It Could Be Dawn

(See Cover)

Sitting with the Western world's chief central bankers as they weighed the gold crisis last week in Washington was a saturnine Frenchman who still bears the scars of his days as a Buchenwald prisoner. Though Pierre-Paul Schweft-zer, 55, spoke rarely, he got undivided attention when he did. As managing director of the 107-nation International Monetary Fund--which acts as an arbiter of exchange rates, guardian of fiscal good behavior among sovereign states, and rescue squad for countries in financial trouble--Schweitzer holds a pivotal role not only in the present struggle to shore up the world's money system but also in the reforms that seem certain to come.

With Schweitzer's full approval, the central bankers of the U.S. and six other leading industrial nations revised a key part of the world's monetary rules. They agreed to stop buying and selling gold, and to use their remaining store of the precious metal only to settle debts between nations. Thus out of their hastily called weekend meeting was born a two-tier pricing system for gold. For central-bank exchanges of gold and dollars, the familiar $35-per-oz. price continues. For speculators, hoarders and industrial users, the price was freed to find its own level in the world's marketplaces.

It was a case of the rescue squad arriving barely in time. The international monetary system was like a man who falls off a cliff and lands on a tree on the way down--bruised and shaken, but alive and susceptible to recovery. More auspiciously, the bankers' decision gave new urgency to the hitherto torpid efforts to turn the creaking system of international exchange into something better fit for today's world.

Fear & Faith. The international monetary system--the agreed way of exchanging one currency for another--runs on faith. For 24 years, the bulwark of that system has been the U.S. Treasury's pledge to redeem dollars held by foreign governments for gold, at an unchanging $35 per oz. Other countries value their own money in terms of dollars, usually keep a big part of their reserves in dollars. After World War II, as other nations gradually followed the U.S. into currency convertibility and trade liberalization, those relationships helped build an enormous, dollar-based world market. Foreigners were delighted to have the mighty dollar--until fear began to erode faith in its strength.

The source of doubt lies in statistics that concern the average American little, but worry bankers, oil sheiks, speculators and most foreign governments profoundly. In 17 of the past 18 years, the U.ST has spent, lent or given away more money than it has taken in from abroad. Compared with the size of the U.S. economy (larger than all of Europe's), that balance of payments deficit seems trivial; it has averaged a mere 0.004% of the gross national product. But the dollars thus placed in foreign hands now total $34 billion, while the U.S. stock of gold has dwindled from a postwar peak of $24.6 billion to $10.4 billion last week, the thinnest gold line since 1936. If all the dollar holders demanded gold at once, there would be too little in Fort Knox to satisfy even a third of them. Already whetted, the speculative appetite for gold was only sharpened by the fall of the British pound last November.

The result was the greatest gold rush in history. Almost all of the demand fell upon the London gold pool, through which the central banks of the U.S., Britain, West Germany, Switzerland, Italy, Belgium and The Netherlands had for 6 1/2years maintained the free-market price of bullion at its $35-per-oz. monetary level. Between Britain's Nov. 18 devaluation and March 15, when the London market was closed at the U.S.'s request, the buying stampede drained the pool of some $2.5 billion of gold -- nearly 2 1/2times the amount mined in California during the 25 years from the gold rush to 1874. That amounted to almost 9% of the gold reserves of the seven countries; the U.S., having provided 59% of the pool's gold since France dropped out last summer, lost $1.5 billion. An estimated $2 billion went into the hands of speculators who were betting that the U.S. would raise the price of gold and so hand them a swift profit.

By their decision to leave the official price intact while abandoning the gold pool, the seven nations pulled a 24-karat rug out from under the hoarders. As Zurich Banker Hans J. Baer put it: "The central banks are saying to the speculators: 'Take it to the dentist.' ! With the London gold market, the world's largest, closed until April 1, the demand for gold dropped abruptly last week in smaller markets elsewhere. In Zurich, gold bars that brought $43 per oz. at the start of the week sold for $39.25 by week's end. In Paris, where the price had shot up to a record $44.36 the week before, the cost of fine gold declined to $37.89 at midweek before rebounding to $38.95.

Temptation to Profit. Welcome as the stabilizing influence of the two-price market was on both sides of the Atlantic, most bankers and economists considered it only a temporary solution to the world's monetary malaise. "All we've bought is a bit more time," said President John E. Whitmore of Houston's Texas National Bank of Commerce. Others were considerably more optimistic. West Germany's Economics Minister Karl Schiller maintained that the split-price arrangement "can endure a very long time."

The decisive element is how long the gap between gold's monetary price and its free-market price remains small. For the present, the latest $2 billion of gold to reach private hands creates a price-depressing oversupply in the market. If the free price rises to $45 per oz. or more, as some European moneymen predict, it may tempt some nations to sell official gold for the profit. Hoping to prevent that, the U.S. last week made it clear that its gold window will be shut to governments that refuse to cooperate with the new system. Could a central bank dump gold on the free market secretly? "Impossible," insisted German Bundesbank President Karl Blessing. "It would become known in twelve hours at the latest."

Though they sprang it on speculators as a surprise, central bankers had been quietly discussing the shutdown of the London gold pool and the move to the split-price system since British devaluation. Italy and Belgium, restive at the growing drain on their reserves, remained in the pool only at U.S. prodding. Timing the switch presented delicate problems. By waiting for repeal of a 1945 law requiring a 25% gold backing for the currency, the U.S. could muster another $10.4 billion of gold for the defense of the dollar abroad. By discomfitingly small margins, the measure squeaked through Congress just in time. Last week, as the scratch of President Johnson's pen abolished the gold cover, the depleted U.S. gold stock just equaled the required 25%.

Red Sneers. From Budapest to Peking, Communists greeted the gold stampede with outright gloating--showing at least that Lenin's followers still heed his counsel: "The way to defeat the capitalist system is to debauch its currency." Crowed the Polish trade-union council, Glos Pracy: "The dollar is doomed. It is possible that joint efforts by world financial circles will stave off the crisis temporarily, but this will only postpone the execution." Sneered the New China News Agency: "The capitalist monetary system has in fact collapsed."

France's Charles de Gaulle, who wants the Western world to return to the gold standard,* was playing only a slightly different tune from the Red band. He called the present international monetary system "inequitable" and "henceforth inapplicable." Its continuance, he maintained, would "condemn the free world to grave economic, social and political trials." De Gaulle's attitude was understandable. By committing themselves in Washington to the two-tier gold system, the five other members of the Common Market had handed France a remarkable rebuff. They not only flouted their partner's wishes, but did so without consultation.

Almost every private and public authority of the Western countries agrees that to avoid a genuinely serious threat to the dollar, the U.S. must dramatically pare the inflationary deficit in both its domestic budget and balance of payments. Says General Director Max Ikle of the Swiss National Bank: "The welfare of the world depends on confidence in the dollar, and this now depends on American fiscal policies."

Threatened Fabric. Most Europeans regard U.S. willingness to raise taxes as the gauge of its resolve to put its fiscal affairs in order. Technically, budget and payments deficits can be curbed by any combination of higher taxes and lower spending that bites deep enough. Since last fall, the impasse between Congress and the President over the mixture has thwarted meaningful action. Now there are a few signs of movement. Two weeks ago, Johnson offered to trim his budget request for fiscal 1969 by $9 billion--but only if Congress approves his plea for a 10% income-tax surcharge to siphon an equal amount from the U.S. economy. Last week the President called for national "austerity," warned that the dangers confronting the dollar are "immediate and serious." Said he: "The fabric of international cooperation upon which the world's postwar prosperity has been built is now threatened. If that fabric is torn apart, the consequences will not be confined to foreign countries but will touch every American."

There was a certain irony in that message. For years, experts vainly tried to convince the President that the dollar was sliding toward an avoidable crisis. Its current predicament springs from Johnson's 1965 guns-and-butter policy, under which he vastly stepped up the Viet Nam war effort and expanded the Great Society programs without making a corresponding effort to raise funds. The war was supposed to cost $10 billion a year. Instead, the price tag jumped to $20 billion, then to its current $30 billion. "Our country is overcommitted at home and abroad," warned Robert Roosa in 1966, not long after he resigned as Treasury Under Secretary for Monetary Affairs. Even that year, Johnson might well have persuaded Congress to enact more taxes. Instead, the Administration devised packages of restrictions limiting the uses to which American citizens could put their dollars abroad. First came a tightening of President Kennedy's "voluntary" restraints against bank lending and corporate investment; finally, last January, came outright controls on capital and a controversial plan to tax tourist travel.

Such controls left the fundamental causes of the dollar-threatening payments deficit uncurbed. Last week Federal Reserve Board Chairman William McChesney Martin summed up the result in gloomy terms. "We are faced with a budgetary problem that has been getting progressively worse--a sad progression toward undermining the currency," he told the Economic Club of Detroit. "The dollar is stronger than gold, but like it or not, the world no longer has the confidence in the dollar that it once had. People doubt that we can handle our own affairs." Economist Raymond Saulnier, who was chairman of the Council of Economic Advisers in the Eisenhower Administration, took sharp aim at the Johnson Administration: "When you live in a managed economy," he said, "you run the risk of mismanagement."

After the Denarius. Throughout history, rulers unable to handle their monetary affairs have resorted to devaluation. The ancient Romans began to debase the denarius under Nero (A.D. 54-68) after they ran into--but failed to recognize--their balance of payments problems. Founded on plunder, Rome as an empire lacked the manufacturing, agriculture and commerce to pay for its costly imports. Trajan added copper to the once 99%-pure-silver denarius, and later the coin became wholly base metal. A century before Alaric sacked the Eternal City in A.D. 410, Rome had lost not only its purchasing power but also the wherewithal to resist barbarians at its borders.

As for recent times, only eight of the world's 120 currencies (those of the U.S., Cuba, Ethiopia, Haiti, Honduras, Liberia, Panama and El Salvador) have survived the 23 years since the end of World War II without a formal devaluation, according to Manhattan Currency Expert Franz Pick. Since Jan. 1, 1949, Chile has devalued 46 times, Brazil 32, Uruguay 18, South Korea 17. The U.S.S.R. has sliced the value of its ruble three times since World War II -- not because of external pressures but to reduce domestic purchasing power.

In its 179-year history, the U.S. has formally devalued the dollar in terms of gold only once, in 1934. Franklin Roosevelt's aim in raising the price of gold from $20.67 to its present $35 per oz. was to mid-Depression.*Not increase only farm did he prices in fail in that objective, but dollar devaluation furthered a chain reaction of compet itive devaluations and trade restrictions aimed at preserving jobs. One effect was to devastate world trade, which fell 57% between 1929 and 1936.

Away from Orthodoxy. Those hard lessons weighed heavily on the dele gates from 45 nations who created day's monetary system during three summer weeks of 1944 in the forest-cupped resort town of Bretton Woods, N.H. Out of their deliberations came the Washington-based International Monetary Fund and its sister agency, the World Bank (now headed by Rob ert Strange McNamara), which makes loans to underdeveloped countries. Bretton Woods' key decision was to stick with gold as the primary international monetary asset. In vain, Britain's John Maynard Keynes argued for creation of a new international money to sup plant gold. He warned that reliance on "the barbarous metal" would ultimately lead to a drying up of reserves and re strictions on trade and capital flow. The U.S. (then holding some 57% of the world's monetary gold) prevailed with its view that creation of the IMF -- a dar ing innovation for its day -- would solve the problem.

In a way, it has -- so far. Each IMF member country contributes a quota of gold and its own currency, to be loaned briety to countries with temporary bal ance'of payments deficits. In all, the IMF has accumulated nearly $21 billion, enabling it to lend a lifetime total of $14,2 billion to 64 nations. Now, however, a shortage of funds to finance expanding world trade will make itself felt as soon as the U.S. reduces its own massive dollar and gold drain. A second departure from prewar monetary orthodoxy adopted at Bretton Woods has also proved to be extraordinarily helpful. This is the provision for IMF-approved devaluations whenever a nation's money slips fundamentally out of line with other currencies. In place of the self-defeating rounds of the '20s and '30s, the orderly devaluations under the IMF have involved only minimal repercussions.

The IMF sprang awake at the hands of Sweden's late Per Jacobsson, Schweitzer's flamboyant predecessor as managing director. He developed the concept of stand-by drawings, extra financial aid for underdeveloped countries, came to Britain's rescue after the 1956 Suez crisis with a giant loan. He even persuaded imperious Charles de Gaulle to stiffen the faltering franc. "Mon general," said Jacobsson, "I do not think there will ever be esteem for a country that has a bad currency."

When Jacobsson died at 69, nine months before his planned 1964 retirement, almost everybody seemed to want Schweitzer as his successor in the $40,-000-a-year (tax free) job--except Schweitzer himself. A French senior civil servant, Schweitzer was reluctant to leave his quiet sinecure as No. 3 man in the Bank of France (the position included a 14-room apartment with a full staff). He relented upon learning that he had been Jacobsson's personal choice.

A nephew of both Conductor CnarU Munch and the late philosopher Albert Schweitzer, second cousin to Jean-Paul Sartre, Schweitzer was born in Alsace-Lorraine. He belongs to the French Protestant elite that has played a role in French finance and civil service out of all proportion to its numbers. After studying at the Ecole Libre des Sci ences Politiques, he joined the French Treasury in 1936, went underground as a Resistance fighter after France's fall in 1940, was captured, tortured and im prisoned at Buchenwald in the war's final months. He became an alternate member of the IMF's executive board in 1947, next year helped De Gaulle plan the devaluation and stabilization of the franc. As Per Jacobsson had fore told, that laid the foundation for a French economic comeback.

Fighting the Frivolous. Despite Schweitzer's roots in the French Establishment, there is little love lost between him and the ruler of France. De Gaulle takes it hard that a Frenchman can tell him no, as Schweitzer has some times done with French monetary proposals that he considered frivolous or downright destructive. Impartially, Schweitzer has also shot down a couple of U.S. plans -- most recently an Administration proposal for an import surtax to help the balance of payments. Schweitzer bluntly pointed out that the tax would violate IMF's articles, to which the U.S. is a signatory.

Schweitzer, his wife Catherine and their daughter Juliette, 13, have come to love the U.S. They live in the same whitewashed brick house he occupied during a 1947-49 stint as a financial counselor to the French embassy. (It just happened to be for sale again when he returned.) Their son Louis, 25, is a student in Paris. Schweitzer finds Washington social life a bore, likes to putter in his garden, walk with his family in his spare time. He has become a fan of hamburgers, motels and dry martinis. At home, he drinks California wine ("to help with your balance of payments"); at IMF's 13-story office compound two blocks from the White House, he imbibes French vintages ("be cause the cost won't show on your payments accounts").

Both as a diplomat and financial fire man, Schweitzer has carried IMF's prestige and power to a new eminence. Example: in 1949, when Britain devalued the pound from $4.04 to $2.80, the IMF learned about it only belatedly. Last year the British consulted with the fund for weeks before making up their minds how much devaluation to risk. Afterward, the IMF gave the U.K. a hefty $1.4 billion stand-by credit to help it get back on its feet. As one condition, IMF aides scrutinized and gave tacit approval to the draconian British budget introduced last week (see THE WORLD) before the Labor Government dared present it to Parliament. Had the IMF considered the British economic cutback too meager, it could have canceled the loan and so forced Britain at least to the brink of a second devaluation. The price Britain is paying for its profligacy is a partial loss of economic sovereignty to one of the most effective international organizations in history. Schweitzer considers it a badge of honor to have been denounced lately in Parliament. That, he says, is the kind of brickbat he usually wins only from backward countries.

Schweitzer's main concern nowadays is to complete the biggest change in the IMF's 24 years: creation of a new international money -- paper gold -- to take the pressure off dollars, pounds and real gold in bankrolling world trade and investment. It goes by the clumsy name of "Special Drawing Rights," or SDKs for short. Actually, SDKs would have some characteristics of currency and some of credit. They would consist of wholly artificial reserves, carried on the IMF's books as a separate fund and backed by pledges of contributions from IMF members in their own currencies. Nations would automatically participate in accordance with their regular IMF deposits; the U.S., for example, provides 24.59% of the fund's resources, the Common Market 17%. But only 30% of the issued SDKs would ever need to be repaid; the balance would become a permanent increase in each country's liquid assets. SDKs would exist only on the books of the IMF and its member nations. Only governments would be eligible to use them--and only to settle debts (not, for example, to buy goods or to raid another country's stock of gold). Ordinary tourists and businessmen would still settle their bills in the familiar national currencies.

After four years of bickering, Finance Ministers of the IMF's member countries unanimously agreed on the scheme at last September's IMF meeting in Rio de Janeiro. Since then, IMF technicians and the executive board have been hammering out the details and putting them into legal language. For a time, after Yale Economist Robert Triffin in 1959 revived and modernized the old idea of letting the IMF create its own money, the French seemed moderately cooperative. France even came up with one version of a plan to establish the "cru" --for collective reserve unit--to be issued in proportion to each country's supply of gold, only to turn away from it again. French Economist Jacques Rueff, who influenced De Gaulle to advocate a return to the old gold standard, argues that the price of gold should be doubled. Though Rueff's stature at home is sufficient to have made him a member of the exclusive 40-man band of intellectuals, the Academic Francaise, his views find little support among other major powers. However, Rueff has conceded that he "would prefer almost any solution to no solution at all."

A handful of issues over SDRs remain unsettled. The most prominent is a French demand for a clause allowing any country to opt out of further use of SDRs. Because such a proviso would surround the new system with a permanent aura of uncertainty, the French have been unable to win support on that point. But they are still pressing it. In the early bargaining, Schweitzer fought a successful diplomatic offensive to overcome the strong European preference for putting the new facility under the thumb of a small group of rich industrial nations instead of under the globally minded IMF.

Other squabbling has involved whether to call the SDRs "money," as the U.S. wanted, or merely a new source of credit, as some conservative European bankers demanded. Diplomatically, Schweitzer took a neutral stand; the SDKs were "a facility of special character," he said. Governor Otmar Emminger of West Germany's Bundesbank teased both camps: the SDKs are really a zebra, he maintained, "so that one can say they are a black animal with white stripes and another can say they are a white animal with black stripes."

Whatever their quintessence, the SDRs are coming onstage just in time to plug the gap in wherewithal to finance world trade that Lord Keynes foresaw at Bretton Woods. Over the past ten years, world trade has doubled; monetary reserves to finance it have increased by only 40%. In both 1965 and 1966 (the latest full-year figures available), the world's central banks suffered a net loss of gold, despite all the metal that was mined. Besides the pressure from hoarders and speculators, industrial demand for bullion is leaping some 15% a year--notably for sophisticated electronic and space apparatus (even the portholes of Boeing's SST passenger transport will be plated with a thin layer of gold to help dissipate the heat from the skin of the fuselage).

Schweitzer lobbied skillfully,.but the muscular push for creation of the SDRs was supplied by U.S. Treasury Secretary Henry Fowler (TIME cover, Sept. 10, 1965). Almost from the day he took office in 1965, Fowler decided that reform of the monetary system was the major task facing free-world finance ministers. Accordingly, he became a vigorous missionary among industrial nations, lining up converts on flying trips abroad.

This week, Fowler, as well as Schweitzer, is scheduled to fly to Stockholm, where IMF's 20 directors and Finance Ministers from the ten leading industrial powers are to try for a final agreement on the SDR pact. If, as expected, De Gaulle finds himself without enough support to continue stalling things, the document will soon reach member countries for ratification. If all goes well, the SDR plan could be ready to go into operation early next year. Yet Schweitzer warns: "Before the SDRs are activated, the U.S. must drastically improve its payments deficit. The SDRs are no miraculous cure for the monetary problems of the world. The cure for these ills is the kind of discipline the British have just shown."

Last Chance. The Federal Reserve and U.S. Treasury have certainly promised the six other members of the gold pool something close to that. "This is our last chance to bring our fiscal affairs under control," warns Allan Sproul, retired president of the New York Federal Reserve Bank. That brings the argument back to those election-year bugaboos, higher taxes and less spending. Despite the massive size of the federal budget, most economists agree that large cuts will mean not just trimming fat but getting at the lean, drastically affecting some programs. There are many theories and arguments on what should be cut. One detailed example is the proposal of former Treasury Under Secretary Roosa, now a Wall Street investment banker, who would slash $1 billion each from farm subsidies and space, $2 billion from harbors, rivers and highways. Many businessmen and bankers would jettison the $4.5 billion farm program in toto, however unlikely that may be because of political considerations.

As the nation revamps its economic priorities, some broader goals should change as well. How, for instance, can full employment, stable prices, sustained economic expansion and balance of payments equilibrium all be maintained? At any given moment, attaining any one of those four is likely to conflict with the other three. Which is most important? Full employment and expansion have had a long run, but at a rising cost in inflation; payments have been in balance only once (1957) in 18 years. Since that imbalance is the key plague of the monetary system, righting it must have high priority. "There is nothing fundamentally wrong with the system," says Pierre-Paul Schweitzer, "but no system can cope with the size of the U.S. payments deficit that got out of control in late 1967."

Gold's new split-level house is beginning to serve as a medium-term solution for the Western world's monetary troubles. For the longer run, the world is moving toward a money system that resembles an international bank much like the Federal Reserve System, with close coordination of money and policy.

If the world is to escape the tyranny of gold, for which man enslaved man, even nations as powerful as the U.S. must prepare to give up some of their economic sovereignty. They will have to allow foreign technocrats a voice in their economic councils. Having sapped its international financial strength, the U.S. cannot hold the wobbly monetary structure together by itself. It needs Europe's help, and in return must accept some of the measures of discipline that Europe demands, unpalatable though that idea may seem. As an alternative, the U.S. could at worst retreat into economic isolationism and perhaps maintain a reasonable living standard. At best, the gold crisis could bring the dawn of a new era of international economic partnership.

-The 19th century system whereby each nation set the value of its currency by weight of gold, and guaranteed to convert paper money to bullion on demand. Honoring that commitment forced nations into ruthless de flations, panics, recessions. Under today's gold-exchange standard, which was evolved in the '20s to economize on the need for the metal, central banks hold some reserves in foreign currencies convertible to gold (such as the dollar). -Tinkering daily with the price of gold during the months before that, F.D.R. liked to decide on a figure in a huddle with Acting Treasury Secretary Henry Morgenthau, Financial Adviser George F. Warren and Reconstruction Finance Boss Jesse Jones as 1 breakfasted in bed at the White House. Wrote Morgenthau in his diary: "If anybody ever knew how we really set the price of gold through a combination of lucky numbers, etc., I think they would be frightened."

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