Forex: The International Monetary Policy
In the course of history, this dilemma has often confronted the policy makers of most countries.
In Britain, the authorities have almost always had to pay close attention to the balance of payments and the nation's gold reserves in formulating monetary and fiscal policies, and not infrequently balance-of-payments considerations have prevented the adoption of policies judged to be desirable from the standpoint of the domestic economy.
For most other countries, the balance of payments has similarly constituted a constraint that has had to be taken into account in the formulation of monetary and fiscal policies. However, largely as a result of a series of lucky historical accidents, for many years prior to about 1958 the United States experienced either balance-of-payments surpluses and gold inflows or conditions in which other countries were eager to accept dollars in settlement of U.S deficits.
As a consequence, the United States was almost continuously in the favorable position of being able to use monetary and fiscal policies to achieve domestic goals without the necessity of worrying about its balance-of-payments position.
The United States has had a balance-of-payments deficit almost continuously since World War II. In the early and middle 1950--- the period of the so-called dollar shortage--- other countries were eager to obtain dollars both to pay for desperately needed imports and to restore their war-depleted foreign exchange reserves, and, as a result, the U.S. deficits created no problems and no significant drains on our gold reserves.
By 1958, however, the leading industrial countries had, partly as a result of U.S. aid, overcome the decline in their competitive positions caused by the war and were able to compete effectively in world markets. As a result of the improvement in their competitive strength, together with the restoration of their foreign exchange reserves, they were able to reestablish currency convertibility and dismantle most of their exchange controls.
After the restoration of currency convertibility, the United States continued to have balance-of-payments deficits---indeed, the deficits increase din size. At the same time, other countries, having restored their holdings of dollars to desired levels, became less willing to hold dollars and more inclined to convert portions of the added dollars resulting from continuing U.S. deficits into gold, thus reducing the gold stock.
The continuing growth of foreign liquid dollar claims against the United States combined with the decline in the U.S. gold stock generated periodic fears that the United States would be forced to devalue the dollar, fears that finally became a reality in 1971. On several occasions, this led to speculative shifts of funds from dollars into other currencies, thereby increasing the deficit still further.
