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The Dollar Abroad

As explained in Chapter 15, continued experience with the use of intrinsic money during the early stages of the development of international trade resulted in the gradual elimination of the less satisfactory kinds of money-goods, and eventually led to general acceptance of gold as the primary form of money. The next development, in the nations with the principal trading roles, was to put their respective currencies on a gold standard by making them convertible to gold at fixed rates. The exchange rates, the values of each currency in terms of each of the others, were thus restricted to a narrow range of variation determined by the cost of shipping gold. If the value of the British pound in terms of dollars, for example, rose above the higher limit, the gold export point, dollars were exchanged for gold, and the gold was shipped to England. Similarly, if the value of the pound dropped to the lower limit, the gold import point, it became profitable to exchange pounds for gold in England and ship the gold to the United States.

Even within the relatively narrow range between the gold import and export points, the variation in exchange values had a substantial regulating effect on international trade, and indirectly on the domestic economies in all of the trading nations. A decrease in the exchange value of the dollar reduced the cost of U. S. goods in terms of foreign currencies, and thus stimulated exports. But these increased exports then increased the foreign demand for dollars with which to make payment, and this, in turn, raised the value of the dollar back toward the equilibrium point. If an unbalance one way or the other continued long enough to make transfer of gold necessary to settle the accounts, further regulation was accomplished by actions to conserve gold resources which were taken by the monetary authorities of the nations that were affected.

But these self-regulating features of the gold standard mechanism were capable of operating only under a limited range of conditions. They were not adequate to deal with a large unbalance in the international accounts. The enormous purchases of American goods by foreign governments during World War I were far beyond the capacity of the exchange system to handle, and the gold standard was abandoned during this emergency. Attempts were made to revive it after the war, but in the meantime another obstacle had developed, the nature of which is not fully appreciated even yet.

The value of gold under present-day conditions is purely arbitrary, and hence there is no inherent relationship between its value and that of the currency of a major nation such as the United States. If they are not interconvertible, the two kinds of money are totally independent. If they are interconvertible, the government has enough control over the situation to be able to set the rate of conversion arbitrarily, within rather wide limits. So far as the domestic economy is concerned, what this amounts to is setting an arbitrary value for gold in terms of goods; that is, establishing the real value of gold in the United States.

The government of any other major nation can likewise establish an arbitrary relation between its currency and gold, and thus define the real value of gold in that country. (A small nation might run into some practical difficulties.) But if the currencies are convertible to gold, no two countries can establish different real values for gold, since this would simply drain all gold out of the country in which it had the lower value. The international gold standard is therefore feasible only if there is sufficient flexibility in the price systems of the different countries to permit the local price levels to adjust themselves to the international real value of gold. As brought out in the earlier discussion, the price level is determined in the production market. The production price must therefore be flexible, and since wages are the principal constituent of the production price, this means that the international gold standard can be maintained only if money wages in all countries are flexible enough to permit the general price level in each country to adjust itself to the international real value of gold, the value in terms of goods.

In the era of the gold standard this wage flexibility was a reality. If the real value of a local currency dropped below the international standard, profit margins decreased, and to protect their positions the employers reduced wages. In the reverse situation, increased demand for labor resulting from higher average profits was soon translated into higher wages by the competitive process. Thus any significant change of the price level from its proper position relative to the international real value of gold was promptly corrected by appropriate adjustments of the wage structure. In the years since World War I, however, this wage flexibility has been almost completely eliminated. As matters now stand, a general reduction of wages is practically impossible, except in major emergencies such as severe depressions, and wage increases are sought and granted with little, if any, regard for the effect on prices. Under present conditions the wage level is essentially arbitrary, and since the market price level is determined by the wage rate, the real value of each national currency is determined by this arbitrarily established level of wages (in terms of wage payment per unit of output).

If we represent the real value of the currency, the general price level, and the wage rate per unit of output by C, P, and W, respectively, we can express the fact that the real value of the currency of country A (its buying power) is the reciprocal of the general price level in that country by the equation CA = k/PA, where k is a constant that depends on the units in which C and P are expressed. By a proper choice of units we can make k equal to unity, in which case the equation becomes

CA = 1/PA

As explained previously, the normal market price level is equal to the production price level. We have now seen that the latter is determined by the wage level. This is, of course, the money wage, but it is not necessarily the amount that the worker receives in his regular paycheck. In modern practice, a part of the wage or salary is received in the form of what are called “fringe benefits”-pensions, paid vacations, insurance, medical benefits, etc.-which are just as much part of the compensation for labor as the payments in cash. Business taxes reduce the amount of revenue that has to be raised by taxing individuals, and thus are also additions to the workers’ compensation. In applications such as the analysis of exchange rates, where we are dealing with two or more economies that operate under different conditions, it is necessary to put all wages on the same basis by correcting for the effects of these modifications of the wage payments. With this understanding, we can substitute W for P in the foregoing equation. Again eliminating the constant of proportionality by an appropriate choice of units, we have

CA = 1/WA

What this equation says is that the real value of the currency varies inversely with the level of money wages per unit of output; that is, if the wage rate is reduced, or if productivity increases while the time rate of wages remains constant, the real value of the currency increases, whereas if the wages per unit of time are increased while productivity remains constant, the real value of the currency falls.

The ratio of the real value of the currency in country A to the real value of the currency in country B, the exchange rate under conditions of free exchange, is equal to the inverse of the ratio of money wages per unit of output in the two countries.


This equation shows that it is mathematically impossible to control the two ratios independently of each other. If the exchange rate, the ratio of the values of two currencies, is fixed, as it is under the gold standard, this establishes the ratio to which the wage rates must conform. On the other hand, if wage rates are to be set by government decree, or by bargaining, or by any other process that does not reflect free market conditions, then the true ratio of values of the two currencies will necessarily fluctuate. Free convertibility to gold is impossible under such conditions, and fixed exchange rates can be maintained only by strict controls over currency transactions and over the “black markets” that inevitably spring up when government attempts to force economic transactions into an arbitrary pattern.

Many economists have advocated a return to the gold standard as a means of overcoming some of the current problems of international trade and finance, but this is another of those instances in which the economists have centered their attention on the question as to what, in their opinion, should be done, to the exclusion of the question as to what can be done. No one is naive enough to believe that it is possible to return to the former flexible wage policy-to again give the employers the power to make arbitrary adjustments of wages up or down to conform to market conditions-and without this, or some equivalent means of attaining cost flexibility, the international gold standard is an impossibility. Any one country could make its currency convertible to gold, but as long as wage rates are determined arbitrarily, rather than being allowed to adjust themselves to the markets, the real values of the various currencies cannot maintain the constant relation to each other that is the essence of the gold standard.

Before World War I the exchange ratio CA/CB was held constant by a fixed relationship between each currency and gold, and the wage ratio WB/WA had to conform. International finance was then on the gold standard. Now the wage ratio is determined by arbitrary actions in each country, and the true exchange ratio has to conform. As J. R. Hicks expressed it, we are now on the labor standard.133 It has to be either one or the other. It is mathematically impossible to apply an arbitrary control to both sides of the wage-currency equation, and hence we cannot have both the labor standard (that is, our present arbitrary methods of establishing wages) and the gold standard (an arbitrary relation between each currency and gold).

Furthermore, the same is true of any fixed exchange rate, irrespective of whether or not it is tied into gold. As long as wage rates are determined arbitrarily in each country, the ratios of the real values of the currencies will vary, and since this ratio is the true exchange rate, maintenance of fixed exchange rates is impossible except as a short term proposition.

If the value of a country’s currency drops in international exchange, the reason normally is that its money wage rates are too high relative to its productivity, and its price structure on the basis of the official exchange rate is therefore excessive, which encourages imports and discourages exports. If the exchange rate is permitted to drop, this corrects the situation by increasing exports and reducing imports, thereby leading to a new exchange equilibrium at a more realistic level. But if an attempt is made to hold the exchange rate at the high official level, the excess of imports continues, and the problem becomes more acute.

It is unfortunate that this purely factual question as to the value of a currency should be so closely identified in governmental thinking with the matter of national prestige. There is a rather general impression that a decrease in the exchange rate of a country’s currency indicates a weakening of international confidence in the soundness of the currency, and of the national economy which it serves. In some cases this is all too true. Where a government tries to live beyond its means and resorts to excessive borrowing or to currency issues to obtain the funds that it cannot get from taxation or other legitimate sources of revenue, confidence in that country’s currency is undermined and its exchange rate falls. But this is not the usual reason for fluctuations in the exchange rates. Every currency has a real value, a buying power in terms of goods, and since that buying power continually changes because of wage adjustments, technological improvements, etc., the real value of the currency likewise changes. All that the fluctuations of the exchange rates normally mean is that these rates are following the ratios of the real values. Confidence has nothing to do with this. No matter how sound a currency may be at its real value, one cannot have confidence that it can be artificially maintained at a point above that real value.

While the reasons for the inability to maintain fixed exchange rates are still not generally understood (as the continued high level of support for a return to the gold standard demonstrates), it is recognized that the attempts to maintain fixed rates have failed. As matters now stand, therefore, the rates are being allowed to “float” at the ratios determined by the markets. Nations that are experiencing financial difficulties do set “official” rates of exchange, and prohibit currency transactions at other rates, but this policy is not very successful. It not only impedes trade with other nations but also leads to the growth of a black market in which currencies are exchanged at illegal rates that are closer to the true relative values.

The abolition of fixed exchange rates by the major trading nations occurred only after a great deal of opposition was overcome. This is not the kind of an action that encounters any serious opposition from the general public. There are a few places where the exchange fluctuations are quite visible. The relative level of the U. S. and Canadian dollars, for instance, has a substantial effect on business relations on both sides of the border. Tourists and other travelers are also very conscious of any change in the value of their money. But the effects of variations in the exchange rates are not usually visible to the general public, and there is no general interest in how they are determined. The opposition to free exchange rates comes mainly from government agencies which are overly concerned with the prestige aspect, and from special groups such as the bankers who feel that their operations are facilitated by the existence of fixed exchange rates.

These opponents warned of dire consequences if their opposition was overruled. “Devaluation or adoption of floating exchange rates,” the American Bankers Association said, while the change to floating rates was under consideration, “would do irreparable damage to the international monetary system, and to the economic, military, and political strength of the entire free world.”134 As so often happens in economic affairs, however, all that this amounts to is an emotional statement with no factual backing. There is no theoretical reason why there should be any disadvantage in allowing the exchange rates to reflect the real value of each currency rather than a fictitious value set arbitrarily by some government agency, and experience has flatly contradicted the gloomy predictions emanating from the bankers.

It may be of interest to note that Keynes was favorably disposed toward freely floating rates. As reported by Harris,135 “Keynes contended that in a world of economic rigidities, particularly in wages and prices, the economy must give somewhere, and the most likely area is the exchange rate.”

The arbitrary “official” exchange rates cannot be maintained for more than a relatively short time in any event. The farther the official rate gets away from the true ratio of values the more difficult it becomes to hold it, and sooner or later it is necessary to revise it upward. The actual effect of controlling the exchange rate, therefore, is not to prevent adjustment of the currency values to more realistic levels, but to cause the adjustments to take place in sudden jumps rather than by slow and gradual changes. The damage that is done to what would otherwise be a profitable international trade is a high price to pay for the very dubious advantage of being able to administer economic medicine in big doses rather than small doses.

It is true that the present state of international finance is far from satisfactory. Far too many nations are unable to generate the foreign exchange needed to pay for imports and meet their commitments with respect to their international debts. There is a tendency to blame the monetary exchange system for this shortage, and efforts are being made by the economists and money managers to devise some kind of cure for the ailments. One experiment now being tried, in a rather half-hearted way, is the creation of a kind of international currency in the form of “special drawing rights” (SDRs) which nations can draw upon when they run out of foreign exchange.

This experiment has not accomplished its objective. On the contrary, the international balance of payments situation has gotten worse rather than better. But the failure was inevitable, as this was an attempt to do something that is impossible. The reason a nation runs out of foreign exchange is that its international spending (its imports and other foreign expenditures) has exceeded its international income (its exports and other receipts from foreign sources). It has been living on credit, and it has exhausted that credit. Now it must face the reality that, in the long run, only goods can pay for goods (Principle II). No financial juggling, however ingenious, can avoid this unpleasant fact. Unless a gift can be obtained from some other country, or from the international community, or the nation is desperate enough to take the drastic step of repudiating the debt, more goods must be produced for export at the expense of the domestic standard of living.

The plain truth is that a nation that has no foreign exchange is in the same position as an individual who has no money. It has no purchasing power. The only cure for this disease-lack of purchasing power-is increased production, because production is the only source of purchasing power, (other than gifts from more prosperous nations, which are necessarily limited and temporary). The SDRs and other financial schemes that the international monetary authorities are trying to devise are simply attempts to evade the economic realities.

Although the immediate purpose of the SDRs was to provide additional credit for nations undergoing what was considered to be a temporary shortage of foreign exchange, the creation of such a support system was influenced to a considerable extent by the desire of the financial authorities to have an international currency, something that would assume the role that gold used to play in an earlier and simpler era. The term “paper gold” that is widely applied to the SDRs is a reflection of the status that it was hoped they would have in international finance. That hope, however, has no chance of being realized, for at least two reasons. First, neither these “rights” nor any other international money has any assured value. Such products are not intrinsic money; they are purely credit money. As such, their value is entirely dependent on the credit of the issuing agency, and under present conditions an international agency has no credit. The extent to which the “rights” will be accepted in lieu of money depends on the attitude of individual nations, and it is safe to predict that, after s few sad experiences, the nations that find themselves paying the bills for the extravagances of others will take steps to see that the credit obtained from international agencies is strictly limited.

The second reason why an international currency is not feasible under present conditions is the same one that prevents a return to the gold standard, and stands in the way of fixed exchange rates-the fact that an international standard of value is impossible as long as each country is free to set wage rates arbitrarily, thus making the true value of its currency arbitrary. It has been proposed that, in order to overcome this objection, the international medium of exchange should be tied to a “basket” of commodities to stabilize its value, but this does not solve the problem. A basket of commodities is not accepted as money, and therefore is not money. This is just another version of John Law’s monetary ideas. Support for the proposals therefore been limited.

In the absence of an international currency since the demise of the gold standard, it has been necessary to handle international financial transactions by means of the various national currencies. For the same reason that resulted in gold displacing the many other types of intrinsic money that have been utilized, there has been a general tendency to use only the most stable of these national currencies as the international standard of value. In order to be stable, in this sense, the currency must be issued by a nation that has a solid political establishment that can be relied upon to maintain a steady course, has an economy that is large enough to accommodate the variations in the international transactions without excessive dislocation of its domestic equilibria , and is relatively resistant to inflationary pressures. On these grounds the U.S. currency has become the de facto international standard.

It must be conceded that U.S. currency is not a fully satisfactory form in which to keep these reserve funds, because their value decreases as inflation reduces the value of the U.S. dollar. But, as matters now stand, there is no better alternative. Gold is no longer satisfactory for this purpose, as its value as intrinsic money-that is, its value as a commodity-no longer has much significance. The value now attributed to it contains a large and highly variable speculative component, which means that this value is primarily credit-created, in the same sense as the value of currency, without the stability of a government-backed currency.

The international use of U.S. currency is, in some respects, advantageous to the United States, but it also has some potential dangers that should have serious consideration. The currency holdings in foreign countries are claims against U.S. assets, and they can be used at any time and in any quantity. There is always a possibility that the financial stability of a nation may be called into question for one reason or another, and if the United States were to get into such a position, the huge foreign holdings of U.S. currency could have very damaging effects. As we saw earlier, foreign purchases of U.S. goods raise the general price level in the United States. Large purchases could produce a money inflation that would disrupt the U.S. economy.

The dangers inherent in the existence of the large foreign holdings of U.S. currency are now greatly increased because they are accompanied by vast amounts of U. S. government and private interest-bearing obligations. A currency crisis resulting from a loss of confidence in the stability of the U.S. economy could easily cause heavy selling-perhaps even panic selling-of these securities and conversion of these claims into goods. This possibility with which we are now faced is something like a run on a bank. Like the banks, we have outstanding a much larger total of obligations payable on demand than we are able to meet on short notice As in the case of the banks, therefore, our present financial situation is stable only because our creditors do not demand payment of any large portion of these obligations simultaneously. The whole financial structure thus rests on foreign confidence in our economic stability.

Whether or not that confidence is justified is a matter of opinion. We must, however, bear in mind that there is a limit to the credit of any institution, even a large and wealthy nation such as the United States. An indication that we may be approaching that limit as these words are being written is the relatively high interest rate that we have to pay in order to attract the amount of foreign money that we need to finance the current budget deficits. Like a shaky business enterprise, we have to pay a substantial premium over what would be the normal rate. In any event, the present policy cannot be continued indefinitely. A “run on the bank” may or may not be imminent, but it is an ever-present threat.

This situation in which the United States now finds itself probably would not have developed if the nation had not become the world’s banker. In that case the United States would have a fairly well defined credit limit like that of any other nation. But the accumulation of U.S. obligations by foreign nations and individuals as financial reserves has greatly enlarged the amount of U.S. debt that can be absorbed without adverse reactions on the nation’s credit. Furthermore, because of the use of U.S. currency as an international standard, the exchange value of this currency is affected by a number of factors other than the true value in terms of goods that determines the exchange value of other currencies. One such factor is the existence of a speculative element in the market evaluation of U.S. currency. An unstable world financial situation, for example, tends to favor investment in the United States. The U.S. interest rate, and estimates of its probable trend, also have a significant effect. And since a large part of the financial reserves of most foreign nations is maintained in the form of U.S. currency, these nations have a vested interest in the stability of the dollar. Their central banks therefore frequently intervene in the currency markets by purchasing or selling dollars to prevent undesired changes in the exchange rates.

This special position in world finance has the effect of exempting the United States from some of the restraints that would otherwise limit the extent of the kind of actions that cause trouble. Unfortunately our nation has been unable to exercise the kind of self-discipline that would take the place of these external restraints. As a consequence, we have succumbed to the financial ailment that is afflicting a large and growing number of the nations of the world, particularly the so-called “underdeveloped” countries-the borrowing disease. Within the last decade the United States has borrowed from foreign sources in quantities unprecedented in financial history, solely for the purpose of meeting government deficits; that is, to enable financing government expenditures without having to ask the taxpayers to pay for them. We are raising the money to meet today’s expenses by mortgaging the earnings of future generations.

In addition to making it relatively easy to borrow from foreigners, the international use of U.S. currency has had the effect of concealing a substantial segment of the national debt. The debt totals as stated by government agencies and other compilers of economic statistics include only the interest-bearing portion of the debt. But large amounts of U.S. currency are being held by foreign governments and individuals as financial reserves. These billions of dollars are debts of the United States in exactly the same sense as our government bonds, and they constitute an important part of the debt total.

Ironically, the financial policy that the United States has been following in recent years is exactly the same as the policies of many nations, particularly in Africa and Latin America, which the financial experts of our government criticize so strongly. The only real difference is that these nations have realistic credit limits, based on the productivity of their economies, and most of them have reached their limits, while our position as the world banker prevents general recognition of the extent to which we are living on credit.

Strangely enough, adoption of this policy of reckless borrowing was the work of some of the most conservative elements of American society. After the theory that we can spend ourselves into prosperity derived from some of Keynes’ ideas was generally recognized as having failed in practice, the pendulum swung back in the other direction, and the ultra-conservatives embraced the idea that the royal road to prosperity was the reduction of government expenditures. This, in itself, is quite harmless, so far as the general operation of the economy is concerned, but unfortunately it was coupled with the belief that the government could be starved into economy by reducing taxes.

Of course, some justification had to be offered for abandoning what had long been regarded, in conservative thinking, as fiscal responsibility, and this was provided by a new (or at least rejuvenated) theory known as “supply side economics,” which was receiving considerable public attention at the time. According to the proponents of this theory, taxes beyond a certain level bring in less, rather than more, revenue to the government, because of their depressing effect on the volume of business activity. Most economists rejected this theory from the beginning, and experience with its application has disillusioned many of the individuals who originally favored it, so it has relatively little active support at this time. However, the underlying premise of the theory, the “supply side” view that taxes are a burden on the economy, has been brought up in other connections, and some comments on its status are therefore in order.

Identification of the true cause of unemployment in The Road to Full Employment makes it evident that, under existing conditions, higher business taxes do have some adverse effect on employment. But the theoretical development also shows that this loss of employment can be avoided by relatively simple means. It also demonstrates that taxes on individuals do not have any direct effect on employment. Their impact on business activity in general depends on what the government does with the tax revenues.

In this connection, it should be kept in mind that the government is not a separate entity with objectives of its own; it is an agent of the citizens of the nation. Its expenditures are made with funds collected from those citizens, and are made for the benefit (presumably at least) of those citizens. The effect on the economy is therefore exactly the same as if the money had been spent for similar products by the citizens themselves. The effect on the individuals is different, simply because these individuals, if left to their own inclinations, would buy different products, items on which they place a higher value.

It follows that the reduction of taxes on individuals, the largest component of the total tax reduction made for implementation of the supply side theories, had no stimulating effect on business, except insofar as the government financed the resulting deficit by inflationary borrowing or printing money. The policy that was actually followed was to minimize the use of new money and finance the large deficits by borrowing from foreign sources (selling credit goods, in the terms used in the theoretical discussion in Chapter 15). This avoided the inflation that otherwise would have produced some of the business expansion that the supply side economists were counting upon. It also enabled the national Administration to claim credit for controlling inflation, although in reality, all that had been done was to postpone it.

If past experience is a reliable guide in this instance, supply side economics will continue to have the support of some economists. Economic theories come and go in the manner of fashions in clothing, but a theory that once gains a measure of acceptance is seldom completely abandoned. However, the legacy that has been left by the supply side experiment, the huge addition to the national debt and the continuing budget deficits that are adding to it, will probably preclude any repetition in the foreseeable future. The present concern is with the question as to how to extricate ourselves from the quagmire of debt, an undertaking in which we are handicapped by the fact that we have never, as a nation, arrived at a general policy with respect to living on credit.

In any event, it is now clear that financial policies that cause the value of the dollar in foreign markets to diverge substantially from its true value have damaging effects on many segments of the domestic economy, as noted in Chapter 16. It is thus evident that we need some kind of controls over our international dealings that will accomplish the same results as the restraints that are automatically applied to all other countries by the currency exchange rates.

Furthermore, it is time for the United States to give some consideration to the effect of U.S. economic policies on the rest of the world. We have assumed a position of leadership in political and economic affairs, at least among the most economically advanced nations, and we should now recognize that this position carries with it some responsibilities.

The tie-in between the U.S. and world currencies that has resulted from the international use of U.S. currency has generated a new set of economic problems that have been gradually increasing in severity. The root of these problems is that, as matters now stand, U.S. actions taken for purely domestic reasons have repercussions throughout the world economies. As a well-known aphorism puts is, “When the United States catches a cold, the rest of the world has pneumonia.” The sheer size of the U.S. economy has something to do with this, of course, but the reliance of the international community on U. S. currency causes the U. S. actions to have results around the world that are not taken into consideration when decisions are made as to U.S. policies.

This brings up the question concerning our relations with the rest of the international community. It would seem that the mere fact that we have accepted the kind of a position in the world that makes it possible for us to play a major part in the affairs of other nations imposes on us an obligation to avoid doing harm to the others by our policies. But we have not, thus far, recognized that obligation. For instance, the high interest the United States has had to offer in order to attract enough foreign money to finance its deficits has drained out of those countries the capital that they need to improve their productive facilities and to meet the requirements of the less affluent nations. Essentially, what has happened is that savings which should have been invested in productive applications in foreign countries have been diverted to financing additional consumption in the United States.

A close competitor of the huge budget deficit for the dubious distinction of being the domestic economic policy with the most destructive effect on international economic relations is the Federal Reserve System’s reliance on an anti-business policy as the primary means of controlling inflation. As noted in the earlier pages, the currently prevailing economic opinion is that there is a “trade-off” between inflation and unemployment, and that the only way to correct an inflationary situation is to institute a “tight credit” policy that will reduce business activity and employment. It must be conceded that this policy, if it is carried out with sufficient firmness, is capable of achieving its objective. The slowdown of business activity produces the conditions described in Chapter 14 which lead to a downswing of the business cycle, thereby eliminating, or at least reducing, money inflation. At the same time, the increased amount of unemployment dampens the pressure for wage increases, and thus reduces cost inflation.

But the reduction in business and employment, even in those cases where it does not reach recession proportions, is a very high price to pay for holding inflation down. For example, Heilbroner and Thurow report that the tight money policy in the United States from 1979 to 1982 “about doubled unemployment,” while “bankruptcies soared to levels that had not been experienced since the Great Depression.”136 Meanwhile, the convulsions in the American economy dislocated economic relations throughout the world.

Use of this costly and destructive method of dealing with the American inflation problem is based on two premises, (1) that it is the only effective means of controlling inflation, and (2) that its results justify its high cost. According to the findings of this work, neither of these assumptions is valid, but in any event, the foreign nations get no benefit at all to offset the damage that the American actions inflict on international financial and commercial relations. Measures taken to control inflation in the United States have no direct effect on inflation in other countries..

Cost inflation is a world-wide phenomenon of a continuing nature, because workers everywhere are striving to improve their standard of living, and since few of them realize that the average standard of living is totally dependent on the productivity of the economy, it appears to them that the road to a better life is via higher money wages, a belief that is reinforced by the fact that those workers who receive earlier and larger increases do benefit at the expense of the rest of the work force. Unless the economy of a nation has some built-in resistance to the pressure that the workers are exerting, the tendency of the respective governments is to follow policies that cause, or at least permit, continuing wage increases, which are promptly followed by the inevitable price increases, leading to further demands for higher wages, and so on—the “wage-price spiral,” as it is called.

The rates of inflation vary widely, often reaching annual levels of over 100 percent in some countries. As pointed out in Chapter 13, cost inflation is a balanced process, and does not change the relation of production price to market price. It therefore has no direct adverse effect on the general operation of the economy, and when arrangements are made to soften the impact of the indirect effects the economic life of the community is able to continue in somewhere near a normal manner. This is another of the aspects of inflation that the economists have found it hard to explain. “The surprising fact, indeed,” say Samuelson and Nordhaus, “is that economies with 200 percent annual inflation manage to perform so well.”137

The variations in the exchange rates take care of the differences in the amount of inflation in the different countries. The value of the currency of a nation that is experiencing a high rate of inflation falls relative to that of a nation with a lower inflation rate. Thus inflation in these countries does not necessarily create inequities in economic relations between nations. What the prevailing American anti-inflation policies are doing internationally is subjecting foreign nations to a substantial part of the costs of economic actions that are actually detrimental to them, rather than beneficial.

The effects of our domestic economic policies on the rest of the world that have been discussed in the foregoing pages raise some questions about the ethics of international relations that are beyond the scope of this work. It is appropriate to point out, however, that the existing mismatch between costs and benefits cannot continue indefinitely. Unless the United States institutes some changes to reduce the detrimental effects of the prevailing policies, the international community will undoubtedly replace the dollar sooner or later with some other internationally accepted currency.

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