“Capitalism and Freedom” Summary, Chapter 4: International Financial and Trade Agreements

by Danny Fenster

This chapter is a free excerpt from Quicklet on Capitalism and Freedom.

The problem of international trade is the problem of setting currency exchanges. This is connected to the previous discussion of monetary policy.

"It's not too much to say that the most serious short-run threat to economic freedom" in the US are "far-reaching economic controls" attempting to solve the balance of international payment problems. The most effective way of turning a market economy into an authoritarian one is to begin imposing direct controls on foreign exchange. One step in that direction leads to further rations and controls.

Restrictions in foreign trade are new in economic history, invented by Hjalmar Schacht for a nascent Nazi regime, which prohibited citizens from trading currencies with other countries.


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The problem of international trade is the problem of setting currency exchanges. This is connected to the previous discussion of monetary policy.

"It's not too much to say that the most serious short-run threat to economic freedom" in the US are "far-reaching economic controls" attempting to solve the balance of international payment problems. The most effective way of turning a market economy into an authoritarian one is to begin imposing direct controls on foreign exchange. One step in that direction leads to further rations and controls.

Restrictions in foreign trade are new in economic history, invented by Hjalmar Schacht for a nascent Nazi regime, which prohibited citizens from trading currencies with other countries.

Gold is a price-supported commodity, like wheat and other agricultural products, but with three important differences: we pay the support price to foreign and domestic producers; we sell the support price only to foreign purchasers; and, more importantly, the Treasury is able to print new money to pay for gold while keeping those expenditures off the books.

The price of gold was set above the free market price in 1934 at $34 an ounce. US gold stocks tripled in six years, giving the US "a 'surplus' of gold for the same reason we accumulated a 'surplus' of wheat"; the government payed a higher-than-market rate for it. The price remains the same though other goods have risen, putting the fixed price of gold below the market price now, resulting in a gold "shortage."

The legal price would have risen like other goods but the primary producers of gold, the beneficiaries of rising prices, were US antagonists--Soviet Russia and South Africa.

Price controls are inconsistent with free economies. Even worse were Roosevelt administration measures like nationalizing the gold stock, prohibiting private possession of gold for monetary purposes, and the elimination of gold clauses from public and private contracts.

In 1933 and 1934 private holders of gold were made to sell their gold to the federal government at below-market prices and private ownership of gold was made illegal. This is equivalent to Fidel Castro's requirement that Cuban land and factories be turned over to the state at below-market prices. "One can hardly imagine a measure more destructive of the principles of private property on which a free society rests."

The move was rationalized as conserving gold for monetary use, but was actually done so the government could either profit from rising gold prices or prevent individuals from profiting.

There are two problems in international monetary relations: the balance of payment and the danger of runs on gold.

US citizens and the government buy foreign currencies with dollars to spend abroad, as foreigners are buying US dollars with foreign currencies to spend here. But there is no guarantee that the number of dollars some want to spend will equal the number others want to buy. This is the problem of the balance of payments.

Because the US has been borrowing abroad to achieve a balance on current accounts, many are interested in converting dollars to gold or foreign currency. A run on gold occurred in 1960 and is likely to happen again unexpectedly.

There is always the possibility that something may come along and alter balanced payments--changes in demand for currencies or "a million and one other changes of the kind that are always occurring."

There are only four ways in which a country may respond to such an imbalance, and some combination of them must be used.

1. US reserves of foreign currencies can be drawn down or foreign reserves of US dollars built up, essentially lowering the US gold stock. This is only temporary.

2. Domestic prices can be forced down. The deficit creates an outflow of gold (mechanism 1) which decreases the US stock of money and increases foreign stocks. US prices and wages drop while abroad they go up, making US products more attractive foreign products less so, thus restoring balance. This is not currently automatic.

3. The same effects can be made by changing exchange rates. This can be done by government declaration, by day-to-day market fluctuations through private transactions or by government manipulations.

Of these, "only the freely floating exchange rate is fully automatic and free from governmental control."

4. Governmental interventions may be used, including tariffs, subsidies, quotas, or any other of a "bewildering array" of exchange controls.

US policy has avoided all of these, effectively putting us "in the position of a man living beyond his income" who cannot earn more, spend less or "borrow or finance the excess out of his assets!"

Because we and our trading partners have been unwilling to adopt one coherent policy we have been forced to use all of the policies above, and increasingly the fourth (exchange controls) "clearly the worst" and most destructive to a free society.

The mechanism consistent with free markets and trade is a system of freely floating exchange rates determined by private market transactions free of government interventions. Anything else leads to more controls on trade. The free floating exchange is the only way to effectively and automatically respond to the natural changes in international trade.

Only a few liberals support this, mostly professional economists, because of the "tyranny of the status quo" or a misunderstanding of  real- and pseudo-gold standards.

But more important is the widely mistaken interpretation of free floating exchanges in South America. Extreme fluctuations existed due to instabilities in underlying economic structures, not the floating exchanges. We want "a system in which prices are free to fluctuate but in which the forces determining them are sufficiently stable," keeping prices in a moderate range.

Some measures needed for a truly free US market in gold and foreign exchange:

1. The US should stop buying or selling gold at a fixed price.

2. Laws banning private buying and selling of gold should be repealed.

3. Present law stating the Reserve must hold certificates equal to 25 percent of its liabilities should be repealed.

4. The government should release all of its gold stocks on a free market gradually over a five year period. Gold certification and storage should be left to private enterprise.

5. The US should not proclaim official exchange rates nor attempt to influence exchange rates, leaving them to the free market.

6. These suggestions conflict with IMF policy, but the same has happened with Canadian policies in the past. There is no reason this cannot be reconciled again.

7. Other nations may still peg their currencies to the dollar; that is fine so long as we undertake no obligations to buy or sell their currency at a fixed rate.

These measures would automatically ensure a balance of payments; "No one could sell dollars unless he could find someone to but them and conversely." This would allow us to move directly to complete free trade of goods and services, barring militarily or politically strategic sanctions.

This says nothing of the living standards of workers in various nations, which here is irrelevant. "If the Japanese worker has a lower standard of living than the American, it is because he is less productive on the average than the American."

The best way to get to free trade is to eliminate all tariffs and other trade restrictions unilaterally.

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