The Monetary System: What's Wrong and What Might Be Done

THE European money crisis only dramatized what many experts have long regarded as an unassailable dictum: the free world's monetary system is overdue for an overhaul. That system--the internationally agreed basis for exchanging one currency for another--was born 24 years ago in the resort town of Bretton Woods, N.H. Imbued with a sense of wartime unity and mindful that competitive currency devaluations had deepened and prolonged the Depression of the '30s, the delegates from 45 nations took only three weeks to devise the fundamentals.

They agreed that gold would remain the primary international asset by which nations settle their debts with one another. The U.S. dollar, then backed by 57% of the free world's nationally held supply of gold, would be the key currency. Under that arrangement, then and today, other nations value their money in terms of the U.S. dollar, which is itself valued in terms of gold. The dollar's acceptability in world finance rests on the U.S. Treasury's pledge to redeem dollars held by foreign governments for gold at an unchanging $35 per oz.

Also out of Bretton Woods came the Washington-based International Monetary Fund, the arbiter of exchange rates. Written into the IMF articles of agreement, and binding upon its 111 member nations, is a proviso that no country may devalue its currency without IMF permission. In practice, the IMF allows devaluation only when economic misfortune (almost always inflation) strips a currency of its hitherto established value. Barring devaluation, every IMF nation must buy, sell or borrow foreign currencies--in practical terms, dollars--in sufficient quantity to keep its own money within 1% of its declared worth.

Though the fact is little understood outside the field of banking and professional economics, the peoples of the Western world owe their rising living standard in large part to the monetary system that now shows increasing signs of fragility. There are at least two separate, but related, troubles. The volume of world trade is rising far more quickly than the global supply of gold. To overcome that gap, the IMF last year devised a sort of "paper gold"--a new international money called "special drawing rights." Use of the SDKs, as they are called, awaits ratification by nations that contribute at least 80% of the IMF's $21 billion bankroll.

The second problem--the one that caused last week's tremors--is the main, and perhaps mortal weakness of the monetary system. While nations that belong to the IMF are obliged to try to keep their currency-exchange rates steady, there is no stipulation that they keep their international payments in balance at the prevailing exchange rate. The result is all too frequent imbalances in international payments, which put new strains on the monetary system.

As inexorably as surf beating upon sand, prolonged payments deficits erode confidence in the value of currencies. France's current difficulties spring from soaring wage rates, the price of quelling last June's student-worker uprising. Whatever their specific cause, enduring payments deficits expose a weakness that political leaders are understandably loath to recognize: lack of economic selfdiscipline.

Devaluation alleviates such problems, at least temporarily, but the political repercussions are painful. Consequently, governments postpone the unpopular. When a country is finally forced to change the value of its money, it almost always does so only after long delay, speculative frenzy and dislocation. West Germany's monetary problem, the reverse of France's, grows out of a payments surplus, generated by an amazing economy that enjoys full employment without wage and price increases. German leaders naturally complain that revaluing the Deutsche mark--raising its price in relation to other currencies--would penalize Germany for the shortcomings of other countries.

Still, for all their political quarrels and economic rivalry, the world's industrial nations are monetarily interdependent. As long as devaluation or revaluation is possible under the fixed-exchange-rate system, traders and bankers in their own interest can scarcely avoid dumping a currency that may fall in value or collecting a currency whose value may rise. Unfortunately, such switching back and forth only magnifies the size of the problem.

A number of patchwork expedients help keep the system together: massive IMF loans to countries with severe payments deficits (as in the case of Britain), currency "swaps" (which enable speculation-threatened countries to buy and thus defend their own currency with foreign currencies), and the two-tiered gold-pricing system. The two-tiered system, which was established last spring to thwart speculation against gold itself, pegs the official cost of gold at $35 an ounce in transactions between governments, but lets it seek its own level in commercial markets. Still, moneymen view with increasing alarm the tendency for new emergencies to erupt every time speculation hits a faltering currency.

What can be done? There is some talk of a new Bretton Woods, where the monetary system might be completely overhauled. Among the possible revisions is a realignment of the values of the world's currencies. Another is an increase in the price of gold, a move that would expand the supply of money in the world's central banks and thus minimize the swings in price caused by speculation. This would mean in effect, however, the devaluation of the dollar--a step that would be extremely difficult for any U.S. President to take.

Other remedies are possible. Last week's crisis heightened interest in a system of so-called flexible exchange rates that would avoid the wrenching upheavals of formal devaluation and revaluation. Rather than keep its currency within 1% of declared value, as current rules require, a country might be allowed to permit swings of 5% or so. Such a plan would necessitate revision of the IMF's articles of agreement and ratification by three-fifths of its member countries, a process that would take a year or more.

Time is running short. The dollar largely escaped the impact of last week's upsets, but next time it may not be so lucky. Clearly, one of the pressing tasks of the incoming Nixon Administration will be to find a way to forestall a more serious world monetary crisis.

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