Letters | Living with the dollar

A letter from Milton Friedman

This letter appeared in the issue of The Economist dated January 3rd 1953

SIR—It is a relief to see even a glimmer of light piercing the dense fog in which you have enveloped the problem of “living with the dollar”. I refer to your statement: “It is true that, at any one time, there must be some dollar that would choke off exchange rate foreign imports from America to such an extent that America’s trade would balance”—though it is puzzling why you should state this elementary truth so indirectly and incompletely. You follow it immediately by two reasons for not using “floating exchange rates” to close the “dollar gap”. Your first reason is that “the rate that would discourage rich men from buying too many Packards (out of tax-free business expenses) might be one that would prohibit a poor man from buying any Canadian wheat at all.” But if it has been decided that a rich man may have a tax-free expense allowance, why say that he may not spend it on imported Packards but may spend it on domestically produced Rolls-Royces or on chauffeurs? What reason is there to believe that the resources used to produce the exports to purchase Packards subtract more from the poor man’s standard of living than the resources that would be used to produce Rolls-Royces at home or to provide additional chauffeurs? Or, if it be said that additional exports cannot be produced (or sold) to purchase the Packards, what reason is there to suppose that the harm done to the poor man by inability to buy Canadian wheat is greater than the harm done to him by inability to buy the goods that could have been produced instead of the Rolls-Royces or additional chauffeurs? The effect of a tax-free expense allowance for a rich man on the volume of goods and services available to the poor man depends in the first instance on the amount the rich man is allowed to spend, not on how he spends it. Mercantilist fallacies ought to be recognised as such in the land of Adam Smith and David Ricardo even when clothed in modern egalitarian jargon.

Your second reason is that “the rate that might choke off dollar payments until they equated with dollar receipts at a time of recession might be a third or a quarter of the rate desirable in a time of commodity boom”. Since there is no discussion at all of what makes a rate “desirable”, there is no way of knowing what this statement means. If it is intended to mean that fluctuations in rates of this magnitude would occur solely as a result of cyclical movements in economic activity, it implies an amazing propensity on the part of speculators to pass up opportunities to make great profits and is contradicted by Britain’s own experience during the thirties. The elementary truth that there always exists a set of exchange rates at which international payments will balance without direct government control over exchange transactions means that there is a way to live with the dollar that is free from the formidable difficulties raised by your proposals. Let Britain follow Canada’s example and set the pound free to find its own level in the market. If the exchange value of the pound is left to be determined primarily by private dealings in a free market, without government support or intervention, Britain can at one blow remove all import restrictions and export subsidies, all restrictions on capital flows, and all discriminatory measures, without fear of any violent repercussions on the internal economy and without any large exchange reserves. The speculators of the world will provide reserves more effectively than any governmentally established clearing union.

Generalised to other countries, the solution of free exchange rates would largely protect each country from being infected by the monetary mistakes of others, without requiring any intervention into the internal affairs of one country by other countries or by an international agency. This solution obviously has difficulties, including, perhaps, the necessity of abandoning the restrictions embodied in the agreements with the International Monetary Fund. But it is vastly easier, as well as vastly preferable, to the plan for an Atlantic Payments Union you suggest—if indeed your vague suggestions deserve to be called a plan. If free exchange rates are to be adopted, the plan is unnecessary; if they are not, it is easy to predict that debtor countries will soon exhaust their drawing rights, and the plan break down.

Yours faithfully,
Milton Friedman

University of Chicago,
Illinois, USA

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Letters to the editor

A selection of correspondence

Letters to the editor

A selection of correspondence


Letters to the editor

A selection of correspondence