the world econ

omy. We undertook a series of far-reaching measures which revitalized our foreign economic policy and set the stage for fundamental and long term reforms in the international economic system.

"The Setting for Change. In the immediate postwar period new arrangements and institutions to govern the international economic system were established. At that time the United States was the preeminent economic power in the world and assumed primary responsibility for the economic viability and security of much of the non-Communist world. We launched the Marshall Plan to help Europe to get back on its feet. We assisted in the economic recovery of Japan. We encouraged European economic cooperation.

"Along with other nations, we helped to establish the International Monetary Fund (IMF) to promote world monetary cooperation; the General Agreement on Tariffs and Trade (GATT) to create a code and a mechanism for the orderly conduct for international trade; and the World Bank to assist reconstruction in Europe and provide assistance to the less developed nations. These formed the institutional basis of an international economic system which promoted the expanding flow of commerce and resources needed to restore free world prosperity.

"Since those institutions were established the world economy has undergone major structural changes. Both the volume of commerce and the transfer of financial resources have increased greatly. The industrial capacities of Europe, Japan, and Canada have grown rapidly, and each is now a strong trading and financial power. These new realities needed to be reflected in both our foreign economic relationships and international institutions and arrangements. In 1971 our policies were directed at achieving that objective.

International Monetary Policy

"After two decades of stability and progress, a series of crises beginning in the late 1960's had shown that the international monetary system could not cope adequately with the scale and

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severity of contemporary world monetary problems. In 1971 the situation reached critical proportions.

"Monetary crises in May and August, and our deteriorating balance of payments position, convinced me that a major realignment of currencies and reform of the international monetary system were necessary. On August 15, I instituted a series of measures-including a suspension of dollar convertibility--which dramatically focused international attention and energies on achievement of these goals.

"It is important to understand the circumstances that led to these decisions.

"Developing Strain. At the Bretton Woods Conference in 1944, to help achieve our objective of rebuilding the free world through the expansion of trade and rapid economic reconstruction, we took the lead in the creation of a new international monetary system. We hoped that this system would avoid the restrictions and competitive devaluations which characterized the 1930's, and would enhance the ability of countries to rebuild their own economies. This system permitted parity adjustments, which were expected to be used when countries were in fundamental balance of payments disequilibrium. Exchange rate stability was to be enhanced by enabling countries to draw on a pool of currencies established in the IMF to supplement their own gold and foreign exchange reserves, and thus tide them over temporary or cyclical balance of payments difficulties. These alternatives were provided to enable countries to avoid having to depart from sound domestic economic policies or impose controls to correct balance of payments problems.

"The Bretton Woods system, our assistance, and the strong efforts made by other nations to rebuild their economies helped to bring about a period of vigorous and sustained economic expansion. Our reconstruction assistance and persistent balance of payments deficits provided substantial liquidity to countries whose reserves had been depleted. Their holdings of both dollars and gold increased substantially. In the immediate postwar era this enabled many nations to support the large flow of imports required for their reconstruction.

"In the 1960's, however, the international monetary system showed increasing strain. The persistent U. S. deficits, once unambiguously helpful to other countries as a source of liquid reserves, led to an increasing imbalance between U.S. liquid assets and liabilities. Eventually, doubts began to arise concerning the ability of the U.S. to maintain convertibility of the dollar into gold or other reserve assets. A supplementary source of reserves was clearly needed, and agreement was reached within the International Monetary Fund in 1969 to create an alternative source of international liquidity in the form of Special Drawing Rights (SDRs).

"This reform did not, however, deal with other sources of stress. In the face of large and continuing balance of payments problems, countries were compelled to alter the value of their exchange rates, usually after long delay and in an atmosphere of crisis. Such adjustments were made with increased frequency in the late 1960's. They were necessarily large in magnitude, psychologically destabilizing, and politically disruptive in the adjusting country.

"Furthermore, pressure to adjust did not apply equally to all countries. Those countries with a significant balance of payments surplus and undervalued currencies felt little pressure to revalue (increase the value of) their currencies. Indeed, they felt an incentive not to do so. Undervalued exchange rates enabled them to achieve the large trade surpluses which some considered desirable in order to enhance the rates of their domestic economic growth and employment and to protect their external financial positions. But countries with overvalued exchange rates eventually had to devalue to correct their balance of payments deficits and halt the drain on their reserves. Thus, devaluations were more frequent than revaluations.

"The dollar, as the world's major reserve and transaction currency, was the linchpin of the international economic system. While other nations were free to change the value of their currencies in relation to the dollar, the U.S. played a passive role, During the 1960's, changes in the values of other currencies tended to push higher the average exchange value of the dollar. This aggravated a relative loss of American economic competitiveness as foreign countries completed their postwar reconstruction,

achieved high levels of productivity, and proved extremely adept at developing export markets. Our domestic inflation in the late 1960's seriously accelerated this trend.

"The key role of the dollar made it difficult to correct this situation through a devaluation, since the stability and liquidity of the system was based on the maintenance of a stable dollar. Even if we had wished to devalue in terms of gold, it would have had no effect on our balance of payments unless other nations agreed not to devalue as well.

"These strains in the system led to a series of crises. In November 1967, following a major speculative assault on the pound, the United Kingdom and a number of other countries were forced to devalue. The subsequent crisis of confidence in currency markets engendered mass purchases of gold by speculators. The gold reserves of central banks were being drained until the introduction of the two-tier system in March, 1968 isolated private gold trading from international monetary transactions. From the spring of 1968, the franc was recurrently subject to speculative attack. France, along with the Franc Area, devalued in August of the following year. A major influx of currency into Germany led to revaluation of the mark in October 1969.

"In 1970, although a major crisis was avoided, a decline in U. S. interest rates relative to rates in major European countries drove large amounts of dollars abroad and complicated European attempts to achieve domestic monetary stability.

"The situation worsened in 1971. Accelerated monetary growth in this country and an outflow of short-term capital, accompanied by a deficit in our balance of trade, caused dollars to flow abroad in record amounts. As a result Europe and Japan took in billions of dollars. In May, Germany decided to float the mark. Speculation continued and extraordinarily large sums were traded in world currency markets.

"The August 1971 Measures. By August, the situation was clearly no longer sustainable. Mainly due to a sharp deterioration in our trade position, the underlying payments position of the United States had turned sharply adverse. It was clear that the dollar was overvalued, while the currencies of certain of our trading partners