The Buck Starts Here: the Federal Reserve and Monetary Politics from World War to Cold War, 1941-1951

Home , Greenspan put, Ralph Flanders, Richard Timberlake

THE BUCK STARTS HERE: THE FEDERAL RESERVE AND MONETARY POLITICS FROM WORLD WAR TO COLD WAR, 1941-1951

A dissertation submitted to Kent State University in partial fulfillment of the requirements for the degree of Doctorate of Philosophy

Timothy W. Wintour

December, 2013

Dissertation written by Timothy W. Wintour B.A., Canisius College, 2002 M.A., John Carroll University, 2006 Ph.D., Kent State University, 2013

Approved by

______, Chair, Doctoral Dissertation Committee Mary Ann Heiss

______, Members, Doctoral Dissertation Committee Walter L. Hixson

______, Steven W. Hook

______, Clarence Wunderlin, Jr.

______, Michael Ellis

Accepted by

______, Chair, Department of History Kenneth Bindas

______, Associate Dean, College of Arts and Sciences Raymond Craig

ii Table of Contents

List of Figures…………………………………………………………………………….iv

List of Tables……………………………………………………………………………...v

Acknowledgments………………..……………………………………………………....vi

Introduction……………………………………………………..…..……………………..1

Chapter One: “If We Lose the War We Cannot Save Freedom”: The Federal Reserve and War Finance, 1941-1945.……………………………..……………..………24

Chapter Two: “For a Peaceful and Prosperous World”: The Federal Reserve and the Political Economy of the World Bank, 1942-1945………………………..……..67

Chapter Three: “New Lanes in Uncharted Seas”: The Federal Reserve and International Exchange Stabilization, 1941-1945……………………………..……………...113

Chapter Four: “Messenger Boys” or “Men of Ability”: The Federal Reserve, Foreign Financial Policymaking, and the NAC…………………………………………174

Chapter Five: “No Particular Fear of Russia, Just of Chaos”: The Federal Reserve, Postwar Reconversion, and the British Loan, 1945-1947……...……………….231

Chapter Six: “On the Horns of a Dilemma”: European Reconstruction, the Postwar Economy, and the Federal Reserve, 1946-1950……...……..……………….....305

Chapter Seven: “The Shadow of the Soviets”: Federal Reserve Policy, Korea, and Perpetual Cold War, 1947-1951…………………………………………….....386

Conclusion……………………………………………………………………………...463

Bibliography……………………………………………………………………………469

iii

List of Figures

1. Consumer Price Index, 1942-1947…………………………………………………..286 2. Federal Cash Surplus or Deficit for the United States, 1945-1951…………….……372 3. Consumer Price Index for All Urban Consumers, 1946-1948………………………405 4. Average Open-Market Money Rates in New York City & Bond Yields, 1946- 1951…………………………………………………………………………….410

iv List of Tables

1. External Liabilities of Great Britain…………………………………………………263 2. Proposed Sterling Balance Reductions……………………………………………....264 3. Postwar Pattern of Interest Rates…………………………………………………….393

v Acknowledgments

There are innumerable individuals who deserve thanks and a substantial amount of credit for the final completion of this dissertation. I owe an immense debt of gratitude to the members of my dissertation committee. First and foremost, my advisor, Ann

Heiss. Her insight, feedback, and patience are present in every facet of the dissertation.

Additionally, her keen editing surely saved me from doing irreparable damage to the

English language. Clarence Wunderlin provided critical understanding of political ideology, and his willingness to indulge my fascination with political economy offered my important opportunities to broaden my exposure and knowledge. Steven Hook helped me to develop an appreciation for the role of social and ideational forces in the process of foreign policy making. His insights helped me to bridge the gap between the worlds of domestic and foreign policy. From the University of Akron, Walter Hixson’s comments on the nature of the military-industrial complex helped push my thinking in enlightening directions. Each and every one of them deserves far more credit and thanks than I can ever express.

There are a number of individuals at Kent State University, the University of

Akron, and at various professional organizations who did not serve on my committee but that nevertheless played an important part in my intellectual development. Either in class or in conversation they helped me to broaden my intellectual horizons in new and sometimes unexpected ways. In this way they played an integral role in this dissertation.

These people include Rebecca Pulju, Kevin Adams, Stephen Harp, Leonne Hudson, and vi

Mark Cassell. I am also grateful to John McNay and Alonzo Hamby. Their thoughtful comments and those of the other conference goers and panelists from the Ohio Academy of History helped clarify and strengthen my thinking at critical points.

I also owe a deep debt of gratitude to professors and teachers who helped shape my academic career before I even arrived at Kent State University. Even before my days as an undergraduate at Canisius College in Buffalo, New York through my early graduate work at John Carroll University, I had the privilege of encountering fine scholars and teachers who encouraged my academic aspirations. These include the late Edwin L.

Neville and the late J. David Valaik, as well as René de la Pedraja, Maria Marsilli, Robert

Kolesar, Daniel Kilbride, and Fr. Lawrence Ober, S.J.

As with every other historical inquiry, unnamed and innumerable archivists, librarians, and clerks, through their diligence and dedication deserve great credit. The employees of the National Archives in College Park, Maryland enabled me to tap into a wealth of documentation. I am also immensely indebted to the Federal Reserve System and its dedication to the preservation of historical materials. The Federal Reserve

Archival System for Economic Research (FRASER) places a tremendous amount of material right at the fingertips of researchers, and to those unnamed souls who scanned, uploaded, and catalogued vast quantities of material that founds its way into this dissertation you have my everlasting thanks.

Friends and family absolutely deserve credit here. My sister, Elizabeth, and my parents, Marcia and William Wintour, encouraged throughout my studies. While my

vii mother did not live to see the completion of this work, I know it would not have been possible without her support first in body and then in spirit. The person, however, who deserve the most credit is my wife, Christa Adams. Without her constant and unwavering support this dissertation would never have been completed. She kept me sane in periods of stress and anxiety and supported me in bouts of research and writing.

A last word. While many people contributed to and strengthened this dissertation any errors are mine alone.

viii

Introduction

In the aftermath of the First World War, American, British, and French policymakers attempted to create a stable international economic and political order.

Unfortunately, that order failed to satisfactorily address a number of potentially destabilizing issues, including harmonizing the restoration of an inherently powerful

Germany with French security concerns; establishing a flexible international monetary system to provide the economic stability of the prewar gold standard without the associated rigidity; ensuring American participation in and commitment to the international political and economic order; and resolving postwar German reparations and

Allied war debts with the restoration of economic prosperity. The result was an ad hoc political and economic system that survived thanks to the superficial prosperity of the

1920s but ultimately collapsed during the 1930s, leading to the Great Depression.

Rejecting the apparent failure of the capitalist democratic model supported by the

Western allies, the Axis sought national economic self-sufficiency through the creation of closed economic blocs controlled by totalitarian and autocratic states and secured by powerful military establishments. The failure to conclude the First World War in a manner that secured universal economic prosperity and political peace set the stage for the conflict of the 1940s.

The United States entered the Second World War still mired in the economic problems of the Great Depression but emerged from the conflict as the world’s premier

1 2

military and economic power. During the war average weekly wages increased 65-70 percent while corporate profits doubled. The nation controlled half the world’s manufacturing capacity and electrical generation and fully two-thirds of the global gold stock, and it dominated industries from international shipping to the production of petroleum. At the same time, inflation remained relatively in check, with prices rising by roughly 28 percent, compared to the First World War experience of 100 percent.1

Militarily, the nation maintained a monopoly control over the newly developed atomic bomb. This vast national wealth and strength positioned the United States to bear the costs of simultaneously reconstructing the economies of Europe and Asia, restoring a system of relatively free international trade, creating an international monetary system essentially based upon the dollar, and building a defense establishment capable of countering Soviet expansion.

Reflecting on the strengths of the United States during the 1940s, the nation’s economic and physical security seems almost inevitable. Such a perspective, however, fails to appreciate the great uncertainty policymakers felt during and after the war. Fear that the United States might sink back into recession or slump under the weight of spiraling price inflation plagued policymakers, including the central bankers of

America’s Federal Reserve System, throughout the war. As the historian Lizabeth Cohen points out, American officials saw containing inflation as critical to both ensuring

1 John Morton Blum, V Was for Victory: Politics and American Culture during World War II (New York: Harcourt Brace & Company, 1976), 141; David M. Kennedy, Freedom From Fear: The American People in Depression and War, 1929-1945 (New York: Oxford University Press, 1999), 641, 846-47.

military victory and establishing a secure postwar world.2 Reflecting on the experiences of the First World War and the interwar period indicated how dangerous economic instability might prove, and how it might translate into military aggression.

During the Second World War officials worked to secure both the domestic and international sources of economic instability. Officials negotiated the establishment of multilateral monetary and investment institutions, culminating in the establishment of the

International Monetary Fund (IMF) and the International Bank for Reconstruction and

Development (commonly known as the World Bank) at the United Nations Monetary and

Financial Conference held at Bretton Woods, New Hampshire, in 1944. Domestically, government officials worked to minimize both the inflation associated with financing the

Second World War and the eventual reconversion to the postwar, peacetime economy.

At the conclusion of the Second World War the powers of Europe and Asia lay prostrate, and in fairly short order the United States found itself assuming increasingly expansive and expensive economic and political commitments. By December 1945, the nation agreed to extend a $3.75 billion loan to Great Britain at extremely low interest and forgave existing Lend Lease obligations to ease postwar financial strains.3 U.S. officials expanded economic commitments for European reconstruction with the enactment of the

Marshall Plan in 1947, accepted currency devaluations and delayed the enactment of the

Bretton Woods Agreements, including currency convertibility, and entered into a series

2 Lizabeth Cohen, A Consumers’ Republic: The Politics of Mass Consumption in Postwar America (New York: Vintage Books, 2003), 63-70. 3 Randall Bennett Woods, A Changing of the Guard: Anglo-American Relations, 1941-1946 (Chapel Hill: University of North Carolina Press, 1990), ch. 12.

of regional bilateral agreements with nations throughout Asia to help restore the Japanese economy.4 American security commitments expanded as well. The United States pledged itself to check the expansion of Soviet power throughout the Near East as articulated in the Truman Doctrine in 1947.5 This evolved into full-fledged support for

European military security by 1949 with the signing of the North Atlantic Treaty and the creation of the NATO military alliance.6 Internally, the National Security Act of 1947 created the bureaucratic infrastructure, including consolidation of the military services and the creation of a dedicated intelligence service, to support these enhanced commitments. By 1950 the United States perceived itself to be clearly involved in an international security competition with the Soviet Union, boiling over into indirect military conflict on the Korean peninsula in June of that year.

Despite the nation’s immense relative economic wealth and military power,

American officials became increasingly concerned about the costs and consequences of the deepening Cold War. While spending on national defense shrank as a percentage of both Gross Domestic Product (GDP) and total federal outlays between 1945 and 1950, with the outbreak of the Korean War spending on defense began to grow dramatically.

Yet, even in fiscal year 1950, when defense outlays reached their lowest point between

4 Michael Hogan, The Marshall Plan: America, Britain, and the Reconstruction of Western Europe, 1947-1952 (New York: Cambridge University Press, 1987); Aaron Forsberg, America and the Japanese Miracle: The Cold War Context of Japan’s Postwar Economic Revival, 1950-1960 (Chapel Hill: University of North Carolina Press, 2000); Francis J. Gavin, Gold, Dollars, and Power: The Politics of International Monetary Relations, 1958-1971 (Chapel Hill: University of North Carolina Press, 2004), ch. 1. 5 Howard Jones, “A New Kind of War”: America’s Global Strategy and the Truman Doctrine in Greece (New York: Oxford University Press, 1989). 6 Lawrence S. Kaplan, NATO 1948: The Birth of the Transatlantic Alliance (New York: Rowman & Littlefield Publishers, Inc., 2007).

the end of the Second World War and the Korean War, the total still represented an amount nearly 250 percent greater than fiscal year 1940. At the same time the U.S. budget moved into deficit for the first time since 1946.7 Unlike the Second World War, however, the war in Korea suggested the ongoing nature of America’s political and military commitments, and the associated economic costs. Victory in World War II after all, had meant defeating the military and ideological threat posed by the Axis. Even a decisive victory in Korea left communists in control of the Soviet Union and the People’s

Republic of China. Financing the military conflict in Korea was therefore fundamentally different, as it represented only a single front in a long-term global struggle.

In many ways this dissertation is the story of two decisions. The first, reached in the spring of 1942, established a pegged yield for government securities. Essentially the

Federal Reserve committed itself to keeping borrowing costs low, even at the risk of creating inflation. The decision represented a commitment by the Federal Reserve to place the national security and foreign policy goals of the Roosevelt administration ahead of a normative belief in price stability. The second decision came almost a decade later in the winter of 1950-51 as the United States confronted the expanded arms requirements of an increasingly militarized Cold War with the Soviet Union as well as the uncertainty associated with Chinese entry into the Korean War. Instead of simply once again prioritizing the imperatives of national security managers and foreign policy experts as it did previously, the Federal Reserve fought both the Treasury Department and President

7 Office of Management and Budget, Historical Tables: Budget of the U.S. Government, Fiscal Year 2010 (Washington, D.C.: Government Printing Office, 2009), 22, 172-4.

Harry S. Truman for the ability to alter Treasury yields, make government borrowing more expensive, and thereby fight inflation. In both instances the Federal Reserve contextualized policy initiatives in the language and rhetoric of foreign affairs and advocated a variety of economic programs to provide the economic means to reach the nation’s international ends.

This dissertation explores the way Federal Reserve officials understood the nation’s international political and economic position and foreign policy goals between these two decisions inclusive. What led Fed officials to take two seemingly different approaches to government financing in the midst of war? How did the evolution of the

Cold War and the international political-economic environment shape the thinking of the central bank? More specifically, how did the evolving context lead Fed officials to evaluate and reevaluate their views on the role of the United States in the world and the implications of this role for the strength and stability of the American economy? In making monetary policy the Federal Reserve actively considered and attempted to understand U.S. foreign policy goals. The fact that the Fed approached generally similar situations of war finances in seemingly diametrically opposite ways reveals this foreign policy analysis to have been an ongoing process.

This dissertation explores the role of the Federal Reserve in the conduct of U.S. foreign relations between the Second World War and the Korean War. During this period Federal Reserve officials perceived an interdependence linking postwar domestic

prosperity with the reconstruction and maintenance of a viable international economic and political order. Yet, Fed officials believed the situation was more complicated than a simplistic causal relationship whereby more domestic economic growth always meant greater international peace and prosperity. Instead, central bankers acknowledged that the nation’s role as the leading political and economic power in the world often created points of conflict between domestic and international goals. Fed officials argued that efforts to promote American economic growth, such as attempting to absolutely maximize American exports, might only be achieved at the cost of erstwhile European and Asian allies. American attempts to dominate global markets, or exclude European and Asian manufacturers from its own, threatened to undermine the restoration of allied export trade, which represented the best basis for achieving economic and political stability in these countries. Similarly, despite the nation’s productive potential, throughout the period the demands of civilian consumers competed for finite resources with those of American national security planners, as well as the war-devastated nations that sought financing and supplies for reconstruction. Central bankers recognized that events in either the domestic or international arena, if improperly handled, threatened to upset the delicate balance between prosperity and peace. The belief in these fundamental interconnections, while often not explicitly expressed, provided a coherent and logical guide to Fed policy, during the era, informing many of its internal debates and policy positions.

As the first extended study of the Federal Reserve as an engaged and active participant in foreign relations, this dissertation is important in several respects. To be

sure scholars of diplomatic history have not completely ignored the central bank, and several have afforded it a prominent place at specific times. But heretofore the Federal

Reserve has usually been treated as an incidental player, mentioned only in the context of a particular time or event when the central bank just so happened to be important. This is particularly true in histories of New Era diplomacy. During this era, described by Jeffry

Frieden as one of “banker internationalism,” the U.S. government used informal means, such as the community of international financiers and central bankers, to implement policies without having to make formal political commitments.8 In Informal Entente,

Michael Hogan stresses the role of the Fed in the context of a larger analysis of attempts to build informal, associative power structures during the era. Similarly, Emily

Rosenberg discusses the role of the Fed in applying American cultural and economic norms through financial advisory missions. Alfred Eckes and Thomas Zeiler also mention the problems created by divorcing Federal Reserve policy from the larger foreign policy structure, but only briefly and in the context of twentieth-century globalization.9 These works foreground major themes such as globalization, the extension of cultural norms and values, or the application of particular political economic beliefs in the international sphere. Their primary purpose, however, is not to situate the

Federal Reserve within the specific diplomatic context or to examine how that

8 Jeffry Frieden, Banking on the World: The Politics of American International Finance (New York: Harper & Row Publishers, 1987), 34-41. 9 Michael Hogan, Informal Entente: The Private Structure of Cooperation in Anglo-American Economic Diplomacy, 1918-1928 (Chicago: Imprint Press, 1991); Emily S. Rosenberg, Financial Missionaries to the World: The Politics and Culture of Dollar Diplomacy, 1900-1930 (Durham: Duke University Press, 2003); Alfred E. Eckes, Jr. and Thomas W. Zeiler, Globalization and the American Century (New York: Cambridge University Press, 2005), 61-2; Similar examples of excellent scholarship that highlight but do not focus on the role of the Federal Reserve can be found in Patrick O. Cohrs, The Unfinished Peace after World War I: America, Britain and the Stabilization of Europe, 1919-1932 (New York: Cambridge University Press, 2008).

international context shaped Fed decision making, meaning that no matter how substantial their treatment of the central bank is, it is fundamentally secondary to their larger purpose. This dissertation differs by foregrounding the role of the Federal Reserve, examining how the central bank interpreted the course of American international relations, as well as how it understood the interactions between foreign affairs and Fed policies, and how this influenced the way it chose to develop, advocate, and implement these policies.

Besides stressing the role of the Federal Reserve in foreign relations and the influence of foreign relations on the debates and attitudes of Fed officials, this dissertation emphasizes American policymaking as opposed to simply how Fed policy affected the international economic environment. Eckes and Zeiler argue that Fed policy stood divorced from the American foreign policy structure in the New Era, that is to say there was little in the way of coordination among the Federal Reserve, the State

Department, the Treasury, or the other major actors traditionally charged with the formation of foreign policy. James Livingston and Lawrence Broz each examine the origins of the Federal Reserve, stressing how other interest groups desired to use the central bank to facilitate international investment and imperialism. Liaquat Ahamed in

Lords of Finance does an excellent job of describing the relations among French, German,

American, and British central bankers during the New Era and Great Depression; his focus, however, is on their relationship rather than specifically examining how well the

Fed operated in the context of American foreign policy. Similarly, Barry Eichengreen focuses on the Fed in the creation and breakdown of the interwar gold exchange standard.

Therefore, where the Federal Reserve is treated as an actor in foreign affairs it is often presented in a manner that highlights its autonomy. This dissertation seeks to understand the Fed within the context of the larger foreign policymaking system of the Second

World War and early Cold War. It seeks to demonstrate how the Fed interacted with other federal agencies and interest groups in influencing the shape of American foreign policy, rather than simply how monetary policy incidently shaped the international economy.10

Many scholars see the Federal Reserve in a distinctly subordinate or secondary role during the period 1941-1951. Allan Meltzer in his magisterial history of the Federal

Reserve describes the period from 1942 to 1951 as one of “Treasury control” and argues that the central bank failed to even undertake discussions on international issues. In this respect Meltzer echoes the judgment of Milton Friedman and Anna Jacobson Schwartz in their equally authoritative Monetary History of the United States. Less charitably,

Richard Timberlake characterizes the Fed as “lackey to the Treasury Department.” Even

Marriner Eccles, the chairman of the Federal Reserve Board of Governors between 1934 and 1948, describes the central bank as “merely [executing] Treasury decisions.”11

10 James Livingston, Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890-1913 (Ithaca: Cornell University Press, 1986); Lawrence J. Broz, The International Origins of the Federal Reserve System (Ithaca: Cornell University Press, 1997); Liaquat Ahamed, Lords of Finance: The Bankers Who Broke the World (New York: Penguin Press, 2009); Barry Eichengreen, Golden Fetters: The Gold Standard and the Great Depression, 1919-1939 (New York: Oxford University Press, 1995). 11 Allan H. Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2003), Ch. 7; Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960 (Princeton: Princeton University Press, 1963), 620; Richard H. Timberlake, Monetary Policy in the United States: An Intellectual History (Chicago: University of Chicago Press, 1993), 312; Marriner S. Eccles, Beckoning Frontiers: Public and Personal Recollections (New York: Alfred A. Knopf, 1966), 382.

Historians of the Second World War and the early Cold War have also minimized the role of the Federal Reserve. Prevailing interpretations of the period emphasize the role of the Treasury, State Department, or other bureaucratic interests and largely ignore the role of the central bank. This is true in analyses of Second World War financing and the crafting of the financial order established at Bretton Woods.12 This conceptual framework has been extended to the immediate postwar period as well, examining the influence of state and non-state interests, including professional economists, journalists, private enterprise, and finance, and officials from the newly created Defense Department,

National Security Council, and Council of Economic Advisors on American foreign economic policy in areas as varied as military appropriations, the Marshall Plan, and the financing of overseas information and development programs, while paying relatively little attention to the influence as regarded the Federal Reserve.13 This approach is

12 Good discussions of WWII economic mobilization and financing can be found in Gregory Hooks, Forging the Military-Industrial Complex: World War II’s Battle of the Potomac (Chicago: University of Illinois Press, 1991); Lawrence R. Samuel, Pledging Allegiance: American Identity and the Bond Drive of World War II (Washington, D.C.: Smithsonian Institution Press, 1997); Paul A.C. Koistinen, Arsenal of World War II: The Political Economy of American Warfare (Lawrence: University of Kansas Press, 2004); Emphasis on the role of the Treasury, particularly Harry Dexter White, in designing the postwar international economic system can be found in Richard N. Gardner, Sterling-Dollar Diplomacy: The Origins and Prospects of Our International Economic Order (New York: McGraw-Hill Book Company, 1969); Armand van Dormael, Bretton Woods: Birth of a Monetary System (New York: Holmes and Meier, 1978); Woods, A Changing of the Guard, particularly Ch. 5; Eckes and Zeiler, Globalization and the American Century; Alternatively historians such as Fred Block conceded the significant influence of the Treasury during the war years, but argued that this power was supplanted by the State Department with the passing of Franklin Roosevelt in The Origins of the International Economic Disorder: A Study of United States International Monetary Policy from World War II to the Present (Berkeley: University of California Press, 1977); Georg Schild contrasts the State and Treasury Departments views for the postwar order in Bretton Woods and Dumbarton Oaks: American Economic and Political Postwar Planning in the Summer of 1944 (New York: St. Martin’s Press, 1995). 13 Robert M. Collins, The Business Response to Keynes, 1929-1964 (New York: Columbia University Press, 1981), 132; Jordan Jay Hillman, The Export-Import Bank at Work: Promoting Financing in the Public Sector (Westport, CT: Quorum Books, 1982); Hogan, The Marshall Plan; Diane B. Kunz, Butter and Guns: America’s Cold War Economic Diplomacy (New York: Free Press, 1997); Michael Hogan, A Cross of Iron: Harry S. Truman and the Origins of the National Security State, 1945-1954 (New

exemplified by Kevin Casey in his history of the National Advisory Council on

International Monetary and Financial Problems (NAC), a coordinating body on which the

Fed Chairman sat. Casey briefly discusses the Fed as a participant but devotes the bulk of the discussion to the NAC as a cohesive institution rather than examining the role of the Fed in that institution.14 This dissertation seeks to redress this treatment. It argues that the Federal Reserve played an active role, interpreting the importance of American foreign policy and developments abroad for central bank policy and the reciprocal impact of central bank monetary and credit decisions for the nation’s international relationships.

That the Federal Reserve did not dominate foreign policymaking during the Second

World War and Cold War is not surprising; scholars, however, have heretofore chosen to interpret the Fed as unconcerned. This dissertation therefore finds itself in agreement with more recent scholarship, such as that of Mary Dudziak, that has demonstrated connections between American foreign policy and the civil rights movement without arguing that civil rights leaders dominated foreign policy or that foreign policymakers were solely concerned with African American civil rights.15 The same holds true about the Federal Reserve and monetary policy.

Thus, while treatment of the Federal Reserve during the era 1941-1951 is limited, some recent scholarship has begun to appear. Discussion of the Fed during this period is

York: Cambridge University Press, 1998); Michael A. Bernstein, A Perilous Progress: Economists and Public Purpose in Twentieth-Century America (Princeton: Princeton University Press, 2000). 14 Kevin M. Casey, Saving International Capitalism During the Early Truman Presidency: The National Advisory Council on International Monetary and Financial Problems (New York: Routledge, 2001). 15 Mary L. Dudziak, Cold War Civil Rights: Race and the Image of American Democracy (Princeton: Princeton University Press, 2000).

usually limited to the objections of Federal Reserve Bank of New York (FRBNY) officials to the Bretton Woods proposal for the multilateral IMF and their support for bilateral Anglo-American negotiations.16 Michele Alacevich and Pier Francesco Asso offer an important revision to this approach in their examination of the efforts of Arthur I.

Bloomfield of the FRBNY as a financial advisor to South Korea in the early 1950s. In this way Alacevich and Asso build upon the legacy of Emily Rosenberg, who stresses the financial advisor role of bankers at the beginning of the twentieth century, carrying the story into the Cold War era. Their analysis, however, is still circumscribed by the focus on Bloomfield the individual, even acting as a representative of the FRBNY, rather than on the attitudes and approaches toward American foreign relations by the Federal

Reserve Board of Governors.17

This dissertation attempts to revise the prevailing views of the Fed as a relatively unimportant institution, at least in terms of its relationship to American foreign policy, between the Second World War and the Korean War. Recent scholarship has begun the process of rethinking this approach. But emphasizing only specific actions undertaken by the Fed fails to appreciate the considerable care and thought central bankers put into both the implications of economic and financial policies on foreign affairs and the corresponding influences that international developments held for the American domestic

16 Alfred E. Eckes, Jr., A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971 (Austin: University of Texas Press, 1975); Robert W. Oliver, International Economic Co-Operation and the World Bank (New York: MacMillan Press, 1975); Harold James, International Monetary Cooperation Since Bretton Woods (New York: Oxford University Press, 1996), Ch. 3; John H. Wood, A History of Central Banking in Great Britain and the United States (New York: Cambridge University Press, 2005), 261-267. 17 Michele Alacevich and Pier Francesco Asso, “Money Doctoring after World War II: Arthur I. Bloomfield and the Federal Reserve Missions to South Korea,” History of Political Economy 41, no. 2 (Summer 2009): 249-70.

situation. The existing scholarship privileges simple relationships and perpetuates the archipelago treatment of the Federal Reserve, where the central bank comes to the surface sporadically and inconsistently, which in turn reinforces the judgment that the institution was powerless if not completely disinterested. By examining the thinking of the Federal

Reserve about both international matters and American foreign relations over an extended period of time, a period in which the major political and economic contours of the postwar world came into being, this dissertation will demonstrate how the central bank responded to the changing international context and adopted policies it believed served American foreign policy as it understood that policy.

The methodological approach of the dissertation can best be characterized as one of constructivist bureaucratic politics. It draws heavily upon a variety of interrelated approaches including the scholarship of international relations theory and bureaucratic politics. In terms of international relations theory, the dissertation is framed by the scholarship of constructivism and foreign policy analysis (FPA), which informs both the understanding of the Federal Reserve, how the central bank understood the nature of the international and domestic political economies, as well as the implications for American foreign relations. To better understand the methodology it is beneficial to examine its component pieces, the constructivist and bureaucratic politics approaches to international relations, and then address how they come together in the context of the Federal Reserve.

Foreign policy analysis, as an approach to international relations, examines the process of making foreign policy decisions. Constructivism argues that the policies and interests of actors are “defined by social norms and ideas rather than by objective or material conditions.” A constructivist foreign policy analysis understands policy decisions not as the product of a unitary state that rationally evaluates alternatives before selecting an objectively defined optimal path but as the product of multiple and varied inputs, each bringing perspectives, constraints, and interests to the process. Consequently, constructivism emphasizes different influences in different contexts, recognizing the historical contingency associated with normative beliefs. A constructivist foreign policy analysis considers the way individuals, rules, and institutions, as well as societal and cultural normative beliefs, shape the foreign policy choices made by leaders.18

The constructivist approach is implicit in much of the historical inquiry into foreign affairs.19 Scholars have emphasized the way individual policymakers and their ideas have influenced the course of diplomatic relations, thereby demonstrating the power of individuals and their ideational beliefs in shaping history, a notion also repeated in the

18 J. Samuel Barkin, “Realist Constructivism,” International Studies Review 5, no. 3 (September 2003), 326; Jean A. Garrison, ed., “Foreign Policy Analysis in 20/20: A Symposium,” International Studies Review 5, no. 2 (June 2003): 155-202; Valerie M. Hudson and Christopher S. Vore, “Foreign Policy Analysis Yesterday, Today, and Tomorrow,” Mershon International Studies Review 39, no. 2 (October 1995): 209-238; Scholars such as David Patrick Houghton and Roxanne Doty as emphasize not just why particular decisions were made, but how these decisions were even possible based upon an evolving understanding and appreciation of contextual circumstances. David Patrick Houghton, “Reinvigorating the Study of Foreign Policy Decision Making: Toward a Constructivist Approach,” Foreign Policy Analysis 3, no. 1 (January 2007): 35. For a more general assessment on the role of ideas and foreign policy see Judith Goldstein and Robert O. Keohane, “Ideas and Foreign Policy: An Analytical Framework,” in Ideas and Foreign Policy: Beliefs, Institutions, and Political Change, ed. Judith Goldstein and Robert O. Keohane (Ithaca: Cornell University Press, 1993), 3-24. 19 A broad framework outlining the ways in which the constructivist approach might be applied to bureaucratic politics is provided by Jutta Weldes, “Bureaucratic Politics: A Critical Constructivist Assessment,” Mershon International Studies Review 42, no. 2 (November 1998): 216-225.

literature on the Federal Reserve.20 FPA also emphasizes the role of domestic and global opinion in enabling or constraining policy choices. This popular opinion is in turn often informed by deeply held cultural norms. Historians of American diplomatic history have made great strides in revealing how cultural values about race, gender, and sexuality, as well as political and economic systems, shaped both elite and popular attitudes. Several historians have also demonstrated how non-state actors such as individuals, communities, and interest groups exerted direct influence, through their actions and beliefs, on

American foreign affairs rather than simply through the mediation of elites. Although historians have become increasingly cognizant of these normative cultural beliefs and values, they have not always drawn explicit links between ideas and specific policy choices.21 By focusing on a single institution, the Federal Reserve, and tracing its policy

20John Milton Cooper, Breaking the Heart of the World: Woodrow Wilson and the Fight for the League of Nations (New York: Cambridge University Press, 2001); Tsuyoshi Hasegawa Racing the Enemy: Stalin, Truman, and the Surrender of Japan (Cambridge: Belknap Press of Harvard University Press, 2005); Wilson D. Miscamble, From Roosevelt to Truman: Potsdam, Hiroshima, and the Cold War (New York: Cambridge University Press, 2007); Donald F. Kettl, Leadership at the Fed (New Haven: Yale University Press, 1986). 21 Excellent scholarship on how normative social and cultural values influenced American foreign policy can be found in Michael E. Hunt, Ideology and U.S. Foreign Policy (New Haven: Yale University Press, 1987); Dennis Merrill, Bread and the Ballot: The United States and India’s Economic Development, 1947-1963 (Chapel Hill: University of North Carolina Press, 1990); Paul Boyer, By the Bomb’s Early Light: American Thought and Culture at the Dawn of the Atomic Age (Chapel Hill: University of North Carolina Press, 1994); Reinhold Wagnleitner, Coca-Colonization and the Cold War: The Cultural Mission of the United States in Austria after the Second World War (Chapel Hill: University of North Carolina Press, 1994); Kristin L. Hoganson, Fighting for American Manhood: How Gender Politics Provoked the Spanish- American and Philippine-American Wars (New Haven: Yale University Press, 1998); John Fousek, To Lead the Free World: American Nationalism and the Cultural Roots of the Cold War (Chapel Hill: University of North Carolina Press, 2000); Mark Philip Bradley, Imagining Vietnam and America: The Making of Postcolonial Vietnam, 1919-1950 (Chapel Hill: University of North Carolina Press, 2000); Robert D. Dean, Imperial Brotherhood: Gender and the Making of Cold War Foreign Policy (Amherst: University of Massachusetts Press, 2001); Mary A. Renda, Taking Haiti: Military Occupation and the Culture of U.S. Imperialism, 1914-1940 (Chapel Hill: University of North Carolina Press, 2001); Amy Kaplan, The Anarchy of Empire in the Making of U.S. Culture (Cambridge: Harvard University Press, 2002); Victoria De Grazia, Irresistible Empire: America’s Advance through 20th Century Europe (Cambridge: Belknap Press of Harvard University Press, 2005); Naoko Shibusawa, America’s Geisha Ally: Reimagining the Japanese Enemy (Cambridge: Harvard University Press, 2006); Donna Alvah, Unofficial

stance over a decade, this dissertation helps to build upon this existing approach by demonstrating how beliefs about political and economic systems, as well as the role of the United States in the global, order led the Fed to advocate specific policies, albeit not always successfully.

The bureaucratic politics approach to foreign policy analysis, as the name implies, examines the way bureaucratic institutions and their structural position shape decision making. The bureaucratic politics approach, as popularized by Graham Allison, argues that foreign policy is not so much the result of conscious choices made by elites but rather the “outcomes of various overlapping bargaining games among players arranged hierarchically.” Aside from the constructivist critique of an objective rationality, the bureaucratic politics approach rightly recognizes that there is “no single ‘maker’ of foreign policy,” that decisions are instead an “amalgam” of different organizational interests and inputs. Scholars have subsequently updated and complicated Allison’s original thesis. Judith Goldstein highlights the need to understand the place of institutions within the structure and hierarchy of the state while James Q. Wilson emphasizes the way the professional background of personnel influences the attitudes and decision making of bureaucracies.22 Naturally, many of the international relations and

Ambassadors: American Military Families Overseas and the Cold War (New York: New York University Press, 2007); Laura A. Belmonte, Selling the American Way: U.S. Propaganda and the Cold War (Philadelphia: University of Pennsylvania Press, 2008); Douglas Little, American Orientalism: The United States and the Middle East since 1945 (Chapel Hill: University of North Carolina Press, 2008); Susan A. Brewer, Why America Fights: Patriotism and War Propaganda from the Philippines to Iraq (New York: Oxford University Press, 2009); David Ekbladh, The Great American Mission: Modernization and the Construction of an American World Order (Princeton: Princeton University Press, 2010). 22 Graham T. Allison, “Conceptual Models and the Cuban Missile Crisis,” The American Political Science Review 63, no. 3 (September 1969): 690; J. Gary Clifford, “Bureaucratic Politics,” in Explaining the History of American Foreign Relations, ed. Michael Hogan and Thomas G. Paterson (New York:

historical studies that emphasize the role of bureaucratic politics focus on institutions such as the State or Defense Departments, the Joint Chiefs of Staff, presidential administrations, intelligence agencies, and legislative bodies traditionally understood as part of the foreign policy establishment rather than non-traditional influences such as the

Federal Reserve System.23

The constructivist bureaucratic politics approach adopted by this dissertation draws upon the insights of both methodological approaches. The bureaucratic politics approach traditionally takes issues such as organizational interests, policy preferences, and position within the structure of government as givens and then examines the “pulling and hauling” between departments and agencies.24 The constructivist approach moves beyond this relatively static understanding and allows a more organic and fluid appreciation of bureaucratic interests. The policy interests of the central bank were not fixed and immutable but instead evolved along with the sociohistorical context.

Furthermore, the agencies defined as having a legitimate voice in policy, and therefore the very structure within which bureaucratic politics operated, evolved as new agencies

Cambridge University Press, 2007), 93; Judith Goldstein, “Ideas, Institutions, and American Trade Policy,” International Organization 42, no. 1 (Winter 1988): 179-217; James Q. Wilson Bureaucracy: What Government Agencies Do and Why They Do It (New York: Basic Books, 1989), 60-1. 23 Several prominent works that explore the role of bureaucratic agencies and their impact on foreign relations can be found in Morton Halperin, Bureaucratic Politics and Foreign Policy (Washington, D.C.: The Brookings Institution, 1974); Amy Zegart, Flawed by Design: The Evolution of the CIA, JCS, and NSC (Stanford: Stanford University Press, 1999); Scholars of diplomatic history who also highlight the role bureaucratic bargaining plays in the formation of policy are exemplified by Melvyn Leffler, A Preponderance of Power: National Security, the Truman Administration and the Cold War (Stanford: Stanford University Press, 1992); Mark Stoler, Allies and Adversaries: The Joint Chiefs of Staff, the Grand Alliance, and U.S. Strategy in World War II (Chapel Hill: University of North Carolina Press, 2000). 24 Allison, “Conceptual Models,” 707; A critical evaluation of the “pulling and hauling” approach can be found in David A. Welch, “The Organizational Process and Bureaucratic Politics Paradigms: Retrospect and Prospect,” International Security 17, no. 2 (Autumn 1992): 112-146.

came into being, such as the NSC, and others slipped in importance. Finally, the priority attached to issue areas and events evolved as well, reflecting the changing political and economic position of the United States vis-à-vis the international system. Thus, the constructivist bureaucratic politics approach, by examining the sociocultural norms and ideas prevalent within both individual agencies and the larger foreign policymaking structure of the government, allows a more complex examination of the Federal Reserve in Second World War and early Cold War foreign policy. It examines how individual choices or events reflected the “pulling and hauling” of influences within the government.

Further, by exploring the discursive struggle to frame the mission of the Federal Reserve, the dynamic influences of the international and domestic economic environment and their connection to the nation’s expanding security commitments, the constructivist bureaucratic politics approach provides a nuanced understanding of why the Fed chose to

“pull and haul” when and how it did.25

This methodological approach helps to explain the shift in Federal Reserve policy vis-à-vis American foreign relations between the Second World War and the Korean War.

As the United States became more embroiled in the Cold War security competition with the Soviet Union central bankers began to reconsider their approach to financial policy.

While the Fed generally supported the financing of the Second World War, as various economic commitments in the form of European economic reconstruction and American military rearmament grew, the central bank changed its approach to the financing of the

25 Robert Hathaway’s discussion of intra and inter-departmental differences over Phase II of American Lend Lease Aid to Great Britain exemplifies this kind of discursive struggle, without fully engaging it in Ambiguous Partnership: Britain and America, 1944-1947 (New York: Columbia University Press, 1981); Weldes, “Bureaucratic Politics,” 224.

Korean War. During the Korean War Fed officials became more concerned with policies it saw as inflationary, particularly as it became apparent that Korea represented only a single front in a larger and ongoing security competition. Furthermore, over the course of the early Cold War the Fed attempted to embed its voice in the bureaucratic structure of the American government, supporting new policymaking bodies such as the NAC.

Within this constructivist bureaucratic politics approach the Cold War rhetoric of the garrison state is particularly important. In the early 1940s the social scientist Harold

Laswell postulated the increased centralization of government authority in the hands of a small circle of professional autocratic elites seen to possess the specialized knowledge necessary to administer an increasingly socially and technologically complex world, to the exclusion of individuals and democratic institutions.26 Michael Hogan points out that both supporters and opponents of American internationalism mobilized the rhetoric and logic of the garrison state during the early Cold War. Aaron Friedberg also recognizes these centralizing impulses, arguing that they were only tempered by a tradition of anti- statism.27 The Fed, with its strong ties to private business and financial interests, remained keenly sensitive to the consequences of centralized state power. Evolving concerns about the power and beliefs of national security managers increasingly mediated the Fed’s policies. The Fed often took great pains to frame its policies in terms of how they reflected the nation’s democratic ideals of individual choice and free enterprise.

Central bankers saw room for positive government action but also warned about the

26 Harold D. Lasswell, “The Garrison State,” The American Journal of Sociology 46, no. 4 (January 1941): 455-68. 27 Hogan, A Cross of Iron, 1-22; Aaron L. Friedberg, In the Shadow of the Garrison State: America’s Anti-Statism and Its Cold War Grand Strategy (Princeton: Princeton University Press, 2000).

dangers of excessive statism and played on contemporary fears of an American garrison state.

This dissertation examines the evolution of Federal Reserve policies, and the attitudes and beliefs that informed them, in two broad sections covering the establishment of the postwar order and its evolution within the context of the emergent Cold War. The first section examines the pattern of wartime financing adopted by the Fed during 1941-

1945, exploring the Fed’s reasons for subordinating the principle of price stability to the goal of ensuring the provision of financial resources necessary to secure military victory.

It also demonstrates, however, the conditional nature of this decision; rather than accepting total subordination, the Fed continually pushed for marginal adjustments to the financing program to the extent that it believed these changes did not endanger the ultimate goal of military victory. Furthermore, the Fed premised its acceptance upon a definite belief about the nature of postwar domestic economic conditions. This section also explores how the Federal Reserve undertook to influence the structure of the postwar international economic order established at Bretton Woods. Again, the Fed based its positions upon the perceived lessons of the interwar period and the necessity of avoiding an unstable monetary order or subjecting prosperity solely to the fickle risk tolerance of private international investment. Ultimately, the Fed both challenged the dominance of the Treasury in making foreign financial affairs, attempted to shape the bureaucratic environment, and advocated new decision-making mechanisms such as the NAC to

embed its voice in the policymaking structure. The central bank’s purposes, however, was never to dominate either domestic or international policymaking, but rather, to moderate what it believed were the more pernicious aspects of each area on the other.

The second section carries the examination into the postwar world. It explores the attitudes and willingness of Fed officials to support major international commitments such as the 1946 Anglo-American Loan Agreement, the Marshall Plan, and the increasing military commitments of the United States in Europe and Asia. Each of these issues increased the financial burden on the United States and enhanced competition for scarce resources among the American military, foreign nations, and the American consumer that threatened to unleash mounting inflationary pressures that could undermine American prosperity, destabilizing both the political-economic recovery of allies and the nation’s own ability to sustain its overseas security commitments. This section traces how the

Federal Reserve’s view of the political environment evolved as the nation became increasingly embroiled in an indefinite security competition with the Soviet Union. The dissertation then explores the culmination of this evolution during the Korean War. The

Fed faced immediate demands to ensure financing for the hot war in Northeast Asia as well as long-term demands to guard the economic prosperity and stability seen as foundational to larger Cold War security commitments. The Fed’s decision to fight for greater bureaucratic autonomy over setting interest rates and monetary policy reflected its increasing prioritization of price stability and its implications for the long-term Cold War security commitment over the immediate demands of the Korean War.

This dissertation makes an effort at bridging a conceptual gap in both the literature on the Federal Reserve and the history of American foreign relations. It argues neither that the Fed dominated foreign policymaking nor that foreign affairs considerations necessarily dominated monetary policy. It does, however, undertake to understand the ways in which the Fed stayed constantly engaged with international affairs, as well as how and why it judged particular developments as warranting attention or specific courses of action. Indeed, central bankers’ arguments and actions demonstrated that this level of larger policy awareness was critical to their institutional responsibilities.

Similar to President Truman’s recognition that ultimate responsibility for many decisions rested on the chief executive, as indicated in his desk sign reading “the buck stops here,” so too did Fed officials believe that the literal buck started at the central bank. They believed that too many or too few held important consequences for the success or failure in achieving domestic goals and fulfilling international commitments. This study, therefore, further highlights the ways the Fed attempted, although not always successfully, to influence domestic and international policy in response to these judgments.

Chapter One

“If We Lose the War We Cannot Save Freedom”: The Federal Reserve and War

Finance, 1941-1945

This chapter argues that the Federal Reserve held a core set of interrelated beliefs that reflected the domestic and international experiences during the period between the

First and Second World Wars, and that these beliefs guided the central bank’s attitude toward the financing program of the latter conflict. First, the nation must assume a position of international leadership because only the United States possessed the resources and capacity to help reconstruct the global economy. Second, a fundamental link existed between economic prosperity and political peace. Third, shared global economic prosperity could only be built upon a cooperative international capitalist system rather than by nationalist and autarkic means. Fourth, the willingness and ability of the United States to assume an international leadership position interdepended with avoidance of falling back into recession or depression after the war. Finally, if the United

States financed the war using policies that created inflation or otherwise caused economic dislocations, this could undermine the basis for postwar prosperity, the willingness of

Americans to assume international leadership, and ultimately the hopes for a peaceful postwar order. Thus, the Federal Reserve believed how the United States financed the

24 25

Second World War held real implications for achieving the nation’s long-term foreign policy objectives.

This does not mean that central bankers aggressively attempted to impose their own policy preferences on others; rather, it positions the Fed as a bureaucratic entity straddling the domestic and international spheres with interests in and beliefs about each.

This chapter demonstrates how the Federal Reserve perceived and attempted to balance competing requirements. Fed officials recognized that pursuit of a long-term liberal capitalist international political-economic order must be balanced against the immediate demands of the ongoing military conflict. Additionally, the Federal Reserve operated within a complex bureaucratic environment that placed constraints on its ability to pursue policies. This required the Fed to pick and choose its battles, trying to press policy preferences while being careful not to alienate itself from the Roosevelt administration and lose influence. How the Fed navigated this complex environment revealed an ongoing and implicit sensitivity to international affairs heretofore often unrecognized in analyses of either the Federal Reserve or American diplomatic history. This chapter, therefore, establishes the Federal Reserve as an active and engaged participant in the making of American foreign policy, sometimes explicitly but more often by the implicit link between the economy and the global political order.

Interwar Political Economy and the Federal Reserve

Understanding the interwar period (broadly defined as 1919-1939) is necessary to understanding the Federal Reserve’s position during the Second World War. The Fed repeatedly referred back to the events of this era, treating them as a kind of case study with lessons for the contemporary war and postwar period. Avoiding a repetition of the interwar experience, particularly a breakdown in economic prosperity that undermined international political peace, weighed heavily on the Fed. Therefore, it is with the history of this era, and more importantly how the Fed understood the history of the era, that we must start.

During the interwar period the United States avoided assuming an official leadership role in international affairs. This is not to say that the nation was uninterested in the rest of the world. Rather, American policymakers sought to exercise influence through unofficial channels, often using businessmen or financers as proxies, and avoided signing on to binding political commitments, such as the U.S. failure to join the League of Nations.1 Americans may have been unwilling to accept the obligations of collective security as they still did not consider events overseas as a direct threat to the United

States itself.2

1 Melvyn P. Leffler, The Elusive Quest: America’s Pursuit of European Stability and French Security, 1919-1933 (Chapel Hill: University of North Carolina Press, 1979); Patrick O. Cohrs, The Unfinished Peace after World War I: America, Britain and the Stabilization of Europe, 1919-1932 (New York: Cambridge University Press, 2008). 2 John Milton Cooper, Jr., Breaking the Heart of the World: Woodrow Wilson and the Fight for the League of Nations (New York: Cambridge University Press, 2001), 423-6; George C. Herring, From Colony to Superpower: U.S. Foreign Relations since 1776 (New York: Oxford University Press, 2008), 434. 27

The unwillingness of Americans to accept international leadership manifested in the nation’s economic policies. The twin issues of German reparations and European war debts dominated the interwar financial system. While Germany owed reparations payments to European nations, primarily France and Britain, these nations owed the

United States money for the repayment of loans extended during the war. As Europe’s creditor the United States represented the critical link in the chain, for only it had the power to reduce European debt obligations allowing a reciprocal reduction in German reparations. Reparations represented a source of political tension with Germany as well as drain on German and thereby European economic recovery. Yet, self-interest, including the desire of Republican administrations to use the revenue from European debt payments to offset lower taxes, led the United States to insist on treating the European debts and German reparations as separate issues. American protectionist trade policies further exacerbated economic conditions as tariffs on imports limited European access to

American markets.3 Instead of assuming international leadership and negotiating a debt- reparations solution, the United States supported the “commercialization” of reparations, by lending money to Germany, which used the funds to pay reparations to Britain and

France, which in turn sent the money right back to the United States in the form of debt payments.4 American bankers, through a nifty trick, turned German reparations obligations into interest bearing loans without ever resolving the fundamental underlying

3 William Barber makes the link between debt and tax policy in From New Era to New Deal: Herbert Hoover, the Economists, and American Economic Policy, 1921-1933 (New York: Cambridge University Press, 1985), 35-41; Leffler discusses the role of American tariff policy in The Elusive Quest, ch. 5. 4 Charles Kindleberger, The World in Depression, 1929-1939 (Berkeley: University of California Press, 1986), 18-26; Liaquat Ahamed, Lords of Finance: The Bankers who Broke the World (New York: Penguin Press, 2009), 130-3. 28

problem. With the contraction of lending during the Great Depression, the façade collapsed.

Reflecting on the interwar experience, Marriner Eccles, the Chairman of the

Federal Reserve Board of Governors (1934-1948), castigated the United States for a failure of economic and financial leadership. He argued that the nation underappreciated its radically enhanced position in the interwar economic system. It continued to act as though it were a debtor nation, attempting to maximize its penetration of global markets while minimizing European access to the U.S. market and failing to assume the responsibilities of leadership commensurate with its creditor status.5 E. A. Goldenweiser, head of the Federal Reserve Board of Governors Research and Statistics Division, made the same point, arguing that the nation’s failure to appreciate its creditor status undercut the willingness of Americans to assume international leadership. According to

Goldenweiser, Americans, being less reliant on exports than European states such as

Great Britain, did not appreciate the full consequence of their policies, particularly tariff issues.6

The model of leadership proposed by the Fed, however, did not mean American economic or financial hegemony but sought instead a role appropriate to the nation’s size and importance in the global economy. Fed officials believed that the United States was

5 Marriner Eccles, Address, “Address at the 25th Anniversary of the Opening of the Federal Reserve Bank of St. Louis,” November 9, 1939, FRASER, http://fraser.stlouisfed.org/historicaldocs/1204/download/66400/Eccles_19391109.pdf (Accessed October 25, 2011).

6 E.A. Goldenweiser, Address, “New Monetary Standard,” April 4, 1945, RG 82 DIF, box 38. 29

critically important to the operation and stability of the international political and economic environment and for this reason could not afford to act purely on self-interested motives. Furthermore, Americans must be aware of the international implications of the nation’s policies, including their ability to undermine the stability of the international economic system.7

In light of interwar experiences, American officials believed that economic prosperity served as a prerequisite to political peace and security. Jeffry Frieden describes the experiences of the era as a vicious cycle whereby collapse of the international economy drove countries to adopt nationalist policies secured by military power, which itself helped to further exacerbate international economic collapse.8

During the late 1930s Fed officials saw German attempts to create closed economic blocs as precipitating this vicious downward spiral, undermining the global economy and engaging in aggressive and militaristic policies that threatened international peace.9

Economic factors appeared to explain the Axis powers’ path of aggressive expansion. In

Germany the Great Depression undermined liberal internationalist businessmen and boosted the supporters of a nationalist autarkic policy. Hitler believed Germany required land and resources, similar to those possessed by the United States and the Soviet Union, to obtain economic self-sufficiency. Hemmed in by other states, growth in Europe could not be achieved through diplomatic negotiation and instead demanded military expansion

7 Federal Reserve System Board of Governors, Postwar Economic Study No. 1: Jobs, Production, and Living Standards (Baltimore: Waverly Press, August 1945), 53-4. 8 Jeffry Frieden, Global Capitalism: Its Fall and Rise in the Twentieth Century (New York: W.W. Norton and Company, 2006), 128-29. 9 Memorandum, “Essentials of American Policy in Event of German Victory,” May 22, 1940, RG 82 DIF, box 186. 30

to secure the markets and resources necessary to ensure a higher German living standard.

A similar series of events unfolded in Japan. Michael Barnhart argues that after the First

World War Japan believed economic self-sufficiency a requirement for great power status. Support for a militant foreign policy blossomed only after internationalists in the

Japanese financial community suffered setbacks during the Great Depression.10

If economic collapse in Germany and Japan helped to spur military aggression, then securing postwar peace necessitated the restoration of economic prosperity. Fed officials defined economic prosperity in broad terms, but generally categorized high living standards and full employment as the critical issues. Marriner Eccles used the rhetoric of Roosevelt’s Four Freedoms speech when he argued that the nation and the world must strive for “freedom from involuntary unemployment; freedom from the fear of insecurity in old age; freedom from poverty; and freedom from want.”11

Throughout the war Fed officials expressed faith in a cooperative international capitalism that attempted to maximize the degree of economic freedom and reliance on

10 Adam Tooze argues that no clear and simple division existed between supporters of internationalism and those of autarky. Indeed many internationally minded businessmen were torn in their desires, and ended up both providing expertise and benefitting from Hitler’s autarchic economic policies. Adam Tooze, The Wages of Destruction: The Making and Breaking of the Nazi Economy (New York: Penguin Books, 2006), Ch. 4-5; Alan Milward that Germany’s decision to bolster employment and production through military spending helped to further isolate it from the global economy in War, Economy and Society, 1939-1945 (Berkeley: University of California Press, 1979), 7-13; Discussion of Japanese drive for autarky can be found in Michael A. Barnhart, Japan Prepares for Total War: The Search for Economic Security, 1919-1941 (Ithaca: Cornell University Press, 1987); Jonathan Kirshner links acts of Japanese aggression to specific bouts of economic crisis during the Great Depression in Appeasing Bankers: Financial Caution on the Road to War (Princeton: Princeton University Press, 2007), Ch. 3. 11 Frank R. Garfield, “Markets and Living Standards,” in Postwar Economic Studies No. 1: Jobs, Production, and Living Standards (August 1945), 53; Marriner Eccles, Address, “Address on the President’s Seven-Point Program to Fight Rising Living Costs,” June 24, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/1207/download/66426/eccles_19420624.pdf (Accessed October 25, 2011). 31

private enterprise, while accepting a dose of government intervention as necessary to secure a high living standard and full employment.12 E. A. Goldenweiser best summarized this approach. On the one hand he recognized that a system of totalitarian statism offered a means to secure full employment, but only at the cost of “things that are more sacred,” such as democracy and free enterprise. On the other he declared clearly that the “day of laissez-faire is over” and that the government now had a permanent role in the economy through domestic policies and internationally through mechanisms of international management negotiated at Bretton Woods. Goldenweiser neatly summarized his views, writing that “government should do nothing that can be done for the individual by himself or in voluntary association with others and should leave undone nothing that needs to be done but cannot be done adequately by individual effort.”13 Fed officials found nothing contradictory in arguing that domestic full employment, and eventual international recovery, depended upon the revival of a healthy system of international trade led by private enterprise, while also expressing a belief that the government had a positive role to play through flexible countercyclical policies such as compensatory budgeting.14

12 Michael Hogan briefly discusses just such an approach in “Corporatism,” The Journal of American History 77, no. 1 (June 1990), 154. 13 E. A. Goldenweiser, “Postwar Problems and Policies,” reprinted in the Federal Reserve Bulletin 31, no. 2 (February 1945), 119; E.A. Goldenweiser, “Jobs,” Postwar Economic Studies No. 1: Jobs, Production, and Living Standards (August 1945), 1-9. 14 Marriner Eccles to Representative Bret Spence, Memorandum, “International Fund and Bank,” March 21, 1945, RG 82 DIF, box 36; Marriner Eccles, Address, “The Dual System of Banking,” September 17, 1943, FRASER, http://fraser.stlouisfed.org/historicaldocs/1209/download/66429/eccles_19430917.pdf (Accessed October 25, 2011); Marriner Eccles, Address, “The Postwar Price Problem – Inflation or Deflation,” November 16, 1944, FRASER, http://fraser.stlouisfed.org/historicaldocs/1210/download/66431/eccles_19441117.pdf (Accessed October 25, 2011). 32

Fed officials saw peace and prosperity, both domestic and international, as fundamentally interconnected. Eccles and the Federal Reserve expressed faith that capitalism and democracy offered the best means for securing prosperity and full employment. Yet the nation’s ability to secure full employment depended upon preserving a system of open international trade, not the closed and exclusive economic blocs of the Axis. Free access to markets removed a significant motive for international aggression as nations no longer rushed to establish exclusive control over regions and resources. All of this depended upon American willingness to avoid falling back into the interwar pattern of protectionist trade practices and fickle overseas lending.

Walter Gardner, the head of the International Research Division for the Federal

Reserve Board of Governors, reflected upon the difficult situation of balancing domestic and international prosperity. The world depended upon imports from the United States to sustain economic recovery. At the same time foreign nations could not purchase these items solely on credit, they needed to increase exports to the United States to earn money for both the purchase of American goods and the payment of existing debts. The necessity of freeing nations from dependence on continuous borrowing from the United

States seemed particularly important given the lesson of the Great Depression and how the interruption in American lending undermined the servicing of German reparations and European war debts. The willingness of the Americans to purchase imports, to travel and spend dollars overseas, or to make loans in turn depended upon domestic prosperity.

If the nation moved too quickly to lower tariffs, however, it might let in a “flood of 33

foreign goods that would displace American industry and employment” and undermine the very domestic prosperity upon which the whole system depended.15

Fed officials recognized that ostensibly internal factors such as inflation presented equally dangerous threats to American domestic prosperity. Inflation not only fueled booms and busts, but if it caused price levels in the United States to diverge from the rest of the world it might threaten the ability to secure postwar international trade. Therefore, inflation, particularly as created by American war finance policies, held direct and concrete implications for American foreign policy. Before proceeding with a brief examination of the lessons Fed officials derived from the World War I financing experience it is useful to define, in general terms, inflation and the general methods employed to finance military conflict.

As the historian Hugh Rockoff argues, nations usually utilize a mix of three policies to finance a war: taxes, borrowing funds, and simply printing money.16 We can plausibly see a fourth war finance policy in government controls on wages, prices, and credit. While price and wage ceilings or regulation of consumer credit did not raise funds for the war effort per se, these measures helped to control the costs of defense mobilization and channeled funds away from competing uses such as consumer spending.

15 Walter Gardner, Memorandum, “Statement on Bretton Woods Agreement,” June 18, 1945, RG 82 DIF, box 36. 16 This is a bit of a simplification as Rockoff himself readily admits because it fails to recognize the myriad of ways countries historically used coercion to extract resources from their own citizens or from occupied territories. Additionally, this ignores the opportunity cost absorbed by individuals who purposely forewent potentially higher wages in industry and voluntarily enlisted in the military, sacrificing potential financial gain for a variety of motives including patriotism. See Hugh Rockoff, “The United States: From Ploughshares to Swords,” in The Economics of World War II: Six Great Powers in International Comparison, ed. Mark Harrison (New York: Cambridge University Press, 2000), 107. 34

During the Second World War central bankers continually assessed how Americans from individual citizens to businesses and banks responded to the government’s war finance policies. Fed officials paid attention to public participation in government war bond drives, the level of spending on consumer goods and business investment for non-defense purposes to name just three areas. Government policy and the choices of individuals often interrelated during the war. Policies influenced the choices of individuals, whether to save money, buy bonds, hoard goods, or demand higher wages or a lower tax burden.

In turn, the choices of Americans created economic bottlenecks, contributed to inflation, or otherwise influenced the larger economic environment effecting the success or failure of government policy.

Inflation occurred when more money existed to buy goods than actual goods to be bought. This asymmetry drove prices to artificial highs, created bottlenecks by distorting the demand for certain goods, made people poorer by reducing purchasing power, meaning each dollar bought less, and caused hardship during the inevitable reversal when prices and demand fell, reducing incomes and helping to create unemployment. With the outbreak of war, American manufacturers were flush with orders for military goods, and the more workers produced for the war the less they produced for civilian consumption.

Thanks to the war-fueled boom, workers took home higher wages and companies garnered increased profits, but both found fewer outlets on which to spend their newfound gains.17

17 Paul A. Sameulson, Economics (New York: McGraw-Hill Book Company, 1948), 282. 35

Taxes and borrowing, particularly borrowing from individuals or institutions such as corporations, generally curbed inflationary pressure by absorbing money that might otherwise have been spent. Money spent on a government bond was not available to spend on tires, clothes, or other consumer goods. Similarly, when corporations invested their money in government securities it meant they were not bidding on goods to stockpile inventory or undertaking non-war related investment. Taxes acted in a similar way. When the government bought guns, and planes, and other war material this contributed to higher profits for corporations and higher wages for workers. Taxes allowed the government to recapture some of this money, preventing people from attempting to use their newfound wealth to drive up prices on the shrinking supply of consumer items. Therefore, both measures absorbed funds that might otherwise have driven up prices and thus helped to curb inflation.

Money creation, simply turning on the printing press and literally creating new dollars, and borrowing from commercial banks represented essentially the same process and threatened to add substantial inflationary pressure to the economy.18 When the government printed dollars this increased the amount of money available to purchase items without increasing the supply of goods available for purchase. When the Treasury sold a security such as a bond to a bank a similar process occurred. The commercial bank transferred dollars to the Treasury while the Treasury transferred the bond to the commercial bank. This exchange meant that the commercial bank possessed fewer

18 E.A. Goldenweiser, American Monetary Policy (New York: McGraw-Hill Book Company, Inc., 1954), 184. 36

dollars, meaning fewer loans to make and seemingly less inflationary pressure since these loaned dollars might have been used to drive up the price on the declining supply of non- war related goods. The presence of a central bank, however, allowed commercial bankers to “rediscount” these Treasury securities. Commercial bankers traded the security (such as a Treasury bill) to the Federal Reserve in exchange for dollars.19 At the end of this series of transactions the Treasury received dollars, the commercial bank received dollars, and the central bank received government securities. This allowed the

Treasury to spend money to meet the costs of the war while also allowing bankers to potentially make loans, extend credit, or buy additional Treasury securities. The amount of money increased while the supply of goods did not.

During the First World War, Treasury Secretary William Gibbs McAdoo promoted the sale of government bonds not only to provide funds for the war but also as a means to check inflation. At first glance this appeared to help the government by providing it funds with which to create and equip a military, while also reducing the disjuncture between the high supply of dollars and the relatively low supply of non- defense goods. McAdoo faced competing imperatives to both fight inflation and finance the war effort, however, resulting in government borrowing policies that may have actually increased the cost of the war and later inflation. Realizing the immense cost of the war and hoping to reduce the burden of future debt payments as much as possible, the

19 Samuelson, Economics, 343-45. The transaction is slightly more complicated but with the same end result. When commercial banks rediscount securities with a central bank they receive a credit on their account with the central bank. Banks may then withdraw these funds, in excess of the minimum amount they are legally required to keep on deposit with the central bank (their “reserve requirement”) and employ these funds to make loans, buy other securities, etc. 37

Treasury adopted a relatively low interest rate of 3.5 percent on the first war bond issue.

McAdoo used his position as an ex officio member of the Federal Reserve Board of

Governors to pressure the adoption of several supporting policies by the central bank.20

Under McAdoo’s influence the Fed lowered reserve requirements, the amount of money banks must hold against deposits and other liabilities. Lower reserve ratios meant banks no longer needed to hold as much money in reserve and could use these newly freed funds to purchase government bonds. The Fed also expanded the collateral it accepted for loans to member banks, making it easier for banks to obtain loans, and provided a preferential rate for bank borrowing by charging a lower rate of interest on loans to banks than banks obtained by purchasing government securities. McAdoo also promoted a policy of “borrow and buy,” encouraging the public to take loans from banks to purchase government securities. The combined effect of these measures was a massive increase in the amount of money in circulation and a doubling of the consumer price index. After the war, the Federal Reserve fought not only to regain bureaucratic independence from the Treasury but also to contain the inflationary pressure unleashed by government borrowing. The Fed’s efforts to restrain inflation after the war tipped the economy into recession and made the central bank the target of much criticism.21

20 The Secretary of the Treasury and the Comptroller of the Currency both served as ex officio members of the Federal Reserve Board of Governors prior to passage of the Banking Act of 1935. 21 David M. Kennedy, Over Here: The First World War and American Society (New York: Oxford University Press, 2004), 102-4; Allan H. Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2003), 84-9; For a deeper discussion of the 1919-21 inflation and recession see Barry Eichengreen, Golden Fetters: The Gold Standard and the Great Depression, 1919- 1939 (New York: Oxford University Press, 1992), Ch. 4. 38

The experience of the First World War held important lessons for the Federal

Reserve’s approach to the financing the next conflict. First, financial distortions caused by war financing created potentially negative consequences that undermined efforts to achieve a stable postwar prosperity. After the war the Treasury faced persistent deficits during the transition to peace. These deficits contributed to a significant floating debt based upon short-term borrowing. Treasury officials feared that holders of these short- term debts might decide to cash-out, to take dollars instead of reinvesting the profits from maturing old securities into new government debt. Under Treasury pressure to support the market for this war-generated floating debt, central bankers adopted policies that contributed to inflationary and deflationary boom and bust from 1919-1921. Bowing to

Treasury demands the Fed kept interest rates low after the war, but these credit terms made borrowing easy and contributed to a postwar inflationary surge. When the Fed raised interest rates in an attempt to contain this inflation it threw the economy into recession.22 While the Fed did not dominate World War II debt policy, neither did it blindly comply with Treasury demands. Instead, Fed officials continually debated among themselves and in public the appropriateness of specific government borrowing practices, casting them in terms of their implications for postwar economic prosperity.

Second, the experience of the First World War and the immediate postwar period again demonstrated the interdependence of American domestic prosperity and global economic stability. Barry Eichengreen points out that Fed officials adopted a policy of

22 Karl R. Bopp, “Three Decades of Federal Reserve Policy,” in Federal Reserve System Board of Governors, Postwar Economic Study No. 8: Federal Reserve Policy (Baltimore: Waverly Press, 1947), 3-5; Friedman and Schwartz, Monetary History, 221-39; John H. Wood, A History of Central Banking in Great Britain and the United States (New York: Cambridge University Press, 2005), 173-76. 39

“liquidation” to purge the inflationary run-up in prices during 1918-1920. As the United

States became more critical to the global financial system, and as nations became more dependent on American lending, however, domestic policies inevitably had international implications. Fed efforts to contract credit and liquidate inflation meant American investors had fewer dollars to lend. A decline in lending meant fewer loans not only for

American borrowers but for all borrowers and forced a global contraction. Ironically, the incomplete restoration of the gold standard by 1920-21 helped to cushion the negative international economic contraction imposed by the United States. The unfortunate consequence of this incomplete lesson was a repeat of the contraction during the late

1920s, when a more robust gold standard meant that nations were more fundamentally interdependent, helping to push the global economy into the downward spiral of the Great

Depression.23

World War II Financing and Inflation

The lessons derived from financing the First World War and the perceived connection between domestic economic prosperity on the one hand and international prosperity and peace on the other informed the Fed’s general attitude toward the Second

World War. Fed officials saw economic instability, particularly as created by wartime inflation, endangering both the immediate war effort and the ability to eventually transition to a stable peacetime economy.

23 Eichengreen, Golden Fetters, 122-4. 40

Fed officials expressed particular concern about the development of an inflationary spiral that might create socioeconomic tensions and undermine the nation’s economic program. Fed officials used highly caustic rhetoric to explain how inflation created economic distortions, depicting it as a “destructive” force that favored “slick” and

“clever manipulators” at the expense of “conscientious” and “thrifty citizens.”

Individuals on fixed incomes became impoverished as inflation drove up prices, reducing the purchasing power of their incomes and leaving them relatively poorer. In the end, according to the Fed, no one benefited because inflationary bubbles inevitably resulted in deflationary busts wiping out the “ill-gotten gains of the profiteer.” Inflation pitted labor and capital against one another, generating demands for higher wages and profits respectively. Yet, these demands added upward pressure to prices and strained the effectiveness of anti-inflationary measures such as taxes and investment in government securities. Fed officials highlighted not only the dangers of a wage-price spiral but also the mutual benefits to be gained by checking inflationary pressure. Central bankers stressed that if saving rather than bidding up the price on the declining supply of goods and services stored up purchasing power, sustained demand in the absence of war orders, and allowed the nation to safely transition to a peacetime economy.24 Therefore, resisting

24 Marriner Eccles, Address, “Address at Meeting of the National Industrial Conference Board,” November 28, 1940, FRASER, http://fraser.stlouisfed.org/historicaldocs/1205/download/66409/Eccles_19401128.pdf (Accessed October 25, 2011); E. A. Goldenweiser, “Inflation,” reprinted in the Federal Reserve Bulletin 27, no. 4 (April 1941), 293; Federal Reserve System Board of Governors, “The Nature and Size of the War Financing Program,” Federal Reserve Bulletin 28, no. 8 (August 1942), 765; Federal Reserve System Board of Governors, “Further Shift to War Economy,” Federal Reserve Bulletin 29, no. 4 (April 1943), 287-8; Federal Reserve System Board of Governors, “War Bonds, Taxes, and Economic Stability,” Federal Reserve Bulletin 29, no. 5 (May 1943), 394. 41

inflation created a sound basis to move to the prosperous postwar economy the Fed believed critical to international political-economic stability.

Avoiding disruptions caused by inflationary pressures seemed particularly important given the way government officials tended to conflate the effort on the home front and war front and argue that “no clear line of demarcation” existed between the two.

On the one hand, American officials argued that the home front had a responsibility to safeguard the nation’s economic security the same way soldiers and sailors fought to protect the country’s physical security.25 Whether through an equitable shouldering of the tax burden or participation in war bond drives, Americans had a patriotic duty to national sacrifice no different than the sacrifices made by American troops. The nation owed a duty to make the necessary home front sacrifices to ensure that returning veterans were not “demobilized into an environment of inflation and unemployment” and that sharp increases in prices and capital values threated to “make a mirage of the hopes of millions of war veterans” leaving them with no economic prospects.26 The larger point is that economic instability threatened to lose at home the values for which Americans fought. There seems little doubt that policymakers must have had the interwar

25 Marriner Eccles, Address, “Address Before the District of Columbia Bankers Association,” May 25, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/1207/download/66425/eccles_19420525.pdf (Accessed October 25, 2011); Franklin Roosevelt, “Message to Congress on an Economic Stabilization Program,” April 27, 1942, John T. Woolley and Gerhard Peters, The American Presidency Project (hereafter APP). Santa Barbara, CA. Available from World Wide Web: http://www.presidency.ucsb.edu/ws/?pid=16251. (Accessed October 25, 2011). 26 Franklin Roosevelt, “Letter to Congress on Tax Bills,” May 17, 1943, APP, http://www.presidency.ucsb.edu/ws/?pid=16400. (Accessed October 25, 2011); Federal Reserve System Board of Governors, “War Bonds, Taxes, and Economic Stability,” Federal Reserve Bulletin, (May 1943), 394-5; Franklin Roosevelt, “Fireside Chat,” July 28, 1943, APP, http://www.presidency.ucsb.edu/ws/?pid=16437. (Accessed October 25, 2011); Marriner Eccles, “Statement by Marriner S. Eccles on a Capital Gains Tax to Curb Rising Prices of Capital Values,” March 3, 1945, reprinted in the Federal Reserve Bulletin, 31, no. 3 (March 1945), 222. 42

experience in mind, when failure to establish a stable economic environment ultimately undermined the political outcome of the First World War.

Officials also cast economic conditions as having a more immediate impact on the war effort. Inflation created bottlenecks, distorted demand, and created scarcities in specialized goods. If prices advanced unduly or created disruptions in the supply of critical materials, it might impede the construction of war related materials.27 President

Roosevelt made the link explicit, highlighting the interdependencies between the military forces confronting the Axis and the workers laboring in factories throughout America.

Further, this interdependence meant that production disruptions caused by price and supply troubles or associated socioeconomic unrest leading to strikes or other interruptions in output had direct implications for the course of the war, delaying the day of ultimate victory and increasing the cost not just in terms of dollars but also in lives.28

Financing World War II – Government Securities

With the lessons of the First World War and the interwar years in mind the

Federal Reserve approached the task of assisting the financing of the Second World War.

Fed officials again found themselves pulled between conflicting responsibilities similar to

27 Marriner Eccles, Address, “Address at Meeting of the National Industrial Conference Board,” November 28, 1940, FRASER, http://fraser.stlouisfed.org/historicaldocs/1205/download/66409/Eccles_19401128.pdf (Accessed October 25, 2011). 28 Franklin Roosevelt, “Fireside Chat,” July 28, 1943, APP, http://www.presidency.ucsb.edu/ws/?pid=16437. (Accessed October 25, 2011); Franklin Roosevelt, “Message to Congress on the Progress of the War,” September 17, 1943, APP, http://www.presidency.ucsb.edu/ws/?pid=16316. (Accessed October 25, 2011). 43

the experience of the last world war: maximizing borrowing to ensure a sufficient volume of funds to finance the war effort while also keeping inflationary pressure and price distortions as low as possible. Given the experiences of the interwar period, failure to contain inflation seemed to threaten both the war effort and the nation’s long-term hopes for peace. Inflationary war finance might result in the kind of boom-bust cycle that followed the First World War, in which case the nation might sink back into economic depression and the world might be mired in autarky and militarism.

Ensuring a stable market for government securities, the instruments the government used to borrow money to pay for the conflict, represented one of the earliest areas of concern. On January 28, 1942, Marriner Eccles forwarded a memo to the

Treasury expressing some concerns about the proposed method for marketing government securities. Eccles summarized the memo at a meeting of the Federal Open

Market Committee (FOMC), the policy body charged with defining the central bank’s open market operations. Eccles did not object to the Treasury’s plan of government borrowing per se, but rather the methods Treasury Secretary Henry Morgenthau proposed to stimulate that borrowing. Eccles expressed concern at Treasury officials’ intention to alter the required reserve ratio to increase the amount of excess reserves held by banks.

Lowering the ratio meant bankers would be legally required to hold less of a cushion against their liabilities and effectively increased the amount of money available to lend 44

and invest, money Morgenthau intended to channel toward the purchase of government securities.29

The Treasury’s proposal to lower reserve requirements touched a nerve among

Fed officials who had already expressed concerns about the growing volume of excess reserves. Furthermore, Eccles doubted the ability of reserve requirement changes to induce banks to purchase government securities. Lowering the reserve ratio did not guarantee that each new dollar of excess reserves would be channeled into the market for

Treasury securities. Instead, he feared that it required an exorbitant volume of excess reserves to achieve the Treasury’s aim, a view shared by the Board of Governors and the

Federal Reserve’s Federal Advisory Committee (FAC). Central bankers feared that this pool of funds might surge into the market, bidding up prices before supply could adjust to meet the increased demand and creating inflationary distortions.30 Additionally, by altering the required reserve holdings of all banks simultaneously the measure threatened to unleash a disruptive force on the market for government securities. Reserves acted as a kind of reassurance for banks, providing confidence in their ability to remain liquid in a

29 Federal Open Market Committee (FOMC), Meeting Minutes, March 2, 1943, FRASER, http://fraser.stlouisfed.org/historicaldocs/2037/download/99035/19410317Minutesv.pdf (Accessed February 25, 2011); A bank’s legal reserves represented the fraction of money required to back deposits and other liabilities. Banks accumulated “excess reserves” when they held more money than the legally required minimum to back their liabilities. In the wake of the Great Depression banks took great pains to build relatively substantial excess reserve positions. Given the legacy of instability in the financial system during the 1930s, retaining excess reserves seemed a reasonable proposition to many financiers. Should loans default or depositors withdraw their funds, excess reserves allowed banks to weather these pressures. Bankers’ attempts to maintain substantial excess reserves persisted as the international situation deteriorated during the late 1930s. Beginning in March 1939 and continuing through January 1941 excess reserves continually increased, topping out at nearly $7 billion. Federal Reserve System Board of Governors, “Reserve Position of Member Banks, January 1940,” Federal Reserve Bulletin, 26, no. 3 (March 1940), 220; Federal Reserve System Board of Governors, “Reserve Position of Member Banks, October 1941,” Federal Reserve Bulletin 27, no. 12 (December 1941), 1244.

30 Marriner Eccles, “Price Fixing Is Not Enough,” Fortune, August 1941. 45

potentially tight market. The Treasury plan to alter reserve requirements threatened to create confusion and uncertainty, undermining the willingness of bankers to run down excess reserves through the purchase of government securities. Fed officials believed bankers might refrain from entering the market for wartime securities fearing a sudden reversal of policy restoring higher reserve requirements, catching them overextended and illiquid.31

Feeling pressured to demonstrate support prior to a large offering of government securities scheduled for May 1942, central bankers suggested an alternative approach utilizing price supports for government debt. Discussion among members of the FOMC initially focused on guaranteeing a yield of 2.5 percent on government securities with maturities greater than fifteen years. An inverse relationship existed between the price of a security and its yield, so as prices declined the effective interest rate, or yield, increased. Conversely, as prices rose the yield declined. By pledging to keep yields at

2.5 percent, the Federal Reserve promised to step in and buy or sell securities as needed to stabilize the price, and therefore the yield, from moving substantially against the promised rate. Given the substantial needs of the government, financiers anticipated that

31 Federal Reserve System Board of Governors, “Banking and Monetary Statistics 1941-1970,” FRASER, 160-161, http://fraser.stlouisfed.org/publications/bms2/page/154/60/download/154.pdf (Accessed February 25, 2011); Federal Reserve System Board of Governors, “Banks and the Defense Program,” Federal Reserve Bulletin (April 1941), 285-86; The New York Times estimated that on December 10, 1941, excess reserves had declined to approximately $3.8 billion, New York Times, December 12, 1941; Federal Reserve System Board of Governors (FRBG), Meeting Minutes, February 16, 1942, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min021642.pdf (accessed February 25, 2011); FOMC, Meeting Minutes, June 22, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/2029/download/99020/19420622Minutesv.pdf (Accessed February 25, 2011); Goldenweiser, American Monetary Policy, 39-41; Samuelson, Economics, 346; An expanded analysis on the uncertainty created by government regulatory and policy changes is provided by Robert Higgs in Depression, War, and Cold War: Studies in Political Economy (New York: Oxford University Press, 2006), 3-29. 46

a large quantity of securities would soon be on the market. Therefore, the Federal

Reserve might safely assume the need to continually purchase government securities to prevent prices from falling and yields from rising beyond the 2.5 percent peg. As for government paper with shorter maturities, the FOMC initially took no firm position although Allan Sproul, the president of the Federal Reserve Bank of New York

(FRBNY), suggested a pegged rate for longer term securities only and argued that market forces should be allowed to operate in determining yields on shorter term securities.32

Aside from eliminating the need for wholesale changes to reserve requirements, the policy of pegging the yield on government securities offered another key advantage from the government’s perspective. It avoided the World War I experience in which financiers waited to purchase government securities, hoping to fetch higher interest rates on their investment. Setting and maintaining a stable rate eliminated incentives to delay purchasing government debt. Such a policy allowed the Fed to create a stable market for low cost government borrowing while also avoiding potentially disruptive changes to banks’ required reserve ratio.

Continued pressure by the Treasury for lower reserve requirements provoked the

Fed to accept an additional compromise. The central bank modified its proposal to support a relatively fixed pattern of rates on government securities as an alternative to general reserve requirement changes. The Fed originally suggested pegging the yield on long-term securities only while allowing short-term securities to fluctuate based upon

32 FOMC, Meeting Minutes, March 2, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/2037/download/99035/19410317Minutesv.pdf (Accessed February 25, 2011); Federal Reserve System Board of Governors, “Treasury War Finance,” Federal Reserve Bulletin, 29, no. 11 (November 1943), 1054. 47

market conditions, but ultimately accepted a plan that essentially expanded this initial position. The Fed agreed to a suggestion from the Treasury to peg the yield on bills, securities with relatively short maturities of less than one year (usually ninety days), at

0.375 percent and then to support a pattern of rates for securities with longer maturities relative to the bills rate.33 In effect the decision pegged the rates on all government debt within a relatively narrow band. As for excess reserves, the Fed and Treasury settled on a plan that allowed the central bank to adjust the reserve ratio in central reserve cities such as New York and Chicago as opposed to system-wide alterations. This allowed banks in those cities to purchase government securities even as correspondent banks drew down balances to facilitate their own acquisitions. In addition Eccles privately assured

Morgenthau of the Federal Reserve’s commitment to meet what the Treasury considered the minimum necessary reserve level of $2.5 billion.34

The Federal Reserve was highly concerned with the distribution of the government’s debt, that is, who purchased the securities. As we have seen, the more commercial banks purchased government securities the greater the potential inflationary pressure. Fed officials were acutely aware of their inability to directly influence taxes, or price and wage controls, those being fiscal policy issues and generally outside the bounds of the Fed’s monetary policy expertise. Therefore, Fed officials believed the central bank

33 FOMC Minutes, May 8, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/2030/download/99017/19420508Minutesv.pdf (Accessed February 25, 2011). 34 Federal Reserve System Board of Governors, “Bank Credit, War Finance, and Savings,” Federal Reserve Bulletin 28, no. 9 (September 1942), 869-70, February 1943, 111; Meltzer, Federal Reserve, Volume I, 598; FOMC Minutes, December 14, 1942, FRASER, http://www.presidency.ucsb.edu/ws/index.php?pid=16316&st=congress&st1=#axzz1bpFmdrYE (Accessed October 25, 2011). 48

needed to pay particularly close attention to encouraging debt purchases outside of the commercial banking system to the greatest extent possible.35 Central bankers argued not only that reliance on commercial banks created inflation but that this inflation impeded both the war effort itself and the creation of a stable postwar political order by way of long-term economic dislocation.

The Fed appealed directly to the public and extolled the immediate and long-term benefits of war bond purchases. In the near-term purchasing war bonds offered one way for Americans on the home front to sacrifice while at the same time contributing to the war effort. War bonds purchased by the public offered a safe way to invest the incomes workers took home, particularly as wages increased during the war.36 When Americans purchased government securities this mobilized funds that might be hoarded and held in the form of idle unutilized cash. In early 1942 the Fed estimated that hoarded money represented over 17 percent of all cash holdings, and by the end of the war the central bank discussed eliminating large denomination bills as a way to discourage the practice.37

Fed officials criticized hoarding as unpatriotic and argued that it contributed nothing to

35 FOMC Executive Committee Minutes, August 18, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/2027/download/99029/19420818MinutesECv.pdf (Accessed October 25, 2011). 36 Federal Reserve System Board of Governors, “War Financing and Banking Developments,” Federal Reserve Bulletin 28, no. 12 (December 1942), 1179; President Franklin Roosevelt made much the same argument when stated that “Hoarding should be encouraged in only one field, that of defense savings bonds.” Franklin Roosevelt, “Annual Budget Message,” January 5, 1942, APP, http://www.presidency.ucsb.edu/ws/?pid=16231. (Accessed February 21, 2011). 37 FRBG, Minutes, September 19, 1944, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min091944.pdf (accessed February 25, 2011); Earlier Fed analysis indicated that hoarded currency was generally held in denominations of $50 of greater, Federal Reserve System Board of Governors, “Recent Changes in the Demand for Currency,” Federal Reserve Bulletin 28, no. 4 (April 1942), 313-14. 49

the war effort.38 Investing in war bonds turned this money over to the government for use in purchasing the materials necessary to prosecute the war and offered a means for individuals to directly contribute to the conflict.

In addition to mobilizing otherwise idle money, purchasing securities also kept these funds from being used for civilian consumption. While the manufacture of civilian products such as automobiles and consumer appliances all but ceased early in the war, increased incomes drove up prices in other areas such as food, clothing, and furniture, causing a spike in the overall cost of living.39 At the same time stores stockpiled inventories of goods in anticipation of wartime shortages, allowing relatively high levels of civilian spending on consumer goods well into 1943.40 Even prior to American entry into the war the Fed feared that competition between civilian and military goods production might create bottlenecks of critical raw materials or otherwise compromise the nation’s ability to efficiently maximize war production. Citizens who bought war bonds redirected their purchasing power away from the shrinking supply of consumer goods, thereby reducing inflationary pressure, and also freed labor and productive

38 The Federal Reserve recognized several motives for hoarding cash, including the fact that many previously poor Americans who had little experience with bank accounts found themselves earning new or significantly larger incomes thanks to the expansion of war industries. Federal Reserve System Board of Governors, “Currency in Circulation,” Federal Reserve Bulletin 29, no. 6 (June 1943), 499. 39 Federal Reserve System Board of Governors, “Commodity Supplies and Prices,” Federal Reserve Bulletin 28, no. 3 (March 1942), 195-7. 40 Federal Reserve System Board of Governors, “National Summary of Business Conditions,” Federal Reserve Bulletin, (April 1942), 328; Federal Reserve System Board of Governors, “Use of Credit for Accumulation of Inventories,” Federal Reserve Bulletin 28, no. 7 (July 1942), 645; Federal Reserve System Board of Governors, “Transition to War Economy,” Federal Reserve Bulletin 29, no. 1 (January 1943), 1-2; Federal Reserve System Board of Governors, “Decline in Consumer Credit,” Federal Reserve Bulletin, (June 1943), 486-8; Roosevelt also made anecdotal reference to the accumulation of civilian goods inventories in a press conference, “Excerpts from the Press Conference,” October 20, 1942, APP, http://www.presidency.ucsb.edu/ws/?pid=16180. (Accessed February 21, 2011). 50

capacity for the war effort. The Federal Reserve echoed Roosevelt administration appeals, depicting public investment in savings bonds as a patriotic measure whereby workers on the home front sacrificed self-interested consumption while simultaneously contributing money to the war effort.41

Even as the Fed appealed for greater voluntary savings through the purchase of bonds, it also advocated a series of confiscatory policies far more aggressive than contemplated by President Roosevelt or Treasury Secretary Morgenthau. Eccles supported a program of compulsory savings similar to the one Britain adopted earlier in the war. Compulsory savings did not represent a necessarily new idea; indeed, proposals circulated even before American involvement in the conflict. Nor was Eccles alone in his support, as Budget Director Harold Smith as well as Vice President Henry Wallace both supported the compulsory savings proposal. These plans usually involved the confiscation of funds from paychecks of workers with the promise of government repayment after the war.42 The Treasury opposed these schemes and instead emphasized

41 Marriner Eccles, Address, “Address at the Meeting of the National Industrial Conference Board,” November 28, 1940, FRASER, http://fraser.stlouisfed.org/historicaldocs/1205/download/66409/Eccles_19401128.pdf (August 20, 2010); Roosevelt, “Message to Congress on an Economic Stabilization Program,” April 27, 1942, APP, http://www.presidency.ucsb.edu/ws/?pid=16251. (Accessed February 21, 2011); Marriner Eccles, Address, “Safeguarding Our Economy,” May 25, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/1207/download/66425/eccles_19420525.pdf (Accessed August 20, 2010).

42 Robert Skidelsky explains that the British rebranded compulsory savings as “deferred savings” as a way of overcoming similar political opposition, John Maynard Keynes: Fighting for Freedom, 1937- 1946 (New York: Penguin Books, 2000), 52-59; Donald Markwell, John Maynard Keynes and International Relations: Economic Paths to War and Peace (New York: Oxford University Press, 2006), 215-18’ Sidney Hymann, Marriner S. Eccles: Private Entrepreneur and Public Servant (Stanford: Stanford University Graduate School of Business, 1976), 286-7; Samuel, Pledging Allegiance, 77-87; John Morton Blum, Roosevelt and Morgenthau: A Revision and Condensation From the Morgenthau Diaries (Boston: Houghton Mifflin Company, 1970), 426-31; Eccles, Beckoning Frontiers, 372; Fortune, “Blood, Sweat, 51

voluntary bond purchases as an important symbolic validation of American democratic values, warning that compulsory savings threatened to undermine this message. Eccles acknowledged that the principle of voluntary action vindicated “the democratic way” but cautioned that if Americans failed to participate, the nation might have no alternative left but compulsory actions.43

Fed officials had reason to doubt the effectiveness of purely voluntary methods.

Allan Sproul of the FRBNY accused Treasury officials of focusing on sales quotas over minimizing inflationary pressure. According to the Fed, the emphasis on drumming up popular participation led local Treasury officials to at least ignore, and in some cases actively encourage, commercial bank practices that undercut the anti-inflation campaign.

These included bankers lending money to customers to purchase new Treasury securities using bank credit in place of their own incomes, which did nothing to reduce citizens’ purchasing power and inflationary potential. Alternatively, some bankers purchased older issues of securities from clients, freeing funds for them to participate in new bond drives, again resulting in no net reduction in outstanding purchasing power. Fed officials

Toil, and Tears,” July 1940, 124; Henry Morgentahu took his argument in favor of voluntary over compulsory savings directly to President Roosevelt arguing that “forced savings” resulted in less revenue than voluntary bond purchases, Morgenthau, Memorandum, April 15, 1942, The Presidential Diaries of Henry Morgenthau, Jr. (1938-1945) (Frederick, MD: University Publications of America, 1981), microfilm. (Hereafter cited as HMD), Reel 2; Morgenthau continued to argue against compulsory savings plans throughout 1942, Morgenthau, Memorandum, December 4, 1942, HMD, Reel 2. 43 Harold G. Vatter, The U.S. Economy in World War II (New York: Columbia University Press, 1985), 108-109; John Morton Blum, V Was For Victory: Politics and American Culture During World War II (New York: Harcourt Brace, 1976), 228; FOMC, Meeting Minutes, May 4, 1944, FRASER, http://fraser.stlouisfed.org/historicaldocs/2016/download/98981/19440504Minutesv.pdf (Accessed February 25, 2011); Marriner Eccles, Address, “Address Before the District of Columbia Bankers Association,” May 25, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/1207/download/66525/eccles)19420525.pdf (Accessed August 30, 2010). 52

appealed to bankers to exercise discretion in extending credit, to actively encourage their customers to put savings in government securities and educate them about the dangers of inflation. As late as June 1945, however, Fed officials complained that banks failed to take many of these requests seriously and continued to act in ways that created inflation.44

As the war progressed Fed officials also began to express concern about the precise spread between the rates of various government securities but hesitated to take direct action. Eccles believed that any change in the pattern of rates should be coordinated with the Treasury, although he also felt that the system was not “indefinitely committed” to the pattern established in 1942. Fed officials discussed increasing the rate on bills to 0.500 and 0.625 percent but came under criticism from Treasury officials who accused the central bank of failing to live up to its commitments by even discussing changes to the rate structure. Fed officials, including Allan Sproul, who recognized the difficulty in maintaining the pattern of rates, also feared that alterations might undermine confidence in the market for government securities.45

44 Federal Reserve System Board of Governors, “Participation of Commercial Banks in the War Financing Program,” Federal Reserve Bulletin, (December 1942), 1190; FOMC, Meeting Minutes, June 20, 1945, FRASER, http://fraser.stlouisfed.org/historicaldocs/2010/download/98971/19450620Minutesv.pdf (Accessed October 25, 2011). 45 FOMC Executive Committee, Meeting Minutes, March 1, 1944, FRASER, http://fraser.stlouisfed.org/historicaldocs/2017/download/98980/19440301MinutesECv.pdf (October 25, 2011); FOMC Executive Committee, PM Meeting Minutes, May 4, 1944, FRASER, http://fraser.stlouisfed.org/historicaldocs/2017/download/98980/19440301MinutesECv.pdf (Accessed October 25, 2011); FOMC Executive Committee, AM Meeting Minutes, December 11, 1944, FRASER, http://fraser.stlouisfed.org/historicaldocs/2014/download/98989/19441211MinutesEC1v.pdf (Accessed October 25, 2011); FOMC Minutes, December 11, 1944, FRASER, http://fraser.stlouisfed.org/historicaldocs/2014/download/98988/19441211Minutesv.pdf (Accessed October 25, 2011). 53

Whether purchased voluntarily or through a scheme of compulsory savings, Fed officials cast popular participation in the bond campaign as beneficial to long-term

American prosperity. Not only did it drain off immediate purchasing power when civilian goods were in short supply it also created a source of stored wealth that could be utilized after the war, sustaining economic demand and helping transition the economy from a war to a peacetime basis.46 The Fed anticipated that the end of the war would bring an end to America’s military commitments and a significant drop in military spending as the armed forces demobilized. This was not an unreasonable assumption, and indeed Franklin Roosevelt believed the country should avoid a long-term and costly commitment of troops to European security.47 With the expanded productive capacity thanks to the war a high level of consumer spending was critical to sustaining postwar domestic prosperity. As previously discussed, the Fed was convinced that preventing the rise of nationalist trade barriers either at home or abroad depended upon domestic prosperity and full employment.48 Given the perceived link between economic autarky and military aggression, when individuals purchased war bonds and contributed to postwar economic prosperity, they implicitly contributed to postwar international political stability.

46 Federal Reserve System Board of Governors, “The Nature and Size of the War Financing Program,” Federal Reserve Bulletin, (August 1942), 765; Federal Reserve Board of Governors, Thirtieth Annual Report of the Board of Governors of the Federal Reserve System: 1943, 3. 47 Randall Bennett Woods, A Changing of the Guard: Anglo-American Relations, 1941-1946 (Chapel Hill: University of North Carolina Press, 1990), 149-50. 48 Marriner Eccles, Address, “The Postwar Price Problem – Inflation or Deflation,” November 16, 1944, FRASER, http://fraser.stlouisfed.org/historicaldocs/1210/download/66431/eccles_19441117.pdf (Accessed August 30, 2010); Ernest G. Draper and Walter R. Gardner, “Goods and Dollars in World Trade,” Federal Reserve Bulletin 30, no. 11 (November 1944), 1051-3. 54

Financing World War II - Taxes

Taxes represented the second major area of concern for the Federal Reserve.

American policymakers debated the specific tax policies to adopt throughout the Second

World War, considering a variety of options connected to both rates and the distribution of the tax burden. Differences of opinion on the optimal policy existed, similar to the differences over government debt. Over the course of the war U.S. officials made continual adjustments, reducing or eliminating exemptions and increasing tax rates for both individual incomes and corporations. Taxing alternatives ranged from congressional calls for a national sales tax to a proposal floated by President Roosevelt to cap after tax incomes at $25,000 for an individual and $50,000 for families. Because taxes removed funds from the economy and thereby reduced inflationary pressure, Fed officials expressed interest in the level of taxation imposed on both workers’ incomes and corporate profits. The heavier the tax burden accepted by Americans the less the nation need rely on borrowing to finance the war, particularly borrowing from commercial banks with its inflationary consequences. In an effort to build support for higher rates

Fed officials linked tax policy to the ideas of sacrifice in support of the war effort and securing postwar prosperity, similar to the position it took with regard to government borrowing policy.49

Throughout the war, Fed officials called for generally higher rates of taxation but consistently confronted obstacles from both the American public and politicians in

49 Koistinen, Arsenal of World War II, 431; Meltzer, Federal Reserve, Vol. I, 589; R. A. Musgrave and H. L. Seligman, “The Wartime Tax Effort in the United States, the United Kingdom, and Canada,” Federal Reserve Bulletin 30, no. 1 (January 1944), 16. 55

Congress. According to Eccles a “depression psychology” left the public skeptical of the need for higher taxes and politicians hesitant to confront the potential “political repercussions” despite the necessity. Insufficient money accounted for the privations of the Great Depression, and according to Eccles people were slow to recognize and understand the new problem, which was insufficient supply of goods. Fed officials believed that the economic slack from unemployed workers and unutilized machinery meant Americans did not begin to experience inflationary pressure until 1942. Once this inflationary pressure started it required immediate attention, but Congress only slowly accepted the necessity of higher taxes while many people hoped to “wage a comfortable war” minimizing their personal economic sacrifices and believed that they could have both “guns and butter.”50

Even while supporting higher taxes generally as a means to control inflation, Fed officials remained sensitive to the distribution of burden. First, they argued that the tax base needed to be broadened so that all of the increase did not fall on a single class or group. Indeed, during the Second World War the tax base did expand considerably, growing from 7.5 million returns (or 7 percent of the population) in 1940 to 42.4 million

(roughly 64 percent of the population) by 1944. Second, to the extent that individuals needed to bear higher rates, they should be focused on those best able to shoulder them.

This attention to the relative burden of taxes led Eccles to reject calls for a national sales tax, arguing that it reached too far into the “pockets of those below subsistence level” and adversely impacted the “poor harder than the rich.” Eccles expressed concern about the

50 Eccles, Beckoning Frontiers, 346-7; Meltzer, Federal Reserve, Vol. I, 590. 56

potential for a national sales tax to disturb the eventual conversion to a peacetime economy after the war. He had already expressed concern that imposing too heavy a burden on any single group would only prompt its members to demand higher wages or increased prices and profits, with all the negative consequences of an inflationary spiral previously mentioned. As for the eventual postwar transition to a stable and prosperous domestic economy, according to the Fed chairman, high sales taxes, by discouraging consumption, translated into lower sales for business and therefore higher unemployment, in addition to penalizing those who consumed a higher proportion of their incomes. 51

Eccles recognized that tax policy must “first turn to the corporations” then enjoying vastly increased profits because of wartime government expenditures, as the

“logical primary source” for government revenue, and that after the war high corporate taxes should remain in place until rates came down for individual incomes, particularly at the lower end of the wage scale.52 The Fed chairman further distinguished between large corporations that depended upon the “existence of markets . . . rather than [low] taxation” for their success, and small businesses that might be induced by high taxes to retain rather

51 “Eccles Warns U.S. of Inflation Peril,” New York Times, February 13, 1942; Marriner Eccles, Address, “Address Before America’s Town Meeting of the Air Over State WJZ and the Blue Network,” February 12, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/1207/download/66424/eccles_19420212.pdf (Accessed October 25, 2011); Marriner Eccles, “Possibilities of Postwar Inflation and Suggested Tax Action,” an address at the Tax Institute Symposium in New York City, February 8, 1944, reprinted in the Federal Reserve Bulletin 30, no. 3 (March 1944), 225-26 Koistinen, Arsenal of World War II, 430; John Morton Blum argues Eccles supported a national sales tax in Blum, V Was for Victory, 228. 52 Marriner Eccles, Address, “Address Before America’s Town Meeting of the Air Over State WJZ and the Blue Network,” February 12, 1942, FRASER, http://fraser.stlouisfed.org/historicaldocs/1207/download/66424/eccles_19420212.pdf (Accessed October 25, 2011). 57

than distribute corporate earnings, not returning these funds to the spending stream to the detriment of postwar employment.53

At the same time, some within the Federal Reserve warned against penalizing banks and corporations, even large ones, too heavily. Robert Fleming, FAC member and president of the Riggs National Bank, argued that any tax program must recognize the variety of free services commercial banks provided the government, particularly the selling of defense bonds, but also the maintenance of “blocked accounts of foreigners.”

Fleming argued that a punitive taxation might undermine the ability of banks to play a constructive role in the eventual postwar transition. S. E. Ragland, FAC member and president of the First National Bank of Memphis, echoed this sentiment and cautioned that a combination of relatively low interest rates and high taxes might result in banks being “bled white.” Similarly, George Harrison, president of the New York Life

Insurance Company and member of the FAC, and John McKee, a member of the Federal

Reserve Board of Governors, expressed concern about tax rates on corporations. Given the Fed’s desire to minimize the government’s reliance on banks for the purchase of securities, Harrison and McKee emphasized the need to settle on a corporate tax policy to reduce uncertainty. Both cautioned that corporations might be unwilling to tie up their money in government securities without a clear understanding of what their potential future tax liability might be.54

53 Marriner Eccles, “Possibilities of Postwar Inflation and Suggested Tax Action,” reprinted in Federal Reserve Bulletin, (March 1944), 226. 54 FRBG, Meeting Minutes, April 9, 1942, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min040942.pdf (accessed February 25, 2011). 58

Federal Reserve consideration of tax policy should be understood within the context of larger and more general discussions of wartime and postwar economic policy.

While the details of individual tax policy positions, such as heavier versus lighter corporate taxes, offer insights into specific ideological beliefs about the role of government and private enterprise, they share a common feature. Central bankers clearly articulated the belief that taxes were an integral part of a larger “social and economic program” necessary to “encourage economic stability and progress.”55 Therefore, domestic prosperity rested, in part, on the ability to set wartime taxes so as to curb inflationary pressures during the war while encouraging business and consumer demand as the nation eventually transitioned to the postwar period. Because of the way Fed officials connected domestic prosperity to international political stability, American tax policy had very real long-term implications for the international system. This is not to argue that the Fed believed the fate of the world hinged on the tax policy of the Second

World War, but rather that it represented another important link in the chain between the domestic economy, the international economy, and the international political environment.

Price Stability vs. War Financing

During the Second World War, Fed officials highlighted the implications of war financing policies for achieving domestic prosperity, and as we have seen, cast this

55 E. A. Goldenweiser, “Postwar Problems and Policies,” address delivered at the Dinner Meeting of the Annual Agricultural Outlook Conference, Washington, D.C., November 14, 1944, reprinted in the Federal Reserve Bulletin 31, no. 2 (February 1945), 116. 59

prosperity as important for obtaining global economic and political stability. Throughout the conflict, however, the Fed continued to subordinate the principle of price stability to the goal of maximizing war finance operations. Given the potentially dire consequences the Fed associated with war finance it is not unreasonable to question why the Fed ordered its priorities as it did.

With regard to the policy on taxes the answer can plausibly be credited to simple jurisdiction. The Federal Reserve, responsible for monetary policy, had very little direct control over taxation and fiscal matters. Fed officials might believe that taxes had an important role to play in securing postwar American prosperity by moderating inflation and supporting demand during postwar reconversion, but taxes were clearly the purview of the Treasury, and more generally the Congress and Roosevelt administration. The

Federal Reserve did not have the power to influence the rate or distribution of the tax burden beyond rhetorical gestures.

Understanding why the Fed chose to subordinate price stability to wartime finance when discussing government securities requires additional explanation. The Fed chose to accept a compromise and support a pegged pattern of interest rates on government securities, continuing to adhere to this pledge throughout the war despite increasing concerns that government borrowing policy created potentially disturbing inflationary pressure. Furthermore, the Fed considered itself bound to this agreement in the absence of any legislative mandate; that is to say, it voluntarily observed the pegged pattern of rates. Understanding why the central bankers acted the way they did requires 60

understanding how the Fed viewed both the war itself and the probable nature of the postwar world.

Federal Reserve officials saw Germany as a threat to the American political economy of democratic free enterprise. Prior to American entry into the war the FRBNY undertook a study of just how Germany might use its economic power in the event of total victory, and what this meant for the United States. This study, actually a series of memos, anticipated an eventual German conquest of the United Kingdom with the British merchant fleet falling under the control of the Reich, giving it powerful leverage over the terms of international trade. Centralized German control of shipping could be used to force U.S. and Latin American shippers out of European waters. German and Japanese control over critical raw materials threatened to drive up prices for U.S. businesses and endangered the American standard of living. At the same time exploitation of conquered areas helped the Axis build industrial sectors to compete with American manufacturing exports. Any chance of countering this advantage required the cartelization of Western

Hemisphere business sectors as a means of resisting exploitative terms of trade from the

Axis.56

The necessity of maximizing defense production became increasingly clear to

American officials. Fed officials blamed conservative financial policies for limiting the preparedness efforts of the Western powers, leaving them vulnerable to Axis aggression.

56 Walter Gardner to E.A. Goldenweiser, Memorandum, “Projected Work on U.S. Adjustment to a Possible German Victory,” June 6, 1940, RG 82 DIF, box 186; Willis, Memorandum, FRBNY, “Current International Accounts of the United States During and After the War,” July 22, 1940, RG 82 DIF, box 186; Willis, Memorandum, FRBNY, “Current International Accounts of the United States During and After the War,” July 29, 1940, RG 82 DIF, box 186. 61

The Fed’s criticism is unfair in certain respects. France rejected exchange controls and domestic economic planning; steps required to pour greater resources into defense production, in an effort to avoid a larger diplomatic break with Great Britain and the

United States. Britain’s rejection was based upon the belief that it could never win a quick victory against Germany; instead the British sought to preserve economic strength for a prolonged conflict with Germany using the weight of greater resources to tip the scales.57 Popular opinion surveys, however, seemed to reflect a belief, at least among the business class, that the United States needed to prioritize arms production over all else.

One public opinion poll revealed that nearly 90 percent of those surveyed believed the

United States must “arm to the teeth at any expense” to defend against Axis aggression.58

Defeating the fundamental challenge to American political economy required temporarily suspending strict notions of price stability or sound finance. Central bankers saw a German victory as requiring the centralization of decision making and the cartelization of American business. Fed officials would have strongly agreed with

Fortune magazine’s contention that “if we lose the war we cannot save freedom.”

Mariner Eccles editorialized that Americans must temporarily set aside preconceived ideas of economic freedoms in the service of the immediate war crisis.59 Therefore, the

57 Joseph Maiolo, Cry Havoc: How the Arms Race Drove the World to War, 1931-1941 (New York: Basic Books, 2010), 184, 238. 58 E.A. Goldenweiser to Emile Despres, Memorandum, “Preparation of General Economic Program for U.S. in Event of German Victory,” June 7, 1940, RG 82 DIF, box 186; “Fortune Survey: XXXIII,” Fortune, August 1940. 59 “Prelude to Total War,” Fortune, July 1941; Marriner Eccles, “Price Fixing is Not Enough,” Fortune, August 1941. 62

Federal Reserve accepted the prioritization of war finance over the pursuit of price stability, in part, because the alternatives seemed worse.

Ironically, the prospective nature of the postwar world may have eased the immediacy of Fed concerns about price stability as much as it created concerns about the long run. There is no doubt that the Fed saw the economic disturbances of the interwar era as a major contributor to the descent into world war. And the Fed continued to be concerned about ensuring postwar prosperity because of the long-term effects, both economic and political. Like many others during the Second World War, however, the

Fed did not anticipate the continued burden of a long and expensive security commitment in the form of the Cold War against the Soviet Union. Instead, American discussions of the postwar order focused on collective security and cooperation, first through

Roosevelt’s Four Policemen concept or later through the United Nations. Gaddis Smith argues that Roosevelt desired a speedy victory in Europe in the hopes of minimizing

American political commitments. Immediate postwar realities seemed to confirm wartime supposition as the United States demobilized fairly rapidly, only reversing course and reconstituting its military might for a prolonged “armed truce” in the wake of subsequent tensions with the Soviet Union.60 American elites in both government and the

60 Elizabeth Borgwardt, A New Deal for the World: America’s Vision for Human Rights (Cambridge: Belknap Press of Harvard University Press, 2005); Gaddis Smith, American Diplomacy during the Second World War, 1941-1945 (New York: Alfred A. Knopf, 1985), 58; Michael Hogan, A Cross of Iron: Harry S. Truman and the Origins of the National Security State, 1945-1954 (New York: Cambridge University Press, 2000), 23. 63

business community emphasized the eventual rewards to be enjoyed after the burdens and sacrifices of the Second World War.61

Additionally, the Federal Reserve generally supported the creation of the

International Monetary Fund (IMF) and the International Bank for Reconstruction and

Development, more commonly known as the World Bank. While central bankers expressed concerns about particular aspects of the plans (detailed in subsequent chapters) discussed at the international conference held at Bretton Woods, New Hampshire, in general these talks indicated positive prospects for the international monetary system and the restoration of international investment. The multilateral solutions discussed at

Bretton Woods established a foundation for the restoration of global economic prosperity helping to ease the burden on the U.S. economy. A cooperative international economic environment governed by established rules and mechanisms for adjustment seemed less dependent on the whims of the American economy and private investors, making the system more tolerant, at least in the short term, of moderate inflationary pressure.

The Federal Reserve’s approach to war finance developed within the context of an expected postwar peace based upon international cooperation. While the Fed argued that economic factors posed threats to the United States and the international system, the threat was to the smooth transition from the wartime to a peacetime economy. The

61 Meg Jacobs, Pocketbook Politics: Economic Citizenship in Twentieth Century America (Princeton: Princeton University Press, 2005), 200-1; As Susan Brewer argues “Even as officials sought to educate Americans about the importance of making a long-term commitment to international peacekeeping, they sold the war with the promise that once it was over everyone could come home to enjoy a prosperous peace.” Susan Brewer, Why America Fights: Patriotism and War Propaganda from the Philippines to Iraq (New York: Oxford University Press, 2009), 89. 64

economic demands of the Second World War represented something akin to financial turbulence to be endured before returning to a more normal peacetime economy. Fed policy focused on minimizing the disruption of war finance as a means to easing the transition back to a peacetime economy, not as a way to begin taking up a new set of long-term demands.62

Finally, throughout the war central bankers hesitated to push their own ideas too aggressively, concerned that doing so might reduce the influence of the Federal Reserve

System within the Roosevelt administration. Eccles admitted to the Board of Governors that although he believed the Fed should make its views known, “it should not try to make its will prevail.” He feared that failing, or appearing to fail, to cooperate with administration policy would “result in the loss of authority and influence” for the Fed.63

Thus, the Fed argued for modifications to American financial policy during the war as

Eccles recognized a limit beyond which the central bank could not or should not press.

The argument, however, is not that the Fed completely abandoned interest in the specific measures used to finance the war or their larger implications, quite the opposite.

Instead, through the war the Fed presented the anti-inflationary program as critical to achieving the goal of a postwar international order based upon peace and prosperity.

This evidenced a clear Fed idea about what the nation’s postwar plans should be, directly linking domestic monetary and price stability with the achievement of these international

62 The significance of this only becomes fully apparent when juxtaposed against the Federal Reserve’s attitude to the financing of the Korean War. By 1950 Fed officials could see the military requirements of the hot war in Korea within the context of long-term military and security commitments. 63 FRBG, Meeting Minutes, February 3, 1942, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min020342.pdf (accessed February 25, 2011). 65

aims. Equating home front sacrifice with military sacrifice allowed the Federal Reserve to stress the need to check inflation and reconcile it with the overriding imperative to win the war and cooperate with the Roosevelt administration’s war finance program.

According to the Fed, if in the process of financing the war the government unleashed extreme economic dislocations these might actually disrupt the production of war materials by creating bottlenecks in critical materials, exacerbating tensions between labor and capital, or otherwise fostering self-interested behavior that detracted from the war effort. In this way the Fed cast anti-inflationary policies as war winning measures, helping to navigate competing imperatives.

Conclusion

The actions, perspectives, and arguments of the Federal Reserve with regard to wartime financing are illuminating in a number of ways. First and foremost the Federal

Reserve maintained an active interest in both the methods used to finance the war and the implications of these policies for American postwar objectives. This constituted an implicit interpretation of American foreign policy, an interpretation that paralleled, in broad terms, the arguments made by others both within the Roosevelt administration and outside of government. The Fed prioritized military victory above maintaining price stability, at least in the immediate term. It also supported the establishment of the liberal capitalist open door system of trade and acknowledged the nation’s need to run import surpluses as a means of facilitating international economic balance and peaceful relations. 66

Furthermore, the Federal Reserve acknowledged not only a fundamental link between global economic and politico-military conditions but also that domestic developments held international implications, and further that the government, of which the Federal

Reserve was a part, must play an active role managing both levels. This presupposed a

Federal Reserve concern with both the structure and operation of the Bretton Woods institutions, and also the nature of America’s Cold War commitments, particularly how these affected the domestic economic prosperity so fundamental to political stability.

At the same time it is important to re-emphasize the active nature of Federal

Reserve concern. Throughout the war the Fed continued to debate the nature of the

American financing effort. In areas such as tax policy, the Fed supported the extension of taxes but also continued to discuss ways to optimize that policy. In areas fundamental to its expertise and operations, such as wartime borrowing, the Fed actively debated the merits of the Treasury’s approach. While the Fed did not succeed in securing some of the major policy initiatives it desired, such as compulsory savings or changes to the pegged rate on yields, this should not distract from the importance of the debate itself. During the Cold War, as near-term measures created friction with perceived long-term foreign policy goals, the Fed became more vocal in pressing for changes to U.S. financial policy.

It is important to recognize that this willingness did not spontaneously emerge during the

Cold War, nor did it simply represent some reassertion of private financial dominance.

Instead, it evolved as an organic aspect of the Federal Reserve’s contribution to the formulation and implementation of foreign policy during the Second World War. Chapter Two

“For a Peaceful and Prosperous World”: The Federal Reserve and the Political

Economy of the World Bank, 1942-1945

Very early in the Second World War U.S. policymakers began planning the structure of the postwar international economy. On May 15, 1942, Treasury Secretary

Henry Morgenthau forwarded a memo to President Franklin Roosevelt proposing the creation of a world stabilization fund and an international bank to facilitate economic cooperation between states and safeguard the postwar “monetary and credit systems” as well as “supply [the] huge volume of capital” required to restore and rehabilitate the global economy. The memo detailed a plan drafted by Harry Dexter White of the

Treasury, Morgenthau’s trusted assistant, who began work on a proposal for a stabilization fund and international bank even before U.S. entry into the war.

Morgenthau argued that such institutions offered the people of the world “a New Deal in international economics,” globalizing the president’s response to the Great Depression that emphasized a state-led rather than privately coordinated economic system.

Morgenthau informed Roosevelt that he hoped to begin discussions with the important agencies of the U.S. government, including the Board of Economic Warfare, the State

Department, and the Federal Reserve Board of Governors, in preparation for an

67 68

international conference of finance ministers.1 Twenty-six months later, Morgenthau stood before 730 delegates from forty-four nations and delivered the closing address of the United Nations Monetary and Financial Conference at the Mount Washington resort in Bretton Woods, New Hampshire.

This chapter examines the attitude of the Federal Reserve toward the formation of the International Bank for Reconstruction and Development (the World Bank) created at the Bretton Woods Conference. Capitalized at $10 billion and empowered to extend either direct loans or guarantee principal and interest repayments, the World Bank was designed to aid in the reconstruction and development of economies after the war. The focus of this chapter is not necessarily on the ways central bankers shaped particular details of the plan, although they are considered. Instead, it examines how the Fed believed the World Bank positively contributed to a stable postwar political economy.

Fed officials contended that foreign investment and trade represented critical vehicles for securing postwar international prosperity and political peace, similar to the war financing program and an overall healthy domestic economy. Foreign and domestic economic growth, in fact, represented different sides of the same coin. On the one hand, postwar recovery could not take place without prudent war finance measures that minimized economic disruption in the United States and facilitated the reconversion of the U.S. economy from a war to a peacetime basis. On the other, U.S. officials, including those at

1 Henry Morgenthau to Franklin Roosevelt, Memorandum, May 15, 1942, HMPD, Reel 2; Elizabeth Borgwardt, A New Deal for the World: America’s Vision for Human Rights (Cambridge: Harvard University Press, 2005), Chs. 3-4; Robert W. Oliver argues that Harry Dexter White began working on plans for postwar international institutions as early as the summer of 1941 in International Economic Co- Operation and the World Bank (New York: MacMillan Press, 1975), 111-14. 69

the Federal Reserve, recognized that prosperity was not a zero-sum game, and that the long-term health of the U.S. economy necessitated restoring economic growth in other countries.2 It did the United States no good, in other words, to be richest nation in a desperately impoverished world. U.S. policymakers sought to rehabilitate the economies of wartime allies in an effort to make them full and mutually prosperous partners in the world trading system required for international peace and stability.

Technical discussions on the World Bank, as well as those related to the creation of the International Monetary Fund (addressed in the next chapter), allowed Federal

Reserve officials to debate the nature of the postwar international political economy.

World Bank talks revealed the Federal Reserve’s belief not only in the critical importance of international investment to the overall health of the global economy but also in the ineffectiveness of the interwar practice of relying solely on private U.S. bankers and businessmen to ensure postwar stability. Instead, Federal Reserve officials supported the creation of a multilateral institution to supplement rather than replace private investment.

Fed officials accepted that states both individually and acting collectively through institutions such as the World Bank played a legitimate role in fostering economic growth. At the same time, Fed officials defined this role as complementary to the operation of private capital markets.3 Through ongoing negotiations over the World

2 Amy L. S. Staples, The Birth of Development: How the World Bank, Food and Agriculture Organization, and World Health Organization Changed the World, 1945-1965 (Kent: Kent State University Press, 2006), 13. 3 The notion of a cooperative government-business partnership in promoting investment has been ably examined by historians such as James Weinstein, The Corporate Ideal in the Liberal State, 1900-1918 (Boston: Beacon Press, 1968); Emily S. Rosenberg, Spreading the American Dream: American Economic 70

Bank the Fed refined its conception of the postwar political economy as one defined by legitimate, but limited, government intervention. The Fed hoped to craft a compromise between what it perceived as the laissez-faire interwar period and the heavily statist wartime period, and it advocated this position as the most stable foundation for postwar economic prosperity and ultimately political peace. Federal Reserve officials hoped to reform, rather than restore or replace, the interwar approach to international investment.

Central bankers believed that the World Bank played a critical role in securing postwar prosperity at home and abroad. An international bank helped restore the confidence of private financiers to engage in foreign lending and investment, particularly during the critical transition period from a war to a peacetime economy. Foreign lending mobilized the resources of credit markets awash in wartime liquidity, channeling these funds into useful overseas investments and preventing them from potentially contributing to inflation at home. These funds, so invested, facilitated the rebuilding of war- devastated industrial economies in Europe as well as the development of the economic potential of states in Latin America and Asia. Revisionist critics of the Bretton Woods system argue that the United States, fearing a postwar economic slump, extended credit to enable borrowers to act as faithful consumers of American exports.4 Fed officials took a more nuanced approach. While they recognized the necessity of sustaining American exports and full employment as part of a program to secure domestic prosperity, they also

and Cultural Expansion, 1890-1945 (New York: Hill and Wang, 1982); Kim McQuaid, Uneasy Partners: Big Business in American Politics, 1945-1990 (Baltimore: Johns Hopkins University Press, 1994). 4 Two classical examples of this argument include William Appleman Williams, The Tragedy of American Diplomacy (New York: W.W. Norton and Company, 1959); Lloyd C. Gardner, Economic Aspects of New Deal Diplomacy (Madison: University of Wisconsin Press, 1964), Ch. 13. 71

believed that the United States’ status as a creditor ultimately required that it import more than it exported.5 Importing from abroad allowed American workers to enjoy the benefits of overseas goods, thus raising the U.S. standard of living. Reciprocally, exporting to the

United States allowed borrowers to earn the dollars necessary to repay debts contracted during the reconstruction and transition period, as well as allowing foreign workers to earn higher incomes, part of which would inevitably translate into the import of

American goods.

This chapter expands upon the existing historical literature of both Bretton Woods and the Federal Reserve. Traditional examinations of the origins of the Bretton Woods institutions, the IMF and the World Bank, either ignore or minimize the role of the

Federal Reserve. When it is discussed, Fed interest is usually limited to discussions of the so-called key currency approach to international monetary stabilization supported by

Allan Sproul and John H. Williams, respectively the president and vice president of the

Federal Reserve Bank of New York (FRBNY).6 These views exclude the Fed from consideration when analyzing the origins of the World Bank, viewing it as a peripheral participant in only one narrow aspect of the larger Bretton Woods structure.

5 Federal Reserve System Board of Governors, “Foreign Trade, Capital Movements, and International Reserves,” Federal Reserve Bulletin 30, no. 11 (November 1944), 1048; Ernest G. Draper and Walter R. Gardner, “Goods and Dollars in World Trade,” Federal Reserve Bulletin, (November 1944), 1049. 6 Richard N. Gardner, Sterling-Dollar Diplomacy: The Origins and the Prospects for Our International Economic Order (New York: McGraw-Hill Book Company, 1969); Alfred E. Eckes, Jr., A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971 (Austin: University of Texas Press, 1975); Fred L. Block, The Origins of the International Economic Disorder: A Study of United States Monetary Policy from World War II to the Present (Berkeley: University of California Press, 1977); Armand van Dormael, Bretton Woods: Birth of a Monetary System (New York: Holmes and Meier, 1978); James Harold, International Monetary Cooperation Since Bretton Woods (New York: Oxford University Press, 1996); 72

Alternatively, Allan Meltzer, in his authoritative history of the Federal Reserve System, argues that the central bank’s consideration of Bretton Woods was “remarkable for the failure to discuss substance.” Meltzer acknowledges active participation by Fed staffers in the early technical discussions preceding the international conference at Bretton

Woods, but he neither delves into the details of these discussions nor seems to consider them important because of what he interprets as the lack of direct involvement by the

Board of Governors.7 This chapter builds upon Meltzer’s existing interpretation rather than rejecting it. Although the Fed did not dominate the crafting of the World Bank, staffers did attempt to influence the ultimate structure and operation, efforts that provide insights into central bank thinking about the international political economy and the role of both the government and private financiers in foreign investment.

Interwar Experience and the Role of the World Bank

The interwar period highlighted several lessons of what to avoid when reestablishing international investment after the Second World War. It is therefore useful to briefly review the primary failings of the era, at least as understood by the Federal

Reserve. Such a discussion reveals how policymakers hoped to reform the system of international investment using the World Bank to promote and support foreign lending.

The weakness in private led investment during the 1920s and 1930s and its collapse during the Great Depression offered officials insight into how to reform the system.

7 Allan Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2003), 616. 73

In the wake of the First World War global capital markets appeared to be asymmetrical and unstable particularly compared to the pre-1914 experiences. At the time war broke out in 1914 Great Britain represented the single largest creditor in the world, accounting for roughly 44 percent of all international investment. British investors generally extended loans for productive purposes according to a stable self- liquidating cycle. They furnished credit to developing economies to expand their production of raw materials and other primary products for export to industrialized nations in North America and Europe, using the proceeds to service their debt. To facilitate increased production of raw materials, borrowers often used these loans to purchase industrial equipment from the creditor nation.8 While some critics argued that such a relationship created a permanent state of dependence on the part of the borrower, subjugating it to the role of peripheral support for wealthy industrialized economies, there is little doubt that the system was at least beneficial for the creditor nation.9 Financiers reaped the profit of interest payments on loans, manufacturers profited from increased capital goods sales to borrowers, and the population enjoyed a generally higher standard of living through increased imports.

According to Federal Reserve officials the interwar system of foreign lending rested upon a comparatively weak and uncertain foundation. While Britain dominated foreign investment prior to World War I, the interwar system, with the United States as the leading creditor nation, was even more asymmetrical. The United States accounted

8 Albert Fishlow, “Lessons from the Past: Capital Markets During the 19th Century and the Interwar Period,” International Organization 39, no. 3 (Summer 1985), 392-416. 9 For an excellent and succinct explanation of dependency theory see Joyce Appleby, The Relentless Revolution: A History of Capitalism (New York: W.W. Norton & Company, 2010), 350. 74

for 70 percent of overseas investment between the end of the First World War and 1929.

Moreover, a significant proportion of interwar lending went not to developing peripheral nations but to industrialized European states, financing not just postwar reconstruction but also currency stabilization and other budget deficits. Furthermore, American loans became increasingly critical to financing German reparations payments and inter-Allied war debts.10

In contrast to the increasing prosperity associated with British investment, officials reflecting upon the American interwar creditor experience believed that it actually created long-term instability that facilitated the ultimate collapse during the

Great Depression. Critics charged that American financiers made investments with little thought for the ability of borrowers to service their debts. Failure to fully account for long-term debt repayment should not necessarily be taken as evidence of banker incompetence. Rather, American financiers found themselves caught up in as much a psychological boom as an economic one. Chasing higher returns, bankers invested aggressively but failed to fully appreciate the weaknesses in the system of international investment and the consequences of an eventual collapse.11 Reflecting on interwar practices, Matthew Szymczak of the Federal Reserve Board of Governors argued that lenders paid insufficient attention to the purpose of their loans. Szymczak charged that

10 Eckes, A Search for Solvency, 14; Fishlow, “Lessons from the Past,” 418-20. 11 This phenomenon is not new and excellent work by economists helps to contextualize the experience of the 1920’s within the larger framework of economic boom-bust cycles, including the financial crisis of 2007-9. Nassim Nicolas Taleb, The Black Swan: The Impact of the Highly Improbable (New York: Random House, 2010); George A. Akerlof and Robert J. Shiller, Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism (Princeton: Princeton University Press, 2009). 75

countries borrowed funds but failed to use these loans to “enlarge the productive resources of the country” a step necessary to ensure ultimate repayment.12 On the other side of the transaction, American investment bankers, filled with the “exuberance of financial adolescence” and aggressively pursuing higher returns often failed to carefully examine either the purpose of the loans they underwrote or the capacity of borrowers to ultimately repay them.13 Indeed, Americans between the wars seemed to revel in their newfound creditor status and economic strength compared to the European powers.14

Disregard for the prospects of long-term debt service meant that borrowers, and ironically creditors, found themselves dependent upon constant recycling of capital.

Without new loans debtors could not repay their old obligations and instead defaulted.

Without new loans the creditors could not get repaid and suffered losses as older loans defaulted. During the 1920s foreign lending experienced a boom-bust cycle, expanding rapidly after the First World War and collapsing near the end of the decade. Both long- term and short-term lending expanded rapidly, particularly from 1924 to 1929, only to collapse just as precipitously.15 America’s own domestic prosperity may have added to

12 M. S. Szymczak, “Monetary and Credit Agreements Entered into at Bretton Woods,” an address delivered before the Illinois Manufacturers Association, Chicago, IL, March 20, 1945, reprinted in the Federal Reserve Bulletin 31, no. 4 (April 1945), 307. 13 Eckes, Search for Solvency, 14-15; Tension between debtor and creditor obligations to ensure efficient and proper use of credit existed throughout the 1920s. For an example of these competing positions see Louis Hyman, Debtor Nation: The History of America in Red Ink (Princeton: Princeton University Press, 2011), 40-1. 14 According to one newspaper correspondent “In the change that has taken place with respect to European loans, there is something that smacks of the relationship between parent and son. Father has come to son to ask for a fiver to tide him over the Friday before pay day.” New York Times, “Europe Remite Us Thrice What It Formerly Drew,” May 31, 1925. 15 Department of Commerce. Historical Statistics of the United States: Colonial Times to 1970, Part 2 (Washington, D.C.: Government Printing Office, 1975), Series U 1-25 Balance of International Payments: 1790 to 1970, U 15-25. 76

the instability as the rising prices on the stock market destabilized the system of international investment. As lenders sought higher returns they plowed money into surging equities, diverting resources away from foreign borrowers and weakening the ability of debtors to obtain the funds necessary to service outstanding obligations.16 Even prior to the economic collapse of the Great Depression American investors began to withdraw funds from the international capital markets, investing their dollars instead in

Wall Street’s bull market. This trend diverted the flow of capital away from international borrowers straining their ability to repay existing debts.17 Foreign borrowers, more heavily dependent on the proceeds of loans than American investors were on their returns, found themselves cut off from the constant flow of financial capital increasing the potential for default.

The economic decline toward the Great Depression complicated debt service by not only curtailing new borrowing, as financiers first searched for higher returns and later attempted to preserve liquidity and in the face of debtor defaults, but also by closing off export markets. If debtors could not borrow new funds to pay off old loans they might have been able to increase exports, particularly to the United States, thereby earning the dollars they required to service outstanding obligations. Just such a connection between finance and trade sustained the pre-1914 capital markets dominated by the British. As economies around the world contracted, however, nations erected tariff barriers, increased trade restrictions, and imposed import quotas in an effort to preserve their

16 William E. Leuchtenburg, The Perils of Prosperity, 1914-1932 (Chicago: University of Chicago Press, 1958), 112. 17 Liaquat Ahamed, Lords of Finance: The Bankers Who Broke the World (New York: The Penguin Press, 2009), 325. 77

markets for domestic producers. American imports fell in tandem with the decline in

American overseas lending and investment, further inhibiting debt service and speeding the associated economic collapse.18 While scholars disagree on the precise causal link between increased tariff restrictions and the Great Depression the fact remains that trade barriers did nothing to alleviate the burden of interwar indebtedness.19

The pattern marked by the overexpansion of international lending followed by defaults and economic collapse should not necessarily have been surprising. The economists Carmen Reinhart and Kenneth Rogoff argue that the expansion-collapse cycle of debt followed a well-developed historical pattern. Although nations did not take defaulting on debt lightly, the risk posed to international lending and investment persisted throughout history and across different national contexts. Even as a boom psychology enthralled many financiers other contemporary American policymakers recognized the potential dangers posed by unregulated foreign lending and attempted to implement safeguards to prevent an eventual collapse. During the 1920s Secretary of Commerce

Herbert Hoover advocated enhanced screening of international lending to prevent just such an overexpansion. Hoover believed that screening ensured that loans went to productive purposes, facilitating their eventual repayment; in cases of default, it also kept the government from being pulled into debt collections as had happened earlier in the

18 “Report of the Special Advisory Committee Appointed by the Bank for International Settlements,” reprinted in the Federal Reserve Bulletin 18, no. 1 (January 1932), 26; M. S. Szymczak, “Monetary and Credit Agreements Entered into at Bretton Woods,” an address delivered before the Illinois Manufacturers Association, Chicago, IL, March 20, 1945, reprinted in the Federal Reserve Bulletin (April 1945), 307. 19 M.E. Falkus, “United States Economic Policy and the ‘Dollar Gap’ of the 1920’s,” The Economic History Review 24, no. 5 (November 1971): 599-623; Charles Kindleberger, The World in Depression, 1929-1939 (Berkeley: University of California Press, 1986), 117-25. 78

century. Benjamin Strong, the Governor of the FRBNY, and Secretary of State Charles

Evans Hughes opposed Hoover, ironically on very similar grounds. Federal Reserve officials sought to avoid what they perceived as paternalistic oversight of international finance, fearing that official government screening might create an implicit guarantee, obligating the government to make good any losses suffered by private investors.20

Despite their disagreements, all parties desired to minimize the government’s ultimate responsibility for the outcome of international lending.21

The Federal Reserve approached discussions of a postwar international bank with this view of the experiences, and failings, of the interwar system in mind. An asymmetrical capital market relied too heavily on American investors. American investors and foreign borrowers, for their part, behaved too casually in the underwriting and use of borrowed funds, resulting in an unsustainable dependence on continuous lending. The United States, not being as dependent on imports and the flow of international goods as had the British, paid inadequate attention to the link between capital markets and trade. Finally, no significant institutional structure, either national or multilateral, existed to overcome temporary disequilibria in the supply and demand for loanable funds. Central bankers believed that these issues must be addressed in order to

20 Carmen N. Reinhart and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly (Princeton: Princeton University Press, 2009), Ch. 4-6; Frederick C. Adams, Economic Diplomacy: The Export-Import Bank and American Foreign Policy, 1934-1939 (Columbia: University of Missouri Press, 1976), 29-31; William J. Barber, From New Era to New Deal: Herbert Hoover, the Economists, and American Economic Policy, 1921-1933 (New York: Cambridge University Press, 1985), 35-41. 21 Additional insight into the relative weakness of direct government oversight during the 1920’s can be found in Michael Hogan, Informal Entente: The Private Structure of Cooperation in Anglo- American Economic Diplomacy, 1918-1928 (Chicago: Imprint Publications, 1991); Emily S. Rosenberg, Spreading the American Dream: American Economic and Cultural Expansion, 1890-1945 (New York: Hill and Wang, 1982), Chs. 7-8. 79

re-establish international capital markets on a stable and sustainable basis and such markets played an important role in securing political peace by way of economic prosperity.

The World Bank and Investor Confidence

The destruction wrought by the Second World War laid bare the necessity of restoring international investment. German occupation of the Soviet Union resulted in the destruction of over 40,000 miles of railroad track, most railway bridges, and tens of thousands of locomotives, wagons, and riverboats, smashing the region’s transportation system.22 In Germany itself roughly 90 percent of the nation’s railroad system lay in ruins. In France the story was much the same with 25 percent of the rail system ruined, upwards of 70 percent of locomotives destroyed, 90 percent of automobiles unserviceable, and nearly every major waterway or port out of commission.23 In Britain, which fell under German air bombardment early in the conflict, the war destroyed nearly

20 percent of national wealth.24 Equally devastating was the loss of human life with

18,500 Europeans perishing every day for six years bringing the death toll for the

Continent to a staggering 40 million.25 Just as dire a situation confronted Asia,

22 Paul Kennedy, The Rise and Fall of the Great Powers (New York: Vintage Press, 1989), 362 23 Barry Eichengreen, The European Economy since 1945: Coordinated Capitalism and Beyond (Princeton: Princeton University Press, 2007), 54-5. 24 Stephen Broadberry and Peter Howlett, “The United Kingdom: ‘Victory at all costs,’” in The Economics of World War II: Six Great Powers in International Comparison, ed. Mark Harrison (New York: Cambridge University Press, 2000), 72. 25 William I. Hitchcock, The Struggle for Europe: The Turbulent History of a Divided Continent, 1945 to the Present (New York: Anchor Books, 2003), 1. 80

particularly China, where nearly of decade of civil and inter-state warfare halted industrialization, destroyed agricultural capacity, and bred financial chaos.26

Given the scope and scale of destruction, several straightforward propositions followed. First, restoring the ability of these nations to simply sustain their populations required the purchase of vast quantities of equipment to revive the communications and transportation systems, as well as rebuild their manufacturing and productive potential.

Second, only the United States possessed the ability to supply the goods and equipment necessary to accomplish this task. Third, these items could either be purchased or obtained as outright gifts, as the goods themselves or the money needed to purchase them. Fourth, assuming the unwillingness of the United States to simply give away assistance, these countries required dollars in order to purchase the necessary goods.

Restoring international investment, therefore, enabling countries to borrow dollars from

Americans and prompting Americans to invest dollars abroad, represented an immediate concern for policymakers. Finally, given both the prospect for an uncertain political- economic environment following the Second World War and the interwar experience with defaults, policymakers aimed to provide some institutional support for facilitating a restart of private investment on a self-sustaining basis.

To address the situation, the State Department and the Roosevelt administration launched the United Nations Relief and Rehabilitation Administration (UNRRA) in 1943 in an effort to speed needed aid to devastated areas. Given the scope and scale of the

26 United States Department of State, The China White Paper, August 1949 (Stanford: Stanford University Press, 1967), 127-9. 81

destruction, however, only a long-term program of private foreign investment held any hope of restoring economic prosperity. Policymakers feared that the experiences of the

1930s and the losses suffered on foreign investments undermined the willingness of private lenders to extend credit. Financiers may have lost confidence in the willingness or ability of foreign borrowers to reliably repay their debts. Historical experience demonstrated how the failure of investor confidence undermined healthy economies and prevented the recovery of those in recession or depression.27 While both contemporaries and historians pointed out that over the long-term international loans performed well relative to domestic investments during the Great Depression, they also recognized that at times perceptions overrode empirical evidence and shaped decisions.28 If the belief in the riskiness of international investment persisted, either because of past performance or future uncertainty, this might prompt borrowers to demand extremely high interest rates and other onerous conditions, or in the worst case, deter creditors from lending altogether. From the outset, then, restoring the confidence of investors represented one of

27 The role of confidence in the rise and fall of the classical gold standard is explored in Giulio M. Gallarotti, The Anatomy of an International Monetary Regime: The Classical Gold Standard, 1880-1914 (New York: Oxford University Press, 1995); Robert Higgs argues that the experimentation and changing policies of Franklin Roosevelt’s New Deal undermined the willingness of investors to commit funds and contributed to anemic recovery between 1935 and 1940 in Depression, War, and Cold War: Studies in Political Economy (New York: Oxford University Press, 2006), 5-10; Modern examples of the failure of investor confidence are demonstrated in the collapse of the hedge fund Long Term Capital Management in 1998 and the investment bank Bear Stearns a decade later. These cases are documented in Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management (New York: Random House, 2001); William D. Cohan, House of Cards: A Tale of Hubris and Wretched Excess on Wall Street (New York: Anchor Books, 2010). 28 John W. Pehle, “The Bretton Woods Institutions,” The Yale Law Journal 55, no. 5 (August 1946), 1133; Barry Eichengreen and Richard Portes, “The Interwar Debt Crisis and Its Aftermath,” The World Bank Research Observer 5, no. 1 (January 1990), 69-94; Akerlof and Shiller discuss the role of “stories” and how they drive beliefs and attitudes towards markets in Animal Spirits, Ch. 5. 82

the primary missions for the proposed World Bank, a purpose the Federal Reserve Board of Governors supported.

The World Bank Articles of Agreement adopted at Bretton Woods established three primary methods for supporting investment. First, they empowered the Bank to guarantee loans against the loss of some portion of their principal and interest. Second, the Bank could extended credit directly to borrowers out of its own subscribed capital should none be forthcoming from private markets. Finally, the international bank might raise money on the open market, selling securities and using the proceeds to finance investment opportunities.29 At the same time the articles of agreement clearly stated that these measures aimed to “promote” and “supplement” the actions of private financers and would only be undertaken when adequate investment could not be obtained from the market so as not to compete with creditors. Individually and taken together, American policymakers, including Federal Reserve officials, hoped that these actions would help to both restore the confidence of lenders and satisfy critical and immediate needs for capital until private lenders fully re-entered the market.

Members of the Federal Reserve Board of Governors believed the World Bank, particularly through loan guarantees, played a critical role in restoring confidence in international investment markets. Alice Bourneuf, an economist with the Board of

Governors, voiced concern that the experiences of private investors during the 1930s made it unlikely they would return to the market very quickly. Not only had creditors

29 United States Department of Treasury, Articles of Agreement: United Nations Monetary and Financial Conference (Washington, D.C.: Government Printing Office, 1948), 51. 83

lost money to foreign default, but borrowing governments had been particularly hostile to investors, manipulating exchange rates, imposing exchange controls, and nationalizing assets, thereby compounding uncertainty and undermining confidence.30 Given the

“general disrepute into which foreign loans [had] fallen” and the prevailing uncertainty as to the capacity of borrowers to service debts, international backing appeared necessary to reassure investors.31 Fed officials saw international cooperation not as a means for extending state control over the economy, but rather as a method for restoring the confidence of private investors.

Federal Reserve officials pointed to domestic American experience to validate the idea that loan guarantees worked to restore the confidence of private investors. Alvin

Hansen, the prominent Keynesian and Harvard professor, served as a special economic advisor to the Federal Reserve Board of Governors during the Second World War and compared the use of international bank guarantees to the American creation of the

Federal Housing Administration (FHA) during the Great Depression.32 The brainchild of

Federal Reserve economist Winfield Riefler, the FHA stimulated investment in the housing market by providing repayment guarantees against the possibility of default and foreclosure, minimizing the downside risk to creditors.33 The FHA demonstrated a successful “commingling” of public and private political economies whereby state power

30 Alice Bourneuf, Memorandum, “The Proposed United Nations Bank for Reconstruction and Development,” October 18, 1943, NARA, RG 82 DIF, box 57. 31 Alice Bourneuf, Memorandum, “Further Details on the Bank for Reconstruction and Development,” March 31, 1944, NARA, RG 82 DIF, box 57. 32 Alvin Hansen, Paper, “International Development and Investment Bank,” November 13, 1943, NARA, RG 82 DIF, box 57; Alvin Hansen, Paper, “International Economic Collaboration After the War,” November 13, 1943, NARA, RG 82 DIF, box 57. 33 Hyman, Debtor Nation, 53-5. 84

mitigated risk and thereby restored the confidence of private financiers without displacing them.34

Officials also highlighted the benefits of the loan guarantee program for borrowing countries. American policymakers expressed concern that even if creditors were willing to lend, because of the uncertainty associated with international investment, financiers might demand very high interest rates or proscribe other conditions that increased the costs for the borrowers. Loans with some portion of principal and interest repayment guaranteed to the lender by the World Bank inherently carried less risk as creditors were assured of recouping at least some of their investment. Officials assumed that in exchange for a higher probability of repayment investors would accept a lower interest rate, reducing the borrowing costs for states and making it easier for them to tap into international capital markets. Furthermore, because the World Bank set the conditions for providing guarantees it could put downward pressure on interest rates in different ways. First, the World Bank might refuse to provide a guarantee for a loan it felt carried an unreasonably high interest rate. Additionally the World Bank could always provide a direct loan if no lenders offered funds at rates and terms acceptable to the Bank. Second, the market disciplined lenders by forcing them to compete with those accepting World Bank conditions. Institutions that failed to conform risked being shut out of viable investment opportunities.35

34 David Kennedy, Freedom From Fear: The American People in Depression and War, 1929- 1945 (New York: Oxford University Press, 1999), 369-70. 35 Federal Reserve Board of Governors, Transcript, “Talk by E. A. Goldenweiser to Federal Reserve Group,” July 31, 1944, NARA, RG 82 DIF, box 38. 85

The FHA experience highlighted the potential benefits of the World Bank loan guarantee program and the way state-created underwriting standards helped narrow the spread on interest rates and terms. In the wake of the Bretton Woods Conference, Alice

Bourneuf and E. A. Goldenweiser argued that the World Bank guarantee program, as well as participation in direct lending, helped “set a pattern of interest rates and other conditions for international loans that would be reasonable, and would tend to eliminate

[the] abuses” seen as common during the interwar period.36 The Board of Governors made much the same point several months later in its official endorsement of the Bretton

Woods Agreement Act.37 By creating an implicit set of standards the Bank pushed private financiers toward them and regularized the practice of international investment.38

Federal Reserve officials also expressed support for the way loans and guarantees extended by the World Bank promoted international cooperation. The agreement required that the government or the central bank of the borrowing state “fully [guarantee] the repayment of the principal and the payment of interest and other charges on the loan.”39 Fed officials responded to skepticism about the quality of guarantees issued by debtor nations by arguing that they contributed to a cooperative international atmosphere.

Central bankers believed borrowers less likely to repudiate a debt owed ostensibly to the collective members of the United Nations rather than a single private financier.

36 E. A. Goldenweiser and Alice Bourneuf, “Bretton Woods Agreements,” Federal Reserve Bulletin 30, no. 9 (September 1944), 863. 37 Federal Reserve System Board of Governors, “International Fund and Bank” statement by the Board of Governors of the Federal Reserve System, March 21, 1945, reprinted in the Federal Reserve Bulletin (April 1945), 305. 38 Marriner Eccles to Representative Brent Spence, Memorandum, “International Fund and Bank,” March 21, 1945, NARA, RG 82 DIF, box 36. 39 United States Treasury, Articles of Agreement: United Nations Monetary and Financial Conference, 57. 86

Policymakers also hoped that guarantees ensured equal treatment for foreign capital since the borrowing government remained on the hook for repayment in cases of discrimination-induced default.40 Nationalizations of private assets and other perceived abuses occurred during the interwar period. By removing or at least reducing this possibility by securing a repayment guarantee from the borrowing country, the World

Bank supporters hoped to restore the confidence of creditors and spur them to lend abroad.41

Fed officials believed the World Bank bolstered the confidence of both lenders and borrowers. Guarantees reduced the downside risk to lenders and increased their assurance in repayment. Reduced risk, in turn, lowered costs and minimized the pressure on borrowers, improving their ability to service contracted debts and progressively contributing to lender confidence. Further, because the World Bank retained the ability to directly enter the market and extend credit in case private capital was not forthcoming, it also enhanced the confidence of debtors that they would not be shut out of financial markets or subject to onerous terms and conditions. Fed officials hoped that the World

Bank might spur a virtuous cycle, intervening to restore the confidence of borrowers and lenders. While they envisioned a positive role for the Bank, the emphasis remained on restarting and supporting private investment rather than replacing it with a statist dominated system.

40 Alice Bourneuf to E. A. Goldenweiser, “Rough Answers to Bankers’ Questions,” September 25, 1944, RG 82 DIF, box 34. 41 Gardner, Economic Aspects of New Deal Diplomacy, 109-22. 87

The World Bank Proposal and Multilateral International Cooperation

Federal Reserve officials agreed that the state had a positive role to play in restarting the flow of private foreign lending but that questions remained about the precise nature of that role. Indeed, during early interagency technical discussions, E. A.

Goldenweiser hesitated to commit the Federal Reserve to support any definite organizational structure.42 Prior to the Bretton Woods Conference Walter Gardner, the chief of the International Section for the Federal Reserve Board of Governors, believed two competing models existed. On the one hand, the United States might support the multilateral solution proposed by the Treasury. On the other, the nation might opt for a nationalist approach to maximize control over resources even under the auspices of an international organization. The push and pull between nationalist and multilateral influences played out over a variety of individual issues connected to the structure and operation of the World Bank, but taken together they represented an important debate over the future of postwar foreign investment.43

One of the most important matters concerned the disposition of subscribed capital and whether or not international contributions would be pooled into a single capital stock.

In the case of pooled funds, the World Bank aggregated individual national contributions into a common holding that it then drew upon at the direction of its management.

Alternatively, subscribed capital contributions might be sequestered and administered at

42 Walter Gardner, Memorandum, “July 10 Meeting on Treasury’s Proposal for a World Fund and Bank,” July 10, 1942, NARA, RG 82 DIF, box 57. 43 Walter Gardner to Matthew Szymczak, Memorandum, “The International Investment Bank Proposed by the Treasury,” February 15, 1944, NARA, RG 82 DIF, box 56. 88

the discretion of individual nations. The method chosen implied the degree of international cooperation embodied by the World Bank.

Fed officials participating in the discussion of the Bank plan noted several advantages of a pooled funds approach. By denationalizing foreign investment, the

World Bank provided concrete steps toward greater “international economic collaboration.”44 This represented an alternative to the historical pattern of investment whereby net lenders traditionally exercised significant control over loans.45 Alice

Bourneuf suggested that pooling funds contributed to the international legitimacy of the

World Bank. She recognized that previously, “private foreign investment” often served as a “major vehicle for imperialist expansion on the part of the lending powers,” thereby contributing to “international friction and war.” By providing “long-term loans through an impersonal international organization,” the World Bank reduced the “dangers of political clashes between debtor and creditor countries.” Furthermore, the Bank allayed the risk of default since borrowers, “being members of the organization,” contributed to the pooled capital and therefore “would probably have a greater incentive to honor their international obligations.”46

44 Untitled Memorandum, September 6, 1943, NARA, RG 82 DIF, box 57. 45 Walter Gardner to E. A. Goldenweiser, “World Investment Bank,” December 6, 1943, NARA, RG 82 DIF, box 56. 46 Alice Bourneuf, Memorandum, “The Proposed United Nations Banks for Reconstruction and Development,” October 18, 1943, NARA, RG 82 DIF, box 57; Edward Bernstein argued that the World Bank removed what he referred to as the “rich Yankee” stigma of international lending. Wallich to Knoke, Memorandum, “Mr. E. M. Bernstein on the Bank for Reconstruction,” January 20, 1944, NARA, RG 82 DIF, box 56; An alternative argument for debtor-creditor relations fostering foreign policy convergence and giving reason to avoid conflict can be found in Jay Sexton, Debtor Diplomacy: Finance and American Foreign Relations in the Civil War Era, 1837-1873 (New York: Oxford University Press, 2005). 89

Other officials at the Federal Reserve echoed Bourneuf’s assessment of the positive attributes of a multilateral denationalized World Bank. Walter Gardner endorsed this method and argued that it offered an approach “free of nationalistic restrictions” and avoided the charge of “dollar diplomacy” that created political tensions between creditors and debtors during the interwar period. According to Gardner, the Treasury plan represented a more responsive model, better able to adjust to the evolving needs of the international investment market, making it a “highly effective instrument” for facilitating lending.47 E. A. Goldenweiser also supported the multilateral administration of funds, although he qualified his support with the belief that the largest creditor members should retain some final say over investment decisions.48

What Walter Gardner termed the “UNRRA model” represented the alternative to the pooling of bank capital under international control. According to this method, the

World Bank still investigated and developed lending opportunities but then submitted the proposals to the individual member nations in a position to extend funds or offer guarantees. While Gardner himself did not necessarily advocate this approach he conceded that it offered several attractive features. The UNRRA model increased the discretionary powers of the United States, putting it in a position to withhold funds and support for specific projects deemed contradictory to the national interest or foreign policy, and therefore enhanced American autonomy within the World Bank. Gardner

47 Walter Gardner to Matthew Szymczak, February 15, 1944, NARA, RG 82 DIF, box 56; The political tensions associated with interwar “dollar diplomacy” are developed in Emily S. Rosenberg, Financial Missionaries to the World: The Politics and Culture of Dollar Diplomacy, 1900-1930 (Durham: Duke University Press, 2003). 48 Bouneuf to Gardner, Memorandum, “Treasury Bank Proposal,” September 9, 1943, NARA, RG 82 DIF, box 57. 90

anticipated difficulty in getting Congress to appropriate sizable resources for a proposed international bank, particularly one that granted debtor nations a voice in the management.49 Ohio Republican Senator Robert A. Taft persistently criticized the international bank plan, arguing that it represented just another attempt at New Deal deficit spending, depicting the institution’s adherence to investment principles as a fiction concealing a give-away of the American people’s money.50 By allowing the United

States to exercise greater control over how the World Bank employed funds for specific projects, Gardner hoped to increase the odds of securing congressional support.51

American policymakers recognized that the UNRRA model also offered advantages for borrowers. One of the persistent concerns about the multilateral Treasury- sponsored approach pertained to the potential for forced lending. An international bank that required members to subscribe capital to a commonly managed pool might place undue pressure on likely debtors, and nations in Europe and Asia might be forced to act as international creditors. When these nations pledged gold and currency to meet their bank subscription requirements these funds were necessarily unavailable to pay for the nation’s own import of raw materials, durable goods, or other items critical to postwar reconstruction and economic development.52 This strain on debtor resources and the international balance of payments made them more likely to require assistance from the

49 Alice Bourneuf to Walter Gardner, Memorandum, “Treasury Proposal for a Bank for Reconstruction,” July 19, 1943, NARA, RG 82 DIF, box 57. 50 New York Times, October 12, 1943, July 13, 1945. 51 Walter Gardner to Matthew Szymczak, Memorandum, “The International Investment Bank Proposed by the Treasury, February 15, 1944, NARA, RG 82 DIF, box 56; Congressional skepticism for postwar multilateralism is emphasized by Randall Bennett Woods, A Changing of the Guard: Anglo- American Relations, 1941-1946 (Chapel Hill: University of North Carolina Press, 1990). 52 Bourneuf to Gardner, Memorandum, February 20, 1944, NARA, RG 82 DIF, box 56. 91

international bank and the stabilization fund. Alice Bourneuf went so far as to suggest that an international bank based upon multilateral pooled funds might consider allowing nations greater discretion over subscription size, essentially allowing countries to decide for themselves how much or how little they would subscribe to the World Bank, rather than using a fixed formula that imposed mandatory minimum contributions on borrowers.53 Bourneuf believed that at the very least the Treasury proposal for an international bank required revision in order to avoid forcing borrowers to act as creditors.54 While the UNRRA model increased national, particularly American, autonomy within the World Bank, it also relieved prospective debtors of an unwarranted obligation to lend.

The debate over multilateral cooperation versus national autonomy within the

World Bank structure played out in discussions over a variety of issues. Were loans contingent upon, or tied to, the promise to spend the proceeds within a particular national market? Did the Treasury plan empower the United States, for instance, to stipulate that loans made in American dollars could only be employed for the purchase of goods from the United States as a means of boosting American exports? If so, did this undermine or in any way endanger the hope for restoring a balanced system of free and open international trade, particularly considering the interwar experience with restrictive bilateral trade practices? How policymakers, including central bankers, struggled with these issues revealed their willingness to accept a multilateral postwar economic system.

53 Bourneuf to Gardner, July 19, 1943, NARA, RG 82 DIF, box 57. 54 Bourneuf to Goldenweiser, Memorandum, “Treasury Bank Proposal,” September 11, 1943, NARA, RG 82 DIF, box 57; Bourneuf to Gardner, Memorandum, “World Investment Bank,” January 27, 1944, NARA, RG 82 DIF, box 56. 92

John Maynard Keynes and other officials with the British Treasury raised concerns about potential tied loan provisions in the American proposal. A loan was considered tied if credit was granted on the condition that the proceeds of the loan were spent only in a specified market, usually that of the lending country. This stipulation benefited creditor countries, boosting their exports and strengthening their position within the system of international trade. The provision seemed particularly onerous to British officials who already faced the prospect of having to forgo preferential trade relations within the Empire in exchange for American Lend Lease assistance.55 Under the Ottawa

Agreements of 1932 the British established a system of imperial preferences, allowing duty free access to Dominion markets, and Americans, particularly ardent proponents of trade liberalization such as Secretary of State Cordell Hull, demanded that these discriminatory barriers be dismantled. British officials feared having to compete with the potential postwar onslaught of imports, especially considering the much stronger position of the American economy.56 Tied loans, from the British perspective, threatened to add a double burden to their postwar economic recovery. Keynes expressed concern that

Americans might stipulate that the proceeds of dollar loans by the World Bank be spent only in the United States.57

55 Gardner, Economic Aspects of New Deal Diplomacy, 277-80. 56 Armand van Dormael, Bretton Woods: Birth of a Monetary System (New York: Holmes and Meier, 1978), Ch. 3; David Reynolds, Creating the Anglo-American Alliance, 1937-1941: A Study in Competitive Co-Operation (Chapel Hill: University of North Carolina Press, 1982), 270; Woods, Changing of the Guard, Ch. 1. 57 “Meeting with British Experts for a United Nations Bank for Reconstruction and Development at the Treasury,” October 11, 1943, FRUS, 1943, 1: 1093. 93

British officials’ concern came from vague language in the international bank proposal that appeared over the course of several revisions. The earliest version of the

World Bank plan explicitly denied any tied provisions and required that loans contain no conditions “as to the particular country in which the proceeds of the loan must be spent.”58 Subsequent revisions updated the proposal to specify that the Bank extended loans in the specific currency required. A November 23, 1943, draft stipulated that the

World Bank provide credits “in the currencies of the countries in which the proceeds of the loan will be spent, and only with the approval of such countries.” Further, if the

World Bank needed to raise additional money it required the approval of the government whose currency it borrowed.59 For example, if France undertook a project with World

Bank assistance that required equipment to be purchased and imported from Britain and the United States, then the Bank would credit the French account the necessary sterling and dollars. If the World Bank coffers ran short of American currency and it needed to raise additional funds, it could sell dollar denominated bonds in the United States, or anywhere else in the world, but only with the permission of the American government.

On the one hand, the proposal retained the provision stipulating that no conditions be imposed “upon a loan as to the particular member country in which the proceeds of the loan must be spent.” On the other, the British feared that some of the new technical details, when taken together, effectively tied “the source of finance to the place of its

58 Suggested Outline of a Bank for Reconstruction and Development of the United and Associated Nations, Section II-6, May 20, 1942, FRUS, 1942, 1: 186. 59 Preliminary Draft Outline of a Proposal for a Bank for Reconstruction and Development of the United and Associated Nations, Section IV-8a, IV-15a, United States Treasury Department, “Preliminary Draft Outline of a Proposal for a Bank for Reconstruction and Development of the United and Associated Nations,” released November 23, 1943, reprinted in the Federal Reserve Bulletin 30, no. 1 (January 1944), 39. 94

expenditure” and gave the United States, the one country with substantial financial resources, leverage to manipulate loans to the benefit of American producers.60

Despite support for multilateral postwar cooperation to restore international investment, Fed officials did not share the same level of concern as the British about the potential for tied loans. First, the ability to impose conditions and channel spending toward American producers was of marginal benefit. Walter Gardner dismissed Keynes’ concerns as irrelevant considering that in the immediate aftermath of the war only

Americans could supply the capital goods demanded for reconstruction.61 E. A.

Goldenweiser argued that the United States faced precisely the opposite problem, it “has too many exports in relation to imports,” thus minimizing the threat of American use of tied loan provisions.62 Alice Bourneuf suggested that tying loans might actually be necessary in the early years of the World Bank’s operations. Anticipating that dollars might be in short supply due to high postwar demand, the Bank might ration access and instead agree only to lend certain available currency, diverting purchases not to the

United States but to other countries. These conditions made the loan no less tied, but, according to Bourneuf, necessity might make “outlawing of tied loans” a “virtual impossibility.”63 Indeed, Allan Fisher, a counselor with the New Zealand Legation based

60 Redvers Opie to Harry Dexter White, enclosure, “Views of British Treasury on Preliminary Draft Plan for a Bank for Reconstruction and Development,” April 20, 1944, FRUS, 1944, 2: 121. 61 Federal Reserve, Minutes, “Meeting at Treasury,” October 11, 1943, NARA, RG 82 DIF, box 55. 62 E. A. Goldenweiser, Transcript, “Talk by Goldenweiser to Federal Reserve Group,” July 31, 1944, NARA, RG 82 DIF, box 38. 63 Alice Bourneuf, Memorandum, “The Proposed United Nations Bank for Reconstruction and Development,” October 18, 1943, NARA, RG 82 DIF, box 57. 95

in Washington, D.C., suggested that tied loans might benefit the British in the long run by serving as a guaranteed source of exports.64

Fed officials did not completely deny that problems arose from requiring the

World Bank to lend dollars and then insisting that they be spent in the American market.

Central bankers recognized that the country best positioned to lend might not be the most efficient, and therefore cheapest, producer of goods or equipment desired.65 These requirements imposed rigidity on reconstruction and developments plans, preventing countries from altering or shifting purchasing to the most efficient market once the Bank dispersed loan funds.66 Fed officials, as well as other American policymakers, also objected to the vague and “somewhat misleading” way the Treasury proposal addressed the issue of tied lending.67 Emilio Collado of the State Department, responding to a reference document produced by the Treasury, condemned the “dishonest way in which the [Treasury] continually contradicted themselves, first saying the loans are not tied and then explaining how they are tied.”68

If the Fed saw the benefit of a multilateral approach to postwar lending and hoped to move away from the unbalanced and asymmetrical relationship that characterized interwar creditor-debtor and trade-finance relationships, why accept provisions that essentially created tied loans? One answer draws from the nature of domestic politics.

64 Allan Fisher to E. A. Goldenweiser, Letter, October 27, 1944, NARA, RG 82 DIF, box 34. 65 Walter Gardner to E. A. Goldenweiser, Memorandum, “World Investment Bank,” December 6, 1943, NARA, RG 82 DIF, box 56. 66 Federal Reserve, Minutes, “Meeting at Treasury,” April 11, 1944, NARA, RG 82 DIF, box 55. 67 Alice Bourneuf, Memorandum, “Comments on the Treasury’s Questions and Answers on the Bank for Reconstruction and Development,” March 17, 1944, NARA, RG 82 DIF, box 56. 68 Federal Reserve, Minutes, “Meeting at Treasury,” April 11, 1944, NARA, RG 82 DIF, box 55. 96

Fed officials conceded that the tied loan provision was more beneficial as a political expedient than detrimental to the operation of the World Bank. Ideally, the World Bank should not include a tied loan provision, according to Bourneuf, but political considerations, specifically the potential for congressional opposition, made it necessary.69 Bourneuf hypothesized that the Treasury hoped to allay politicians’ concerns about the United States simply giving away postwar assistance to the detriment of the domestic economy.70 Expanding their capacity to set the terms of the loans, therefore, induced surplus countries to participate in the World Bank project as well as addressed congressional skepticism.71 Walter Gardner believed that the Treasury plan offered an “illogical but expedient mixture of philosophies” suggesting that tied loans held “considerable appeal to Congress” and thus represented a “workable compromise” between the national and multilateral approaches while hoping that over time and with experience some of the more restrictive interpretations might be loosened and “increasing freedom” offered to the World Bank.72 Furthermore, Fed officials believed that the

British hoped to secure the right of free exchange, the ability to borrow one currency from the World Bank and then to use the proceeds of a loan in the foreign exchange

69 Alice Bourneuf to Walter Gardner, Memorandum, October 21, 1943, NARA, RG 82 DIF, box 57; Alice Bourneuf to Walter Gardner, Memorandum, “The Treasury Bank Proposal as Published November 23,” December 6, 1943, NARA, RG 82 DIF, box 56. 70 Critics accused the Bretton Woods institutions as simply a surrender of the nation’s wealth threatening to make the United States a “planetary Santa Claus.” Justus D. Doenecke, Not to the Swift: The Old Isolationists in the Cold War Era (Lewisburg: Bucknell University Press, 1979), 56. 71 Alice Bourneuf to Walter Gardner, Memorandum, “World Investment Bank,” February 1, 1944, NARA, RG 82 DIF, box 56. 72 Walter Gardner to Matthew Szymczak, Memorandum, “The International Investment Bank Proposed by the Treasury,” February 15, 1944, NARA, RG 82 DIF, box 56; Alice Bourneuf to E. A. Goldenweiser, Memorandum, February 15, 1944, NARA, RG 82 DIF, box 56. 97

market to purchase another currency.73 Additionally, considerable criticism of the proposed IMF, as well as an argument by some within the New York banking community, including members of the FRBNY, to combine the Bank and Fund into a single institution, something the Board of Governors and their staff opposed, may have motivated the tepid reception given to the free exchange proposal.74

Another answer points to the structure of the postwar international financial system anticipated by Federal Reserve officials. Policymakers interpreted the tied loan provision as only applying to cases where the World Bank itself extended direct credits.

Tied loan constraints did not apply to loan guarantees that accounted for 80 percent of the

Bank’s activity, and could not apply to private investment.75 Central bankers counted on the World Bank to revive the confidence of private investors and where it did take action, to do so through supportive measures, such as loan guarantees. Walter Gardner even suggested that the revival of international investment through the Bank represented a more fundamental project than even the stabilization of currencies through the proposed

International Monetary Fund.76 Therefore, accepting a World Bank plan that allowed for tied loans, considering their relatively small applicability, represented a modest

73 British Treasury, Memorandum, April 20, 1944, NARA, RG 82 DIF, box 56; Alice Bourneuf to Walter Gardner, Memorandum, “British Comments on the Bank,” May 2, 1944, NARA, RG 82 DIF, box 56; Federal Reserve, Memorandum, June 28, 1944, NARA, RG 82 DIF, box 38. 74 The objections to the International Monetary Fund are treated in greater detail in the next chapter. 75 Federal Reserve, Transcript, “Talk by Goldenweiser to Federal Reserve Group,” July 31, 1944, NARA, RG 82 DIF, box 38; E. A. Goldenweiser to Allan Fisher, Letter, November 9, 1944, NARA, RG 82 DIF, box 34. 76 Walter Gardner to Matthew Szymczak, Memorandum, “Notes Which You Request for Board Meeting Tomorrow,” March 2, 1944, NARA, RG 82 DIF, box 56. 98

compromise in exchange for securing American participation and leadership in an international program to restore the world economy.

The World Bank and International Investment for Productive Purposes

The need to restore the confidence of private capital in the stability and reliability of international investment addressed why the postwar economy required the World

Bank. The Fed also debated the issue of how the World Bank might operate, either as a multilateral institution or as one that granted greater national autonomy within the scope of an international organization. Central bankers hoped to maximize multilateral aspects of the World Bank so as to reduce the barriers to the flow of financial capital and trade, thereby fostering investor confidence. At the same time policymakers accepted some national autonomy within the institution as a necessary condition for securing political support and moderating the burdens, including a potential obligation to lend, on potential borrowers, particularly during the immediate postwar transitional period. This, however, did not answer the question as to when the World Bank should act. Under what conditions were borrowers to be permitted to obtain funds directly from the Bank? When and under what circumstances should guarantees be extended? While backing the World

Bank plan demonstrated Federal Reserve support for a positive and cooperative international capitalism, specifying when and under what circumstances to empower the

Bank clarified the extent of that intervention. 99

Article I of the World Bank agreement adopted at Bretton Woods in July 1944 charged it with assisting “in the reconstruction and development of territories of members by facilitating the investment of capital for productive purposes, including the restoration of economies destroyed or disrupted by war, the reconversion of productive facilities and resources in less developed countries.” The key term seems to be that investment of funds should be for “productive purposes.”77 While the phrase emerged in its final form at Bretton Woods, the principle of using international bank lending to increase economic productivity represented a fundamental goal during the preceding technical negotiations.78 A definition of what constituted productive lending, however, emerged only slowly. Given the failure of interwar lending to adequately assess borrowers’ ability to service debt, did productivity imply only commercially profitable investments or was a broader understanding appropriate? Should lending be evaluated not only in terms of the individual project but also in relation to the economy of the borrowing state, or even potentially the entire global economy, and if so how? In struggling with these issues

Federal Reserve officials engaged in a larger debate about the role of the state in the economy and the place of international organizations, such as the World Bank, in the market. Fed policymakers, having witnessed the economic collapse of the 1930s and the eventual outbreak of military conflict actively participated and hoped to construct a more stable international investment system less prone to crises. While central bankers did not

77 United States Treasury, United Nations Monetary and Financial Conference, 51. 78 One alternative suggested at Bretton Woods proposed the phrase “facilitating provision of capital for sound and constructive international investment” in place of the emphasis on productivity. “Preliminary Draft of Proposals for the Establishment of a Bank for Reconstruction and Development,” Department of State, “Preliminary Draft of Proposals for the Establishment of a Bank for Reconstruction and Development,” July 10, 1944, Proceedings and Documents of United Nations Monetary and Financial Conference, Volume I (Washington, D.C.: Government Printing Office, 1948), 365-9. 100

always reach consensus on these questions or succeed in shaping American policies when they did, Fed officials revealed themselves, as a group, to be very concerned with the postwar international political economy.

The World Bank proposal attempted to overcome one of the perceived paradoxes of interwar investment. Americans criticized interwar lenders that extended credit to cover foreign budget deficits with little or no consideration for how borrowers planned to restore economic balance and eventually service their debts.79 This resulted, in part, when outsized rates of interest mitigated the perceived risks. So long as most borrowers serviced their debts, even if this required still more borrowing, overall returns outweighed the cost of any single loan defaulting. Many of these same bankers, however, shunned ostensibly productive investments, such as improvements to infrastructure or social overhead that, in themselves, did not generate a profit but contributed to the overall economic growth of the nation in question.80 Policymakers believed that investors failed to appreciate how large-scale socioeconomic projects such as sanitation, disease prevention, and conservation, while not earning an income themselves, served to raise the standard of living, and thereby the productivity, of the society at large.

Attempting to correct perceived interwar failings, Keynesian members of the

Federal Reserve, such as Alvin Hansen, supported an expansive definition of productive lending. According to Hansen, instead of focusing on the profitability and the likely

79 Alice Bourneuf to E. A. Goldenweiser, Memorandum, “Cleveland Trust Bulletin,” April 26, 1945, NARA, RG 82 DIF, box 34. 80 Frank Tamanga, Federal Reserve Bank of New York (FRBNY) Memorandum, “Problem of Investment Banking After the War,” March 31, 1943, NARA, RG 82 DIF, box 34. 101

return from any single project, the international bank should focus on the overall implications for “world economy.” He took specific inspiration from the American experience with the Tennessee Valley Authority (TVA). The TVA built dams, instituted flood control programs, and facilitated the electrification of rural America, thereby contributing to the economic viability of the region and demonstrating that “basic development projects” increased the overall productivity of a country. Hansen went further than most within the Federal Reserve, however, when he argued that the World

Bank should actually be willing to take losses on loans that were “thoroughly sound from the economic standpoint” in that they contributed to the profitability of “the economy as a whole even though the [lender] does not get back one hundred cents on the dollar, with no interest at all.”81 The TVA and similar programs promoted economic modernization and growth and served to link the national economy.82 Hansen hoped to achieve similar results on a global scale through the World Bank. He believed that aggressive economic investment, even in social overhead that itself did not generate a commercial return, created positive externalities, additional economic opportunities, and a more closely interconnected world economy resulting in greater international economic prosperity and thereby a more peaceful political order.

81 Alvin Hansen, Paper, “International Development and Investment Bank,” November 13, 1943, NARA, RG 82 DIF, box 57; Alvin Hansen, Paper, “International Economic Collaboration after the War,” November 13, 1943, NARA, RG 82 DIF, box 57; William E. Leuchtenburg, Franklin D. Roosevelt and the New Deal, 1932-1940 (New York: Harper and Row, 1963), 54-5; David Ekbladh examines the TVA as an exportable model for international investment and overseas development projects, particularly during the Cold War, in The Great American Mission: Modernization and the Construction of an American World Order. (Princeton: Princeton University Press, 2010); An excellent examination of the economic thinking of Alvin Hansen and critical link between investment and prosperity can be found in Theodore Rosenof, Economics in the Long Run: New Deal Theorists and Their Legacies, 1933-1993 (Chapel Hill: University of North Carolina Press, 1997), Ch. 5. 82 Robert Collins, More: The Politics of Economic Growth in Postwar America (New York: Oxford University Press, 2000), 8-10. 102

Other members of the Federal Reserve also adopted a catholic definition of what constituted productive, and therefore legitimate, areas for World Bank investment. Alice

Bourneuf supported a World Bank that evaluated projects based upon how they ultimately contributed to “a higher productivity and living standard” and the “more subtle ways” they promoted economic prosperity rather than “direct monetary returns.”83

Ronald Ransom, vice chairman of the Federal Reserve Board of Governors, and E. A.

Goldenweiser expressed similar views and even argued that early versions of the

Treasury’s proposal for an international bank might be too conservative in their approach to lending and suggested further liberalizing the Bank’s lending criteria.84 Goldenweiser believed that investment opportunities should be evaluated not based on an individual projects’ profitability, but instead on how over the long term it created a “reasonable prospect that during the life of the loan” the borrower’s balance of payments position would support debt service.85

Support for a liberal definition of what constituted productive, and therefore legitimate, lending did have limits amongst Federal Reserve officials. While he accepted that something less than full return on investment did not necessarily constitute “blind waste,” Walter Gardner believed that limits still existed to the indirect benefits that might be accrued from foreign investment. Gardner worried that the World Bank might find itself drawn into supporting loans for purely humanitarian purposes, rather than for

83 Alice Bourneuf, Memorandum, “The Proposed United Nations Bank for Reconstruction and Development,” October 18, 1943, NARA, RG 82, DIF box 57. 84 Excerpt of Minutes, Federal Reserve Board of Governors Meeting, September 27, 1943, NARA, RG 82 DIF, box 55; Memorandum, “Bank Proposal,” September 30, 1943, NARA, RG 82 DIF, box 55. 85 Federal Reserve Board of Governors, Treasury Bank Proposal with Marginal Notes, June 6, 1944, NARA RG 82 DIF, box 57. 103

specific projects that served to permanently raise the productivity and standard of living for the borrower. This is not to say Gardner opposed humanitarian assistance. Rather, he believed that these types of operations should be channeled through UNRRA or similar agencies, and that the World Bank must operate on a paying basis. He worried that the vague “general benefit” approach advocated by Hansen, as well as Britain’s John

Maynard Keynes, went too far in blurring the distinction between productive lending and humanitarian giving.86 Considering the need to secure congressional support, keeping these differences clear reduced the ammunition for those who saw the World Bank as simply charity and a way for the United States to play “Santa Claus” rather than focusing on sound investments.87

In an effort to legitimize a broader definition of productive lending, Federal

Reserve officials emphasized the tangible benefits the United States accrued as a result of

World Bank existing. This is not to argue that central bankers saw an international investment organization as a way for the United States to enrich itself at the expense of the rest of the world. Instead, they stressed how dollars invested abroad came back to the

United States in terms of not only greater American exports but also a rising standard of living, within a large and mutually beneficial international capitalist system.

Fed officials saw the World Bank as a useful mechanism for employing funds and forestalling inflationary pressures within the American market that might disrupt

86 Walter Gardner to Matthew Szymczak, Memorandum, “The International Investment Bank Proposed by the Treasury,” February 15, 1944, NARA, RG 82, DIF, box 56. 87 Hopkins to Szymczak, Memorandum, “Statement of Secretary Morgenthau before Senate Small Business Committee’s Subcommittee on Foreign Trade,” April 23, 1945, NARA, RG 82 DIF, box 36. 104

domestic credit structures and undermine attempts to secure postwar prosperity. The

World Bank provided American investors and financiers with a useful mechanism for putting to work the anticipated glut of postwar savings.88 Fed officials estimated that business holdings of liquid assets rose from $17.5 billion in 1939 to $66 billion by

December 1944.89 Given the Federal Reserve’s concern for the disruptive effects of postwar inflation, reviving international investment offered a way of mobilizing funds that might otherwise create price distortions within the United States, undermining domestic prosperity. Similarly, lending already existing American dollars kept foreign nations from releasing accumulated gold reserves to finance the purchase of goods from the United States. Fed officials recognized that large inflows of gold into the United

States contributed to the expansion of the monetary base and exerted an inflationary influence on the domestic economy.90 The World Bank therefore eased the job of the

Federal Reserve by removing a potentially disruptive force and enabling the central bank to better manage domestic monetary and credit conditions.91

The World Bank also directly contributed to postwar domestic prosperity by sustaining American employment and providing outlets for American production in a way that promoted long-term economic growth. American policymakers saw a complex

88 Valdemar Carlson, “Bretton Woods and Wall Street,” Antioch Review 4, no. 3 (Autumn 1944), 355-7. 89 Federal Reserve System Board of Governors, “Liquid Asset Holdings of Individuals and Businesses,” Federal Reserve Bulletin 31, no. 6 (June 1945), 533. 90 Alice Bourneuf to E. A. Goldenweiser, Memorandum, “Cleveland Trust Company,” April 26, 1945, NARA, RG 82 DIF box 34; Walter Gardner to Marriner Eccles, Memorandum, “The Proposed International Bank and American Interests,” June 18, 1945, NARA, RG 82 DIF, box 38. 91 Matthew Szymczak, Address to the Chicago Chapters of the American Statistical Association and the American Marketing Association, “The Federal Reserve and the Bretton Woods Proposals,” March 21, 1945, NARA, RG 82 DIF, box 38. 105

interrelationship between foreign investment, international trade, and full employment.

Foreign investment spurred American exports by creating demand for capital goods to rebuild devastated economies. This contributed to American employment, wages, and standards of living, enriching workers and increasing business profits. Individuals and corporations, wealthier from higher exports and in search of outlets to spend their newfound gains, drove up foreign imports, resulting in higher wages, profits, and standards of living overseas, as well as easing the repayment burden of outstanding debt.

This, in turn, contributed to the willingness of investors to lend overseas and politicians to support multilateral international cooperation through institutions such as those created at Bretton Woods. Although not explicitly articulated in this manner, American policymakers, including officials at the central bank, emphasized different aspects in their bid to support American acceptance of the World Bank proposal. They therefore linked

American domestic economic self-interest to ostensibly international cooperative policies.

As the United States transitioned back to a peacetime economy the nation confronted a variety of challenges including sustaining demand for American production.

The end of the war found manufacturers turning out vastly larger quantities of goods and employing far more workers, across nearly every sector of the economy, than before the conflict. According to an index compiled by the Federal Reserve Board of Governors, total industrial production rose from 109 points in 1939 to 235 by March 1945. Much of this growth occurred in durable goods manufacturing, such as transportation equipment, as well as various metals, but nondurable sectors, such as textiles, food, and chemicals, 106

also experienced growth, as did the production of minerals.92 Agriculture also underwent a tremendous expansion during the war with food output 28 percent greater than the prewar average and total sector employment rising by some 9 million workers compared to 1939.93

The end of the Second World War meant the need to reconvert manufacturing to a peacetime basis, shifting labor to different sectors and even different geographical regions as companies released workers from war production. With the end of the conflict the United States also anticipated the demobilization of a great portion of the 12 million soldiers and sailors in the armed forces. Central bankers estimated that a significant proportion, as high as 30 percent, of the labor force produced goods just for the war effort and lend lease.94 Long-term postwar prosperity demanded that the economy find some way of retaining those workers in the labor market. Additionally, the capitulations of

Germany and Japan curtailed government orders for military equipment, resulting in broad production declines and reducing the need for workers. Employment across the metal, rubber, and chemical industries dropped 20 percent (1.4 million workers) simply between July and August 1945 alone. Indeed, by July 1945 employment in American

92 Federal Reserve System Board of Governors, “Transition to Peacetime Economy,” Federal Reserve Bulletin 31, no. 9 (September 1945), 853. 93 Ibid., 855; Prewar average based upon 1935-1939 period. Director of War Mobilization and Reconversion, Third Report to the President, the Senate, and the House of Representatives: The Road to Tokyo and Beyond (Washington, D.C.: Government Printing Office, 1945), 41. 94 Federal Reserve System Board of Governors, “Transition to Peacetime Economy,” Federal Reserve Bulletin (September 1945), 855; Marriner Eccles, Address, “The War Program and Inflation,” November 3, 1943, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19430311.pdf (accessed December 27, 2011). 107

factories was some 18 percent below its 1943 peak.95 Fed officials argued that the World

Bank provided support as the American economy transitioned from wartime to peacetime and found employment for not only workers previously engaged in war production but also those released from the military back into the labor market.

Federal Reserve officials argued that a bold lending policy facilitated postwar reconstruction and economic development by promoting international trade and thereby

American domestic employment and prosperity. Fred Klopstock, an economist with the

FRBNY, wrote that international investment in reconstruction and development by the

World Bank and the Export-Import Bank of the United States spurred demand for capital goods, sustained American exports, and therefore provided a “major instrument for maintaining full employment, facilitating reconversion, and achieving a high national income” even as demand for war materials fell off.96 The Federal Reserve emphasized a link between reviving foreign investment and higher demand for American exports as a means of not only sustaining postwar domestic employment but also for transitioning the world economy to a more sustainable basis.97 Walter Gardner in particular emphasized that American wartime supplies for the Allied war effort created serious distortions in the nation’s economic relations. Given the “wariness of the American people lest they play

Santa Claus,” Gardner argued that reviving international investment offered to reduce potential disequilibria as the world economy reoriented to peacetime. Gardner believed

95 Federal Reserve System Board of Governors, “Transition to Peacetime Economy,” Federal Reserve Bulletin (September 1945), 849-850. 96 Fed Klopstock, Paper, “Past and Future Role of the Export-Import Bank,” January 23, 1945, NARA, RG 82 DIF, box 57. 97 Board of Governors of the Federal Reserve System, Draft Memorandum, “Board Program on Bretton Woods,” December 1, 1944, NARA, RG 82 DIF, box 36. 108

that since loans and investment “cost something” in terms of expected repayment they exerted a “steady influence toward [the] selection of productive projects” and therefore benefited the world economy over the long term.98

Policymakers highlighted the fundamental interdependence between international and domestic prosperity. Treasury Undersecretary Daniel Bell told the Kiwanis Club of

New York that the United States could not “divorce [itself] from the economic problems of the world” and that global and domestic economic health remained linked.99 Federal

Reserve officials believed that any attempt to sustain American domestic prosperity by pushing exports without regard to the international economy’s ability to absorb and pay for goods on a self-sustaining basis risked repeating the boom and bust cycle of the interwar period.100 Marriner Eccles, Chairman of the Federal Reserve Board of

Governors, echoed the belief that a fundamental interconnection existed between restored and viable international trade and domestic full employment.101 In reviewing an early draft of Eccles’ statement to Congress on the Bretton Woods Agreements, Walter

Gardner also emphasized the need to clearly link American domestic prosperity with the restoration of the international economy.102 Officials at the Board of Governors rejected the contention raised by some that the United States should focus on domestic full

98 Walter Gardner, Memorandum, “The Future International Position of the United States as Affected by the Fund and Bank,” February 27, 1945, NARA, RG 82 DIF, box 38. 99 Daniel W. Bell, Address, “Domestic and International Stabilization,” March 7, 1945, NARA, RG 82 DIF, box 38. 100 E. A. Goldenweiser, Memorandum, “Response for Comment from Editor of Banker about International Monetary Fund and Dr. Einzig,” January 2, 1945, NARA, RG 82 DIF, box 34. 101 Marriner Eccles to Representative Brett Spence, Letter, March 21, 1945, NARA, RG 82 DIF, box 36. 102 Walter Gardner to E. A. Goldenweiser, Memorandum, “Comments on First Draft of the Chairman’s Bretton Woods Testimony,” April 12, 1945, NARA, RG 82 DIF, box 36. 109

employment as a precondition for international cooperation. Central bankers believed that placing primary emphasis on domestic employment cast the role of the Bretton

Woods institutions, including World Bank spurred international investment, as so much charity and failed to appreciate the interdependencies of global economic recovery.103

Central bankers also picked up on the link between economic prosperity and peaceful international political relations. Early versions of the World Bank plan suggested that the institution might use its powers to review projects as a means of monitoring industrial investment and preventing nations from building large armaments industries. The bank could then threaten to cut off access to international capital markets to nations deemed aggressor states.104 Powers to directly enforce international peace through the World Bank mechanism came fraught with a variety of complications, not the least of which was the potential for requiring all investment, inter-state or private, to be overseen and approved by an international institution, a proposition unlikely to gain political support in the United States.105 Fed officials, however, also highlighted the indirect contributions to international political peace that might accrue just from the

103 Ibid.; Walter Gardner to Kenneth William, Memorandum, “Memorandum on Melville,” April 14, 1945, NARA, RG 82 DIF, box 34; Kenneth Williams to Elliot Thurston, Memorandum, “Attached Paper on Bretton Woods by L.G. Melville,” April 17, 1945, NARA, RG 82 DIF, box 34. 104 Alice Bourneuf to Walter Gardner, Memorandum, “Treasury Proposal for a Bank for Reconstruction,” July 19, 1943, NARA, RG 82 DIF, box 57. The United States Treasury removed the proposal to use the World Bank to monitor and punish potential aggressor states early in the drafting process. Alice Bourneuf, Memorandum, “Changes in the Treasury’s Draft on the Bank for Reconstruction and Development,” October 19, 1943, NARA, RG 82 DIF, box 57. 105 Frank Tamanga, Memorandum, “Problems of Investment Banking after the War,” March 31, 1943, NARA, RG 82 DIF, box 34; Board of Governors of the Federal Reserve System, Untitled Treasury Bank Proposal with marginal notes, June 30, 1944, NARA, RG 82 DIF, box 57; Aside from domestic objections, Soviet delegates already suggested they be freed from any World Bank oversight of projects if they participated in the project because “since a socialistic country would borrow only for productive purposes.” Walter Gardner to E. A. Goldenweiser, Memorandum, “Suggested Federal Reserve Position at Russian Meeting This Morning,” April 26, 1944, NARA, RG 82 DIF, box 56. 110

simple presence and operation of the World Bank. In an address to the Catholic

Association for International Peace, Alice Bourneuf argued that by assuring continued access to the credit necessary to reconstruct their economies and encouraging access to markets required to sell goods produced, the World Bank plan alleviated the need to resort to the economic autarky associated with Nazi domination of Europe. Bourneuf argued that acceptance of Bretton Woods and the plan for an international bank represented “further economic cooperation and action in the field of international trade,” which she considered “a vital requirement for a peaceful and prosperous world.”106 In an earlier draft of the address Bourneuf expressed concern that failure to adopt the plans might “cast grave doubts on the future of any . . . international cooperation.”107 The

World Bank plan therefore served American interests more broadly by demonstrating

American leadership in the economic realm, thereby helping to secure long-term political peace.

Conclusion

The World Bank never operated in the manner its founders intended. The management of the international bank fundamentally altered its approach to international markets after the adoption of the Bretton Woods Agreements but before the Bank actually began operations. Policymakers bowed to pressure from international investors

106 Alice Bourneuf, Address to the Catholic Association for International Peace, “The Bretton Woods Agreement,” March 8, 1945, NARA, RG 82 DIF, box 34. 107 Alice Bourneuf, Draft of Address to the Catholic Association for International Peace, “The Bretton Woods Agreement,” March 8, 1945, NARA, RG 82 DIF, box 34. 111

who preferred to lend directly to the World Bank itself rather than to foreign governments, even with the guarantee of the international institution. This meant, however, demonstrating the “business acumen” of the World Bank, leading it to adopt conservative underwriting standards and undermining its ability to promote postwar reconstruction.108 At the same time, the international context changed. The institutions proposed at Bretton Woods aimed at creating an integrated international economy; the postwar reality, however, was of two competing blocs dominated by the United States and the Soviet Union. The World Bank became integrated into the Western bloc, focusing on increasing the living standards of peripheral states as a means of checking the spread of communism.109

The manner in which postwar geopolitical and financial forces confounded the hopes of wartime planners, however, should not obscure the ways that central bankers thought deeply about the meaning and purpose of the Bretton Woods institutions.

Officials with the Federal Reserve actively engaged in discussions over the purpose and function of the World Bank proposed at Bretton Woods. They saw the institution as a means of promoting the restoration of an international capitalist system based primarily on private enterprise and capital flows, but with states acting in a cooperative supporting role. Throughout, Fed officials attempted to walk a fine line, believing that states had a positive and constructive role to play in the international economy while also seeking to

108 Edward S. Mason and Robert E. Asher, The World Bank since Bretton Woods (Washington, D.C.: The Brookings Institution, 1973), Ch. 3; Robert W. Oliver, International Economic Co-operation and the World Bank (New York: MacMillan Press, 1975), 237-41. 109 Gardner, Sterling-Dollar Diplomacy, Ch. 15; Staples, Birth of Development, 37-40. 112

avoid replacing the existing system of free enterprise with one characterized by centralized planning. Chapter Three

“New Lanes in Uncharted Seas”: The Federal Reserve and International Exchange Stabilization, 1941-1945

On the evening of July 22, 1944, Treasury Secretary Henry Morgenthau Jr. addressed the closing plenary session of the United Nations Monetary and Financial

Conference held at Bretton Woods, New Hampshire, over the preceding three weeks.

Morgenthau told the delegates of the forty-four assembled nations that while the technical details of financial policy eluded most of the public, the matters addressed at Bretton

Woods, despite their “mysterious” appearance, represented “the most elementary bread and butter realities of daily life.” Despite being cloaked in academic jargon, he argued, the conference achieved a relatively straightforward goal, the creation of a mechanism for international cooperation that allowed the restoration of a mutually beneficial economic prosperity. While some saw “national interest” and “international cooperation” as mutually exclusive, Morgenthau instead saw them as reinforcing. Selfish economic policies such as bilateral trade agreements, exchange controls, and competitive currency manipulation provoked “economic aggression,” which put nations on the “disastrous road to war.” Bretton Woods, however, represented the acceptance of a new “enlightened form of national self-interest” through, rather than instead of, multilateral cooperation.

According to Morgenthau, the International Monetary Fund (Fund) created at Bretton

Woods provided a critical mechanism for fostering the kind of postwar international cooperation required to secure prosperity and peace, while at the same time ensuring

113 114

nations’ domestic “freedom of action.”1 The precise trade-off between national autonomy and international cooperation, however, was not without controversy, and reconciling those two ideas occupied much of the debate both within the U.S. government and between countries prior to and after the Bretton Woods Conference.

This chapter examines the role of the Federal Reserve in the formation and adoption of a plan for postwar international exchange stabilization. It pays particular attention to the way the interwar experience shaped the Federal Reserve’s approach to postwar currency issues just as it influenced the central bank’s concern with domestic wartime finance and the revival of international investment. It explores the positions taken by Fed officials toward the Fund, based primarily on a proposal by Harry Dexter

White of the U.S. Treasury. It also considers, when appropriate, the Fed’s position on some of the major alternatives, including the scheme to create an International Clearing

Union (Clearing Union) put forward by Britain’s John Maynard Keynes and the so-called key currency approach championed by John H. Williams of the Federal Reserve Bank of

New York (FRBNY).

Fed officials desired an active U.S. leadership role in the maintenance of the international monetary system. Central bankers believed that Britain fulfilled such a role under the classical gold standard, but that the strains of the First World War inhibited the

British from resuming this position. They believed that American failure to fill the power vacuum created by Britain’s relative decline resulted in the collapse of the interwar gold

1 United States Department of State, Proceedings and Documents of the United Nations Monetary and Financial Conference, Volume I (Washington, D.C.: United States Government Printing Office, 1948), 1116-18. 115

standard, the rise in economic nationalism, and ultimately the turn to militarism and political aggression that touched off the Second World War. At the same time, Fed officials believed that American leadership could not simply be the imposition of

American hegemony or even a great power (i.e., Anglo-American) arrangement. Instead, they argued that the United States must foster widespread acceptance of a multilateral cooperative venture that created a permanent structural arrangement and legitimized

America’s position. Moreover, central bankers believed that system must be flexible.

That is, stable enough to engender confidence and credibility in its operation while simultaneously avoiding the perceived rigidities of the gold standard. Flexibility, central bankers recognized, must permit sufficient domestic autonomy in economic affairs to allow progressive adjustment in nations’ balance of payments and avoid imposing deflationary policies that eroded international cooperation. Finally, Fed officials paid particular attention to and opposed aspects of the plans they feared might further contribute to domestic inflation and undermine American willingness to assume a leadership role in international monetary affairs. At the same time, the Federal Reserve, particularly the Board of Governors, felt bound to support the Bretton Woods proposals and feared too strenuous opposition might derail the entire agreement. Thus, while the

Fed sought to adjust specific aspects of the agreement it also tempered its arguments and sought ways to secure a voice in the management and oversight of American representatives as the likelihood of alterations to the Bretton Woods plan itself diminished. 116

While the specifics will be established in greater detail throughout the chapter, it is useful to provide a brief description of the Fund here at the outset. Under the

International Monetary Fund proposal ultimately adopted at the Bretton Woods

Conference, nations committed to fixing their national currencies in terms of gold as well as to take the necessary actions to support those exchange values. Countries then contributed a mixture of gold and national currencies to a centrally administered Fund.

Should a nation, such as Britain, encounter temporary difficulty in its balance of payments with another country, the United States for example, Britain would purchase the required foreign exchange from the Fund. That is to say, Britain would sell sterling to the Fund in exchange for an equivalent amount of dollars based on the previously agreed upon exchange rates. The Fund proposal included oversight provisions that placed quantitative and qualitative restrictions on how and for what purposes its resources could be utilized in an effort to prevent flagrant abuse. To this end, the Fund proposal included penalties based upon a deficit country’s level of indebtedness.2

White’s Fund left the responsibility for the adjustment burden somewhat ambiguous.3 In addition to restrictions on how rapidly a nation’s quota could be drawn upon, the Fund included provisions for imposing charges on countries drawing upon its resources, increasing the penalty as the size of a country’s indebtedness grew.4 The plan

2 United States Department of Treasury, Articles of Agreement: United Nations Monetary and Financial Conference, Bretton Woods, New Hampshire, July 1 to 22, 1944 (Washington, D.C.: Government Printing Office, 1948), 1-47. 3 Richard N. Gardner, Sterling-Dollar Diplomacy: The Origins and the Prospects of Our International Economic Order, Expanded ed. (New York: McGraw-Hill Book Company, 1969), lxiii-lxxiii. 4 United States Treasury, Articles of Agreement: United Nations monetary and Financial Conference, 11. 117

also based voting power, and therefore administration of the Fund, upon quota size, giving the United States, with the largest quota, a dominant voice in the management of the system. At the same time, however, access to the Fund, even with certain penalties and restrictions, provided breathing room for nations to take the steps necessary to reduce or eliminate their trade deficits. The Fund also provided definite rules for adjusting a nation’s exchange rate in case an imbalance in international payments represented a fundamental disequilibrium rather than a temporary trade deficit. Further, it recognized the need for domestic policy autonomy and prohibited the Fund from objecting to changes in exchange rates if the persistent deficits that caused the change were the result of “domestic social or political policies of the member proposing the change.”5 Finally, should a particular currency, such as dollars, be in a high demand, the Fund included a

“scarce currency” clause that effectively allowed members to impose discriminatory controls in order to conserve limited foreign exchange.6

There has been no dearth of scholarship on the origins of the Fund and the diplomatic and economic implications of the Bretton Woods Conference; there has, however, been a surprisingly uneven treatment of the Federal Reserve in this process.

Given the diversity of interests and nations, it is not surprising that the Federal Reserve’s role has been relatively neglected in past accounts.7 Even where it is covered the Federal

5 Ibid., 6. 6 Ibid., 13-15. 7 On the one hand histories of Bretton Woods and postwar financial policy tend to ignore the role of the Federal Reserve such as Gardner, Sterling-Dollar Diplomacy; While histories of the Federal Reserve tend pay only cursory attention to the central bank’s consideration of the Keynes and White plans such as in Allan H. Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2003). 118

Reserve is usually examined in relatively narrow, economically oriented, terms. Alfred

Eckes offers one of the best succinct accounts of the Fed’s interest at Bretton Woods, particularly in regard to the central bank’s concern with how the White plan treated potentially disruptive and inflationary gold flows. This analysis, however, remains largely divorced from the larger political context, which while technically not within the official purview of the Fed, nevertheless, played an important role in its thinking.8 It is beneficial, therefore, to highlight the ways in which the Federal Reserve demonstrated simultaneously an active concern for the economic consequences of the Bretton Woods proposal and sensitivity to the larger political environment and the potential risks of failing to establish a structure able to balance the contradictory demands for both exchange stability and flexibility.

This chapter, therefore, examines the way the Federal Reserve navigated the interrelated issues of the extent of American leadership, the need for multilateral cooperative structures, the requirement that these structures be flexible enough to make the system survivable but not so flexible as to endanger confidence, and the need to mitigate the inflationary pressures any such plan imparted on the American economy.

The Fed hoped that the creation of an international stabilization mechanism, similar to those proposed by White, provided a means to restore confidence in the value of foreign exchange. This, in turn, central bankers suggested, promoted international trade by reassuring importers, exporters, and lenders of the value and costs of the obligations they

8 Alfred E. Eckes, Jr., A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971 (Austin: University of Texas Press, 1975), 93-6. 119

entered into and reduced the potential for the kind of beggar-thy-neighbor manipulative economic warfare that unfolded during the economic crisis of the Great Depression. By helping to restore international economic prosperity, therefore, exchange stabilization contributed to the overall goal of postwar political stability, eliminating an important factor that central bankers believed contributed to the outbreak of military conflict.

The Gold Standard

Prior to examining the Federal Reserve’s position on specific issues that arose during technical negotiations on the Fund it is useful to get a sense of how the previous international monetary regime operated. During the nineteenth and early twentieth centuries the gold standard mediated economic relations between many large and important economies. The gold standard operated according to a set of norms and informal rules that dictated the domestic and foreign economic policies countries should adopt based upon whether their balance-of-payments position was one of deficit

(importing more than exporting) or surplus (exporting more than importing). An examination of central bankers’ attitudes toward the Fund proposals must therefore be built upon several interrelated stories. What was the gold standard and how did it operate? What weakness ultimately brought about the collapse of the gold standard during the interwar period? What did the collapse of the gold standard mean for any postwar regime that hoped to avoid a similar fate? Specifically, why did members of the 120

Federal Reserve Board of Governors opt to support the creation of a multilateral institution through which to manage currency relations?

Maintaining a stable relationship between national currencies under a fixed rate regime such as the gold standard was, at its core, a fairly straightforward and simple proposition. To be on a gold standard all a country needed to do was announce that it would buy and sell gold at a certain rate and then do it. When more than one country made a similar pledge the result was the two currencies became fixed through the mutual national promise to buy and sell gold at the established rate. Prior to the First World War the United States bought and sold gold at a rate of $20.67 per ounce. Similarly, Great

Britain bought and sold gold at a rate of £2, 17s, 10 1/2d per ounce. By each pledging to buy and sell gold at these fixed prices, the United States, and Britain created a de facto dollar-pound exchange rate of $4.867 per £1.9 In theory, the system merely required that nations commit to freely convert currencies into gold (and vice versa) at the fixed rate of exchange and that they allow gold to flow freely in and out of the market and across national borders.10 So long as nations adhered to these two preconditions the gold standard appeared to operate in an otherwise automatic way known as the price-specie flow.

9 Michael Bordo, “The Classical Gold Standard: Some Lessons for Today,” Federal Reserve Bank of St. Louis Review (May 1981), 2-3. 10 J. Lawrence Broz, “The Domestic Politics of International Monetary Order: The Gold Standard,” in International Political Economy: Perspectives on Global Power and Wealth, eds., Jeffry A. Frieden, David A. Lake, and J. Lawrence Broz, 5th ed. (New York: W.W. Norton and Company, 2010), 228-30. 121

The price-specie flow model, as developed by the eighteenth-century English philosopher David Hume, argued that if left undisturbed simply pledging to convert national currency into gold at a fixed rate produced equilibrium over the long term in a country’s international balance of payments. The easiest way to understand the price- specie flow mechanism is to take a two country example, such as America and Britain, although a similar series of events occurred between all nations on the gold standard.

According to Hume’s model, if Americans imported more from Britain than Britain bought from the United States the result was a flow of gold into Britain in exchange for export goods. The influx of gold brought about an expansion in British money because there was now more gold that could be converted into sterling, and relatedly, an increase in prices. The price increases occurred because while the supply of sterling grew thanks to the inflow of gold, the supply of goods available for purchase did not expand proportionately. Conversely, as the United States lost gold the supply of money fell as importers traded dollars for specie with which to pay for British goods. The decline in the money supply brought about a decline in prices in a manner similar to the way the expansion of the money supply inflated prices in Britain. According to Hume’s model,

Britons, flush with money, found the low prices of American goods attractive and began to import more, while Americans, increasingly unable to pay inflated British prices, imported less.11 This meant that over time the process reversed itself and gold flowed out of Britain and into the United States thanks to changes in relative prices and thus produced a balance-of-payments equilibrium over the long term. So long as surplus and

11 Paul A. Samuelson, Economics (New York: McGraw-Hill Book Company, 1948), 389. 122

deficit countries did not alter the price at which they bought and sold gold, and did nothing to inhibit the free flow of gold between nations, the system appeared to work more or less automatically.

The reality of the system, however, did not necessarily comport with the theory.

Over time the circulation of gold coins declined and people came to prefer more convenient forms of money such as notes and bills of exchange. Furthermore, physically shipping gold in and out of countries entailed a variety of costs, everything from packing the bars to paying the freight and insurance costs for their movement, to say nothing of the considerable risks. Over time countries adopted policy changes to avoid the actual shipment of gold but achieve the same results. If Americans imported more from Britain than they exported, this served as a signal to American policymakers to take measures to dampen American demand, such as increasing taxes or raising interest rates. In essence,

Americans engineered an economic contraction, depressing wages and prices and accepting higher unemployment. Price and wage decreases made American exports relatively more attractive to Britons. At the same time British investors, seeking the highest possible returns on their capital, invested their profits back in the American market, sending money right back where it came from.12 In extreme cases, such as a major banking crisis or war, nations temporarily suspended convertibility either officially

12 Ibid., 390; John Singleton, Central Banking in the Twentieth Century (New York: Cambridge University Press, 2011), 46-8. 123

or de facto through the implementation of bureaucratic obstacles to the export of gold or the conversion of currency into gold, but without suffering major adverse effects.13

The system worked as long as surplus and deficit nations had confidence in each other to play by the so-called rules of the game. According to these informal rules, surplus countries experiencing an influx of gold should allow their monetary base to expand, submitting to an inflationary increase in prices and a decline in interest rates.

Nations running a balance-of-payments deficit should allow their monetary bases to contract, either by exporting gold or adopting restrictive financial and monetary policies, accepting a deflationary price decline and permitting interest rates to rise.

Indeed, prior to the First World War the system more or less worked as intended thanks to a combination of sociocultural and economic factors. On the one hand, in many gold standard countries the balance of political power was held by groups that believed maintaining their nation’s commitment to a fixed exchange rate served their interests.

These were often business or financial elites that benefited from ensuring stability in the value of repayment for credit extended or contracts entered into. Holding the balance of political power they were able to impose deflationary contractions and oppose inflationary proposals, such as those offered by William Jennings Bryan and the Populists in the United States, who sought to ease the burden of debtor obligations. Prevailing cultural norms associated adherence to the gold standard with hierarchical notions of

13 At times the sheer confidence of a nation’s commitment to maintain convertibility actually served to ease pressures that would otherwise have necessitated just suspension. This point is developed in John H. Woods, A History of Central Banking in Great Britain and the United States (New York: Cambridge University Press, 2005), 272. 124

civilization and advancement while associating silver, bimetallism, paper currency, and other inflationary alternatives to backwardness that facilitated the creditor-friendly distribution of political power.14

On the other hand, the gold standard provided real economic benefits. Nations adhering to it reduced the barriers to international capital flows, which both supported the equilibrating mechanism that enabled currency stability and allowed “the vast enlargement of international trade and investment” resulting in the “integration of the world economy” as states became increasingly interdependent.15 Statistical evidence bears out the contention that the gold standard coincided with at least aggregate economic expansion, even if those gains were unevenly distributed. During the century between the end of the Napoleonic Wars and the outbreak of the First World War the value of global trade increased from $550 million to $19.8 billion. The value and volume of international trade also grew steadily under the gold standard. In the fifty years prior to the First World War the value of global trade increased by an average 34 percent each decade, while the volume increased by as much as 37 percent per decade.16

14 The complex set of sociocultural-political values that favored adherence to the gold standard over alternatives is expertly explored by a number of scholars. James Livingston, Origins of the Federal Reserve System: Money, Class, and Corporate Capitalism, 1890-1913 (Ithaca: Corn ell University Press, 1986); Giulio M. Gallarotti, The Anatomy of an International Monetary Regime: The Classical Gold Standard, 1880-1914 (New York: Oxford University Press, 1995); Jean Strouse, Morgan: American Financier (New York: Perennial, 2000); Emily S. Rosenberg, Financial Missionaries to the World: The Politics and Culture of Dollar Diplomacy, 1900-1930 (Durham: Duke University Press, 2003); Barry Eichengreen, “Hegemonic Stability Theories of the International Monetary System,” in International Political Economy, 257-8. 15 Mira Wilkins, “Conduits for Long-Term Foreign Investment in the Gold Standard Era,” in International Financial History in the Twentieth Century: System and Anarchy, ed. Marc Flandreau, Carl- Ludwig Holtfrerich, and Harold James, (New York: Cambridge University Press, 2003), 52. 16 Eckes, Search for Solvency, 2. 125

The Breakdown of the Interwar Gold Standard

The willingness to accept the underlying precepts of the gold standard, however, broke down after the First World War and resulted in increased instability and eventually the collapse of the entire monetary regime. Both surplus and deficit countries increasingly violated the so-called rules of the game of the international gold standard, eroding the confidence each had in the other. Surplus states, particularly the United

States, failed to act in a way that promoted stability, that is to say they failed to act as an international “lender of last resort,” providing liquidity for nations that found their currencies under pressure or required a market for distressed exports.17 At the same time deficit nations increasingly resisted the economic burdens required to restore equilibrium and defend their commitment to gold. A third factor added to the problems of convertibility. The movement of short-term investment capital across international borders, seen as a balancing force under the pre-1914 gold standard, became increasingly regarded as a source of instability.

Central bankers recognized that surplus states contributed to the collapse of the interwar gold standard by failing to act as international lenders of last resort. The British journalist Walter Bagehot articulated the lender of last resort principle during the late nineteenth century, exploring the idea within the context of examining the role of the

Bank of England during a domestic crisis. According to Bagehot, during banking crises depositors rushed to withdraw funds, draining resources from the banking system.

17 Charles P. Kindlgeberger, The World in Depression, 1929-1939 (Berkeley: University of California Press, 1986), 294-6. 126

Therefore, ostensibly sound banks collapsed when faced with these unexpected shocks, often touched off by exogenous factors unrelated to the solvency of a bank facing a run.

To counteract this situation Bagehot counseled central banks to lend “freely,” shoring up sound establishments and thereby “allay[ing] a panic.”18 In this way, he suggested, central banks saved institutions faced with abnormal withdrawals from having to liquidate assets at distressed prices and thus acted as lenders of last resort, reassuring the financial system that it stood ready to meet liquidity demands. If no one stood ready to act as the lender of last resort, panicked withdrawals at one institution threatened to create similar pressures on others, endangering both healthy and troubled banks and resulting in the ultimate collapse of the entire financial system.

Many of the same pressures that appeared during a domestic banking crisis also influenced the operation of the international gold standard. A persistent imbalance in international payments drained deficit countries of gold and foreign exchange.

Eventually doubts appeared about the nation losing gold and its ability to maintain its exchange rates. To be sure countries could not simply fold up and disappear the way a bank did when it collapsed. Nations faced with continued deficits, however, could devalue their currency, reducing its value in terms of gold, or might simply abandon convertibility altogether. In this situation holders of a foreign currency rushed to convert their balances into gold the same way depositors in a bank panic hurried to withdraw their savings. This created a negative feedback loop, further draining the nation’s gold

18 Walter Bagehot, Lombard Street: A Description of the Money Market (London: Kegan Paul, Trench, Trubner, and Company, 1895), 175. Kindle edition. 127

reserves, making it even harder to sustain the gold peg and prompting yet more flight from the currency. This was the situation that confronted England in 1931, ultimately forcing it to leave the gold standard. Furthermore, as in a banking panic where one bank’s collapse increased doubts about the survivability of remaining institutions, as one nation after another abandoned convertibility it only served to increase the pressure on those that remained linked to gold.19 In the absence of an international lender of last resort willing to alleviate a deficit country’s gold drain by lending to it or providing a market for its exports, the international system collapsed.

Prior to 1914 the British willingly recycled their surpluses, lending abroad income from merchandise exports and providing various services. Central bankers believed that the United States, in contrast, when faced with a widespread economic downtown in

1928 abruptly halted foreign lending. According to the Federal Reserve Bank of

Richmond, this course of action created a “dangerous state of unbalance” among foreign nations dependent on imports from the United States.20 Continued lending abroad might have allowed deficit countries more time to reduce their imports, increase their exports, and move toward reestablishing equilibrium in the international balance of payments. As

Emanuel Goldenweiser of the Federal Reserve recognized, however, by constricting foreign lending surplus states like the United States shifted the entire adjustment burden onto deficit countries.21 Goldenweiser’s comments reflected a position taken earlier by

19 Eichengreen, Golden Fetters, 258-86. 20 Federal Reserve Bank of Richmond Department of Research and Statistics, Memorandum, “International Monetary Stabilization,” October 1, 1943, NARA, RG 82 DIF, box 64. 21 E. A. Goldenweiser, Address to the Academy of Political Science, “New Monetary Standard,” April 4, 1945, NARA, RG 82 DIF, box 38. 128

the Federal Reserve Bank of Philadelphia. In a confidential memo assessing the collapse of the interwar economic system and the prospects for postwar restoration, the

Philadelphia Reserve Bank blamed a propensity on the part of all nations to place self- interest above a sense of the common good and recognition of the need for sharing the burden of international adjustment for the failure of surplus states. This attitude of

“irresponsibility of countries for each other’s welfare,” and the failure of the United

States to assume the role of international lender of last resort vacated by the British, eventually undermined both strong and weak countries alike.22

Federal Reserve policy may have also contributed to this collapse in lending.

Concerned with “liquidating” what it believed to be a speculative excess in financial markets, the Washington, D.C. based Board of Governors restrained attempts by the

Federal Reserve Bank of New York (FRBNY) to undertake open market purchases and ease credit conditions in the immediate aftermath of the 1929 stock market crash.23

Eventually the Fed relented and undertook open market purchases in 1930 in an effort to pursue what it believed to be a “policy of monetary ease.”24 Scholarly disagreement exists as to the effect of the Fed’s actions. According to Milton Friedman and Anna

Jacobson Schwartz, the stock of money fell during this period of so-called easing,

22 Federal Reserve Bank of Philadelphia, Memorandum, “Current Proposal for International Currency Reconstruction (Preliminary Draft),” July 9, 1943, NARA, RG 82 DIF, box 63. 23 Barry Eichengreen, Golden Fetters: The Gold Standard and the Great Depression, 1919-1939 (New York: Oxford University Press, 1995), 250-1. 24 Federal Reserve Board of Governors, Seventeenth Annual Report of the Federal Reserve Board of Governors Covering Operations for the Year 1930 (Washington, D.C.: Government Printing Office, 1931), 1. 129

reducing available credit.25 Peter Temin in a later analysis that looked at real, as opposed to nominal, money supply concludes that balances actually rose during this period.26

While Emanuel Goldenweiser, writing shortly after the war, argued that many overestimated the negative consequences of central bank policy, even he admitted a

“bolder policy by the Federal Reserve would have been more in accord with the needs of the time.”27 A more aggressive easing policy might have checked the reduction in credit to foreign borrowers and enabled them to continue funding their balance-of-payments deficits. In assessing the performance of the international community as a whole

Goldenweiser concluded that a track record of failure marred attempts at currency stabilization during the gold standard and that greater efforts were required to ease the deflationary burdens on deficit countries.28

In the absence of an international lender of last resort the willingness of deficit countries to undertake the deflationary measures required to restore balance-of-payments equilibrium declined just as surplus countries attempted to saddle them with an increasing share of the adjustment burden. The First World War created political coalitions increasingly responsive to the demands of newly empowered working classes throughout

Europe, the center of the gold standard world. As Barry Eichengreen correctly points out, the changing domestic political dynamic created immense political tensions. On the

25 Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867- 1960 (Princeton: Princeton University Press, 1963), 375. 26 Peter Temin, Did Monetary Forces Cause the Great Depression? (New York: W.W. Norton and Company, 1976). 27 E. A. Goldenweiser, American Monetary Policy (New York: McGraw-Hill Book Company, 1951), 159. 28 E. A. Goldenweiser, Statement, “Statement by Mr. Goldenweiser, Economist of the Federal Reserve Open Market Committee, at the Meeting of the Committee on June 28, 1943,” June 28, 1943, NARA, RG 82 DIF, box 61. 130

one hand, external pressure mounted from the operation of the gold standard, as defending the exchange rate demanded economic contraction and deflationary policies.

On the other, domestic interest groups resisted the unemployment and wage contraction that exchange rate stability demanded. Indeed as the economic collapse of the Great

Depression worsened many began to call for expansionary domestic policies to combat unemployment and alleviate economic suffering.29

Rather than suffer the burden of deflation, deficit states simply opted not to play by the rules of the gold standard game. They abandoned the link to gold and devalued their currencies in an effort to make their exports more attractive. Any advantage gained, however, lasted “only so long as other countries did not follow suit.” Indeed, it did not take long for the entire gold standard to break down with countries quickly resorting to nationalistic currency manipulation that only served in “stimulating more drastic restrictive practices” amongst other states.30

The economic pressures unleashed by the Great Depression revealed that the so- called rules of the game broke down on both sides of the gold standard. According to

Alice Bourneuf, earlier monetary theory overemphasized both the efficiency and effectiveness of the supposedly automatic stabilizing nature of the gold standard. The

Great Depression forced nations to confront the fact that “drastic changes in income and price levels” might be required before balance-of-payments equilibrium was restored. In

29 Barry Eichengreen, Globalizing Capital: A History of the International Monetary System, 2nd ed., (Princeton: Princeton University Press, 2008), 89. 30 Federal Reserve Bank of Richmond, Statement, “Statement of Comments of a Majority of the Board of Directors and Senior Officers of the Federal Reserve Bank of Richmond with Respect to Plans for the Stabilization of Post-War Currencies,” August 12, 1943, NARA, RG 82 DIF, box 64. 131

the face of this uncertainty, exacerbated by the absence of an international lender of last resort, deficit countries refused to subject their economies to draconian deflationary policies. Similarly, surplus countries, such as the United States, sterilized the gold influx rather than allow it to exert an inflationary pressure on their own economies. The decision to abandon gold convertibility simply represented the “path of least resistance” in the breakdown of the rules of the game.31 Alvin Hansen succinctly summarized the changed thinking toward the gold standard. In the past, states attached tremendous prestige and importance to sustaining fixed exchange rates. Increasingly, however, countries came to consider the requirement that they adjust their entire economic structure to defend commitment to gold “an absurd procedure.”32

Federal Reserve officials saw the Treasury’s Fund proposal as a mechanism for addressing several interrelated problems. The Fund ensured that the United States assumed a leadership role in the international economy, something Fed officials saw as vital for postwar prosperity and stability. Additionally, it embedded that leadership within a formal structure that operated as an international lender of last resort according to clearly defined obligations rather than informal norms or rules of the game.

Furthermore, by creating a reliable international lender of last resort it lessened the potential for a repeat of the interwar experience, including not just the economic instability caused by the collapse of the gold standard but also the political strife that accompanied economic nationalism. In this way, Fed officials understood the Fund

31 Alice Bourneuf, Memorandum, “Postwar International Monetary Institutions,” January 22, 1944, NARA, RG 82 DIF, box 38. 32 Alvin Hansen, Memorandum, “The International Monetary Plan,” June 1, 1944, NARA, RG 82 DIF, box 61. 132

proposal as making a positive contribution to a peaceful postwar political environment and decreasing the potential for yet a third world war.

American Leadership, the Danger of Isolationism and Postwar Currency Stabilization

Much as they had with postwar international investment (Chapter 2), Fed officials continued to support an expanded and direct leadership role for the United States in currency stabilization. Central bankers made similar arguments for American leadership in the field of currency stabilization. In late August 1943 the Federal Reserve Bank of

Chicago, along with several other Midwestern Federal Reserve banks, hosted a conference to discuss postwar plans for currency stabilization. Emanuel Goldenweiser of the Board of Governors, along with Harry White of the Treasury and Graham Towers, governor of the Bank of Canada, presented the various schemes for postwar economic reconstruction.33 During an address to the assembled attendees Goldenweiser laid out the necessity for greater American leadership, linking the breakdown of the interwar system to the nation’s attempts to avoid its international responsibilities. Goldenweiser argued that after the First World War the United States attempted to “remain aloof from world affairs” both politically and economically, but that the instability of the interwar period proved that “isolationism” had “become entirely unfeasible.” He insisted that the nation could not “escape from the responsibilities of world citizenship” and that if it assumed a leadership role commensurate with its power and influence then it could help “establish

33 New York Times, August 27, 1943. 133

friendly intercourse among nations and enduring peace.” If Americans continued to resist and clung instead to “a short-sighted and selfish role,” however, they would only help “to sow the seeds of economic restriction and future war.”34

Goldenweiser’s argument drew a number of important connections. It cast the interwar period as one where the United States attempted to shirk the duties of international leadership. He believed that the nation failed to act as an international lender of last resort, and that this failure resulted in economic breakdown and war. He also proposed that the way to avoid a similar and equally tragic replay of the interwar experience was for the United States to take concrete steps in assuming leadership in the postwar era. Federal Reserve officials who supported American participation in the Fund consistently returned to the idea that the nation must avoid repeating the mistake of the interwar period, which they defined as self-interested isolationism that only resulted in the rise of autarkic and autocratic regimes. In this way the perspective of central bankers foreshadowed many of the imperatives the drove postwar American international leadership. Central bankers believed the United States had a global responsibility to foster conditions conducive to the success of peaceful democratic relations served by liberal capitalist economies.35

Alvin Hansen contrasted the current planning of the postwar economy with the failure to create an adequate structure following the last world war. According to Hansen

34 E. A. Goldenweiser, Address, “International Post-War Monetary Stabilization Conference,” August 26, 1943, NARA, RG 82 DIF, box 64. 35 The underlying motivations of American international leadership is explored in greater depth by John Fousek in To Lead the Free World: American Nationalism and the Cultural Roots of the Cold War (Chapel Hill: University of North Carolina Press, 2000), 63-5. 134

the decision of whether or not to participate in a plan for currency stabilization was “no less significant than the question of our adherence to the League of Nations after World

War I.” He suggested that “without economic international collaboration” political cooperation was “bound to fail” and that there remained a “grave danger” the United

States might “remain isolationist on economic lines,” presumably with tragic consequences.36 Similarly, Matthew Szymczak of the Board of Governors believed that hopes for postwar peace and prosperity depended upon whether the United States reverted “to isolationism.” According to Szymczak the willingness of the nation to participate in an international organization “designed to prevent the formation of warring economic blocs” represented the nation’s “first major test” of its willingness to cooperate; the rest of the world would “be watching” to see how the United States acted.37

Federal Reserve officials therefore linked the credibility of U.S. leadership and the prospects for postwar currency stability with U.S. willingness to participate in the

Fund. Central bankers clearly believed that if the United States failed to take an active leadership role and instead returned to prewar isolationist policies the result would be the collapse of the global economy and ultimately the return of conflict. The Board of

Governors made explicit its belief in the connection between economic collapse and war.

According to the Board, the deterioration of international economic relations created the conditions for “revolution” and “dictators.” If “democracy is to thrive as a future type of

36 Alvin Hansen, Memorandum, “The International Monetary Plan,” June 1, 1944, NARA, RG 82 DIF, box 61; Alvin Hansen, Memorandum, “The International Monetary Fund,” June 6, 1944, NARA, RG 82 DIF, box 38. 37 Matthew Szymczak, Memorandum, “Draft of a Talk by Governor Szymczak at the June 6 Meeting,” June 5, 1944, NARA, RG 82 DIF, box 38. 135

government” it required the restoration of currency stability, which in turn depended upon American leadership in the Fund.38

It should be noted that modern scholars have demonstrated that so-called isolationism did not represent a monolithic attitude in why or even how the United States should refrain from international involvement. Indeed, as Christopher McKnight Nichols demonstrates, isolationism and internationalism often interacted in complex and unexpected ways.39 Nevertheless, over the course of the war public opinion shifted clearly and decisively in favor of some sort of internationalist engagement, a fact further reflected by the loss dealt to isolationists in the 1944 elections.40 By associating a rejection of Bretton Woods with the negative consequences of supposed U.S. interwar isolationism, central bankers highlighted the dangers to both the United States and the world at large. Failure to participate in an international scheme for postwar currency cooperation threatened a replay of the interwar experience, with presumably the same tragic outcomes.

38 R. M. Evans, Memorandum, “Plans for International Currency Stabilization,” October 1, 1943, NARA, RG 82 DIF, box 61. 39 Christopher McKnight Nichols, Promise and Peril: America at the Dawn of a Global Age (Cambridge: Harvard University Press, 2011); Justus D. Doenecke also explores the very different motivations for opposing American intervention in the Second World War in Storm on the Horizon: The Challenge to American Intervention, 1939-1941 (New York: Rowman and Littlefield, 2003). 40 Elizabeth Borgwardt, A New Deal for the World: America’s Vision for Human Rights (Cambridge: The Belknap Press of Harvard University Press, 2005), 80-2; Robert Dallek notes that after 1944 Roosevelt, while optimistic, continued to harbor some fears about the public fickleness toward international engagement in Franklin D. Roosevelt and American Foreign Policy, 1932-1945 (New York: Oxford University Press, 1979), 502-3. 136

The Federal Reserve, Multilateral Stabilization, and the Key Currency Alternative

U.S. leadership in international currency stabilization, however, did not necessarily demand a multilateral organization. Indeed, some who notionally supported the idea of U.S. leadership argued for less formal alternatives. Edwin Kemmerer, the former Princeton professor and long-time gold standard advocate, opposed the multilateral approach. He insisted that the best way to reestablish currency stability was to restore the gold standard as quickly as possible and drop the “misguided attempts at monetary management” that he saw as responsible for its interwar collapse.41

Alternatively, FRBNY president Allan Sproul and vice president and Harvard economist John H. Williams supported the so-called key currency approach that called for initially stabilizing the dollar-pound exchange before incorporating other countries and other currencies. Instead of a solution that created a permanent formal international managing body and a comprehensive agreement that included the widest number of nations possible, Williams proposed a streamlined approach to currency stabilization. As early as 1934 he argued that because of the importance of the United States and Britain in international trade, an approach that focused just on dollar-pound stabilization still represented an important advance for the rest of the global economy. Stabilizing the internal values of the dollar and the pound, and then their values vis-à-vis one another, offered to create a substantial area for imports and exports that imparted stability on the

41 Kemmerer’s influence on the development of the gold standard is explored in Rosenberg, Financial Missionaries to the World, 151-65; Congress, House of Representatives, Committee on Foreign Relations, Reconstruction Fund in Joint Account with Foreign Governments for Rehabilitation, Stabilization of Currencies, and Reconstruction. 78th Cong., 2nd sess., 26 April 1944, 28, 39; Alice Bourneuf to Walter Gardner, Memorandum, “Hearings on Dewey Bill,” April 27, 1944, NARA, RG 82 DIF, box 36. 137

rest of the world economy.42 According to Williams, the world economy, in practice, did not consist of “some sixty autonomous states” but rather “a few key countries and economic spheres.”43 In essence, Williams argued that monetary instability in large or

“key” countries imposed negative consequences on the entire global economy and undermined the stability of small states, so stability in these key countries naturally supported stability in peripheral economies.

Williams’ support for the key currency approach as a basis for postwar stabilization began to intensify during the summer of 1943. In a statement prepared for the June 28, 1943, meeting of the Federal Reserve Bank Presidents and Board of

Governors, Williams laid out a list of concerns with the Keynes and White proposals, establishing themes that he periodically drew upon over the course of the next two years.

Williams began by favorably comparing the efforts to address monetary stabilization early on with the “complete lack of planning” that marred the last war. He also expressed general concurrence with the broad goals of the Keynes and White plans for preventing destabilizing capital movements, avoiding exchange controls, and forestalling the “evils of bilateralism and other restrictive trade policies” that spoiled the interwar era. Williams expressed concern, however, that the Keynes and White plans dominated discussion to the exclusion of potential alternatives, presumably key currency stabilization. He warned that the complexity of the multilateral approaches made them inappropriate for the dynamic transitional period after the war as nations struggled to put their economies back

42 John H. Williams, “The World’s Monetary Dilemma: Internal versus External Monetary Stability,” Proceedings of the Academy of Political Science 16, no. 1 (April 1934), 66. 43 John H. Williams, “Monetary Stabilization from an International Point of View,” The American Economic Review 25, no. 1 (March 1935), 161. 138

in order. He felt that the pressing need for relief and reconstruction limited the ability of many nations to concurrently pursue monetary stabilization. Importantly, Williams believed that an idealistic commitment to multilateralism blinded the United States to how the world actually worked and likened the Keynes and White plans to the League of

Nations’ proposal, full of “high sounding words and sentiments that do not get us anywhere.”44

Williams’ support for key currency did not represent a rejection of internationalism. Indeed restoring dollar-pound stability required U.S. recognition of the nation’s dependence on the health of the international economy and its role in helping to manage it. Specifically, stabilization likely necessitated a sizeable loan by the Americans to the British, which in itself represented a break with the nationalist policies of the interwar era.45 Instead, Williams supported a selective approach to international engagement compared to the Keynes and White plans.46

The division between the supporters of key currency, particularly the FRBNY, and multilateralism may constructively be viewed as differences in the type of coordination proposed. In this regard, the work of political scientist David Andrews is particularly helpful in clarifying both the source of the division as well as the implications for understanding the role of the Federal Reserve System in the crafting of

44 John H. Williams, Statement, “Currency Stabilization: The Keynes and White Plans,” June 28, 1943, NARA, RG 82 DIF, box 62. 45 Fred L. Block, The Origins of the International Economic Disorder: A Study of United States International Monetary Policy from World War II to the Present (Berkeley: University of California Press, 1977), 52. 46 Eckes, Search for Solvency, 88-90. 139

American foreign policy. Andrews distinguishes between what he terms “procedural coordination” built upon “mutual participation” between all members of the internal monetary system and “substantive coordination” whereby monetary policies may be

“mutually appropriate without having been mutually determined.”47

Supporters of the key currency approach emphasized substantive coordination.

Key currency limited stabilization at the outset to the United States and Britain.

Advocates believed that establishing a sustainable exchange rate between the two key currencies allowed prosperity to trickle down to other states.48 As nations recovered from the war, reoriented their economies to peacetime production, and restored internal price stability they could then remove exchange controls and other manipulative devices and enter into normal trade relations with an established and prosperous dollar-pound bloc.

Substantive coordination, from this vantage point, served the general welfare of all countries. For the key countries it allowed efforts to be prioritized on restoring currency stability to a small number of important states, rather than spreading resources across many states simultaneously, potentially diluting their effectiveness. For smaller nations it offered the freedom to dictate the pace at which they reentered the global economy rather than forcing them to conform to a set of rules created prior to the conclusion of the conflict with imperfect knowledge of the multifaceted problems likely to be posed during the postwar transition period. The structure of the overall system, however, reflected the preferences of the United States and Britain and thereby shaped the choices available to

47 David M. Andrews, “Monetary Policy Coordination and Hierarchy,” in Andrews, ed. International Monetary Power, 93-6. 48 Eckes, Search for Solvency, 88-90. 140

peripheral countries rather than providing them a voice in determining the nature of the system. In this way, as David Andrews argues, substantive coordination in international monetary policy reflected Thucydides’ axiom “the strong do what they can while the weak suffer what they must.”49 In the case of John H. Williams’ plans for postwar monetary stabilization, the strong key countries set the terms and structure of the international monetary system while weak peripheral states were left to suffer the choice of accepting, albeit on their own timeline, or rejecting the system and risk being excluded from the dollar-sterling bloc. At its core then the key currency proposal assumed a clear hierarchy of nations and currencies with the dollar and pound at the top. Furthermore, many key currency advocates, particularly Williams, believed that their position at the top of the financial hierarchy imbued the United States and Britain with a natural hegemonic power and legitimized a system based upon an Anglo-American worldview.50

Despite the emphasis on hierarchy, Williams took pains to emphasize that the key currency proposal did not represent a rejection of American international involvement.

He denied the accusation that the plan implied an acceptance of bilateral stabilization and instead sought to reconcile it with the goal of multilateralism. Williams argued that his approach emphasized the process of stabilization, and that it recognized the ability to either speed up or slow down stabilization for individual states based upon their unique circumstances. Williams believed the postwar global economy required greater emphasis on stabilizing the major financial centers coupled with greater sensitivity to the process of

49 Quoted in Andrews, “Monetary Policy Coordination,” 101-14. 50 The implied economic imperialism of Anglo-American financial hegemony is explored in Anthony M. Endres, Great Architects of International Finance: The Bretton Woods Era (New York: Routledge, 2005), Ch. 4. 141

stabilizing smaller states rather than the creation of more “elaborate machinery” such as the Fund or Clearing Union.51 Although he accepted the need for the United States to play a greater role in the management of the international financial system, he believed that this could be done progressively and cautioned against acting too hastily in committing to a comprehensive solution and an international institution.52

Williams and the FRBNY were not alone in at least expressing doubts about the multilateral proposals. The Federal Reserve Bank of Cleveland doubted the implication that the lack of an international adjustment mechanism similar to the Fund resulted in the collapse of the interwar gold standard. While the Cleveland Reserve Bank did not reject the Fund proposal or explicitly endorse the key currency alternative, it did caution against signing a “blank check payable to the rest of the world” and counseled that greater detail about America’s obligations under the Keynes and White proposals was necessary before entering into any agreement.53 The Federal Reserve Bank of Dallas ultimately argued for accepting something along the lines of the Keynes or White plan but also emphasized the need for caution and maintained that a full and public understanding of the agreement was necessary “before we make any binding commitment” that the United States might not be able to withdraw from without great pain.54 The Federal Reserve Bank of San

Francisco floated the idea of delaying operation of any stabilization fund until after

51 William F. Treiber, Secretary, Federal Reserve Bank of New York, Memorandum, “Notes on Discussion Regarding Post-War International Currency Stabilization,” September 2, 1943, NARA, RG 82 DIF, box 62. 52 John H. Williams, Memorandum, “International Currency Stabilization,” NARA, RG 82 DIF, box 62. 53 Federal Reserve Bank of Cleveland, Memorandum, “Commentary on International Monetary Stabilization,” September 9, 1943, NARA, RG 82 DIF, box 63. 54 Federal Reserve Bank of Dallas, Memorandum, “Commentary on the Proposed International Currency Stabilization Plans,” February 10, 1944, NARA, RG 82 DIF, box 64. 142

immediate instability of the postwar transition to peace, instead utilizing existing internationally oriented organizations such as the Bank for International Settlement or the

Export-Import Bank.55

Supporters of the Fund approach within the Fed pursued two different lines of argument to both make the case for multilateralism and counter the advocates of the key currency approach. First, they anticipated objections from nations, large and small, not defined as key currencies. They argued that a key currency solution might be viewed as simply great power or Anglo-American domination in international monetary affairs.

Central bankers worried that opposition to the appearance of being left at the mercy of key countries might lead non-key ones to resume the very nationalist economic policies that Fed officials blamed for the breakdown of interwar economic prosperity and political peace. Second, Board officials linked their arguments to the rhetoric of the idealistic postwar vision articulated in the Atlantic Charter. They framed American acceptance of the Fund proposal as an indicator of the nation’s postwar leadership, implying that failure to adopt multilateral currency stabilization threatened to derail the entire postwar liberal internationalist order. Both approaches highlighted the belief held by many central bankers that multilateral cooperation in currency stabilization served as an important litmus test for cooperation in other equally vital areas, especially the liberalization of postwar trade relations.

55 Federal Reserve Bank of San Francisco to E. A. Goldenweiser, Memorandum, “International Monetary Stabilization,” November 23, 1943, NARA, RG 82 DIF, box 64. 143

The Board of Governors was not alone within the Federal Reserve System in anticipating opposition from other nations to the narrowly defined key currency style stabilization plan. In a memorandum prepared in response to a request by the Board of

Governors that the individual regional Reserve Banks discuss the proposals for postwar stabilization, the Federal Reserve Bank of Philadelphia neatly captured one of the inherent defects opponents saw with the key currency approach.56 Summarizing the views of key currency opponents, the Philadelphia Reserve Bank acknowledged that some viewed the approach as essentially the domination of a “benevolent despot.” It left non-key countries with “virtually no power in financial affairs” but instead required them to “adjust themselves to the policies of the great powers.” Furthermore, this left the plan open to the danger that “smaller countries may resent the despotism of the great” and that

“such an atmosphere generates war.”57 While not explicitly endorsing the position of key currency opponents, the Philadelphia Fed’s analysis devoted considerable length to their position. Furthermore, characterizing the view of key currency proponents as ignoring

“economically unimportant” peoples in “lesser countries” and adopting the view a

“benevolent despot” certainly did not constitute a ringing endorsement.58 Williams assumed the ability of small states to insulate themselves against external economic pressures while they stabilized their economies. The dissent summarized by the

Philadelphia Reserve Bank denied such a possibility. Instead, it suggested that

56 Chester Morrill to Chairmen and Presidents of all Federal Reserve Banks, Letter, June 25, 1943, NARA, RG 82 DIF, box 61; Alfred Williams to the Federal Reserve Board of Governors, Letter, July 22, 1943, NARA, RG 82 DIF, box 63. 57 Federal Reserve Bank of Philadelphia, Memorandum, “Current Proposal for International Currency Reconstruction (Preliminary Draft),” July 9, 1943, NARA, RG 82 DIF, box 63. 58 Ibid. 144

international economies were too interconnected for any state to pursue an essentially isolationist course.

The Philadelphia Fed expressed greater consensus in support of the multilateral approach several days later during a presentation of the plans by Emanuel Goldenweiser and Walter Gardner of the Board of Governors. During the discussion Fed officials expanded on their earlier concerns about great power domination. While admitting that a simpler plan such as key currency might be politically easier to sell in the United States, they considered how such a narrowly construed solution might be offset by increased international skepticism. Fed officials believed that smaller, economically weaker countries likely harbored suspicions of a key currency system.59

Board officials also found the vague definition of key versus non-key currencies problematic. First, as one official from the Bank of Canada pointed out, which currencies were actually key currencies was a relative notion. Different sectors within the American economy differed in their views; for example, American wheat producers likely considered Argentine and Canadian currencies “key” because of their particular economic interests.60 This kind of divergence threatened to expose the key currency system to a different version of the same domestic interest group pressures that brought down the gold standard. Central bankers also recognized that an Anglo-American based key currency system excluded other great powers that were important to the stability of the postwar order but that did not qualify under Williams’ proposal, particularly the

59 Federal Reserve Bank of Philadelphia, Memorandum, “Notes on Discussion of Current Proposals for International Currency Stabilization,” July 14, 1943, NARA, RG 82 DIF, box 63. 60 Louis Raminsky to John H. Williams, Letter, July 15, 1943, NARA, RG 82 DIF, box 62. 145

Soviet Union. Fed policymakers believed that it was “quite possible that Russia would refuse to enter a program based on the key-country approach.”61

Central bankers realized that an Anglo-American dictated postwar currency stabilization plan that antagonized the Soviets was unlikely to find favor within the

Roosevelt administration.62 Secretary of State Cordell Hull insisted from the outset that technical negotiations on postwar plans be inclusive so that the Soviets and other major powers did not feel they were being presented a fait accompli.63 American Treasury officials shared this view and remained solicitous of the Soviets, eager for their participation in the international institutions that eventually emerged from Bretton

Woods. Indeed, Harry Dexter White made the case for including the Soviet Union in one of his earliest drafts of the Fund proposal.64 These concerns were not without merit.

American planners persistently encountered difficulty in obtaining Soviet acceptance of the distribution of voting power in the World Bank plan. The Soviets believed that political factors entitled them to a greater say in the institutions than simple economic statistics suggested.65 Regardless of its political importance, there were reasons to doubt

61 Federal Reserve Bank of Philadelphia, Memorandum, “Notes on Discussion of Current Proposals for International Currency Stabilization,” July 14, 1943, NARA, RG 82 DIF, box 63. 62 Dallek, Franklin Roosevelt and American Foreign Policy, 533. 63 Secretary of State Cordell Hull to Ambassador in the United Kingdom, Telegram, May 14, 1942, Foreign Relations of the United States, 1942 (Washington, D.C.: U.S. Government Printing Office, 1960), 1:170 (hereafter FRUS, with appropriate year and volume). 64 Randall Bennett Woods, A Changing of the Guard: Anglo-American Relations, 1941-1946 (Chapel Hill: University of North Carolina Press, 1990), 140-3; United States Treasury, “Preliminary Draft Proposal for a United Nations Stabilization Fund and a Bank for Reconstruction and Development of the United and Associated Nations,” April 1942, in International Monetary Fund, III, ed. J. Keither Horsefield (Washington, D.C.: International Monetary Fund, 1969), 73. 65 Federal Reserve Board of Governors, Minutes of Technical Group Meeting at the Treasury, April 22, 1944, NARA, RG 82 DIF, box 55; Federal Reserve Board of Governors, Details of Treasury Bank proposal with marginal notations, June 30, 1944, NARA, RG 82 DIF, box 57. 146

the Soviet Union was economically unimportant as the key currency proposal implied.

Indeed, some at the Fed anticipated the Soviets eventually becoming an “industrial exporter of considerable magnitude,” with market penetration beyond neighboring

“backward Asiatic countries,” even if not immediately.66 Thus, there were both real political and potential economic incentives for ensuring Soviet participation in all facets of postwar planning, including international currency stabilization, a fact that Board officials obviously believed Williams neglected.

Multilateralists continually emphasized the dangers of the reality or even the appearance of Anglo-American great power domination. In a lengthy but collegial response to Williams’ key currency proposals, Louis Rasminsky of the Bank of Canada expressed concern that it represented an extension of great power domination into international monetary affairs.67 Advocates of multilateralism emphasized the need to avoid “imperialistic policies” and instead “work toward . . . partnership between all the countries of the world.”68 This view derived rather naturally from the Fed’s assessment of the collapse of the interwar gold standard. States, particularly those with persistent balance-of-payments deficits, felt themselves squeezed between the impersonal deflationary demands of gold convertibility and the adoption of nationalist and autarkic alternatives. A workable postwar system required sufficient sensitivity to the demands of

66 Alexander Gerschenkron, “Future Composition of Russian Exports,” Federal Reserve Board of Governors Review of Foreign Developments (hereafter RFD), January 22, 1945, Federal Reserve Board of Governors, http://www.federalreserve.gov/pubs/rfd/1945/2/rfd2.pdf (accessed December 4, 2009). 67 Louis Rasminsky to John H. Williams, Letter, July 15, 1943, NARA, RG 82 DIF, box 62. 68 E. A. Goldenweiser, Address before the International Post-War Monetary Stabilization Conference, August 26, 1943, NARA, RG 82 DIF, box 64. 147

all states to ensure that the incentives for adhering to the proposed monetary order exceeded those for leaving.69

Fund advocates worried not only about the potential reaction of small states to exclusion from a key currency plan but also about the implications of their actions for larger states. Here the Board found itself in agreement with Treasury officials during a meeting with the FRBNY. Responding to Williams’ plan, Harry Dexter White acknowledged the need to stabilize the value of the so-called key countries but feared that in response, small countries, left out of the solution, might resort to currency depreciation or other manipulative techniques. These actions, in turn, would pressure other small countries to follow suit, with the cumulative effect of ultimately undermining the stability of the so-called key currencies. White specifically cited the possibility of currency depreciation putting pressure on parts of the British Empire, ultimately transmitting the instability to Britain and threatening one of the two pillars of the key currency approach.

Goldenweiser concurred, arguing that the key currency approach ignored the vulnerability to cumulative disturbances in small countries making it better to incorporate them into the solution earlier rather than later.70

According to Goldenweiser and White, therefore, the multilateral approach of the

Fund provided a more complete solution. It incorporated the largest number of states at

69 The dynamic relationship between the leaders and followers of a monetary order is a point stressed in Louis W. Pauly, “Monetary Statecraft in Follower States,” in International Monetary Power, Andrews ed., Ch. 9. 70 William F. Treiber, Secretary, Federal Reserve Bank of New York, Memorandum, “Notes on Discussion Regarding Post-War International Currency Stabilization,” September 2, 1943, NARA, RG 82 DIF, box 62. 148

the beginning and thereby prevented instability in large or small states from infecting other economies. In contrast the Williams approach stabilized key countries but left them vulnerable to a multitude of small crises. In essence, central bank advocates of the Fund recognized that, without a reliable lender of last resort, the contagion effect of economic crises in small states threatened exchange rates in much the same way that the cumulative effect of small banking crises during a bank panic threatened the domestic economy.

Fed officials went even further in turning what Williams saw as the liabilities of the Fund plan into assets. Where Williams believed that the desperate needs of the postwar transitional period threatened to overwhelm the resources of the Fund,

Goldenweiser took the opposite approach. He argued that stabilizing Britain alone required a massive American loan, while the multilateral Fund approach allowed U.S. resources to help stabilize the currencies of smaller countries that could then serve as a reliable customer base for British exports.71 Ultimately stabilizing the pound did require a substantial loan negotiated during 1945-46; nevertheless support for the Fund and opposition to the key currency proposal highlights the sincere belief many central bankers had in the benefits of a comprehensive multilateral currency stabilization plan for assisting member states.

The other major line of argument pursued by supporters of the Fund proposal framed U.S. participation as a demonstration to the rest of the world of American commitment to international cooperation. The Fund not only incorporated the largest

71 E. A. Goldenweiser, Memorandum, “Senator Taft’s Criticism,” July 18, 1944, NARA, RG 82 DIF, box 38. 149

number of states, offering them the reassurance of an international lender of last resort and collective action, it also bound the United States to the rest of the world. Alvin

Hansen argued that White’s plan for a stabilization fund represented a test case for the willingness of American postwar cooperation.72 Participation in a multilateral organization provided confidence that in a potential crisis a viable international lender of last resort existed. It is improbable that a Fund without the United States, clearly the economically strongest nation in the wake of the war, would have possessed the resources necessary to fulfill this role. Alternatively, a key currency Anglo-American system provided no assurance that smaller states would have access to liquidity in times of acute payments imbalance.

Reference to the links between the Fund proposals and the rhetoric of the U.S. vision for the postwar world increased as Congress began considering adoption of the

Bretton Woods Agreements following the July 1944 conference. Goldenweiser echoed

Hansen’s earlier argument and supported the adoption of the Fund plan based upon the implications for American leadership and the lessons of the interwar era. Rejection of

American membership in the Fund meant that U.S. global “leadership in the world will be jeopardized,” which threatened the prospects for long-term global prosperity. He cautioned that rejection presented the nation with “the same situation as after the last war when we didn’t join the League of Nations, but it will be more fatal this time.”73 He believed collective action on currency stabilization was far more in line with the United

72 Alvin Hansen, Memorandum, “The International Monetary Plan,” June 1, 1944, NARA, RG 82 DIF, box 61. 73 Federal Reserve Board of Governors, Transcript, “Talk by Goldenweiser to Federal Reserve Group, July 31, 1944,” July 31, 1944, NARA, RG 82 DIF, box 38. 150

Nations approach than key currency and urged policymakers to “break away” from their

“usual moorings . . . and explore new lanes in uncharted seas,” seeking “bolder methods” in addressing the problems likely to confront them in the postwar era. Goldenweiser expressed a comparable sentiment in a paper he co-authored with Alice Bourneuf. They saw the Bretton Woods Agreement as a test of the “ability of the United Nations to cooperate in working out problems.”74 Walter Gardner similarly argued that other nations were waiting to see how the United States acted toward Bretton Woods, which they considered a good indication of the prospects for international cooperation in other areas.75

The link between cooperation on currency stabilization and collaboration in other areas is particularly important given the way central bankers saw the Fund fitting into the larger postwar economic system. Fed officials continually and frequently stressed their belief that the Fund did not represent a “panacea” but rather part of a “broad financial stabilization program.”76 Some of the required reforms were purely domestic, like a commitment to maintain high employment. Others required international cooperation, such as efforts to control speculative movements of short-term capital or to liberalize

74 E. A. Goldenweiser and Alice Bourneuf, Paper, “Bretton Woods Agreements,” August 12, 1944, NARA, RG 82 DIF, box 38; E. A. Goldenweiser, Statement, “Statement by Mr. Goldenweiser, Economist of the Federal Open Market Committee, at the meeting of the Committee on June 28, 1943,” June 28, 1943, NARA, RG 82 DIF, box 61; A modified version of the paper appeared in the Federal Reserve Bulletin but without reference to the significance of Bretton Woods for demonstrating United Nations postwar cooperation. E. A. Goldenweiser and Alice Bourneuf, “Bretton Woods Agreements,” Federal Reserve Bulletin 30, no. 9 (September 1944), 850-70. 75 Walter Gardner, Memorandum for Radio Talk on WFBR in Baltimore, “The Bretton Woods Agreements Now Before Congress,” NARA, RG 82 DIF, box 38. 76 R. M. Evans, Memorandum, “Plans for International Currency Stabilization,” October 1, 1943, NARA, RG 82 DIF, box 61; Alice Bourneuf, Memorandum, “The Fundamental Requirements of a Satisfactory Stabilization Plan,” November 4, 1943, NARA, RG 82 DIF, box 61. 151

international trade and reduce tariff barriers.77 They also denied accusations that cast

Fund membership as a compromise of American sovereignty.78 From the Fed’s perspective, cooperation in currency stabilization reinforced the confidence of nations to participate in international arrangements in these other areas, while rejection complicated measures seen as vital to restoring economic prosperity and political stability.

Beyond general appeals to the economic benefits of cooperation, supporters sought to explicitly link the Fund to the ideals of the Atlantic Charter and the collective security goals of the United Nations. They argued that the Anglo-American great power collaboration implied by key currency was not “in line with the Atlantic Charter and other democratic pronouncements.”79 The Board of Governors found support from outside the central bank, such as economist Michael Heilperin, who forwarded

Goldenweiser a paper he wrote for Bristol-Myers on the Bretton Woods plans. In it he argued that a fundamental link existed between Bretton Woods and Dumbarton Oaks so that the failure of collaboration in one area threatened other multilateral schemes.80

77 Alice Bourneuf, Address, “Talk to be Given Before the Middle Atlantic Division of the American Association of Bank Women,” January 14, 1945, NARA, RG 82 DIF, box 38. 78 The Federal Reserve Bank of Philadelphia suggested that the Fund represented no more a compromise of American sovereignty than did adherence to gold standard norms. Federal Reserve Bank of Philadelphia, Memorandum, “Notes on Discussion of Current Proposals for International Currency Stabilization,” July 14, 1943, NARA, RG 82 DIF, box 63; William F. Treiber, Secretary, Federal Reserve Bank of New York, Memorandum, “Notes on Discussion Regarding Post-War International Currency Stabilization,” September 2, 1943, NARA, RG 82 DIF, box 62; John H. Williams to Federal Reserve Bank Board of Governors, forward of FRBNY Wallich Memorandum, “Sovereignty Under the White Plan,” dated September 30, 1943, NARA, RG 82 DIF, box 62; Alice Bourneuf to Walter Gardner, Memorandum, “Comments on the Statement on International Currency Stabilization submitted to the Board of Governors by Mr. Sproul on October 7, 1943,” November 9, 1943, NARA, RG 82 DIF, box 62. 79 E. A. Goldenweiser to Chester Morrill, Memorandum, September 18, 1944, NARA, RG 82 DIF, box 38. 80 Michael Heilperin to E. A. Goldenweiser, Letter, February 23, 1945, NARA, RG 82 DIF, box 34; Michael Heilperin, Memorandum, “Economic Memorandum #24: ‘The American Bankers Association and Bretton Woods,’” February 21, 1945, NARA, RG 82 DIF, box 34. 152

Similarly, a group of Philadelphia bankers penned a statement expressing the belief that

Bretton Woods represented a necessary corollary to the United Nations proposal.81 The recognition that economic conditions provided the basis for political stability certainly resonated with the way the Board of Governors understood the interwar era.

Thus, from the perspective of the Federal Reserve Board of Governors, the Fund addressed a major concern by at least reducing the potential for the kinds of nationalist economic policies that led to political nationalism, dictatorship, and eventually war. It avoided the possibility that key currencies might mutate into exclusive economic blocs with small states becoming politically subordinate to key countries.82 Indeed, Karl Bopp of the Philadelphia Federal Reserve in an address to the Business Advisory Council warned of the potential “for blocs with key countries in the center and satellites moving in their orbit.” This created the conditions not just for economic warfare as nations focused on their own short-term interests but also for military conflict should one key country find itself encroaching on the satellites and interests of another.83 Board officials firmly believed that the Fund reduced the danger of key currencies degenerating into

81 Randolph Evans, et. al., Memorandum, “Bretton Woods Agreements,” March 20, 1945, NARA, RG 82 DIF, box 36. 82 Wallich to Knoke, Memorandum, “Address by Canadian Minister of Finance J.L. Ilsley on ‘The Problems of Monetary Stabilization,’” November 17, 1943, NARA, RG 82 DIF, box 62. 83 Karl Bopp, Memorandum, “International Monetary Fund: Substance of Remarks to the Business Advisory Council,” June 29, 1944, NARA, RG 82 DIF, box 63; the Treasury Department echoed this assessment of the key currency approach. Department of the Treasury, Memorandum, “The Bretton Woods Program: Answers and Questions Submitted by a Joint Committee of the ABA and ARCB,” October 21, 1944, NARA, RG 82 DIF, box 34. 153

warring economic blocs centered on key currencies or great power collusion, the very conditions central bankers blamed for the outbreak of the Second World War.84

A point must also be made about the nature of the debate between key currency and multilateral approaches to exchange stabilization and how the Fed saw its role within the larger bureaucratic structure. Board members recognized the important implications of both the Fund and the proposed World Bank for their ability to manage domestic credit conditions. Yet, while Chairman Marriner Eccles supported open debate about the key currency plan among central bankers, he sought to prevent this debate from moving into the public arena.

Eccles’ desire to temper the form of the Fed’s concerns with the Bretton Woods plan and its advocacy of alternatives, including the key currency approach, grew from two interrelated issues. On the one hand, he recognized that the multilateral approach represented a compromise solution.85 Board members did not believe it was possible to object too strongly to the specifics of the Fund plan, concerned that a serious and public dissent on the part of the Fed might throw a “monkey wrench into the machinery,” of international cooperation. Central bankers argued that it was better to adopt any plan, even a less than perfect Fund, and rely on sound management to correct any mistakes,

84 Earnest Draper, Statement, “Statement by Mr. Draper to Board of Governors, June 191, 1944,” June 19, 1944, NARA, RG 82 DIF, box 38; Federal Reserve Board of Governors Division of Research and Statistics, Memorandum, “Replies to Objections to the Fund and Bank Plans Presented by Representative Wolcott as Listed in the American Banker, February 28, 1945,” March 26, 1945, NARA, RG 82 DIF, box 36. 85 Federal Reserve Board of Governors, Transcript of Telephone Conversation, May 31, 1944, NARA, RG 82 DIF, box 38. 154

than to adjourn the international conference without an agreement and risk the breakdown of cooperation on currency stabilization and potentially other pressing concerns.86

On the other hand, central bankers hoped to prevent compromising their ability to influence the development of the operation of the Bretton Woods proposals. Indeed, concurrent with technical negotiations on the White plan, Fed officials supported the creation of an interagency council that included a representative from the Board to oversee and manage the American delegates to the proposed Fund and World Bank.87

Board members expressed concern that “public expressions of differences of opinion within the System would tend to impair effective representation at the international conference and to destroy any influence that the System might have in subsequent dealings with the outcome of the Conference.”88 Eccles denied accusations from Sproul that he was attempting have opposition “muzzled”; rather, he feared that a split within the

Fed would appear to the public as a split between the central bank and the Treasury and

“would very likely result in the complete exclusion of the Board thereafter from any participation in the development of the plan or in its workings if it were put into effect.”89

In many ways the importance the Fed put on this approach is evident from the fury Eccles felt when the debate about the key currency approach failed to remain within the confines of the Federal Reserve. John H. Williams in particular took great pains to

86 Albert Creighton to Chairmen of Federal Reserve Banks (except Boston), Letter, June 8, 1944, NARA, RG 82 DIF, box 38. 87 The proposal for what ultimately became the National Advisory Council on International Monetary and Financial Problems is explored at greater length in Chapter 4. 88 Federal Reserve Board of Governors (FRBG), Meeting Minutes, June 19, 1944, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min061944.pdf (accessed February 25, 2011). 89 Federal Reserve Board of Governors, Minutes, “Joint Meeting Federal Reserve Bank Presidents and Federal Reserve Board of Governors 9/22/1944,” September 22, 1944, NARA, RG 82 DIF, box 38. 155

publicize his key currency plan, publishing several articles during the war, most prominently in Foreign Affairs.90 Even more galling from Eccles’ perspective was the appearance of both Sproul and Williams before Congress in the summer of 1945 to testify against the Fund plan.91 In the aftermath of their testimony Eccles exploded in a letter to

Beardsley Ruml, the Macy’s executive and chairman of the FRBNY. Eccles claimed to have been blindsided by the appearance of Sproul and Williams before Congress, a somewhat dubious assertion given their consistent opposition to the Fund proposal.

Nevertheless Eccles condemned them for creating a “spectacle” and suggesting that the

Federal Reserve opposed to the Truman administration-backed Bretton Woods

Agreement.92

Central bankers’ attitudes about the nature of the key currency debate help to clarify their thinking about the nature of multilateral currency stabilization as well as their views about the larger postwar environment. They reveal that many, particularly at the Board of Governors, were committed to the principle of multilateral cooperation.

They saw a less than ideal multilateral plan as superior to either the key currency approach or to no plan at all. Board members went further, however, and believed that once nations accepted the principle of multilateralism, a sufficiently prudent management structure could overcome any defects in the details of the plan. With all of this in mind

Fed officials chose to temporarily subordinate their immediate concerns while seeking to

90 John H. Williams, “International Monetary Plans: After Bretton Woods,” Foreign Affairs 23, no. 1 (October 1944): 38-56. 91 Both Sproul and Williams appeared before the United States Senate. Congress, Senate, Committee on Banking and Currency, Bretton Woods Agreements Act. 79th Cong., 1st sess., June 21, 1945, 301-49. 92 Marriner Eccles to Beardsley Ruml, Letter, June 29, 1945, NARA, RG 82 DIF, box 36. 156

put in place a mechanism to influence the development of the Fund after the war. In many ways this parallels the approach central bankers took to wartime finance, muting immediate concerns about inflationary policies and focusing on supporting the administrations official policy and planning to address outstanding concerns during the conversion to peacetime conditions.

Currency Stabilization: Capital Controls versus Trade Liberalization

The Fund approach to currency stabilization went far in addressing many of the structural problems the Federal Reserve perceived with the interwar gold standard. It established a reliable international lender of last resort and replaced the ad hoc reliance on creditors that marked the operation of the gold standard. An examination of the way the adjustment burden contributed to the breakdown of the interwar gold standard, as well as a better understanding of the consequences as central bankers understood them, helps to further clarify how the Fed saw the International Monetary Fund as a critical component in securing an economically prosperous and politically stable postwar order.

According to the price-specie view of the gold standard international movement of investment capital exercised a stabilizing influence on economies. As gold and international reserves flowed out of a deficit economy prices and interest rates increased, helping exports and attracting investment income. Reflecting upon the interwar experience and the onset of the Great Depression, however, Fed officials came to see international capital flows not as a stabilizing force but rather as intensely disruptive. 157

They believed that short-term investment capital movements, so-called hot money, reacted not to real economic conditions but rather to speculative attempts to reap substantial profits.

During the operation of the gold standard hot money weakened a currency when investors believed, correctly or not, that a country faced a persistent drain of its international reserves that threatened its ability to defend its exchange rate. Speculators, hoping to reap a quick profit, fled the currency. For instance, speculators might anticipate that gold outflow endangered Britain’s commitment to sterling convertibility, and in anticipation of a crisis rush to exchange their sterling balances for gold and then change back into sterling at a higher exchange rate following the devaluation. This movement of hot money was problematic for two reasons. First, as speculators rushed out of national currencies, such as sterling, and into gold they actually intensified the crisis they hoped to profit from. Second, the uncertainty in the value of currencies created by such speculative movements deterred traders and investors fearful of finding the worth of foreign deposits or investments devalued from conducting business.

Fed officials believed that hot money flows resulted in high unemployment and lower economic activity as businesses and financiers sought to protect themselves from currency risk. Policymakers in the United States and abroad saw hot money as a particularly disruptive force during the interwar era, one that exacerbated many of the economic and monetary problems of the period.93 They contended that speculative

93 Federal Reserve Bank of Richmond Department of Research and Statistics, Memorandum, “The International Currency Plans,” August 2, 1943, NARA, RG 82 DIF, box 64; 158

movements of short-term capital compromised their ability to manage domestic credit conditions. According to Matthew Szymczak of the Board of Governors, hot money resulted in an influx of gold to the United States as investors sought a safe haven, undermining the Fed’s domestic responsibilities as well as contributing to the generally unstable international balance-of-payments situation.94

The Fed believed the Fund restored confidence in currency values by serving as an international lender of last resort and also by facilitating the application of capital controls under specific circumstances, both of which served to check speculative hot money flows. First, the knowledge that the Fund offered a reliable international lender of last resort for states during times of crisis eliminated the incentives for these types of self- fulfilling speculative attacks. As Alice Bourneuf recognized, this was particularly important for assisting the recovery of small nations.95 The economies of small countries, with fewer international reserves, were less able to stand up to speculative attacks or intense capital flight. Incorporating them into the Fund gave them access to international liquidity and made them less vulnerable to movements of hot money. Thus, from the perspective of the Board of Governors, the Fund’s ability to act as an international lender of last resort reduced a major interwar weakness that had been the source of currency instability while also lending weight to the supporters of a multilateral approach to currency stabilization.

94 Matthew Szymczak, Speech, “Federal Reserve and the Bretton Woods Proposals: Delivered before Chicago Chapters of the American Statistical Association and the American Marketing Association,” March 21, 1945, NARA, RG 82 DIF, box 38. 95 Alice Bourneuf, Memorandum, “Postwar International Monetary Institutions,” January 22, 1944, NARA, RG 82 DIF, box 38. 159

The Fund proposal also directly addressed the issue of speculative hot money flows by providing for the application of capital controls. Some of the earliest versions of both the Keynes and White plans included provisions to control capital movements.96

Central bankers, including officials with the FRBNY, generally recognized the destabilizing effect of speculative capital movements and therefore supported the idea of controls.97

Fed officials saw a regime that allowed capital controls as beneficial to all members of the Fund, including the United States. Considering the likely strength of the

U.S. economy relative to the rest of the world, it seemed reasonable to anticipate high demand for dollars to purchase goods only available from the American market. Capital controls that prevented speculative flight into dollars ensured that these resources remained available for use and did not sit idle.98 Controls, therefore, not only prevented destabilizing capital flights, but also contributed to the effort to restore the postwar economy by ensuring that the largest supply of dollars remained available for productive purposes. The stability provided by capital controls extended to the American economy.

Additionally, the economic expansion of the war (Chapter 1) created significant inflationary potential, and the potential influx of hot money threatened to further

96 John Maynard Keynes, “Proposal for an International Currency (or Clearing) Union,” February 11, 1942, in International Monetary Fund, III, ed. Horsefield, 13; United States Treasury, “Preliminary Draft Outline of a Proposal for an International Stabilization Fund of the United and Associated Nations,” July 10, 1943, in International Monetary Fund, III, ed. Horsefield, 95. 97 Arthur Bloomfield, Memorandum, “Keynesian Plan for a Postwar International Clearing Union,” January 6, 1943, NARA, RG 82 DIF, box 63; Alice Bourneuf to E. A. Goldenweiser, Memorandum, “Non-Technical Summary of White Plan,” August 14, 1943, NARA, RG 82 DIF, box 61. 98 Walter Gardner, Memorandum, “A Plan for International Monetary Stabilization Without Destroying Federal Reserve Control of Credit,” March 24, 1943, NARA, RG 82 DIF, box 61. 160

exacerbate the situation.99 Capital controls thereby served Fed efforts to manage domestic credit conditions by eliminating a destabilizing source of credit expansion.

At the same time Federal Reserve officials remained cognizant of the potential for a regime of stabilizing capital controls to devolve into restrictive discrimination. Walter

Gardner voiced reservations that a system of capital controls might necessitate an equally broad system of exchange controls. Gardner feared that if a currency stabilization system enabled states to impose broad and sweeping exchange controls, this might undermine confidence and inhibit the revival of international investment. He expressed particular concern that the Keynes plan implied licensing all international transactions, both commercial and capital, to prevent unproductive or covert transfers of funds.100

Essentially, Gardner feared that plans for capital controls might become self-defeating.

The intention of preventing flows of hot money was to insulate states against speculative attacks that threatened their exchange rates, with the ultimate goal of restoring postwar investment and trade as private markets gained greater confidence in currency values. A system of extensive exchange controls that potentially allowed states to trap investors threatened to offset these benefits. While investors and commercial interests might have their confidence bolstered that states were no longer as vulnerable to hot money flows, they might still refrain from reentering the market to an extent that ensured postwar prosperity out of concern that they were now vulnerable to exchange controls.

99 Karl Bopp, Memorandum, “International Monetary and Financial Proposals,” April 6, 1945, NARA, RG 82 DIF, box 36; Matthew Szymczak, Memorandum, “Some Opinions on Bretton Woods,” May 1, 1945, NARA, RG 82 DIF, box 38. 100 Walter Gardner to Matthew Szymczak, Memorandum, “The Treasury's Plan for a World Stabilization Fund,” January 29, 1943, NARA, RG 82 DIF, box 61; Walter Gardner, Memorandum, “The British Proposal for an ‘International Clearing Union,’” February 17, 1943, NARA, RG 82 DIF, box 64. 161

In the end the language of the Fund plan included a compromise that the Board of

Governors found acceptable. The Bretton Woods Agreement empowered the Fund to request that members impose capital controls to prevent misuse of Fund resources. It also permitted members to “exercise such controls as are necessary to regulate international capital movements” but that did not act in a discriminatory way or inhibit current account payments.101 Fed officials supported language “sufficiently general” so as to encourage states gaining and losing capital to take action to control its movement, while also not imposing a rigid control regime.102

The Fund plan for capital controls therefore addressed a number of shortcomings that central bankers saw with the interwar monetary system. The plan provided a degree of flexibility. It did not impose rigid requirements, dictating when and under what circumstances nations must impose capital controls, but rather allowed them sufficient leeway to account for unique national or situational circumstances. Nevertheless it included incentives to make use of capital controls, for instance predicating continued access to Fund resources on their not being used to facilitate capital transfers. At the same time the Fund Agreement also prohibited the use of discriminatory exchange controls. Thus, it incentivized nations to act responsibly and to impose capital controls when appropriate but not so extensively as to represent discriminatory exchange practices if they wished continued access to the Fund. Considering the way Fed officials continually linked the breakdown of the economic order to the ultimate collapse of

101 United States Treasury, Articles of Agreement: United Nations Monetary and Financial Conference, 13-14. 102 Federal Reserve Board of Governors, Memorandum, “The International Monetary Fund and Measure to Safeguard the Federal Reserve System,” June 5, 1944, NARA, RG 82 DIF, box 38. 162

political peace, the Fund’s check on speculative capital therefore made a positive contribution to a stable postwar environment.

Central bankers also recognized that restrictive American trade practices compounded the interwar adjustment burden and anticipated the Fund helping, indirectly, to alleviate this problem. During the interwar era the United States was relatively less dependent upon both imports from and exports to the rest of the world than vice versa.

The fact that the United States bought substantially less from foreigners contributed to a

“chronic” shortage of dollars.103 This gap only grew when American officials imposed and increased tariff barriers that further impeded the ability of foreign countries to earn dollars by selling to the United States.104 While countries found it harder to borrow the dollars necessary to purchase American exports, the breakdown of trade relations made it increasingly difficult to earn those dollars by increasing their own exports to the United

States

The Fund, Fed officials believed, made several adjustments to the structure and operation of the international economy that indirectly contributed to the revival of international trade, a point they emphasized in officially endorsing the Bretton Woods

Agreements.105 They particularly highlighted how control of speculative capital restored confidence and stimulated trade. Frank Neely of the Federal Reserve Bank of Atlanta

103 Charles Kindleberger, Memorandum, “International Monetary Stabilization,” September 4, 1942, NARA, RG 82 DIF, box 61. 104 Arthur C. Bunce, Paper, “The Bretton Woods Agreements,” April 28, 1945, NARA, RG 82 DIF, box 38. 105 Federal Reserve System Board of Governors, “International Fund and Bank,” statement by the Board of Governors of the Federal Reserve System, released March 21, 1945, reprinted in the Federal Reserve Bulletin 31, no. 4 (April 1945), 304-5. 163

stressed the dynamic interrelationship between trade and currency stability. According to

Neely, currency instability resulted in fluctuations in international trade. This, in turn, led to swings in nations’ balance of payments and prompted speculative capital flows.106

As doubts arose about a nation’s ability to defend its foreign exchange rate speculators withdrew short-term capital, resulting in greater currency instability that added to the vicious speculative cycle. The Fund’s allowance of capital controls reduced speculative attacks and restored confidence in currency values, while its provision of liquidity during balance-of-payments disequilibrium reduced the need to choose between protective tariffs or painful deflations. This encouraged importers and exporters to reenter the market while also lowering the barriers they faced, making it easier to stabilize international payments. Greater trade and equilibrium in international payments eliminated an important reason for speculative capital movements and further eased pressures on nations’ international reserves. Thus, by restoring confidence in the value of currencies the Fund made a positive, if indirect, contribution to the resumption of international trade.107 The Board of Governors therefore accepted a tradeoff inherent in the Bretton Woods proposal, accepting restrictions on international capital movements in exchange for the promise of greater trade liberalization.108

106 Frank Neely to Ronald Ransom, Letter, October 12, 1943, NARA, RG 82 DIF, box 64. 107 Federal Reserve Board of Governors, Transcript, “Talk by Goldenweiser to Federal Reserve Group, July 31, 1944,” July 32, 1944, NARA, RG 82 DIF, box 38; Federal Reserve Board of Governors, Draft Memorandum, “International Fund and Bank (Statement by Board of Governors of the Federal Reserve System),” December 1, 1944, NARA, RG 82 DIF, box 36. 108 This tradeoff between capital controls and trade liberalization is developed in Eric Helleiner, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s (Ithaca: Cornell University Press, 1994), Ch. 2. 164

The Fed’s endorsement of the Bretton Woods Agreement also built upon a long and protracted debate about the precise link between domestic and international prosperity. A complex interrelationship existed among trade and tariffs, pro-growth and employment policies, and exchange stability. The Fund contributed to this dynamic by fostering multilateral collaboration to control destabilizing short-term speculative capital movements. Additionally, by serving as an international lender of last resort and financing temporary imbalances in international payments the Fund allowed nations faced with a downturn to undertake expansionary policies. This reduced the pressure on debtors to accept economic contraction and higher unemployment, a policy path states found increasingly unacceptable and that, from the perspective of central bankers and other policymakers, only inspired economic nationalism and autarky. Conversely, a commitment to full employment, both within the United States and in other nations, promoted general economic growth. While some Fed officials saw full employment as extremely critical, even more skeptical voices, such as Alice Boruneuf, recognized that full employment, which increased American imports, promoted a balanced international trade relationship, if only over time.109 Finally, by giving nations greater scope to pursue full employment policies, Fed officials believed this domestic autonomy reduced opposition to lowering tariff barriers and progressively liberalizing trade relations.110

109 Federal Reserve Board of Governors, Memorandum, “International Fund and Bank (Statement by Board of Governors of the Federal Reserve System),” December 1, 1944, NARA, RG 82 DIF, box 36; Alice Bourneuf to Walter Gardner, Memorandum, “Comments on the Statement on International Currency Stabilization submitted to the Board of Governors by Mr. Sproul on October 7, 1943,” November 9, 1943, NARA, RG 82 DIF, box 62. 110 Walter Gardner to Federal Reserve Board of Governors, Memorandum, “The White Plan and control of the gold inflow,” July 3, 1943, NARA, RG 82 DIF, box 61. 165

Fed officials recognized that trade and tariffs represented a far more politically sensitive area than short-term capital flows and took pains to explain the benefits of the

Fund in this area. Central bankers argued that in reviving international trade the Fund not only benefited not just elite business interests but also made a direct and positive contribution to the lives of average Americans who worked in export-oriented industries.

In this way, the benefits of the Fund diffused throughout society.111 At the same time Fed officials stressed that while the Fund might make recommendations about trade policy it did not possess the power to compel the United States to take a specific action on tariffs.112 In this way it sought to alleviate fears of an international institution dictating

American trade policy. Rather than compulsion, Fed officials emphasized the need for

Americans to rethink their approach to exports and imports. Walter Gardner argued that the nation needed to increase its consumption of imports to contribute to a rebalanced international trade system. He attempted to navigate the tricky situation by suggesting that an immediate reduction of American tariffs could have a disruptive effect on the

American economy. He also reiterated that a stable international trade system could not be built simply upon borrowing American dollars.113 It is reasonable to assume that

Gardner believed a system based upon continued American lending rather than allowing countries to earn dollars through exports risked repeating the interwar experience with

111 E. A. Goldenweiser, Memorandum, “International Monetary Fund (Purposes, Methods, Consequences),” July 21, 1944, NARA, RG 82 DIF, box 38. 112 Federal Reserve Board of Governors Division of Research and Statistics, Memorandum, “Replies to Objections to the Fund and Bank Plans Presented by Representative Wolcott as Listed in the American Banker, February 28, 1945 Prelim Draft,” March 26, 1945, NARA, RG 82 DIF, box 36. 113 Walter Gardner, Memorandum, “Statement on Bretton Woods Agreements,” June 18, 1945, NARA, RG 82 DIF, box 36. 166

presumably the same tragic results. In many ways this paralleled the argument central bankers mobilized in support of the plan for a World Bank.

Finally, Fed officials connected the operation of the Fund to the resumption of long-term foreign investment. As previously discussed (Chapter 2) the Federal Reserve supported the creation of the World Bank to help restore the flow of private investment required for long-term economic prosperity. Central bankers recognized yet another dynamic relationship whereby the Fund contributed to the success of the Bank and vice versa. Currency stabilization reassured lenders that the return on funds invested in long- term development projects would maintain their value.114 At the same time the Bank reinforced the success of the Fund by encouraging economic growth and the development of export-oriented industries in war-ravaged countries, promoting balance in international payments.115 In this way Board officials believed that the Fund supplemented another piece of the postwar international structure deemed critical to economic prosperity and political peace.

Despite political concerns Federal Reserve officials recognized the positive contributions the Fund made in restoring a liberal trading system and reviving international investment. The rise of economic nationalism and trade barriers undermined currencies and destabilized the gold standard. By providing liquidity in the

114 E. A. Goldenweiser and Alice Bourneuf, Paper, “Bretton Woods Agreements,” August 12, 1944, NARA, RG 82 DIF, box 38. 115 Federal Reserve Board of Governors, Transcript, “Talk by Goldenweiser to Federal Reserve Group, July 31, 1944,” July 31, 1944, NARA, RG 82 DIF, box 38; Walter Gardner, Memorandum, “The Future International Position of the United States as Affected by the Fund and Bank,” February 27, 1945, NARA, RG 82 DIF, box 38; E. A. Goldenwesier, Memorandum, “International Monetary Cooperation,” May 2, 1945, NARA, RG 82 DIF, box 38. 167

face of payments imbalances, the Fund allowed nations to stretch out the adjustment process, running temporary deficits while avoiding either increased tariffs or acceptance of deflation, increased unemployment, and a decline in domestic standards of living.

This very flexibility, by reducing the tendency to adopt restrictive trade practices, therefore contributed to overall stability of the world economy and increased the chances for securing postwar peace and prosperity.

Balancing Creditor and Debtor Interest

While the Federal Reserve supported a multilateral Fund it did not necessarily support an egalitarian one. Indeed, the Federal Reserve backed a number of provisions that strengthened the voting and oversight power of creditor nations, i.e., the United

States, in the operation of the Fund. Central bankers rationalized the voting distribution as a necessary step to ensure the overall stability of the system. The central bank’s position and reasoning is therefore instructive. It demonstrates how Fed officials attempted to navigate competing imperatives, instilling confidence in the survivability of the currency stabilization system against both international and domestic pressures, while at the same time adhering to their stated, and sincerely held, desire for a more cooperative and multilateral system. It also demonstrates the difficulties Fed officials recognized, yet still accepted, in replacing the informal interwar gold standard with a formal and administered system. 168

National quotas played an important role in the operation of the Fund. As previously mentioned the Fund functioned by selling countries foreign exchange they required. Should a country run into a short fall in its balance of payments with the United

States, instead of having to accept a deflationary contraction it simply sold some of its currency to the Fund for dollars, repaying those dollars over a period of time as it corrected the imbalance. The quota size determined the total amount of foreign exchange a country was eligible to obtain through the Fund. Additionally, the White plan linked a nation’s quota size to its voting power, apportioning a certain voting share to each nation according to its contribution. Therefore a nation with a high national quota possessed the potential to draw upon more Fund resources as well as greater voice in its management.

To be certain, many aspects of the plan, including the right to obtain foreign exchange from the Fund, operated along predefined rules. Other issues, particularly changes in the par value of national currencies, in essence the authorization for a country to devalue its currency, required approval by a certain percentage of votes. The system created an incentive for nations, particularly relatively weak countries, to seek the highest quota possible.

Central bankers expressed concern that early versions of the Fund proposal did not place a maximum cap on national subscriptions.116 As Walter Gardner pointed out because of the link between subscription size and voting power this in effect required the

United States to increase its own contribution any time another nation did in order to

116 Alice Bourneuf to Walter Gardner, Memorandum, “December 11 Draft of the White Stabilization Fund,” December 18, 1942, NARA, RG 82 DIF, box 61. 169

prevent its voting power in Fund operations from being diluted. Indeed during consideration of early drafts of the White plan Fed officials believed it vital that the

United States command at least 25 percent of the votes. According to Gardner, this represented a critical plurality that ensured effective veto over Fund policies the nation opposed as well as providing a substantial base of enacting those policies it deemed important, requiring it to sway only a few key allies to ensure passage.117 Indeed, the fact that the Keynes Clearing Union plan, the main alternative to the Fund, skewed voting power against the United States was one of the important concerns central bankers had with it.118

Fed officials struggled to reconcile the tension between the desire for enhanced debtor voice in the management of the Fund and the perceived need for creditor control.

On the one hand, central bankers recognized the need to increase autonomy of debtors to avoid the rigid, and failed, creditor domination of the gold standard. On the other, some minimum creditor control appeared necessary to ensure the stability of the system and avoid abuse of its resources. Central bankers were particularly concerned given the potential of the Fund for influencing domestic credit conditions. At some level they acknowledged the inevitability of a high postwar demand for dollars as the United States offered one of the few markets able to produce the critical goods needed to reconstruct

117 Walter Gardner to Matthew Szymczak, Memorandum, “The Treasury’s Plan for a World Stabilization Fund,” January 29, 1943, NARA, RG 82 DIF, box 61. 118 Walter Gardner, Memorandum, “The British Proposal for an ‘International Clearing Union,’” February 17, 1943, NARA, RG 82 DIF, box 64; Alice Bourneuf to E. A. Goldenweiser, Memorandum, “Distribution of Control in the Two Stabilization Plans,” April 10, 1943, NARA, RG 82 DIF, box 61. 170

war ravaged economies.119 To counteract this potential, Fed officials consistently pressed

Treasury officials to support an increase in the central bank’s ability to impose credit controls and offset the anticipated influx of international reserves.120 Nevertheless, Fed officials still saw a positive role for a strong creditor voice in the management of the

Fund. Specifically, a dominant role for creditors dampened the potential for debtors to abuse the Fund, drawing on it as a means of permanently financing trade deficits.121

The negative implications of extreme debtor abuse that drained to Fund of its resources resulting in its collapse are fairly obvious. Such an eventuality not only promised a return to the economic disequilibrium and nationalism of the interwar era but also threatened to sour American views on multilateral cooperation. Less extreme, yet still problematic, was the potential that a too accommodating Fund might fail to promote the necessary steps to reestablish balance in international payments, disrupting trade or creating an inflationary surge in the American market. As seen in the discussion of wartime finance, Fed officials feared that disruptive inflation might undermine American domestic prosperity and undercut the willingness of the American people to accept a leadership role in international economic and political affairs. The Fed’s concern with

119 Federal Reserve Bank of Richmond Department of Research and Statistics, Memorandum, “The International Currency Plans,” August 2, 1943, NARA, RG 82 DIF, box 64. 120 Walter Gardner to E. A. Goldenweiser, Memorandum, “The Proposed Division Memorandum on Scope for Federal Reserve Financing in the International Field,” February 19, 1943, NARA, RG 82 DIF, box 64; Walter Gardner to Matthew Szymczak, Memorandum, “Mr. Berle's Hurry-up Meeting on the White-Keynes Plans,” May 28, 1943, NARA, RG 82 DIF, box 61; E. A. Goldenweiser to Federal Reserve Board of Governors, Memorandum, “Current status of the monetary stabilization discussions,” August 9, 1943, NARA, RG 82 DIF, box 61. 121 Walter Gardner to Matthew Szymczak, Memorandum, “US Participation in International Agencies: UNRRA and the Proposed Bank and Fund,” April 12, 1944, NARA, RG 82 DIF, box 56; E. A. Goldenweiser, Address before the Academy of Political Science, “New Monetary Standard,” April 4, 1945, NARA, RG 82 DIF, box 38. 171

the distribution of voting power must be understood within this larger domestic- international context. The Fund created demands on the American market at a time when latent inflationary pressures were already high. Increasing creditor control in the management of the Fund therefore represented a prudent measure to avoid undermining support for the larger multilateral program, not simply a power grab or a restoration of gold standard era creditor dominance.

To this end, Board members supported a Canadian proposal that a nation’s voting power increase or decrease in proportion to its transactions with the Fund. Thus, if a state, such as Great Britain, purchased a certain number of dollars from the Fund, then

U.S. voting power increased while British voting power decreased. An April 1943 version of the White plan published in the Federal Reserve Bulletin omitted this provision, but it appears to have been incorporated into the Fund plan following the publication of a Canadian proposal in June 1943, and a version of the provision made its way into the final agreement adopted at Bretton Woods.122 Walter Gardner expressed support for the inclusion of a scalable voting power.123 Indeed he wrote to Harry Dexter

White that such a provision likely made the entire Fund plan more appealing to Congress by reassuring it that the more other nations relied upon the United States the greater the

122 For the reprinted text of the April 6, 1943 draft of the White plan see the Federal Reserve Bulletin 29, no. 6 (June 1943), 502-7; For a slightly revised version of the Canadian plan that includes the voting provisions see Federal Reserve Bulletin 29, no. 8 (August 1943), 718-28; For a version of the White plan which incorporates the voting provisions see United States Treasury, “Preliminary Draft Outline of a Proposal for an International Stabilization Fund of the United and Associated Nations,” July 10, 1943 in International Monetary Fund, III, ed. Horsefield, 94; United States Treasury, Articles of Agreement, 26-7. 123 Walter Gardner, Memorandum, “Power of United States to limit financing under Keynes and White Plans,” June 1, 1943, NARA, RG 82 DIF, box 61. 172

nation’s say in the operations of the plan became.124 This armored the Fed and other supporters of multilateralism against criticism that the Fund placed likely debtors in a management position, creating the risk for potential abuse.125

Fed officials believed the Fund plan represented a workable compromise that served the needs of both creditors and debtors and balanced the need for stability against the desire to allow as much flexibility and national autonomy as possible. They rejected the FRBNY’s assertion that attempting to give power to small or economically weak countries was a “fiction” that resulted in either “disappointment and bitterness” or

“confusion and frustration.”126 Instead, Board officials believed the Treasury proposal struck a balance, strengthening the voice of the United States while also allowing it to remain “one of the crowd” and not creating the appearance of American dominance.127

This view seems justified when the discussion of voting power is viewed within the context of the Board’s larger support for a multilateral and cooperative approach to currency stabilization.

Conclusion The multilateral approach to postwar currency stabilization therefore appealed to

Fed officials in a number of interrelated ways. Membership committed the United States

124 Walter Gardner to Harry Dexter White, Letter, June 12, 1943, NARA, RG 82 DIF, box 61; E. A. Goldenweiser, Memorandum, “Senator Taft’s Criticism,” NARA, RG 82 DIF, box 38. 125 Alice Bourneuf to Walter Gardner, Memorandum, “Comments on Mr. de Vegh's Paper of September 11, 1944,” September 27, 1944, NARA, RG 82 DIF, box 34. 126 Allan Sproul to Federal Reserve Board of Governors, Forwarded FRBNY Memorandum, “International Currency Stabilization,” October 7, 1943, NARA, RG 82 DIF, box 62. 127 Walter Gardner to Federal Reserve Board of Governors, Memorandum, “The White Plan and control of the gold inflow,” July 3, 1943, NARA, RG 82 DIF, box 61. 173

to a leadership role in the postwar international economy. Additionally, it resolved one of the major shortcomings of the interwar gold standard by reassuring members of access to foreign exchange, particularly dollars, in times of acute crisis. This removed uncertainty about the lack of an international lender of last resort. Furthermore, by including small states and likely debtors in the management and operation of the Fund it offered a sense of shared responsibility, making them joint stakeholders in the survival of a mutually agreed upon and mutually beneficial international system. The result was to remove many of the incentives for nationalistic or autarkic economic policies, which many central bankers, including supporters of the key currency approach, saw as responsible for the political instability and conflict that followed the Great Depression, particularly competitive currency devaluation and beggar-thy-neighbor practices. Thus, by creating a shared interest in the success of a multilateral institution the Fund benefited debtors and small states by providing flexibility while simultaneously reassuring creditors of the stable currency values that diminished risk of competitive currency manipulation.

This puts the Federal Reserve in line with Elizabeth Borgwardt’s view of postwar planners who saw Bretton Woods as a mean for nations to cooperate in constructing a

“just, durable, and legitimate postwar order.”128

128 Borgwardt, New Deal for the World, 139. Chapter Four

“Messenger Boys” or “Men of Ability”: The Federal Reserve, Foreign Financial

Policymaking, and the NAC

In May 1944 members of the Washington, D.C. based Federal Reserve Board of

Governors telephoned the Board’s Chairman Marriner S. Eccles at his family home in

Utah to discuss the upcoming United Nations Monetary and Financial Conference convening in Bretton Woods, New Hampshire. The Roosevelt administration had tapped central bankers to serve at Bretton Woods; Eccles was to appear as a member of the official American delegation while additional members and staffers of the Board of

Governors would attend in other capacities. At the end of a long conversation during which Eccles and other members of the Board of Governors expressed various frustrations with the process leading up the Bretton Woods Conference, the chairman summed up his opinion of the upcoming meeting by declaring, “well, this damn thing is pretty largely a Harry White show.” Harry Dexter White of the Treasury Department had principally authored the proposals for the International Monetary Fund (IMF) and

International Bank for Reconstruction and Development (World Bank), known collectively as the White Plan, to be discussed at the meeting.1 In response to the

1 Policymakers at the time, when referring to the White Plan, often meant only the international stabilization fund proportion of the proposal. This chapter uses the term White Plan to refer to the combined proposals for an international stabilization fund and an international bank for reconstruction and development devised and proposed by Harry Dexter White. When referring to just one portion of this proposal the chapter will specifically state either the Fund or Bank. The reason for the chosen use of

174 175

sarcasm Elliott Thurston and Matthew Szymczak joked that Eccles’ attendance might not be required because if Harry Dexter White was tapping the Chairman’s phone he would not be a delegate for long.2 The exchange, while facetious, demonstrated the recognition among Federal Reserve officials that the Treasury dominated the policymaking process and exerted control over both foreign and domestic economic decision-making.

This chapter examines the active interest of the Federal Reserve in the structure and operation of postwar foreign economic policy. It explores the Fed’s support for the creation of an inter-agency council, within the Bretton Woods enabling legislation, to guide foreign economic policy. Federal Reserve interest developed slowly in the months leading up the July 1944 Bretton Woods Conference but took on new urgency as

Congress debated the Bretton Woods Agreement Act passed in July 1945. The seeds of the plan, however, stretched back to the earliest days of American involvement in the

Second World War. Over the course of the war the Federal Reserve found itself consistently hemmed in by the Treasury and the Roosevelt administration when it came to the formulation and implementation of monetary and financial decisions. While central bankers acknowledged the important roles of other agencies such as the Treasury and State Departments in economic policy, they vigorously fought to preserve their own voice in the postwar bureaucracy. Officials hoped to achieve this objective by creating a formal interagency council, with the Federal Reserve as a legislatively mandated

terminology is to increase the precision of the analysis. To refer to a Bretton Woods plan prior to July 1944 is anachronistic and does not sufficiently distinguish White’s proposal from the so-called Keynes Plan for an international clearing union proposed by the British economist John Maynard Keynes. 2 Federal Reserve Board of Governors, Transcript of Telephone Conversation, May 31, 1944, NARA, RG 82 DIF, box 38. 176

member, to oversee U.S. representatives to the IMF and World Bank. As this chapter demonstrates, the Federal Reserve fought to include this proposal in the Bretton Woods enabling legislation as a way of preventing the Treasury from monopolizing foreign policy. Furthermore, it reveals how central bankers, by embedding the Federal Reserve within the formal international economic policy decision-making structure, hoped to establish themselves as active participants in the crafting and execution of American foreign policy. Fed officials saw this role as particularly important given the way they viewed the interdependence of the health and success of the domestic economy with the larger international system. In passing the enabling legislation Congress created a body similar to the Fed’s proposed interagency council, dubbed the National Advisory Council on International Monetary and Financial Problems (NAC), with the Federal Reserve as an official member.3

The Federal Reserve did not respond passively to the White Plan, simply adapting to the structure of the new postwar international economy as dictated by other interest groups. Rather, central bankers demonstrated a keen awareness of the dynamic interdependence of both the domestic and international economy and how new institutions and bureaucratic structures influenced links between the two. Fed officials sought to secure a voice in postwar economic decision making by both embedding the central bank in new institutional structures as well as developing a capacity to act independently of them.

3 Emanuel Goldenweiser later pointed to the Federal Reserve’s involvement in the creation of the NAC to demonstrate the active involvement of the central bank in the crafting of national policy vis-à-vis Bretton Woods. See E. A. Goldenweiser, American Monetary Policy (New York: McGraw-Hill Book Company, 1954), 236-40. 177

This chapter contributes to an already substantial body of scholarship on the postwar era that highlights the ways growing U.S. international commitments touched, directly or indirectly, nearly every facet of American life. After the Second World War the U.S. government created new agencies such as the National Security Council (NSC) and the Central Intelligence Agency (CIA). It also reorganized existing bureaucracies such as the War and Navy Departments under the auspices of the new Department of

Defense and formally codified the status of existing bodies, like the Joint Chiefs of Staff in new laws.4 Influence on foreign and national security policymaking extended beyond the substantial realignment of the government bureaucracy. Private policy think tanks from the RAND Corporation to the Ford Foundation found themselves increasingly incorporated into the American foreign policymaking structure. The John F. Kennedy

School of Government at Harvard University and other academic institutions turned out the personnel to staff this expanding foreign affairs bureaucracy, thereby establishing an indirect influence over policy.5 Participation in American international affairs transcended formal organizations to interest groups often concerned with issues not directly connected to foreign policy. The business community, labor unions, and the civil rights movement all exerted influence on foreign policy decision-makers, either directly or by the international implications of their domestically oriented activities, and were in

4 The creation of the Department of Defense in chronicled in detail by Samuel Huntington, The Soldier and the State: The Theory and Politics of Civil-Military Relations (Cambridge: Belknap Press of Harvard University Press, 1981); Amy Zeigart discusses the creation of several national security organizations in Flawed by Design: The Evolution of the CIA, JCS, and NSC (Stanford: Stanford University Press, 2000). 5 Bruce Kuklick, Blind Oracles: Intellectuals and War from Kennan to Kissinger (Princeton: Princeton University Press, 2006); David C. Engerman, Know Your Enemy: The Rise and Fall of America’s Soviet Experts (New York: Oxford University Press, 2009). 178

turn shaped by the deepening of America’s global commitments.6 The impact of international affairs even extended to the households that individual American families made for themselves both at home and on military bases overseas.7 This chapter builds upon the existing historiographical trend. Past experience with interagency cooperation on domestic and international issues motivated the Federal Reserve to support the creation of the NAC. Interest in the NAC, however, naturally positioned the Federal

Reserve to participate in defining the terms of the nation’s emerging long-term security commitments. This chapter not only demonstrates how the experiences of the Second

World War shaped the bureaucratic structure of the postwar foreign policy establishment but also begins to address a significant gap in the existing historical literature. While historians have recognized the ways the emerging Cold War influenced everything from security policy to Broadway musicals, few have appreciated or explored its importance for the Federal Reserve System.

Bureaucratic Politics, Political Uncertainty, and the Inter-Agency Council Proposal

The proposal for an interagency council to coordinate American policy toward the

Bank and Fund must be understood within the dynamic policymaking context of the

6 Elizabeth A. Fones-Wolf, Selling Free Enterprise: The Business Assault on Labor and Liberalism, 1945-1960 (Urbana: University of Illinois Press, 1994); Mary Dudziak, Cold War Civil Rights: Race and the Image of American Democracy (Princeton: Princeton University Press, 2000); John Fousek, To Lead the Free World: American Nationalism and the Cultural Roots of the Cold War (Chapel Hill: University of North Carolina Press, 2000). 7 Elaine Taylor May, Homeward Bound: American Families in the Cold War Era (New York: Basic Books, 1988); Donna Alvah, Unofficial Ambassadors: American Military Families Overseas and the Cold War (New York: New York University Press, 2007). 179

Second World War as well as the years and decades leading up to it. Before examining the council proposal itself it is useful to first examine some of the tensions that already existed between departments and agencies of the U.S. government. The larger bureaucratic framework as it existed in the early 1940s, and the associated constraints facing central bankers, will then inform the analysis of the discussions on the size, composition, form, and powers of the proposed interagency council.

The proposal for an interagency council emerged as Federal Reserve officials considered the potential implications of the White Plan for the domestic financial environment. As discussed previously Fed officials expressed great interest, and concern, in how the Fund and Bank proposals shaped U.S. credit and monetary conditions directly and by their effect on the global economy. In order to appreciate the Fed’s perspective it is beneficial to briefly summarize the functions of the Fund and Bank plans as established at Bretton Woods.

The White Plan proposed the creation of two institutions, the International

Monetary Fund and the World Bank, for the stabilization and restoration of the postwar international economy. The Fund promoted exchange rate stability with the goal of expanding global trade. It stabilized currencies and offered a reliable source of funding for short-term balance of payments deficits. The Fund did not lend money in the conventional sense. Instead, it allowed members to remit their own national currencies in exchange for the currency of another member.8 In return, members pledged to avoid

8 United States Department of Treasury, Articles of Agreement: International Monetary Fund and International Bank for Reconstruction and Development, United Nations Monetary and Financial 180

exchange controls or other restrictive policies. The Fund further provided an institutional mechanism for cooperative adjustment of exchange rates in the case of fundamental disequilibrium in the international balance of payments, thus avoiding the competitive depreciations of the 1930s.9

The Bank acted as a companion institution to the Fund. The Bank financed the reconstruction of war-devastated economies with the goal of reviving private investment.

The Bank used only a fraction of its resources to directly grant loans, focusing the bulk of its operations on guaranteeing private lending.10 By aiding war-devastated economies the

Bank promoted the “long-range balanced growth of international trade and the maintenance of equilibrium in balances of payments” and thereby supplemented Fund operations.11

The Federal Reserve acted as the regulator of the national money supply. It fulfilled this function in several ways, including its ability to conduct open market operations. If the central bank wished to expand the supply of money it purchased securities from banks, expanding credit available for lending. To restrain credit the Fed sold securities, shrinking the pool of funds available. But, the central bank’s wartime pledge to support yields on government securities effectively neutralized its ability to

Conference, Bretton Woods, New Hampshire, July 1 to 22, 1944, (Washington, D.C.: Government Printing Office, 1948), 4. 9 Ibid., 15-18. 10 The Bank followed conservative underwriting standards in an effort to convince private investors of its soundness and entice them to re-enter the market. For an expanded discussion see Richard N. Gardner, Sterling-Dollar Diplomacy: The Origins and the Prospects of Our International Economic Order (New York: McGraw-Hill Book Company, 1969), 118; Alfred E. Eckes, Jr., A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971 (Austin: University of Texas Press, 1975), 156-57. 11 Treasury, Articles of Agreement: United Nations Monetary and Financial Conference, 51. 181

employ this tool. Alternatively the Fed could affect credit conditions by altering banks’ required reserves, that portion of funds bankers kept on deposit at the Fed relative to deposits and other liabilities. Lowering reserve requirements freed up funds for lending, loosening monetary conditions, while increasing reserves tightened conditions and served as a restraint. A variety of factors inhibited effective use of reserve requirements as a tool for monetary management, such as their inherent operation based upon negative rather than positive action, concerns about the ability to effectively target reserve changes, and legislative curbs on the ability to alter required ratios.12 The Fund and

Bank, through potential sales or purchases of gold in the American market and their borrowing and lending of dollars, and foreign nations through their employment of those funds, added an additional complicating factors to the Fed’s mission.

Federal Reserve officials, cognizant of the potential implications of the Fund and

Bank for domestic monetary and credit conditions, conceived of the interagency council proposal as a means of protecting their bureaucratic autonomy. James Q. Wilson argues that government agencies invest substantial importance in maintaining their autonomy or bureaucratic “turf.” Wilson defines a high degree of autonomy as the exclusion of external interest groups and potential bureaucratic rivals from specific tasks. Autonomy therefore concentrates the decision-making process in a smaller number of stakeholders, resulting in a more “cohesive sense of mission.” Wilson argues that agencies often give up certain responsibilities or define and/or reinterpret their mission along narrow parameters in an attempt to increase their autonomy. While this approach may reduce the

12 Paul A. Samuelson, Economics (New York: McGraw-Hill Book Company, Inc., 1948), 337-48. 182

size, funding, and indeed overall power of the agency, Wilson argues that bureaucracies will often view the trade as beneficial if it results in higher autonomy over those tasks that remain within its purview.13 The Federal Reserve supported the interagency council proposal, at least in part, as will be demonstrated, because of a desire to preserve domestic policy autonomy.

This interpretation adds to the existing scholarship that traditionally views the council proposal as a means of curbing the Treasury’s power in international economic decision-making.14 In doing so, it demonstrates how ostensibly domestic concerns drew groups into greater involvement in the foreign affairs.

The critical position anticipated for the Fund and Bank in the postwar economy and the essential interdependencies between the international and domestic conditions made the notion of narrowing the Federal Reserve’s mission to exclude the potential influence of proposed institutions a basic impossibility. While the Federal Reserve’s proposal for its inclusion on an interagency council to oversee the American representatives to the Fund and Bank presented an expansion rather than contraction or narrowing of the central bank’s overall authority it was no less an effort to defend its autonomy in already existing areas of responsibility. In this case the Fed sought to expand its autonomy not by asserting greater authority per se, but rather by acquiring the ability to check potential external influences on domestic credit conditions, the core of

13 James Q. Wilson, Bureaucracy: What Government Agencies Do and Why They Do It. (New York: Basic Books, 1989), Ch. 10. 14 This more traditional line of argument is developed in Fred L. Block, The Origins of the International Economic Disorder: A Study of United States International Monetary Policy from World War II to the Present (Berkeley: University of California Press, 1977), 46-54. 183

the central bank’s mission. Understanding the Federal Reserve in these terms further clarifies its interest in international affairs, harmonizing its position toward the Fund and

Bank with the reasons it emphasized an anti-inflationary war finance program, the revival of postwar international investment, and the relative stabilization of currencies. Fed officials recognized the ways domestic factors influenced international conditions and vice versa. The interagency council proposal represented an attempt to stop the erosion of its existing autonomy rather than bureaucratic empire building.

Before examining the Federal Reserve’s arguments and connecting them to the idea of increased bureaucratic autonomy it is necessary to at least touch on the concept of central banker independence (CBI). CBI refers to the ability of central bankers to operate with the minimum of political constraints on policy formulation or implementation. The degree of CBI fluctuated historically and across international contexts reaching high points generally during the 1920s and then again during and after the 1980s. CBI was particularly low and political constraints especially high during the Great Depression and through the Second World War as the economic collapse of the 1930s appeared to discredit the judgment of central bankers in the United States, Western Europe, and

Japan. In some ways the goals of CBI and those of the interagency council proposal were somewhat analogous. The interagency council, however, aimed at defending, to the extent possible, the Federal Reserve’s autonomy by fundamentally intertwining it within the larger foreign economic policy decision-making structure rather than by separating the central bank and investing it with independent authority. In many ways this is much closer to FRBNY president Allan Sproul’s later characterization of the Federal Reserve 184

as “independent within the government” rather than independent from the government.15

Therefore an argument that the Federal Reserve supported a new structure that increased its autonomy also demonstrates how the Fed sought greater CBI without fundamentally challenging its accountability to the nation’s political leaders and obligations to support larger national goals.16

As Fed officials participated in interagency technical discussions on the proposed

White Plan they recognized the potential implications the Fund and Bank had for domestic conditions. During a September 1943 meeting of the Board of Governors,

Matthew Szymczak considered the effects of a proposal to allow the World Bank to rediscount its obligations with national central banks. That is to say that the World Bank could exchange notes or other obligations with national central banks, such as the Federal

Reserve, receiving in exchange funds for use in other ventures. Szymczak, along with

Emanuel Goldenwesier and Vice Chairman Ronald Ransom, saw this proposal as infringing upon the Fed’s autonomy to determine the quality of obligations it accepted for discounting. Members of the Board of Governors feared that the Fed might come under significant pressure to discount obligations of dubious quality. Szymczak did not simply argue that the Federal Reserve should oppose this specific grant of power to the World

Bank. Rather, he believed that the Fed should go further and secure a voice in the selection of the American representatives to the Bank, a move that presumably would

15 Sproul quoted in Richard H. Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (Chicago: University of Chicago Press, 1993), 319. 16 The concept of central banking independence or CBI is examined on a trans-national comparative level by John Singleton, Central Banking in the Twentieth Century (New York: Cambridge University Press, 2011), Ch. 12; See also “Central Bank Independence,” in The Federal Reserve System: An Encyclopedia, ed. R. W. Hafer (Westport, CT: Greenwood Press, 2005), 52-5. 185

allow the Federal Reserve to head off any actions that might disturb domestic credit conditions.17

Alice Bourneuf from the staff of the Board of Governors made a similar argument for the Fed to secure some say in the selection of representatives to the Bank. Bourneuf went so far as to suggest that the Federal Reserve threaten to withhold support for the

Treasury’s World Bank plan until it guaranteed the central bank a role in selecting the

American representatives.18 Considering the relatively greater power of the Treasury as compared to the Federal Reserve within the Roosevelt administration and the fact that national central banks played a relatively minor role in the actual Bretton Woods

Conference, the practical benefits of Bourneuf’s approach are questionable. It does, however, highlight the importance Fed officials attached to having a say in choosing representatives for the proposed institutions. That central bankers even considered putting the Fed in open opposition to the Treasury over this issue, when it compromised on so many other points including support for the wartime pegging of interest rates, highlights their view of the potential long-term implications of the Bank in relation to their mission.

The topic of securing a voice for the Federal Reserve in the selection of American representatives to the Fund and Bank came up repeatedly in the months leading up to the

Bretton Woods Conference. Fed officials often coupled participation in choosing

17 Federal Reserve Board of Governors, Minutes from Meeting on Treasury Bank Proposal, September 27, 1943, NARA, RG 82 DIF, box 55. 18 Alice Bourneuf to E. A. Goldenweiser, Memorandum, February 15, 1944, NARA, RG 82 DIF, box 56. 186

representatives with proposals to increase their ability to offset what they saw as the potentially disturbing effects of Fund and Bank actions on the U.S. market.19 In both cases they linked their demands with how the Fund and Bank impinged upon the Federal

Reserve’s ability to execute domestic monetary responsibilities and thus highlighted how these demands represented an attempt to preserve autonomy rather than expand actual power. By April 1944 nearly all members of the Board of Governors accepted the basic premise that the Federal Reserve must secure some voice in at least the selection of

American representatives to both the Bank and the Fund.20 During the Board’s pre-

Bretton Woods conference call at the end of May 1944 both Szymczak and Eccles concurred that establishing the Fed’s role in determining the American representatives to the proposed Fund and Bank was of critical concern.21 Just weeks prior to the actual conference Fed officials determined that the central bank “should definitely have a voice in an agency [the Fund] which may affect to a major degree the power of the System to discharge its responsibilities with regard to bank credit and the money supply.” This included not only the power to recommend individuals to serve as representatives to the

Fund and Bank but also the ability to recommend their potential removal from this role.22

Power over who received the job helped ensure that it went to individuals who shared the

Fed’s views. The power to remove those individuals from their position provided some assurance that they would continue to share those views after their appointment.

19 Walter Gardner, Memorandum, “The White and Keynes Plans,” May 25, 1943, Memorandum, NARA, RG 82 DIF, box 61. 20 Federal Reserve Board of Governors, Minutes AM, April 18, 1944. 21 Federal Reserve Board of Governors, Transcript of Telephone Conversation, May 31, 1944, NARA, RG 82 DIF, box 38. 22 Federal Reserve Board of Governors, Memorandum, “The International Monetary Fund and Measure to Safeguard the Federal Reserve System,” June 5, 1944, NARA, RG 82 DIF, box 38. 187

The issue came to a head during a Board of Governors meeting on June 6, 1944.

Although the Federal Reserve had concerns about specific aspects of the White Plan,

Alfred Williams, the president of the Philadelphia Reserve Bank, felt that the situation was too far along for any open dissent prior to or at the Bretton Woods Conference.

Williams believed that a lack of Fed support might throw “a monkey wrench into the machinery” of postwar financial cooperation, potentially wrecking the system. Board members discussed the need for a Fed voice in the management of the proposed Fund, and while they failed to reach a clear consensus general agreement existed for at least having an influence in the selection of the American director. Chester Davis, the president of the St. Louis Reserve Bank argued, “good management could get good results from an imperfect plan whereas bad management would defeat a good plan.”23

Given that the Fund held important implications for the “credit situation in this country and the credit powers of the system,” according to Matthew Szymczak, the Fed needed to give consideration to its “management.”24 Federal Reserve officials recognized, therefore, that while they might not agree with all aspects of the White Plan, if they secured a voice in the management of the institutions they could influence policies in such a way as to not impinge upon the central bank’s autonomy in credit and monetary matters.

Central bank officials also considered other means of preserving autonomy in the area of domestic policy, aside from having a voice in the selection of American

23 Albert Creighton, Letter, June 8, 1944, NARA, RG 82 DIF, box 38. 24 Federal Reserve System Board of Governors (FRBD), Meeting Minutes, June 6, 1944, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min060644.pdf (accessed February 25, 2011). 188

representatives to the Fund and Bank. This included a proposal to require that official foreign balances be held on deposit at the Federal Reserve rather than at commercial banks. Fed officials expressed concern that foreign nations, in need of American goods, might convert their stockpiles of gold into dollars and that these dollars would pile up “on top of the redundant money supply” already burdening the market. Depositing these funds at commercial banks rather than at Reserve Banks increased the potential for credit expansion. Foreign balances allowed foreign nations to in effect “conduct open market operations” without America’s “consent.”25 While this proposal did not necessarily bear upon the management of the Fund or Bank it demonstrated the persistent concern with maintaining bureaucratic autonomy.

The politics of bureaucratic autonomy and “turf” composed one aspect of the

Federal Reserve’s approach to the Fund and Bank and help to explain why the Fed desired a voice in the selection of American representative to the Fund and Bank. Such considerations, however, do not explain why it was necessary to secure this voice through a council structure formalized and legally established in the enabling legislation. That aspect of the approach requires the proposal to be understood within the context of the central bank’s place within the American government and its historical relationships with other agencies, particularly the Treasury Department.

25 Federal Reserve Board of Governors, Memorandum, “The International Monetary Fund and Measure to Safeguard the Federal Reserve System,” June 5, 1944, NARA, RG 82 DIF, box 38. 189

Rather than being the product of a coherent unitary decision maker, policy decisions often result from bargaining among a variety of actors.26 Bargaining, however, is not simply a synthesis of different views but instead results in outcomes that turn on the dynamics of interagency relations. The state of interagency relations and relative bargaining powers is fluid, shifting with issues, context, and political philosophies and thereby creating a sense of uncertainty about their future status. Just such a sense of uncertainty motivated the Federal Reserve’s desire to firmly embed, within the enabling legislation, its voice in the Fund and Bank. As Terry Moe argues, “political uncertainty” plays a powerful role in guiding the actions and views of policymakers. Moe points out that “actors may be very powerful today, but they cannot count on maintaining their positions of power in the future.” Instead, decision making structures might be undermined or dismantled by future actors with “very different interests.” Therefore, if the policies put in place at any given time are to have “staying power . . . they must somehow be insulated from tomorrow’s exercise of authority.”27 An interagency council created by executive order might be just as easily undone or fundamentally changed by executive order. While establishing the council in the legislation did not place it beyond alteration, it did create additional obstacles, most obviously the need for Congress to amend the law.

26 Stephen D. Cohen, The Making of United States International Economic Policy: Principles, Problems, and Proposals for Reform. 2nd ed. (New York: Praeger, 1981), 34-5. 27 Terry M. Moe, “The Politics of Structural Choice: Toward a Theory of Public Bureaucracy,” in Organization Theory: From Chester Barnard to the Present and Beyond, ed. Oliver E. Williamson (New York: Oxford University Press, 1995), 124. 190

The White Plan conceived of the Fund and Bank as perpetual organizations to help manage the international economy, not simply institutions to overcome immediate postwar transitional issues. Perpetual institutions, therefore, held perpetual implications for the domestic economy. Fed officials were not interested in helping merely to select the first American representatives to the Fund and Bank and instead sought a permanent role. If the Federal Reserve secured a voice in the appointment and actions of the initial

American representatives to the Fund and Bank, however, there was no way to guarantee that they would continue to exercise that role without establishing it in law. Political uncertainty plagued the history of Federal Reserve-Treasury relations and offers insight into the uncertainty and vulnerability to shifting contextual circumstances that represented real concerns for central bankers. Historically, the Fed found its authority challenged by the Treasury as the attitudes and imperatives of presidential administrations changed. More recently the Federal Reserve experienced uncertainty about its position in interagency technical negotiations on the White Plan in the lead up to the Bretton Woods Conference. To appreciate the central bank’s perspective, therefore, it is useful to briefly review the course of Fed-Treasury relations. This provides context for the post-conference debates and highlights why the Federal Reserve attached such importance to establishing the council in the enabling legislation.

The history of bureaucratic tensions between the Fed and the Treasury reach back to the drafting of the Federal Reserve Act in 1913. The act appointed the Secretary of the

Treasury as an ex officio member of the Board of Governors, providing direct influence over the development of central bank policy. In its early years of operation the Federal 191

Reserve relied heavily on former Treasury personnel. Furthermore, during its early years the Board of Governors lacked its own facilities and instead operated out of offices in the Treasury building, only reinforcing the perception of subordination.28 During

World War I Treasury Secretary William Gibbs McAdoo used his position and influence to secure predominance over wartime financial policy at the expense of the central bank.29 In 1917 the Board of Governors went so far as to state that the Federal Reserve was “not responsible for the financial policy of the Government, except in so far as the

Secretary of the Treasury may choose to call upon its members for service in an advisory capacity.”30 This is not to say that the Federal Reserve was totally subservient, but that the demands of the war significantly shaped the bureaucratic environment in ways favorable to the Treasury.31

The relationship between the Fed and Treasury went through a general rebalancing during the interwar period. Several scholars have depicted interwar financial policy as being substantially influenced by international cooperation between central bankers, particularly in Western Europe and the United States. This focus on central

28 Singleton, Central Banking in the Twentieth Century, 56. 29 This argument is made in William Silber, When Washington Shut Down Wall Street: The Great Financial Crisis of 1914 and the Origins of America’s Monetary Supremacy (Princeton: Princeton University Press, 2007). See chapter 1 for additional discussion of the role of the Federal Reserve in financing the First World War. 30 Federal Reserve Board of Governors, Fourth Annual Report of the Federal Reserve Board Covering Operations for the Year 1917 (Washington: Government Printing Office, 1918), 7. 31 Prior to American entry into the war in 1917, Federal Reserve officials debated how central bank policies might accommodate either the Entente or the Central Powers and whether this compromised the nation’s neutrality. Federal Reserve freedom of action or subordination to the Treasury was never a clear cut issue. The debate is also important in demonstrating awareness by central bankers that their action had wide-ranging implications, including the potential to influence the outcome of international conflict. Priscilla Roberts, ““Quis Custodiet Ipsos Custodes?”: The Federal Reserve System’s Founding Fathers and Allied Finances in the First World War.” The Business History Review 72, no. 4 (Winter 1998): 585-620. 192

bank cooperation, however, obscures the way tensions between the Fed and the Treasury persisted after the war.32 To the extent that the Federal Reserve did influence policy it came only after a hard fought battle to free itself from the wartime yoke of Treasury dominance.33 Even after the Fed gained greater freedom of action the Treasury remained a powerful and direct force with the secretary retaining ex officio board member status throughout the period. While the Banking Act of 1935 removed the Treasury Secretary and enhanced the power of the Board of Governors vis-à-vis the regional Reserve Banks, the reform came in the midst of the Great Depression and the relative ascendency of the

Treasury under Henry Morgenthau within the Roosevelt administration. Private and central bankers bore the brunt of public blame for the Great Depression, and their influence waned with the apparent discrediting of their policy judgment.34

Throughout the Second World War the Treasury Department played a prominent role in guiding American war finance policy (see chapter 1). Morgenthau’s personal relationship with Franklin Roosevelt as well as a general cynicism toward bankers allowed the Treasury to guide policy on borrowing, economic controls, and taxation while muting objections from the Federal Reserve. Despite the considerable discretion

Morgenthau exercised over economic policy during the Roosevelt administration the

32 Representative of the view that central bankers dominated interwar financial policy is Liaquat Ahamed, Lords of Finance: The Bankers who Broke the World (New York: Penguin Press, 2009); The variety of interests involved in interwar economic and financial policy is best demonstrated in Carl Parrini, Heir to Empire: United States Economic Diplomacy, 1916-1923 (Pittsburgh: University of Pittsburgh Press, 1969); Joan Hoff Wilson, American Business and Foreign Policy, 1920-1933 (Lexington: University of Kentucky Press, 1971). 33 Allan H. Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2003), 90. 34 Ibid.; E. A. Goldenweiser, American Monetary Policy (New York: McGraw-Hill Books, 1954), 132-36; Richard H. Timberlake, Monetary Policy in the United States: An Intellectual and Institutional History (Chicago: University of Chicago Press, 1993), 282. 193

secretary continued to express a deep suspicion of Wall Street and central bankers. Years later Chairman Eccles recounted a May 14, 1943 meeting where Morgenthau recalled an incident alleged to have occurred shortly after he assumed his position in the Treasury.

Morgenthau told of being called to a meeting at the home of George L. Harrison, the president of the FRBNY, at which Harrison and Owen D. Young, the chairman of the

FRBNY “stood over him” and commanded that if he did not follow their directives they would “not support [the] government bond market.” Morgenthau told Eccles that this was only one of several occasions in which he felt that the central bank “pointed a gun at his head.” Eccles remembered how Morgenthau’s “outburst” left listeners

“dumbfounded” and “at a loss to understand the Secretary’s attack.” The resentment between the Treasury members of the Federal Reserve reached such a pitch that Eccles feared “the presidents of the Reserve banks would issue a public blast at Morgenthau and then walk out on their jobs.”35 Morgenthau’s perception of past mistreatment made him more abrasive toward Fed officials and further soured the trust between the two groups.

Mutual distrust and political uncertainty informed the relationship between the

Treasury and the Federal Reserve. At different times each side felt threatened by the other. During the Second World War, however, the perception of Fed subordination reached new depths. Not only did the Great Depression undermine the public credibility of the central bankers, but they appeared to face a Treasury, under Morgenthau’s leadership, determined to carve out a bureaucratic empire and establish a permanent

35 Marriner S. Eccles, Beckoning Frontiers: Public and Personal Recollections (New York: Alfred A. Knopf, 1966), 340-42. 194

position controlling the commanding heights of domestic and international economic policymaking.

Morgenthau’s vigorous efforts to defend and expand his area of influence gives credence to the perception of the Treasury as seeking to secure a dominant position in policy, at the expense of other agencies. Morgenthau worked doggedly to prevent other departments from encroaching on areas he defined as within the Treasury’s domain. In early 1942 he described Budget Director Harold Smith as a “termite undermining the foundation of the Treasury” and accused Smith of attempting to usurp Treasury authority over tax policy.36 In December of that year he leveled a similar accusation against James

Byrnes. Morgenthau complained to Roosevelt that Byrnes, the former Supreme Court justice then heading the wartime Economic Stabilization Office, attempted to co-opt the

Treasury’s control over tax policy.37 Morgenthau wrote to Roosevelt and accused

Byrnes’ successor, Fred Vinson, of the same acts. Morgenthau went so far as to enclose a draft statement publicly reaffirming his role as the “chief fiscal officer of the

Government” and asked Roosevelt to sign it.38

Simply defending the Treasury’s bureaucratic turf was not enough for

Morgenthau who also attempted to influence postwar policy regarding the fate of

Germany. Morgenthau proposed the postwar de-industrialization and pastoralization of

Germany, including the possibility of disaggregating it into multiple smaller states. This

36 Henry Morgenthau, Memorandum, April 15, 1942, Henry Morgenthau Diaries, Reel 2. 37 Henry Morgenthau, Memorandum, December 3, 1942, Henry Morgenthau Diaries, Reel 2. 38 Henry Morgenthau to Franklin Roosevelt, Letter, July 23, 1943, Henry Morgenthau Diaries, Reel 2. 195

proposal essentially redrew the political and security map of Europe, placing a much weakened buffer between the West and the Soviet Union. Morgenthau’s proposal encroached on the purview of other agencies and set the stage for conflicts with the

Secretary of War Henry L. Stimson and the Secretary of State Cordell Hull, both of whom opposed the plan.39

Real philosophical differences between the Treasury and other agencies, particularly the Federal Reserve, offered a motive for these bureaucratic fights. To be sure, bureaucratic competition and the desire for administrative autonomy fostered conflicts between the Treasury and other departments. But those conflicts also emerged from differing beliefs regarding the best means for achieving the same end, political peace and economic prosperity for the United States and the rest of the world. The

Federal Reserve’s decentralized structure, with a Washington, D.C. based Board of

Governors coordinating the actions of twelve regional Reserve Banks, one of which sat physically and philosophically close to the heart of Wall Street in New York City, opened the central bank to seemingly contradictory, but from the Treasury secretary’s perspective, valid, charges. On the one hand Morgenthau linked the FRBNY with the conservative financiers at the American Bankers Association (ABA) and private Wall

Street firms, associating the Federal Reserve, through the FRBNY, with conservative opponents of the Roosevelt administration and the New Deal. Reflecting on the resistance of financiers to aspects of the Bretton Woods program, Morgenthau

39 Gaddis Smith, American Diplomacy During the Second World War, 1941-1945. 2nd ed. (New York: Alfred A. Knopf, 1985), 116-24; David M. Kennedy, Freedom From Fear: The American People in Depression and War, 1929-1945 (New York: Oxford University Press, 1999), 803-04. 196

complained that opponents represented the same conservative old-guard always attempting to control financial affairs and that the issue boiled down to “whether the

Government should control these things, or a special country club of business and the

Federal Reserve” should do so.40 Morgenthau, therefore, rhetorically defined the Federal

Reserve as outside of the government and having more in common with private banking interests than the Roosevelt administration. By this logic, minimizing or excluding the

Fed represented an aspect of the Treasury secretary’s larger goal to drive “the usurious money lenders from the temple of international finance.”41 At the same time the secretary expressed an opposite set of misgivings regarding Marriner Eccles.

Morgenthau distrusted Eccles’ Keynesian approach to economic problems.42 The central bank’s own confused bureaucratic structure, the product of Progressive Era compromise between centralizing and decentralizing political philosophies, opened it to attacks because of the wide variety of philosophies and views contained within the larger Federal

Reserve System. The development of the White Plan, therefore, must be understood as taking place within an already contentious policymaking environment.

40 Indeed officials at the Federal Reserve Bank of New York did break with the Board of Governors and sided with the ABA opposing the creation of the International Monetary Fund. Randall Woods, A Changing of the Guard: Anglo-American Relations, 1941-1946 (Chapel Hill: University of North Carolina Press, 1990), 228-32; Morgenthau quoted in Alfred E. Eckes, Jr., “Open Door Expansion Reconsidered: The World War II Experience,” Journal of American History 59 (March 1973), 920. 41 Morgenthau quotes in Gardner, Sterling-Dollar Diplomacy, 76. Gardner explains that the Treasury aimed not to eliminate any role for private enterprise but rather to harmonize it with the objectives of the New Deal. 42 William E. Leuchtenburg, Franklin D. Roosevelt and the New Deal (New York: Harper Torchbooks, 1963), 158-61, 245-48; Alan Sweezy, “The Keynesians and Government Policy, 1933-1939,” The American Economic Review 62, no. 1/2 (March 1972), 116-119; John G. Ikenberry, “A World Economy Restored: Expert Consensus and the Anglo-American Postwar Settlement,” International Organization 46, no. 1 (Winter 1992), 297-305. William J. Barber, “Government as a Laboratory for Economic Learning in the Years of the Democratic Roosevelt,” in The State and Economic Knowledge: The American and British Experiences, ed., Mary O. Furner and Barry Supple (New York: Cambridge University Press, 2002), 105-15. 197

Early technical discussion on the White Plan highlighted not only the tensions between the Federal Reserve and the Treasury but also the pitfalls of failing to formally secure the central bank’s place in the bureaucracy, and therefore the potential political uncertainty threatening its role. In May 1942 Morgenthau communicated to President

Roosevelt his desire to begin technical discussion on the Bank and Fund proposals. The secretary suggested bringing the State Department, Board of Economic Warfare, and the

Federal Reserve Board of Governors in to the talks.43 Shortly thereafter the Morgenthau communicated to Eccles his desire for Fed participation in the formal discussions.44

Emanuel Goldenweiser, who Eccles appointed to represent the Fed in technical negotiations, argued that the central bank should seize on the opportunity and contribute to the maximum extent possible.45 Having the Federal Reserve formally represented and engaged would provide central bankers a voice in shaping the postwar order.

Goldenweiser’s vigorous support for a Federal Reserve voice in these technical discussions also highlighted the importance the central bank attached to the international sphere. It offered the Fed a voice in shaping the international economy, which they considered important because of the potential impact on American domestic economic health and the implications for the management of postwar credit and monetary conditions.

43 Henry Morgenthau to Franklin Roosevelt, Memorandum, May 15, 1942, NARA, RG 82 DIF, box 57. 44 Henry Morgenthau to Marriner Eccles, Memorandum, May 20, 1942, NARA, RG 82 DIF, box 57. 45 E. A. Goldenweiser to Marriner Eccles, Memorandum, May 25, 1942, NARA, RG 82 DIF, box 57; Marriner Eccles to Henry Morgenthau, Memorandum, May 26, 1942, NARA, RG 82 DIF, box 57. 198

Despite Morgenthau’s request for Federal Reserve participation a controversy broke out in July 1942 regarding the precise status of the central bank in the talks.

During a July 10, 1942, meeting, Harry Dexter White proposed to Adolph Berle of the

State Department that the various agencies identify topics of concern based upon a list of issues earlier circulated by the Treasury. White suggested that the agencies then draft memoranda on the topics as a basis for future evaluation by the larger group. When

Berle asked Goldenweiser if he found this proposal acceptable, White suddenly interjected that while the Treasury was “glad to have the advice of the Federal Reserve

Board of Governors it was not essential to have its approval.” The fact that White chose to make an issue out of this point is somewhat perplexing. It may have stemmed from

White’s annoyance with Goldenweiser who earlier in the meeting expressed skepticism about committing to either of the institutional structures, the Fund or the Bank, proposed in the White Plan. White’s jab, however, while spiteful, was technically correct as

Walter Gardner later discovered upon reviewing Morgenthau’s May 20, 1942, letter to

Eccles. While Morgenthau requested Roosevelt’s permission to begin technical discussions with the State Department, the Board for Economic Warfare, and the Federal

Reserve, the president, in his reply, substituted the Export-Import Bank for the Federal

Reserve.46 White accepted the central bank’s participation in interagency discussions, but viewed Roosevelt’s omission of the Fed as justification for denying Goldenweiser equal status with other representatives, throwing into question their ability to affect the development of the Fund and Bank proposals.

46 Walter Gardner, Memorandum, July 10, 1942, NARA, RG 82 DIF, box 57. 199

If Eccles attempted to clarify the Fed’s precise status with Morgentahu, however, other central bank officials expressed less concern. Gardner believed that the extent of the Fed’s “influence depended more upon the” substance of the “contribution” than

“upon any formal position.”47 Goldenweiser concurred and made a similar argument in a memorandum to William L. Clayton, then vice president at the Export-Import Bank.

Goldenweiser attributed the exchange to personality conflicts and “a piece of bad manners on the part of Harry White with whom such conduct is habitual.” Goldenweiser asserted that because no one except White questioned the status of the Federal Reserve in the discussions, making an issue out of the conflict only threatened to complicate future cooperation with the Treasury.48

Several months later, however, a similar issue arose when Morgenthau asked

Roosevelt to approve continued study of postwar international plans by the State

Department, the Board for Economic Warfare, and the Federal Reserve with the intention of calling an international conference of finance ministers. Roosevelt’s reply approving the request again substituted the Export-Import Bank for the Federal Reserve. Despite

Roosevelt’s exclusion of the central bank, Morgenthau again reached out to Eccles and requested participation and input from the Fed.49

47 Walter Gardner to E. A. Goldenweiser, Memorandum, “Letter on Board’s Status in Treasury Post-War Project,” August 3, 1942, NARA, RG 82 DIF, box 61. 48 Marriner Eccles apparently concurred as well, penciling “I agree” on a copy of Goldenweiser’s memo to Clayton. E. A. Goldenweiser to William L. Clayton, Memorandum, August 4, 1942, NARA, RG 82 DIF, box 61. 49 Walter Gardner to Matthew Szymczak, Memorandum, “The Treasury’s Plan for a World Stabilization Fund,” January 29, 1943, NARA, RG 82 DIF, box 61. 200

Even though the Treasury voluntarily reached out to the Fed for participation and thereby avoided any confrontation, the incidents must have been cause for concern. To be sure, Goldenweiser correctly understood that the earlier incident reflected more Harry

White’s abrasive personality than a real attempt to exclude the Federal Reserve, and the central bank continued to participate in the technical discussions through the period prior to the Bretton Woods Conference. Having the Federal Reserve’s position heard on the details of the Fund and Bank plans represented a more fundamental issue and ultimately a more constructive method of influencing their development than quibbling about semantic interpretations of over the structure of internal technical discussions. At the same time, however, central bankers could not have ignored the potential consequences.

Whether by accident or intent, Roosevelt twice excluded them in instructions to

Morgenthau. While the negotiations remained at the technical and theoretical level such exclusions did not necessarily represent an immediate concern. The stakes increased, however, once the Fund and Bank proposals began to take shape, and particularly after the Bretton Woods Conference as Congress considered formally committing the nation to the White Plan. The potential of being excluded from future decision-making and policy formulation in the postwar international economy must have concerned central bankers.

They soon began pushing not only for the creation of a permanent inter-agency council to coordinate foreign economic policy but also to have the council’s powers and composition concretely spelled out in the law. By securing a place on a formal interagency council, Fed officials may have hoped to avoid a repeat of the confusion during 1942-43 and ensure they could not be excluded from future policymaking. 201

The Federal Reserve’s desire to establish a formal bureaucratic structure should, therefore, also be understood within the context of the uncertainty that emerged during technical discussions with the Treasury. Harry Dexter White’s abrasive attitude and

Franklin Roosevelt’s chaotic approach to management fostered a sense of insecurity on the part of the Fed regarding its future place in the decision-making structure, and thereby shaped the central bank’s response to it. On the one hand, given the potentially antagonistic attitude of the Treasury, personified by White and Morgenthau, the Fed surely recognized the need to secure a formal role in the decision-making structure of foreign financial policy. On the other hand, central bankers could not rely on a simple presidential directive as a guarantee for that formal role. Not once but twice Roosevelt swapped the Export-Import Bank for the Federal Reserve in instructions to Morgenthau.

The best way to avoid future exclusion, either purposeful or accidental, was to have the new coordinating structure enshrined in the law and to include a provision explicitly appointing the Federal Reserve to that structure.

Evolution of the Interagency Council Proposal: Structure and Composition

The idea of securing bureaucratic autonomy and insulating the Federal Reserve from an uncertain political environment shaped the approach to an interagency council.

These ideas continued to inform the Fed’s justification of the proposal generally, as well as its position on the precise composition and the necessity of formalizing the structure in the Bretton Woods enabling legislation. Beginning particularly in the autumn of 1944 202

and continuing up until the passage of the Bretton Woods Agreement Act in July 1945 the Federal Reserve fought doggedly for the creation of the interagency council.

The idea of a multi-departmental coordinating body to oversee American foreign financial relations was not, however, an idea unique to the Federal Reserve. The 1940

Inter-American Bank plan contained a proposal for a similar interagency board to oversee the relationship between the proposed international institution and the American government.50 Fed officials also expressed great interest in a plan for a proposed board to manage international economic relations associated with the so-called Dewey Bill.

Illinois Republican Congressman Charles S. Dewey proposed a single joint reconstruction fund to fulfill many of the functions of the two institutions proposed by the

White Plan, including economic rehabilitation, reconstruction, and currency stabilization.

Section six of Dewey’s plan called for a board to oversee the operations of this fund that would include members from several pertinent agencies including the State Department,

Treasury Department, the Reconstruction Finance Corporation, and Federal Reserve, as well as members of the House and Senate.51 Walter Gardner noted that Dewey’s proposal excluded the Foreign Economic Administration (FEA), which included the

50 Federal Reserve Board of Governors, Memorandum, “Currency Stabilization: Problems to be discussed on Thursday, Aug. 12,” August 11, 1943, NARA, RG 82 DIF, box 61. J. Keith Horsefield also references the 1940 Inter-American Bank proposal as inspiration for the NAC in The International Monetary Fund, 1945-1965: Twenty Years of International Monetary Cooperation, Volume I: Chronicle (International Monetary Fund: Washington, D.C., 1969), 114. 51 Dewey’s proposal called for Chairman appointed by the President but confirmed by the Senate. The proposed oversight board would then be composed of two members each from the State Department, Treasury Department, Reconstruction Finance Corporation, as well as two members, one from each political party, from the Federal Reserve System, the House of Representatives, and the Senate. Congress, House, Committee on Foreign Affairs, Reconstruction Fund in Joint Account with Foreign Governments for Rehabilitation, Stabilization of Currencies, and Reconstruction: Hearings before the Committee on Foreign Affairs, 78th Cong., 2nd sess., April, 25 1944, 2. 203

Export-Import Bank, and clearly represented an attempt to enhance congressional influence in the decision-making process.52 Given the desire to enhance the Federal

Reserve’s bureaucratic autonomy, the inclusion of so many diverse voices and interests in the oversight council must have struck Gardner as problematic. At the same time, however, he believed the Dewey Bill offered a potential opportunity. The possibility of

Federal Reserve testimony about the Dewey Bill provided an “admirable opportunity to urge” the Fed’s “viewpoint with regard to joint management of this country’s participation in international finance.”53 Although the Federal Reserve ultimately did not provide testimony before the House Foreign Affairs Committee on the proposed legislation, it did maintain a keen interest, sending observers to listen to and provide analysis on nearly each day of the hearings.54

While the Federal Reserve made various references about the need to secure some voice in at least the appointment of American representatives to the Fund and Bank, possibly extending to the operations of the institutions, prior to the Bretton Woods

Conference in 1944, these suggestions took on new importance in the aftermath of the

52 Chartered in 1934 the Export-Import Bank had been incorporated into a variety of agencies and bureaus. Executive Order 9380 transferred it to the oversight of the FEA on September 25, 1943. It was finally made an independent agency with the passage of the Export-Import Bank Act of 1945. 53 Walter Gardner to Matthew Szymczak, Memorandum, “Hearings in Prospect on Dewey's alternative to the Monetary Fund and Investment Bank,” March 29, 1944, NARA, RG 82 DIF, box 36. 54 Alice Bourneuf to Walter Gardner, Memorandum, “Dewey Bill Hearings,” April 25, 1944, NARA, RG 82 DIF, box 36; Alice Bourneuf to Walter Gardner, Memorandum, “Hearings on Dewey Bill,” April 27, 1944, NARA, RG 82 DIF, box 36; Alice Bourneuf to Walter Gardner, Memorandum, “Hearings on the Dewey Bill,” April 28, 1944, NARA, RG 82 DIF, box 36; Alice Bourneuf to Walter Gardner, Memorandum, “Dewey Bill Hearings,” May 16, 1944, NARA, RG 82 DIF, box 36; Alice Bourneuf to Walter Gardner, Memorandum, “Dewey Hearings,” May 17, 1944, NARA, RG 82 DIF, box 36. 204

international meeting.55 Central bankers came out strongly in favor of a three member council composed of representatives from the Federal Reserve Board of Governors, the

State Department, and the Treasury. Walter Gardner argued that these three represented the “agencies chiefly concerned” with the operations of the Fund and Bank. Similar to the Dewey Bill, the Federal Reserve’s proposal omitted the FEA from the council.

Gardner expressed doubts about including the FEA since it was a “temporary” agency created to serve the imperatives of the war effort. Furthermore, while he admitted that the council needed to keep Congress informed “to gain popular acceptance for the policies” he questioned its formal inclusion, as proposed by Dewey legislation, particularly the wisdom of “putting legislators on an executive body.” Similarly, Gardner conceded that the Commerce Department might have “claims to membership,” but he did not favor the idea. Weeks later in another memorandum on the proposed council structure he reiterated the three member composition and did not include the Commerce

Department.56 The three member council structure composed of Treasury, State, and the

Federal Reserve was also listed as one of three major points of interest for the enabling legislation in a draft letter from Chairman Eccles to Secretary Morgenthau.57

In early December 1944 Federal Reserve officials finally had an opportunity to preview a draft of the enabling legislation provided by the Treasury. It did include a

55 Federal Reserve Board of Governors, Memorandum, “The International Monetary Fund and Measure to Safeguard the Federal Reserve System,” June 5, 1944, NARA, RG 82 DIF, box 38; Albert M. Creighton, Letter, June 8, 1944, NARA, RG 82 DIF, box 38. 56 Walter Gardner to Federal Reserve Board of Governors, Memorandum, “Presentation of Bretton Woods to Congress and Federal Reserve Interests,” November 11, 1944, NARA, RG 82 DIF, box 36; Walter Gardner, Memorandum, “Board Program on Bretton Woods,” November 30, 1944, NARA, RG 82 DIF, box 38. 57 Marriner Eccles to Henry Morgenthau, Letter, December 5, 1944, NARA, RG 82 DIF, box 36. 205

council, termed the International Financial Organization Board that included representatives from the Treasury and State Departments, as well as from the Federal

Reserve Board of Governors. The Treasury proposal also included representatives from the FEA as well as the Securities and Exchange Commission (SEC) and the Commerce

Department.58 Fed officials continued to oppose the FEA since it was not a permanent agency, although Alice Bourneuf conceded that central bankers might have a harder time opposing the SEC. She also suggested that if the council were to be a six member structure it might make more sense to substitute the Export-Import Bank for the FEA, and that both its and the SEC’s input should be limited to the operations of the World Bank.59

Bourneuf couched her critique in the impermanence of the FEA as well as the relatively narrow operational scope of the Export-Import Bank and the SEC. A memorandum produced by the Board of Governors, however, more succinctly summarized the likely concerns, stating that the “Federal Reserve Board would be just one of the crowd” in a six member council “instead of holding a balance-of-power position as in its own three- agency proposal.”60

The Federal Reserve’s opposition to an enlarged interagency council to oversee the Fund and Bank derived from a desire to maintain bureaucratic autonomy. Federal

Reserve officials continued to discuss the Bank and Fund in terms of their potential

58 Federal Reserve Board of Governors, Memorandum, “Treasury Enabling Legislation: International Fund and Bank,” December 7, 1944, NARA, RG 82 DIF, box 36. 59 Bourneuf made no critique of the potential inclusion of the Commerce Department, presumably Federal Reserve officials already anticipated, or at least accepted, its inclusion based up Walter Gardner’s memorandum from November 11, 1944. Alice Bourneuf to Walter Gardner, Memorandum, “Comments on the Treasury's Preliminary Draft of the Fund and Bank Enabling Legislation,” December 6, 1944, NARA, RG 82 DIF, box 36. 60 Federal Reserve Board of Governors, Memorandum, “Treasury Enabling Legislation: International Fund and Bank,” December 7, 1944, NARA, RG 82 DIF, box 36. 206

implications for the domestic-cum-international economy. They argued that international conditions fundamentally affected domestic credit conditions and that “unbalanced world conditions are inevitably reflected in disturbances in the domestic economies of all countries,” including the United States.61 A memo from the Board of Governors spelled out how they perceived the management of the Fund and Bank as influencing the domestic and international financial structure. It is worth quoting here at length because it clearly demonstrates the fundamental connections and highlights the fact that exercising influence over the Fund and Bank was conceived in terms of preserving the

Fed’s ability to manage domestic economic conditions, not expanding its bureaucratic powers into fundamentally new areas:

The special interest of the Federal Reserve System arises from the fact that both the Fund and the Bank will influence the balance of international payments of this country to an extraordinary degree. The balance of payments in turn plays directly into the domestic banking and credit situation, affecting the money supply and member bank reserves as well as general business conditions. The 1930’s afford ample evidence of what it can do to the Federal Reserve System. If the Fund and Bank are not properly managed – and there will be powerful forces (even within our own country) working in that direction – they may gravely impair the ability of the System to discharge its credit responsibilities. But if they are properly managed, they will work strongly in the direction of strengthening the System in its work. The System, therefore, has a special interest in being on the committee to guide the American representatives on the two institutions. This interest is distinct from the general interest shared by all agencies of the Government in encouraging institutions that will contribute to the general economic welfare.62

61 Federal Reserve Board of Governors, Memorandum, “International Fund and Bank (Statement by Board of Governors of the Federal Reserve System),” December 1, 1944, NARA, RG 82 DIF, box 36. 62 Federal Reserve Board of Governors, Memorandum, “Three Proposals for Inclusion in the Bretton Woods Enabling Legislation,” December 5, 1944, NARA, RG 82 DIF, box 36. 207

Fed policymakers made several important connections between the operation of the Fund and Bank and their domestic responsibilities. First, they suggested that a systemic link existed between domestic and international conditions and the operation of the Bretton Woods institutions. Second, central bankers cast this linkage as fundamentally intersecting with their own institutional mission to manage banking and credit conditions. Finally, Federal Reserve officials linked the issue to their larger concern with how economic prosperity supported or undermined political peace. As argued in previous chapters, Fed policymakers linked the potential for postwar political peace with the ability to achieve domestic and international economic prosperity. By referencing the interwar period the Federal Reserve also highlighted that third and fundamental piece of its international outlook. A large council that created onerous bureaucratic obstacles and/or infringed on the ability of the Fed to carry out its domestic responsibilities threatened not just economic instability and created the potential for political breakdown. In essence, Federal Reserve officials made the argument that preserving the central bank’s autonomy served not simply their own narrow bureaucratic interests but the interests of the entire postwar international system.

From the Federal Reserve’s perspective, even worse than a large council that diluted the central bank’s voice and compromised its bureaucratic autonomy was the other extreme and the potential that no such structure would be created at all. Walter

Gardner initially feared that the Treasury might seek to exclude the council proposal from the enabling legislation, theorizing that it preferred to leave the matter of structure and 208

composition to the discretion of the president.63 This concern fits with the assessment of scholars who believe that Morgenthau favored a “strong executive” and, as a close personal friend of Franklin Roosevelt, worked to increase executive discretion.64

Gardner surmised that by deferring to the president rather than establishing a council in the enabling legislation Morgenthau hoped that Roosevelt would “set up no formal arrangement” but would instead “rely primarily on the Treasury for advice,” leaving “the

Federal Reserve System on the outside.”65 Considering the historical relationship between the Fed and the Treasury, as well as the uncertainty surrounding the central bank’s status during technical discussions, the possibility of an informal arrangement rather than a formal council system with defined members raised obvious concerns.

Federal Reserve officials were certainly pleased to have the council structure included in the first Treasury draft of the enabling legislation, they did not abandon their desire for a smaller three member body. After the initial release of the Treasury draft

Chairman Eccles reiterated the central bank’s commitment to a three, rather than six, member body.66 A confidential Federal Reserve alternative draft of the enabling

63 Terry Moe argues that presidents prefer the highest degree of discretionary control possible over the operation of government bureaucracy. Moe, “Politics of Structural Choice,” 141. 64 John Morton Blum, Roosevelt and Morgenthau: A Revision and Condensation From the Morgenthau Diaries. (Boston: Houghton Mifflin Company, 1970), 350; Warren F. Kimball, The Juggler: Franklin Roosevelt as Wartime Statesman (Princeton: Princeton University Press, 1991), 49-50; Marriner Eccles also recognized the benefits of presidential discretion, at least in the area of fiscal policy which John H. Wood suggests may have motivated his attempts to develop a cooperative policy approach that ultimately resulted in Treasury domination during the war years. John H. Wood, A History of Central Banking in Great Britain and the United States (New York: Cambridge University Press, 2009), 219-33. 65 Walter Gardner to Federal Reserve Board of Governors, Memorandum, “Presentation of Bretton Woods to Congress and Federal Reserve Interests,” November 11, 1944, NARA, RG 82 DIF, box 36. 66 Federal Reserve Board of Governors, Memorandum, “Points to Keep in Mind Regard to Federal Reserve Draft of Enabling Legislation for the Fund and the Bank,” December 8, 1944, NARA, RG 82 DIF, box 36. 209

legislation proposed the creation of an International Financial Committee composed of the Secretaries of the Treasury (chair) and State, as well as the Chairman of the Federal

Reserve Board of Governors while also providing for the appointment of alternates to act on behalf of their principals.67 Alice Bourneuf, comparing the two versions of the enabling legislation, continued to advance the argument that only the Fed and Treasury and State Departments possessed direct responsibility for international financial policy.

This fact, she maintained, meant not simply that they should be included but that all other agencies should be excluded. She admitted that “there are a great many other agencies . .

. which are indirectly concerned with or affected by foreign policy,” she went on to assert that if these agencies were included the proposed council the body “would be too large for effective action and responsibility for its decisions would be too diffused.”68 Federal

Reserve justifications for a smaller council structure conform to James Q. Wilson’s argument that the more agencies involved the more difficult coordination becomes.69

Limiting the number of potential decision-makers, therefore, fit with the Federal

Reserve’s desire to prevent bureaucratic encroachment and maximize domestic policymaking autonomy.

Establishing the council within the enabling legislation also meant that time was of the essence. If the Federal Reserve hoped to influence final legislation it needed to act

67 Federal Reserve Board of Governors, “Federal Reserve Preliminary Draft - Joint Resolution,” December 9, 1944, NARA, RG 82 DIF, box 36. 68 Alice Bourneuf, Memorandum, “Draft Memorandum on the Important Differences Between the Federal Reserve Draft of the Fund and Bank Enabling Legislation and the Treasury Draft of December 6,” December 12, 1944, NARA, RG 82 DIF, box 36. 69 Wilson, Bureaucracy, 192. 210

before the drafting process “was too far advanced.”70 Eccles made a similar argument during a meeting of the Board of Governors, stressing the need for quick action.71 Walter

Gardner went so far as to suggest that the Federal Reserve meet secretly with officials from the State Department, including Assistant Secretary of State for Economic Affairs

Dean Acheson. Gardner hoped to come to some kind of arrangement with Acheson for the creation of a formal council and its inclusion in the draft of the enabling legislation.

At the same time he believed that any talks should be conducted over lunch or some other informal setting so that there “could be no question of our organizing meetings without including the Treasury.”72 While of considerable importance, the Federal Reserve did not want to risk a further deterioration of its relationship with the Treasury over the council proposal, although during later stages of the legislative drafting process Emanuel

Goldenweiser did communicate with Acheson in an attempt to keep him abreast of the

Fed’s preferences, including the interagency council proposal.73 Central bankers sought to force a compromise, not a confrontation.

The pressure to get a deal done increased following a December 13, 1944, meeting convened by the Treasury to discuss the enabling legislation. Attendees

70 Matthew Szymczak argued that issues the Board of Governors considered critical should be included in the draft legislation prior to it getting to Congress rather than attempting to amend a polished draft prior to passage. Federal Reserve Board of Governors, Excerpt from Meeting Minutes, November 21, 1944, NARA, RG 82 DIF, box 36. 71 Federal Reserve Board of Governors, Excerpt from Meeting Minutes, December 1, 1944, NARA, RG 82 DIF, box 36. 72 Walter Gardner to Federal Reserve Board of Governors, Memorandum, “Presentation of Bretton Woods to Congress and Federal Reserve Interests,” November 11, 1944, NARA, RG 82 DIF, box 36. 73 Federal Reserve Board of Governors, Memorandum, “Suggested Revisions of Draft of the Bretton Woods Enabling Legislation Distributed by the Treasury on December 6, 1944,” January 16, 1945, NARA, RG 82 DIF, box 36; Dean Acheson to E. A. Goldenweiser, Letter, January 27, 1945, NARA, RG 82 DIF, box 36. 211

included representatives from the Board of Governors, the FEA, the State and Commerce

Departments, the SEC, and the Budget Bureau. The topics discussed included various aspects of the council proposal, ranging from basic structure to more mundane issues such as the proposed name for the board.74 Fed policymakers focused on a series of concerns raised by Oscar Cox of the FEA. Cox objected to including the council proposal in the enabling legislation at all and instead preferred to leave the entire matter to the discretion of the president. Recognizing the impermanence of the wartime bureaucracy, he argued that naming specific agencies to a council, agencies that might cease to exist at some point in the future, needlessly complicated the issue, a point

Gardner believed impressed Harry Dexter White. In an effort to prevent White from backing away from a definite council structure Gardner suggested a compromise position, proposing membership for State, Treasury, and the Federal Reserve Board of Governors, as well as two additional spots to be appointed at the discretion of the president. This proposal preserved the Federal Reserve’s voice in the Fund and Bank in the law while at the same time holding out benefits to the proponents of greater executive discretion, such as Cox and Morgenthau. While Gardner suggested that Vice Chairman Ronald Ransom meet with Acheson and Harry White to discuss the proposal for more than three council members, he cautioned that the Federal Reserve should be open to compromise. Central bankers, he argued, should not press their case so vigorously as to “alienate other agencies who might later be placed on the Council anyhow.”75 This more flexible

74 The Federal Reserve preferred the International Financial Council and Walter Gardner objected to more byzantine International Financial Organization Board. 75 Walter Gardner to Matthew Szymczak, Memorandum, “Status of discussions on Bretton Woods enabling legislation,” December 21, 1944, NARA, RG 82 DIF, box 36. 212

alternative was incorporated into subsequent Federal Reserve drafts of the proposed enabling legislation.76

Walter Gardner, Emanuel Goldenweiser, and Matthew Szymczak met with Harry

White two weeks later to press their case for keeping the council as small and precisely defined as possible. Gardner later recalled that while White agreed with the principle that the council should be kept small to ensure effectiveness, he hedged and suggested there were additional complications. White expressed concern that if the council membership was defined too narrowly, other bureaucrats, such as Jesse Jones of the RFC, might lobby their supporters in Congress to intervene and force their inclusion.77 White likely feared opening the door to a variety of congressional changes to the enabling legislation that might lead to alterations that fundamentally affected the nature of American participation in the Bretton Woods institutions.78 White mused that the smaller council proposal might have a better chance if the precise make-up were left to the discretion of the president.

He brushed off concerns from Goldenweiser about how future presidents might treat the council in that case by arguing that “there were so many ways in which a President could

76 Karl Bopp and Alice Bourneuf to Matthew Szymczak, Memorandum, January 27, 1945, NARA, RG 82 DIF, box 36; Federal Reserve Board of Governors, Memorandum, January 30, 1945, NARA, RG 82 DIF, box 36. 77 Walter Gardner, Memorandum, “Notes on December 29 luncheon with Harry White,” January 2, 1945, NARA, RG 82 DIF, box 36. 78 Elizabeth Borgwardt argues that the technical nature of the White Plan limited congressional and public input prior the Bretton Woods administration. However, following the international conference the Roosevelt administration needed to overcome the opposition of conservatives, such as Robert A. Taft of Ohio who voiced various objections to the Bretton Woods Agreements. Elizabeth Borgwardt, A New Deal for the World: America’s Vision for Human Rights (Cambridge: The Belknap Press of Harvard University Press, 2005), Chs. 3-4; Also see Gardner, Sterling-Dollar Diplomacy, 129-33. 213

make or break the Council that we just had to take our chances.”79 White departed shortly thereafter while Fed officials continued to discuss the matter and became increasingly convinced that the Federal Reserve needed to establish its position on the council and have that position enshrined in legislation. They expressed a less than sanguine attitude about the prospects of presidential discretion since “cordial verbal assurances . . . too often meant nothing in the way of action.”80

If officials hoped to come away from the lunch meeting with their concerns eased about the council and the implications of the Fund and Bank for the Federal Reserve eased, they must certainly have been disappointed. White appeared to adopt the position of Oscar Cox and the FEA, backing away from any firm commitment on the composition of the interagency council. White’s attitude played right to the Federal Reserve’s concern about political uncertainty. While having an undefined council may have been better than no council, the fact remained that under the Cox proposal the president retained the ability to exclude the Federal Reserve if he so chose. Furthermore, even if appointed such an impermanent position naturally compromised the Fed’s bureaucratic autonomy, undermining one of its fundamental reasons for existing. What might happen on such an indefinite council if the Federal Reserve failed to act in a way that pleased the current administration? Might it then find itself excluded? Could this then force the Federal

Reserve into a compromising situation, requiring it to tacitly endorse a policy to maintain its position on the interagency council that otherwise ran against the grain of preferred

79 Walter Gardner, Memorandum, “Notes on December 29 luncheon with Harry White,” January 2, 1945, NARA, RG 82 DIF, box 36. 80 Ibid. 214

monetary and credit policy? Indeed, Federal Reserve officials confronted just such fickleness during the Truman administration when the president replaced two chairmen of the Board of Governors, Marriner Eccles and Thomas B. McCabe, within quick succession following disputes over policy.81 Fed policymakers remained uneasy regarding the direction Harry White might adopt for the Treasury’s draft of the enabling legislation. They received verbal commitments of representation that did little to ease their sense of political concern.82

Ultimately, however, concern about the role of congressional lobbying and interest groups, which White had originally seen as a reason for excluding a definite council structure, may actually have saved the proposal. Fed officials themselves considered making a strong appeal directly to Congress for a defined council established by law by arguing that such a structure represented the only means to prevent the body from becoming a “rubber stamp” for decisions made by the executive.83 The idea of appealing directly to Congress apparently represented an attractive avenue for Eccles. He drafted, but ultimately did not send, a strong defense of the council proposal to Senator

81 Marriner Eccles was replaced as Chairman of the Board of Governors in 1948 following a series of disputes over with President Truman over Federal Reserve attempts to limit holding companies such as the Transamerica Corporation, controlled by the Giannini family whom Truman courted during the presidential election. Although as Allan Meltzer points out Eccles was also involved in bureaucratic spats with the Treasury and had politically aligned himself with Republicans in criticizing Truman’s budget. Thomas McCabe, Eccles successor, was forced to resign in 1951 following a dispute over continued support for yields on government securities during the Korean War. Eccles, Beckoning Frontiers, 443-56; Alonzo L. Hamby, Man of the People: A Life of Harry S. Truman (New York: Oxford University Press, 1995), 583; Meltzer, History of the Federal Reserve, Volume I, 656, 712. 82 Walter Gardner to E. A. Goldenweiser, Memorandum, “A Couple of Matters to Discuss with Harry White,” NARA, RG 82 DIF, box 36. 83 The memorandum argued that "When . . . a body is created to operate permanently in important areas of policy, the Congress can assure itself that the new body will carry out its wishes in coordination with policies of existing agencies only by specifying the composition of the new body. Only in this way can the new body be made responsible to the Congress." Federal Reserve Board of Governors, Memorandum, January 30, 1945, NARA, RG 82 DIF, box 36. 215

Robert Wagner of New York. The Federal Reserve did, however, make a strong appeal within its March 1945 statement in support of the Bretton Woods Agreement. While the

Fed’s statement did not propose specific members it emphasized the Federal Reserve’s major arguments, including the creation of a relatively small body to facilitate quick action and enshrinement in the enabling legislation rather than establishment by some less formal method. A statement of the importance of the Fund and Bank for the creation of prosperous domestic and international economic environments immediately preceded the call for an interagency council, thereby indirectly suggesting a link between the issues.84 Furthermore, Kevin Casey argues that Henry Morgenthau, desiring to build as large a coalition as possible and faced with potential stiff opposition from the New York financial community and their congressional supporters, accepted several compromises pushed by the ABA.85 Among those compromises was the interagency council creating the NAC composed of the Treasury Secretary (to serve as chair), the Secretary of State, the Secretary of Commerce, the Chairman of the Federal Reserve Board of Governors, and the Chairman of the Export-Import Bank.86

The significance is not in apportioning credit between the groups or agencies involved in the creation of the NAC. For this study, instead, the debate concerning the

84 Marriner Eccles to Senator Robert F. Wagner, unsent Letter, February 7, 1945, NARA, RG 82 DIF, box 36; Alice Bourneuf to Walter Gardner, Memorandum, “Draft of Possible Statement of the Chairman before House Banking and Currency Committee on Bretton Woods,” April 5, 1945, NARA, RG 82 DIF, box 36; Congress, Senate, Committee on Banking and Currency, Bretton Woods Agreement Acts, 79th Cong., 1st sess., June 28, 1945. 85 Allan H. Meltzer argues that the Treasury conceded inclusion of the council as a way of assuaging the concerns of private bankers. Meltzer, History of the Federal Reserve, Vol. I, 622. 86 Casey, Saving International Capitalism, 48-52; The argument that NAC represented an attempt to alleviate the concerns of congressional critics of the International Monetary Fund proposal is also made by Robert A. Pollard, Economic Security and the Origins of the Cold War, 1945-1950 (New York: Columbia University Press, 1985), 14-17. 216

reform is important in what it reveals about the Federal Reserve’s approach to the domestic and international spheres of the postwar economy. Fed officials consistently defended the council proposal in terms of its implications for the central bank’s domestic responsibilities. They did not seek to push their authority into the realm of foreign economic policymaking but rather expanded their involvement in an effort to guard what they considered their core mission, the management of domestic credit and monetary affairs. They attempted to defend their bureaucratic autonomy against additional encroachments, while at the same time seeking to cement their role in law, hedging against future unknowns or threats to that autonomy.

Evolution of the Inter-Agency Council Proposal: Powers and Authority

Debate over the precise powers of the NAC started relatively late in the process.

At the outset, as discussed earlier, Fed officials spoke of the desire for a council structure as a way to give the central bank voice in the appointment of American representatives to the White Plan’s proposed institutions. The specifics of that voice only really began to take shape during the winter of 1944-45 as policymakers considered the Bretton Woods enabling legislation. Should the NAC have the power to appoint American representatives or should it act to advise the president? Did the NAC have the power to either remove or recommend removal of American representatives? Presumably, once policymakers began to consider the proposal for a permanent council, the NAC had some say in American decisions regarding the Fund and Bank, but just how extensive was that 217

input? Was the NAC a consultative body only able to exercise moral force over representatives or did it have the power to compel certain decisions? Additionally, how did the NAC’s powers relate to those of the Congress vis-à-vis the Fund and Bank? The specifics of how to integrate the NAC into the larger bureaucratic structure of the

American government all needed to be worked out, to some extent, in order to give meaning to the council.

The specific authority invested in the NAC represented an issue almost as important as defining its membership and establishing it in the Bretton Woods enabling legislation. At the same time the Federal Reserve fought to include itself on the NAC it took a balanced approach to the powers the council might exercise, hoping to temper contradictory impulses. On the one hand, Fed officials sought to invest the NAC with explicit powers and authority to prevent either the president or the Treasury Department from circumventing it. If the legislation diffused powers too broadly, allowing the executive to bypass the NAC, then the council served only as a symbol and did nothing to preserve the Fed’s bureaucratic autonomy.87 On the other hand, Federal Reserve officials resisted endowing too much power in the hands of the NAC, often arguing that such authority over American representatives to the Fund and Bank only deterred capable individuals from accepting those positions and making the positions little more than figure heads. This balanced approach fits with Terry Moe’s assertions about political uncertainty and fears that competing agencies or interest groups might usurp powers by

87 Terry Moe argues that agency opponents, whose buy-in is necessary to forge political compromise, seek to undermine the effective operation of the agency by fragmenting or decentralizing its power. Moe, “Politics of Structural Choice,” 138. 218

gaining control of the machinery of government bureaucracy. Moe argues that for this reason bureaucratic bodies are often designed in ways that are objectively suboptimal and create “formal restrictions on bureaucratic discretion” or impose “complex procedures.”88

Despite the Federal Reserve desire to secure voice in the appointment of

American representatives to the Fund and Bank, the final version of the enabling legislation did not grant the NAC a voice in this process.89 That is not to say that the

Federal Reserve did not fight vigorously to have it included. Fed officials hoped to at least empower the interagency council to recommend to the president candidates to serve as American representatives to the Fund and Bank.90 Fed officials anticipated the council acting as an informal advisor to the president, rather than exercising direct responsibility over the selection of representatives.91 Central bankers also desired that the council possess the power to suggest recall of representatives, again however, without the power to compel the president to act.92

More complicated matters concerned policy guidance for American officials appointed to the Fund and Bank. Here the Federal Reserve sought to balance conflicting interests. It hoped to concentrate enough authority in the hands of the council to make it an effective vehicle for defending Federal Reserve bureaucratic autonomy. At the same

88 Ibid., 137. 89 Bretton Woods Agreements Act, Public Law 171, 79th Cong., 1st sess., July 31, 1945, reprinted in the Federal Reserve Bulletin 31, no. 8 (August 1945), 764-67. 90 Federal Reserve Board of Governors, Memorandum, “The International Monetary Fund and Measure to Safeguard the Federal Reserve System,” June 5, 1944, NARA, RG 82 DIF, box 38. 91 Federal Reserve Board of Governors, Memorandum, “Three Proposals for Inclusion in the Bretton Woods Enabling Legislation,” December 5, 1944, NARA, RG 82 DIF, box 36. 92 Federal Reserve Board of Governors, Memorandum, “Points to Keep in Mind Regard to Federal Reserve Draft of Enabling Legislation for the Fund and the Bank,” December 8, 1944, NARA, RG 82 DIF, box 36. 219

time it recognized that creating an overly powerful council might actually deter proper functioning of the Fund and Bank.

Certain provisions in the Bretton Woods Agreement required the consent of the

American government, including how an institution such as the Fund operated in the

American market. The actual Bretton Woods Agreement Act reserved some decisions to

Congress, such as changes to the American quota or alterations of the par value of the dollar.93 Who had authority to grant consent in more routine operational matters, such as allowing the Fund to borrow in dollars inside or outside the United States, remained to a point of debate. Treasury drafts invested the authority in the president but allowed the executive to delegate decision-making authority on specific matters to whomever he chose. Federal Reserve officials expressed concern over the obvious turf conflict this model created. Walter Gardner feared a situation where the council consented to an operation by the Fund only to have it rejected by another agency.94 Considering the

Fed’s desire to preserve its autonomy on domestic credit matters the president’s ability to delegate consent authority effectively enlarged the pool of interest groups involved. It essentially enlarged the council on a case by case basis creating obvious impediments to policymaking. Fed officials presumed that before consenting to operations within the

American market some consideration would be given to their effect on domestic

93 Bretton Woods Agreements Act, Public Law 171, 79th Cong., 1st sess., (July 31, 1945), 3. 94 Walter Gardner to Matthew Szymczak, Memorandum, “Status of discussions on Bretton Woods enabling legislation,” December 21, 1944, NARA, RG 82 DIF, box 36. 220

monetary and credit conditions.95 Allowing the president to delegate authority to bodies other than the NAC undermined a fundamental rationale, from the Fed’s perspective, for creating the council to begin with.

Similar concerns motivated Federal Reserve objections to allowing information provided by the United States to the Bretton Woods institutions to be assembled and conveyed by a group other than the NAC.96 Fed officials believed information gathering, along with consulting and advising American representatives to the Fund and Bank, to be among the NAC’s primary missions.97 Fed officials proposed allowing the NAC to designate an outside body to gather and disseminate the information but opposed the

Treasury’s suggestion of leaving this fully to the discretion of the president. Emanuel

Goldenweiser advocated investing some degree of policymaking authority in the council, and information gathering and dissemination played a critical role in that process. By potentially excluding the council from access to certain information, the Treasury’s proposal limited the NAC’s ability act effectively. Goldenweiser assumed this represented another attempt by the Treasury to neuter the powers of the council. Fed officials again believed that the Treasury anticipated the president would delegate any special authority to it and that it would “abuse the power to get information from other

95 Matthew Szymczak, Address, “Federal Reserve and the Bretton Woods Proposals: Delivered before Chicago Chapters of the American Statistical Association and the American Marketing Association,” March 21, 1945, NARA, RG 82 DIF, box 38. 96 Alice Bourneuf to Walter Gardner, Memorandum, “Analysis of Amendments Made by House Banking and Currency Committee in Bretton Woods Bill,” May 25, 1945, NARA, RG 82 DIF, box 36. 97 Federal Reserve Board of Governors, Memorandum, “Three Proposals for Inclusion in the Bretton Woods Enabling Legislation,” December 5, 1944, NARA, RG 82 DIF, box 36; Federal Reserve Board of Governors, Memorandum, “Explanation of Important Features of the Proposed Bretton Woods Enabling Legislation,” December 15, 1944, NARA, RG 82 DIF, box 36. 221

agencies and might, through failing to share it fully, build for itself a special position.”98

In supporting a provision to have information gathering and dissemination channeled through the NAC, the Federal Reserve sought to prevent the development of alternative decision-making channels that effectively reduced its say in domestic monetary and credit policies.

Federal Reserve officials proposed an alternative that placed greater power in the hands of the council but stopped short of creating an agency that might dominate policymaking. They argued in favor of investing the council with the authority to either grant or withhold consent on matters that required the approval of the American government.99 The Federal Reserve’s proposal stipulated that the American representatives keep the council fully informed of decisions made and the various operations of the Fund and Bank, allowing it to coordinate government policy with the two new institutions. The Fed, however, did provide some autonomy for self-direction on the part of the American representatives. Fed officials objected to Treasury language in early drafts of the enabling legislation that required governors and directors to “consult with and act pursuant to the direction of the” NAC. They instead suggested replacing this with a less binding statement requiring American representatives to “act in a manner generally consistent with the views” of the NAC. The Federal Reserve coupled this with provision allowing the NAC to recall the American representatives if they were deemed

98 E. A. Goldenweiser, Memorandum, “Proposed Bretton Woods Enabling Legislation,” December 21, 1944, NARA, RG 82 DIF, box 36. 99 Alice Bourneuf to Walter Gardner, Memorandum, “Draft of Possible Statement of the Chairman before House Banking and Currency Committee on Bretton Woods,” April 5, 1945, NARA, RG 82 DIF, box 36. 222

to be acting in a manner inconsistent with American policy.100 Central bankers therefore supported ex poste accountability rather than the Treasury’s preferred ex ante instruction.

Reliance on accountability after the fact rather than dictating the actions of

American representatives comported with the Federal Reserve’s goal of insulating itself against potential political uncertainty and encroachment on its policy autonomy. Federal

Reserve officials repeatedly argued that requiring direct instructions was “too rigid,” and threatening to transform representatives into “messenger boys” and discouraging “men of ability” from accepting the position, a description that may have been apropos of the

Fed’s view of its relationship with the financial and economic decision-making environment.101 While Arthur Bloomfield of the FRBNY was more sanguine about a stronger council, believing that it prevented the United States from being “played for a sucker” by the Fund and Bank, he still recognized the potential downside of restricting the “freedom of action” of representatives to the institutions.102

Federal Reserve officials expressed similar concerns over modifications to the enabling legislation during the early summer of 1945. These late amendments empowered the council to not only coordinate policy between the government and the

100 Federal Reserve Board of Governors, Memorandum, “Suggested Revisions of Draft of the Bretton Woods Enabling Legislation Distributed by the Treasury on December 6, 1944,” January 16, 1945, NARA, RG 82 DIF, box 36. 101 Walter Gardner to Matthew Szymczak, Memorandum, “Status of discussions on Bretton Woods enabling legislation,” December 21, 1944, NARA, RG 82 DIF, box 36; E. A. Goldenweiser, Memorandum, “Proposed Bretton Woods Enabling Legislation,” December 21, 1944, NARA, RG 82 DIF, box 36; Federal Reserve Board of Governors, Memorandum, “Suggested Revisions of Draft of the Bretton Woods Enabling Legislation Distributed by the Treasury on December 6, 1944,” NARA, RG 82 DIF, box 36. 102 Arthur Bloomfield to L. W. Knoke, Memorandum, “House Committee Amendments on the Bretton Woods Bill,” June 5, 1945, NARA, RG 82 DIF, box 36. 223

representatives to the Fund and Bank but also to coordinate policy amongst the government agencies. According to Alice Bourneuf the amendments covered all agencies “to the extent that they make or participate in the making of foreign loans or engage in foreign financial, exchange or monetary transactions.” Importantly, such an inclusive definition potentially empowered the council to oversee the actions of the

Federal Reserve Board of Governors.103 Allowing the NAC to oversee and regulate the actions of the Fed ran against the fundamentals of what the central bank hoped to accomplish, namely greater autonomy in policymaking.

Federal Reserve officials with the Board of Governors sought to balance the powers of the council, granting it enough authority to prevent it from simply being disregarded while at the same time not so much power that might serve to undermine rather than enhance Federal Reserve policy autonomy. They anticipated that the representatives to the Fund and the Bank would regularly consult with members of the

NAC, and that the NAC would in turn regularly report to the president and Congress.104

At the same time they sought a balanced approach to the council’s power structure to mitigate political uncertainty. Federal Reserve officials believed that the implications of the Fund and Bank for domestic conditions as well as the past history of tense relations with other agencies meant that they could not rely upon verbal assurances for inclusion in important policy discussions, and therefore led them to favor a formal council system.

Similarly, Fed officials refused to gamble away their policy autonomy potentially

103 Alice Bourneuf to Walter Gardner, Memorandum, “Analysis of Amendments Made by House Banking and Currency Committee in Bretton Woods Bill,” May 25, 1945, NARA, RG 82 DIF, box 36. 104 Federal Reserve Board of Governors, “Federal Reserve Preliminary Draft - Joint Resolution,” December 9, 1944, NARA, RG 82 DIF, box 36. 224

permanently by subordinating themselves to an unknown position of influence on council of which they held only one of five seats.105

The Federal Reserve System and Foreign Affairs

Congress finally passed the Bretton Woods Agreement Act on July 31, 1945. The law committed the United States to membership in the International Monetary Fund and the World Bank and formally created the NAC with the Chairman of the Board of

Governors as a member.106 Fed officials recognized that the central bank now

“indirectly” held “responsibilities and powers in the field of foreign financial operations.”

This meant that chairman needed to wear two hats when assessing policy, evaluating, for example, how “international transactions . . . might affect domestic reserves and credit and banking conditions,” as well as how “the Board’s policies . . . relate to the foreign financial policies of other agencies.” Thus, while the Federal Reserve now possessed newfound influence in the field of foreign financial affairs it also had a reciprocal responsibility to keep the NAC fully informed of foreign financial, exchange, and monetary transactions.107

In anticipation of the role of the central bank in foreign financial affairs, the

Board of Governors took steps in early 1945 to bolster consideration of international

105 Moe, “Politics of Structural Choice,” 138. 106 Bretton Woods Agreements Act, Public Law 171, 79th Cong., 1st sess., (July 31, 1945), 2. 107 Federal Reserve Board of Governors, Memorandum, “Relations of the Federal Reserve System with the National Advisory Council and Advisory Board of the Export-Import Bank,” NARA, RG 82 DIF, box 38. 225

issues and how their implications for the Federal Reserve System. Anticipating the end of the war Allan Sproul, the president of the FRBNY, wrote to Eccles suggesting that the

Fed attempt to re-establish personal relationships with European central bankers.108

Matthew Szymczak followed up Sproul’s proposal with a brief memo forwarding a variety of suggestions, including that the Board of Governors consolidate foreign missions to central banks under its auspices, that it undertake “long range research programs relating to foreign matters,” that the Board of Governors expand its research staff to support this task, and that the Board create a permanent three member committee to coordinate the relationship between the Federal Reserve and foreign missions.109

In a longer memo to the Board of Governors Szymczak argued that three paths faced the central bank. First, it could “minimize” foreign contacts, a move that would concede foreign relations to the Treasury and private bankers. Second, the Board might delegate the job of foreign contact to the Reserve Banks, specifically the FRBNY, as it had during the 1920s. He argued, however, that either of these courses would inevitably result in the “dimunition of the Board’s influence” not only over international affairs but also eventually domestic affairs as well. The Third option, which Szymczak favored, was for the Board of Governors itself to become directly involved in led a unified and engaged policy of direct engagement. Similar to the NAC proposals, he justified this active engagement in terms of domestic policy, writing that such foreign missions helped

“remedy foreign monetary conditions that would otherwise disturb credit conditions here

108 Allan Sproul to Marriner Eccles, Letter, February 6, 1945, NARA, RG 82 DIF, box 216. 109 Szymczak suggested that the committee consist of the Chairman of the Board of Governors, the President of the FRBNY, and one other member of the Board of Governors. Matthew Szymczak to Marriner Eccles, Memorandum, February 26, 1945, NARA, RG 82 DIF, box 216. 226

in the domestic economy” and averring that the Board’s responsibilities required it to

“keep informed continuously in the international field and to widen the foreign contacts and activities of both the Board Members and the staff.”110

The Federal Reserve responded by creating the Staff Group on Foreign Interests, enlarged from Szymczak’s proposal. The group convened for the first time at 10:00 AM on Thursday, August 9, 1945, at the FRBNY headquarters in New York City. Members of the Board of Governors, the FRBNY, and the Philadelphia Reserve Bank attended, discussing a variety of issues, including suggestions for Federal Reserve relations with the Fund and Bank as well as proposed procedures for the NAC.111 The body met periodically thereafter to discuss and coordinate Federal Reserve System policy on major international issues.

Additionally, at the beginning of 1945 the International Section of the Board of

Governors Division of Research and Statistics began publishing and circulating a bi- weekly “Review of Foreign Developments.” The review represented an attempt by the

Federal Reserve to develop a more sophisticated understanding of the variety of international economic developments unfolding. Rather than attempting to gain a comprehensive understanding of a single country or issue the reviews gave brief synopses of various issues ranging from the valuation of the Turkish pound to the development of central banking in Brazil to wool surpluses in the British Empire and Hungarian inflation.

110 Matthew Szymczak to Federal Reserve Board of Governors, Memorandum, February 26, 1945, NARA, RG 82 DIF, box 216. Szymczak, attempting to get his preference across, wrote his third proposal, calling for active engagement in foreign affairs, in all capital letters. 111 Federal Reserve Board of Governors, Memorandum, “Memorandum of the Meeting of the Staff Group on Foreign Interests,” August 9, 1945, NARA, RG 82 DIF, box 216. 227

The review incorporated confidential data, which restricted its circulation, but the editors hoped that this fact would also enable a “greater freedom of expression.”112

Conclusion

In the aftermath of the Second World War, however, the realities of postwar economic dislocations and geostrategic frictions quickly undermined the hopes of the

Bretton Woods planners.113 As the European economic situation deteriorated between

1945 and 1947 the United States turned to alternative measures such as the European

Recovery Program. Marshall Plan assistance served to offset the flight of European capital unleashed by a brief period of financial liberalization between 1945-47, allowing states to import the critical items they required to restart their export economies and begin to establish equilibrium in the international balance of payments.114 Meanwhile, the

Economic Cooperation Administration (ECA), created to administer many of the aspects of the Marshall Plan, began to supplant the NAC. In contrast to the NAC’s council structure, a single cabinet level administrator directed the ECA. The head of the ECA

112 Federal Reserve Board of Governors, “Review of Foreign Developments,” January 8, 1945; Federal Reserve Board of Governors, “Review of Foreign Developments,” March 5, 1945; Federal Reserve Board of Governors, “Review of Foreign Developments,” October 22, 1945. 113 Eckes, Search for Solvency, 212-19; Michael J. Hogan, The Marshall Plan: America, Britain, and the Reconstruction of Western Europe, 1947-1952 (New York: Cambridge University Press, 1987), 31. 114 Eric Helleiner, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s (Ithaca: Cornell University Press, 1994), 58-62; Barry Eicehngreen, The European Economy Since 1945: Coordinated Capitalism and Beyond (Princeton: Princeton University Press, 2007), 65-9. 228

also received a spot on the NAC, further enhancing the new body’s voice within the council.115

The Federal Reserve’s role in the creation of the NAC is important because it demonstrates an active interest in the Bretton Woods regime specifically, and the larger dynamic of domestic-international economic prosperity. Central bankers were unwilling to concede the field of international monetary and financial policy to the Treasury despite their relative loss of prestige and influence during the Great Depression. Nor were Fed officials simply interested in voicing their opinions on the scope or nature of the

International Monetary Fund and the World Bank proposals. While they accepted relative subordination in policymaking between 1941 and 1945, support for the NAC demonstrated that this was not a permanent condition. Instead, the Federal Reserve sought to secure a voice for itself in the ongoing management of the Bretton Woods institutions, creating a permanent role within the postwar international financial policymaking structure.

Earlier chapters demonstrated a clear pattern of behavior on the part of the

Federal Reserve culminating in the formation of the NAC. During the Second World

War the Fed accepted inflationary war finance policies, believing that the threat to the

American political economy posed by the Axis trumped immediate concerns. At the same time, Fed officials suggested alternative measures, establishing a set of policy preferences for the future, while still supporting accommodative war finance. Fed officials also expressed a set of beliefs about the role of long-term foreign investment,

115 Hogan, The Marshall Plan, 102-7; Casey, Saving International Capitalism, 222-3. 229

currency stability, and financial capital movements. They saw the revival of a liberal trade system as critical to global postwar prosperity, which they connected with maintenance of political peace. At the same time they accepted a restrictive environment for international financial flows, hoping to avoid the beggar-thy-neighbor policies that had undermined the interwar economy. With the creation of the NAC the Federal

Reserve inserted itself into the decision-making structure of foreign financial policy while also couching the measure as a means to safeguard domestic economic and credit conditions.

As the United States found itself engaged in an increasingly costly political and security competition, the Federal Reserve, with a developing view of the domestic and international political economy necessary for peace and prosperity, found itself better positioned to act on these beliefs. And as the Cold War competition developed the tools required to face the Soviet challenge became increasingly distinct from those that were necessary to defeat the Axis. The Cold War required the restoration and maintenance of economic prosperity not just the immediate mass manufacture of arms. Price stability, and its larger social implications, became relatively more important. As the Cold War required a re-evaluation of the relationship between economic and political-military strength the Fed was positioned ideologically and institutionally to react. This is not to argue that the Fed ever sought to dominate economic policy or that it subordinated strategic political needs to economic financial ones. Instead, it sought to balance the relationship and progressively challenged economic policies that it believed threatened 230

the long-term viability of American economic prosperity and thereby the nation’s ability to fulfill its newfound Cold War responsibilities.

Chapter Five

“No Particular Fear of Russia, Just of Chaos”: The Federal Reserve, Postwar Reconversion, and the British Loan, 1945-1947

This chapter examines the role of the Federal Reserve in the adoption of the

Anglo-American Financial Agreement (British Loan).1 Negotiated during the autumn of

1945 and enacted into law in July 1946, the British Loan provided Great Britain access to a $3.75 billion line of credit to finance its international payments dollar deficit during the immediate postwar transitional period. The credit was to be available for five years, after which the loan amortized at a fixed 2 percent interest rate over the next fifty years. The agreement included further provisions for waiving annual interest payments conditioned upon specific benchmarks in Britain’s balance-of-payment and international reserve situation. Furthermore, the British Loan also financed the final settlement of outstanding

Lend Lease and surplus property obligations incurred during the course of the war and its immediate aftermath. In exchange for financial assistance, Britain committed to make sterling convertible for current transactions as well as pledged to terminate a number of practices American negotiators found discriminatory or restrictive. These included the progressive liquidation of large blocked sterling debts owed to Britain’s creditors, ending

1 This chapter assumes an expansive definition of the term British Loan using it to describe not only the new money credit provided to Britain to finance its balance-of-payments deficit, but also funds provided to liquidate surplus property and Lend Lease obligations as well as the British commitment trade and currency liberalization measures described below.

231 232

the so-called dollar pool, and reducing the trade barriers associated with the Imperial

Preference system established in the 1932 Ottawa Agreement.2

As members of the National Advisory Council on International Monetary and

Financial Problems (NAC), Federal Reserve officials, played an active role in all stages of the British Loan negotiation process, as well as championing its approval by

Congress.3 Central bankers’ approach to the British Loan highlights their continued support for the creation of the multilateral international trading system they believed necessary for postwar economic prosperity, and, in turn, political stability and peace. At the same time, it demonstrates how Fed officials struggled with the changed circumstances of the postwar era. The end of the war meant the end of the immediate

Axis threat, one of the factors that had suppressed the Fed’s concerns about Treasury war financing policies, and while many officials, including central bankers, perceived a potential menace to an American-led liberal capitalist order in the Soviet Union, the nature and extent of that challenge was as yet unclear. A more obvious danger, at least from the perspective of the Fed, was the inflationary pressure latent in the American economy that threatened to derail both domestic and international postwar prosperity.

Federal Reserve officials approached the British Loan with this myriad of interrelated imperatives in mind. On the one hand, they continued to believe that the

2 United States Department of State, Anglo-American Financial and Commercial Agreements (Washington, D.C.: Government Printing Office, 1945). 3 The Truman administration tapped the heads of the constituent agencies of the NAC, along with Stuart Symington of the Surplus Property Board and Army-Navy Liquidation Commissioner Thomas McCabe as members of the Top Committee to spearhead talks with the British. Kevin M. Casey, Saving International Capitalism During the Early Truman Presidency: The National Advisory Council on International Monetary and Finance Problems (New York: Routledge, 2001), 76. 233

United States must assume an active leadership role in reviving the international economic order, a task intended to simultaneously facilitate domestic reconversion to a peacetime prosperity able to sustain high employment and productivity as well as prevent other nations, particularly the sterling area, from adopting the type of nationalist policies associated with the totalitarianism and political conflict. On the other, central bankers sought to avoid allowing the measures adopted in pursuit of international goals to exacerbate inflation at home. Such an outcome risked scuttling the very domestic recovery they believed critical to long-term international prosperity while also reducing the effectiveness of dollar assistance.

The British Loan is an important but often overlooked event in American foreign economic policy. Negotiated in late 1945, it came after the defeat of Japan and therefore fell beyond the scope of the Second World War. Additionally, while scholars have attributed its adoption by Congress to the deterioration of relations with the Soviet Union, the politics of what became the Cold War were not yet as prominent as they would be in later undertakings, such as the Greco-Turkish Aid Bill or the European Recovery

Program (Marshall Plan).4 Yet another possible reason for the relative disregard of the

British Loan is the fact that it can be seen as a failure. One of its primary goals, restoring the convertibility of sterling, met a disastrous setback. Under terms agreed to during negotiations, Britain resumed convertibility of sterling on July 15, 1947, but was forced

4 The nebulous position of the British Loan between war measure and Cold War policy is explained in Richard N. Gardner, Sterling-Dollar Diplomacy: The Origins and the Prospects of our International Economic Order (New York: McGraw-Hill Book Company, 1969), 242, 252-53; John Lewis Gaddis interprets the British Loan more explicitly within the context of the Cold War seeing as an important milestone in overcoming “isolationist tendencies” on the road to containment in The United States and the Origins of the Cold War, 1941-1947 (New York: Columbia University Press, 2000), 342. 234

to suspend it again just thirty-six days later, on August 20, as a rush to convert pounds into dollars substantially drained international reserves.5 The fact that the British Loan was quickly followed by the larger and more comprehensive Marshall Plan only reinforces this perception of failure.6

Despite the inability of the British Loan to achieve its full objectives, an examination of its negotiation and the fight for its adoption by Congress is instructive as it reveals the complex environment the central bankers perceived, and how they attempted to navigate it. Scholars have interpreted the period 1945-1947 as an attempted

“restoration of orthodox economic policy” in international relations.7 This led to evaluations of the Federal Reserve’s stance on the British Loan that, for various reasons, does not adequately acknowledge the difficult balancing act central bankers engaged in.

At one end, Robert Skidelsky in his multivolume biography of British economist John

Maynard Keynes criticized the attitude of Federal Reserve Board of Governors Chairman

Marriner Eccles, arguing that the Fed took a narrow approach in dealing with Britain and behaved like a banker treating with a “bankrupt company” by focusing on how the British planned to repay their creditors.8 At the other extreme at least one scholar argues that if given his druthers Eccles would simply have gifted money to the British.9 The fact that

5 Barry Eichengreen, The European Economy Since 1945: Coordinated Capitalism and Beyond (Princeton: Princeton University Press, 2007), 75. 6 Michael J. Hogan, The Marshall Plan: America, Britain, and the reconstruction of Western Europe, 1947-1952 (New York: Cambridge University Press, 1987), 50. 7 Eric Helleiner, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s (Ithaca: Cornell University Press, 1994), 54. 8 Robert Skidelsky, John Maynard Keynes: Fighting for Freedom, 1937-1946 (New York: Penguin Books, 2000), 388-90, 409-14. 9 Sydney Hyman, Marriner S. Eccles: Private Entrepreneur and Public Servant (Stanford: Stanford University Graduate School of Business, 1976), 316-18. 235

scholars have reached diametrically opposed conclusions should be taken as evidence not that either is incorrect but rather that both are, albeit by highlighting different aspects of the Fed’s Janus-faced negotiating position, driven as it was by the interplay of domestic and international interests and responsibilities.

This chapter aims to revise the prevailing interpretation of the British Loan at least as far as the Federal Reserve’s involvement is concerned. It is true that Marriner

Eccles often aligned himself with the Treasury Department during negotiations, supporting conservative policies seen as less generous than those the State Department adopted. Missing from earlier studies, however, is an analysis of why the Federal

Reserve adopted the positions it did. This chapter will demonstrate that it is not possible to divorce central bankers’ views of the British Loan from their understanding of the domestic economic situation and the larger relationship between the American and global economies. Any attempt to do otherwise breaks up what Fed officials believed was a dynamic and interdependent system. Instead, the Federal Reserve strongly supported the

British Loan and believed it critical to avoiding the kinds of competitive economic policies that marred the 1930s and resulted in political instability. At the same time, however, Fed officials were also sensitive to the highly inflationary domestic economic situation. Therefore, the Fed’s position during the British Loan negotiations must be understood as an attempt to steer a middle course, as best it understood, that promoted stable economic reconversion without risking either international autarky or domestic inflation. Thus, to the extent that Fed officials advocated what some contemporaries at 236

the time and scholars subsequently have interpreted as conservative positions, they did so in support of a larger agenda favorable to British recovery.

Within the context of the British Loan negotiations this chapter demonstrates how the Federal Reserve’s approach to the formulation of American foreign economic policy continued to develop after the Second World War. Federal Reserve officials advocated an active role for the government in guiding the domestic and international economy back to a state where private enterprise and free markets could operate effectively. This meant continued central bank engagement in consideration and formulation of foreign and domestic economic policy guided by a political economic philosophy consistent with their positions staked out during the World Bank and International Monetary Fund (Fund) discussions. Importantly, however, where the Treasury dominated the crafting of the

Bretton Woods institutions, negotiations on the British Loan unfolded within the context of the NAC. This gave Fed officials greater scope to express their own views and attempt to influence the terms of the financial assistance package. Furthermore, the chapter will demonstrate that Fed officials sought to curb what they perceived as the potentially inflationary aspects of the Loan proposal. This argument, therefore, further bolsters the earlier contention that central bankers supported the interagency council not out of a desire to dominate foreign economic policymaking, but rather, because of the interrelationship of domestic and international financial matters, to preserve autonomy in their monetary and credit management responsibilities. The Fed used its position not to promote a conservative or austere loan package to Britain for its own sake, but, from central bankers’ perspective, to ensure that the foreign loan did not exacerbate 237

inflationary conditions within the United States and thereby undermine its very purpose.

That is not to say, however, that Federal Reserve officials accurately judged or correctly anticipated the full extent of problems facing either the United States or Great Britain during the period of postwar reconversion. They certainly did not. This chapter does argue, though, that the Fed’s increasingly assertive behavior on foreign policy issues, such as the British Loan, derived from its twin desires to both maintain domestic economic stability while also serving the nation’s foreign policy goals, at least to the extent that it understood those goals.

The issues discussed in the process of negotiating the British Loan were, for the most part, interrelated and codependent, complicating attempts to neatly untangle them.

Policymakers grappled with the implications of technical details at both the international level, between the United States and Great Britain, and at the national level, amongst the departments and interests engaged. While the division is admittedly artificial, a detailed examination of the negotiations and implications of the British Loan may be facilitated by examining different clusters of issues. First, there were those items that for the lack of a better phrase may be classified as known unknowns, primarily the state of domestic inflation and Britain’s prospective balance-of-payments deficits for the transitional period. Policymakers recognized that these issues were linked with the final loan agreement, but even absent this additional factor reaching a consensus on the size and composition of something as complicated as Britain’s international payments was difficult to say the least. Nevertheless, these issues represented ever present considerations throughout the British Loan negotiations process. 238

Second, policymakers debated the amount of the assistance to Britain as well as its domestic and international implications. On the domestic side, central bankers sought to keep the dollar assistance as small as possible and prevent the creation of unnecessary purchasing power that might exacerbate domestic inflation. They also pressed for additional anti-inflationary policies to limit the price pressure that might result anyway.

On the international side, Federal Reserve officials supported a variety of reforms seen as necessary for maximizing the long-term effectiveness of the British Loan. These included measures to liberalize international trade and currency relations, such as a

British commitment to make sterling convertible, the elimination of the so-called dollar pool, the liquidation of blocked sterling balances, and termination of discriminatory trade practices symbolized by the Imperial Preference System. This required a careful balancing, ensuring that the terms were strict enough to secure popular and congressional support, but not so severe as to risk undermining Britain’s acceptance or creating the sort of burden that compromised Britain’s long-term ability to play its role in the liberal multilateral political and economic order the United States envisioned.

Finally, there were the terms and conditions of the British Loan itself, including whether or not to charge a rate of interest as well as the specifics of the repayment process. Here central bankers still expressed concern for political constraints but found less reason to be concerned about domestic price stability. At heart, this entailed a debate over the very nature of the aid itself, that is to say whether it would take the form of a credit requiring repayment, or a grant with no repayment requirement, or some mixture in between. Sensitivity to domestic political considerations meant setting the rate and terms 239

of repayment at a level acceptable to conservative members of Congress. At the same time, however, officials aimed for sufficient flexibility in these provisions, such as allowing a waiver of some or all of the repayment under certain circumstances, to avoid a repeat of the interwar experience where nations opted for default rather than bear increasingly onerous debt servicing obligations.

American negotiators saw the British Loan and the associated trade and currency pledges discussed below as part of an interconnected whole. The dollar amount of the loan needed to be large enough to help the British economy cover its international payments deficit, which might, in the short term be aggravated by the liquidation of the termination of the dollar pool and the acceptance of sterling convertibility. At the same time, Britain’s commitments were both a concession to help ensure the political acceptability of the loan and a necessary economic step on the path to the multilateral trade system deemed critical for postwar prosperity and peace. American policymakers, including Federal Reserve officials, thereby linked the loan to restoration of multilateral trade and defended the arrangement as necessary to ensure the interdependent goals of domestic prosperity, foreign prosperity, and the avoidance of economic-cum-political warfare. This chapter, therefore, helps to demonstrate continuity with the justification and arguments marshaled by central bankers in support of the Bretton Woods institutions.

As in those cases, the Federal Reserve believed that the situation called for a proactive government policy, specifically by facilitating the British balance-of-payments deficits.

The intent behind this activist government policy, however, remained the creation of an economic system conducive to private enterprise and political democracy. As 240

policymakers saw it, without the loan the troubles of the immediate postwar transitional period might prove prohibitive, forcing Britain and eventually the United States to adopt self-interested trade protection, resulting first in economic and then potentially military conflict. American dollar assistance to Britain during the postwar reconversion therefore had an important role to play in securing the long-term survivability of liberal democratic capitalism.

The Domestic Economic Situation during Reconversion, 1945-1947

In order to appreciate the Federal Reserve’s stance on the British Loan it is necessary to first gain a sense of the domestic economic and credit conditions that confronted policymakers at the conclusion of the Second World War. Observers, both at the time and subsequently, recognized the important shift in aggregate economic power and influence to the United States that took place during the war. At the same time, however, policymakers remained cognizant of the significant challenges in smoothly reconverting the American economy from a wartime stance to one able to support high levels of production and employment during peacetime. Indeed, Fed officials believed that sustaining full employment, which they defined as “a condition under which every person who is able and willing to work can find enough employment in the course of a year to earn not less than enough to maintain his habitual standard of living,” represented 241

the most pressing long-term issue facing the United States.10 One potential threat came from inflationary pressure that distorted prices, disrupted economic relationships, and undermined the pace of postwar reconversion.

Central bankers worried that the high volume of liquid assets held by individuals, banks, and corporations, a consequence of both the war and the choices made in how to finance it, represented a potentially dangerous source of inflationary pressure. While taxes had increased they failed to keep pace with the expansion of incomes, and the lack of consumer goods meant the accumulation of savings in the form of bank deposits and government securities.11 Cash and demand deposit holdings among individuals increased dramatically during the war, growing from $14.1 billion in December 1939 to $45 billion by December 1944. This expansion of liquid asset holdings occurred across the economic spectrum, with American corporations ending the war with a similar growth in their positions.12 Any one of these groups might choose to liquidate their holdings after the war, using the reserve of purchasing power they represented to bid up the price of critical raw materials or goods during the early reconversion period before supply could catch up with potential demand.13 Consumers in particular had taken the opportunity to pay down outstanding debts, halving overall consumer credit debt from $10 billion in

1941 to $5 billion by 1944. The implication was that not only might prices be driven

10 E. A. Goldenweiser, “Jobs,” Federal Reserve System Board of Governors, Postwar Economic Study No. 1: Jobs, Production, and Living Standards (Washington, August 1945), 4. 11 Federal Reserve System Board of Governors, “Liquid Asset Holdings of Individuals and Businesses,” Federal Reserve Bulletin 31, no. 6 (1945): 532. 12 Ibid., 533. 13 Federal Reserve System Board of Governors, “Civilian Supplies and Prices,” Federal Reserve Bulletin 31, no. 3 (1945): 214. 242

upward by a liquidation of existing assets but also that any allowance of consumers to take on new debt would only add to this inflationary pressure.14

Policymakers anticipated the increase in bank deposits as a result of war fueled economic expansion. Central bankers hoped, however, to lock up some of this purchasing power in the form of government securities purchases and urged that even as the war ended and government purchasing declined, non-bank investors should still be encouraged to acquire government securities as an anti-inflation measure.15 Individuals who purchased bonds tied up savings in government securities, making it unavailable for use in purchasing goods and thereby reducing pressure on prices during the postwar reconversion.

Central bankers supported a variety of other domestic monetary and economic provisions designed to curb inflationary pressure during the transitional period. A brief examination of these measures will help to contextualize the Fed’s approach to the

British Loan. The credit to Great Britain was seen as vital to facilitating the liberalization of international payments, making sterling convertible, and also to reviving a multilateral trade system. At the same time, the credit expanded Britain’s purchasing power, and therefore needed to be balanced against its inflationary potential.

Federal Reserve officials supported the continued use of various economic controls including government limits on credit, prices, and wages, as a means of

14 Federal Reserve System Board of Governors, “Course of Consumer Credit,” Federal Reserve Bulletin 31, no. 5 (1945): 411-412. 15 Federal Reserve System Board of Governors, “Treasury Financing and Bank Credit,” Federal Reserve Bulletin 31, no. 8 (1945): 721-22. 243

containing inflationary pressure during the postwar reconversion. Wartime price controls had received a mixed reception, with “grudging support” from business but popular acceptance on the part of American consumers.16 Federal Reserve officials expressed an equally ambiguous attitude toward controls. Intervention in the market place, including the use of controls, was, from the perspective of central bankers, a necessary evil required to guide the economy during the reconversion to peacetime activity. Precipitously removing controls before the supply of consumer goods had an opportunity to catch up with purchasing power threatened to touch off an inflationary boom similar to the experience after the First World War. They still believed, however, that controls should be removed as soon as possible.17 In opaqueness typical of central bankers, however, they did not articulate a clear benchmark on when or how the nation should go about reducing these controls.

Nonetheless, central bankers realized that the enlarged pool of domestic purchasing power, combined with high postwar international demand for American goods, evidenced the need for price controls into the postwar period.18 In response to this recognition, the Federal Reserve, well into 1946, continued to defend the use of price controls and call for their retention.19 On the one year anniversary of the end of the war in Europe, Chairman Marriner Eccles, in testimony before Congress, reiterated support

16 Lizabeth Cohen, A Consumers’ Republic: The Politics of Mass Consumption in Postwar America (New York: Vintage Books, 2003), 66. 17 Federal Reserve System Board of Governors, “Transition to Peacetime Economy,” Federal Reserve Bulletin 31, no. 9 (1945): 851-65. 18 Federal Reserve System Board of Governors, “Economic Activity and Demand at High Levels,” Federal Reserve Bulletin 31, no. 12 (1945): 1184-88. 19 Federal Reserve System Board of Governors, “The Federal Budget in the Transition Economy,” Federal Reserve Bulletin 32, no. 2 (1946): 115-17. 244

for price controls in blunt terms, and argued that the nation was in the “crucial stages in the war on inflation” and that it was “futile to talk about winning if price controls are abandoned or hopelessly crippled now.” Instead, Eccles cautioned that if the “nation

[were] to be saved from an inflationary spiral that can only end in deflationary collapse” it must “hold on to the controls that are left” rather than reducing them.20

The Federal Reserve did not advocate the retention of price controls alone.

Instead, it recognized the need for a variety of measures, including wage restraints, taxes, and credit controls, working in concert to constrain inflationary forces while businesses converted to civilian output and the supply of consumer goods recovered to levels commensurate with the demands of the domestic and international economy. And higher prices reduced the purchasing power of incomes, which might in turn prompt workers to demand higher wages. Higher wages only increased potential demand without changing the supply of goods available and creating an inflationary spiral.21 Continued taxation helped siphon off excess purchasing power, but wage increases threatened to undercut their effectiveness by reducing the relative tax burden.22 Furthermore, even should wages and taxes be kept relatively in check, loosening controls on consumer credit threatened to

20 The text of Eccles’ May 8, 1946 statement “Extension of the Emergency Price Control Act of 1942” delivered to the Senate Banking and Currency Committee was republished in the Federal Reserve Bulletin 32, no. 6 (1946): 573. 21 Marriner Eccles, “Economic Conditions and Public Policy,” Address to the Sixteenth New England Bank Management Conference of the New England Council in Boston, October 25, 1946, reprinted in the Federal Reserve Bulletin 32, no. 11 (1946): 1235. 22 Federal Reserve System Board of Governors, “Current Price Developments,” Federal Reserve Bulletin 32, no. 8 (1946): 834. 245

expand purchasing power with inflationary consequences.23 Finally, disputes over prices, wages, and their implications for workers’ standard of living threatened to result in labor- management conflict and strikes that disrupted output and impeded the production of the goods necessary to ease inflationary pressure.24 Early in the postwar period, therefore,

Fed officials recognized the need for a multifaceted approach to control inflation.

While inflation represented an immediate and potentially disruptive concern, policymakers understood that their long-term problem remained the maintenance of full employment. Full employment, furthermore, was interlinked with the efficient utilization of America’s vastly expanded productive capacity as well as efforts to contain inflation.

Full employment and maximum production ensured a sufficient supply of goods to meet the demands of both the American domestic market and the foreign buyers struggling to recover from the war, thereby capping pressure on prices. Additionally, as seen during the discussions pertaining to the International Monetary Fund and the World Bank, officials realized that postwar prosperity depended upon a system of liberal multilateral trade. Just as too much demand relative to supply was disruptive to prices, too little because of trade barriers or inconvertible currencies undercut the long-term goal of full employment. The war, however, significantly weakened the position of Great Britain and its ability to reduce barriers to trade and allow sterling convertibility. Without some means of reviving the British economy and unwinding the obligations incurred during the

23 Federal Reserve System Board of Governors, Thirty-Second Annual Report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1945 (Washington: 1946), 23- 25. 24 Eccles, “Extension of the Emergency Price Control Act of 1942,” Federal Reserve Bulletin (June 1946): 573. 246

war, policymakers feared the creation of a discriminatory sterling bloc that excluded

American exports and harmed both the American and world economies. To further muddy the waters, however, policymakers also realized that liberalizing trade to ensure the long-term demand necessary to maintain full employment meant, additional inflationary pressure in the short term. The stability of the domestic and international economies was thus intertwined in a variety of ways that required balancing policy goals that were not necessarily always compatible.

Negotiating the British Loan: Defining Britain’s Postwar Balance-of-Payments

On September 4, 1945, just two days after the surrender of Japan, American officials met in the office of Secretary of State James Byrnes to discuss the economic problems facing Great Britain. During the meeting Assistant Secretary of State William

L. Clayton recounted his recent visit to London to gather information on Britain’s prospective financial situation during the postwar transitional period. According to

Clayton, the British expected a balance-of-payments shortfall of $6 billion over the next three years, of which $5 billion required some form of external assistance to finance.

Byrnes proposed the creation of a series of committees to investigate the interrelated issues of Britain’s financial and commercial situation, as well as Lend Lease and postwar surplus property obligations, with the obvious intent of extending some form of

American assistance. From even this early stage, however, Eccles remained cognizant of the potential domestic inflationary consequences of dollar aid to Great Britain. He 247

emphasized to Clayton and the others assembled in Byrnes’ office that the Loan should be seen not as “making dollars available” but rather as a credit that “involved making goods available.” According to Eccles, the size of any loan was intimately connected with the domestic supply of goods available for purchase, as any loan to Great Britain created greater relative purchasing power. Therefore, international assistance, according to central bankers, must be reconciled with the supply of goods available to purchase and the demand, both at home and abroad.25 Eccles realized that failure to match purchasing power to the availability of goods threatened disruptive price increases.

This initial meeting commenced a vigorous debate regarding how much assistance to provided to Britain, which in turn depended upon the postwar international payments situations. Before examining how Fed officials sought to balance their desire to limit domestic inflationary pressure while also reviving Britain as a full partner in a multilateral trading system it is necessary to briefly discuss the composition of that balance of payments. This is important because it spoke to both the scale of the problem, the timeframe contemplated for addressing it, and the distribution of the burden. Along with the domestic inflationary situation, the size of Britain’s postwar deficit represented an additional variable fundamentally interconnected with the size of the loan.

For purposes of analysis American officials generally broke Britain’s balance of payments it into two categories that while not technically precise nevertheless

25 Chester Morrill to Files, Memorandum, “Coordination of Governmental Policies in the Foreign Lending Field,” September 4, 1945, NARA, RG 82 DIF, box 309. 248

represented the sorts of broad generalizations that eased policy discussions.26 One category consisted of Britain’s current account. This included the net between imports and exports of merchandise as well as so-called invisibles, such as the income from shipping or interest on overseas investments. Britain’s current account position eroded substantially during the course of the Second World War as it reoriented its economy to producing arms for the conflict. Britain entered the war with an import surplus of £387 million in 1938 but this ballooned to just over £1 billion by 1944. Federal Reserve officials also pointed out that the sheer physical volume of Britain’s exports in 1944 was just 31 percent of its 1938 levels. While the volume and value of merchandise exports declined so did Britain’s income from invisibles, with income from overseas investments falling 50 percent in 1945 as compared to 1938.27 The second general category consisted of Britain’s sterling balances. During the Second World War, Britain used sterling to pay for the purchase of critical goods and material overseas. The British credited sterling to the accounts of countries to finance the cost of everything from constructing airbases to paying for troops or securing raw materials.28 Over the course of the conflict these external liabilities rapidly mounted with increasing levels of indebtedness, particularly to

India and Egypt. While these balances were blocked or inconvertible their ultimate size as well as the rate of their eventual liquidation created important uncertainties in

26 A more technically precise discussion of balance-of-payments can be found in Paul A. Samuelson, Economics (New York: McGraw-Hill Book Company, 1948), 360-4. 27 Federal Reserve System Board of Governors, “The United Kingdom of Postwar International Trade,” Federal Reserve Bulletin 32, no. 1 (1946): 9; “British White Paper Published in Connection with the Anglo-American Financial Agreement,” republished in the Federal Reserve Bulletin 32, no. 1 (1946): 21. 28 Ibid. 249

calculating both Britain’s deficit size as well as the amount of American assistance required.

Finding a way to progressively liquidate these external liabilities was critically important given the paradoxical tensions they exerted on Britain’s likely deficits as well as the American goal of reconstructing the international economic system on the basis of multilateral trade and convertible currencies.29 External liabilities represented a claim by foreign governments on the resources of Great Britain. After the war, however, Britain was in the midst of attempting to rebuild its economy following several years of devastating conflict. This meant that near-term demand for exports from holders of external sterling balances would either go unfulfilled, because Britain was not producing much that other countries wished to purchase, or would simply drain those few goods that were available, requiring additional austerity measures and further reducing Britons’ standard of living. Given Britain’s pressing postwar reconstruction needs and its likely inability to satisfy creditor demands, a third alternative was for creditors to exchange their sterling balances for international reserves, such as gold or dollars, which they could use to make purchases elsewhere. Convertibility, however, created another conundrum.

If Britain allowed creditors to exchange sterling for dollars, this reduced its own holdings

29 There had been hope to address Britain’s blocked sterling balances within the International Monetary Fund but officials come to believe that these required direct negotiations with Great Britain. Walter Gardner to Harry Dexter White, Memorandum, “Questions on the December 24 Draft of the Treasury Plan for a Stabilization Fund,” January 21, 1943, NARA, RG 82 DIF, box 61; Alice Bourneuf to Walter Gardner, Memorandum, “Blocked Balances,” January 25, 1943, NARA, RG 82 DIF, box 61; Alice Bourneuf to Walter Gardner, Memorandum, “Blocked Balances,” January 28, 1943, NARA, RG 82 DIF, box 61; Walter Gardner to Matthew Szymczak, Memorandum, “The Treasury’s Plan for a World Stabilization Fund,” January 29, 1943, NARA, RG 82 DIF, box 61; E. A. Goldenweiser to Board of Governors, Memorandum, “Issues at Bretton Woods,” July 29, 1944, NARA, RG 82 DIF, box 38; E. A. Goldenweiser to Allen Fisher, Letter, November 9, 1944, NARA, RG 82 DIF, box 34; E. P. Penrose, Economic Planning for the Peace (Princeton: Princeton University Press, 1953), 43-7. 250

of international reserves, increased its deficit with the United States, and again required a choice between austerity and lower standards of living, on the one hand, or ever larger

American dollar assistance, on the other.

The liquidation of sterling balances had very real implications for price stability and long-term full employment goals in the United States. As external creditors exchanged sterling for dollars, for example, they increased demand on the U.S. market without either increasing the supply of goods available or reducing Britain’s overall demand. This contributed further price pressure to an already highly inflationary domestic market. The reverse scenario was not much better. If Britain blocked sterling balances, as it was likely to do, making them inconvertible into dollars, it tied up foreign demand, leaving countries with idle funds and unable to purchase exports from American producers. The result deprived U.S. manufacturers of potential markets, which over the long term harmed efforts to achieve full employment. Addressing this tangle of issues, defining them in precise quantitative terms, and then determining how they related to the size of the required assistance presented significant problems for policymakers, a fact

Secretary of the Treasury Fred Vinson made during the first meeting of the U.S. Financial

Committee (FINCOM) in mid-September 1945.30

Therefore, simply understanding Britain’s aggregate international payments position, setting aside issues of to whom it would owe money, represented a significant challenge, creating points of contention both between and within national delegations. In

30 Draft Minutes of a Meeting of the U.S. Group of the Financial Committee, September 20, 1945, NARA, RG 82 DIF, box 306. 251

early October, Eccles, along with Walter Gardner and Matthew Szymczak, attended a meeting of the United States Top Committee where the issue of aggregate deficits continued to be debated. Harry Dexter White reported that the British still estimated net deficits between $5-6 billion before finally settling on a final figure of $5.3 billion over the next three years. For his part, White believed these estimates “too pessimistic,” reporting that the American finance working group anticipated a much smaller deficit of around $3.3 billion but then offered a not insignificant caveat that his “figures might be out to the extent of $1 billion either way.” Translating this into the size of the assistance from the United States, White offered a range of solutions. He suggested that a $4 billion credit would “clean up the British balance of payments and sterling accounts ‘nicely,’” that a $2 billion credit would do a “less adequate” job, and that anything under $2 billion was unlikely to achieve any “useful result.”31 In yet another rather dramatic turn, less than a week later White suggested that American assistance, if confined simply to the transitional period, could be as small as $1 billion.32 James W. Angell and other officials took a slightly different tack and found the British estimates, specifically for 1946 deficits, “too optimistic.” Nevertheless, Clayton concurred that the total loan size would likely be “something less than $4 billion.” Treasury Secretary Vinson, again, urged the development of better estimates of Britain’s payments position before further contemplating the probable loan size.33 Thus, initial estimates of Britain’s deficit and the

31 Minutes of a Meeting of the United States Top Committee, October 6, 1945, Foreign Relations of the United States, 1945 vol. 6 (Washington D.C.: Government Printing Office, 1969): 141-42. 32 Minutes of Meeting of the U.S. Financial Committee, October 11, 1945, NARA, RG 82 DIF, box 306. 33 Minutes of Second Meeting of the U.S. Financial Committee, October 10, 1945, NARA, RG 82 DIF, box 306. 252

amount of assistance required to finance it ranged widely, highlighting the uncertainty associated with the topic. Nevertheless, a British loan of $4 billion as compared to $1 billion meant very different things for domestic credit management, making a determination of Britain’s likely deficit a pressing issue for central bankers.

Federal Reserve officials struggled to devise their own estimates of the British balance-of-payments position. An early October estimate predicted a British current account deficit of $4.5 billion with a further $1 billion for the financing of external sterling balances and found the estimates of the American technical committee and the

British “too high” and “too low,” respectively.34 Just two days later, however, Matthew

Szymczak sent a memo to Marriner Eccles increasing Britain’s anticipated deficit by

$500 million.35 By the end of October the Federal Reserve would still be attempting to determine the size of Britain’s balance-of-payments deficit. In a memo to Walter

Gardner, Arthur Bloomfield finally conceded that attempts to create specific estimates

“could amount to little more than pure guesswork” in terms of determining both a geographic distribution of Britain’s debt and an aggregate level assessment.36 Reaching a consensus on the size of Britain’s deficit, even within a single agency, proved challenging and further contributed to uncertainty in the negotiating process and an understanding of how the loan affected the domestic economy.

34 Arthur Bloomfield, Randall Hinshaw, and Lloyd Metzler to Walter Gardner, Memorandum, “Proposed Treatment of British Balance-of-Payments Problem,” October 9, 1945, NARA, RG 82 DIF, box 309. 35 Matthew Szymczak to Marriner Eccles, Untitled Memorandum, October 11, 1945, NARA, RG 82 DIF, box 309. 36 Arthur Bloomfield to Walter Gardner, Memorandum, “Geographical Distribution of Britain’s Balance of Payments Deficit: 1946-1948,” October 31, 1945, NARA, RG 82 DIF, box 309. 253

Even when estimates were similar, officials recognized that they often differed substantially on how they reached their respective conclusions. Lloyd Metzler of the

Federal Reserve Board of Governors discovered some of the problems when comparing figures compiled by Keynes and British negotiators with similar deficit estimates formulated by an NAC staff committee. According to Metzler, both sides produced similar estimates of British deficits for the last four months of 1945 through the end of

1946 with a British figure of $3.7 billion and a slightly larger American one of $3.97 billion. Yet these similar totals derived from different factors. Keynes assumed a more rapid recovery for British exports than did the Americans, but at the same time he assumed that this recovery would be driven by a relatively smaller volume of more expensive exports.37 Additionally, both Keynes and the NAC staff committee failed to elaborate on critical assumptions such as level of consumption and the proposed rate of capital formation.38 Given that Britain likely required a certain amount of raw material and capital formation, a relatively rapid recovery implied an equally rapid purchase of goods necessary for postwar reconversion and reconstruction. Thus, British demand might be concentrated on the American market as the United States itself attempted to meet increasing domestic demand and thereby contribute additional purchasing power to an already inflationary environment.

American officials recognized that estimates of Britain’s balance of payments assumed some level of continued austerity and restrictive trade practices to hold down

37 Lloyd Metzler, Memorandum, “Notes on the British Balance-of-Payments Estimates,” September 13, 1945, NARA, RG 82 DIF, box 309. 38 Walter Gardner to Marriner Eccles, Memorandum, “Keynes’ estimate of England’s international deficit compared to those of the NAC group,” September 13, 1945, NARA, RG 82 DIF, box 309. 254

import levels.39 Some central bankers remained cautious, however, of Keynes’ assumption that Britain could hold down consumption to 1944 levels through the end of

1946. They also recognized that the pace of Britain’s demobilization and the estimated level of military spending factored into how quickly it could reduce its deficit, but that so close to the end of the war these were highly uncertain factors.40 As Britain liberalized, the result was a double-edged sword. Greater trade meant higher demand for imports, but this also meant a larger international payments deficit. Policymakers estimated that the removing commercial and financial restrictions potentially doubled the size of Britain’s deficit in 1946. Retaining restrictions that lowered imports meant smaller deficits, but it also potentially meant less consumption, capital formation, and economic recovery.41 To the extent that the British did liberalize, Fed officials estimated that the composition of the balance-of-payments shortfall would tend to focus on dollar imports. Therefore, not only would Britain’s overall international payments position deteriorate, the United

States would be faced with the onus of financing a nominally and relatively greater portion of that deficit with potentially inflationary consequences.42

Problems in estimating the size of Britain’s deficit as well as the pace of its reduction presented the Federal Reserve with interrelated problems. Central bankers reasonably suspected that a larger balance-of-payments shortfall required equally bigger dollar assistance from the United States. A larger dollar loan meant more dollars

39 Dean Acheson to John Winant, September 14, 1945, FRUS, 1945 6:127. 40 Lloyd Metzler to Walter Gardner, Memorandum, “Use of Resources in the United Kingdom in 1946,” October 2, 1945, NARA, RG 82 DIF, box 309. 41 Walter Gardner, Untitled Memorandum, September 17, 1945, NARA, RG 82 DIF, box 309. 42 Lloyd Metzler, Memorandum, “Trade Controls in the United Kingdom,” September 17, 1945, NARA, RG 82 DIF, box 309. 255

available to make purchases within the American market without necessarily changing the supply of goods available for purchase. This threatened to add to an already inflationary environment. At the same time, central bankers certainly recognized that there was not necessarily a causal link between a smaller loan and less inflationary pressure. Even a small loan, if used very rapidly to bid up prices before supply recovered, could lead to price distortions. This was further complicated, as discussed in greater detail below, once policymakers began to wrestle with external sterling balances owed to Britain’s other creditors

The purpose here is not to give a full accounting of the gyrations in calculating the size and composition of Britain’s international payments. The discussion does, however, serve to highlight the multiplicity of technical factors to be accounted for.

Thus, as American policymakers, including Marriner Eccles, began to discuss the specific terms of the British Loan they did so within a highly fluid environment.

Negotiating the British Loan: Determining the Size of the Assistance

Discussions on the size of the assistance required by Great Britain involved a multifaceted balancing act. American policymakers sought a loan large enough to address Britain’s financial needs as predicated by the highly contingent balance-of- payments estimates. Providing too little assistance they well understood would not solve the problem and might lead to a request for more dollars in the future. At the same time, policymakers, including central bankers, expressed concern that too large an assistance 256

package threatened defeat at the hands of fiscal conservatives in Congress. Given the disputes over adoption of the Bretton Woods Agreement the possibility that Congress might balk at a large loan to Great Britain could not be discounted. Additional factors not directly related to the size of the loan also influenced the debate. The extent to which the loan was linked to British trade and currency concessions, elimination of the so-called dollar pool, Britain’s willingness to eliminate the Imperial Preference system, and the free convertibility of sterling into dollars all influenced the talks to different degrees.

Deliberation regarding the size of the British Loan broke down into two general camps. On the one side, the State Department accepted a relatively “liberal” estimate of

Britain’s deficits and favored a large line of credit on the grounds that the appearance of generous American assistance, approximately $4 billion, provided a psychological boost to the markets, reassuring them of Britain’s ability to meet its payment obligations. At the same time, however, the State Department hoped that Britain would be able to restore sterling convertibility earlier and work with its creditors to liquidate outstanding sterling balances without direct U.S. aid. On the other side, the Treasury Department took a

“very strict estimate of the [British] deficit” but was willing to delay sterling convertibility until the end of 1946 and provide funds for the liquidation of large external sterling balances. Fed officials believed their own position to fall somewhere between the two. As negotiations commenced in earnest, central bankers hoped for a smaller

American credit of $2.5-3 billion and were willing to delay convertibility as the price for greater stability, similar to the Treasury. Central bankers, however, opposed allowing the

British to use the credit to pay off their external creditors, fearing both opposition from 257

Congress and the creation of additional “foreign buying power” during the postwar reconversion. Federal Reserve officials believed the British might also favor this provision to avoid becoming heavily indebted to the United States.43

The issue of loan size arose at the October 17, 1945, FINCOM meeting. Clayton reported receiving a request from British negotiators for a $5 billion assistance package consisting of a $2 billion grant and $3 billion in long-term low interest rate loans, an aggregate amount well beyond anything American policymakers were contemplating.

Eccles suggested that the only possible way of securing assistance of the size Britain contemplated was with a British pledge to restore full sterling convertibility early in

1946, and even then case such an enormous aid package was unlikely to be acceptable to

Congress. Eccles sided with Secretary Vinson, favoring the U.S. push for a smaller, $3.5 billion loan, in opposition to Clayton, Secretary Wallace, and James Angell, who favored a larger $4 billion package.44 Even this smaller amount, Eccles believed, offered the

British “considerable margin” for error.45 Considering the highly uncertain nature of the

British deficit estimates coupled with the equally volatile domestic inflationary situation,

Eccles’ proposal suggests an attempt to find a happy medium that balanced competing imperatives, rather than simply an attempt to take a hard line with the British.

By early November each side became increasingly entrenched in its view about the size of the proposed British Loan. Small shifts up or down occurred as the parties

43 Burke Knapp to Marriner Eccles, Untitled Memorandum, October 15, 1945, NARA, RG 82 DIF, box 309. 44 Minutes of Meeting of the U.S. Financial Committee, October 17, 1945, NARA, RG 82 DIF, box 306. 45 Walter Gardner, Untitled Memorandum, October 22, 1945, NARA, RG 82 DIF, box 306. 258

moved closer to consensus, but each remained unwilling to give in to the other. Clayton and the State Department continued to press for a larger loan, arguing that the offer of a generous line of credit in the area of $4 billion increased American bargaining power in obtaining British concessions on issues such as trade liberalization and a firm schedule for reducing sterling balances.46 Clayton also appealed to cultural tropes and argued that the British were a “careful people” and could be counted on not to abuse the credit, implying that, given the difficulty in estimating Britain’s future payments position, the

United States could offer a large credit, providing a margin of error in case international payments worsened or improved less quickly than expected, but that if conditions improved the aid would not be abused or wasted.47 While Clayton and the State

Department generally stuck to a position calling for $4 billion in new money, they expressed a willingness to reduce that amount to $3.85 billion provided it was part of a larger assistance package that totaled $4.5 billion, including loans to help Britain reimburse the United States for surplus property left after the war and to pay for Lend

Lease delivered after the termination of the program. The State Department, supported by Commerce Secretary Wallace, consistently argued for a larger assistance package.48

46 Minutes of a Meeting of the U.S. Financial Committee, November 8, 1945, NARA, RG 82 DIF, box 306; A longer elaboration on Clayton’s linkage of economic liberalization and political peace is provided by Timothy Healey in “Will Clayton, Negotiating the Marshall Plan, and European Economic Integration,” Diplomatic History 35, no. 2 (April 2011): 229-56. 47 Minutes of a Meeting of the United States Top Committee, November 7, 1945, FRUS, 1945 6:160. 48 Minutes of a Meeting of the U.S. Financial Committee, November 14, 1945, NARA, RG 82 DIF, box 306; Minutes of a Meeting of the U.S. Financial Committee, November 26, 1945, NARA, RG 82 DIF, box 306; Burke Knapp to Matthew Szymczak, Untitled Memorandum, November 29, 1945, NARA, RG 82 DIF, box 309. 259

On the other side of the debate the Federal Reserve, represented primarily by

Marriner Eccles, and the Treasury Department continued to push for a smaller agreement.

Eccles personally believed $3 billion sufficient to meet British needs but expressed willingness to accept $3.5 billion in new money to ensure sufficient flexibility should

Britain’s balance of payments position deteriorate.49 Additionally, central bankers firmly believed that the loan should be used to meet a shortfall in current payments and that

Britain should use its own resources to eliminate external sterling balances. On the basis of this approach, Fed officials estimated a British deficit of $4.5 billion, closer to

Britain’s own estimate of $5 billion than the American Technical Committee’s $3.3 billion figure. Since, according to Fed officials, the British indicated the ability to secure

$1.5 billion in outside assistance, and since they retained some $500 million in overseas assets that might be liquidated to further offset an international payments shortfall, a $3.5 billion line of credit gave the British potentially $5.5 billion in assistance.50 In addition,

Eccles supported $650 million to settle Lend Lease and surplus property claims.51

Eccles’ position, therefore, reflected the general Federal Reserve stance taken throughout the negotiating process of balancing support for a generous assistance package with efforts to keep it as small as possible to prevent the creation of unneeded and inflationary purchasing power.

49 Minutes of a Meeting of the U.S. Top Committee, November 7, 1945, FRUS, 1945 6:161. 50 Burke Knapp to Marriner Eccles, Untitled Memorandum, November 7, 1945, NARA, RG 82 DIF, box 309; Minutes of a Meeting of the U.S. Financial Committee, November 8, 1945, NARA, RG 82 DIF, box 306. 51 Burke Knapp to Matthew Szymczak, Untitled Memorandum, November 29, 1945, NARA, RG 82 DIF, box 309. 260

Central bankers navigated countervailing forces in negotiating the final size of the loan to Great Britain. On the one hand, they reiterated their belief, expressed repeatedly during discussions over the World Bank and International Monetary Fund that revived international trade, which included Great Britain, was critical to postwar economic prosperity and political peace. As Treasury Secretary Vinson pointed, out the assistance offered to Britain was minuscule compared to the cost of fighting the Axis during the

Second World War, a point repeated by advocates of the British Loan, including Eccles, who calculated that it equated to approximately fifteen days of war, and was therefore a small price to pay.52 Federal Reserve officials did not see the loan just in nominal or relative dollar terms either. They related it to the larger goal of liberalizing international economic relations seen as critical to preserving democratic free enterprise at home and abroad while also avoiding a repeat of competitive and ultimately destructive interwar political-economic experience. In a memorandum to Chairman Eccles early in the negotiations, Matthew Szymczak spelled out the implications of the British Loan negotiations. Because Britain represented a significant force in the global economy, according to Szymczak “the sooner we help Britain and the more we help Britain, the sooner and the more we help the United States.” Furthermore, almost in direct refutation of Robert Skideslsky’s claims, he argued that “Britain is not bankrupt” and that it would continue to play an important role in the global economy. He cautioned, however, that

52 Draft Minutes of a Meeting of the U.S. Group of the Financial Committee, September 20, 1945, NARA, RG 82 DIF, box 306; Thomas B. McCabe, Address, “The Loan to Britain: A Sound Economic Step,” Address by Thomas B. McCabe, Foreign Liquidation Commissioner before the American Academy of Political and Social Science, January 9, 1946, NARA, RG 82 DIF, box 309; Congress, Senate, Committee on Banking and Currency, Anglo-American Financial Agreement: Hearings on S.J. Res. 138, 79th Cong., 2nd sess., March 8, 1946, 224. 261

failure to provide “substantial” assistance to the British threatened to force them to turn inward to the sterling area, relying upon “discrimination against American exports” and ultimately resulting in “economic warfare.” Szymczak argued “the issue is clear. Either we wish to retain free enterprise or not,” that failure to assist the British, and the resulting progressive restriction of international trade, would force the United States to adopt equally self-interested policies that would eventually undermine private enterprise at home.53 Thus, in Szymzcak’s estimation, assistance to Britain not only aided the overall reconversion of the American economy but also was critical to the defense of the

American political economy of liberal capitalism. On the other hand, Fed officials recognized that too large a loan might not only create additional inflationary pressures as well as jeopardize necessary congressional support.

With these and other factors in mind central bankers pressed for greater assistance from Britain’s trading partners to keep down the size of the loan, called on Britain to liberalize its trade and currency practices to spur economic recovery, and continued to emphasize the need to check domestic sources of inflation. This demonstrated a continued sensitivity on the part of central bankers to the interconnected nature of the domestic economy and threats to price stability with the still fragile nature of the international environment.

Negotiating the British Loan: International Considerations

53 Matthew Szymczak to Marriner Eccles, October 11, 1945, NARA, RG 82 DIF, box 309. 262

The state of international economic relations influenced the course of negotiations on the size of the British Loan. American officials argued that the more assistance

Britain received from its sterling area partners such as a loan from Canada or the reduction of external balances by India and Egypt, the less assistance would be required from the United States and the further U.S. dollar assistance could go to addressing the immediate balance-of-payments situation. American officials also believed that as a condition of dollar assistance the British must liberalize trade and currency practices, taking steps such as eliminating the so-called dollar pool, which distorted international trade, reducing or at least modifying quantitative import barriers, and accepting convertibility of sterling for current transactions. At the same time both sides recognized that greater liberalization was fraught with contradictory tensions. While it contributed to the development of an open multilateral international economy that Fed officials believed necessary for long-term peace and prosperity, it risked exacerbating Britain’s international payments position if the ultimate size of the British Loan proved insufficient.

Britain’s sterling balances represented possibly the most significant complicating factor in an already extremely muddled situation. From the earliest meetings, U.S. policymakers recognized the need to take a multipronged approach to reducing Britain’s external liabilities. The American strategy combined write downs by Britain’s creditors, limited convertibility to allow creditors to exchange sterling for dollars or other international reserves, payoff of some percentage by liquidation of Britain’s remaining 263

overseas assets, and finally the refinancing of the remaining balances into a long-term obligation with repayment terms similar to the proposed American credit.

External Liabilities of Great Britain [Millions of dollars] Creditor Dec. Dec. Dec. Dec. Dec. Dec. Jun. 31, 31, 31, 31, 31, 31, 30, 1939 1940 1941 1942 1943 1944 1945

Sterling Area Dominions - - 560 765 950 1,380 1,550 India, Burma, Middle East - - 1,605 2,800 4,595 6,195 6,980 Other Sterling Area States - - 1,285 1,560 1,910 2,235 2,445

Sterling Area Total - - 3,450 5,125 7,455 9,810 10,975

Rest of the World Total - - 1,785 2,200 2,475 2,575 2,550 Total 2,240 2,960 5,235 7,325 9,930 12,385 13,525 Table 1 Source: Federal Reserve Bulletin, Jan. 1946, 25.

American officials, particularly central bankers, believed that Britain’s other creditors must bear some portion of the responsibility for eliminating wartime sterling balances. At the initial FINCOM meeting John Clayton of the State Department suggested that Britain’s creditors write down 40 percent of the value of the balances.

Marriner Eccles voiced the Federal Reserve’s general concurrence, contrasting sterling balances with American provision of Lend Lease. As he saw it, if states such as India or

Egypt had rendered assistance to Britain during the war on terms equivalent to Lend

Lease then they would never have accumulated such large liabilities to begin with.54

Central bankers believed that India and Egypt, and similar creditors had failed to make material contributions to the war and in the name of equality of sacrifice should take

54 Draft Minutes of a Meeting of the U.S. Group of the Financial Committee held in Secretary Vinson’s Office on Thursday, September 20, 1945 at 11:00 A.M., NARA, RG 82 DIF, box 306. 264

therefore voluntary reductions in sterling balances. At the same time, they admitted that no one policy fit all circumstances and that an across the board reduction in sterling debts was not appropriate. Issues such as length of neutrality, whether credits were owed to foreign government or private citizens, how these debts related to the creditor’s own domestic reserve requirements, and the level of suffering the creditors themselves had endured all had to play a role in calculating the level of write downs.55 Ironically, Britain made this very same argument in appealing for a generous aid package from the United

States.56

Proposed Sterling Balance Reductions [Millions of dollars] Country Sterling Balances Suggested Amount Percentage as of June 30, 1945 of Cancellation Canceled India 4,588 1,000 21.80 Egypt 1,620 450 27.78 Ireland 718 100 13.93 Palestine 467 100 21.41 Argentina 342 50 14.62 Portugal 314 50 15.92 Iraq 283 70 24.73 British Colonies (cumulative) 2,226 250 11.23 South Africa 132 100 75.76 Total 8,464 2,170 25.64 Table 2 Source: Arthur Bloomfield to Walter Gardner, Memorandum, “Handling Britain’s War Debt,” September 20, 1945, NARA, RG 82 DIF, box 309.

Fed officials argued for pressing the British to engage their creditors in negotiations to scale down sterling balances. At the same, time Arthur Bloomfield

55 Arthur Bloomfield to Walter Gardner, Memorandum, “Scaling Down Britain’s Sterling Debt,” September 17, 1945, NARA, RG 82 DIF, box 309. 56 Burke Knapp, Memorandum, “Summary of Economic and Financial Agreements Recently Negotiated between the Governments of the United States and the United Kingdom,” December 17, 1945, NARA, RG 82 DIF, box 309. 265

argued that the United States should take the matter directly to creditor countries if the

British proved unwilling to broach the issue. Bloomfield also believed that the British should be pushed to liquidate outstanding investments and pay down as much as their outstanding balance as possible as a good faith measure that might encourage creditors to be more generous in forgiving sterling debts. Bloomfield went so far as to lay out the proposal for debt reductions for some of the major sterling creditors.57

Central bankers appealed to what they believed were sterling creditors’ vested financial interest in voluntarily reducing sterling balances. Write downs eased Britain’s debt servicing obligation and allowed it to devote more of its resources to postwar reconstruction. Many of the holders of large sterling balances were also heavily dependent on Britain as an export market. Given the highly unsettled state of the international economy in the wake of the Second World War central bankers doubted that sterling creditors would be able to find sufficient alternative foreign markets should

Britain’s position decline substantially. This was particularly true for some of Britain’s largest creditors, such as India, which sent 32 percent of its 1938 exports to Britain and only 10 percent to the United States. Similarly, Egypt relied on Britain to absorb 21 percent of its exports during that year compared to only 7 percent going to the U.S. market. According to Fed officials, if these nations wished to maintain their own domestic prosperity over the long term they had an incentive to accommodate Britain in

57 Arthur Bloomfield to Walter Gardner, Memorandum, “Handling Britain’s War Debt,” September 20, 1945, NARA, RG 82 DIF, box 309. 266

the short term.58 Fed officials recognized the fundamentally interconnected nature of the global economy and that it transcended simple zero sum calculations. Central bankers believed that while sterling creditors might lose in the short term by writing down debts, by ensuring the recovery of the British market they secured their long-term economic well-being.

In addition to writing down outstanding debts, Federal Reserve officials hoped

Britain might be able to obtain loans from its other trade partners, easing the U.S. burden.

During the earliest discussions Marriner Eccles hoped that as much as half of the financing for Britain’s deficit, approximately $2-3 billion, could be secured from other countries, a contention officials in both the Treasury and State Department officials doubted.59 While Harry Dexter White initially dismissed potential outside assistance for

Britain as “peanuts,” American officials continued to attempt to maximize the contribution to the British Loan from nations such as Canada or South Africa.60 By the beginning of October, White expressed hope that as much as $1 billion in outside assistance might be secured, with $600 million from South Africa and $400 million from

Canada.61 By mid-month, however, Clayton reported that Britain might obtain $500 million, later adjusted up to approximately $800 million following conversations with

Graham Towers, Governor of the Bank of Canada, in assistance from Canada, good news

58 Arthur Bloomfield to Walter Gardner, Memorandum, “Financing Britain’s Prospective Deficit with Countries Other than the United States,” September 25, 1945, NARA, RG 82 DIF, box 309. 59 Draft Minutes of a Meeting of the U.S. Group of the Financial Committee, September 20, 1945, NARA, RG 82 DIF, box 306. 60 Walter Gardner to Marriner Eccles, Memorandum, “Your Statement at the Meeting in Secretary Vinson’s Office on September 20,” October 3, 1945, NAR, RG 82 DIF, box 309. 61 Minutes of a Meeting of the U.S. Top Committee, October 3, 1945, FRUS 1945 6:142. 267

that offset the unlikelihood of a South African loan.62 In the end, Canada wound up extending $1.25 billion in new money assistance to Great Britain on terms essentially similar to the Anglo-American agreement.63 This effort to maximize the amount of assistance from other interested parties demonstrated the Federal Reserve’s persistent concern with the interdependent nature of the world and domestic economies. Increasing non-American assistance further curbed demand on the American market as a means of reducing inflationary purchasing power to the greatest extent possible.

In exchange for assistance, American policymakers pressed the British to liberalize trade by eliminating the so-called dollar pool ending restrictions associated with the Imperial Preference system, and by making sterling convertible for current transactions. Officials justified this position on the grounds that these measures were necessary to promote the creation of the kind of open liberal trade and currency system the United States defined as necessary for both economic prosperity and political peace.

American negotiators, particularly central bankers, were not motivated by the desire to secure special advantage for the United States. They recognized that American exporters would gain through trade liberalization, but also insisted that the United States could not be both the world’s largest creditor and largest exporter and that reforms should not be enacted solely to expand the nation’s market share, thereby risking a repeat of the interwar experience. Nevertheless, officials did drive a hard bargain that likely

62 Minutes of a Meeting of the U.S. Financial Committee, October 17, 1945, NARA, RG 82 DIF, box 306; Burke Knapp to Marriner Eccles, Untitled Memorandum, October 22, 1945, NARA, RG 82 DIF, box 309. 63 New York Times, “Britain Will Get $1,250,000,000 Under Canadian Loan Agreement,” March 8, 1946. 268

underestimated the problems faced by the rest of the world and overestimated the ability of the global economy to rebound from the Second World War. In this way, they contributed to the ultimate collapse of the British Loan in 1947.

Federal Reserve officials believed that the Imperial Preference system adversely skewed trade toward the Empire and away from the United States and resulted in an inefficient distribution of commerce. Statistical comparisons compiled by the central bank indicated that the Imperial Preference system accounted for approximately 10 percent of import demand, around $500 million, that, in the absence of the system, would be shifted from the Empire to the United States. At the same time, as Walter Gardner pointed out, this did not necessarily mean that Britain required an additional $500 million in dollar assistance. Instead, he anticipated that ending the Imperial Preference system would lead to a rebalancing of exports and offset 60 to 80 percent of Britain’s additional dollar imports.64 Indeed, Gardner saw the elimination of the Imperial Preference system as part of a quid pro quo for a large loan while at the same time accepting the need for continued British import restrictions to prevent the generation of excessive demand that threatened to unbalance international payments.65 Thus, this represented a move toward the greater liberalization of the international trading system defined as critical to postwar peace and prosperity rather than simply an attempt to gain markets at Britain’s expense.

64 Randall Hinshaw to Walter Gardner, Memorandum, “Effect of Abandonment of Imperial Preference on British Imports,” September 24, 1945, NARA, RG 82 DIF, box 309; Walter Gardner to Marriner Eccles, Memorandum, “Effect of Removing Imperial Preference,” September 25, 1945, NARA, RG 82 DIF, box 309; Randall Hinshaw to Walter Gardner, Memorandum, “Effect of Imperial Preference on Source of British Imports,” October 5, 1945, NARA, RG 82 DIF, box 309. 65 Walter Gardner, Untitled Memorandum, October 22, 1945, NARA, RG 82 DIF, box 309; Federal Reserve System Board of Governors, “The United Kingdom and Postwar International Trade,” Federal Reserve Bulletin (January 1946): 10. 269

Eccles stressed this very point during the negotiation process. He argued that the

British Loan, to the extent that it benefited American producers, should not be viewed as a “mechanism for taking foreign markets away from the British.” Instead, he articulated the belief that multilateral trade expanded the entire market, growing the overall size of the economic pie.66 He repeatedly cautioned against reverting to a policy that emphasized the promotion of American exports at the same time that he expressed concern that failure to open up international trade resulted “inevitably” in an “undeclared economic war” and warned that without the loan nations would be forced into defensive economic blocs, a position shared by others throughout the Federal Reserve System.67

Growing the overall economic pie included increasing American imports by a factor greater than its exports, a point repeatedly emphasized during the Bretton Woods discussions. As the United States increased its imports it paid for them with dollars, supplying foreign countries with the resources necessary to fund their own purchase of

American goods. Increased U.S. imports also helped maintain stable currency values and directly contributed to the British Loan by ensuring the resources necessary to service the credit. Eccles recognized the need to prioritize American imports as much as American

66 Minutes of a Meeting of the U.S. Financial Committee, October 10, 1945, NARA, RG 82 DIF, box 306. 67 Marriner Eccles to Knight G. Aulsbrook, Letter, January 29, 1946, NARA, RG 82 DIF, box 309; Marriner Eccless to Ralph Flanders, Lerrer, January 28, 1946, NARA, RG 82 DIF, box 309; H. G. Leedy to Marriner Eccles, Letter, February 4, 1946, NARA, RG 82 DIF, box 310; Alfred William to Marriner Eccles, Letter, February 4, 1946, NARA, RG 82 DIF, box 310; Watrous Irons to Marriner Eccles, Paper, “The British Loan: A Sound Venture,” February 6, 1946, NARA, RG 82 DIF, box 310. 270

exports and opposed efforts by Senator Claude Pepper (D-FL) to create a system of export insurance that the Fed chairman believed reversed priorities.68

Federal Reserve officials drew upon similar justifications when calling for the elimination of the so-called dollar pool, which operated as a voluntary arrangement whereby members of the sterling area agreed to pool their dollar exchange. Member states transferred their holdings of dollars and convertible exchange to a common pool and then used various import licensing mechanisms to maintain this supply. The purpose of the dollar pool was to preserve dollar resources, but as Richard Gardner pointed out, it also had the effect of lowering aggregate purchases from the dollar area below what would have existed in its absence.69 Harry Dexter White explained that in order to preserve the pool’s dollar holdings, “funds were not allocated to buy goods in the United

States that [could] be secured in any sterling area country.” The result was that American exporters of these goods found themselves “shut out of the sterling area markets.”70 The

British also recognized that the operation of the pool during peacetime ran counter to

American interests, but feared the consequences of eliminating it if the United States failed to supply the dollars necessary to meet the demands of the sterling area.71 It was

68 Marriner Eccles to Claude Pepper, Letter, March 21, 1946, NARA, RG 82 DIF, box 216; Memorandum on Meeting of the Staff Group on Foreign Interests, March 27, 1946, NARA, RG 82 DIF, box 216; Ironically this represented one area where Eccles and Senator Robert A. Taft agreed. Taft expressed concern that the British Loan would artificially swell American exports creating an unsustainable basis for American prosperity. See Clarence E. Wunderlin, Robert A. Taft: Ideas, Tradition, and Party in U.S. Foreign Policy (New York: Rowman and Littlefield, 2005), 120-21. 69 Kenneth M. Wright, “Dollar Pooling in the Sterling Area, 1939-1952,” The American Economic Review 44, no. 4 (September 1954): 560; Gardner, Sterling Dollar Diplomacy, 215. 70 Harry Dexter White, Address delivered at the Civitan Club, “Anglo-American Financial Agreement,” April 9, 1946, NARA, RG 82 DIF, box 309. 71 John Maynard Keynes to Harry Dexter White, Memorandum, “Sterling Area Arrangements,” November 5, 1945, NARA, RG 82 DIF, box 309. 271

therefore not unreasonable for Federal Reserve officials to see the elimination of the dollar pool as a necessary step toward rebalancing the global economy that, in the long- term, benefitted all parties.

Closely connected with the elimination of the Imperial Preference system and the dollar pool was the convertibility of sterling. Sterling earned in the course of trade with

Great Britain was not freely convertible into other currencies, which distorted international trade patterns by limiting choice and focusing trade on the sterling area even when it was not the most efficient or lowest cost market.72 Indeed, Lloyd Metzler believed that sterling convertibility represented one of the most significant contributions of the British Loan agreement to the restoration of multilateral international trade.73

American negotiators pushed Britain to end bilateral clearing arrangements and accept sterling convertibility for all current transactions as of mid-1946. They did, however, allow for some exemptions, such as capital movements or sterling accumulated from military spending.74 Exempting military spending from convertibility presumably allowed Britain to carry out its international security commitments, which might otherwise become the responsibility of the United States. Americans further permitted the British to use import restrictions rather than exchange controls to limit excessive

72 Melvyn P. Leffler, A Preponderance of Power: National Security, the Truman Administration, and the Cold War (Stanford: Stanford University Press, 1992), 63. 73 Lloyd Metzler to Walter Gardner, Memorandum, “The British Loan,” February 13, 1945, NARA, RG 82 DIF, box 309. 74 During informal conversations with American central bankers, British officials expressed the concern that if their financial issues were not resolved in the next several years they would need to “close up shop” and “turn the Empire over to [America] and be a little country” as documented by E. A. Goldenweiser, Memorandum, “Conversations and Reflections in Europe, Summer 1945,” October 9, 1945, NARA, RG 82 DIF, box 123. 272

demand.75 Additionally, as Eccles pointed out, not making convertibility retroactive and only insisting on convertibility for current sterling as of a certain date reduced the likely

British demand for dollars and thereby reduced the need for a larger loan.76

In the end, Fed officials divided over nature of American demands on the British.

Some, like Burke Knapp, believed that the United States could have pushed for greater concessions or a reduced American commitment. Others, such as Arthur Bloomfield, feared that the United States demanded too much of the British and that the terms of the loan might prove self-defeating.77 The British, too, were critical of the commitment to convertibility but, as Knapp assessed the situation, Keynes and his fellow negotiators recognized that there was “no real alternative to assistance from the United States.”78 In either case the Fed’s position represented a persistent sensitivity to the interconnected nature of the domestic-international economy and an attempt to reconcile the unique demands of each. It further demonstrates that Federal Reserve officials actively engaged with international issues and sought to influence them so as to minimize the negative consequences for domestic price stability and economic reconversion, factors they saw as a necessary precondition for long-term prosperity and peace.

75 Minutes of the Meeting of the United States Top Committee, November 7, 1945, FRUS 1945, 6:161-2; Minutes of the Meeting of the U.S. Financial Committee, November 8, 1945, NARA, RG 82 DIF, box 306. 76 Minutes of a Meeting of the U.S. Financial Committee, November 13, 1945, NARA, RG 82 DIF, box 306. 77 Burke Knapp to Matthew Szymczak, Untitled Memorandum, November 27, 1945, NARA, RG 82 DIF, box 309; Arthur Bloomfield to Allan Sproul, Memorandum, “The British Loan Agreement,” December 12, 1945, NARA, RG 82 DIF, box 310. 78 Burke Knapp to Marriner Eccles, Untitled Memorandum, December 29, 1945, NARA, RG 82 DIF, box 309. 273

Peace, Prosperity, and the British Loan

American officials, including central bankers, recognized the importance of securing a sufficiently large loan as well as Britain’s acceptance of trade and currency liberalization in contributing to the nation’s postwar goals. They repeatedly emphasized the links between domestic and international prosperity as well as the relationship to peaceful political relations between states. Supporters of the British Loan engaged in a vigorous public education campaign, in many ways similar in form and content to the one used to push for acceptance of the Bretton Woods agreement.79

In fact, one of the main reasons Federal Reserve officials gave for adoption of the

British Loan was that it cleared the way for the establishment of the Bretton Woods institutions. As critics of the Bretton Woods approach, both at the time and subsequently pointed out repeatedly, there was a transitional gap between the end of wartime measures and the full functioning of the International Monetary Fund and World Bank.80

Nonetheless, the loan did contribute to the Bretton Woods agreement by offering the

United States a political lever to finally force British acceptance of the Fund and World

Bank in late December 1945.81 Eccles further argued that the loan and Bretton Woods were interdependent and fended off charges from Senator Robert A. Taft (R-OH) who

79 Gardner, Sterling-Dollar Diplomacy, 243-45. 80 A generally supportive but no less critical assessment of the failure to plan for the postwar transition can be found in Penrose, Economic Planning for the Peace, 43-5. 81 Gardner, Sterling-Dollar Diplomacy, 191. 274

brought up John H. Williams’ key currency proposal, offering a large loan to help the

British stabilize sterling.82

Some scholars have charged that in light of the problems in bringing the Bank and

Fund into operation as originally conceived, the United States essentially defaulted to a key currency position.83 At first glance, such charges appear to have merit, but they obscure the critical issue of the timing and the sequencing of the agreements, something

Eccles noted during his testimony before the U.S. Senate.84 The fact that Britain now needed a substantial assistance package to deal with its balance-of-payments deficits did not negate the earlier contention during the Fund debate that instability could come from small countries and that getting states to act cooperatively earlier on was a better approach than postponing a multilateral agreement into the indefinite future.

Furthermore, at least in late 1945 and early 1946, central bankers and other American officials appear to have believed that the British Loan represented a special case and did not create a precedent for future American assistance packages. This is not to say that they believed that the United States would not lend abroad, but rather that other loans should be sought through regular channels such as the Export-Import Bank (Eximbank) and be judged more strictly upon their purely economic merit. Indeed Eccles argued that

82 Senate, Anglo-American Financial Agreement, 225-30. 83 Fred L. Block, The Origins of International Economic Disorder: A Study of United States International Monetary Policy from World War II to the Present (Berkeley: University of California Press, 1977), 56. 84 Senate, Anglo-American Financial Agreement, 227. 275

having the Treasury rather than Eximbank handle the British Loan was important so as to reinforce this distinction.85

In making their case for the loan, advocates of assisting the British painted a portrait of an interconnected global economic and political system whereby the failure to revive international trade threatened the American goal of full domestic employment.86

Furthermore, full employment was seen as a critical to staving off inflation and ensuring a stable postwar prosperity. Policymakers, including central bankers, recognized that full employment and maximum output facilitated the reconversion of domestic manufacture, allowing the supply of goods in the economy to close the gap with demand and thereby counteract inflationary pressures while also ensuring the availability of goods needed for international reconstruction.87 Indeed, even before the end of the war Federal Reserve officials recognized that maintenance of full employment represented one of the most significant postwar tasks facing the United States.88 Emanuel Goldenweiser believed that given the ability of totalitarianism to eliminate unemployment, postwar full employment was a particularly crucial goal if democracy and private enterprise were to survive as a

85 Marriner Eccles to Fred Vinson, Letter, December 20, 1945, NARA, RG 82 DIF, box 309; Lloyd Metzler to Walter Gardner, Memorandum, “The British Loan,” February 13, 1946, NARA, RG 82 DIF, box 309; Senate, Anglo-American Financial Agreement, 236-37. 86 John Winant to James Byrnes, November 6, 1945, FRUS 1945 6:157. 87 Daniel Bell, Address before the Kiwanis Club of New York, “Domestic and International Stabilization,” March 7, 1945, NARA, RG 82 DIF, box 38; Alice Bourneuf, Draft of Address before United Office and Professional Workers of America, March 8, 1945, NARA, RG 82 DIF, box 38; Marriner Eccles to Brent Spence, Memorandum, “International Fund and Bank,” March 21, 1945, NARA, RG 82 DIF, box 36. 88 Board of Governors Meeting Minutes, March 3, 1945; E. A. Goldenweiser, Jobs,” in Federal Reserve System Board of Governors, Federal Reserve Postwar Study No. 1: Jobs, Production, and Living Standards (Baltimore: Waverly Press, 1945), 1-5. 276

viable political economic model.89 America’s vastly expanded productive power, however, required healthy international trading partners to provide a critical customer base once reconversion was complete. Dollar assistance played an important role in facilitating foreign nations’ purchase of U.S. exports and thereby supporting full employment while at the same time assisting these countries in rebuilding their economies to the point that they could become self-supporting trading partners with the

United States.90

Foreign economic recovery, facilitated by the British Loan, came back not only in the form of greater economic prosperity but also in a more pacific international political environment. William Clayton of the State Department argued that the American credit was a necessary precondition to allow the British to eliminate the dollar pool and other discriminatory trade practices. Failure to aid the British would force them to adopt defensive trade policies akin to economic warfare. Facilitating liberalization laid the foundation for the generalized growth of American trade, general expanding economic prosperity and, by implication, political peace.91 In the absence of a coherent program such as the British Loan the world threatened to return to the “anarchy” of the 1930s, a result, Walter Gardner cautioned, that “spelled the end of free enterprise in the

89 E. A. Goldenweiser, “Postwar Problems and Policies,” Federal Reserve Bulletin 31, no. 2 (1945): 119. 90 Walter Gardner earlier argued for the interconnectedness between domestic full employment and viable international trade partners during discussion of the Bretton Woods institution in a memo to E. A. Goldenweiser, “Comments on First Draft of Chairman’s Bretton Woods Testimony,” April 4, 1945, NARA, RG 82 DIF, box 36; Janet G. Chapman, “Potential Foreign Lending by the United States,” Review of Foreign Developments, December 3, 1945, Board of Governors of the Federal Reserve System Website (hereafter FRB), http://www.federalreserve.gov/pubs/rfd/1945/24/rfd24.pdf (accessed July 13, 2012). 91 Remarks by the Honorable William L. Clayton, Assistant Secretary of State, at a Press Conference During the Anglo-American Trade-Financial Talks, December 6, 1945, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/036_05_0006.pdf (accessed August 17, 2012). 277

international field.”92 The implication, of course, was that the end of free enterprise would inevitably spell the end of democracy and peaceful postwar relations.

Federal Reserve officials continued to press for approval of the British Loan right up until its actual acceptance by Congress in July 1946. Throughout this period they continued to link the loan to the domestic-international economic prosperity and depict it as necessary to avoid economic chaos, political conflict, and ultimately open warfare.

While testifying before the U.S. Senate Eccles explicitly cautioned that “without economic or political stability, we can expect only a continued drift of world affairs toward a catastrophe of a Third World War,” a warning republished in the Federal

Reserve Bulletin and repeated during testimony before the House of Representatives several months later.93

The revival of a system of multilateral trade that included Great Britain must have seemed particularly important as Federal Reserve officials watched the Soviet Union progressively consolidate its control over large portions of Eastern and Central Europe.

Almost as soon as the war ended central bankers repeatedly warned about the creation of a Soviet-dominated economic zone that potentially excluded Western European trade.94

92 Walter Gardner, Memorandum, “Draft Statement on Advantages to United States of the Proposed British Loan,” February 12, 1946, NARA, RG 82 DIF, box 309. 93 Senate, Anglo-American Financial Agreement, 225; Text of Eccles statement reprinted in the Federal Reserve Bulletin 32, no. 4 (1946): 375; Marriner Eccles, “Statement of Marriner S. Eccles Chairman of the Board of Governors of the Federal Reserve System, Before the Banking and Currency Committee of the House of Representatives, May 22, 1946 on the Financial Agreement Between the United State and Great Britain,” May 22, 1946, NARA, RG 82 DIF, box 309. 94 J. Herbert Furth, “New Plans for a Danubian Customs Union,” Review of Foreign Developments, June 23, 1945, FRB, http://www.federalreserve.gov/pubs/rfd/1945/13/rfd13.pdf (accessed July 12, 2012); Alexander Gerschenkron, “Russia and the International Trade Organization,” Review of Foreign Developments, August 27, 1945, FRB, http://www.federalreserve.gov/pubs/rfd/1945/17/rfd17.pdf 278

Convinced that the Soviets promoted inflation in their sphere of control, they feared such a move might have “serious political as well as economic consequences” for countries like Austria, where interwar hyperinflation had played a role in eroding popular support for democratic government.95 In conversations with British officials, E. A. Goldenweiser acknowledged the progressive codification of the world into two competing economic and political spheres, arguing that “the real test of relative strength is still between democratic countries on the one hand and totalitarianism on the other.” He believed that cooperation between the dominant democratic powers in the United States and Britain was necessary and that if they were not able to demonstrate the benefits of Western methods “we shall lose them in favor of dictatorship.” At the same time one should be careful not to exaggerate the role of the Soviets because, as Goldenweiser admitted, while there was a general sense of “gloom” in London, there was “no particular fear of Russia, just of chaos.”96

Another supporter who voiced this interwoven logic of economic prosperity and political peace was Thomas McCabe, who served as chairman of Scott Paper before taking a leave of absence to enter government service dealing primarily with Lend Lease matters. McCabe was also a Class C director of the Philadelphia Reserve Bank and

(accessed July 12, 2012); Alexander Gerschenkron, “The U.S.S.R. and Bilateralism in Eastern Europe,” Review of Foreign Developments, October 22, 1945, FRB, http://www.federalreserve.gov/pubs/rfd/1945/21/rfd21.pdf (accessed July 13, 2012). 95 J. Herbert Furth, “Currency Problems in Southern Europe,” Review of Foreign Developments, July 9, 1945, FRB, http://www.federalreserve.gov/pubs/rfd/1945/14/rfd14.pdf (accessed July 12, 2012); J. Herbert Furth, “Currency Problems and Currency Reform in Central and Southeastern Europe,” Review of Foreign Developments, January 1, 1946, FRB, http://www.federalreserve.gov/pubs/rfd/1946/26/rfd26.pdf (accessed July 14, 2012). 96 E. A. Goldenweiser, Memorandum, “Conversations and Reflections in Europe Summer 1945,” October 9, 1945, NARA, RG 82 DIF, box 123. 279

eventually succeeded Marriner Eccles as Chairman of the Board of Governors in 1948.

In his capacity as Army-Navy Liquidation Commissioner, McCabe was intimately involved in the negotiation of the British Loan. When he spoke before the American

Academy of Political Science in January 1946, he referred to his association with the

Federal Reserve but argued that he had come to talk “as a business man,” thereby leveraging his credibility as an unofficial representative of private enterprise. McCabe cautioned against the formation of economic blocs, which threatened to impose

“centralized control” over the economy and were therefore “not in keeping with the

American way of life.” He linked the British Loan with the Bretton Woods Agreement and the proposed International Trade Organization as vital if the postwar world were to avoid the “nationalistic, archaic form of trading” that dominated the interwar period and proclaimed that “peace in the world” depended on avoiding a return to closed economic blocs. McCabe also argued that the British Loan was insignificant compared to the cost of the Second World War, but that both would pale in comparison to the cost of a third global conflict.97

The support of McCabe and other prominent business interests appeared particularly important to securing passage of the British Loan, especially in early 1946 when polls showed 46 percent of Americans supported the loan, up from the previous

December and while those disapproving dropped from 45 to 37 percent this still

97 Thomas B. McCabe, Address before the American Academy of Political Science, “The British Loan: A Sound Economic Step,” January 9, 1946, NARA, RG 82 DIF, box 309. 280

represented a sizeable minority.98 In February 1946 the U.S. Chamber of Commerce circulated a pamphlet expressing its qualified support for the British Loan. The Chamber stressed the need for U.S. leadership to avoid “economic warfare” among rival blocs. At the same time, it cautioned that American policymakers needed to take vigorous actions to ensure that the loan did not result in adverse inflationary pressure that threatened the stability of America’s own reconversion.99 Similar and often less qualified expressions of support came from private interest groups, academic economists, and representatives of private industry. The National Planning Association forwarded a statement of support that echoed many of the arguments put forward in defense of the British Loan. The NPA warned that without the revival of trade countries would be forced to look inward to nationalist economic blocs, resulting in greater global political conflict and the potential regimentation of American society and leading to “centralized government trade control .

. . alien to our traditions.”100 Finally, the Carnegie Endowment compiled pamphlets containing statements from newspapers and prominent political, business, and religious leaders from all sections of the country in an effort to demonstrate the breadth of support for the British Loan.101

98 Burke Knapp to Marriner Eccles, Untitled Memorandum, February 20, 1946, NARA, RG 82 DIF, box 309. 99 United States Chamber of Commerce, Pamphlet, “Financial Agreement with the United Kingdom: Related Settlements and Understandings on Trade Policies,” February 1946, NARA, RG 82 DIF, box 310. 100 National Planning Association, Report, “America’s Stake in the British Loan: An NPA Committee Report,” April 8, 1946; NARA, RG 82 DIF, box 309; Statement by American Economists on the Proposed Financial Agreement, Undated, NARA, RG 82 DIF, box 309. 101 Committee on International Economic Policy and the Carnegie Endowment for International Peace, Pamphlet, “We quote for the British Loan Agreement,” June 1946, NARA, RG 82 DIF, box 310. 281

Federal Reserve backing for the British Loan coexisted with the knowledge that the international political economic situation had the potential to further deteriorate. On the one hand the rhetoric was backward looking, in that it echoed much of the language and arguments used in defense of the Bretton Woods institutions. It expressed concern about the potential formation of nationalistic economic blocs that held the seeds of political conflict, and thus failure to assist Great Britain threatened to replay the interwar experience. On the other hand, Federal Reserve arguments were forward looking. That is, central bankers were obviously aware of the increasingly tense relationship with the

Soviet Union and expressed concern about that nation’s apparent attempts to create an economic bloc that encompassed Eastern and Central Europe. Taken together, these concerns pointed up the need to ensure that Britain did not backslide into a closed imperial bloc and instead that it was further integrated into the open multilateral trade and currency system central bankers defined as a prerequisite for prosperity and peace. While tensions with the Soviet Union were not the immediate cause for the British Loan negotiations, growing bilateral antagonism offered a constant reminder of the consequences of failure.

Negotiating the British Loan: Domestic Factors

Concurrent with consideration of the loan’s international aspects, Federal Reserve officials continued to push for policies intended to reduce domestic sources of inflation.

Alf Williams of the Philadelphia Reserve Bank believed that the British Loan made 282

domestic anti-inflationary measures, an existing point of concern for central bankers, even more important.102 Emanuel Goldenweiser proposed a multipronged program for slowly constricting the money supply. This included paying down the wartime debt using the Treasury’s large cash holdings, thereby removing those funds from the banking system and preventing their use in expanding credit. He also suggested instituting a special requirement stipulating that banks hold a certain ratio of government securities relative to demand deposits. Possibly most significantly he advocated ending the pegged rate on bills, maintained at 0.375 percent since early in the war.103 The effect of these recommendations eliminated banks’ incentive to acquire government securities beyond their needs by reducing their ability to easily monetize them by selling to the central bank at the pegged rate. In effect, this practice made government securities essentially as liquid as cash and facilitated the expansion of potentially inflationary bank lending.

Federal Reserve officials recognized that, to the extent domestic factors contributed to inflation, they reduced the purchasing power of dollars held by foreign countries like Great Britain. The result, therefore, undercut their relative effectiveness in helping restore eventual balance-of-payments stability.104 Furthermore, the more

American prices increased the more they distorted prices in foreign countries by driving

102 Alfred Williams to Marriner Eccles, Letter, January 12, 1946, NARA, RG 82 DIF, box 310. 103 FOMC Executive Committee Meeting Minutes, January 23, 1946, Federal Reserve Archive for Statistical and Economic Research (hereafter FRASER), http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19460123MinutesECv.pdf (accessed August 13, 2012); E. A. Goldenweiser, Draft Paper, “Debt, Inflation, and the Federal Reserve System,” February 25, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/101_05_0001.pdf (accessed August 17, 2012). 104 Federal Reserve officials discussed how inflation reduced the effectiveness of foreign loans, Memorandum of the Meeting of the Staff Group on Foreign Interests, October 30, 1946, NARA, RG 82 DIF, box 216. 283

up costs and altering the relative value of imports and exports. Indeed, the Canadian

Minister of Finance cited this very reason, specifically the removal of American price and wage controls that led to a spike in inflation, in mid-1946 when that nation appreciated its currency. Without appreciation the only alternative was to inflate Canadian prices and risk “social unrest” and “wage conflicts” as individuals struggled to keep up.105 While the specific circumstances differed, Federal Reserve officials undoubtedly anticipated a similarly disruptive influence on the British economy if the United States failed to adequately contain price pressures.

The campaign to secure approval of the British Loan coincided with attempts by the Federal Reserve to increase its autonomy over domestic credit and monetary policy in an effort to prevent inflation. The FOMC began considering the need to exercise greater

Federal Reserve discretion in monetary and credit policy during the course of negotiating the British Loan. The pegged rate on Treasury bills remained in effect as did the reasons for the Federal Reserve’s opposition to the rate. The context, however, changed dramatically following the defeat of the Axis and the disappearance of the immediate need to subordinate credit management concerns to achieving victory in the military conflict. As the crisis of the war receded, the possibility arose of adjusting policy to mitigate its more inflationary effects. Although Eccles expressed an unwillingness to act before the scheduled Victory Drive, afterward the central bank needed to begin discussions with the Treasury about the “volume of Government securities

105 Minister of Finance J. L. Ilsley, “Statement by the Minister of Finance on the Appreciation of the Canadian Dollar,” before House of Commons, July 5, 1946, reprinted in the Federal Reserve Bulletin 32, no. 8 (1946): 859-65. 284

outstanding.”106 Eccles began to voice support for a stronger stand during a January 1946 meeting of the FOMC Executive Committee. Recounting a memo to Treasury Secretary

Vinson, Eccles emphasized that the Federal Reserve “had a statutory responsibility in the field of credit” that “rested solely on the System” and “would not be relieved . . . because the Treasury did not want the System to take action.”107 Eccles reiterated this point a month later during a full meeting of the FOMC, arguing that the Fed had “a responsibility for independent action.” It would be “entirely justified” in taking action that would increase interest rates he averred and should “report to Congress that the powers of the

System were inadequate to cope with the existing situation, other than by an increase in rates, and what the alternatives might be.”108

While Eccles talked about independent action to increase interest rates, the

Federal Reserve ultimately held back. Instead, it continued to push for the Treasury to pay down the national debt out of its large cash balances. The national debt increased by

$196.4 billion during the course of the war, with over $80 billion of this increase held by commercial banks or the Federal Reserve System.109 In addition to its overall size, more than $50 billion of the debt was held in the form of Treasury bills or certificates, relatively short-term securities that needed to be refunded on a regular basis. The result

106 FOMC Meeting Minutes, October 17, 1945, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19451017Minutesv.pdf (accessed August 13, 2012). 107 FOMC Executive Committee Meeting Minutes, January 23, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19460123MinutesECv.pdf (accessed August 13, 2012). 108 FOMC Meeting Minutes, February 28, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19460228Minutesv.pdf (accessed August 13, 2012). 109 Federal Reserve System Board of Governors, “Wartime Monetary Expansion and Postwar Needs,” Federal Reserve Bulletin 31, no. 11 (1945): 1096. 285

was that any increase in interest rates also raised the cost to the Treasury of rolling over this debt and only served to enhance bank profits.110 Banks were reaching record levels of profitability, and the issue was already politically sensitive. President Harry Truman personally and publicly expressed resistance to further contributing to the trend of increasing bank profits.111 Federal Reserve officials estimated that member bank net profits increased from $349 million in 1940 to $649 million in 1944. Overall earnings on securities increased from $431 million to $960 million during the same period, but even more to the point they had gone from approximately 33 percent of member bank total earnings to over 50 percent.112 With these factors in mind, the Federal Reserve certainly would have considered a campaign to raise short-term interest rates both economically counterproductive and politically risky. As a consequence, Eccles chose to emphasize measures such as price and wage controls as well as shrinking the money supply by retiring the debt out of the Treasury’s existing cash balances.113

The issue of postwar anti-inflationary policies defined the limits of central bankers’ autonomy in determining monetary and credit policy spoke to the importance of limiting external pressure on prices. On the one hand, Fed officials found themselves

110 Bureau of the Budget, The Budget of the United States Government for the Fiscal Year Ending June 30 1947(Washington, D.C.: Government Printing Office, 1946), 770; Federal Reserve System Board of Governors, 1945 Annual Report, 5. 111 Harry S. Truman, “Message to the Congress of the State of the Union and on the Budget for 1947,” January 21, 1946, John T. Woolley and Gerhard Peters, The American Presidency Project (hereafter APP). Santa Barbara, CA. Available from World Wide Web: http://www.presidency.ucsb.edu/ws/index.php?pid=12467&st=profit&st1= (Accessed September 27, 2012). Indeed it was not until 1951 that the economic and inflationary implications of debt policy became acute enough to overcome the political obstacles. 112 Federal Reserve System Board of Governors, “Member Bank Earnings, First Half of 1945,” Federal Reserve Bulletin (November 1945): 1106. 113 Marriner Eccles, “Extension of the Emergency Price Control Act of 1942,” Federal Reserve Bulletin (June 1946): 573. 286

economically and politically constrained from altering the system of pegged exchange rates established in 1942. The fact that overall price levels remained in check through the first half of 1946 surely must have represented a contributing factor in this regard.

Additionally, when prices did begin to rise in late 1946 and into 1947 those increases came only after the lifting of price controls following Truman’s veto of a bill that would have renewed the powers but in a way that provided “no real safeguards.”114

Figure 1: Consumer Price Index, 1942-1947

Federal Reserve officials continued to voice their displeasure with the current arrangement. Using price and wage controls and the liquidation of large government cash balances to pay down the existing debt as a means of checking and reducing

114 Harry S. Truman, Veto of the Price Control Bill,” June 29, 1946, APP, http://www.presidency.ucsb.edu/ws/index.php?pid=12437&st=price&st1=control (accessed September 27, 2012). 287

inflationary pressure left discretion over the pace of operations in the hands of other agencies, particularly the Treasury. At the same time, as Allan Meltzer points out, the

Federal Reserve believed that any inflation that occurred would be blamed on central bankers. On the domestic front this led Fed officials to promote a variety of regulatory measures, particularly during and after 1947, intended, in the absence of interest rate increases, to offer some active attempt to check inflation.115

Federal Reserve officials, therefore, approached the issue of foreign assistance cognizant of the interrelationship between domestic and international economic factors.

This awareness informed central bankers’ general support for the multilateral trade and exchange regime established at Bretton Woods as a means of ensuring the restoration of domestic full employment. At the same time they recognized that the that the measures required for full employment at home and economic rehabilitation overseas were not always mutually compatible, at least in the short term. The more the United States provided in foreign assistance the greater it expanded total demand relative to the goods available for purchase, and the more imperative it made efforts to hold down domestic sources of inflation. Lowering foreign assistance too much, however, while it reduced inflationary pressure, threatened to force nations to adopt autarkic and nationalistic economic policies and deprived the United States of the open trade system necessary for full employment.

115 Allan H. Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2003), 643-51. 288

Federal Reserve officials ultimately defended the loan on the grounds that the benefits of a revived Great Britain outweighed any resulting inflation. Eccles made this argument explicitly in a letter to Bernard Baruch. In response to Baruch’s fear that the foreign lending was being conducted in an uncoordinated way prone to create inflation

Eccles reassured the aging financier turned presidential adviser that policymakers were not “recklessly throwing fuel on the inflationary fires.”116 He made a very similar argument in a letter to the presidents of the various Reserve Banks, reminding them that he was “not one to enter lightheatedly upon new commitments” that both expanded the debt and created “further purchasing power to press upon our already strained economy.”

At the same time, without the loan he feared a return to “rival economic blocs, strangling restrictions on world trade, and increasing international friction” all of which undermined the “economic foundations for a durable peace.”117 He also expressed hope spreading purchases out over several years would reduce the immediate price pressure.118

Eccles reiterated many of these same points during testimony before the Senate

Committee on Banking and Currency. He acknowledged that the loan added inflationary pressure, but hoped that a combination of American export controls and the number of years over which the British were to spread their purchases would make the impact less acute. He also attempted to reassure senators that the United States would see material

116 Bernard Baruch to Marriner Eccles, Letter, January 20, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_07_0001.pdf (accessed August 16, 2012); Marriner Eccles to Bernard Baruch, Letter, January 28, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_07_0002.pdf (accessed August 16, 2012). 117 Marriner Eccles to Ralph Flanders, Letter, January 28, 1946, NARA, RG 82 DIF, box 309. 118 FOMC Meeting Minutes, February 28, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19460228Minutesv.pdf (accessed August 13, 2012). 289

benefits from the loan, and that the nation did not lend money simply “for the sake of playing the role of world bank.” He argued that the loan was necessary for the British to normalize their international trade, referring to it as akin to a “blood transfusion” required to aid a critical patient. In response to questions from Robert Taft regarding failure to gain more explicit commitments on trade liberalization, Eccles talked in terms of the larger political consequences of inadequate U.S. assistance to the British, maintaining that if nations failed to “make an effort” to restore a “multilateral world” they would be forced to adopt restrictive measures that threatened capitalism and democracy and created the potential of “going the Russian way” to centralization of control over trade and ultimately political “totalitarianism.”119

Negotiating the British Loan: Terms and Repayment Conditions

Federal Reserve officials took a strong stance on the size of the British Loan and the associated trade and currency liberalization measures because they most directly influenced price pressures in the United States and thereby the Fed’s credit management responsibilities, not to mention the nation’s larger political economic goals. When it came to the terms of repayment, however, central bankers accepted an easier stance while also remaining sensitive to perceived political and economic constraints. They sought to reduce the ways the British Loan might indirectly contribute to inflation, particularly waiver provisions that potentially encouraged dollars to be too quickly diverted to external sterling creditors. At the same time, reflecting on the interwar experience with

119 Senate Committee, Anglo-American Financial Agreement, 223, 231, 235. 290

Allied debt servicing, central bankers remained determined to avoid repeating perceived mistakes of the interwar era that made debt service burdensome and soured international relations during the 1920s and 1930s.

Whether or not to charge interest on the British Loan was a point of contention between the American and British negotiators. Keynes, leading the British delegation, hoped to obtain an interest-free assistance package and was possibly encouraged in this outlook by Harry Dexter White of the Treasury.120 During the course of early negotiations, Keynes and Lord Halifax urged the Americans to consider an interest-free credit, but never received a clear commitment.121 Amongst American policymakers

White himself pointed out the difficulties of charging interest. He argued that if the

United States charged interest on its credit to Britain it would likely complicate attempts to obtain interest free assistance from other countries such as Canada. Alternatively, according to White, if the United States charged Britain a low rate of interest equivalent to or below the cost of borrowing so that it did not make a profit, that would be

“tantamount to admitting that the U.S. was attempting to . . . profit on loans to other nations” that presumably fought and suffered during the war and also looked to the

United States for assistance.122 By November the British had yet to fully reconcile themselves to paying interest and still hoped to obtain a $2 billion interest free line of credit to be used specifically for liquidating external sterling balances. The British reasoned that since these funds would be used to meet the “dollar demand” of sterling

120 Skidelsky, Keynes, 408. 121 Minutes of a Meeting of the U.S. Top Committee, October 6, 1945, FRUS, 1945 6:141. 122 Minutes of Meeting of the U.S. Financial Committee, October 11, 1945, NARA, RG 82 DIF, box 306. 291

creditors which consequently benefited the United States by freeing up resources for international trade, Britain should not be forced to pay interest.123 The Americans dismissed this proposal, however, as well as the idea of using any portion of the British

Loan to liquidate external sterling balances.

American negotiators for the most part agreed on the need to charge interest but sought to keep the charge relatively low. Like discussions over the size of the loan, U.S. policymakers feared that an interest-free credit or even an abnormally low rate threatened congressional opposition.124 Officials quickly settled on a nominal rate of 2 percent, which as Burke Knapp of the Federal Reserve pointed out was roughly equivalent to the

“average cost of money to the United States” at the time, as the lowest likely to be acceptable to Congress.125 The actual cost to Britain was even lower when considering the structure of the British Loan. The Anglo-American Loan Agreement was not a loan per se but rather a line of credit open for the British to tap any time during an initial five- year window. Only after the initial five-year period did the fifty year repayment schedule commence, effectively stretching the term of the loan to fifty-five years. Because no interest was charged during the first five years, the interest rate was effectively lowered from a nominal rate of 2 percent to a real rate of approximately 1.63 percent.126

123 John Winant to James Byrnes, November 6, 1945, FRUS, 1945 6:157; John Maynard Keynes to Fred Vinson, Letter, November 6, 1945, NARA, RG 82 DIF, box 309. 124 Minutes of Meeting of the U.S. Financial Committee, October 11, 1945, NARA, RG 82 DIF, box 306. 125 Burke Knapp to Marriner Eccles, Untitled Memorandum, October 12, 1945, NARA, RG 82 DIF, box 309. 126 James Byrnes to John Winant, November 5, 1945, FRUS, 1945 6:154-55. 292

Federal Reserve officials went beyond simply supporting an interest rate as low as acceptable to Congress. Marriner Eccles advocated that flexibility be built into the amortization schedule allowing for the waiver of all or some portion of the payment due from the British and pushed for this provision to be explicitly included in the loan agreement. As he explained to the member of the FINCOM, he wished to avoid past experiences where “creditor and debtor were agreed that some waiver of service charges might be advisable, but were prevented from acting by the terms of the loan contract.”

He believed, rather, that it “might be advisable to include a clause giving the British the privilege of requesting the deferment or waiver of the annual service charge, with the

U.S. reserving the right to waive or defer the interest and amortization charges.”127

Considering how the interwar experience shaped the Fed’s approach to the Bretton

Woods institutions and the way central bankers believed economic and political relations interacted, Eccles likely hoped to avoid a repeat of the breakdown that occurred during the Great Depression. Including a waiver or deferment provision within the actual loan agreement at least minimized the likelihood of national passions seeping into and complicating international economic relations. Thus, a kind of continuity existed with the Bretton Woods negotiations. Just as the International Monetary Fund included a mechanism for adjusting currencies in case of persistent international payments imbalances, so too did the British Loan in the form of the waiver provision.

127 Minutes of Meeting of the U.S. Financial Committee, October 11, 1945, NARA, RG 82 DIF, box 306. 293

While many on the American side favored the idea of a waiver or deferment they disagreed on specifically how it should operate. When should the waiver apply? Was it incumbent upon the British to request the waiver? Did the Americans have to accept it when requested, and if so was that decision the responsibility of the NAC acting collectively or did it fall to an individual such as the secretary of the treasury or the president? Furthermore, just what part of the payment was to be waived? Did the waiver apply to both principal and interest or just one component of the payment and how were those missed payments to be factored into the overall amortization of the loan?

A brief discussion regarding the details of the waiver provision is beneficial as it highlights the way Fed policymakers continued to assert themselves in foreign economic affairs in ways that applied the apparent lessons of the interwar period and sought to restore the multilateral trading system seen as necessary for international peace and prosperity.

American officials considered different variations on the wavier provision including automatic, discretionary, and mixed approaches.128 The Federal Reserve vacillated throughout the negotiations and voiced different levels of support for each of the variations at some point during the discussions. If the ultimate conclusion was the product of ongoing deliberations rather than premeditated design it still addressed a number of the Federal Reserve’s concerns, avoiding the rigidity of the interwar era while also ensuring that, to the greatest extent possible, the dollars provided by the loan want to

128 Frank Coe, Undated Memorandum, “Memorandum for U.S. Financial Group on the Postponement Clause,” NARA, RG 82 DIF, box 309. 294

facilitating Britain’s balance-of-payments position and not to simply paying off external sterling creditors.

Early Federal Reserve opinion preferred greater discretion but over the course of the negotiations moved to an emphasis on automatic criteria that appeared to remove the appearance of political considerations. Indeed, one of the earliest internal considerations of repayment suggested leaving even the annual size of the installments completely at the discretion of the British. Central bankers believed that so long as a fixed 2 percent interest accumulated on the loan Britain would be discouraged from abusing this discretion.129 Not surprisingly, however, this suggestion went nowhere. During negotiations, Marriner Eccles continued to express concern about not adopting policies that threatened a congressional backlash. He undoubtedly recognized that a proposal that allowed Britain to simply pick the repayment it amount it deemed appropriate was unlikely to gain support even from sympathetic legislators. As a set of more realistic alternatives Eccles considered two contrasting versions. At first he suggested that the responsibility for requesting a waiver should fall to the British, but upon discussion among the FINCOM a consensus developed for using some “objective criteria,” such as

Britain’s international reserves or balance-of-payments position.130 This later evolved into a suggestion that a waiver be solely at the unilateral discretion of the United States.

While the latter seemed a conservative approach that reserved power in the hands of the

129 Arthur Bloomfield, Randall Hinshaw, and Lloyd Metzler to Walter Gardner, Memorandum, “Proposed Treatment of British Balance-of-Payments Problem,” October 9, 1945, NARA, RG 82 DIF, box 309. 130 Ibid.; Burke Knapp to Marriner Eccles, Untitled Memorandum, October 12, 1945, NARA, RG 82 DIF, box 309. 295

United States, more benign intentions seem to have motivated Eccles. He apparently believed that reserving the ability to unilaterally apply a payment waiver alleviated

Britain the embarrassment of having to request one, and thereby having to admit its economic weakness.131

Federal Reserve officials, therefore, began considering how to reconcile the automatic and discretionary aspects of the proposed waiver relatively early in the negotiations. In a memo to Walter Gardner, Randall Hinshaw, an economist with the

Board of Governors’Division of International Finance, suggested a procedure that balanced both automatic criteria while still preserving discretionary authority for both

American and British officials alike by breaking the waiver into the two parts, the request and the approval. For the request of the wavier, Hinshaw proposed that if Britain’s stock of gold and convertible foreign exchange dropped by 10 percent or more from the previous calendar year and if these reserves represented less than 20 percent of the “total value of commodity imports,” then Britain’s Chancellor of the Exchequer could apply for a waiver of interest or a postponement of the amortization of the loan. As for approval, it was left to the discretion of the United States whether to permit the waiver as long as the request was not made during the first four years of the repayment with as many as five payment waivers during the life of the loan.132 Although Hinshaw’s original plan invested the secretary of the treasury with the power to grant a request for a waiver, a

131 Minutes of the Meeting of the U.S. Financial Committee, October 17, 1945, NARA, RG 82 DIF, box 306. 132 Randall Hinshaw to Walter Gardner, Memorandum, “Proposed Provisions Concerning Waiver of Interest on Loan to Britain,” October 15, 1945, NARA, RG 82 DIF, box 309. 296

consensus developed among Federal Reserve officials to endow this authority to the NAC as a collective body.133

By the middle of November, however, as American officials began to consider the specific quantitative benchmarks for the waiver clause, Eccles voiced support for a purely automatic mechanism. He feared that a fully automatic waiver might arouse opposition from Congress but sympathized with Clayton’s concern that discretion risked personalizing and politicizing the postponement provision. Eccles therefore suggested his willingness to accept a fully automatic payment waiver when British national income fell below £866 million based upon a moving average, so long as there the agreement contained some provision for catch-up payments when it rose above that benchmark. At the suggestion of Harry Dexter White, an additional stipulation was added that the wavier only apply when reserves fell below 25 percent of the value of imports.134 When presented with the proposal the British objected to the demand for catch-up payments while Keynes criticized the American formula on the grounds that the reserves to imports ratio appeared intended to keep Great Britain economically weak and its reserve position dangerously low, a contention Walter Gardner rejected as “palpably absurd.”135

Nevertheless, Federal Reserve officials believed that the American negotiators would

133 Robert Triffin to Walter Gardner and Burke Knapp, Memorandum, “Proposed Provisions Concerning Waiver of Interest on Loan to Britain,” October 17, 1945, NARA, RG 82 DIF, box 309; Eccles apparently accepted a later suggestion by Treasury Secretary Vinson that that discretion be left to the President, Minutes of the Meeting of the U.S. Financial Committee, November 8, 1945, NARA, RG 82 DIF, box 306. 134 Minutes of the Meeting of the U.S. Financial Committee, November 13, 1945, NARA, RG 82 DIF, box 306. 135 Burke Knapp to Matthew Szymczak, Untitled Memorandum, November 20, 1945, NARA, RG 82 DIF, box 309; Walter Gardner to Marriner Eccles, Memorandum, “The 15-25 Per Cent Formula as the Basis for the Waiver of Interest,” November 19, 1945, NARA, RG 82 DIF, box 309. 297

only accept an automatic deferment if the agreement contained a reciprocal obligation for the British to make catch-up payments.136

It appears that the Federal Reserve’s major concern was that the British might either use their waiver provision on the American loan while continuing to pay on pay external sterling creditors, or conversely that in the process of paying off these creditors it might weaken the British to the point where they were forced to use the waiver on the loan. One of the inherent weaknesses of the loan, as central bankers recognized, was that while it contained specific prohibitions on using the proceeds to pay Britain’s other creditors, money was fungible.137 That is to say reserves used to pay for imports might be diverted to pay sterling creditors like India or Egypt and those reserves replaced by dollars from the loan. Thus, the United States faced a trade-off between trusting the

British and risking misappropriation of the loan proceeds and opposition by Congress or demanding greater control and hazard rejection of the agreement by Parliament.138 The solution supported by the Federal Reserve and ultimately incorporated into the British

Loan represented something of a soft cap on British repayment of sterling balances.

The compromise attempted to both preserve Britain’s freedom of action while also guarding the United States against abuse of the waiver. The waiver clause permitted

Britain the right to request a payment waiver if its average income from exports of

136 Burke Knapp to Matthew Szymczak, Untitled Memorandum, November 15, 1945, NARA, RG 82 DIF, box 309. 137 Arthur Bloomfield to Allan Sproul, Memorandum, “The British Loan Agreement,” December 12, 1945, NARA, RG 82 DIF, box 310. 138 Burke Knapp to Marriner Eccles, Memorandum, Draft Statement on British Credit, November 27, 1945, NARA, RG 82 DIF, box 309. 298

merchandise and invisibles such as income from shipping or financial services during the preceding five years fell below £866 million. The provision dropped reference to catch- up payments as well as any analysis of Britain’s gross reserve position. Furthermore, it made no reference regarding American discretion in needing to accept the request for a waiver and based upon the analysis of the agreement published in the Federal Reserve

Bulletin central bankers at least appear to have simply assumed U.S. acceptance, referring to British as “entitled” to it.139 At the same time the agreement included a stipulation that

British payments on sterling balances above $175 million (or £43.75 million) should be deducted from the calculation of invisible income. Eccles originally considered this amount as a trigger for mandating accelerated British repayment of the loan, but at the end of November, Knapp Burke of the Federal Reserve suggested it be used for determining application of the waiver.140 The soft cap thereby balanced countervailing pressures for control and flexibility. It left discretion over requesting a payment waiver in the hands of the British assuming certain quantitative benchmarks applied. At the same time by discounting excess payments to sterling holders it discouraged the flow of dollars into the hands of external creditors likely to turn to the American market and thereby exert inflationary pressure. It did so in a way that did not impose a hard ceiling on Britain and risk political antagonism.

139 Federal Reserve System Board of Governors, “The United Kingdom and Postwar International Trade,” Federal Reserve Bulletin 32, no. 1 (1946): 2. 140 Minutes of the Meeting of the U.S. Financial Committee, November 17, 1945, NARA, RG 82 DIF, box 306; Minutes of the Meeting of the U.S. Financial Committee, November 28, 1945, NARA, RG 82 DIF, box 306. 299

The waiver was far from perfect. As Richard Gardner points out in his analysis of

Anglo-American foreign economic relations, the £866 million threshold for national income was based upon 1936-1938 averages, when Britain’s population was smaller and subsisted on a lower standard of living, a criticism the Federal Reserve was not unaware of.141 Furthermore, by using a five-year moving average the waiver did not allow for

“violent short-run fluctuations in international trade.”142 These are valid criticisms but rather than judging the British Loan against the ideal arrangement, it is important to keep in mind what was politically feasible, at least from the perspective of the American negotiators, including Federal Reserve officials.

American negotiators sought to create a situation that eased the payment burden on Great Britain during lean years while also avoiding the perception that the British

Loan would never be paid back. Members of the Senate expressed doubts about repayment and criticized Britain for defaulting on its World War I obligations.143 Federal

Reserve officials attempted to counter this assertion, compiling memos demonstrating

Britain’s relative success in repaying World War I obligations and characterizing unpaid principal as material that would have been provided free under a Lend Lease style

141 Burke Knapp, Memorandum, “Summary of Economic and Financial Agreements Recently Negotiated between the Governments of the United States and the United Kingdom,” December 17, 1945, NARA, RG 82 DIF, box 309. 142 Gardner, Sterling-Dollar Diplomacy, 212. 143 Burke Knapp to Matthew Szymczak, Untitled Memorandum, December 6, 1945, NARA, RG 82 DIF, box 309; Robert A. Taft to R. A. Blessing, April 25, 1946 in The Papers of Robert A. Taft, Volume III: 1945-1948, ed. Clarence E. Wunderlin, Jr. (Kent: Kent State University Press, 2003), 146. 300

program.144 Eccles stressed this point in testimony before Congress and argued that the

United States was “largely responsible” for Britain’s default.145

It is therefore reasonable to see the waiver and repayment provisions of the

British Loan as an attempt by American negotiators, especially at the Federal Reserve, to avoid a repeat of the interwar experience. Stressing the success of Britain’s repayment during the interwar period suggests an attempt to assuage concerns that the United States was simply pouring money down a hole. Not only could it expect to gain benefits from a restored Britain able to fully participate in a multilateral trade and convertible currency system but the nation could reasonably expect full repayment on its investment as well, and easing repayment during lean years only further helped avoid the interwar experience.146 That the British Loan could have done more to alleviate Britain’s burden is not debated. The provisions, however, should be understood as a demonstration of the sensitivity of the Federal Reserve and other policymakers to the countervailing domestic and international political-economic pressures and a sincere attempt to balance these competing imperatives. Furthermore, it demonstrates how central bankers continued to apply the perceived lessons of the interwar experience and used those insights to restore an international economic system that avoided the major mistakes of the past.

144 Lloyd Metzler to Burke Knapp, Memorandum, “Britain’s Debt to the United States After World War I,” March 4, 1946, NARA, RG 82 DIF, box 309; Burke Knapp to Marriner Eccles, Memorandum, “British World War I Debts,” March 7, 1946, NARA, RG 82 DIF, box 309. 145 Senate, Anglo-American Financial Agreement, 251-55. 146 Lloyd Metzler, “The Agreement with Britain: An Appraisal,” Review of Foreign Developments, December 10, 1945, FRB, http://www.federalreserve.gov/pubs/rfd/1945/25/rfd25.pdf (accessed July 14, 2012); Federal Reserve System Board of Governors, “The United Kingdom and Postwar International Trade,” Federal Reserve Bulletin (January 1946): 2. 301

That being said, it is not unreasonable to wonder why, given the belief among some that Britain would never repay the loan regardless of the provisions, central bankers and others did not push for even more liberal terms and why they spent so much time trying to convince legislators otherwise. The most reasonable explanation is that, given the time sensitive nature of the negotiations, supporters were simply unwilling to press their luck, risk a legislative rejection of the British Loan, and threaten the breakdown of the entire process. Given the dire consequences for postwar prosperity and peace that central bankers associated with the liberalizing provisions of the Bretton Woods institutions and the British Loan, this may have seemed too big a risk, and they therefore thought it better to err on the side of caution.

While imperfect, the nature of the waiver and how it related to the eventual payoff of the British Loan, while seemingly esoteric, demonstrates how the Federal Reserve preferred a relatively generous structure. Eccles originally supported allowing Britain to defer both principal and interest payments, shifting their due date to the end of the loan.

For a loan with a five year draw period and then a set of fifty annual installments, this meant that the first deferred payment fell due in year fifty-six, the second deferred payment in year fifty-seven, and so on in payments equal to those originally due.147 As the discussions turned to reliance on more purely automatic mechanisms, however, the

American negotiators, including the Federal Reserve, dropped consideration for waiving

147 Burke Knapp to Marriner Eccles; Untitled Memorandum, October 16, 1945, NARA, RG 82 DIF, box 39; Marriner Eccles to Fred Vinson, Letter, October 16, 1945, NARA, RG 82 DIF, box 309. 302

principal payments and narrowed the application of the waiver to interest only.148

Nevertheless, the waiver provision that included only interest as Arthur Bloomfield of the

FRBNY recognized, represented an important concession to flexibility for the British.

Since the loan amortized over fifty years, the vast majority of the earliest payments, when the waiver would most likely be needed, would be interest with only a small fraction consisting of principal.149 Additionally, since the loan was repaid in equal annual installments, officials presumably believed the real burden of the payments would diminish as the British and international economies grew.

Conclusion

In the end the loan failed to solve Britain’s international payments issues, and currency liberalization only exacerbated them. On July 15, 1947, in accordance with the agreement, the United Kingdom allowed sterling to be freely convertible for current transactions. Faced with a severe deterioration of its international reserve position, however, Britain was forced to reverse course and suspended convertibility on August 20,

1947. Additionally, while it was intended to be available for five years, by August 1947 only $400 million of the $3.75 billion line of credit remained, the rest having already been drawn on. In a postmortem analysis of the dollar crisis of 1947 the Federal Reserve blamed many of the issues it had identified during the negotiating process. Price

148 Burke Knapp to Matthew Szymczak, Untitled Memorandum, November 20, 1945, NARA, RG 82 DIF, box 309. 149 Arthur Bloomfield to Allan Sproul, Memorandum, “The British Loan Agreement,” December 12, 1945, NARA, RG 82 DIF, box 310. 303

increases for goods from the Western Hemisphere, particularly the United States, drove up the cost of imports and reduced the purchasing power of the credit. At the same time

British imports recovered more slowly than hoped and overseas expenditures declined less quickly than desired. Additionally, the failure of other countries to step up to the plate and assist in financing Britain’s 1946 and early 1947 payments deficits put further pressure on the credit and the nation’s international reserves.150 As many scholars have pointed out, the British Loan ultimately represented the failure of American policymakers to understand the full extent of Europe’s devastation during the Second World War and forced them toward the more comprehensive approach embodied by the Marshall Plan.151

Even more important than the success of any one plan was the way the Federal

Reserve attempted to balance the domestic and international implications of the British

Loan. In the larger scope of American foreign relations, the loan represented a watershed, awakening U.S. officials to the need for a wider ranging approach to

European reconstruction. From the perspective of the Federal Reserve, however, it represented less a change than the natural progression of central bank attitudes. Fed officials had been uncomfortable with the inflationary implications of the methods used to finance the Second World War. Ironically, the large national debt and the considerable pool of liquid assets, both products of the way the war was financed, hampered the Fed’s

150 Federal Reserve System Board of Governors, “The British Crisis,” Federal Reserve Bulletin 33, no. 9 (1947): 1071-76. 151 Alfred E. Eckes, Jr., A Search for Solvency: Bretton Woods and the International Monetary System, 1941-1971 (Austin: University of Texas Press, 1975), 212-19; Eichengreen, The European Economy Since 1945, 75; An alternative view that finds the Marshall Plan as unnecessary is presented by Alan S. Milward, The Reconstruction of Western Europe, 1945-1951 (Berkeley: University of California Press, 1984). 304

ability to loosen the peg on government securities yields or otherwise undo the bureaucratic fetters accepted in 1942. At the same time the fragile state of the international economy required American assistance that threatened to further exacerbate domestic price instability. In many ways, this represented the very reason Federal

Reserve officials pushed for the creation of the NAC and a greater voice in foreign economic policy during the debates over the Bretton Woods enabling legislation. It ensured Fed officials a seat at the table so that they were able to advocate, even if not always totally successfully, for specific policies, even if they seemed relatively esoteric and technical, that they deemed important to insulating the domestic economy against additional inflationary pressure. Federal Reserve intention was never to dominate the making of foreign economic policy, a position it adhered to during the British Loan talks.152 As the international and domestic contexts changed so did the Fed’s position. It became increasingly assertive in domestic and international affairs while remaining supportive of Truman administration policy. Yet it still demonstrated that Fed officials were willing to exert influence, successful or not, in pushing for those policies it saw critical to economic prosperity while also recognizing the implications for postwar political peace and cooperation.

152 Representatives with the Board of Governors vigorously opposed a proposal by Allan Sproul of the FRBNY to scrap the credit to Britain in place of a Federal Reserve controlled swap line with the Bank of England. Allan Sproul to Matthew Szymczak and Federal Reserve Board of Governors, Telegram, October 24, 1945, NARA, RG 82 DIF, box 310; Burke Knapp to Matthew Szymczak, Untitled Memorandum, October 24, 1945, NARA, RG 82 DIF, box 310; Walter Gardner, Memorandum, “Conversation with John Williams Regarding October 24 Telegram,” October 25, 1945, NARA, RG 82 DIF, box 310; Burke Knapp to Marriner Eccles, Untitled Memorandum, October 29, 1945, NARA, RG 82 DIF, box 310; Burke Knapp to Marriner Eccles, Untitled Memorandum, December 3, 1945, NARA, RG 82 DIF, box 310. Chapter Six

“On the Horns of a Dilemma”: European Reconstruction, the Postwar Economy,

and the Federal Reserve, 1946-1950

This chapter examines Federal Reserve views and policies in light of the nation’s steadily expanding global economic and security commitments in the years between the conclusion of the British Loan negotiations in December 1945 and the outbreak of the

Korean War in June 1950. Over the course of this nearly half decade, the United States and the Soviet Union increasingly perceived the other as a hostile political and economic system.1 American officials believed an expansionist Soviet Union posed a threat not only to the postwar world order based upon multilateral economic relations and liberal democracy but also to the security of the United States itself.2 Faced with such a challenge the United States responded with growing urgency to the persistent political and economic problems in Western Europe. Many Americans believed that Soviet expansion preyed upon poverty and social distress, demanding a vigorous U.S. led

1 The growing perception of a monolithic international communist movement is documented in Marc J. Selverstone, Constructing the Monolith: The United States, Great Britain, and International Communism, 1945-1950 (Cambridge: Harvard University Press, 2009); A corresponding Stalinist association of Western capitalism with international aggression is examined in Richard B. Day, Cold War Capitalism: The View from Moscow, 1945-1975 (Armonk, New York: M.E. Sharp, 1995). 2 Melvyn P. Leffler, A Preponderance of Power: National Security, the Truman Administration, and the Cold War (Stanford: Stanford University Press, 1992), 10-12.

305 306

program to revive and integrate European economies, fostering prosperity and insulating these societies from subversion.

In response to international developments the United States progressively adopted measures intended to bolster democratic capitalism in Western Europe while also safeguarding the region against a potential communist military threat. The United States embraced actions to alleviate persistent economic stagnation, including a comprehensive foreign aid program under the aegis of European Recovery Program (ERP), more commonly known as the Marshall Plan. Through ERP the United States provided direct financial assistance while also promoting greater European economic integration through measures such as the creation of a system of intra-European payments clearing and trade liberalization. Over the course of the 1940s the focus of American assistance shifted from economic to military aid but maintained the goal of alleviating the total recovery and rearmament burden confronted by Western Europeans. At the same time the United

States debated the composition and size of its own postwar defense establishment, a battle eventually decided in favor of a sizeable military force by the outbreak of the

Korean War in the summer of 1950. The size of the American military and the associated costs of additional ground, air, and naval power, however, remained an uncertain factor in American budgets throughout much of the period and therefore a pressing concern for the Federal Reserve.

The expanded commitments took place within the context of a continued struggle to reorient the nation’s economy to the new realities of the postwar world. This required 307

balancing the competing demands of domestic consumers and producers for still scarce, albeit expanding, supplies of goods and raw material. At the same time the precise allocation of limited resources between civilian and defense priorities as well as the need to meet the demand coming from the rest of the world, Europe in particular, created a potentially unstable mixture. As a result the Federal Reserve found itself pulled between conflicting imperatives in domestic and international policy. On the one hand, the Federal

Reserve supported the restoration of an international economy based upon revived

European trading partners using convertible currencies and exporting enough to the

United States and the rest of the dollar area to sustain their international payments obligations. This had been a longtime concern for American officials, including central bankers, and served as a focal point during the debates over the Bretton Woods institutions. That it continued to dominate the thinking of policymakers is not necessarily surprising. Central bankers recognized that foreign assistance, including ERP aid played a critical role in the pursuit of these goals. Similarly, Fed officials increasingly came to believe that the Soviet Union represented an antagonistic political economy that threatened the proposed postwar order based upon liberal multilateral capitalism, further justifying dollar assistance. On the other, foreign aid and defense spending increased the pressure on already limited resources, and the process of restoring the international system risked unleashing these stresses through price inflation or balance-of-payment distortions that threatened those ends. Additionally, the Federal Reserve had a statutory responsibility for credit management and members of the central bank worried how their 308

accommodation of the Truman administration’s various goals conflicted with this charge and endangered efforts to re-establish a greater degree of institutional independence.

The conflict between the Federal Reserve and the Treasury did not come to a head until after the outbreak of the Korean War, yet the years leading up to both conflicts serve to highlight the evolution of the Federal Reserve’s thinking about both America’s role to the postwar global system and the implications of the interdependence of domestic and international political-economic stability. During the Second World War central bankers readily accepted the need to subordinate monetary policy to the fiscal requirements of the immediate global conflict. They further anticipated and supported an active American leadership role in restoring a system of convertible currencies and multilateral trade relationships. For those reasons the Federal Reserve backed the creation of the

International Monetary Fund and the World Bank. As the scope, scale, and duration of the commitments demanded by the emergent Cold War came into view, however, Fed officials faced mounting international demands on American resources. Recognizing the likely permanence of an international commitment greater than anything anticipated during the Second World War, Fed officials expressed growing concern with the negative consequences of ballooning federal deficits, enlarged in part because of sizable defense and foreign aid commitments, as well as the inflationary implications of the wartime policy of pegging the yield of government securities. Faced with the prospect of perpetual commitments driven by the nation’s evolving postwar foreign policy, Fed officials began resisting the restraints they had accepted during the war and in effect laid 309

the groundwork for the final confrontation with the Treasury over government finance that unfolded during the Korean War.

This chapter focuses on the development of Fed policy toward domestic issues other than the debate over the pegging of government securities except insofar as fiscal and credit policy developments referenced the matter. The next chapter will examine more closely the Federal Reserve’s campaign for increased discretion over government debt yields. These debates occurred simultaneously, making the division somewhat artificial. Nevertheless, it was the outbreak of the Korean War that brought the issue of pegging government securities to a head, and it therefore can best be understood within the context of the Korean crisis.

In order to fully appreciate the Federal Reserve’s position leading into the Korean

War it is first necessary to understand how it viewed the international situation. As previously discussed, central bankers supported the creation of the International

Monetary Fund and the World Bank as measures crucial to reviving a productive flow of international investments, restoring a system of multilateral international trade, and securing stable and sustainable exchange relations. Fed officials supported the belief that postwar economic prosperity and political peace required American leadership. The reality of the postwar problems, however, exceeded initial expectations. Even prior to

Britain’s attempt at sterling convertibility in 1947 American policymakers recognized that substantial troubles still confronted the postwar global economy. Despite the hopes placed on UNRRA, the International Monetary Fund, the World Bank, and various 310

efforts of direct financial assistance such as the British Loan, European economic recovery continued to stagnate through 1946 and into 1947.

Western policymakers, including central bankers, recognized the necessity of a variety of overlapping international reforms that demanded continued and substantial

American assistance. None of these issues can be easily compartmentalized, and each was in some way interlinked with other issues both global and domestic. These included the revival of European productivity through the provision of ERP assistance, the liberalization of European payments and trade relations, the revival and political- economic reintegration of Western Germany into the regional and global postwar order, and the implications of the Soviet Union’s expanded control over Eastern and Central

Europe. The purpose in this chapter, therefore, is not to recount the entire history of each of these issues as an extensive historical literature already exists. Rather, this chapter simply aims to examine how the Federal Reserve viewed these matters, thereby integrating central bankers’ position into the existing historiography. This will then provide perspective for the Federal Reserve’s stance on domestic fiscal and monetary policies and shed light on why they felt the need for increasingly forceful anti- inflationary policies given the nation’s international commitments.

The Federal Reserve, European Recovery, and Economic Prosperity

While attending commencement ceremonies at Harvard University on June 5,

1947, Secretary of State George C. Marshall sketched a general proposal for the United 311

States to act cooperatively with its partners in Europe to jumpstart postwar economic recovery.3 The plan represented an American response to the sluggish pace of postwar economic growth. From that time until the 1951 shuttering of the Economic Cooperation

Administration (ECA), the body charged with coordinating and administering aid on the

American side, the United States disbursed approximately $13 billion in foreign assistance to seventeen participating European countries. Scholars disagree on the impact of the Marshall Plan. Some have taken a positive view of American aid, arguing that it saved Europeans from slipping into misery and despair. Others have downplayed its economic importance or even suggested its essential irrelevance to the postwar recovery of the Continent.4 Similar disputes examine American motivations, differing over whether the Marshall Plan was driven by idealism, a self-interested attempt to secure export markets for American business, the desire to reshape the European political- economic system on the basis of the American historical experience, fear of international communism coopting depressed European states particularly France and Italy, or some mixture of factors.5 Indeed, the historian Robert A. Pollard’s assessment that the

3 Remarks by the Honorable George C. Marshall, Secretary of State, at Harvard University on June 5, 1947, Foreign Relations of the United States, 1947 vol. 3 (Washington, D.C.: Government Printing Office, 1972): 237-39. 4 Imanuel Wexler argues that viewed of the long-term the Marshall Plan was critical to pointing the European economy on an upward trajectory in The Marshall Plan Revisited: The European Recovery Program in Economic Perspective (Westport, CT: Greenwood Press, 1983); Barry Eichengreen argues that the Marshall Plan allowed European states to overcome important economic and political hurdles but this is embedded within a larger analysis that stresses a number of other factors in promoting “catch-up” with the United States in The European Economy Since 1945: Coordinated Capitalism and Beyond (Princeton: Princeton University Press, 2007), 65-70; Alan Milward contends that the supposed European crisis of 1946-1947 was simply a temporary occurrence and obscured the significant economic recovery already underway in The Reconstruction of Western Europe, 1945-1951 (Berkeley: University of California Press, 1984). 5 William Appleman Williams, The Tragedy of American Diplomacy, New ed. (New York: W.W. Norton and Company, 1972), 271; Fred L. Block, The Origins of International Economic Disorder: A Study of United States International Monetary Policy from World War II to the Present (Berkeley: 312

Marshall Plan was “all things to all men” may be equally true for scholarly analyses of the program.6 Rather than re-adjudicating any one of these debates the purpose here is to integrate the Federal Reserve into the story as a way of highlighting both the reasons why central bankers supported ERP and the implications they derived for domestic fiscal and monetary policy.

Federal Reserve officials were predisposed to support the Marshall Plan for many of the same reasons they backed Bretton Woods and the British Loan. To the extent that dollar aid helped secure European economic rehabilitation it contributed to the restoration of prosperity both at home and abroad. Furthermore, the interwar experience sensitized the Federal Reserve to the link between economic conditions and political relations between nations. Economic stagnation brought restrictive trade and currency practices, increased political tensions, and potentially led to war. To avoid a repetition of this destructive cycle it was necessary to secure prosperity, and central bankers increasingly believed that dollar aid was both needed and could achieve this goal.

In the wake of the Second World War the nations of Europe confronted a troublesome catch-22 in their efforts at economic recovery. Countries strove to expand

University of California Press, 1977), Ch. 4; Michael J. Hogan, The Marshall Plan: America, Britain, and the Reconstruction of Western Europe, 1947-1952 (New York: Cambridge University Press, 1987); Thomas J. McCormick, America’s Half-Century: United States Foreign Policy in the Cold War (Baltimore: The Johns Hopkins University Press, 1989), 78-81; Melvyn P. Leffler, A Preponderance of Power: National Security, the Truman Administration, and the Cold War (Stanford: Stanford University Press, 1992), 157-65; Diane B. Kunz, Butter and Guns: America’s Cold War Economic Diplomacy (New York: Free Press, 1997), Ch.3; Arnold Offner, Another Such Victory: President Truman and the Cold War, 1945- 1953 (Stanford: Stanford University Press, 2002), Ch. 9; Greg Behrman, The Most Noble Adventure: The Marshall Plan and the Time When America Helped Save Europe (New York: Free Press, 2007); 6 Robert A. Pollard, Economic Security and the Origins of the Cold War, 1945-1950 (New York: Columbia University Press, 1985), 134. 313

production in order to provide the goods necessary to both sustain their populations and export to the global market to help finance the cost of their own imports. At the same time, however, increased production intensified immediate demands for imports, particularly from the Western Hemisphere, to replace stocks of capital equipment destroyed or run down during the course of the war. This near-term demand threatened to drain away precious reserves of foreign exchange such as dollars and gold faster than exports could be expanded to replace them. Europeans needed to trade to produce, but they also needed to produce to trade. E. A. Goldenweiser of the Federal Reserve personally encountered this issue during a trip to Europe shortly after the end of the war.

Goldenweiser toured the continent from July through September 1945 speaking with leaders in politics, finance, and banking from London to Moscow. In a summary of the trip written for the Fed he recounted an incident during his return voyage that seemed to capture the plight of Europeans. Stopping in Ireland, customs officials instructed passengers not to purchase anything because strict export controls were in effect.

Goldenweiser believed the incident a “fitting conclusion” to his time in Europe. To

Goldenweiser, the incident demonstrated that the people of Europe were so desperate for

“things to eat, to wear, and to build with” that they would choose to hold on to the little they had at the cost of foregoing critically needed “foreign exchange” needed for long- term economic recovery.7

7 E. A. Goldenweiser, Paper, “Conversation and Reflections in Europe Summer 1945,” October 9, 1945, NARA, RG 82 DIF, box 123. 314

By the summer of 1947 the economic stagnation of Europe showed signs of troubling persistence and appeared to require a comprehensive response. France and

Italy presented particular concerns for American policymakers who feared that absent strong economic turnaround indigenous communist movements in one or both nations might gain power.8 The situation after the war appeared desperate. Industrial output in

France and Italy hovered around 40-50 percent of prewar levels. Destruction of transportation and agriculture, the wartime displacement of workers, and disruptions to power generation all inhibited restoration of productivity. At the same time, the collapse of wartime financial controls unleashed intense inflationary pressures that further distorted markets.9 More than a year after the war’s conclusion, Federal Reserve officials estimated French output at only 60 percent of 1938 figures, a level judged far “too low” to meet the competing requirements of current consumption necessary to sustain the populations’ standard of living while also satisfying investment demands. Fed officials expressed only tepid enthusiasm at French plans to improve industrial production to 115 percent of 1938 levels by the end of 1947, noting that the base year was one of “mediocre industrial activity” and that achieving the target still placed French industry at approximately 88 percent of 1929 output levels. The situation was not much better when

8 Sallie Pisani, The CIA and the Marshall Plan (Lawrence: University Press of Kansas, 1991), 81- 5. 9 Federal Reserve Board of Governors, “France and Italy: Patterns of Reconstruction,” Federal Reserve Bulletin 33, no. 4 (April 1947), 353. 315

it came to revival of French agricultural production, which was not anticipated to exceed

1938 output levels until 1950.10

Lack of sufficient critical raw materials presented one of the more significant barriers to European recovery of postwar manufacturing. Modern industrial production depended upon coal, and dating back to the 1890s France depended upon imports from the coal mines of the Ruhr in Germany.11 By October 1946 France managed to increase its domestic coal production to 118 percent of prewar output, but this recovery was only possible by using thousands of former German POWs, preventing them from returning home. The result was a serious misallocation of labor that, while aiding French coal production, hampered overall European output. Consequently, by late spring 1947 coal output in the far more productive German Ruhr achieved just 50 percent of prewar levels.12 At the same time, German coal consumption was itself increasing, meaning additional demand for the already limited supply. Consequently, European demand for

American coal skyrocketed. From 1936-1938 U.S. coal exports averaged 2,960 tons quarterly; exports jumped to an average of 10,226 tons during 1945-1946 with more than

16,000 tons exported July and September 1946. American coal cost roughly twice as much as continental production, further straining European international payments.13

Without both long-term rationalization of the market and immediate additional foreign

10 M.A. Kriz, “United States-French Economic and Financial Agreements,” Review of Foreign Developments, June 17, 1946, Federal Reserve Board of Governors Website (hereafter cited as FRB), http://www.federalreserve.gov/pubs/rfd/1946/38/rfd38.pdf (accessed November 27, 2012). 11 Milward, Reconstruction of Western Europe, 130. 12 Federal Reserve Board of Governors, “France and Italy: Patterns of Reconstruction,” Federal Reserve Bulletin (April 1947), 354-55. 13 C.R. Harley, “United States Coal for Europe,” Review of Foreign Developments, December 17, 1946, FRB, http://www.federalreserve.gov/pubs/rfd/1946/50/rfd50.pdf (accessed November 29, 2012). 316

assistance, international payments pressure threatened to force Europeans to curtail the pace of reconstruction.14 Reducing the pace of European recovery threatened the revival of prosperity for the entire Atlantic economy.

Officials recognized that the Marshall Plan needed to go beyond simply restoring

European manufacturing or agricultural production to certain nominal or easily quantifiable levels. Instead, it was necessary to create a “stable and self-supporting

Europe.”15 Foreign countries remained dependent upon U.S. material and financial assistance to provide critical relief not just in coal but in a whole variety of goods.

Exports to the United States for 1946, however, continued to lag behind prewar averages.16 The result was higher demand for American goods that exacerbated the dollar gap and reinforced the need for aid. The United States ran a $4.8 billion export surplus in 1946, with $3.3 billion coming from Europe alone.17 During the first half of

1947 American exports to Europe increased 30 percent compared to the same period in

1946 while imports from Europe rose by a paltry 2 percent. Additionally, with the end of

UNRRA assistance U.S. trade with Europe shifted decisively to the West. During

January-June 1946 74.5 percent of the America’s trade surplus with Europe came from

14 M.A. Kriz, “United States-French Economic and Financial Agreements,” Review of Foreign Developments, June 17, 1946, FRB, http://www.federalreserve.gov/pubs/rfd/1946/38/rfd38.pdf (accessed November 27, 2012). 15 Memorandum Prepared for the Use of the Under Secretary of State for Economic Affairs William Clayton, June 5, 1947, FRUS, 1947 3:248. 16 Federal Reserve System Board of Governors, Thirty-Third Annual Report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1946 (Washington, D.C.: Government Printing Office, 1947), 35. 17 Ibid., 37. 317

the Marshall Plan nations, but this ballooned during the first half of 1947 to 92 percent.18

Thus, Western European countries became increasingly dependent upon imports from the

United States but fell significantly short in their ability to earn the dollars necessary to pay for these goods through their own exports.

While European imports from the dollar area increased, the prospect for exports to the Western Hemisphere, particularly the United States, appeared mixed at best. From the earliest days of the Marshall Plan proposal the NAC emphasized the need to move forward with liberalization of international trade.19 Freeing commerce was critical to ensuring Europe’s long-term ability to earn dollars. While total exports from ERP countries, including Germany, increased 47.5 percent in 1947 over 1946, exports to the

United States were up just 2.6 percent. Some nations, such as Sweden, Norway, and

Britain, demonstrated markedly higher exports to the United States, but this was offset by double-digit declines among others, including France, Italy, Turkey, Belgium, and

Luxembourg.20 Furthermore, modest increases in exports were overwhelmed by the relatively larger demand for American imports as well as rising Western Hemisphere prices, which eroded the purchasing power of the dollars Europeans did earn.21

18 Gretchen Fowler, “U.S. Foreign Trade: First Half of 1947,” Review of Foreign Developments, October 4, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/71/rfd71.pdf (accessed December 5, 2012). 19 National Advisory Council, “Report of National Advisory Council on International Monetary and Financial Problems,” Federal Reserve Bulletin 33, no. 7 (July 1947), 850. 20 Gretchen Fowler, “U.S. Imports from E.R.P. Countries During 1947,” Review of Foreign Developments, March 9, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/82/rfd82.pdf (accessed December 29, 2012). 21 Albert O. Hirschman and C. Lichtenberg, “French Exports and the Franc,” Review of Foreign Developments, September 23, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/70/rfd70.pdf (accessed November 30, 2012); Federal Reserve System Board of Governors, “The British Crisis,” Federal 318

Fed officials noted that even though the United States disbursed sizeable amounts of aid during 1946 it was insufficient to cover European needs. Foreign countries still drew upon their gold and dollar reserves, resulting in an influx of $775 million in gold to the United States. Additionally, Europeans liquidated their holdings of American securities, such as a $335 million Dutch and British disinvestment. Such actions deprived Europeans of critical sources of dollars that might help offset balance-of- payments deficits. This trend continued into 1947, compounded by inflation that drove up the price of American exports and eroded the purchasing power of foreign held dollars. Indeed, Fed officials predicted that to the extent American exports shrank it would not be from lack of demand but rather “limited mainly by the volume of available purchasing power in foreign hands.” In the absence of foreign aid central bankers anticipated Europeans would be forced to further run down their remaining reserves, which threatened “to create a serious dollar financing problem” by the end of 1947.22

Policymakers expressed particular concern about the rapid rate at which the British drew down the proceeds of the $3.75 billion loan extended in 1946 and the use of that money to meet demands for consumer goods rather than investment.23 Thus, Fed officials remained cognizant of the demand for additional dollars in order to avoid undermining the postwar recovery.

Reserve Bulletin 33, no. 9 (September 1947), 1074-76; Gretchen Fowler, “US Foreign Trade, First Nine Months of 1947,” Review of Foreign Developments, December 30, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/77/rfd77.pdf (accessed December 6, 2012); J. Burke Knapp, “The Balance of Payments Approach in the European Recovery Program,” Review of Foreign Developments, January 14, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/78/rfd78.pdf (accessed December 6, 2012). 22 Federal Reserve Board of Governors, Annual Report, 1946, 39-41. 23 C. R. Harley, “The Balance of Payments and Dollar Deficit of the United Kingdom,” Review of Foreign Developments, May 6, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/60/rfd60.pdf (accessed November 29, 2012). 319

Not only did Europeans need dollars it appeared increasingly obvious that only special action by the U.S. government could provide them. Unless European imports from the United States were to be significantly curtailed, with presumably damaging implications for the pace of European economic recovery, the shortfall required an increase in private loans or public aid to bridge the gap. The political and economic uncertainty associated with the postwar transition, however, limited Europeans’ ability to secure private loans or dollar aid from sources other than the U.S. government. World

Bank officials hewed to a conservative lending policy in an effort to gain support for its securities from Wall Street investors.24 Additionally, the NAC noted that private capital had not expanded as much as hoped but rather re-entered the market “only on a very limited scale.”25 Thus, central bankers increasingly recognized not only the importance of dollar assistance to Europe but also the reality that only the American government was positioned to extend such help.

As Marshall Plan aid began to flow after 1947, Federal Reserve officials recognized both the real contribution it made, as well as the necessity to not prematurely terminate or curtail assistance. Well into 1948 ERP aid appeared critical to meeting

European balance-of-payments needs. Analysis indicated that American foreign aid in various forms amounted to nearly 35 percent of the funds available to foreign countries, continuing to outpace assistance from other external sources, such as the International

24 Edward S. Mason and Robert E. Asher, The World Bank Since Bretton Woods (Washington, D.C. The Brookings Institution, 1973), 40-5; Alfred E. Eckes and Thomas W. Zeiler, Globalization and the American Century (New York: Cambridge University Press, 2005), 126-7. 25 National Advisory Council, “Report of National Advisory Council on International Monetary and Financial Problems,” Federal Reserve Bulletin 33, no. 7 (July 1947), 848. 320

Monetary Fund or the World Bank. ERP assistance alone accounted for 14.9 percent of available financing.26 At the same time, Marshall Plan dollars seemed important if there was to be any hope of salvaging the multilateral institutions created at Bretton Woods.

As the Bank for International Settlements (BIS) argued in an annual report republished by the Federal Reserve, ERP assistance not only provided immediate relief, both financial and psychological, it also reduced the burden of postwar transition on the Bretton Woods institutions.27

Despite persistent balance-of-payments deficits, the Federal Reserve noted a progressive upturn in the European economic situation, particularly during 1948 and

1949. This only reinforced support for the Marshall Plan as central bankers attributed the recovery to the effects of dollar aid. While American merchandise exports reached record highs in 1947 they began to dip slightly into 1948.28 At the same time, however,

Federal Reserve officials noted “truly remarkable” growth in European production during the same year.29 The result was a shift in trade and an expansion of European exports to the United States. Additionally, while the American export surplus remained substantial,

26 Florence Jaffy and Frank Tamagna, “US Balance of Payments Outlook for 1948,” Review of Foreign Developments, June 15, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/89/rfd89.pdf (accessed December 31, 2012); National Advisory Council, “Special Report of the National Advisory Council,” Federal Reserve Bulletin 34, no. 7 (July 1948), 795. 27 Bank for International Settlements, “The Eighteenth Annual Report of the Bank for International Settlements,” Federal Reserve Bulletin 34, no. 10 (October 1948), 1222. 28 Gretchen Fowler, “The Annual Rate of US Trade in January and February,” Review of Foreign Developments, May 4, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/86/rfd86.pdf (accessed December 31, 2012). 29 Randall Hinshaw, “Industrial Production in the ERP Countries,” Review of Foreign Developments, June 29, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/90/rfd90.pdf (accessed December 31, 2012); Randall Hinshaw, “European Production in the Second Quarter,” Review of Foreign Developments, November 2, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/99/rfd99.pdf (accessed January 1, 2013). 321

this was attributed more to higher prices in the United States.30 Thus, the benefits of ERP were evident despite the persistent U.S. export surplus. While admitting that Europeans still had a long way to go to correcting the dollar shortage and that the level of recovery remained “well below the 1938 percentages,” central bankers found “noteworthy” the

“sharp rise in the per cent of ECA imports” particularly following their drop-off during the 1946-47 period. Indeed, comparing 1947 to 1948 central bankers noted a 33 percent reduction in the export surplus with ECA countries, a reduction that jumped to 43 percent when Germany, Austria, Greece, and Turkey were excluded.31

Despite these improvements, future prospects appeared daunting and suggested that Europe’s international payments deficit was likely to remain sizeable for some time to come. An analysis published in the February 1948 Federal Reserve Bulletin anticipated a total Western European trade deficit with the Western Hemisphere of between $8.1 and $8.5 billion during the first fifteen months of the proposed European

Recovery Program.32 Central bankers predicted a $4.8 to $5.3 billion trade deficit for

Western Europe with the United States, more than $3 billion of which was accounted for by Britain, France, and Italy alone. Additionally, Fed officials assumed a roughly $3.2

30 Gretchen Fowler and Samuel I. Katz, “US Exports Continue Decline in Third Quarter of 1948,” Review of Foreign Developments, December 28, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/103/rfd103.pdf (accessed January 1, 2013); Federal Reserve System Board of Governors, “Economic Developments in 1948,” Federal Reserve Bulletin 35, no. 1 (January 1949), 1-2, 9-10. 31 Gretchen Fowler and Samuel I. Katz, “US Export Surplus Drops 43 Per Cent in 1948,” Review of Foreign Developments, March 29, 1949, FRB, http://www.federalreserve.gov/pubs/rfd/1949/109/rfd109.pdf (accessed January 6, 2013). 32 Federal Reserve System Board of Governors, “Relations of Individual Western European Countries with the Western Hemisphere,” Federal Reserve Bulletin 34, no. 2 (February 1948), 148. 322

billion Western European deficit with the rest of the Western Hemisphere.33 All indications, therefore, pointed to a continuation of the European dollar shortage well into

1948.34 Marshall Plan dollars offered a means for overcoming this persistent shortfall and facilitating European recovery, which in turn appeared important for long-term economic prosperity.

The Federal Reserve understood that ERP aid played a critical role in cushioning the balance-of-payments pressure, reducing social and political unrest, and facilitating the economic recovery of Europe. Officials recognized that a tremendous effort still remained in overcoming persistent European balance of payments deficits, but that

American aid played an important role in the recovery that had already taken place.35 In

August 1949 Woodlief Thomas reported back to the Board of Governors on a recent trip to survey economic conditions across Europe. During his time on the continent Thomas conducted some 125 interviews with American embassy officials, representatives of the

ECA and U.S. Treasury, as well as with European central bankers, and his views reflected a cautious optimism. He reported easing inflationary pressures, increased production, and rising levels of consumption and savings. He further argued that “ERP has made an essential contribution” to European recovery. He tempered this, however, noting that it was not yet clear that a self-sufficient balance could be reached by the

33 Ibid., 149. 34 Florence Jaffy and Frank Tamagna, “Foreign Gold and Dollar Resources,” Review of Foreign Developments, July 15, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/65/rfd65.pdf (accessed November 30, 2012); National Advisory Council, “Report of the National Advisory Council on International Monetary and Financial Problems, April 1-September 30, 1947,” Federal Reserve Bulletin 32, no. 4 (February 1948), 161-66. 35 Woodlief Thomas to Michael Hoffman, August 5, 1949, NARA, RG 82 DIF, box 224. 323

planned termination of aid in 1952. Instead, Thomas supposed that “some sort of aid beyond 1952 may be essential.”36

Aside from financing the revival of Europe’s productive capacity, Federal

Reserve officials also understood that dollar aid contributed to permanently eliminating the restrictive trade and currency practices adopted during the Great Depression and subsequent war. In particular, bilateral trade and clearing remained important concerns.

Federal Reserve officials consistently equated bilateral trade with the restrictive economic environment of the interwar period, and its elimination had been one of the justifications for the Bretton Woods Agreement as well as the Anglo-American Financial

Agreement.37 Into 1947, however, significant amounts of intra-European trade continued to be conducted on a bilateral basis. While officials conceded that some degree of bilateralism was undoubtedly necessary during the postwar transition period they believed that the “beneficial effects . . . are rapidly receding into the background before the detrimental effects” on overall trade.38 Recognizing the continued foreign dependence on American financial assistance the Fed contemplated how the United

States might leverage this reliance to foster greater European integration. Fed policymakers believed a more cooperative approach served several interrelated purposes

36 Woodlief Thomas, Memorandum, “Progress of European Recovery: Impressions obtained from interviews in Europe May-July 1949,” August 25, 1949, NARA, RG 82 DIF, box 224. 37 Alice Bourneuf, Memorandum, “Postwar International Monetary Institutions,” January 22, 1944, NARA, RG 82 DIF, box 38; Alice Bourneuf, Draft Statement for Catholic Association for International Peace, March 8, 1945, NARA, RB 82 DIF, box 34; Walter Gardner, Memorandum, “Draft Statement on Advantages to United States of the Proposed British Loan,” February 12, 1946, NARA, RG 82 DIF, box 309. 38 J. Burke Knapp, “Intra-European Financial Arrangements,” Review of Foreign Developments, July 15, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/65/rfd65.pdf (accessed November 30, 2012). 324

simultaneously. European integration maximized the benefits of American foreign aid, reducing the potential for “misinvestment,” allowing for allocation of resources to projects that benefited the entire continent, such as improved transportation. Integration also allowed for cooperative administration of foreign exchange resources through some

“European Foreign Exchange Board.”39 Dollar aid offered a means to break down bilateralism, holding out the prospect of assistance to encourage trade liberalization while also easing the burden of the transition. Therefore, even to the extent that it increased short-term demands on the American market or higher levels of spending, both of which were concerns that will be explored later, this was offset by the long-term benefits.

The intention here is not to argue that the Federal Reserve played a critical role in the intellectual development of the Marshall Plan or its associated initiatives. The proposal emerged out of combination of normative ideas stretching back to the New Era of the 1920s as well as contemporary policy analysis coming primarily from the State

Department.40 It does, however, demonstrate that the Fed recognized that American assistance was critical to breaking the logjam of European production, and that a restored

Europe was necessary for American domestic prosperity. Additionally, as will be developed below, central bankers shared the concerns of other American officials

39 Albert O. Hirschman to J. Burke Knapp, Memorandum, “U.S. Lending Policy and European Economic Unity,” May 27, 1947, NARA, RG 82 DIF, box 123. 40 The intellectual pedigree of Marshall Plan is developed in Hogan, The Marshall Plan, 1-25; Behrman emphasizes the unique contribution of undersecretary of state for Economic Affairs William Clayton in The Most Noble Adventure, 63-65 and a similar argument is found in Benn Steil, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order (Princeton: Princeton University Press, 2013), 311-14; While acknowledging the Hoover era origins of the Marshall Plan John Lewis Gaddis pays particular attention to the contributions of then head of the State Department Policy Planning Staff George F. Kennan in George F. Kennan: An American Life (New York: Penguin Press, 2011), Kindle Electronic Edition, Location 5217-5368. 325

regarding the problems facing Europe and sympathized with many of the core solutions that eventually found their way into the Marshall Plan as either implemented policy or underlying philosophy.

Given the importance Fed officials attached to postwar economic recovery and the links they had previously drawn between prosperity and political peace, the problem certainly must have appeared critical for the long-term success of the postwar order.

With a population of 270 million, Federal Reserve officials recognized that Western

Europe continued, simply by weight of numbers, to occupy an influential position in the postwar international system, and prospects for its population appeared to depend upon the “fate of the European Recovery Program.”41 If the United States were to avoid a repetition of the disastrous political collapse of the interwar period, avoiding a replay of the Great Depression economic crisis was also critical. Thus, Federal Reserve officials were disposed to support continued American financial commitments through the

Marshall Plan because of the aid’s importance to Europe and Europe’s importance in the international political and economic system.

More specifically, central bankers perceived positive economic benefits from the

Marshall Plan that disposed them to support continued dollar assistance. By no means was the Federal Reserve blind to the problems facing European recovery, and it did not simply believe that a specific amount of dollars represented a panacea to all the

Continents’ problems. Nor did Fed officials paint a rosy picture of the near future. At

41 Federal Reserve System Board of Governors, “Recovery in Western Europe,” Federal Reserve Bulletin 34, no. 2 (February 1948), 133. 326

the very least, however, central bankers clearly saw the positive effects of ERP in preventing the situation from getting worse. Marshall Plan assistance covered persistent deficits with the dollar area and prevented a severe curtailment of imports that might have undermined long-term recovery. As we will see later, this led central bankers to continue to support foreign assistance even as they criticized other aspects of government spending that they deemed inflationary.

The Federal Reserve, European Recovery, and Political Peace

Federal Reserve support for the Marshall Plan was also framed in terms of its political dimension. Central bankers continued to draw causal links between international economic stability and political peace. Marriner Eccles spelled out this connection to a group at the University of Utah when he contended that without substantial American assistance “large portions of Europe and Asia would have been reduced to starvation, unemployment, and widespread social unrest.”42 More specifically, central bankers understood the Marshall Plan as addressing two important challenges to the postwar political order. First, they recognized that Marshall Plan dollars checked the expansion of Soviet influence, increasingly defined as antithetical to

American liberal democratic capitalism. Federal Reserve officials accepted and supported the role of the Marshall Plan in creating a prosperous Western European

42 Marriner Eccles, Address before the Foreign Affairs Group of the University of Utah, “The Postwar Foreign Lending Program of the United States,” August 14, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_14_0001.pdf (accessed January 5, 2013). 327

economy able to withstand potential communist pressure. While the link between the

British Loan and the emergent superpower conflict remained somewhat nebulous, ERP was quite clearly a Cold War initiative. Truman administration officials understood that

Europe’s economic stagnation threatened to leave it vulnerable to potential communist subversion.43 While Marshall’s initial proposal held open the possibility of Soviet participation little real enthusiasm existed for such a prospect, a point reinforced by the fact that much of the pre-planning concentrated primarily on Western European integration.44 Second, Fed policymakers also understood how the plan contributed to the political pacification of recently defeated Germany. Reviving Germany and binding it to a prosperous European system eliminated a source of antagonism that many blamed for the breakdown of the international order prior to the Second World War.45 In both cases the Federal Reserve drew direct association between the willingness of the United States to finance European recovery and the kind of peaceful postwar order, albeit without the

Soviet Union, Americans hoped to establish in the aftermath of the war.

The Federal Reserve paid increasing attention to efforts by the Soviet Union to extend and consolidate its economic and political influence over Eastern and Central

Europe. Central bankers noted the Soviet use of political pressure to maintain economic dominance within Moscow’s sphere of influence and the apparent suspicion with which

43 Pollard, Economic Security, 133. 44 Hogan, The Marshall Plan, 44-5. 45 Although written prior to the breakdown of the international order the potential risks were clearly anticipated in John Maynard Keynes, The Economic Consequences of the Peace (New York: Harcourt, Brace and Howe, 1920), Kindle edition. 328

the Russians viewed efforts at European political or economic integration.46 Fed officials also expressed increased concern regarding the Soviets’ heavy-handed administration within this sphere of influence and its implications for general European recovery.

Policymakers cited incidents such as Soviet efforts to treat Austrian industrial facilities as

“German assets,” squelching political dissent to this hardline approach by threatening resistors with “deportation to Siberia” and thereby hampering Austria’s economic recovery.47 Besides physically disrupting the European economy, Fed officials noted the

Soviets’ “blackout on economic news” limited Western information about developments within the Eastern bloc itself and its sphere of domination in Europe, forcing western observes to resort to “guestimation.”48 The lack of transparency not only signaled the

Soviets’ intentions to forego cooperation with the Bretton Woods institutions but further inhibited efficient economic planning and served to further divide the European continent.

46 Alexander Gerschenkron, “Russia’s Post-war Trade with Some of the ‘Zone’ Countries,” December 31, 1946, Review of Foreign Developments, FRB, http://www.federalreserve.gov/pubs/rfd/1946/51/rfd51.pdf (accessed November 29, 2012); Burke Knapp to Elliot Thurston, Memorandum, “Federated Europe,” January 22, 1947, NARA, RG 82 DIF, box 123; J. Herbert Furth to Matthew Szymczak, Memorandum, “The Role of Central Europe Within the Framework of European Cooperation,” September 2, 1947, NARA, RG 82 DIF, box 123. 47 J. Herbert Furth, “Financial Developments in Austria,” March 11, 1947, Review of Foreign Developments, FRB, http://www.federalreserve.gov/pubs/rfd/1947/56/rfd56.pdf (accessed November 29, 2012). 48 J. Herbert Furth, “Economic Developments in Yugoslavia,” June 3, 1947, Review of Foreign Developments, FRB, http://www.federalreserve.gov/pubs/rfd/1947/62/rfd62.pdf (accessed November 30, 2012); Alexander Gerschenkron, “Economic Information from Russia,” July 1, 1947, Review of Foreign Developments, FRB, http://www.federalreserve.gov/pubs/rfd/1947/64/rfd64.pdf (accessed November 30, 2012). 329

Federal Reserve officials therefore recognized that dollar aid played an important role in preventing “western Europe from being overrun by Communism.”49

Policymakers characterized states such as Austria, Italy, and Greece as existing on the

“fringes of the Russian sphere of influence.” They argued the nature of Soviet postwar claims created additional barriers to economic recovery beyond simple supply and demand factors and warned that failure to provide assistance to Western European states created the potential for them to be pulled into the Soviet orbit.50 At the same time Fed officials saw the benefits of using foreign aid and associated European integration to create a countervailing attraction on “Soviet-Dominated Europe” while also diffusing influence within a larger European community to prevent a single power from dominating Europe and posing a “threat to democratic liberties.”51

Federal Reserve officials, therefore, remained cognizant of the ways Marshall

Plan aid served the nation’s larger political goals of countering Soviet influence and creating a prosperous and democratic Europe. Writing near the conclusion of ERP, the

President of the Federal Reserve Bank of St. Louis Chester Davis summarized the program’s political importance, arguing that assistance sprang from America’s

“conviction that Europe must not fall prey to World Communism.”52 Davis

49 Randall Hinshaw to Lewis Dembitz, Memorandum, “Summary of Major Activities on Recent Trip to Europe,” June 3, 1949, NARA, RG 82 DIF, box 224. 50 J. Herbert Furth, “Post-UNRRA Needs of European Countries,” Review of Foreign Developments, November 18, 1946, FRB, http://www.federalreserve.gov/pubs/rfd/1946/48/rfd48.pdf (accessed November 27, 2012); Federal Reserve Board of Governors, “International Transactions of the United States in the First Postwar Year,” Federal Reserve Bulletin 32, no. 12 (December 1946), 1333-34. 51 Albert O. Hirschman to J. Burke Knapp, Memorandum, “U.S. Lending Policy and European Economic Unity,” May 27, 1947, NARA, RG 82 DIF, box 123. 52 Chester C. Davis, “Review and Outlook,” Federal Reserve Bank of St. Louis Monthly Review 32, no. 1 (January 1950), 1 available on FRASER, 330

acknowledged that American commitments to Europe “involve heavy expenses and high taxes, and when added to other outlays, have led to deficit spending.” He went on to assert, however, that while higher deficits were not “particularly desirable,” they were

“part of the price of our major objectives.”53 Davis concluded with a positive assessment, praising Marshall Plan countries for their progress toward “economic rehabilitation” and added that the American “foreign aid program . . . seems to be paying off well.”54

Therefore, despite the increased pressure dollar aid placed on the American economy through potentially inflationary deficits and demand for goods relative to supply, it was still justified. By preventing an economic collapse similar to the interwar experience and by helping check the encroachment of a Soviet Union increasingly perceived as hostile to

American liberal democratic capitalism, dollar aid made a direct contribution to the twin goals of economic prosperity and political peace long supported by Federal Reserve officials.

Just as troubling as the expansion of the Soviet Union was the postwar stagnation of Germany and the strain it created on European recovery generally. From an early date the State Department supported the inclusion of Germany in the Marshall Plan, viewing it as the critical driver of the European economy.55 Central bankers concurred and supported the contention that failure to revive German manufacturing and production created a drag on overall recovery effort. A weak Germany created additional burdens on

http://fraser.stlouisfed.org/docs/publications/frbslreview/rev_stls_195001.pdf (accessed February 22, 2013). 53 Ibid. 54 Ibid., 2. 55 Leffler, A Preponderance of Power, 156. 331

the United States and Great Britain, forcing the occupying powers to supply critical raw materials to sustain the Western German population. This, however, added to the already substantial demand for American goods, resulting in at least near-term inflationary pressure on U.S. prices, creating distortions in the domestic economy while also eroding the purchasing power of dollar aid. For Britain, it drained away financial reserves that might otherwise have gone to restoring its own economy. Additionally, Fed officials feared that German economic torpor, combined with the growing split between the

Western and Eastern powers, risked the same social and political tensions that marred the interwar period and led to a breakdown of the international order.56

In early 1947 Federal Reserve officials expressed concern regarding the lackluster efforts at German rehabilitation and the potential consequences. The Austrian born economic advisor for the Board of Governors J. Herbert Furth blamed the Potsdam agreement for limiting German industrial recovery, distorting the economy and preventing it from “developing along its most economical lines.” Furth argued that failure to revive production presented a fundamental problem for Germany and kept it from moving forward with other efforts such as progressive currency reform and removing economic controls.57 While praising the administration of the American occupation zone, Paul Hermberg of the Fed warned of inter-zonal chaos resulting from a

56 Paul Hermberg, “The German Political Situation at the Beginning of 1946 Part I: The German Political Situation in Berlin,” Review of Foreign Developments, FRB, http://www.federalreserve.gov/pubs/rfd/1946/34/rfd34.pdf (accessed November 26, 2012); Paul Hermberg, “The German Political Situation at the Beginning of 1946 Part II: The German Political Situation in the American Zone of Occupation,” Review of Foreign Developments, FRB, http://www.federalreserve.gov/pubs/rfd/1946/35/rfd35.pdf (accessed November 27, 2012). 57 J. Herbert Furth, “The Exchange Value of the German Mark,” Review of Foreign Developments, January 14, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/52/rfd52.pdf (accessed November 29, 2012). 332

morass of overlapping and contradictory regulations. According to Hermberg, official controls and rationing, combined with the black market, resulted in the degeneration of the German economy into a state of “primitive direct barter” that undermined attempts at economic reconstruction.58 At the end of January 1947 Furth wrote a lengthy analysis of the situation in Germany for the Fed’s internally circulated Review of Foreign

Developments. In the introduction to the paper he offered a brief summation of conditions that is worth quoting as it neatly captures the multiple economic, social, and political as well as the domestic and international ramifications of Germany’s persistent stagnation as the Federal Reserve understood them:

Peaceful industries [in Germany] are working at a small fraction of their pre-war level. At least in the American and British zones, the occupying forces and displaced persons must rely entirely upon the contributions of the occupying powers. Average living standards of the German people, far from tending to exceed those of other European nations, have been prevented from falling below a minimum subsistence level only by relief imports from the United States and the United Kingdom. Many essential commodities are distributed among the several zones of occupation neither equitably nor inequitably, but not at all. The need for imports has been increased rather than reduced. Coal production and agricultural output have dropped rather than risen. The Germans are in dire need of external assistance although, at least in the American and British zones, scarcely any reparations are being paid. Allied controls pervade the entire economy without making it possible to carry out the Potsdam program. Moreover, the zones of occupation have been separated from each other more rigidly than Germany was ever isolated from the outside world under the Nazi regime.59

While acknowledging the need to assuage the fears of its European neighbors, Furth argued that the United State and Britain had a vested interest in seeing Germany

58 Paul Hermberg, “Price Control in Germany,” Review of Foreign Developments, January 28, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/53/rfd53.pdf (accessed November 29, 2012). 59 J. Herbert Furth, “The Economic Merger of the American and British Zones in Germany,” Review of Foreign Developments, January 28, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/53/rfd53.pdf (accessed November 29, 2012). 333

rehabilitated. On the one hand, a productive Germany contributed to the general prosperity of other European states, at least those not within the Soviet sphere of influence. On the other, by alleviating the “misery” faced by German citizens it removed a potential source of aggressive nationalist agitation. At the same time a self-sufficient

Germany also eliminated a major drain on American foreign aid, allowing it to be used more efficiently. Therefore, according to Furth ending the “present pauperization of

Germany [was] an aim justified by humanitarianism as well as by the interest of the

American taxpayer.”60 Furth made a very similar case during an extensive presentation to the Federal Reserve Staff Group on Foreign Interests, criticizing the “wasteful” attempts to extract reparations while emphasizing the political and economic benefits to be accrued from integrating a revived Germany into the larger European system.61

Federal Reserve officials continued to highlight the issue of Germany during the first half of 1947, connecting it to the prospects for international peace and prosperity and alleviating the burden on the American economy, presumably making domestic credit management easier. Matthew Szymczak of the Board of Governors presented this case in an address to the Economic Club of Detroit and republished in the Federal Reserve

Bulletin. The address came following Szymczak’s return to the Board of Governors after a leave of absence from July 1946 to May 1947 during which time he served as an advisor to the Office of the Military Government in Germany (OMGUS), providing him with firsthand insight into the conditions faced by the occupying powers. Szymczak

60 Ibid. 61 Federal Reserve System, Minutes, Memorandum of the Meeting of the Staff Group on Foreign Interests, January 29, 1947, NARA, RG 82 DIF, box 216. 334

contended that the lesson of the world wars made it clear that Germany represented a pressing international concern and its recovery made a positive contribution to the international sphere by preventing it “from remaining a source of perpetual unrest in

Europe” and by aiding “in the recovery of our Allies.” Specifically, he asserted that “the availability of German goods would help meet the foreign demand for many American goods” and that this would “lighten the burden” on the United States while also helping

Europeans conserve scarce dollars. He concluded by directly linking the future political prospects with economic circumstances, stating “we want peace, and we know that in order to have peace, we must have economic stability in Germany and the rest of

Europe.”62 The continued deterioration of economic conditions through the first half of

1947 only further highlighted the importance of Szymczak’s point.63

Thus, the Federal Reserve had been concerned with conditions in Germany even prior to Marshall’s Harvard speech. Central bankers naturally paid close attention to plans for the pace of German recovery thereafter. Estimates indicated that to return

Germany to a self-supporting basis by 1952 required aid to finance an approximately $5 billion import surplus during over 1948-1951. Fed officials acknowledged that although this increased the near-term burden on the United States, which would inevitably shoulder the lion’s share of that requirement, it was nevertheless “justified by the

62 Matthew Szymczak, “Out Stake in German Economic Recovery,” delivered on May 19, 1947 before the a luncheon meeting of The Economic Club of Detroit, reprinted in the Federal Reserve Bulletin 33, no. 6 (June 1947), 681-88. 63 J. Herbert Furth, “The Foreign Trade of the American and British Zones of Occupation,” Review of Foreign Developments, July 1, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/64/rfd64.pdf (accessed November 30, 2012); J. Herbert Furth to J. Burke Knapp and Alexander Gerschenkron, Memorandum, “Comments on ‘A Program for European Self-Help, Part I,’” July 11, 1947, NARA, RG 82 DIF, box 123; J. Herbert Furth, “US Economic Policy in Germany,” Review of Foreign Developments, July 29, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/66/rfd66.pdf (accessed November 30, 2012). 335

economic and political advantages resulting from the reintegration of Western Germany into the European economy.”64

Central bankers therefore understood that the long-term benefits in terms of economic prosperity and political peace far outweighed the near-term costs to the United

States in higher demand for American goods and potentially larger budget deficits. This is not to argue that the Fed eagerly accepted federal outlays on foreign aid with no consideration for their cost, a fact that will be clear below. It does, however, demonstrate that central bankers recognized the need to find a balance that ensured sufficient support for beneficial foreign policy initiatives while also safeguarding against disruptions to the domestic economy.

Fed Support for European Self-Help: Balanced Budgets, Exchange Rates, and Trade

Federal Reserve interest in foreign affairs was not confined simply to the

American provision of dollars through the Marshall Plan. Indeed, policymakers believed that Europeans themselves must undertake a host of reforms. These included adopting sufficiently anti-inflationary policies, such as balanced budgets, while also liberalizing trade and modifying exchange rates to make their exports more competitive and help restore a sustainable international payments system.

64 J. Herbert Furth, “Germany and the Plan for European Economic Cooperation,” November 4, 1947, Review of Foreign Developments, FRB, http://www.federalreserve.gov/pubs/rfd/1947/73/rfd73.pdf (accessed December 6, 2012). 336

Liberalizing intra-European trade and reforming payments clearing represented a critical component to the success of the Marshall Plan. Many European states adopted programs of bilateral trade clearing after the war, programs that remained in place as economic recovery remained limited and the dollar shortage continued. American officials, however, recognized that the persistence of these arrangements posed a threat to the long-term success of ERP even once European production began to revive. As

European output expanded it became more difficult to balance imports and exports between any two nations. Once a country became a net importer in a bilateral relationship its ability to continue obtaining goods was limited by the net exporter’s willingness to extend credit or that importer’s ability to drain existing international reserves such as gold or dollars. At the same time net exporters might be reluctant to extend credit to other countries with inconvertible currencies, particularly if the imbalanced trade position seemed unlikely to change in the future. The result was to either inhibit economic growth if the importer was simply unable to make additional purchases, or if alternative sellers existed, to distort trade along less efficient lines. This was further complicated, as Fed officials recognized, by the fact that bilateral deals between states were often conducted on wildly different terms creating a chaotic and 337

muddled set of barriers to economic recovery.65 As late as 1948 Federal Reserve officials estimated that intra-European trade remained 15-20 percent below 1938 averages.66

For the Federal Reserve, therefore, rationalizing the European system of clearing and trade was an important step to achieving a sustainable postwar prosperity. In an early assessment of the European situation prepared by the Board of Governors Division of

Research and Statistics the central bank highlighted persistent bilateralism and suggested the creation of a centralized agency, a regional body analogous to the International

Monetary Fund, to pool international reserves to encourage intra-European trade. It suggested that the United States might also play a role in this system by providing dollar aid to liquidate “intractable” credit balances, but presumably these would be smaller should a cooperative approach be adopted.67 Federal Reserve officials, therefore, took notice when the New York Times reported a Benelux proposal for a European clearing system to facilitate implementation of the Marshall Plan.68 The French ultimately took

65 Albert O. Hirschman and M. J. Roberts, “Trade and Credit Arrangements Between the ‘Marshall Plan Countries,’” Review of Foreign Developments, August 26, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/68/rfd68.pdf (accessed November 30, 2012). 66 Guenter H. Mattersdorff, “Trade Among European Recovery Program Countries in 1948,” Review of Foreign Developments, August 2, 1949, FRB, http://www.federalreserve.gov/pubs/rfd/1949/118/rfd118.pdf (accessed January 7, 2013). 67 Federal Reserve Board of Governors Division of Research and Statistics, Paper, “A program for European Self-help – Suggestions for Implementation in the Financial Field,” July 7, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_15_0004.pdf (accessed January 3, 2013); J. Herbert Furth to J. Burke Knapp and Alexander Gerschenkron, Memorandum, “Comments on ‘A Program for European Self-Help, Part I,’” July 11, 1947, NARA, RG 82 DIF, box 123. 68 J. Burke Knapp to Marriner Eccles and Matthew Szymczak, Untitled Memorandum, July 10, 1947, NARA, RG 82 DIF, box 123; Jefferson Caffery to George C. Marshall, July 20, 1947, FRUS, 1947 3:334. 338

the lead in scuttling the Benelux proposal, however, concerned that it would undermine their efforts to make France the hub of European integration.69

Despite the failure of the Benelux proposal, Federal Reserve officials continued to pay close attention to the problem of bilateralism and repeatedly voiced support for various reforms to liberalize European trade relations. Central bankers suggested that

NAC interim aid be used as leverage to pressure the adoption of an intra-European clearing mechanism, while criticizing as inadequate those methods that the Europeans did adopt.70 The reform of European payments remained one of the few areas where central bankers hoped to exert direct NAC influence in the operation of the Marshall Plan, although the extent of that sway remained uncertain. Fed policymakers paid close attention to the issue during 1948 and continued to hope to put an automatic clearing mechanism in place sometime during the year.71 The archaic system of trade and clearing was particularly concerning given how it forced Europeans to run down international reserves to finance intra-European trade, leaving fewer dollar resources

69 Hogan, The Marshall Plan, 61-4. 70 Federal Reserve System, Minutes, Memorandum of the Meeting of the Staff Group on Foreign Interests, December 3, 1947, NARA, RG 82 DIF, box 216; Robert W. Bean, “European Multilateral Clearing,” Review of Foreign Developments, January 27, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/79/rfd79.pdf (accessed December 29, 2012). 71 J. Burke Knapp to Thomas McCabe and Matthew Szymczak, Memorandum, “National Advisory Council meeting tomorrow,” May 4, 1948, NARA, RG 82 DIF, box 279; Lewis Dembitz to Thomas McCabe, Memorandum, “National Advisory Council meeting tomorrow,” May 26, 1948, NARA, RG 82 DIF, box 279; Lewis Dembitz to Matthew Szymczak, Memorandum, “Today’s NAC Meeting,” June 3, 1948, NARA, RG 82 DIF, box 279; Lewis Dembitz to the Board of Governors, Memorandum, “Report on NAC Developments,” June 22, 1948, NARA, RG 82 DIF, box 279; Frank Tamagna to Winfield Riefler, Memorandum, “NAC Staff Committee on Intra-European Trade,” July 12, 1948, NARA, RG 82 DIF, box 279; Lewis Dembitz to Board of Governors, Memorandum, “Report on NAC developments,” August 4, 1948, NARA, RG 82 DIF, box 279. 339

available for importing critical items from the Western Hemisphere.72 Liberalizing intra-

European trade, and reducing its reliance on international reserves, potentially reduced the overall cost of American aid or at least helped it to operate more efficiently. In either case it hastened the return of a stable economic system seen as important to international peace.

Reforming trade between Western European states appeared even more important given the deterioration of relations with the Soviet Union. The breakdown in economic links between East and West Europe resulting from increased tensions with the Soviets further distorted trade. Natural trade links were broken by the Cold War political cleavage, forcing countries to look to alternative, and potentially more costly, markets for certain imports. This added political pressure made efficient intra-West European trade even more important.73 At the same time Fed officials hoped that Western Europeans would be able to re-open some economic links with Eastern Europe. Some central bankers went so far as to hope that resumption of East-West trade might not only have beneficial economic effects by lowering the demand for dollar aid but might also help to

72 Robert W. Bean, “Belgian Gold and Dollar Receipts in Europe,” Review of Foreign Developments, June 15, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/89/rfd89.pdf (accessed December 31, 2012); Albert O. Hirschman and Caroline Lichtenberg, “Payments and Trade Between ERP Countries in 1947,” Review of Foreign Developments, June 15, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/89/rfd89.pdf (accessed December 31, 2012). 73 Caroline Lichtenberg, “Notes on the Significance of Selected Commodities from Eastern Europe for the European Recovery Program,” Review of Foreign Developments, July 13, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/91/rfd91.pdf (accessed December 31, 2012). 340

east political tensions as well, thereby making a direct contribution to the goal of a peaceful and prosperous postwar order.74

Nevertheless, many American policymakers, including central bankers, continued to support an institutional solution to the problem of intra-European payments clearing.

In early November 1949 Harold Van B. Cleveland of the State Department forwarded to the ECA a memo prepared by Albert Hirschman of the Federal Reserve. Hirschmann produced the memo in response to a request for input, and, while not a formal policy statement by the Federal Reserve it still highlighted central bankers’ general support for a

European payments system. Hirschmann focused on economic and monetary cooperation rather than political and fiscal issues. He hoped that the former set of issues would be easier to secure common agreement. In the paper Hirschman proposed the creation of a European Monetary Authority (EMA) to function as a coordinating body between member states’ central banks. In many ways the proposed institution was rather weak, eschewing direct pooling of members’ international reserves or the creation of a common European currency. The plan acknowledged continued autonomy for national central banks and emphasized moral suasion rather than statutory power over member fiscal policies. While admittedly a “halfway house” on the road to European integration it still represented an important step toward coordination.75

74 Gregory Grossman and Gordon B. Grimwood, “Recent Trends in East-West Trade,” Review of Foreign Developments, July 19, 1949, FRB, http://www.federalreserve.gov/pubs/rfd/1949/117/rfd117.pdf (accessed January 7, 2013). 75 Albert O. Hirschman, Memorandum, “Proposal for a European Monetary Authority,” November 2, 1949, NARA, RG 82 DIF, box 216. 341

The Hirschmann proposal was significant in several respects. It demonstrated the

Federal Reserve’s continued interest in a range of international developments. Central bankers were concerned not simply with American foreign policy directed at Europe.

They also understood that European initiatives held implications for the United States.

The success or failure of intra-continental payments reform held important implications for the United States and the management of domestic credit conditions. Failure presumably implied a much higher American aid burden and therefore greater inflationary pressure, while success pointed in the opposite direction. Additionally, even if the economic benefits were limited, central bankers recognized that the EMA proposal served a useful political purpose, demonstrating to a potentially skeptical Congress that

Europeans were making real progress toward self-help.76

In December 1949 the ECA offered a “sweeping” proposal to reform the intra-

European economy.77 Negotiations over the next several months culminated in the

Organization for European Economic Cooperation (OEEC) adopting the European

Payments Union (EPU) on July 7, 1950. The EPU represented many of the intra-

European trade and clearing reforms that central bankers supported as a necessary adjunct to American aid and demonstration of financial “European solidarity.”78 That is not to say that Federal Reserve officials were totally uncritical of the EPU proposal. Indeed, they expressed concern that the ECA had excluded the NAC, and therefore the Fed, from

76 Federal Reserve System, Minutes, Memorandum of Meeting of the Staff Group on Foreign Interests, November 10, 1949, NARA, RG 82 DIF, box 216. 77 Hogan, The Marshall Plan, 291. 78 Albert O. Hirschman, “The European Payments Union,” Review of Foreign Developments, August 15, 1950, FRB, http://www.federalreserve.gov/pubs/rfd/1950/145/rfd145.pdf (accessed February 18, 2013). 342

involvement in the negotiations, as well as reservations about specific aspects of the proposal that central bankers believed might lead to too rapid creation of credit and the unleashing of inflationary pressures within Europe. There was also concern that the EPU might inhibit the movement of individual countries to currency convertibility. As early as the negotiations on the International Monetary Fund the Federal Reserve believed convertibility was vital to the kind of international trading system necessary to long-term prosperity and peace. Nevertheless, central bankers remained generally supportive of the proposal, recognizing that by 1949-50 the major obstacle to European recovery was no longer productivity but rather the inefficient system of bilateral payments clearing.

Indeed, Federal Reserve officials played an important role mediating what was described as a “violent discussion” amongst members of the NAC, and securing ultimate acceptance for the proposal.79

While the Federal Reserve had any number of concerns about the specific operations of the EPU, in hindsight the plan appears to have made an important contribution to those areas of European economic recovery of greatest concern to the central bank. Intra-European trade improved dramatically following the adoption of the

EPU. Furthermore, the EPU played a role in assisting Western Germany in overcoming

79 Board of Governors of the Federal Reserve System, Memorandum, “Annex IV: The Agreement on the European Payments Union – Statement by Federal Reserve Representatives,” June 22, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/049_14_0004.pdf (accessed January 5, 2013); Matthew Szymczak to Board of Governors, Memorandum, “European Payments Union,” June 26, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/049_14_0005.pdf (accessed January 5, 2013); Board of Governors of the Federal Reserve System, Memorandum, “Annex I: The European Payments Union – A Short History,” June 26, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/049_14_0006.pdf (accessed January 5, 2013); Milward, Reconstruction of Western Europe, 322; Wexler, The Marshall Plan Revisisted, 161-4, 172; Eichengreen, The European Economy Since 1945, 79-85. 343

an unexpected strain on its balance-of-payments position, thereby furthering its economic integration with its neighbors and demonstrating the ability of European states to work cooperatively in overcoming financial challenges.80 Federal Reserve support for the

EPU, however, is best understood in terms of what central bankers believed European trade liberalization meant for the United States. By beginning the process of European integration and unwinding the complex system of bilateral arrangements that had grown up in the wake of the Second World War, the EPU contributed to the creation of a more self-sustainable trade system while economizing international reserves. These were critical to avoiding the kind of U.S. dependent system that developed during the interwar period and so ultimately destabilized the international political and economic order.

While the EPU facilitated the expansion of intra-European trade, policymakers continued to express concern about the competitiveness of European exports to the dollar area. American officials feared that inflation within Europe resulted in the overvaluation of continental currencies, making exports to the United States more expensive and less competitive, and therefore promoting the adoption of restrictive trade practices. As early as January 1948 Truman administration officials considered the need for European exchange rate devaluations as integral to the larger American aid program.81 Central bankers began to express similar beliefs about the overvaluation of European currencies in relation to the dollar in 1949, and although the NAC had not yet settled on firm support

80 Hogan, The Marshall Plan, 362-63; Eichengreen, The European Economic Since 1945, 81; Behrman, Most Noble Adventure, 281. 81 Treasury Secretary John Snyder statement before the Senate Committee on Foreign Relations, January 14, 1948 quoted in the “Report of the National Advisory Council on International Monetary and Financial Problems, October 1, 1947 – March 31, 1948,” reprinted in the Federal Reserve Bulletin 34, no. 9 (September 1948), 1094-96. 344

for devaluation as the solution, these anxieties became particularly acute with the onset of recession in the United States that same year.82 Devaluation, however, was not necessarily popular with all Europeans, especially the British, who worried that it might touch off inflationary wage or price demands to offset the higher price of American imports.83 While it made European exports more competitive with the dollar area, it also increased the cost of imports from the United States.84

By the summer of 1949, however, American officials with the ECA considered devaluation of European currencies, especially sterling, as “particularly critical” to long- term recovery.85 Additionally, the NAC, which had generally hedged its opinion about currency revaluations, came to see it as an important method for reviving European exports to the dollar area.86 Federal Reserve officials made the case for devaluation, and while they temporized on pressuring the Europeans directly, the general consensus

82 FOMC Meeting Minutes, February 28, 1949, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19490228Minutesv.pdf (accessed January 5, 2013); Federal Reserve System, Minutes, “Memorandum of the Meeting of the Staff Group on Foreign Interests,” May 9, 1949, NARA, RG 82 DIF, box 216; Eichengreen, The European Economy Since 1945, 77. 83 Federal Reserve System Board of Governors, “Notes on Currency Readjustment,” Federal Reserve Bulletin 35, no. 11 (November 1949), 1328-30. 84 Harold James, International Monetary Cooperation Since Bretton Woods (New York: Oxford University Press, 1996), 85-8. 85 Despite the growing belief among the ECA of the need for devaluation some members of the Bank of England were making the case for appreciating sterling. Randall Hinshaw to Lewis Dembitz, Memorandum, “Summary of Major Activities on Recent Trip to Europe,” June 3, 1949, NARA, RG 82 DIF, box 224. 86 National Advisory Council, “Report of the National Advisory Council on International Monetary and Financial Programs, October 1, 1948 – March 31, 1949,” reprinted in the Federal Reserve Bulletin 35, no. 9 (September 1949), 1069. 345

existed amongst American central bankers that “sterling and certain other currencies were overvalued and would sooner or later have to be devalued.”87

Europeans finally opted to devalue their currencies in the autumn of 1949 with sterling leading the way on September 18, and many others following over the course of the next several weeks. Most countries devalued by 30.5 percent, with other countries, such as France, making efforts to eliminate multiple exchange rate practices. Federal

Reserve officials voiced their support for these actions. Central bankers argued that by relying on higher domestic prices for American imports, rather than “further [dollar] aid,” represented an important step toward the restoration of a stable international economic system. Fed officials argued that the dollar’s undervaluation vis-à-vis European currencies had inhibited convertibility, and subsequent devaluation cleared the way for the “price mechanism” to replace nationalist trade restrictions. Ultimately, central bankers anticipated increased American demand for the exports of devaluing countries, reducing the postwar U.S. trade surplus as well as helping to revive the German economy and thereby securing ultimate “financial and economic stability.”88

Despite their support for the measure, Federal Reserve officials recognized that devaluation was not a panacea, but should be coupled with yet additional reforms.

Devaluation needed to be coupled with increased efforts at trade liberalization and

87 Randall Hinshaw, “Export Prices and the Dollar-Sterling Rate,” Review of Foreign Developments, August 2, 1949, FRB, http://www.federalreserve.gov/pubs/rfd/1949/118/rfd118.pdf (accessed January 7, 2013); Federal Reserve System, Minutes, “Memorandum of the Meeting of the Staff Group on Foreign Interests,” August 23, 1949, NARA, RG 82 DIF, box 216. 88 Federal Reserve System Board of Governors, “Readjustment of Foreign Currency Values,” Federal Reserve Bulletin 35, no. 10 (October 1949), 1169-81; Gordon B. Grimwood, “Western Germany’s Foreign Trade,” Review of Foreign Developments, November 8, 1949, FRB, http://www.federalreserve.gov/pubs/rfd/1949/125/rfd125.pdf (accessed January 9, 2013). 346

expansion of production, already taking place as previously discussed, as well as efforts to restrain inflationary pressures.89 A vigorous anti-inflationary program included balancing national budgets in conjunction with other currency reforms.90 This is not to say that returning European budgets to surplus would be easy. Central bankers acknowledged that many roadblocks to the goal must first be overcome, such as the persistence of tax evasion in some European countries, but Fed officials still considered these efforts a “step in the right direction.”91 Policymakers argued that inflationary pressure created economic dislocations, particularly in the proliferation of black markets.

Black market economic activity pushed Europeans out of the legitimate economy and tended to create unproductive idle balances as illegally earned funds were not easy to reinvest or spend.92 Anti-inflationary policies, therefore, helped to revive production as increased confidence in the purchasing power of the currency helped draw workers out of the black market and into the legitimate economy.93

Thus, central bankers appreciated that anti-inflationary measures, much like intra-

European trade liberalization or currency reform, were not alternatives to American aid, but rather interlinked parts to a comprehensive program. The interdependence of various

89 Federal Reserve System Board of Governors, Readjustment of Foreign Currency Values,” Federal Reserve Bulletin (October 1949), 1179. 90 Central bankers also supported used budget surpluses as a means of reducing inflationary pressure in the United States as will be discussed in greater detail below. 91 Samuel I. Katz,”Investment and Budgetary Policy in Western Europe,” Review of Foreign Developments, March 29, 1949, FRB, http://www.federalreserve.gov/pubs/rfd/1949/109/rfd109.pdf (accessed January 6, 2013). 92 Fred Klopstock, Paper, “Some Reflections on Black Markets in Europe,” September 29, 1947, NARA, RG 82 DIF, box 123. 93 J. Herbert Furth, “Domestic Effects of Currency Reform in Western Germany,” Review of Foreign Developments, March 8, 1949, FRB, http://www.federalreserve.gov/pubs/rfd/1949/108/rfd108.pdf (accessed January 6, 2013). 347

exchange rate and budget reforms within European countries, their implications for the restoration of a sustainable system of international trade and its implicit significance for

American economic prosperity, were of great importance. Fed officials continued to voice their support for reforms they believed helped impart long-term stability.

Surveillance of international developments also played an important role in shaping central bankers’ views on appropriate domestic economic and credit policy.

The Federal Reserve System and the Administration of European Aid

While the Federal Reserve may not have had a hand in the formation of Secretary

Marshall’s proposal prior to June 1947, central bankers took a serious interest in its development afterwards. Central bankers certainly did not attempt to control Truman administration economic policy or the policies of ERP. Nevertheless, Fed officials realized that the dynamic interrelationship between the European and American economies meant that the scope and pace of recovery had a direct bearing on domestic monetary and credit conditions. Just as the Fed attempted to secure some voice in

American attitudes toward the International Monetary Fund and the World Bank through the creation of the National Advisory Council (NAC), so too did central bankers attempt to gain a seat at the table in setting Marshall Plan policy. The justification was similar to that put forward during the debate over Bretton Woods. Officials hoped to maximize central bank independence and ensure some influence in policies that might impinge upon domestic credit policy rather than to proactively exert influence over international 348

affairs. As George B. Vest the general counsel of the Board of Governors advised

Chairman Marriner Eccles, given the “effect of the Marshall Plan upon the domestic economy and the Board’s powers in the national credit field, it [was] desirable that the

Board be represented” on any government body charged with administering the European aid program.94

Domestic-international economic interdependence made the potential total exclusion of the Federal Reserve from a body or organization intended to guide European reconstruction aid particularly worrying. In September 1947 Robert A. Lovett of the

State Department tapped his assistant Charles H. Bonesteel to chair the Advisory Steering

Committee (ASC) in an effort to coordinate various government agencies.95 Similar to the early days of the White Plan and Bretton Woods, the Federal Reserve was initially omitted as a member of the ASC, although it did include, among others, representatives from the Departments of State, Treasury, and Commerce, three of five members of the

NAC. Fed officials worried about their exclusion given the “uncertainty” of how the

Marshall Plan related to the existing NAC machinery and feared that the central bank might easily become the “least informed member of the NAC” if it did not secure its own spot on the ASC.96 Concern undoubtedly mounted when the Federal Reserve was also left off the Advisory Committee on Economic Cooperation proposed in the initial draft

94 George Vest to Marriner Eccles, Memorandum, “Meeting at State Department regarding Marshall Plan legislation,” October 3, 1947, Federal Reserve Archival System for Economic Research (hereafter cited as FRASER), http://fraser.stlouisfed.org/docs/historical/eccles/037_13_0001.pdf (accessed November 22, 2012). 95 Hogan, The Marshall Plan, 75. 96 Alexander Gerschenkron to Matthew Szymczak, Memorandum, “Marshall Plan Machinery,” September 22, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_12_0017.pdf (accessed November 22, 2012). 349

legislation. This only meant further exclusion from a “central part of the permanent machinery” designed to oversee European reconstruction and heightened the importance of securing Fed membership on the ASC so that central bankers might “be able to influence the future composition” of any administrative body.97 Thus, Eccles must have felt particular relief on September 24 when Lovett finally requested that he provide a representative to the ASC.98

Fed officials further sought to leverage their existing position on the NAC by advocating a greater role for that body in the oversight of European aid. This was particularly attractive given the uncertainty over the potential composition of yet another new bureaucratic entity. Given the scope of the Marshall Plan, Fed officials recognized early on that some new administrative body would likely be required, nevertheless Eccles wrote to Averell Harriman and Treasury Secretary John Snyder suggesting that ERP should make “maximum use . . . of existing Governmental machinery,” i.e., the NAC, for the purposes of coordinating European aid.99 Here Eccles found an ally in Snyder, who,

97 Alexander Gerschenkron to Matthew Szymczak, Memorandum, “Marshall Plan,” September 24, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_12_0018.pdf (accessed November 22, 2012). 98 Robert A. Lovett to Marriner Eccles, September 24, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_15_0001.pdf (accessed January 4, 2013). 99 Marriner Eccles to Averell Harriman, October 29, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_15_0006.pdf (accessed January 4, 2013); Marriner Eccles to John Snyder, October 29, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_15_0007.pdf (accessed January 4, 2013). 350

as the historian Kevin Casey explains, hoped to retain administrative control over foreign aid within the Treasury rather than risk losing it to the State-controlled ASC.100

During the winter of 1947-48 Federal Reserve officials followed the evolution of the Marshall Plan draft legislation. This included offering input to a statement by Snyder calling for the proposed ECA administrator to extend aid only “after consulting the

National Advisory Council.”101 While Snyder may have been fighting to maintain control, the Federal Reserve was more likely simply hoping to maintain its position.

Investing the NAC with coordinating powers meant lodging that authority in a body to which the central bank already belonged and avoided the possibility of the Fed being shut out of a new agency. Given the fundamental interdependence perceived between developments in the international and domestic economies, having a voice in the formulation and execution of foreign aid must certainly have been of the utmost importance. The issue was ultimately settled when the Treasury recommended the ECA administration be made a member of the NAC.102 While the NAC played a role in

100 Kevin M. Casey, Saving International Capitalism During the Early Truman Presidency: The National Advisory Council on International Monetary and Financial Problems (New York: Routledge, 2001), 221-22. 101 George Vest to Marriner Eccles, Memorandum, “Status of Marshall Plan Legislation,” November 14, 1937, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_13_0012.pdf (accessed January 3, 2013); J. Burke Knapp to Marriner Eccles, Untitled memorandum regarding Treasury Secretary Snyder Statement on Marshall Plan, January 7, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_16_0002.pdf (accessed January 5, 2013). 102 J. Burke Knapp to Marriner Eccles, Untitled memorandum on relationship of ECA administration to the NAC, January 14, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/037_17_0002.pdf (accessed January 5, 2013). 351

advising the ECA on policy, particularly exchange rate and payments issues, its role was circumscribed and far less influential than the Snyder hoped for.103

At the same time Fed officials took steps to expand their own independent sources of economic information regarding conditions in Europe. Along with paying attention to mechanisms for administering European aid, central bankers continued an earlier policy of re-establishing what Federal Reserve Bank of New York (FRBNY) president Allan

Sproul hoped would be permanent missions in Europe.104 As passage of the European aid bill approached the Federal Reserve expanded these contacts. Woodlief Thomas and

J. Burke Knapp of the Board of Governors staff proposed dispatching Albert O.

Hirschman of the Board’s Division of Research and Statistics on a mission to visit central bankers in France and Italy as a means of surveying conditions there. In their proposal to the Board, Thomas and Knapp justified the mission in terms of its implications for the

European aid program. They anticipated “the Administrator of the European Recovery

Program [would] consult closely with the National Advisory Council with regard to the progress of monetary and fiscal reforms in Europe – and in particular with the Treasury and with the [Federal Reserve] Board.” While doubts arose over the likelihood of

Marshall Plan officials utilizing the Fed in this way, European missions still appeared

103 Hogan, The Marshall Plan, 119, 166-67; Casey, Saving International Capitalism, 222-23; Immanuel Wexler perceives a far more active role for a Treasury dominated NAC in constraining the actions of the ECA in The Marshall Plan Revisited, 82-6, 153. 104 Allan Sproul to Marriner Eccles, Letter, February 6, 1945, NARA, RG 82 DIF, box 216; Federal Reserve Board of Governors, Minutes, Conference on Foreign Missions, May 4, 1945, NARA, RG 82 DIF, box 216. 352

beneficial.105 In discussing the proposal with the Board of Governors, Eccles emphasized that, in light of the importance of the European Recovery Program, it was important for the Federal Reserve to remain abreast of foreign developments, a point that elicited general support.106 Similar missions continued through 1949 with the Federal Reserve visiting with European policymakers and central bankers as well as consulting with

American ECA officials.107

Developing contacts in Europe allowed central bankers to keep lines of communication open with their counterparts across the Atlantic. Central bankers again saw it as important, not simply for understanding how European issues affected the

United States but also for determining how domestic developments influenced the international economy. For instance, Fed officials acknowledged that should there be an

American recession, possibly as a consequence of a post-inflation collapse, that weakness could easily spread to European economies. This, in turn, might create a kind of negative feedback loop and “threaten a spreading crisis for international capitalism.”108 Foreign

105 Woodlief Thomas and J. Burke Knapp to Board of Governors, Memorandum, “Proposed trip to France and Italy by Mr. Hirschman,” March 16, 1948, NARA, RG 82 DIF, box 224; Personnel Committee to Marriner Eccles, Memorandum, “Foreign Mission & Europe General,” March 30, 1948, NARA, RG 82 DIF, box 224; 106 Federal Reserve System Board of Governors Meeting Minutes, April 2, 1948, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min040248.pdf (accessed February 10, 2013). 107 Woodlief Thomas to Thomas McCabe and Matthew Szymczak, Untitled Memorandum on European Missions, March 16, 1939, NARA, RG 82 DIF, box 224; Paul Hoffman to Thomas McCabe, March 20, 1949, NARA, RG 82 DIF box 224; Woodlief Thomas to Board of Governors, Memorandum, “Proposed Trip to Paris, Geneva, and London by Mr. Hinshaw,” March 21, 1949, NARA, RG 82 DIF, box 224; Meeting Minutes of Federal Reserve Staff Group on Foreign Interests on May 9, 1949, NARA, RG 82 DIF, box 216; Frank Tamagna, Memorandum for Files, “Meeting of ECA Finance Officers in Paris,” July 15, 1949, NARA, RG 82 DIF, box 224. 108 Ralph Young to Matthew Szymczak, Untitled Memorandum, July 13, 1949, NARA, RG 82 DIF, box 224. 353

missions facilitated transparency and ensured a clearer understanding of international economic developments.

Both the Federal Reserve’s approach to the oversight and administration of

Marshall Plan aid, as well as its desire to reestablish direct foreign missions, demonstrated both change and continuity with the wartime experience. On the one hand, these actions demonstrated a relatively greater willingness on the part of the Fed to assert itself in the policymaking process compared to the wartime period. During the Second

World War, the central bank willingly accepted its subordination to the immediate imperatives of the conflict. This was partly out of necessity as states increasingly sought to centralize diplomatic and economic decision-making during the war. At the same time, as discussed in earlier chapters, the Fed, particularly the Board of Governors, supported the prioritization of the war effort and the defeat of the Axis above other considerations. On the other hand, central bankers continued to justify this expanded international role in terms of the Fed’s domestic mission and how it affected global economic conditions. Fed officials were not challenging the Treasury or State

Departments for primacy in foreign economic or financial policy. Instead, as with their role in the Bretton Woods negotiations and the formation of the NAC, Federal Reserve officials sought greater voice as a means of preventing international developments from undermining domestic price and credit stability while at the same making sure their own policies were in accord with U.S. foreign policy goals as central bankers understood them. 354

The Federal Reserve, International Responsibilities, and Domestic Obligations

While Federal Reserve officials supported the multifaceted efforts to revive the

European economy they also recognized the role of domestic finance in facilitating or inhibiting this process. During the Second World War central bankers subordinated concerns about inflationary fiscal and credit policies to the immediate tasks of defeating the Axis powers and the institutional structure of a stable postwar international political- economic order. With the end of the war, however, Fed policymakers began to reassess their priorities and in doing so demonstrated a greater willingness to advocate for changes in American domestic economic and financial policy. Central bankers expressed concern regarding fiscal and monetary policies they believed created disruptive upward pressure on prices. These critiques were often framed both in terms of inflation’s implications for the future of European recovery as well as the health of the domestic economy. This is not to say that Fed officials automatically accepted all international commitments.

Central bankers analyzed and critiqued aspects of the Bretton Woods arrangements as well as the British Loan. Indeed, they clearly recognized how the increasingly open- ended foreign aid and national security commitments associated with the emerging Cold

War complicated a successful anti-inflationary agenda. The years leading up to the outbreak of the Korean War therefore saw a continued, if uneven, evolution in the

Federal Reserve’s views of the interrelationship of the domestic and international economies. On the one hand, the Fed remained sensitive to the nation’s larger 355

international goals, at least as central bankers understood them, and sought to balance these imperatives against the need for price stability at home. On the other hand, with the removal of the immediate Axis military threat they were also more willing to emphasize the domestic stabilization side of the equation. This does not mean that central bankers necessarily secured all or even most of the reforms they advocated, but rather highlights the continuing development in policymakers’ views in light of competing goals.

Early in Marshall Plan discussions, Marriner Eccles demonstrated an understanding of the Cold War and economic benefits of dollar aid while also recognizing the interdependence between foreign assistance of domestic financial and monetary policies. The Fed chairman warned that even though the United States faced significant inflationary pressures at home, it should not allow “what is left of European democracy to perish through starvation and communism.” Indeed, he linked the future to domestic prosperity and one of the major solutions to inflation at home to revival of

“Europe’s vast productivity” while cautioning that the uncertain state of the Continent left its people “susceptible to the lure of political panaceas” and were “likely to generate feelings of hatred” and represented a “threat to stability and peace in the world.”109

Providing assistance to Europe offered not only important economic benefits for the

United States by reviving a partner in global trade and easing inflationary demand on the

American market but also served the nation’s political interests by staving off communist subversion of Western democracy. This link between international prosperity and

109 Marriner Eccles, Address before the National Association of Supervisors of State Banks in Washington, D.C. on September 25, 1947, “Postwar Bank Credit Problems,” republished in the Federal Reserve Bulletin 33, no. 10 (October 1947), 1208. 356

international peace was not new to the Federal Reserve, as discussed earlier, and it aligned with the approach to the Marshall Plan of many in the Truman administration.110

Eccles, however, went on to develop the tensions, as he saw them, between the nation’s international commitments and its domestic responsibilities. It is useful to quote his statement at length because it demonstrated central bankers’ awareness of the uneasy trade-offs between domestic and international imperatives as well as their recognition of the need for continued American involvement in restoring the international political- economic order. After cautioning listeners about the rising cost of military spending,

Eccles argued:

We should be fully aware of the costs and risks of providing foreign aid and make adjustments in our policies accordingly. We cannot be lavish in aid to other countries without suffering the consequences of inflation, heavier taxation, or the reimposition of controls. Countries receiving assistance should recognize the burden that is being imposed on our economy, and it is imperative that they take measures to assure the most effective use of their own resources as well as of those received from us. If these requirements are met, it would be shortsighted, as well as highly selfish, for us to deny aid needed to prevent starvation and to reconstruct productive capacity in other countries. Our reason for denying the aid would be that we wanted to increase our already large consumption in order to counteract inflation. Yet the best remedy for inflation is more production, and the greatest unused productive resources now lie outside of this country, but they cannot be effectively operated by starving people devoid of equipment and supplies.111

110 Truman administration links between the Marshall Plan, international prosperity, and international peace are developed in Thomas G. Patterson, “The Quest for Peace and Prosperity: International Trade, Communism, and the Marshall Plan,” in Politics and Policies of the Truman Administration, ed., Barton J. Bernstein (Chicago: Quadrangle Books, 1972), 78-112. 111 Marriner Eccles, Address before the National Association of Supervisors of State Banks in Washington, D.C. on September 25, 1947, “Postwar Bank Credit Problems,” republished in the Federal Reserve Bulletin 33, no. 10 (October 1947), 1208-09. 357

Eccles used his speech, therefore, to establish a sense of European-American mutual obligation. On the one hand, aid recipients needed to act in a responsible and prudent manner to efficiently employ assistance from the United States. These included measures previously discussed, such as maximizing aid by restoring domestic economic equilibrium and liberalizing intra-European trade to hold down unnecessary purchases from the dollar area, policies the Federal Reserve supported throughout the Marshall Plan era. On the other hand, Eccles recognized that the United States had a moral and practical interest in exercising leadership and providing nations with the aid they required to restart their industries and realize productive potential. Restored prosperity not only assisted the United States by ensuring the stability of European democracies, it also reduced long-term inflationary demands on the American economy.

A third critical piece of Eccles’ statement pertained to American domestic policies, a point he reiterated at the conclusion of his address. The Fed chairman argued:

We are on the horns of a dilemma. We simply cannot reduce taxes drastically and at the same time assist Europe. We cannot expand domestic credit, both public and private, for the purpose of having all we want and assist Europe to avoid inflation. We must give up something or we are going to pay much more dearly in the long run. If we desire to preserve democracy and peace in the world, we must assist in feeding the starving people in the democracies of Europe and help them to get into production because it is only by their production that we will be relieved and more will be available in the economy. If controls are needed to do that, we should have controls. If the public understands the problems and voluntary rationing can do it, of course that is the desirable way to do it. We have got to deal with the economic facts of life as they are.112

112 Ibid., 1211. 358

Eccles recognized the need for foreign aid but also emphasized the necessity of balanced domestic policies. While acknowledging that the United States should not prioritize domestic anti-inflationary policy above the aid critical the securing European democracy and capitalism, the Fed chairman warned not to err too far in the other direction either.

Low taxes increased the purchasing potential of business and individuals. Easy access to consumer or business credit held similar implications. Both, if left completely unchecked, threatened to compete with increased European demand for American goods and touch off an inflationary price spiral. Eccles therefore highlighted not only the need to balance domestic and international priorities, but the necessity of prioritizing within domestic needs, and adopting the measures necessary to restrain unnecessary purchasing power.

In November 1947 Eccles took the opportunity to lay out his concerns in a statement to Congress. He opened by pointing to expansion of the money supply, the result of wartime deficits, for creating current inflationary circumstances. He argued, however, that once the “elaborate harness of controls,” such as higher taxes and wage and price controls, adopted during the war was “prematurely removed” after the conclusion of hostilities, it unleashed a “flood of effective demand” that made the present “sharp rise in prices . . . inevitable.”113 While he recognized that the extensive system of controls

113 Statement by Marriner Eccles, Chairman of the Board of Governors of the Federal Reserve System, before the Joint Committee on the Economic Report, Special Session of Congress, November 25, 1947, “The Current Inflation Problem – Causes and Controls,” reprinted in the Federal Reserve Bulletin 33, no. 12 (December 1947), 1456. 359

acceptable during the war was no longer feasible, he argued that fiscal policy could be used to manage demand and limit price increases.114

The Fed chairman then laid out a five-point program of domestic reforms he believed necessary to bring inflationary pressure under control. This program, with some changes in emphasis following Thomas B. McCabe’s replacement of Eccles as Fed chairman in 1948, broadly reflected central bankers’ approach to domestic economic policy in the years leading up to the Korean War. First, echoing his earlier statements,

Eccles called for higher production from both domestic and foreign sources as well as efforts to reduce consumption in order to balance supply and demand. Second, he called for wage and price constraints. Third, emphasizing the role of fiscal policy, Eccles advocated for reductions in government spending and a suspension in further tax cuts in order to ensure budgetary surpluses that could be applied to reduce the outstanding national debt. Fourth, he proposed increasing the powers of the Federal Reserve the control bank credit. Finally, he pressed for a more aggressive Treasury bond program to shift the existing debt from banks to non-bank investors and to focus retirement of outstanding debt on those securities currently held by the financial system.115 This last point was particularly important given the wartime limits on securities yields, discussed in the next chapter, under which the Fed still operated that guaranteed banks the ability to liquidate their holdings of government debt, and thereby expand credit with potentially inflationary consequences.

114 Ibid., 1457. 115 Ibid., 1457-58. 360

Eccles’ five point program translated into a number of specific issues that the

Federal Reserve began to advocate over the next several years. While the emphasis placed upon any one issue evolved over time, together the program demonstrated an increased willingness by central bankers to publicly voice concern regarding the need to balance the nation’s growing international commitments with appropriate domestic policies to reduce unnecessary inflation. While policymakers did not frame every issue in terms of its implications for European recovery or the nation’s growing international role, Fed officials recognized the broader implications of domestic economic stability.

Guns or Butter: Inflation and Postwar Defense Spending

When it came to government spending on international obligations, the Federal

Reserve paid particular attention to the balance between outlays for national defense and those for foreign aid. Central bankers expressed optimism about the prospect for a 1947-

48 budget surplus, the first since the onset of the Great Depression, but remained wary of the size of defense spending. Although down from wartime highs, military spending represented 90 percent of the increase in the size of the budget over prewar levels and therefore appeared to be a significant factor moving forward. Furthermore, as arms became more technically sophisticated they also became more expensive. This 361

represented a considerable unknown for federal budgets given that there was little indication about likely future needs of the War and Navy Departments.116

Eccles voiced concern about rising military spending in his September 1947 address to the National Association of Supervisors of State Banks, a position that drew both praise and criticism. F. R. von Windeggar and John J. Kirk, president and vice president of the Plaza Bank of St. Louis , respectively, separately wrote to Eccles praising his address as timely. Kirk criticized the “unwarranted sums” of money turned over to the military based upon the “appeal to patriotism” and expressed his hope that the nation would recognize that the stable employment and prices offered the “best guaranty against the spread of Communism,” an assessment Eccles concurred with in his response.117

Similarly, von Windeggar noted the apparent contradiction between “people crabbing about high taxes” but simultaneously accepting a “more or less secret armament race.”

Von Windeggar went on to touch on themes that central bankers themselves had long expressed concern about, fearing that if the country stayed on its present course it risked economic depression and the radicalization of American politics.118 Similar handwritten notes came in from other Americans praising Eccles for his suggestion to “feed the

116 Federal Reserve System Board of Governors, “The New Budget,” Federal Reserve Bulletin 33, no. 1 (January 1947), 117-18. 117 John R. Kirk, Jr. to Marriner Eccles, September 26, 1947, and Marriner Eccles to John R. Kirk, October 13, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_16_0009.pdf (accessed March 2, 2013). 118 F. R. von Windeggar to Marriner Eccles, September 26, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_16_0010.pdf (accessed January 4, 2013). 362

hungry instead of building up armaments” and to prioritize foreign aid over defense outlays that would “do us no good if Europe goes communist.”119

A more critical assessment came from Frank Hecht, the president of the civilian

Navy League of the United States. After reading excerpts from Eccles’ speech published in the Washington Post, Hecht took issue with the Fed chairman’s criticism of military spending, warning that a failure to devote sufficient resources to defense left the nation open to “attack and conquest” and threatened to repeat the experience of the Second

World War. In his response, drafted by Woodlief Thomas, Eccles took the opportunity to further highlight the perceived pressure international obligations placed upon the

American budget and the need to prioritize between spending on aid and armaments.

According to the Fed chairman the country could devote significant resources to either

“preparing for the next war” or to aiding the “starving and destitute Western European democracies” but not to both at the same time. Any attempt to take up both goals threatened to unleash “serious inflation with a subsequent disastrous collapse.”120

By late 1947, therefore, Eccles and the Federal Reserve had been drawn into the unfolding political-economic debate over spending priorities, guns versus butter. Eccles,

119 Jean Paton to Marriner Eccles, postcard, September 26, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_16_0004.pdf (accessed March 2, 2013); Similar notes of praise came in from other Americans such as Melvin Brethouwer to Marriner Eccles, September 26, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_16_0021.pdf (accessed March 2, 2013); Lee Lynne to Marriner Eccles, September 26, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_16_0020.pdf (accessed January 5, 2013); W. Clay Marks to Marriner Eccles, September 26, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_16_0008.pdf (accessed January 5, 2013). 120 Frank Hecht to Marriner Eccles, September 26, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_15_0005.pdf (accessed January 5, 2013); Marriner Eccles to Frank Hecht, September 30, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/081_15_0005.pdf (accessed January 5, 2013). 363

to be sure, was not a balanced budget ideologue, and he supported Keynesian solutions to resolve the economic crisis of the Great Depression.121 As Allan Meltzer points out, however, Eccles’ prioritization of fiscal policy as the primary means for dealing with inflation or depression led him to counsel for postwar spending restraint.122 The Fed chairman rejected the argument of other postwar Keynesian economists who believed

American economic growth sufficient for the United States to simultaneously shoulder a variety of international commitments without risking domestic prosperity.123 Rather,

Eccles’ position more closely paralleled that of President Harry S. Truman, who believed in the need to balance domestic and international obligations, and therefore advocated restraint of military outlays.124 If the United States attempted to pursue vigorous rearmament and a generous foreign assistance program simultaneously, particularly in light of recently reduced taxes, it risked running large fiscal deficits. Fed officials feared that the combined effect of the large pool of liquid assets held by banks and the public, the result of the Second World War, the rollback of restraints in the form of lower taxes and fewer price or credit controls, and the continued obligation by the Fed to maintain the

121 L. Dwight Israelsen, “Marriner S. Eccles, Chairman of the Federal Reserve Board,” The American Economic Review 75, no. 2 (May 1985), 357-58. 122 Allan H. Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2000), 633; Eccles explicitly argued that the best anti-inflationary measure was a “vigorous fiscal program to insure the largest possible budgetary surplus consistent with the Government’s obligations at home and abroad,” in late 1947 Marriner Eccles, Statement, “Statement by Chairman Eccles as a Result of Conference with Secretary Snyder,” FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19471210.pdf (accessed November 11, 2012). 123 This pro-growth Keynesian policy is developed in Lester H. Brune, “Guns and Butter: The Pre- Korean War Dispute over Budget Allocations: Nourse’s Conservative Keynesianism Loses Favor against Keyserling’s Economic Expansion Plan,” American Journal of Economics and Sociology 48, no. 3 (July 1989): 357-71; Robert M. Collins, More: The Politics of Economic Growth in Postwar America (New York: Oxford University Press, 2000), 27-31. 124 Michael J. Hogan, A Cross of Iron: Harry S. Truman and the Origins of the National Security State, 1945-1954 (New York: Cambridge University Press, 2000), 83. 364

yield on certain government securities created the conditions for dangerous inflation, which inevitably resulted in a deflationary contraction.125 Even without deficits, military spending risked additional inflationary pressure if it intensified demand on goods in short supply because of competing domestic or foreign claims.

Eccles continued this refrain through his tenure at the central bank and used one of his final statements as chairman of the Federal Reserve to caution government officials about the implications of ladling additional defense spending on top of existing programs, warning of the potentially disastrous political and economic consequences if the nation failed to properly balance its domestic and international obligations. He framed the alternatives facing the country not only in terms of economic consequences but also political implications. Eccles warned that if the United States continued to pursue a simultaneous policy of “providing essential foreign aid” while also “carrying out a military program on a scale of, as yet, undetermined size and cost,” the nation risked a dangerous inflation that played directly into the Soviets’ hands. Without naming the

Soviet Union directly, the Fed chairman warned that those who viewed America “with a hostile eye” undoubtedly hoped that the United States would destroy its own economy

“on the shoals of inflation,” which offered “a cheap way to defeat us.” Alternatively, pursuit of international obligations without regard to domestic inflation risked subverting

American values and turning the nation into a garrison state. Eccles advised that attempting to pursue international objectives without regard to domestic implications

125 The Federal Open Market Committee (FOMC) warned of the dangers of deflationary contraction in early 1948, FOMC Meeting Minutes, February 27, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19480227Minutesv.pdf (accessed January 5, 2013). 365

meant subjecting the country to “a full harness of direct economic controls,” which amounted to “regimentation of the economy” and even then offered no absolute guarantee against the dangers of inflation. Instead, he believed that the critical element was time, and that the United States needed to pursue some settlement to the emerging

Cold War conflict. While he did not set out a specific solution, the Fed chairman warned that the United States could not “go on year after year bearing these crushing costs without jeopardizing what we seek save.”126

After the conclusion of his time as chairman in 1948, Eccles remained a member of the Federal Reserve Board of Governors and used this position to continue speaking out about the need to prioritize fiscal commitments. He continued to sketch out the connection of the increasingly open-ended security competition between the United

States and the Soviet Union and its implications for the survival of American political economy. Furthermore, he also drew linkages to the earlier interwar experience, which remained a powerful touchstone for American policymakers. During an April 1949 address before the Commonwealth Club of California he counseled that “economic stability” remained the “foremost long-run problem of democratic capitalism” and that the Soviets were already anticipating the “timing and severity of our next collapse.”

Furthermore, he argued that the interwar period clearly demonstrated the inability of

“political and other freedoms . . . [to] survive in the midst of widespread unemployment and destitution.” He concluded by warning against what he perceived as the increasing

126 Marriner Eccles, Statement, “Statement before the Joint Committee on the Economic Report,” April 13, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19480413.pdf (accessed November 12, 2012). 366

dependence of the domestic economy on a “huge military preparedness program and a large world aid program, both without foreseeable terminal points as to time or amount.”127 The argument was not that foreign aid was bad per se, but rather that it must be in the pursuit of a specific goal, such as the revival of a Europe able to export to the

United States and the rest of the world as much as it imported.

Furthermore, Eccles’ statements clearly highlight the link many central bankers drew between domestic economic health and international security, a point he himself began to lay out during his September 1947 exchange with Frank Hecht of the Navy

League. While Hecht saw a strong military as critical to national security, Eccles prioritized a healthy economy and warned that a bristling defense meant little if the nation rotted from the inside. More specifically, it demonstrates how central bankers were able to frame their support for specific anti-inflationary measures in terms of the nation’s larger foreign policy goals. Failure to pay sufficient attention to the economic instability created by inflation threatened to undermine the ability of the United States, over the long term, to stand up to the Soviet Union. By implication, a prudent anti- inflationary policy increased the security of the nation by giving it the wherewithal to continue to meet communist challenges that arose. The Fed’s continued support for

European aid, and the recognition of the role of dollar assistance in reviving the international economy precludes the possibility that central bankers opposed all international obligations and reinforces the emphasis on the need for a prioritization of

127 Marriner Eccles, Address at Luncheon of the Commonwealth Club of California in San Francisco, California, “Today’s Challenge to Democratic Capitalism,” April 8, 1949, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19490408.pdf (accessed November 12, 2012). 367

obligations. Finally, it foreshadowed the conflict among the Truman administration,

Treasury, and the Federal Reserve that erupted during the Korean War and will be discussed in greater detail in the next chapter. The outbreak of the Korean War seemed to portend an intensification of the open-ended security competition between the United

States and the Soviet Union. Given the link drawn by the Federal Reserve between anti- inflation and national security, and the likely fiscal demands of meeting a long-term

Soviet challenge, the Korean War reinforced the central bank’s willingness to break with the administration and demand additional powers to keep price pressure down to the greatest extent possible. The Federal Reserve was motivated by a desire to increase its autonomy over domestic credit policy but also with an understanding that it had important implications for the viability of the nation’s Cold War struggle.

Possibly the most significant development involved the willingness of Fed officials to discuss the issue of military spending at all. During the Second World War the Federal Reserve subordinated the concerns it had about waste in the military budget to the primary task of winning the war. That Fed officials now felt free, if not to oppose defense spending, to at least emphasize the need to prioritize it with the nation’s other foreign policy goals is telling. During the Second World War policymakers believed that without a strenuous military effort to defeat the Axis the American political economic values of liberal democratic capitalism could not survive. As the context changed from total war to Cold War, central bankers demonstrated an evolution in their thinking as well. A permanent political-economic and security challenge from the Soviet Union ran the risk of the United States defeating itself by adopting short-term policies that 368

undermined its own long-term prosperity. Thus, emphasizing the need to prioritize military spending along with domestic economic prosperity and foreign aid did not mean that Fed officials were challenging the nation’s foreign policy goals. Rather, the reforms advocated were understood as allowing the United States to fulfill those goals while also addressing the central bank’s institutional concerns with domestic credit conditions and price stability.

Because of the budgetary implications of defense spending, and therefore its importance to the Fed’s anti-inflationary agenda, central bankers continued to pay attention to military outlays prior to the Korean War. Federal Reserve officials considered how foreign aid and military spending competed with the civilian economy for critical manpower and material and increased budget deficits with inflationary implications.128 Central bankers also worried how the apparently immediate demands for military spending undermined their own attempts to restrict bank credit and reduce other inflationary forces.129 Even as foreign aid appeared to decline, Fed officials recognized that the expansion of military rearmament, continued strategic stockpiling, and the potential for universal military training represented important increases in the budget and

128 Federal Reserve System Board of Governors, “Real Estate and Construction Markets,” Federal Reserve Bulletin 34, no. 7 (July 1948), 755, 764; Federal Reserve System Board of Governors, “Bank Credit Developments,” Federal Reserve Bulletin 34, no. 10 (October 1948), 1205-06; FOMC Meeting Minutes, November 15, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19481115Minutesv.pdf (accessed January 5, 2013); Federal Reserve System Board of Governors, “Expenditures and Incomes in the Postwar Period,” Federal Reserve Bulletin 34, no. 11 (November 1948), 1329-30, 1332-33; Federal Reserve System Board of Governors, “Economic Developments in 1948,” Federal Reserve Bulletin 35, no. 1 (January 1949), 2-4. 129 FOMC Meeting Minutes, October 4, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19481004Minutesv.pdf (accessed January 5, 2013). 369

contributed to inflation remaining a “threat to the economy.”130 With the outbreak of the

Korean War in June 1950 the fiscal pressures, including military spending and its potential economic consequences, increased dramatically.

The Federal Reserve and the Postwar Anti-Inflation Program

The debate about defense spending took place within a much larger discussion of the role of the postwar budget in restraining inflationary pressure. Specifically, central bankers advocated large fiscal surpluses whereby government receipts exceeded expenditures. One way to bring about surpluses was to hold down outlays, keeping unnecessary expenses to a minimum. This position informed the Federal Reserve’s concern about military spending, because of the way it increased expenses relative to receipts. Another way to generate fiscal surpluses was by increasing what the government brought in, such as through higher rates of taxation. Taxes possessed the additional benefit not only of contributing to a fiscal surplus but also skimming off excess purchasing power from the public at a time when available supplies were tight relative to demand. The Federal Reserve, therefore, did not favor higher taxes per se, but they did attribute the postwar inflationary upsurge, in part, to premature reduction in tax rates during 1945-46. 131 To the extent that tax reform was undertaken, central bankers argued

130 Federal Reserve System Board of Governors, “Federal Budget for Fiscal Year 1950,” Federal Reserve Bulletin 35, no. 2 (February 1949), 109-12. 131 Federal Reserve System Board of Governors, “Readjustment of Margin Requirements,” Federal Reserve Bulletin (February 1947), 149; Federal Reserve System Board of Governors, “Demand, Production, and Prices in 1947,” Federal Reserve Bulletin 34, no. 1 (January 1948), 9; Council of 370

that it should be withheld until a period of clear economic recession and then aimed at middle and lower income brackets as a means of stimulating demand. 132 While potential demand remained high, however, policymakers supported at least maintaining existing tax rates to maximize the budget surplus.

Federal Reserve officials and members of the Truman administration favored fiscal surpluses for their practical anti-inflationary potential and effect on domestic credit conditions.133 A budget surplus meant that the Treasury held cash relative to the substantial national debt. To the extent that the Treasury used these balances to retire securities owned by the commercial banking system or the Federal Reserve, the program exerted a deflationary force on the economy by contracting bank reserves. The reduction in bank reserves thereby constrained the ability of banks to extend private credit, and thus reduced its potential inflationary potential. Central bankers recognized, however, that the policy was of limited effectiveness if banks could dispose of government securities by selling them to the central bank, restoring their depleted reserves, and extend credit without limit.134 Budget surpluses for the purposes of debt retirement were important; however, given the Federal Reserve’s commitment to maintain yields on certain government securities, discussed in greater length in the next chapter, they were not sufficient by themselves. To enhance the effectiveness of the debt retirement policy the

Economic Advisors, Midyear Economic Report of the President Transmitted to the Congress, July 1948 (Washington, D.C.: Government Printing Office, 1948), 4. 132 Richard Musgrave to Marriner Eccles, Memorandum, “Tax Program for 1948,” September 17, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/026_10_0009.pdf (accessed January 5, 2013). 133 Council of Economic Advisors, The Economic Report of the President Transmitted to the Congress, January 1949 (Washington, D.C.: Government Printing Office, 1949), 10. 134 Federal Reserve System Board of Governors, “Federal Reserve Support of Government Securities Market,” Federal Reserve Bulletin (January 1948), 13. 371

Federal Reserve coupled its support for fiscal surpluses with proposals to increase its ability to regulate reserves and commercial credit in order to prevent any additional inflationary leakage. At the same time, policymakers recognized that the effectiveness of these anti-inflationary measures were both dependent upon and had implications for the nation’s growing international commitments.

Throughout 1947 and 1948 the Federal Reserve paid close attention to the scope of the Treasury’s debt retirement program. Central bankers recognized that the Fed depended upon the ability of the government to maximize its surpluses, and this turned, in part, on the size of defense spending and other obligations.135 Early in the postwar era the United States made important strides to retire outstanding debt, reducing the total from $279 billion in February 1946 to $258 billion, an approximately 7.5 percent drop, by June 1947.136 This decline, however, only had a slight effect on bank reserves, which actually experienced a net increase in 1947 compared to 1946.137 The result was to expand the ability of banks to make loans and potentially increase inflationary pressure on the economy. The ability to effect debt reduction became further constrained as the

United States shifted from large postwar surpluses to cash deficits in 1949. This

135 Federal Reserve System Board of Governors, “The New Budget,” Federal Reserve Bulletin (February 1947), 121. 136 Federal Reserve System Board of Governors, “Debt Retirement and Bank Credit,” Federal Reserve System (July 1947), 777. 782-83. 137 Federal Reserve System Board of Governors, Thirty-Fourth Annual Report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1947 (Washington, D.C.: Government Printing Office, 1948), 21. 372

undermined the government’s efforts to retire existing obligations and therefore removed an important plank from the postwar anti-inflationary fight.138

Figure 2: Federal Cash Surplus or Deficit for the United States, 1945-1951 Central bankers understood the intimate link between the reconstruction of the international economy and the ability of the Treasury to continue its debt redemption policy. On the one hand, higher spending on defense and foreign aid relative to revenues decreased fiscal surpluses. On the other hand, instability in foreign countries and the international market also created expansionary pressures. To the extent that foreign nations were unable to satisfy dollar deficits in their international balance of payments they might resort to drawing upon the resources of the International Monetary Fund. If the Fund ran low on its own dollar holdings it could redeem the dollar demand notes the

138 Federal Reserve System Board of Governors, Thirty-Sixth Annual Report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1949 (Washington, D.C.: Government Printing Office, 1950), 31-8. 373

United States had used as part of its subscription. Through redemption the Treasury exchanged dollars for the demand notes, thereby reducing the cash on hand for further debt retirement. Similarly, should foreign countries run substantial trade deficits with the

United States they could be forced to liquidate their own gold and dollar holdings, which itself exerted an expansionary pressure on the U.S. money supply.139 Thus, the sooner and the more effectively the restoration of a sustainable European economy took place, the less chance for it to exert a disturbing influence on American credit and price conditions.

While debt reduction remained an important anti-inflationary strategy, as the historian of the Federal Reserve Allan Meltzer points out, it ultimately left central bankers at the mercy of Treasury policy.140 Meltzer, however, does not appear to be wholly correct in his assertion that Fed officials “denied the effect of money growth on inflation.”141 While he is correct that certain policymakers, particularly members of the

Board of Governors such as Eccles, emphasized the weakness of monetary policy and argued for stronger fiscal measures, they did so in part because they saw no alternative.

Meltzer’s critique of the Federal Reserve may be understood in light of his own scholarship, which minimizes the link between deficits and inflation.142 Contemporary analysis by Keith Sill of the Philadelphia Federal Reserve, however, points out that the

139 Federal Reserve System Board of Governors, “The Postwar Drain on Foreign Gold and Dollar Reserves,” Federal Reserve Bulletin 34, no. 4 (April 1948), 379-80. 140 Meltzer, History of the Federal Reserve, Vol. I, 631. 141 Ibid., 633. 142 Allan H. Meltzer, “Deficits and Inflation,” in Towards a Reconstruction of Federal Budgeting: A Public Policy Research Program Conducted by the Conference Board (New York: The Conference Board, 1983), 46-51. 374

independence of monetary policy has an important role in determining the relationship, with lower monetary policy independence meaning a higher correlation between fiscal deficits and inflation.143 While still bound to the wartime pledge to purchase government securities at specific yields, the Fed believed itself unable to autonomously effect money growth in the economy. This left fiscal policy, through budget surpluses and debt retirement as the primary, although not only, viable alternative.

This is not to say that central bankers abandoned efforts to gain greater authority over monetary conditions. Fed officials supported applying a special secondary reserve requirement of government securities as well as increasing their powers over consumer credit in an effort to maximize the effectiveness of debt retirement and reassert greater control over domestic money conditions. For most of the period prior to the Korean War, however, policymakers continued to emphasize the leading role of fiscal policy in restraining price pressure. Nevertheless, support for other reforms demonstrated an increasing willingness to at least advocate greater central bank autonomy.

Marriner Eccles championed the so-called secondary or special reserve plan, which he proposed as a means of containing inflationary pressure without disturbing the market for government securities or imposing strict controls. As previously discussed in the opening chapter, a bank’s reserve requirement represented that fraction of funds banks were required to maintain in relation to their liabilities, such as time or demand

143 Keith Sill, “Do Budget Deficits Cause Inflation,” Federal Reserve Bank of Philadelphia Business Review, (Fall 2005), 32. 375

deposits.144 Eccles’ proposal called for banks to hold a reserve of government securities in proportion to their deposits. According to that proposal, a draft of which Eccles forwarded to Senator Robert A. Taft (R-OH), banks would be required to hold special reserve assets consisting of either currency or cash items, Federal Reserve deposits, or demand deposits due to other banks, or alternatives such as Treasury bills, certificates, or notes with less than two-year maturity. Power to set and adjust the reserve level would be invested in the Federal Open Market Committee (FOMC), but would not exceed 25 percent of demand deposits or 10 percent of time deposits. According to the proposal, the special reserve was necessary to restrain “monetary and credit expansion, at a time when total effective demand for goods and services is in excess of the supply which can be produced by the nation’s productivity capacity and labor force” and might otherwise

“further aggravate inflationary pressures on prices” with negative consequences.145 The intent of the plan was to immobilize a certain portion of commercial bank held government securities, preventing bankers from selling them to the Federal Reserve and thereby circumventing the intention of government debt reduction policies.

Eccles recognized that the secondary reserve proposal offered a means to increase the central bank’s control over domestic credit conditions. Fed officials noted that a similar proposal had been successfully adopted in Belgium, which faced similar

144 The Federal Reserve’s proposal dated to at least 1946 when it discussed a secondary reserve requirement. Federal Reserve System Board of Governors, Thirty-Second Annual Report of the Board of Governors of the Federal Reserve System, Covering Operations for the Year 1945 (Washington, D.C.: Government Printing Office, 1946), 7-8. 145 Marriner Eccles to Robert A. Taft, letter and attached draft of proposed special reserve legislation, December 8, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/068_07_0001.pdf (accessed January 5, 2013). 376

circumstances of large government obligations in the hands of the banking system, and increased the influence of the National Bank of Belgium as well as stabilizing the

“monetary situation.”146 Eccles’ proposal was not necessarily popular with the banking community, which denied that bank lending, which the proposal aimed to control, was responsible for inflationary pressure and which criticized the secondary reserve as too restrictive and threatening to bring about dangerous deflation. Indeed, the Federal

Advisory Council (FAC) of the Federal Reserve System warned that the secondary reserve proposal represented a “step towards the socialization of banking.”147 Eccles rejected these charges and argued that the secondary reserve represented a “middle-of- the-road proposal” that left final decision-making on loans in the hands of bankers and did not prevent them from making critical loans, and thereby did not conflict with free market principles. Furthermore, he argued that the deflationary collapse following an uncontrolled inflationary boom represented a more immediate threat. The Board of

Governors supported the proposal because of the wartime expansion of government securities in the hands of the banking system as well as the demands of European reconstruction.148

146 Robert A. Rennie, “Monetary Policy in Belgium,” Review of Foreign Developments, June 3, 1947, FRB, http://www.federalreserve.gov/pubs/rfd/1947/62/rfd62.pdf (accessed November 30, 2012); Later in the decade the French also adopted a special reserve requirement to strengthen their control over credit, Albert O. Hirschman and Robert Rosa, “Postwar Credit Controls in France,” Federal Reserve Bulletin 35, no. 4 (April 1949), 353-57. 147 Federal Advisory Council, “Statement of Federal Advisory Council on Bank Credit, Consumer Credit Controls, and Bank Reserves,” November 18, 1947, reprinted in the Federal Reserve System Annual Report, 1947, 98-100; Robert A. Taft, Speech to the St. Andrew’s Society of Philadelphia, December 1, 1947 in The Papers of Robert A. Taft, Volume III: 1945-1948, ed. Clarence E. Wunderlin, Jr. (Kent: Kent State University Press, 2003), 344-45. 148 Marriner Eccles, Statement before the Joint Committee on the Economic Report, December 10, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19471210_2.pdf (accessed 377

While Eccles continued support for the secondary reserve proposal, official discussion amongst central bankers quickly faded following his replacement by Thomas

McCabe as chairman of the Board of Governors.149 There had been divisions within the

Fed about the secondary reserve proposal, as evidenced by the FAC’s rejection of the plan. Allan Sproul of the FRBNY also opposed it.150 Instead, the New York Fed president favored strengthening traditional central bank powers by loosening the wartime peg of interest rates and allowing greater flexibility over yields on government securities, a position that will be explored in greater depth in the next chapter.151 While officials occasionally discussed the need for additional powers along the lines of the secondary reserve proposal, nothing ever came of it.152 In part this is due to the fact that the need for a secondary reserve requirement seemed to abate as immediate inflationary pressure appeared to ease during late 1948 and into 1949.153 Thus, in testimony to Congress,

Chairman Thomas McCabe called for a secondary reserve power, but tempered support, recognizing that it represented the “most controversial” of the central banks’ requests.

Furthermore, McCabe presented the secondary reserve as simply one of a variety of

November 12, 2012); Marriner Eccles, Statement filed with the House of Representatives Committee on Banking and Currency, “Proposal for a Special Reserve Requirement Against the Demand and Time Deposits of Banks,” December 8, 1947, republished in the Federal Reserve Bulletin 34, no. 1 (January 1948), 16-18; Federal Reserve System, Annual Report, 1947, 3-11. 149 Eccles continued to advocate a secondary reserve proposal late into 1948, Marriner Eccles, Address before the Iowa Bankers Association Convention in Des Moines, Iowa, “Out Economic Dilemma,” October 27, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19481027.pdf (accessed November 12, 2012). 150 J. S. Fforde, The Federal Reserve System, 1945-1949 (Oxford: Clarendon Press, 1954), 245-46. 151 Meltzer, History of the Federal Reserve, 634-5. 152 FOMC Meeting Minutes, October 4, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19481004Minutesv.pdf (accessed January 5, 2013). 153 Federal Reserve System Board of Governors, “Interruption of Monetary Expansion,” Federal Reserve Bulletin 35, no. 5 (May 1949), 465-73. 378

enhancements to Federal Reserve open market powers that also included a “mechanism of policy coordination on the domestic financial front” similar to the role played by the

“National Advisory Council on the international financial front.”154

Concern about inflation also led central bankers to support more direct methods of regulation including greater controls over consumer installment credit. Total consumer credit rebounded rapidly in the first full year after the war and had expanded from a wartime low of $1.7 billion in 1943 to more than $3.7 billion in outstanding credit in

1946. Consumer credit represented a significant portion of the expansion of all bank credit, rising from 31 to 43 percent during 1943-1946. Nor was the expansion in bank lending confined to the financing of consumer goods, as mortgage lending rose dramatically during 1946 as well.155 Fed officials judged that the expansion would have been larger still had it not been for the continued application of Regulation W, which restrained consumer credit by setting minimum down payments and maximum terms.156

During the postwar period Federal Reserve officials pressed wider permanent authority to regulate consumer credit. While central bankers saw the secondary reserve proposal as important to prevent banks from easily replenishing their reserves in the face of debt retirement, consumer credit regulation was equally important to prevent those reserves from enhancing the public’s purchasing power and effecting prices. Despite

154 Thomas B. McCabe, Statement of Chairman Thomas B. McCabe of the Board of Governors of the Federal Reserve System before the Senate Banking and Currency Committee, May 11, 1949, reprinted in the Federal Reserve Bulletin (May 1949), 476-79. 155 Federal Reserve System Board of Governors, “Postwar Revival in Bank Lending,” Federal Reserve Bulletin 33, no. 3 (March 1947), 239-41. 156 Federal Reserve System, Annual Report, 1946, 20-1. 379

greater success in advocating for consumer credit powers compared to the failed campaign for the secondary reserve, the Fed’s actual authority fluctuated continuously over the period.

Policymakers believed that given the highly inflationary circumstances, long-term political economic stability depended, in part, on effective consumer credit regulation.

Central bankers did not anticipate conditions changing significantly given the high levels of employment as well as the increasing importance of consumer durable goods to the overall economy. Instead, according to Marriner Eccles, the danger of an inflationary boom followed by collapse and depression required a permanent expansion of the Fed’s ability to regulate consumer credit. At the same time he made efforts to position consumer credit regulation as in accordance with American liberal capitalist values, arguing that such powers “reduce economic instability and thus help to provide conditions more favorable to the maintenance of our private enterprise system.”157

Federal Reserve officials were chagrined when, despite their protests and those of the Truman administration, Congress reduced the scope of Regulation W in 1946 before allowing it to expire entirely effective November 1, 1947.158 Even more disconcerting was that the expiration of Regulation W coincided with efforts to promote home

157 Marriner Eccles, “Regulation of Consumer Instalment Credit,” Statement before the Banking and Currency Committess of the Senate and House of Representatives, June 10, 1947, reprinted in the Federal Reserve Bulletin (July 1947), 828. 158 Harry S. Truman to Marriner Eccles, July 5, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/041_06_0009.pdf (accessed March 8, 2013); Harry S. Truman, “Statement by the President Upon Approving Resolution Continuing Regulation of Consumer Credit,” August 8, 1947, online by Gerhard Peters and John T. Wolley, The American Presidency Project, http://www.presidency.ucsb.edu/ws/?pid=12736 (accessed March 7, 2013); Federal Reserve System Board of Governors, “Discontinuance of Instalment Credit Controls,” October 27, 1947, reprinted in the Federal Reserve Bulletin 33, no. 11 (November 1947), 1356. 380

ownership through the Federal Housing Administration (FHA) and mortgage lending provisions of the G.I. Bill. Not only did the government help subsidize this private lending but homeownership stimulated demand for consumer goods, and therefore credit.159 Marriner Eccles highlighted the paradox of the need to restrain consumer credit and the progressive easing of lending standards on mortgages, which undercut the effectiveness of any anti-inflation program.160 Indeed, Federal Reserve officials noted an explosion in outstanding mortgage debt on residential dwellings. While the amount of outstanding debt remained steady during the war years, it jumped from $4.7 billion in

1945 to $9.47 billion in 1946 and passed $10 billion in 1947, where it remained through

1948. This expansion in mortgage debt was facilitated, at least in part, by the “federally financed secondary market” provided by Fannie Mae.161 In April 1948 Eccles wrote to

Senator Charles Tobey (R-NH), chairman of the Senate Banking and Currency

Committee, opposing aspects of proposed legislation intended to further ease access to mortgage credit. The Fed chairman couched his concerns within the larger budgetary and international context. He argued that given recent reductions in taxes, greater spending commitments as part of the Marshall Plan, and the call “for a large increase in military expenditures,” as well as the increasing prospects of a fiscal deficit, the proposed easing of mortgage financing not only intensified immediate “inflationary pressures” but also

159 Lizabeth Cohen, A Consumers’ Republic: The Politics of Mass Consumption in Postwar America (New York: Vintage Books, 2003), 122-3; Glenn C. Altschuler and Stuart M. Blumin, The GI Bill: A New Deal for Veterans (New York: Oxford University Press, 2009), Ch. 7. 160 Marriner Eccles, “Inflationary Aspects of Housing Finance,” Statement before the Joint Committee on the Economic Report, Special Session of Congress, delivered November 25, 1947, republished in the Federal Reserve Bulletin (December 1947), 1463-64. 161 Federal Reserve System Board of Governors, “Real Estate and Construction Markets,” Federal Reserve Bulletin 34, no. 7 (July 1947), 762; Federal Reserve System Board of Governors, “Construction Markets in Mid-1949,” Federal Reserve Bulletin 35, no. 8 (August 1949), 890. 381

inhibited the long-term ability to counter “further inflation or future deflation.”162

Consumer and home credit, therefore, by the pressures it placed on the price for materials and labor threatened to at least complicate Marshall Plan aid and other global commitments. This is not to say that the Federal Reserve believed European recovery hinged on the ease of domestic consumer or mortgage credit. Central bankers, however, continued to reveal an awareness of the links between domestic and international economic developments, and the two-way nature of economic pressures.

In the absence of additional regulatory authority, anti-inflationary consumer credit policies depended on voluntary restraint by bankers. Federal Reserve officials recognized that such restraints were important but in themselves insufficient to curb the danger of inflation.163 In calling for the Congress to revive the central bank’s powers under Regulation W, Fed officials conceded that as much as American might “dislike compulsion,” voluntary methods of credit restraint had to be “reinforced” with regulatory authority.164 Rudolph Evan cautioned against relying upon the “philosophy of rugged individualism” and instead argued that regulation of consumer credit was “entirely consistent with democratic and capitalist institutions” and did not necessarily imply

162 Marriner Eccles to Senator Charles W. Tobey, April 5, 1948, reprinted in the Federal Reserve Bulletin (July 1948), 764-5. The Federal Reserve Bulletin also included a resolution passed on April 27, 1948 by the private banker-composed Federal Advisory Council concurring with the inflationary risk of further easing access to mortgage credit. 163 Marriner Eccles, “The Current Inflation Problem- Causes and Controls,” November 25, 1947, Federal Reserve Bulletin (December 1947), 1463-65; R. M. Evans, “Proposed Regulation of Consumer Instalment Credit,” Federal Reserve Bulletin (December 1947), 1467; Marriner Eccles, Statement, “Statement by Chairman Eccles as a Result of Conference with Secretary Snyder,” December 10, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19471210_2.pdf (accessed November 12, 2012). 164 R. M. Evans, “Regulation of Consumer Instalment Credit,” Statement before the House Banking and Currency Committee, August 2, 1948, reprinted in the Federal Reserve Bulletin 34, no. 8 (August 1948), 913. 382

“regimentation” of the economy.165 Thomas McCabe, who replaced Eccles as Chairman of the Board of Governors in 1948, expressed a more sanguine view of voluntary restraint but also recognized the limitations. In discussing a voluntary restraint program supported by the American Bankers Associations, McCabe praised the effort but also cautioned against the narrow vision of individual bankers, warning that what might reasonably appear non-inflationary from the perspective of one lender, might still have a negative effect on the economy as a whole.166 While Congress renewed Fed authority to administer Regulation W consumer and installment credit controls on August 16, 1948, it did so for less than a year, setting an automatic expiration of June 30, 1949.

The balance between voluntary restraint and regulatory authority over credit conditions became an increasingly important part of Federal Reserve policy under the chairmanship of Thomas McCabe. McCabe, a member of the Committee for Economic

Development, also increased the Federal Reserve’s efforts to regain discretionary authority over yields on government securities and use an activist monetary policy to achieve economic stability, a topic that will be explored in greater detail in the next chapter.167 The urgency of Fed’s efforts to regain influence over domestic policy only intensified with the communist invasion of South Korea and the marked increase in demand for rearmament. In the years prior to the Korean War the Federal Reserve

165 R. M. Evans, “Regulation W – Its Role in Economic Stability,” address before the Consumer Instalment Credit Conference of the American Bankers Association in St. Louis, Missouri, March 30, 1949, republished in the Federal Reserve Bulletin 35, no. 4 (April 1949), 346. 166 Thomas B. McCabe, Statement before the Housing Banking and Currency Committee, August 2, 1948, reprinted in the Federal Reserve Bulletin (August 1948), 909. 167 The growing significance of an activist monetary policy amongst so-called commercial Keynesians is explored in Robert M. Collins, The Business Response to Keynes, 1929-1964 (New York: Columbia University Press, 1981). 383

demonstrated an increased willingness to advocate for the fiscal and monetary policies it believed necessary to support the nation’s long-term domestic and international policy goals. The outbreak of a new war in Asia and the immediate fiscal pressures it brought, combined with the long-term demands of the larger ongoing Cold War led central bankers to become more assertive in their fight against inflation.

Conclusion

In the years between the Second World War and the outbreak of the Korean War policymakers called for a set of reforms they believed necessary to ensure domestic economic stability and long-term prosperity, while also purposefully situating them as compatible with American liberal capitalism as well as the nation’s international commitments. On the one hand, this demonstrated continuity in approach with the

Second World War experience. During that war central bankers called for policies such as minimizing borrowing from the commercial banking system. They argued that this, and similar policies, reduced inflationary pressure while also contributing to the defeat of the Axis powers. On the other hand, the postwar period found the central bankers, particularly Marriner Eccles, much more willing to question specific international commitments, such as postwar defense spending. While central bankers were certainly not the most vocal critics of postwar American policy, they did take pains to emphasize the need to prioritize commitments given the increasingly open-ended danger presented by the Soviet Union. 384

While describing specific developments that occurred during the previous year, the Federal Reserve’s 1949 Annual Report, published a little over a week after the outbreak of the Korean War, can be interpreted as neatly summarizing the entire period between the conflicts. Assessing the situation confronting the United States, central bankers wrote that the nation faced persistent domestic and international issues including:

[M]aintaining stability with growth in the peacetime economy in which expenditures for military and foreign aid would continue to be large and an abundant supply of money and credit would be readily available. In the international field, there continued to be a dollar gap, pressure for further adjustment in patterns of trade and finance in response to devaluation of currencies, and a need for further progress towards freer exchange of goods, convertibility of currencies, and an expanding world trade. The paramount problem of maintaining world peace continued to overshadow all others.168

Federal Reserve officials understood the complex interdependence of domestic and international factors in achieving postwar economic prosperity and political peace. They expressed concerns about this balance during the negotiations of the Bretton Woods

Agreement as well as the British Loan, and continued to pay close attention to the interdependence during the Marshall Plan era as well. Central bankers supported those policies at home and abroad they believed essential to establishing and maintaining a sustainable international economy, something they long viewed as critical to avoiding the type of collapse that marred the interwar experience. Under the chairmanship of

Marriner Eccles this involved emphasizing fiscal measures to restrain potentially inflationary budget deficits and pursue anti-inflationary debt retirement, as well as

168 Federal Reserve System Board of Governors, Thirty-Sixth Annual Report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1949 (Washington: 1950), 3. 385

increasing the Fed’s powers to regulate credit. Under Thomas McCabe, as will be explored in the next chapter, emphasis shifted to enhancing the Fed’s discretionary authority to undertake open market operations and conduct an activist monetary policy, while also emphasizing voluntary credit restraints as a supplement to additional regulatory authority. Despite different approaches, however, the Fed maintained a consistent belief in the interdependence of domestic and international economic stability, as well a belief that the reforms it advocated were necessary and facilitated the nation’s pursuit of its international commitments. Chapter Seven

“The Shadow of the Soviets”: Federal Reserve Policy, Korea, and Perpetual Cold War, 1947-1951

At 4:00 A.M. local time, June 25, 1950, the military forces of the Democratic

People’s Republic of Korea (DPRK) unleashed an artillery and mortar barrage on its southern neighbor, the Republic of Korea (ROK). Shortly thereafter, North Korean forces, with political and material support from the Soviet Union and the People’s

Republic of China, launched a ground invasion across the thirty-eighth parallel, capturing the South Korean capital of Seoul just three days later. By that point, however, President

Harry S. Truman had already committed the air and naval forces of the United States to the defense of the South Korean regime and was quickly moving toward the deployment of American ground troops to the peninsula.1 For the next three years the United States, along with a coalition of partners from the United Nations, engaged in a military confrontation with North Korea, and, after November 1950, Mao’s China.2 Ultimately, the Korean conflict became inextricably bound up with the larger security competition between the United States and the Soviet Union.

1 Harry S. Truman, “Statement by the President on the Situation in Korea,” June 27, 1950, online by Gerhard Peters and John T. Woolley, The American Presidency Project (hereafter cited as APP), http://www.presidency.ucsb.edu/ws/index.php?pid=13538 (accessed March 14, 2013); Dean Acheson, Present at the Creation: My Years in the State Department (New York: W.W. Norton and Company, 1987), 407-12. 2 In all sixteen members of the United Nations sent military forces to defend South Korean including: the United States, Great Britain, Canada, France, Belgium, the Netherlands, Colombia, Ethiopia, South Africa, New Zealand, Turkey, Greece, Thailand, the Philippines, and Luxembourg. An additional five nations contributed humanitarian assistance: Norway, Sweden, Denmark, India, and Italy.

386 387

While the Korean War became fundamentally linked with the U.S.-Soviet superpower struggle, in many ways it owed its origins to the Second World War. In part the conflict’s origins dated to the indecisive division of the peninsula between the United

States and the Soviet Union after a half-hour examination of a National Geographic map, motivated by immediate expediency rather than careful consideration of long-term sustainability.3 It represented the culmination of persistent tensions between the United

States and the Soviet Union while providing a critical demonstration of the credibility of the American commitment to take the necessary steps to stand firm against perceived communist expansion.4 Additionally, the war hastened the trend toward the militarization of America’s Cold War commitment by providing evidence for those, such as the authors of NSC 68, who advocated the expansion of the nation’s spending on conventional armed forces.5 The war itself, however, did not produce any immediate and decisive outcomes, with a precarious balance persisting between the superpowers, and

Korea still divided at the thirty-eighth parallel.

The evolution of Federal Reserve policy in the years between the Second World

War and the Korean War followed a similar, if less martial, course. During the Second

World War the Federal Reserve subordinated concerns about price stability and domestic

3 William Stueck, Rethinking the Korean War: A New Diplomatic and Strategic History (Princeton: Princeton University Press, 2002), 12; Ronald H. Spector, In the Ruins of Empire: The Japanese Surrender and the Battle for Postwar Asia (New York: Random House, 2007). 4 The role of American credibility is examined in William Stueck, The Road to Confrontation: American Policy toward China and Korea, 1947-1950 (Chapel Hill: University of North Carolina Press, 1981). 5 Michael J. Hogan, A Cross of Iron: Harry S. Truman and the Origins of the National Security State, 1945-1954 (New York: Cambridge University Press, 1998), Ch. 8; Paul G. Pierpaoli, Jr., Truman and Korea: The Political Culture of the Early Cold War (Columbia: University of Missouri Press, 1999), 8, 21- 3. 388

credit management to the immediate priority of defeating the Axis powers. As the optimistic hopes of early postwar planning failed to fulfill expectations, the Fed carefully navigated an unfamiliar policy landscape, seeking to balance new and uncertain international obligations against domestic issues that began to reassert themselves in the aftermath of total war. For the Fed the Korean War also represented a culmination in its long struggle to regain monetary policy independence from the Treasury. Again, similar to the larger American experience, the outcome of this struggle was less than decisive, and for the Fed greater independence did not necessarily equate to fundamentally different policy.

This chapter seeks to demonstrate two critical points in Federal Reserve policy.

First, it establishes the Fed’s willingness to fight for and to adopt new policy approaches based upon its understanding of domestic and international priorities and its own institutional responsibilities for domestic credit management. This evolution in approach to a greater assertion of central bank independence existed to various degrees, as seen in earlier chapters, dating back to the Fed’s participation in the Bretton Woods negotiations, and had become progressively more evident in the years following the Second World

War. Second, this chapter sets policymakers’ advocacy of new means of credit management within a larger continuity. While the central bank finally broke with the

Truman administration Treasury over interest rate policy that dated to 1942, Federal

Reserve policymakers believed this necessary to ensure the nation’s ability to pursue its long-term domestic and international commitments. Federal Reserve officials differentiated between the near-term demands of the Korean War and the long-term 389

commitments of the Cold War. Reasserting greater autonomy over the yields on government securities was not seen as a rejection of or indifference to the global political and security obligations of the Cold War. Instead, officials framed the measure as serving those ends. Breaking with the Treasury prevented the inflationary surge that accompanied the outbreak of fighting in Korea from disrupting the American domestic economy and potentially resulting in the establishment of excessive controls that compromised the American political economy and threatened to turn the nation into a garrison state, or alternatively from undermining the administration’s ability to check perceived communist expansionism over the long term. In doing so this chapter demonstrates Fed officials’ consideration and attention to international developments, an aspect of policy that scholars have heretofore largely ignored. It further demonstrates central bankers’ willingness and ability to change tactics in monetary and credit policy based upon an understanding of the dynamic interrelationship between domestic and international developments.

Before looking at the events of the Korean War and how central bankers responded, it is necessary to establish two important points of context. First, we must examine the Federal Reserve’s efforts to assert greater autonomy and allow more flexibility in the market for government securities. The efforts of the Fed, as well as the difficulties it encountered in the years prior to the Korean War, help to demonstrate that its stance evolved progressively. Thus, the Korean War acted as a catalyst rather than an instigator to a fundamentally new position. Second, we will examine the Federal

Reserve’s attitude toward the Soviet Union and how central bankers shared a view of an 390

antagonistic communist bloc at odds with the political and economic goals that many other American officials came to hold in the years after the Second World War. This is also important for framing Fed monetary policy during the Korean War. It helps demonstrate that while the Federal Reserve dissented from certain Korean War finance measures, this was not the same as a rejection of America’s international mission or a subordination of foreign policy objectives to domestic credit management. Although central bankers continued to cite foreign policy goals to justify their dissenting from

Treasury interest rate policy, they did so in reference to the larger Cold War.

Understanding the Fed’s view of the Soviet Union, therefore, helps to understand how and why policymakers prioritized the sustainability of American financial policy to meet the long-term challenges of the Cold War over easing the immediate demands of Korean

War mobilization. This differentiation in timescales did not exist during the Second

World War, and the Fed’s awareness of it helps to demonstrate a sophisticated understanding and persistent interest in foreign affairs on their part.

An “Engine of Inflation”: The Federal Reserve and Postwar Interest Rate Policy

Shortly after being replaced by Thomas B. McCabe as chairman of the Federal

Reserve Board of Governors, Marriner Eccles appeared before a group of bankers in his home state of Utah. Eccles spoke to the assembled representatives of the financial industry, cautioning them that the Federal Reserve had become an “engine of inflation” in 391

the postwar economy, a warning he repeated to Congress several weeks later.6

Specifically, he referred to the easy availability of credit in the American economy, the result, in part, of a 1942 pledge by the Federal Reserve System to maintain a stable pattern of yields on government securities by providing a buyer of last resort. As described in Chapter 1, the Federal Reserve agreed to buy various securities in the open market to prevent their yields from rising above certain predetermined levels. The effect was to allow banks to easily liquidate their holdings of government securities, expanding their loanable reserves, and adding potential inflationary pressure to the economy.7

Eccles did not invent the phrase engine of inflation; it appeared as early as the 1920 annual report of the Board of Governors in reference to the role of the Federal Reserve in facilitating Treasury borrowing during the First World War.8 He did, however, repeat it frequently in the years after the Second World War to warn about the legacy of Second

World War financial policy and the implications for the postwar economy.9

This section, therefore, will examine the evolution in the Federal Reserve’s view of the government securities market prior to the outbreak of the Korean War. It will explore how central bankers gradually coalesced around support for greater central bank

6 Marriner Eccles, Address Before Utah Bankers Association, June 29, 1948, Federal Reserve Archival System for Economic Research (hereafter FRASER), http://fraser.stlouisfed.org/docs/historical/eccles/085_19_0001.pdf (accessed March 27, 2013); Marriner Eccles, “Means of Combating Inflation: Statement of Marriner S. Eccles, Member Board of Governors of the Federal Reserve System From the Hearing before the Committee on Banking and Currency, House of Representatives, on S. J. Res. 157,” August 3, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19480803.pdf (accessed March 27, 2013). 7 John H. Wood, A History of Central Banking in Great Britain and the United States (New York: Cambridge University Press, 2009), 336. 8 Federal Reserve System Board of Governors, Seventh Annual Report of the Federal Reserve Board, Covering Operations for the Year 1920 (Washington, D.C.: Government Printing Office, 1921), 11. 9 Indeed Eccles entitled one of the chapters of his memoir “engine of inflation.” Marriner S. Eccles, Beckoning Frontiers: Public and Personal Reflections (New York: Alfred A. Knopf, 1966). 392

autonomy over interest rates, but found their plans continually frustrated by an inability to secure backing from the Treasury for the new policy. Once this context is established we can look at the outbreak of the Korean War, and how the surge in inflationary price pressure from the combined hot and cold wars in Asia and Europe respectively pushed the Federal Reserve to assert greater independence over monetary policy. It should be noted that greater central bank independence over interest rates did not necessarily mean establishing a new specific fixed pattern of rates, nor did it mean removing all support and leaving interest rates subject to the dictates of the market for government securities.

Instead, Fed officials supported allowing interest rates to increase, restraining bank credit, while not allowing them to fluctuate wildly or otherwise disrupt the market for government debt.

Federal Reserve autonomy over interest rate policy and the persistence of the wartime agreement to peg yields on government securities remained an issue of contention throughout the period between the Second World War and the Korean War.

Differences of opinion existed not only between the Federal Reserve and the Treasury but also amongst central bankers themselves. For much of the period in question the Federal

Reserve Bank of New York (FRBNY) under the leadership of Allan Sproul advocated the greater independence and restoration of traditional central banking powers over monetary policy. Marriner Eccles, concerned with ensuring stability in the sizeable postwar government debt market, balked, and instead, at least initially, preferred narrow changes to short-term interest rates supplemented by a variety of alternative methods to control price pressure and end the Fed’s role as an “engine of inflation” in the economy. Eccles 393

favored fiscal restraint in the form of budget surpluses and retirement of outstanding debt, as well as the strengthening of new Fed powers, such as the so-called secondary reserve and revival of Regulation W commercial credit restrictions discussed in the previous chapter. His successor, Thomas McCabe, privately pressed the issue of allowing greater flexibility in the pattern of interest rates on government securities with the Treasury but similarly refrained from taking decisive independent action. It took the intensification of inflationary pressure with the outbreak of the Korean War, however, to bring the issue of central bank independence over Treasury yields to a head in March 1951.

Postwar Pattern of Interest Rates

Security Maturity Yield Bill 90 days 0.375 Certificate 1 year 0.875 13-Month Note 13 Months 0.900 54-Month Note 4.5 Years 1.500 Bond 25 Years 2.500 Table 3 Source: Mark Toma, “Interest Rate Controls: The United States in the 1940s,” The Journal of Economic History 52, no. 3 (September 1992), 634.

The issue of yields derived from a wartime agreement between the Federal

Reserve and the Treasury whereby the central bank supported a fixed pattern of interest rates ranging 0.375 percent for short-term bills to 2.5 percent for the longest maturities.

The spread in yield between the various maturities resulted in a practice known as playing the pattern of rates.10 Banks sold short-term securities and used the excess reserves created to purchase longer-term securities. In turn the Federal Reserve was obliged to enter the market and absorb these short-term securities to prevent their yields

10 In the literature on finance the practice is sometimes referred to as riding the yield curve. 394

from rising, in effect allowing bankers to hold them without risk. When the higher yielding long-term securities approached the maturities of short-term ones their price moved to a premium, allowing banks to reap easy profits. As Woodlief Thomas of the

Federal Reserve later wrote, the system of pegged yields offered “an almost perfect mechanism for promoting unlimited purchases of government securities” but helped turn the central bank into an “engine of inflation.”11 Promoting the acquisition of government debt was certainly beneficial during periods of heavy borrowing and spending, such as during American mobilization for fighting the Second World War. The result, however, was to handicap a potentially useful tool, higher interest rates, to restrain credit during times of high inflation.

The pattern of rates supported during the war had been, in part, a byproduct of the

Great Depression. Traditional interpretations of the period argue that an influx of foreign gold helped create an abnormal interest rate structure that then became locked in place during the Second World War with the Fed’s pledge to support the pattern of rates on government securities.12 Indeed, during the war Federal Reserve officials worried about the need to correct this misalignment, occasionally proposing alterations in short-term rates but declining to press for action during the conflict. As late as March 1945, the

Federal Open Market Committee (FOMC) unanimously approved continuing to support

11 Woodlief Thomas, “Lessons of War Finance,” The American Economic Review 41, no. 4 (September 1951), 623; E. A. Goldenweiser, American Monetary Policy (New York: McGraw-Hill Book Company, Inc., 1954), 192-94. 12 J. S. Fforde, The Federal Reserve System, 1945-1949 (Oxford: Clarendon Press, 1954), 13-15. 395

the Treasury bills’ 0.375 percent rate.13 Within several weeks of the defeat of Germany, however, and with only victory over Japan remaining, central bankers began to discuss the need to regain greater flexibility in the price of government securities to prevent the rigid system of supports from being frozen in place in perpetuity, although they still refrained from pressing the issue too vigorously, even following the conclusion of the war.14

The pattern of rates on government securities, therefore, remained an unresolved issue of concern for the FOMC at the beginning of 1946. In an executive committee session at the beginning of the year, officials discussed a number of proposals intended to reorient monetary policy to a peacetime basis. These included ending the preferential discount rate that allowed banks to borrow cheaply and use those funds to purchase higher yielding government securities, as well as an appeal for a special secondary reserve on bank holdings of government securities, a measure discussed in greater detail in the previous chapter. The Fed’s desired changes included a plan to “discontinue the bill buying rate” and allow yields on the Treasury bills to gradually increase as a way of restraining demand for credit. E. A. Goldenweiser of the Federal Reserve Board argued that central bankers must emphasize to the Treasury that “further expansion of bank

13 Federal Open Market Committee (FOMC), Morning Executive Committee Meeting Minutes, December 11, 1944, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19441211MinutesEC1v.pdf (accessed March 28, 2013); FOMC Meeting Minutes, March 1, 1945, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19450301Minutesv.pdf (accessed August 13, 2012). 14 FOMC Meeting Minutes, June 20, 1945, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19450620Minutesv.pdf (accessed August 13, 2012); FOMC Meeting Minutes, October 17, 1945, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19451017Minutesv.pdf (accessed August 13, 2012). 396

credit should be stopped” and that in order to “stop such expansion which arises from the open-door to the Federal Banks” the “buying rate on bills” should be eliminated.

According to Goldenweiser, this would put the central bank in a position to “restrict credit as required by the needs of the situation” rather than serving as a source of easy reserves for banks holding government securities.15 Marriner Eccles then read into the record the text of a memo drafted at his request by George Vest, the Board of Governors’ general counsel, to the Treasury. The memo reiterated that the “System had a statutory responsibility in the field of credit” imbuing it with an obligation to act “in the public interest” which it “would not be relieved of” even if “the Treasury did not want the

System to take action which it [the Fed] believed in the exercise of its responsibility should be taken.”16 Eccles reiterated this point a month later during a meeting of the full

FOMC.17

Federal Reserve officials framed the issue of interest rate pegging in terms of both economic and institutional imperatives. Withdrawing Fed support for the bills rate allowed market forces to reassert themselves, thereby eliminating what officials believed to be an abnormal and overly inflationary distortion. At the same time central bankers staked out a justification for taking action even if the Treasury might object by couching the move in terms of the Fed’s institutional responsibilities for domestic credit

15 FOMC Executive Committee Meeting Minutes, January 23, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19460123MinutesECv.pdf (accessed August 13, 2012). 16 Ibid. 17 FOMC Meeting Minutes, February 28, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19460228Minutesv.pdf (accessed August 13, 2012). 397

management. While subtle, and by no means decisive, it represented an effort by the Fed to adjust interest rate policy to the postwar domestic-international context. Without the pressing need to finance an ongoing total war effort, officials began to question the need to subordinate their own priorities to those of the Treasury.

At the same time, contrasting positions existed among central bankers over how to check the inflationary pressure resulting from the pegging of interest rates. On the one side, Eccles and like-minded central bankers favored changes to the interest rate structure but prioritized complementary measures such as debt retirement, consumer credit regulation, and the secondary reserve. Eccles’ position was born, in part, from his

Keynesian belief in the superiority of fiscal measures to monetary policy. At the same time, he felt constrained by the Fed’s pledge to maintain stability in the market for government securities and feared that dramatic moves to reassert central bank autonomy over interest rates might unhinge the vast market for government debt. On the other side,

Allan Sproul and the FRBNY called for the restoration of traditional monetary powers and the progressive reassertion of market forces over yields. The differences between

Sproul and Eccles emerged in light of yet a third position, that of the Treasury

Department. The Treasury, under the leadership of first Fred M. Vinson and thenm after

June 1946 John Snyder, opposed virtually any change in interest rate policy. Financing the substantial national debt accumulated during the Second World War made maintaining low interest rates, and taking no action to disturb the market for government securities, a top priority for the Treasury. The difference in positions within the Federal 398

Reserve came into view slowly during first half of 1946, just as the contrasting priorities of the Fed and Treasury began to emerge.

The conflicting priorities between central bankers and with the Treasury began to emerge in late March 1946. Treasury Secretary Vinson wrote to Eccles objecting to a central bank proposal for ending the 0.500 percent preferential discount rate. Vinson denied the Fed’s assertion that the low discount rate represented an inflationary disruption and instead linked it to support for government, arguing that the preferential rate was an important psychological prop for the private market. He worried that the central bank’s desire to “haul down” this important signal conflicted with the Truman administration’s desire for low interest rates. Further, the Treasury secretary cautioned that the administration and the central bank could not afford to be “at cross purposes” during a “critical year in the reconversion of the domestic economy.” As for interest rate changes, Vinson contended that while he was “as interested in combating inflation as any man in the country” he did not believe that increases in short-term rates made any appreciable difference. Vinson raised the issue of interest rates because of the apparent difference of opinion between Eccles and Sproul. During a January 30, 1946, meeting among the three, Sproul qualified Eccles’ assertion that the Fed did not plan on increasing short-term rates, in particular the 0.875 percent pegged rate on certificates, which the FRBNY president suggested might eventually be necessary. Vinson argued that not only were yield changes of limited anti-inflationary value, but that continued Fed support for the pattern of rates was a national good. He concluded with the assertion that

“we owe it to the country that these problems continue to be solved in the public interest” 399

and maintained that the Treasury and President Truman counted on the “continued cooperation of the Federal Reserve in this matter,” a position that implied central bank resistance would represent at least bad faith if not failure to consider the best interests of the country.18

In considering how to respond to Vinson’s letter, Fed officials debated the best approach to take on interest rate changes. Although Allan Sproul hedged on just how far interest rates should change in the short term, he made strong arguments in favor of some action to re-establish Federal Reserve independence. Sproul argued that the Fed should at least leave open the potential for future action on interest rates and not “bind the

System . . . as to deprive it of all initiative.” Indeed, he asserted that the very uncertainty

Vinson eschewed was necessary to “dispel the belief that interest rates could only go down.”19 Other members of the FOMC executive committee also concurred that the Fed should avoid disruptions to the market for certificates but also strive to develop the principle of greater flexibility and should not accept a “commitment to maintain a rigid interest rate structure indefinitely, regardless of economic conditions.”20 At the same time, however, Marriner Eccles hedged on even this general assertion of Fed independence. In his official reply, approved by the Board of Governors but not submitted to the FOMC on which Sproul sat, Eccles denied that the discount rate proposal was part of a larger plan to alter the structure of interest rates but rather to

18 Fred M. Vinson to Marriner Eccles, March 28, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/012_09_0007.pdf (accessed April 1, 2013). 19 Federal Reserve System Board of Governors Meeting Minutes, April 19, 1946, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min041946.pdf (accessed April 1, 2013). 20 Ibid. 400

“avoid giving further impetus to the inflationary forces” already at work in the economy.

Speaking for the Board of Governors he reaffirmed support for the 0.875 rate on Treasury certificates and argued that any Federal Reserve suggestion pertaining to short-term interest rates was confined to the 0.375 bills rate only. Eccles concluded by reasserting the Fed’s desire for cooperation and commitment to discharging its “responsibilities effectively as part of the general program of the Government.”21 Beyond these private assertions, the central bank took pains to publicly pledge its support for the pattern of rates on government securities even as it moved to terminate the preferential discount rate. In an official statement the Board of Governors asserted that a “higher level of interest . . . than the Government is now paying” was undesirable and that its actions to change the discount rate did not in any way increase the “cost to the Government of carrying the public debt.”22 Finally, Eccles accompanied the public announcement of the move with additional private reassurances to Vinson affirming the Fed’s support for the pattern of interest rates on government securities.23

The difference in positions between Eccles and Sproul burst into the open at the next regularly scheduled meeting of the FOMC on June 10, 1946. Sproul argued that the

Board’s April 19 letter and the subsequent announcement on discount rate policy represented an effective guarantee of the 0.875 certificate rate. Appealing to the central

21 Ibid.; Marriner Eccles to Fred Vinson, April 19, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/070_10_0012.pdf (accessed April 1, 2013). 22 Board of Governors of the Federal Reserve System, Statement for the Press, April 24, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/012_09_0012.pdf (accessed April 1, 2013). 23 Marriner Eccles to Fred Vinson, April 24, 1946; Marriner Eccles to Fred Vinson, April 25, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/012_09_0012.pdf (accessed April 1, 2013). 401

bank’s institutional responsibility, Sproul again opposed a firm commitment that took the

“initiative out of the hands of the System” and placed it “with the Treasury on a matter which was the responsibility” of the Fed. He hoped that the June 6 announcement by

President Truman that John Snyder was succeeding Vinson at the Treasury, however, offered “an excellent opportunity to seek a reconsideration of the matter.”24 Sproul desired to use to chance to increase the rate on certificates from 0.875 to 1 or 1.125 percent, a proposition to which Eccles immediately objected. Eccles continued to believe that Sproul’s proposal offered insufficient anti-inflationary benefits and that the increase in interest rates necessary to curb the inflationary demand for private credit would have to be so high as to “seriously affect the Government security market.” Eccles denied that there was anything the Fed could do to “unfreeze the rate structure,” and asserted that the best approach was to appeal to Congress for additional powers as a means of containing inflationary pressure.25

Between March 28 and June 10, 1946, three conflicting positions were staked out.

The Treasury opposed any moves that it saw as increasing interest rates. Vinson denied that short-term interest rate changes had an appreciable effect on inflation and might, in the worst case, disturb the market for government securities, increasing the difficulties in financing the substantial debt accrued during the Second World War. Federal Reserve

24 President Truman made the announcement that Snyder would take over at Treasury following his nomination of Fred Vinson as Chief Justice of the Supreme Court during a press conference. Harry S. Truman, “The President’s New Conference,” June 6, 1946, APP, http://www.presidency.ucsb.edu/ws/index.php?pid=12411&st=vinson&st1=snyder (accessed April 1, 2013). 25 FOMC Meeting Minutes, June 10, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19460610Minutesv.pdf (accessed April 1, 2013). 402

officials believed more aggressive anti-inflationary measures were necessary, and that the central bank needed enhanced powers in pursuit of this objective, but disagreed over the means of achieving it. Eccles and like-minded supporters represented one approach, favoring a variety of new powers for the Fed, including the ability to apply a secondary reserve requirement to banks, forcing them to retain government securities in proportion to their deposits as a way of preventing the monetization of this debt. Eccles also favored

Regulation W consumer credit controls, as well as fiscal restraints through higher taxes to divert excess purchasing power and an aggressive debt retirement policy to keep bank reserves under pressure. And while he did not necessarily object to altering the pattern of interest rates, Eccles proceeded more cautiously than his opponents and continued to couple these moves with various supplementary measures. In contrast, Allan Sproul called for the progressive restoration of traditional monetary tools, specifically greater flexibility in the rate structure that had remained largely unchanged since 1942. This approach closed the spread between short- and long-term securities, increased the cost of credit, and reduced the incentive to play the pattern of rates. Importantly, while Sproul confined his early suggestions to short-term bills and certificates he at least did not explicitly rule out challenging the 2.5 percent interest rate peg on long-term government bonds.

The debate within the Federal Reserve continued over the rest of 1946 and into

1947 as Eccles retained a guarded stance toward strong assertions of central bank independence. Nevertheless, over the course of the year he progressively moved closer to Sproul’s position. By 1948, when Thomas McCabe succeeded Eccles as head of the 403

Board of Governors, a rough, but by no means unanimous, consensus had developed favoring greater flexibility for short-term rates. After 1948, the issue remained one of challenging the Treasury, which in itself was a daunting task from the perspective of many central bankers.

In October 1946 Sproul again called for the elimination of the Treasury bills rate and what he termed a “defrosting” of the certificate rate, implying greater flexibility at the short-term end of the yield curve. Eccles, however, continued to resist altering the certificate peg and hoped that continued Treasury efforts at debt retirement, an increase in reserve requirements for banks located in central reserve cities, and a termination of the bills buying rate would be sufficient. Eccles’ position downplayed Sproul’s assertion that termination of the bills buying rate was “meaningless” if not coupled with adjustment to the certificate rate.26 By early 1947 the Federal Reserve continued to move slowly, focused primarily on allowing the bills rate to move above the 0.375 peg but making no mention of changes to the rate of certificates or any other yields.27 Indeed, Eccles briefly took the position that the Treasury debt retirement program was effective enough so that no action on the bills rate need be undertaken, although he rather quickly moved away from this position.28 In a full meeting of the FOMC the chairman clashed with Sproul over the wording of a memo to the Treasury on the proposed bills rate increase. Eccles

26 FOMC Meeting Minutes, October 3, 1946, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19461003Minutesv.pdf (accessed December 7, 2012). 27 FOMC Executive Committee Meeting Minutes, February 17, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470217MinutesECv.pdf (accessed December 7, 2012). 28 FOMC Executive Committee Meeting Minutes, January 10, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470110MinutesECv.pdf (accessed December 7, 2012). 404

opposed removing verbiage stating Fed changes to the rate would only take place after

“concurrence by the Treasury,” concerned that its removal might be misconstrued as a dramatic break with the Treasury and create the perception of an “assertion of independence” by the Fed “which would not in practice be carried out.” Sproul attacked

Eccles’ position and argued that it “was important not to abandon whatever independence we have.” A rather weakly worded compromise was struck calling for a review of wartime financial policies “with the view of reaching an agreement for adjustment of policies and action to change conditions.” Eccles accepted the rewording but only after expressing his continued support for the original language.29

As 1947 wore on, and faced with continued Treasury resistance to altering the pattern of rates, however, Eccles progressively warmed not only to raising the bills rate but also to allowing the rate on certificates to increase, a position he had rejected just months before.30 Indeed, in his memoirs Eccles expressed regret for not adopting a

“more independent position despite Treasury resistance” earlier.31 As for what changed his mind, the answer is likely a combination of factors. The inability of debt retirement to put sufficient pressure on bankers net reserves, which actually increased in 1947 compared to 1946, the removal of wartime controls and taxes, as well as the impending

29 FOMC Meeting Minutes, February 27, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470227Minutesv.pdf (accessed December 7, 2012). 30 FOMC Executive Committee Meeting Minutes, May 2, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470502MinutesECv.pdf (accessed December 9, 2012); FOMC Executive Committee Meeting Minutes, June 5, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470605MinutesECv.pdf (accessed December 9, 2012); FOMC Meeting Minutes, June 5, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470605Minutesv.pdf (accessed December 9, 2012). 31 Eccles, Beckoning Frontiers, 425. 405

expiration of Regulation W consumer credit controls in November 1947 all seemed to add inflationary fuel to the economy.32 As the consumer price index continued to rise sharply through 1946 and into 1947, adjustment to the pattern of rates likely appeared increasingly critical to restrict bank credit and maintain price stability.

Figure 3: Consumer Price Index for All Urban Consumers, 1946-1948

Consensus gradually emerged among Federal Reserve officials on the desirability of unpegging the 0.375 bills rate with the FOMC taking action on July 10, 1947.33 The

32 Federal Reserve System Board of Governors, Thirty-Fourth Annual report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1947 (Washington: 1948), 21; Statement by Marriner Eccles, Chairman of the Board of Governors of the Federal Reserve System, before the Joint Committee on the Economic Report, Special Session of Congress, November 25, 1947, “The Current Inflation Problem – Causes and Controls,” reprinted in the Federal Reserve Bulletin 33, no. 12 (December 1947), 1456; Federal Reserve System Board of Governors, “Discontinuance of Instalment Credit Controls,” October 27, 1947, reprinted in the Federal Reserve Bulletin 33, no. 11 (November 1947), 1356. 33 Federal Reserve System Board of Governors, “Debt Retirement and Bank Credit,” Federal Reserve Bulletin 33, no. 7 (July 1947), 775-6. 406

response of the market was fairly rapid in closing the spread between the bills rate and the 0.875 certificate peg, with the bills rate jumping from 0.375 in June to 0.703 in July and hitting 0.766 percent by the end of August.34 While it took nearly nine months between Sproul’s first serious proposal to unpeg the bills rate in October 1946 and final action by the FOMC the following July, it is significant nonetheless. First, it demonstrated the willingness of the Federal Reserve to assert greater independence in domestic credit management relative to its wartime subordination to the Treasury, albeit after considerable debate. Second, as the historian of the Federal Reserve Allan Meltzer points out, the rise in the bills rate increased the pressure for “reconsideration of the rate on certificates” and represented the “first small steps” toward the reassertion of market forces over interest rates.35 Indeed, following the easing of the peg on the bills rate

Eccles proposed next steps and suggested allowing the certificate rate to increase from

0.875 to 1.250 percent. Doubters still remained, like Rudolph Evans of the Board of

Governors, who likened the measure’s anti-inflationary potential to “fighting a grizzly bear with a slingshot,” but they were quickly brushed aside.36 Nonetheless, the Federal

Reserve had made small but important steps to asserting greater autonomy over monetary policy.

34 Federal Reserve System Board of Governors, “Open-Market Money Rates in New York City,” Federal Reserve Bulletin 33, no. 9 (September 1947), 1141. 35 Allan H. Meltzer, A History of the Federal Reserve, Volume I: 1913-1951 (Chicago: University of Chicago Press, 2003), 643. 36 FOMC Meeting Minutes, June 5, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470605Minutesv.pdf (accessed December 9, 2012); FOMC Executive Committee Meeting Minutes, June 30, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470630MinutesECv.pdf (accessed December 9, 2012). 407

Agreement among central bankers in support of higher yields, however, was only a first step. The more difficult task became convincing the Treasury, which remained reluctant believing that higher yields only increased the cost of rolling over the national debt. The Treasury may have tolerated higher interest rates if they performed a clear anti-inflationary role; however, officials there voiced concern about the lackluster effect of the higher rates on bills. Eccles recognized the Treasury would be unwilling to accept further adjustments to short-term interest rates without clear evidence that they contributed to containing inflation. Thus, while the FOMC did make an additional move during its October 6, 1947, meeting, voting to continue pushing short-term interest rates up to 1.125 percent by refunding maturing securities into higher yielding instruments, the situation remained largely frozen into 1948.37 In a way the Treasury’s position represented resistance to any further change in interest rates, for if changes in the short- term end of the maturity spectrum did have a clearly anti-inflationary effect, additional changes to the rate structure may not have been necessary. Alternatively, this position necessarily interpreted the lack of significant price restraint as evidence not of the need for additional yield increases, but for dropping the plan altogether.

Thus, as inflationary pressure continued to advance the Federal Reserve felt unable to take more aggressive steps because of the need to maintain stability in the market for government securities. While central bankers sought to reassure the Treasury

37 FOMC Executive Committee Meeting Minutes, August 6, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19470806MinutesECv.pdf (accessed December 10, 2012); FOMC Meeting Minutes, October 6, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19471006Minutesv.pdf (accessed December 10, 2012). 408

of their desire for cooperation in managing the national debt by explicitly reiterating support for the 2.5 percent peg on long-term bonds, they continued to chafe at administration statements that implied a Fed obligation to support all government securities.38

In 1948, President Truman declined to reappoint the outspoken Eccles to another term as chairman of the Board of Governors. Instead, hetapped Thomas B. McCabe, a long-time businessman and president of the board of the Philadelphia Federal Reserve

Bank to head the Board. Eccles himself later professed ignorance at the reason for the move, suggesting possibly political differences over the Fed’s investigation of the

Transamerica Corporation.39 Political scientist Donald Kettl, however, cited a number of policy differences, including Treasury Secretary John Snyder’s loss of faith in Eccles’ support for the pattern of rates on government securities.40 While Eccles still held reservations about the anti-inflationary effectiveness of the interest rate program, it was true that the Fed succeeded in both abandoning the 0.375 bills rate as well as pushing short-term rates up to 1.125 percent, making the doubts justified from the Treasury’s

38 FOMC Meeting Minutes, December 9, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19471209Minutesv.pdf (accessed December 10, 2012); Marriner Eccles, “Statement by Chairman Eccles as a Result of Conference with Secretary Snyder,” December 10, 1947, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19471210.pdf (accessed November 11, 2012); FOMC Meeting Minutes, February 27, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19480227Minutesv.pdf (accessed January 5, 2013). 39 Eccles, Beckoning Frontiers, 443. 40 Donald F. Kettl, Leadership at the Fed (New Haven: Yale University Press, 1986), 63; Alonzo Hamby also cites Snyder as a reason for Eccles dismissal in Man of the People: A Life of Harry S. Truman (New York: Oxford University Press, 1995), 581. 409

perspective.41 McCabe, for his part, appeared to represent a less vocal alternative and more likely to appease Treasury demands for maintaining the pattern of rates.42

The notion that Thomas McCabe was simply a passive appeaser of Treasury demands for low interest rates, however, is unfair. McCabe supported higher rates on short-term securities and expressed his “grave disappointment” with continued Treasury intransigence.43 He testified before Congress that allowing short-term rates to increase offered a useful anti-inflationary tool, drawing off excess purchasing power. At the same time, McCabe was careful to reaffirm his continued support for the 2.5 percent peg on long-term bonds, recognizing the fine line he walked and the need for “teamwork” with the Treasury to maintain a stable market for government securities while refunding the debt at lowest interest rate possible.44 Despite his willingness to cooperate with the

Treasury, McCabe did believe that the Federal Reserve had an institutional

“responsibility for the credit situation” and made that case directly to Secretary Snyder.

According to the new Fed chairman, while he was committed to coordinating policy with the Treasury he felt that higher rates on short-term securities represented a small but important measure in demonstrating the Fed’s commitment to fight inflation through

41 Eccles continued advocating for alternative measures, particularly a secondary reserve on bank holdings of government securities. Meltzer, History of the Federal Reserve, Vol. I, 646. 42 Ibid., 686; Donald D. Hester, The Evolution of Monetary Policy and Banking in the US (Heidelberg, Germany: Springer-Verlag, 2008), 15. 43 FOMC Executive Committee Meeting Minutes, May 20, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19480520Minutesv.pdf (accessed January 5, 2013). 44 Congress, House of Representatives, Committee on Banking and Currency, Inflation Control, 80th Cong., 2nd sess., August 2, 1948, 95-6. 410

monetary policy.45 Frustratingly for the FOMC, Snyder, however, continued to rebuff the

Fed’s appeals, repeatedly delaying or putting off taking up central bankers’ proposals for higher short-term rates.46 Therefore, while short-term rates inched upward in 1948 they remained steady throughout the first half of 1949, in part thanks to slackening demand for credit as the economy entered a brief recession.47

Average Open-Market Money Rates in New York City & Bond Yields 3.000 2.500 2.000 1.500 1.000 0.500

0.000

Jul-46 Jul-47 Jul-48 Jul-49 Jul-50

Jan-46 Jan-47 Jan-48 Jan-49 Jan-50

Oct-46 Oct-47 Oct-48 Oct-49

Apr-47 Apr-49 Apr-46 Apr-48 Apr-50

Bills Certificates Notes (3-5yr) Bonds (>15 yrs)

Figure 4: Average Open-Market Money Rates in New York City & Bond Yields, 1946-1951

Source: Federal Reserve Bulletin, December 1946-January 1951.

45 FOMC Executive Committee Meeting Minutes, June 23, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19480623MinutesECv.pdf (accessed January 5, 2013); FOMC Executive Committee Meeting Minutes, August 11, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19480811MinutesECv.pdf (accessed January 5, 2013). 46 FOMC Meeting Minutes, November 15, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19481115Minutesv.pdf (accessed January 5, 2013); FOMC Executive Committee Meeting Minutes, January 4, 1949, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19490104MinutesECv.pdf (accessed January 5, 2013). 47 Federal Reserve System Board of Governors, “Open-Market Money Rates in New York City,” Federal Reserve Bulletin 35, no. 7 (July 1949), 826; FOMC Meeting Minutes, February 28, 1949, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19490228Minutesv.pdf (accessed January 5, 2013). 411

As 1949 gave way to 1950 and the economy slowly began to recover its brief recessionary phase, Federal Reserve officials once again took up the call for higher interest rates to counteract a potential revival of inflationary pressure. On the eve of the

Korean War the need for central bank independence and more active and flexible monetary policy appeared increasingly important as the fiscal restraints Eccles had earlier advocated weakened. While some conditions appeared to warrant an easy monetary policy, Woodlief Thomas reported to the FOMC that the growing prospect of large peace time fiscal deficits called into question this easy policy going forward and required the

Fed to assert greater influence over interest rates. McCabe concurred with this assessment and argued that “every effort” should be made to convince the Treasury to support a flexible credit policy.48

During the years between the end of the Second World War and just prior to the outbreak of the Korean War, the Federal Reserve made slow but steady strides toward asserting greater independence over monetary policy. Policymakers pressed for, and gained, modification of the yield on bills and certificates. This narrowed the spread between the two maturities and, while not an ultimate solution, represented progress down the path toward an effective anti-inflationary monetary policy. These developments coincided with a variety of new and expanded international commitments on the part of the United States. As larger foreign aid and defense obligations helped move fiscal surpluses into deficits and hindered the Treasury’s debt retirement policy, the

48 FOMC Meeting Minutes, December 13, 1949, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19491213Minutesv.pdf (accessed January 5, 2013). 412

use of interest rate tools gained in importance. At the same time, however, these very same forces made debt management increasingly difficult and made the Treasury reluctant to accommodate central bankers’ calls for greater rate flexibility.

Additionally, in the year prior to the outbreak of the Korean War, Federal Reserve officials, at least internally, reconsidered their support for the 2.5 percent peg on long- term bonds, a step that both Thomas McCabe and Marriner Eccles objected to in 1948.49

By mid-1949, however, central bankers began to question even this commitment, and argued that even if the Federal Reserve did not abandon its commitment to the rate in practice, it should at least make it vague so as to inject a healthy uncertainty into the market.50 During the final meeting of the FOMC prior to the outbreak of the Korean War an important shift appeared to take place. Allan Sproul delivered a lengthy statement on the nature of the Federal Reserve relationship with the Treasury. Sproul argued that the country was experiencing a rapid expansion in credit and associated economic activity thanks to easy financing of purchases on everything from automobiles to houses. Given these circumstances, Sproul declared that should there be “some further decline in prices of long-term Governments and if we come to a situation when we are faced with the decision whether to let long-term bonds go below par, I would let them go below par.” In effect the FRBNY chief advocated allowing the yield on long-term bonds to move above the 2.5 percent peg, and restore flexibility throughout the yield curve. While other

49 Marriner Eccles, “Our Economic Dilemma,” Address before the Iowa Bankers Association Convention in Des Moines, Iowa, October 27, 1948, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19481027.pdf (accessed November 12, 2012). 50 FOMC Meeting Minutes, June 28, 1949, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19490628Minutesv.pdf (accessed January 5, 2013). 413

attendees at the FOMC meeting, including Marriner Eccles and Rudolph Evans, questioned whether the time was right for Sproul’s announcement, the fact remained that the Federal Reserve’s commitment to the 2.5 percent peg on long-term bonds was now a topic of discussion.51 Testament to the fact that the Federal Reserve did not drop discussion of the proposal came when even after the outbreak of the Korean War, and faced with the immediate pressures military mobilization, central bankers continued to discuss interest rate flexibility as an important anti-inflationary measure.

The Federal Reserve, the Cold War, and the Soviet Challenge

The outbreak of fighting on the Korean peninsula certainly intensified America’s

Cold War conflict. It remained, however, only the latest in a series of confrontations between the United States and communist countries. Throughout the postwar period

Federal Reserve officials remained attuned to international developments, including the increasingly tense rhetoric in the brewing superpower competition. Central bankers were sensitized to the language of the Cold War, a vocabulary they internalized and used when discussing credit and monetary policy. This section will elaborate on the Federal Reserve understanding of American-Soviet tensions and how that understanding influenced officials’ views of financial and monetary policy. Establishing central bankers’ general recognition of the threat posed by the Soviet Union will be important to contextualizing

51 FOMC Meeting minutes, June 13, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19500613Minutesv.pdf (accessed April 7, 2013). 414

the Korean War fight over interest rate policy. As will be seen later on, it will help to demonstrate that the Fed’s stance on interest rates was not simply a domestic monetary policy measure and that reaction against specific war finance policies was not the same as a rejection or ignorance of the nation’s larger Cold War commitments. In fact, the Fed’s recognition of the Soviet Union as the ultimate political economic challenge to the United

States and American officials’ hope for a stable postwar order provided justification for prioritizing measures aimed at long-term stability over immediate war finance measures.

During the Second World War the Axis powers, particularly Germany, posed both an immediate military and long-term political economic threat to the United States and its allies. The Germans in Europe and the Japanese in Asia attempted to create closed political and economic blocs to serve as bases for projecting further international power.52 Preventing a repetition of this experience, wherein rival closed blocs threatened the political and economic security of the United States and its allies, was therefore a pressing concern of American foreign policy during and after the war. Thus, following the Second World War American officials remained alert to the danger posed by the expansion of Soviet influence over the populations and resources of Eurasia, and the possibility that these developments portended just such a closed bloc threat.

In addition to recent experience with the Axis, American policymakers also drew upon the thinking of early twentieth century academics Nicholas Spykman and Halford

52 Michael A. Barnhart, Japan Prepares for Total War: The Search for Economic Security, 1919- 1941 (Ithaca: Cornell University Press, 1987), 17-19; Adam Tooze, The Wages of Destruction: The Making and Breaking of the Nazi Economy (New York: Penguin Books, 2006), 383-91; Mark Mazower, Hitler’s Empire: How the Nazis Ruled Europe (New York: Penguin Books, 2008), 3. 415

Mackinder who posited that a hegemon able to control the Eurasian landmass would be able to exercise global power.53 By implication, any such nation would be able to threaten the United States itself. While Spkyman and Mackinder’s specific terminology and geostrategic cartography found particularly receptive audiences in the postwar world, they resonated with a long-standing strain of thought that saw hostile ideologies abroad as threatening to the United States and potentially requiring American action to check.54

Indeed, while less convinced of the ability of nations to become globally dominant, John

Mearsheimer argues that at least since the First World War the United States strove to prevent any power from exercising “regional hegemony” in Europe or Asia.55 While the

Federal Reserve did not necessarily engage in extensive geostrategic theorizing, it did share many concerns about the expansion of Soviet power.

During the Second World War the United States sought to include the Soviet

Union within a multilateral framework of political and economic cooperation. Recent scholarship provides a range of reasons for this American approach, running from the influence of individuals with pro-communist inclinations such as Harry Dexter White to

53 Mackinder conceived of power flowing out from a “central core” of Russia and Eastern Europe, while Spkyman reversed this argued that control of peripheral areas in coastal Europe through Southeast Asia and China, or the so-called “Rimland” were the means of controlling Eurasia. The basic philosophies of Spykman and Mackinder are sketched out in Richard Rosecrance, Rise of the Trading State: Commerce and Conquest in the Modern World (New York: Basic Books, 1986), 124; For its influence on American postwar thinkers see Melvyn P. Leffler, “The American Conception of National Security and the Beginnings of the Cold War, 1945-48,” The American Historical Review 89, no. 2 (April 1984), 356-7. 54 Robert W. Tucker and David C. Henrickson, Empire of Liberty: The Statecraft of Thomas Jefferson (New York: Oxford University Press, 1990); N. Gordon Levin, Jr., Woodrow Wilson and World Politics: America’s Response to War and Revolution (New York: Oxford University Press, 1968). 55 John J. Mearsheimer, The Tragedy of Great Power Politics (New York: W. W. Norton & Company, 2003). 416

long-standing American desires to reform and “westernize” Russia.56 From the perspective of central bankers, the likely postwar influence of Russia made it important to any political economic settlement, a fact recognized even by proponents of the bilateral key currency proposal.57 By implication, however, a Soviet Union outside of or antagonistic to America’s desired postwar order certainly represented a threat. As we have seen to this point, American officials, including central bankers, equated a cooperative international order with the maintenance of political peace and economic prosperity. Soviet intransigence, therefore, necessarily imperiled these hopes.

As relations deteriorated with the Soviet Union the Federal Reserve understandably expressed concern about the danger posed by the communist dominated

Eastern bloc. Policymakers believed that the creation of an exclusive Soviet political- economic sphere of influence over Eastern and Central Europe threatened to disrupt postwar recovery and create the conditions for another global war. As the historian

Gregory Mitrovich contends, this concern motivated many of the proponents of an aggressive effort to rollback Soviet influence, who believed that action was necessary to rescue the international situation from an even more dangerous downward spiral later on.58 While central bankers were not vocal champions of overthrowing Soviet power they did share concerns that Soviet actions ran counter to American goals. Specifically,

56 Benn Steil, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order (Princeton: Princeton University Press, 2013); David S. Foglesong, The American Mission and the “Evil Empire”: The Crusade for a “Free Russia” since 1881 (New York: Cambridge University Press, 2007). 57 John H. Williams, “Problems of Post-War International Monetary Stabilization,” Proceedings of the American Philosophical Society 87, no. 2 (August 1943), 138. 58 Gregory Mitrovich, Undermining the Kremlin: America’s Strategy to Subvert the Soviet Bloc, 1947-1956 (Ithaca: Cornell University Press, 2009). 417

Fed officials feared that a “zone of Russian political supremacy” in Eastern Europe might result in a “Russian foreign trade monopoly” in the region. Central bankers worried that such an exclusive bloc might not be limited to Eastern Europe but rather might serve as the basis for an expansionist Soviet threat, fearing that “some parts of the Asiatic

Continent may before long find themselves in a similar situation.”59

Reviving liberal democratic capitalist economies so that they could resist this extension of communist influence, therefore, became a top priority for American officials, including those at the Federal Reserve. This concern began to inform the way policymakers presented various economic reconstruction measures. While denying that the British Loan was anti-Soviet, policymakers characterized it as a measure “aimed against totalitarian manipulation of foreign trade,” a methodology Marriner Eccles previously associated with the “Russian way” of trade.60 By the time the United States began considering the Marshall Plan in late 1947 a more explicitly anti-Soviet rhetoric began to emerge. Supporters of European aid warned of “Russian imperialism” and the

“extension of Soviet power to the Atlantic Seaboard” of Europe endangering not just the

59 Alexander Gerschenkron, “Russia and an International Trade Organization,” Review of Foreign Developments, August 27, 1945, Federal Reserve Board of Governors website (hereafter cited as FRB), http://www.federalreserve.gov/pubs/rfd/1945/17/rfd17.pdf (accessed July 12, 2012). 60 Federal Reserve System Board of Governors, Untitled memorandum on reasons to support the British Loan, May 22, 1946, NARA, RG 82 DIF, box 309; Senate Committee on Banking and Currency, Anglo-American Financial Agreement: Hearings on S.J. Res. 138, 79th Cong., 2nd sess., March 8, 1946, 235. 418

security of the United States but apocalyptically warning of the “destruction of Western civilization” if it were not checked.61

Federal Reserve officials highlighted the failure to conclude final peace agreements with former Axis powers as a major source of superpower tension. Central bankers already expressed disquiet at efforts to extend Soviet domination over Germany, fostering division that placed a “tinderbox in the center of Europe” while also reporting that elements of the German population feared succumbing to a “bolshevist infection.”62

While not singling out Soviet-American tensions, Fed officials pointed out that these

“international political” affairs compromised efforts to put the United States and the international economy on a self-sustaining and prosperous basis.63 This only compounded concerns regarding Soviet efforts to exert greater control over Eastern and

Central Europe and the failure to create a true integrated global economy.64 Such an expansion of Soviet influence must have been particularly disconcerting as so much of

American wartime planning derived from the belief that the revival of multilateral

61 National Planning Association, “America’s Vital Interest in European Recovery: A Statement by the Committee on International Policy of the National Planning Association,” September 3, 1947, NARA, RG 82 DIF, box 123. 62 Paul Hermberg, “The German Political Situation at the Beginning of 1946 Part I: The German Political Situation in Berlin,” Review of Foreign Developments, April 22, 1946, FRB, http://www.federalreserve.gov/pubs/rfd/1946/34/rfd34.pdf (accessed November 26, 2012); Paul Hermberg, “The German Political Situation at the Beginning of 1946 Part II: The German Political Situation in the American Zone of Occupation,” Review of Foreign Developments, May 5, 1946, FRB, http://www.federalreserve.gov/pubs/rfd/1946/35/rfd35.pdf (accessed November 27, 2012). 63 Federal Reserve System Board of Governors, “Economic Developments in 1948,” Federal Reserve Bulletin 35, no. 1 (January 1949), 2. 64 Caroline Lichtenberg, “Eastern Europe’s Intertrade,” Review of Foreign Developments, April 6, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/84/rfd84.pdf (accessed December 30, 2012). 419

international trade was critical to avoiding the experience of the interwar period.65 Thus, central bankers interpreted Soviet actions not simply as threatening to create a closed economic bloc, the type associated with the Axis, but also as fundamentally hostile to

America’s desire for a cooperative and prosperous international economy.

In a speech before the Commonwealth Club of California, Marriner Eccles echoed many of these themes while placing a major share of the blame for the state of international affairs on the Soviet Union. Eccles agreed, he said, with Churchill’s contention that there need not have been a Second World War had the Western powers been more assertive in the face of Nazi aggression, and intoned his conviction that there

“need have been no Munich and no Pearl Harbor.” In this context, Eccles believed that the United States needed to be more assertive in checking the Soviet Union’s advances globally, not just in Europe but also in the Asia, where he warned, “we have been losing the cold war.” Eccles coopted the image of Munich in expressing his belief that the

United States must stand up to the Soviet Union, telling the assembled audience that “the best hope of peace in our time, is to confront the Soviets with the decisions which will lay the foundations and the conditions for a lasting peace while we have the strength to do so.” Finally, he concluded by warning that “it is impossible to consider realistically

65 Randall Hinshaw, “The Case for Discrimination in Trade,” Review of Foreign Developments, May 18, 1948, FRB, http://www.federalreserve.gov/pubs/rfd/1948/87/rfd87.pdf (accessed December 31, 2012). 420

either our short-run or long-run economic outlook without recognizing that the shadow of the Soviets looms behind every major issue.”66

In the years between the end of the Second World War and the outbreak of the

Korean War, Federal Reserve officials came to share the view held by many policymakers of the Soviet Union as antagonistic to America’s vision of the postwar international order. Eccles’ speech to the Commonwealth Club included many of the themes of the emergent Cold War. First, it reflected the belief that the United States should take a more assertive stance in the face of Soviet pressure. During the early years of the Cold War the so-called Munich Analogy argued that failure of the Western powers to take a firm stand against Nazi aggression in 1938 only encouraged Adolph Hitler and helped bring about a war that might have been averted had democratic states stood up to

Germany. In the context of the Cold War, this view held that softness in the face of communist expansionism in Europe and Asia only invited additional challenges, that the

Western democracies must stand firm or risk a third global conflict, an assessment

Eccles’ supported in his 1949 speech.67 Second, and more broadly, it interpreted the

Soviet Union as a monolithic threat present behind every point of tension in international relations, not just in Europe. Both the Manichean presentation of U.S.-Soviet relations and the depiction of the communist world as a monolithic danger were increasingly

66 Marriner Eccles, Address at Luncheon of the Commonwealth Club of California in San Francisco, California, “Today’s Challenge to Democratic Capitalism,” April 8, 1948, FRASER; http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19490408.pdf (accessed November 12, 2012). 67 Rosemary Foot, The Wrong War: American Policy and the Dimensions of the Korean Conflict, 1950-1953 (Ithaca: Cornell University Press, 1985), 45-53; Melvyn Leffler, The Specter of Communism: The United States and the Origins of the Cold War, 1917-1953 (New York: Hill and Wang, 1994), 76-81. 421

common tropes in the early Cold War.68 Thus, while the language of Eccles’ 1949 speech appeared particularly stark, the position he staked out, as we have seen, was not a unique or exceptional one. Instead, it fitted into an evolving outlook that increasingly depicted Soviet Union as responsible for much of the hostility in the postwar international system.69

The rhetorical stance the Federal Reserve adopted toward the Soviet Union prior to the outbreak of the Korean War is significant in several respects. On the one hand, it demonstrated that central bankers shared the view of the Soviet Union held by many other American policymakers, specifically, that the Soviets represented both a military and a political-economic threat. Attempts by the USSR to create a closed political- economic sphere of influence compromised American efforts to build the kind of cooperative multilateral postwar order seen as critical to long term-peace and prosperity.

Additionally, such a closed bloc positioned the Soviets to expand their influence into neighboring regions, presumably at the expense of American style political democracy and capitalism. On the other hand, however, the Fed’s stance during the Korean War demonstrated that while central bankers took many cues from the Truman administration, they were not simply parroting its rhetoric. Rather than once again subordinating their own institutional imperatives to the Treasury’s war finance plan, central bankers pushed the need to minimize the inflationary methods adopted. While central bankers made

68 Marc J. Selverstone, Constructing the Monolith: The United States, Great Britain, and International Communism, 1945-1950 (Cambridge: Harvard University Press, 2009). 69 Eccles personally did soften his personal views on the Cold War and called for the recognition of the People’s Republic of China. Eccles, Beckoning Frontiers, 477. 422

similar arguments during the Second World War, the response to Korea differed in that policymakers backed up their rhetoric with action.

Federal Reserve officials approached the financing of the Korean War from a rather straightforward set of premises that, while not explicitly articulated, took form following June 25, 1950. First, the Federal Reserve believed the United States faced two distinct challenges operating on different time scales. These were the near-term threat of military conflict on the Korean peninsula and the long-term political-economic challenge of the Soviet Union. While victory in Korea might contribute to checking the expansion of Soviet influence, it was, by itself, insufficient. Second, central bankers believed that a stable dollar and an economically prosperous America were critical to sustaining the long-term commitment to contain the Soviet Union and preserving liberal democratic capitalism. Finally, while the United States could not win the Cold War in Korea, central bankers feared that it could lose it there by financing the war in ways that allowed price inflation to distort the value of the dollar. If the country did not adopt prudent measures early on to check inflation, it risked one of two potential outcomes. First, overly inflationary war finance risked undermining the dollar, destroying the basis of American international influence and thereby aiding the Soviet Union. Second, inflation might precipitate draconian controls, turning American society into a regimented garrison state, and undermining the very political and economic values the United States was fighting to defend. 423

During the Korean War the Federal Reserve differentiated, although not always clearly or consistently, between the near-term goal of financing the military conflict and the nation’s long-term Cold War commitment.70 Preventing fundamental disruptions to the economy, according to the Fed, was critical to sustaining the nation’s ability to meet the long-term challenge from the Soviet Union. This included containing inflationary pressure caused the pegged yield on government securities, a measure the Treasury still believed necessary to facilitate borrowing and ease the burden of servicing the nation’s debt. In essence, central bankers believed the Korean War mobilization effort should be constrained by “virtual limits” that were consistent with competing goals such as long- term political and economic stability and the sustainability of foreign policy commitments.71 Federal Reserve officials were not alone in recognizing that, barring a major escalation in hostilities and the expansion of the war to Europe, even a total victory for the United Nations on the Korean peninsula would not decisively alter the larger Cold

War. On the basis of this assessment, central bankers pushed a variety of policies to restrain inflationary pressure rather than simply subordinate themselves to the Treasury’s war finance plans as had been the case during the Second World War. By linking their proposals to the long-term Cold War struggle, however, Fed policymakers cast themselves as supporting the Truman administration’s foreign policy goals even if they differed on the specific means.

70 Central bankers were not alone in struggling to remain consistent with their differentiation between the two conflicts, a problem that also plagued the State Department. Gordon H. Chang, Friends and Enemies: The United States, China, and the Soviet Union, 1948-1972 (Stanford: Stanford University Press, 1990), 78. 71 Such “virtual limits” and how they influence policy choices are explored in Aaron L. Friedberg, The Weary Titan: Britain and the Experience of Relative Decline, 1865-1905 (Princeton: Princeton University Press, 1988), 90-2. 424

The Korean Mobilization: War Finance Redux

The outbreak of the Korean War resurrected many of the same problems in war finance that confronted the United States during the Second World War. These included determining appropriate fiscal policies, including taxes and borrowing to mobilize the financial resources necessary to pay for the war effort. Similarly, officials faced the necessity of determining what types of controls on prices and wages, as well as on consumer and business credit, should be applied. For the central bank in particular, the conflict highlighted the issue of the pegged yield on government securities. Similar to the earlier wartime experience, each one of these factors needed consideration in light of the competing demands of providing the financial means to prosecute the war while not unleashing inflationary pressure at home or abroad. Unlike the Second World War, however, the Korean War was neither a total mobilization nor did it come following a lengthy economic depression. As a consequence, the inflationary pressures faced by the

United States after June 1950 were particularly acute, while the means to restrain prices were less than those available after December 1941.

Central bankers favored a combination of fiscal and monetary measures to provide the financial resources to prosecute the war while also checking inflationary pressure. On the fiscal front, Fed officials supported higher taxes, including corporate taxes and the elimination of existing tax breaks, as well as maximizing borrowing from non-bank investors to draw off excess purchasing power from the economy, measures 425

similar to those favored during the Second World War. As for monetary policy, they argued for greater power to regulate credit, particularly for consumer goods and real estate, long perceived as sources of postwar inflationary pressure. Additionally, Fed officials also favored expansion of traditional central bank measures such as increasing the discount rate and gaining greater flexibility over yields on government securities. On the one hand, the mix of policies mirrored the Second World War experience where the

Fed supported many of the same approaches, particularly in terms of fiscal measures and consumer credit control. On the other, during the Korean War, central bankers were much more vocal in their support for greater autonomy over both monetary and credit policy as necessary to fight inflation. They were also more assertive in linking their preferred policies to larger ideas such as the preservation of American values of freedom and liberty, as well as maintaining the nation’s ability to meet an open-ended political- security challenge from the Soviet Union, points that will be demonstrated below.

At the time of the North Korean attack the United States already faced renewed inflationary pressures on its economy. By mid-1949 private credit, which had begun to contract slightly in 1948, began a renewed expansion, driven by real estate finance as well as growing consumer and business demand.72 Central bankers shared a consensus that the war came at a time when the American economy was “moving along near peak levels” making the danger of inflation particularly acute.73 Furthermore, new spending

72 Federal Reserve Board of Governors, “Resumption of Bank Credit and Monetary Expansion,” Federal Reserve Bulletin 37, no. 7 (July 1950), 771-75. 73 Federal Reserve Bank of San Francisco, “Review of Business Conditions,” Monthly Review (July 1950), 87, FRASER, http://fraser.stlouisfed.org/docs/publications/frbsfreview/rev_frbsf_195007.pdf (accessed May 6, 2013); Federal Reserve Bank of Richmond, “Business Conditions and Outlook,” Monthly 426

requirements necessitated by wartime mobilization further added to already high levels of peacetime military spending. Larger defense outlays meant not only greater competition for material and labor, thus driving up prices, but also reduced fiscal surpluses, which eroded the Treasury’s anti-inflationary debt reduction program.

After June 1950 the allocation of resources to defense only increased, with some

Americans calling for total mobilization to provide the material and financial resources necessary.74 Manpower requirements jumped as the American armed forces swelled by

1.5 to over 3 million personnel as the new divisions, air wings, and naval vessels entered service.75 Indeed, a tightening in the American labor market began appearing within weeks of the North Korean attack.76 Demand also intensified on the financial resources of the country after President Truman requested an additional $10 billion for defense, arguing that the sum was necessary for the “defense of the free world” even while acknowledging the “repercussions upon our domestic economy.”77

Federal Reserve officials initially struggled with uncertainty over the prospective length of the Korean conflict. When the FOMC executive committee met in early July they discussed what credit measures were likely necessary to prevent inflation. FOMC

Review (July 1950), 6, FRASER, http://fraser.stlouisfed.org/docs/publications/frbrichreview/rev_frbrich195007.pdf (accessed May 6, 2013); Federal Reserve Bank of Atlanta, “District Business Conditions,” Monthly Review 35, no. 6 (June 1950), 58, FRASER, http://fraser.stlouisfed.org/docs/publications/frbatlreview/rev_frbatl_19500731.pdf (accessed May 6, 2013); Federal Reserve Bank of St. Louis, “Survey of Current Conditions,” Monthly Review 32, no. 7 (July 1950), 98, FRASER, http://fraser.stlouisfed.org/docs/publications/frbslreview/rev_stls_195007.pdf (accessed May 6, 2013). 74 Malcolm Forbes, “Fact and Comment,” Forbes, August 15, 1950, 9. 75 Hogan, Cross of Iron, 322. 76 “State of Business: Creeping Mobilization,” Time, July 17, 1950, http://www.time.com/time/subscriber/article/0,33009,935013-2,00.html (accessed April 26, 2013). 77 Harry S. Truman, “Special Message to the Congress Reporting on the Situation in Korea,” July 19, 1950, APP, http://www.presidency.ucsb.edu/ws/?pid=13560 (accessed April 12, 2013). 427

members generally supported restraint on consumer and real estate credit as likely sources of disruption, yet the uncertain duration of the war complicated implementation.

Some members of the FOMC expressed concern that if it became necessary to secure new regulatory powers through legislation this might delay implementation of restraint and, with the knowledge that restrictions were coming, touch off a wave of anticipatory buying. Thus, the very measures intended to prevent inflation could themselves be precipitating factors. Furthermore, if the situation in Korea were settled relatively quickly FOMC members believed this itself would ease price pressures, meaning that the central bank would have needlessly created an inflationary surge.78

In addition to consumer and real estate credit controls, FOMC members considered the likely scope of Treasury borrowing to finance government deficits during the conflict. If the fighting “lasted for some time,” the FOMC recognized, this implied

“substantially larger” Treasury borrowing than might otherwise have been the case, meaning the size and composition of government securities offered to the market for a short conflict might not be appropriate for longer and larger mobilization. Committee members discussed their preferred mixture of interest rates and marketability of various government securities should the conflict drag on and unanimously approved a letter to

Treasury Secretary Snyder urging the Treasury to issue a special non-marketable bond issue to help finance the conflict. FOMC members hoped that such an issue would absorb the funds of non-bank investors while also alleviating pressure on the central bank

78 FOMC Executive Committee Meeting Minutes, July 10, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19500710MinutesECv.pdf (accessed April 10, 2013). 428

by reducing the incentives of commercial bankers to sell their current holdings of short- term securities to the Fed.79 The FOMC followed this up with another letter that emphasized the “joint responsibility” of the Fed and Treasury in debt management and for appropriate deficit financing measures to minimize inflation.80 From the outset, then,

Fed officials considered the economic strains caused by the system of pegged interest rates, as well as their independent institutional responsibility for managing domestic credit conditions.

On at least one level the uncertain length of the conflict made credit restraint more imperative from the perspective of the Federal Reserve. Central bankers believed that the prospect of a limited war precluded many of the controls associated with total mobilization. Speaking in Salt Lake City after the outbreak of fighting, Marriner Eccles alluded to this point, doubting that most Americans would tolerate the full set of economic controls imposed during Second World War “unless the Korean situation develops into World War III.” Should this happen, he added pessimistically, the conflict would “likely be an atomic war that would not last long.”81 Despite the understandably gloomy assessment of what a Third World War would mean, the former chairman of the

Board of Governors made a prescient point. Less than total war meant less than total mobilization. During the Second World War economic controls played an important role

79 Ibid. 80 FOMC letter to the Secretary of the Treasury dated July 31, 1950, FOMC Meeting Minutes, August 18, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19500818Minutesv.pdf (accessed April 20, 2013). 81 Marriner Eccles, “Statement Issued at Salt Lake City, Utah, by M. S. Eccles, Member, Board of Governors of the Federal Reserve System,” July 18, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19500718.pdf (accessed April 12, 2013). 429

in containing the inflationary pressures created by other financing measures, such as the

Treasury’s borrowing from the commercial banking system and the Fed’s support for pegged yields on government securities. Without the harness of full price and wage controls, which Eccles deemed unlikely in the limited context of the Korean War, the risk remained of the central bank running loose as an engine of inflation.

Eccles proposed both monetary and fiscal measures for the United States to adopt in financing the Korean War mobilization. The policy proposals were intended to coincide with a program of credit restraint that Fed officials anticipated President Truman would propose to Congress in the coming days.82 On the monetary front, Eccles called for greater credit restraint on the part of bankers and consumers, supported, when necessary, by additional Fed regulatory power over reserve requirements, consumer credit controls, and higher short-term interest rates. On the fiscal side, he called for higher tax revenues by ceasing any additional tax cuts, closing loopholes, and reinstating an excess corporate profits tax, as well as voluntary wage restraints by labor and efforts by the Treasury to borrow from non-bank investors.83 Eccles’ proposal did reflect many of the policies ultimately called for by President Truman, including tax rate increases and the elimination of deductions, as well as greater controls on consumer and mortgage credit. One item proposed by the former Fed chairman excluded from the president’s

82 Elliott Thurston to Marriner Eccles, Untitled Memorandum on Korean War Finance, July 17, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/093_19_0006.pdf (accessed April 24, 2013). 83 Marriner Eccles, “Statement Issued at Salt Lake City, Utah, by M. S. Eccles, Member, Board of Governors of the Federal Reserve System,” July 18, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19500718.pdf (accessed April 12, 2013). 430

message, however, was alteration to short-term interest rates.84 Central bankers continued to press for greater flexibility in short-term interest rates, and thus greater autonomy over monetary policy, a point the Truman administration continued to ignore.

In early August 1950 the Federal Reserve issued a formal analysis of the challenges of financing the Korean War that largely reflected Eccles’ earlier proposal. In it central bankers set out their support for a pay-as-you-go tax policy that included closing loopholes and employing a corporate excess profits tax. Policymakers also advocated increased borrowing from non-bank investors as a means of diverting excess income, as well as credit restraint, including limits on Fed purchases of government securities. This would mean providing greater discretion over short-term interest rates, although the Fed carefully avoided mentioning any changes to the 2.5 percent peg on long-term bonds. Policymakers argued “some proponents of easy and cheap money advance the thought that it is more important for the Government to have access to unlimited Federal Reserve funds . . . than to use open market operations to combat inflation and maintain the basic strength of the American economy” a stance the Fed, by implication, clearly disagreed with.85 At the outset, therefore, the Federal Reserve highlighted the benefits of greater central bank autonomy over open market operations

84 Harry S. Truman, “Special Message to the Congress Reporting on the Situation in Korea,” July 19, 1950, APP, http://www.presidency.ucsb.edu/ws/?pid=13560 (accessed April 12, 2013); Federal Reserve System Board of Governors, “Statement by the Board of Governors of the Federal Reserve System on the Defense Production Act of 1950,” July 24, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/101_16_0001.pdf (accessed April 12, 2013); Harry S. Truman, “Letter to the Chairman, Senate Committee on Finance, on the Need for an Increase in Taxes,” July 25, 1950, APP, http://www.presidency.ucsb.edu/ws/?pid=13569 (accessed April 12, 2013). 85 Federal Reserve System Board of Governors, Staff Memorandum prepared at the request of the Joint Committee on the Economic Report, “Fiscal and Credit Policies in Present Emergency,” August 1, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/101_17_0001.pdf (accessed April 12, 2013). 431

not just in terms of the Korean War but also as serving the nation’s larger interest by ensuring continued domestic prosperity in the face of near-term military commitments.

Days later Thomas McCabe and other central bankers met with Treasury officials, including Secretary Snyder, whom the chairman described as “irritated” by the Fed’s earlier analysis. Snyder argued that the uncertain duration of the Korean fighting combined with the still substantial requirements of debt management meant a rate change was undesirable. Indeed, Snyder, according to Fed observers, made it “clear that the

Treasury had no intention” of either increasing its emphasis on non-bank borrowing or allowing further increases in short-term interest rates.86 Faced with Treasury intransigence, Allan Sproul pushed for the Federal Reserve to take a strong unilateral stand. Prior to the outbreak of the Korean War, the Fed pushed the Treasury for adjustments in the rate structure and had been met with delay. Given the changed circumstances, Sproul declared:

We have marched up this hill several times and then marched down again. This time I think we should act on the basis of our unwillingness to continue to supply reserves to the market by supporting the existing rate structure and should advise the Treasury that this is what we intend to do – not seek instructions. If we don’t act we will have failed to take the action required by the economic situation and the national program for meeting the present emergency . . . If we allow ourselves to be diverted from our main responsibility we will expose ourselves to further delay and frustration.87

86 FOMC Meeting Minutes, August 18, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19500818Minutesv.pdf (accessed April 10, 2013). 87 Ibid. 432

Eccles voiced his support and argued that the central bank needed to act “if it expected to survive as an agency with any independence whatsoever,” a position Matthew Szymczak of the Board of Governors shared. Others, such as Rudolph Evans, supported increased flexibility for short-term rates but remained hesitant to make changes to the long-term 2.5 percent bond rate. There was also support for using other Federal Reserve powers to put bank credit under pressure, including changes to the discount rate and required reserve ratio.88 Thus, a very different view of credit controls began to form amongst central bankers compared to the Second World War. During the earlier conflict, central bankers continually pushed for the Treasury to adopt more aggressive anti-inflationary measures but ultimately deferred to the administration’s preferred credit management policies. In the weeks following the launch of the Korean War, even as United Nations forces fought to stabilize the military lines around Pusan, Federal Reserve officials openly discussed asserting greater autonomy over monetary policy.

While central bankers debated monetary measures the United States moved relatively cautiously to enact economic mobilization and stabilization plans by September

1950.89 On September 8 President Truman signed into law the Defense Production Act of 1950. The act provided the president with enhanced powers over prioritization and allocation of critical materials, created a loan guarantee program under the auspices of the

Federal Reserve to encourage the expansion of war-related productive capacity, and granted the president discretionary authority to set price and wage ceilings in an effort to

88 Ibid. 89 Pierpaoli, Truman and Korea, 41. 433

contain inflationary pressure. For the Federal Reserve the law also revived authority over consumer credit and real estate construction lending, but not, interestingly, over mortgage lending for existing properties. Credit control measures included setting maximum loan- to-value ratios and dollar amounts, as well as fixing maturities and repayment terms.90 In turn, the Federal Reserve formally revived Regulation W on September 18, stipulating maturities and terms on a variety of consumer goods ranging from automobiles to sewing machines.91 Congress followed this up by passing the Revenue Act of 1950, which increased maximum individual and corporate tax rates as well as included an excess profits tax retroactive to July 1, 1950. Under the act, effective tax rates rose for income years 1950 and 1951 relative to 1948-49 levels, but still generally remained below rates associated with the Second World War.92 A month later, on October 12, 1950, the

Federal Reserve issued Regulation X to limit credit for residential real estate construction.93

Federal Reserve officials navigated a tricky path as the requirements of Korean

War finance meshed with efforts to assert greater autonomy over monetary and domestic credit policy. For example, concerned that credit controls were more in line with

American values of freedom of choice than more statist measures such as direct price or wage regulation, Federal Reserve officials supported credit restraint as part of a broad

90 Defense Production Act of 1950, Public Law 774, 81st Congress, 2nd Session (September 8, 1950), reprinted in Federal Reserve Bulletin 36, no. 9 (September 1950), 1158-1177. 91 Federal Reserve System Board of Governors, “Law Department: Regulation W,” Federal Reserve Bulletin (September 1950), 1177-85. 92 Department of the Treasury, Annual Report of the Secretary of the Treasury on the State of the Finances for the Fiscal Year Ended June 30, 1950 (Washington, D.C.: Government Printing Office, 1951), 34-9, 248-50. 93 Federal Reserve System Board of Governors, “Federal Reserve Action Under the Defense Production Act of 1950,” Federal Reserve Bulletin 36, no. 10 (October 1950), 1284-1286. 434

anti-inflation program. At the same time, however, they believed that the types of controls authorized by the Defense Production Act remained insufficient, which in itself posed a danger to American domestic and international priorities by risking an inflationary spiral. Instead, central bankers argued that greater power over the expansion of bank credit was necessary to more effectively prevent inflationary price increases.

This line of argument implicitly merged with the Fed’s effort to gain greater independence over open market operations and loosen the support for Treasury yields.

The Federal Reserve did make use of traditional monetary tools to restrict bank credit as the FOMC had previously discussed, such as raising the discount rate banks paid to borrow directly from the central bank. A higher discount rate made the cost of borrowing more expensive creating a disincentive to expand bank credit. To affect this restraint, on August 18 the Board of Governors authorized a quarter point increase of the discount rate from 1.5 to 1.750 percent. Additionally, the Board of Governors and the

FOMC pledged to “use all the means at their command to restrain further expansion of bank credit consistent with the policy of maintaining orderly conditions in the

Government securities market.”94 Tellingly, however, the statement did not pledge was to continue to support a pegged yield on those securities. Central bankers followed its action on the discount rate with increases in the ratio of reserves member banks were required to maintain at the Fed. On December 28, 1950, Fed officials announced a series of reserve requirement hikes on demand and time deposits to be phased in between

94 Federal Reserve System Board of Governors and Federal Open Market Committee, “Federal Reserve Statement of Policy, August 18, 1950,” reprinted in the Federal Reserve Bulletin (September 1950), 1110. 435

January 11 and February 1, 1950. Policymakers estimated that the higher ratios would lock up approximately $2 billion reserves that might serves as the basis for as much as $6 billion in bank loans.95

Despite these measures, inflation surged after the start of the war, thanks in large part to fears of shortages and more restrictive government control measures that, as central bankers feared, prompted a surge in consumer demand.96 Given the acute rise in demand, Federal Reserve officials recognized the importance of credit controls in restraining inflation. As the postwar economy expanded, consumer credit grew as well, rising from approximately $500 million per month in new credit extended in 1946 to an average $1.9 billion per month by 1950.97 Furthermore, even this number may have been an underestimation as structural changes in the way credit was provided and used made accurate surveillance difficult.98 Private spending rose dramatically during the second half of 1950 even as large federal outlays for defense increased demand for goods and labor.99 While industrial production rose 20 percent during 1950, this did not check the rise in prices, with “basic commodities” jumping 45 percent and consumer prices rising 7

95 Federal Reserve System Board of Governors, “Changes in Federal Reserve Credit Regulations,” reprinted in the Federal Reserve Bulletin 37, no. 1 (January 1951), 13. 96 Meltzer, History of the Federal Reserve, Vol. I, 684. 97 Federal Reserve System Board of Governors, “Recent Developments in Instalment Credit,” Federal Reserve Bulletin 36, no. 11 (November 1950), 1428. 98 Ralph A. Young and Homer Jones, “Measurement of Consumer Credit,” Federal Reserve Bulletin (November 1950), 1456-64; Louis Hyman, Debtor Nation: The History of America in Red Ink (Princeton: Princeton University Press, 2011), 113-18. 99 Federal Reserve System Board of Governors, “Expenditures and Incomes in 1950,” Federal Reserve Bulletin 36, no. 12 (December 1950), 1565. 436

percent on the year, with most of the increase coming after June 1950.100 As a result,

Federal Reserve officials were forced to progressively tighten credit restrictions, issuing revisions to Regulation W within a month of its initial implementation.101 While overall inflationary pressure seemed to be easing toward the end of 1950, policymakers hesitated to attribute this to consumer credit regulation, and even when voicing their support for selective consumer credit controls central bankers repeatedly emphasized that these measures alone were insufficient.102

In addition to consumer credit, Federal Reserve officials continued to advocate greater control over bank credit more generally. A broad program of credit restraint treated not just the symptoms of inflationary pressure, as price and wage controls did, but also what the central bank identified as its root cause.103 Indeed, policymakers judged that by the end of the year the “forces of inflation” were “far more powerful” compared to those buffeting the economy at the start of the war, requiring “more direct action than has thus far been taken to prevent inflation from continuing its destructive spiral.”104 Fed

Chairman Thomas McCabe made this case directly, arguing that the consumer credit controls provided under Regulation W “will not of themselves check all of the

100 Federal Reserve System Board of Governors, Thirty-Seventh Annual Report of the Board of Governors of the Federal Reserve System Covering Operations for the Year 1950 (Washington, D.C.: Government Printing Office, 1951), 6-7. 101 Federal Reserve System Board of Governors, “Recent Developments in Instalment Credit,” Federal Reserve Bulletin 36, no. 11 (November 1950), 1427. 102 Federal Reserve System Board of Governors, “Recent Developments in Instalment Credit,” Federal Reserve Bulletin (November 1950), 1436; Rudolph M. Evans, “Consumer Credit Regulation in a Garrison Economy,” address at a meeting of the Tr-State Convention, Atlantic City, NJ, October 13, 1950, reprinted in the Federal Reserve Bulletin (November 1950), 1440. 103 Marriner Eccles to Leon Keyserling, December 15, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/005_03_0004.pdf (accessed April 20, 2013). 104 Ibid., 42. 437

inflationary forces.” Instead, the situation demanded “an adequate program of fiscal and general controls that restrain all types of bank credit.”105 This meant addressing credit at its source in the banking system.

The Fed-Treasury Accord of 1951

It was in this inflationary context that Federal Reserve officials continued to debate interest rate policy. Allan Sproul pressed for greater flexibility in interest rates arguing that it should take priority over other policies, including reserve requirement changes. Sproul warned of the “danger” of becoming “frozen into the existing pattern of rates,” which only complicated use of the reserve requirement, and instead the argued that the Fed should “proceed” with its “program of increasing the short-term rate,” a position that had widespread acceptance among members of the FOMC executive committee. Marriner Eccles went further, pointing out that continued pegging of the long-term bond rate at 2.5 percent limited flexibility on short-term interest rates.106 Even while members of the full FOMC generally expressed support for maintaining the long-

105 Thomas B. McCabe, “Statement on Regulation of Consumer Credit,” Statement by Chairman Thomas B. McCabe on behalf of the Board of Governors of the Federal Reserve System before the Joint Committee on Defense Production, December 8, 1950, reprinted in the Federal Reserve Bulletin (December 1950), 1581. 106 FOMC Executive Committee Meeting Minutes, September 27, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19500927MinutesECv.pdf (accessed April 10, 2013). 438

term rate at 2.5 percent “during the present emergency,” several Reserve Bank presidents suggested that the peg “should not be held indefinitely.”107

After some delay, on October 16, the FOMC informed Secretary Snyder that, despite his objections, given the Fed’s “statutory responsibility” and the “general credit situation,” which appeared to have grown more inflationary and increasingly uncertain since August, the central bank intended to allow short-term interest rates to rise. The

FOMC stressed that the credit restraining effects of the increase would offset the higher cost to debt management. It also emphasized as its intention to maintain the 2.5 percent peg on bonds, a point the FOMC reinforced in an October 26 follow-up communication with Snyder.108 Furthermore, the FOMC couched the measures as part of and complementary to the larger anti-inflation program of credit restraint and therefore in line with the goals of the Truman administration.

Following the Chinese entry into the war in November 1950, business and commercial loans surged by $700 million in three weeks compared to just $160 million

107 FOMC Meeting Minutes, September 28, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19500928Minutesv.pdf (accessed April 10, 2013). 108 FOMC Executive Committee Meeting Minutes, October 5, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19501005MinutesECv.pdf (accessed April 10, 2013); FOMC Executive Committee Meeting Minutes, October 11, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19501011MinutesECv.pdf (accessed April 10, 2013); Secretary Snyder had expressed to Thomas McCabe his opposition to changing short-term interest rates during an October 9 telephone conversation, FOMC Meeting Minutes, October 11, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19501011Minutesv.pdf (accessed April 10, 2013); FOMC Executive Committee Meeting Minutes, October 30, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19501030Minutesv.pdf (accessed April 10, 2013). 439

total in the months since the start of the conflict.109 As inflationary pressure intensified, the Fed voiced greater support for moving beyond short-term rate flexibility and breaking the 2.5 percent peg on the long-term bonds as well. Woodlief Thomas reported to the

FOMC that combined military and consumer demand showed little sign of abating, making further credit restraint critical. Eccles argued the ability of the Fed to put pressure on bank credit was restrained so long as the central bank was forced to support yields on long-term securities. Sproul concurred with this assessment and suggested that the Fed “look toward unfreezing the long end of the rate pattern.”110 Pressure to take action mounted as the war continued into 1951. Central bankers warned that the expanded defense program combined with higher incomes meant that “additional measures” would likely be necessary “to hold the line generally against inflationary forces.”111 This necessity seemed even more important as the scope of the defense program grew. In February 1951, the Federal Reserve estimated total national security spending of $52.3 billion for the fiscal year ending June 30, 1952, up from the $17.6 billion for the 1950 fiscal year.112

The difference of opinion between the Treasury and the Federal Reserve exploded into the public in early 1951. During a January 3 meeting with Snyder, Sproul and

McCabe argued that previous war finance experience suggested the need for slightly

109 Council of Economic Advisers, The Economic Report of the President Transmitted to the Congress, January 12, 1951 (Washington, D.C.: Government Printing Office, 1951), 40. 110 FOMC Meeting Minutes, November 27, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19501127Minutesv.pdf (accessed April 10, 2013). 111 Federal Reserve System Board of Governors, “The Supply and Price Situation,” Federal Reserve Bulletin (January 1951), 12. 112 Federal Reserve System Board of Governors, “The Federal Budget for Rearmament,” Federal Reserve Bulletin 37, no. 2 (February 1951), 126. 440

increasing the 2.5 percent long term interest rate.113 Two weeks later, McCabe met with

President Truman and Secretary Snyder at the White House. During that meeting

Truman surprised McCabe by pressing for no change in the Fed’s support for long-term securities yields. While McCabe did not explicitly commit to Truman’s request, Snyder later claimed that, indeed, the Fed chairman had assured the president of continued support for the 2.5 percent yield on government securities.114 For his part, Treasury

Secretary Snyder further enflamed the dispute the very next day in an address before the

New York Board of Trade. During his speech the treasury secretary spoke about the problems of war finance and inflation facing the nation. He addressed the measures necessary to control inflation, including expanded production and higher taxation, but explicitly excluded increases to yields on government securities. Snyder argued that there was “no tangible evidence” that higher interest rates would offer an effective restraint on inflation. He railed against the “delusion that fractional changes in interest rates can be effective in fighting inflation” and urged listeners that any such considerations “must be dispelled from our minds.”115 According to Allan Metlzer,

Snyder’s speech offered a “turning point” on the issue of supporting the peg on government securities.116

113 Sproul recounted the meeting during the next regularly scheduled session of the FOMC. FOMC Meeting Minutes, January 31, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19510131Minutesv.pdf (accessed April 10, 2013). 114 Ibid.; Meltzer, History of the Federal Reserve, Vol. I, 700-1. 115 Treasury Secretary John Snyder, address before a luncheon meeting of the New York Board of Trade, New York, New York, January 18, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/martin/15_05_19510118.pdf (accessed April 10, 2013). 116 Meltzer, History of the Federal Reserve, Vol. I, 701. 441

Marriner Eccles, who had progressively become one of the most outspoken champions of greater interest rate flexibility, responded almost immediately. In a statement before the Joint Committee on the Economic Report, Eccles urged a variety of anti-inflationary measures already supported, such as greater reliance on taxes as well as reforms to close tax loopholes. He then laid out a defense for greater Federal Reserve autonomy over interest rates, arguing:

Under our present powers, the only way to [restrain credit] is by denying banks access to Federal Reserve funds which provide the basis for a six-fold expansion in our money supply. The only way to stop access to Federal Reserve funds is by withdrawing Federal Reserve support from the Government securities market and penalizing borrowing by the member banks from the Federal Reserve Banks. As long as the Federal Reserve is required to buy Government securities at the will of the market for the purpose of defending the fixed pattern of interest rates established by the Treasury, it must stand ready to create new bank reserves in unlimited amounts. This policy makes the entire banking system, through the action of the Federal Reserve System, an engine of inflation.

Eccles further urged that interest rates be allowed to increase to put them on a “self- sustaining” basis and that they be “allowed to rise in response to market forces.” He argued that with the current system of pegged interest rates it was “hard to conceive of a more inflationary monetary policy.”117

A chronology of events produced by the Treasury detailing the dispute over interest rate policy offers a contrasting interpretation of the debate while reinforcing the growing tensions. In it the Treasury painted an image of the Federal Reserve prioritizing

117 Marriner Eccles, “Preparedness Against Both War and Inflation,” Statement by Marriner S. Eccles before the Joint Committee on the Economic Report on its hearings on the President’s Economic Program, January 25, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19510125.pdf (accessed April 12, 2013). 442

higher interest rates over stability in the market for government securities. According to the Treasury’s interpretation of events, during the January 17 meeting with President

Truman, McCabe “agreed that market stability [was] essential” and that the 2.5 percent

“rate on long-term Government bonds shall be maintained.” The Treasury asserted that

Snyder’s January 18 speech focused on a “policy of market stability,” which was then attacked by Sproul and other central bankers. The Treasury accused central bankers of acting in bad faith throughout the first six months of the war and claimed that “the

Federal Reserve continuously circulated rumors about imminent increases in short-term interest rates and in reserve requirements” that resulted in a “constant state of confusion and unsettlement” in the bond market.118 Thus, by the end of January 1951 Federal

Reserve and Treasury officials each viewed the other as distorting the record of events and acting in bad faith.

On January 31, 1951, relations with the Treasury reached a tipping point. In an unprecedented move, the full Federal Open Market Committee convened its meeting in the Cabinet Room of the White House, with President Truman in attendance. As historians have rightly pointed out, Truman was predisposed to support a continuation of the pattern of rates on government securities for moral as well as economic reasons.

Recalling his own experience with a decline in the value of Liberty bonds after World

War I, the president believed that the government had a moral obligation to support bond

118 Chronology of Events Relating to the Government Security Market, Undated, President Harry S. President Harry S. Truman's Office Files, 1945-1953 (Frederick, MD: University Publications of America, 1989), microfilm, Part 3, Reel 3. 443

prices and therefore yields.119 Central bankers, in their meeting the president emphasized this as well as the magnitude of the multifaceted conflict the United States confronted in international communism and the importance of maintaining confidence in the American dollar to that effort. He also spoke of the immediate military conflict in Korea.

According to the Federal Reserve’s account of events, McCabe expressed his support for the administration’s goals but also noted that there would inevitably be “differences of opinion as to just how the best results could be obtained.” Those accounts also note that

McCabe pledged to work closely with the Treasury and agreed that, if differences of opinion did arise, they would be brought to Truman for further consultation.120

Considering the matter settled, Federal Reserve officials were shocked, therefore, when shortly after the meeting the Truman administration released a statement to the press indicating that the Fed had agreed “to maintain the stability of Government securities as long as the emergency lasts.”121 According to an Associated Press report, a

Treasury spokesman further clarified Truman’s announcement as meaning “the market for Government securities will be stabilized at the present levels and that these levels will be maintained during the present emergency.”122 The announcement stunningly implied that the Federal Reserve was again subordinating its own concerns about domestic credit management to the administration’s goal of maintaining a fixed pattern of rates on

119 Alonzo L. Hamby, Man of the People: A Life of Harry S. Truman (New York: Oxford University Press, 1995), 582. 120 McCabe’s recounting is included in FOMC Meeting Minutes, January 31, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19510131Minutesv.pdf (accessed April 10, 2013). 121 Felix Blair, Jr., “Truman Puts Rein on Reserve Board,” New York Times, February 2, 1951. 122 The Associated Press report quoted in FOMC Meeting Minutes, January 31, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19510131Minutesv.pdf (accessed April 10, 2013). 444

government securities, certainly not what McCabe or the other members of the FOMC believed they had done. After the president released a letter addressed to “Dear Tom

[McCabe]” to the press that furthered the impression of Federal Reserve support for the pattern of interest rates, Marriner Eccles took it upon himself to release the Rudolph

Evans memo recounting the events of the January 31 meeting.123 Eccles, according to the

New York Times, was “astonished” by the president’s position, prompting the former Fed chairman to take action.124 In any case, the release clearly contradicted the administration’s assertions of an agreement and threw the dispute into the public.

Placing the dispute between the Federal Reserve and the Truman administration within the larger context of the Korean War will help to highlight the significance of the

Fed’s stance. Following the mid-September 1950 landing of American forces at the port of Inchon, United Nations troops succeeded in driving North Korean forces back up the

Korean peninsula. By mid-October, UN forces captured Pyongyang and advanced toward the Yalu River and the border of the People’s Republic of China. On October 25,

1950, the first clashes between communist Chinese and South Korean forces began, and by the end of November the Chinese were fully committed to the conflict in Korea.125

From there the tide of the Korean War seemed to reverse, with communist forces recapturing the South Korean capital of Seoul by the beginning of January 1951. The

123 Eccles, Beckoning Frontiers, 492-4; Meltzer, History of the Federal Reserve, Vol. I, 705-6; Robert L. Hetzel and Ralph F. Leach, “The Treasury-Fed Accord: A New Narrative Account,” Federal Reserve Bank of Richmond Economic Quarterly 87, no. 1 (Winter 2001), 45-6. 124 Felix Blair, Jr., “Truman Is Disputed By Reserve Board,” New York Times, February 4, 1951. 125 The decision of the Chinese to enter the conflict is detailed by Chen Jian in China’s Road to the Korean War: The Making of the Sino-American Confrontation (New York: Columbia University Press, 1994). 445

final major Chinese attack would not be checked until mid-February 1951 and Seoul would remain under communist control until mid-March. Thus, the dispute over support for the pattern of rates on government securities intensified just as the military situation in Korea began to deteriorate. Rather than acceding to the demands of the Truman administration and prioritizing the provision of funds for the military effort above any inflation concerns, as the Federal Reserve had done in 1942, central bankers chose what, in the larger political context, appeared to be a highly risky occasion to make a stand.

Over the course of the next month the Federal Reserve, the Truman administration, and the Treasury Department hashed out what subsequently became known as the Fed-Treasury Accord. In mid-February, Treasury Secretary Snyder was hospitalized and delegated negotiations with the central bank to Assistant Secretary of the

Treasury William McChesney Martin.126 Bill Martin, the son of the first chairman of the

Federal Reserve Bank of St. Louis, possessed an extensive and distinguished government service and private sector record. Elected the youngest chairman of the New York Stock

Exchange at age 31, he resigned his position at the start of 1941 to accept conscription into the United States Army as a private. During the war he worked on Soviet Lend

Lease issues; after the war, he headed the Export-Import Bank before finally moving on to the Treasury at the beginning of the 1949. In Martin the Federal Reserve apparently

126 FOMC Executive Committee Meeting Minutes, February 14, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19510214MinutesECv.pdf (accessed April 10, 2013). 446

found a partner supportive of a transition to a more flexible rate structure, and he worked with the FOMC urging the Treasury to move toward an unpegging of yields.127

Close cooperation between Martin and McCabe’s assistant Winfield Riefler resulted in a proposal being laid before the FOMC on March 1, 1951.128 In the resulting compromise the Fed pledged to maintain the discount rate at 1.750 percent through

December 1951 while the Treasury exchanged nonmarketable 2.75 percent bonds for the existing 2.5 percent marketable issues. To make the offering attractive, the Treasury offered to make any new bonds exchangeable for 1.5 percent five year notes and the

Federal Reserve pledged to support the market for these securities during the transition period.129 On March 4, 1951, the Federal Reserve and the Treasury announced their an agreement on debt management and interest rate policies, with a supplementary announcement of the five year notes coming days later on March 8.130 The next day

Thomas McCabe resigned his position as Chairman of the Board of Governors effective

March 31, and was succeeded by the Treasury’s Bill Martin.131

With the conclusion of the Fed-Treasury Accord in March 1951, the central bank finally began to move away from its pegged support of yields on government securities

127 Robert P. Bremner, Chairman of the Fed: William McChesney Martin Jr. and the Creation of the American Financial System (New Haven: Yale University Press, 2004), 77. 128 According to Robert P. Bremner Bill Martin focused on winning support from Riefler as critical to securing McCabe and therefore the FOMC’s backing. Ibid., 78. 129 Martin-Riefler memorandum included in FOMC Meeting Minutes, March 1, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/FOMC/Historical/19510302Minutesv.pdf (accessed April 10, 2013); Hetzel and Leach, “The Treasury-Fed Accord,” 50-1; Meltzer, History of the Federal Reserve, Vol. I, 709. 130 Announcements included in Federal Reserve System Board of Governors, “Treasury and Federal Reserve Statements,” Federal Reserve Bulletin 37, no. 3 (March 1951), 267. 131 Harry S. Truman, “The President’s News Conference at Key West,” March 15, 1951, APP, http://www.presidency.ucsb.edu/ws/?pid=14035 (accessed May 1, 2013). 447

initially adopted in 1942. The 1942 decision to subordinate the Fed’s concerns about the inflationary potential of the peg and the Treasury’s war finance plans resulted from central bankers’ understanding of the domestic and international situation. The later effort to assert greater Fed authority over credit management, including loosening the peg, although it also came in the midst of a military crisis, did not, however, represent a repudiation of this decision. Indeed, if anything, the Fed-Treasury Accord resulted from an equal concern by central bankers for the nation’s international obligations.

The Garrison State and Postwar Political Economy

Before examining how the debate over Korean War finance became entangled with larger Cold War foreign policy debates it is beneficial to briefly elaborate on the notion of the so-called garrison state, which involved fear that the nation was devolving into a regimented Fortress America. The concept loomed behind many of the ongoing debates over wartime political economy, including those involving the Federal Reserve.

A brief examination of the idea as well as how it meshed with the world view of central bankers offers important context for understanding the Fed’s support for greater rate flexibility.

Throughout the course of the Second World War the United States promoted international conferences to bring order to the postwar international system. As elaborated in previous chapters, these discussions began almost with the first shot of the conflict and continued throughout the war. Bretton Woods and Dumbarton Oaks were 448

attempts to create a cooperative multilateral institutional framework for the international economy and state system.132 While, as we have seen, at least on the economic front,

Bretton Woods did not represent the final say in the international system it was nevertheless a thoughtful effort by the United States to create a viable and stable postwar environment.

Unfortunately, while policymakers were no less interested in the fate of the postwar domestic economy their ability even to plan ahead was more limited. The result was a rather haphazard mixture of policies, often dictated by political exigencies rather than economic benefits. Some existing wartime measures were quickly curtailed, such as the termination of price controls and reduction in tax rates. Others, such as the pegged support for yields on government securities, remained in place with glacial modification.

Still others, such as Regulation W restrictions on consumer credit, fluctuated, being renewed and expiring as immediate economic conditions changed. Simultaneously, interest groups struggled to gain influence in this evolving postwar economy, particularly business, which attempted to regain some authority lost to government during the Great

Depression and the war.133

As the economic pressures associated with enlarged international security commitments mounted, early Cold War planners expressed growing concern that the

132 The shared ideas informing Bretton Woods and Dumbarton Oaks are examined in Elizabeth Borgwardt’s A New Deal for the World: America’s Vision for Human Rights (Cambridge: Belknap Press of Harvard University Press, 2005); An alternative interpretation emphasizing the influence of the great powers at the founding of the United Nations is found in Mark Mazower, No Enchanted Palace: The End of Empire and the Ideological Origins of the United Nations (Princeton: Princeton University Press, 2009). 133 Efforts by business to reassert their political economic influence postwar are examined in Elizabeth A. Fones-Wolf, Selling Free Enterprise: The Business Assault on Labor and Liberalism, 1945-60 (Urbana: University of Illinois Press, 1994). 449

United States would morph into a garrison state, although they disagreed over just what the term meant. The social scientist Harold Lasswell gave the term prominence in an article penned just prior to American entry into the Second World War. Lasswell contended that a fundamental shift had taken place in society “away from the dominance of the specialist on bargaining, who is the businessman, and toward the supremacy of the soldier.”134 In the postwar period rhetoric of the garrison state was fluid, sometimes adopted by groups on opposite sides of the same argument, contending that the policies of others threatened the regimentation of American society. The historian Michael J.

Hogan aptly demonstrates that both supporters and opponents of an enlarged Cold War national security program used the danger of the garrison state to support their positions.

Advocates of a more aggressive security program argued that failure to take adequate measures to defend the so-called free world would leave the United States isolated and with no choice but to regiment society in order to survive as an independent country.

Opponents, however, feared that in an effort to defend the United States, political liberties and economic freedoms would be so subverted by taxes, controls, conscription, and other restrictions that this would itself undercut American values and principles.135

In an effort to assuage these fears American policymakers advocated, when possible, public-private cooperative measures, an approach that continued during the Korean War

134 Harold D. Lasswell, “The Garrison State,” The American Journal of Sociology 46, no. 4 (January 1941), 455. 135 Hogan, Cross of Iron, 138, 325-30; The role of garrison state rhetoric in American Cold War policymaking and discourse is also examined in Aaron L. Friedberg, In the Shadow of the Garrison State: America’s Anti-Statism and Its Cold War Grand Strategy (Princeton: Princeton University Press, 2000). 450

mobilization.136 To the extent that the Korean War blurred with the larger imperatives of the Cold War it suggested a state of perpetual mobilization that raised the specter of the garrison state.137

The Federal Reserve, particularly after the outbreak of the Korean War, found itself increasingly entangled in political economic debate over the garrison state and

America’s mobilization effort. Federal Reserve officials often implicitly but occasionally explicitly couched their position toward specific policies in terms of their potential for bringing about an American garrison state. This was not necessarily a crass effort to play on existing political anxieties, but rather fit with the Fed’s established world view.

Federal Reserve officials long argued that closed blocs undermined prosperity and created political tension, leading to war. Policymakers advocated this position during the debates over Bretton Woods and continued to voice it in different ways during the British

Loan negotiations as well as in support of the Marshall Plan. If, in the course of war finance or mobilization, the United States should adopt measures that regimented society or alternatively failed to sufficiently restraint inflation requiring extensive economic controls later on, it threatened to turn the country into a closed economic bloc. Central bankers must certainly have found the prospects of an American economic bloc just as troubling as a German, Japanese, British, or Soviet one. Indeed, one of the reasons the

Fed supported the Bretton Woods proposals was in the belief that the United States must

136 Laura A. Belmonte, Selling the American Way: U.S. Propaganda and the Cold War (Philadelphia: University of Pennsylvania Press, 2008), 9-17; Paul G. Pierpaoli, Jr., Truman and Korea: The Political Culture of the Early Cold War (Columbia: University of Missouri Press, 1999), 3-5. 137 Steven Casey, Selling the Korean War: Propaganda, Politics, and Public Opinion, 1950-1953 (New York: Oxford University Press, 2008), 173, 181-5. 451

not retreat into economic isolation and thereby prompt the creation of competing exclusive spheres of influence. This larger line of thinking and the need to prevent an inflationary surge that might touch off a reactionary retreat into political or economic regimentation, powerfully influenced the Fed’s position on Korean War finance.

Korean War Finance: The Federal Reserve and the Political Economy of Credit Restraint

Federal Reserve officials appealed to the nation’s domestic and international policy goals to justify their call for a more assertive credit control scheme. Central bankers linked the nation’s ability to carry out its military and political commitments with the stability of the American economy, casting the dollar and Treasury securities as proxies for the strength of the nation itself. From a very early date Federal Reserve officials recognized the role anti-inflation measures played not only in serving the needs of the Korean War but also in ensuring the nation’s ability to meet the long-term challenges of the Cold War. The Board of Governors clearly indicated the need to keep the long-time horizon in mind when it stressed the importance of preventing “inflation both during and after” the Korean crisis.138 Marriner Eccles reinforced this point several months later during a speech in Chicago, warning that the “end of the war in Korea” would not mean the end of “our present emergency.” Instead, he cautioned the audience that the United States faced the prospect of “building up and maintenance of a large

138 Federal Reserve System Board of Governors, Staff Memorandum prepared at the request of the Joint Committee on the Economic Report, “Fiscal and Credit Policies in Present Emergency,” August 1, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/101_17_0001.pdf (accessed April 12, 2013). 452

military establishment and helping out countries do the same for many years to come.”139

Thus, if the United States failed to adequately restrain inflation in pursuit of victory in the

Korean War, it risked undermining its ability to compete in the Cold War.

Central bankers argued that checking inflation and safeguarding American prosperity were critical to the nation’s long-term success while linking failure to secure financial stability with the rise of autocratic and autarkic regimes. Speaking in Boston shortly after the passage of the Defense Production Act, Thomas McCabe asserted that the “peace and safety of the world are dependent on a strong American economy.”

McCabe warned about the negative implications of unchecked price advances, and argued that “runaway inflation in Germany after World War I ushered in Hitler” while

“astronomical Chinese inflation paved the way for communism in China.”140 Beyond maintaining that inflation brought about the rise of illiberal regimes in those countries,

McCabe implicitly participated in the conflation of the two threats by linking the legacy of Nazism with the emergence of new communist states. During the Cold War, some policymakers, including President Truman, drew links between communism and fascism, sometimes directly mixing the two under the title of “red fascism” or the more generic totalitarianism to support an activist foreign policy to combat the perceived threat

139 Marriner Eccles, Address of Marriner S. Eccles, Member of the Board of Governors of the Federal Reserve System, at Banquet of the 17th Biennial Congress of the Cooperative League of the USA, Chicago, Illinois, October 12, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19501012.pdf (accessed April 12, 2013), emphasis in the original. 140 Thomas B. McCabe, “Our Common Defense,” Address by Thomas B. McCabe before the National Association of Supervisors of State Banks, Boston, Massachusetts, September 21, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/bog_members_statements/mccabe _19500921.pdf (accessed April 14, 2013). 453

abroad.141 In the case of the Federal Reserve, it also meant ensuring that the nation did not adopt policies that undercut its ability to meet this challenge through disruptive price instability.

Throughout 1950, central bankers continued to press the twin themes of the need to stand up to communist aggression, broadly defined, and the belief in a stable dollar as a prerequisite for world peace. McCabe argued that one of the two major issues facing the United States was how to “build up our defenses to meet the threat of world aggression by the Communist forces.” Here again the Fed chairman stressed the long- term and expansive nature of the Cold War contest, casting the American defense effort as ongoing and global rather than simply an issue of financing the Korean War. The second issue, deeply connected with the first, was “how to maintain the value of the

American dollar,” which was critical because, as McCabe asserted, neither a defense program nor international political peace itself was possible “without a sound dollar.”142

Increasingly, these discussions blended with assertions by the Federal Reserve that use of central bank directed credit restraint, in conjunction with non-inflationary fiscal measures such as taxes and non-bank borrowing, served the nation’s foreign policy

141 Les K. Alder and Thomas G. Paterson, “Red Fascism: The Merger of Nazi Germany and Soviet Russia in the American Image of Totalitarianism, 1930’s to 1950’s,” The American Historical Review 75, no. 4 (April 1970), 1046-64; David C. Engerman, Know Your Enemy: The Rise and Fall of America’s Soviet Experts (New York: Oxford University Press, 2009), 206-7; Susan A. Brewer, Why American Fights: Patriotism and War Propaganda from the Philippines to Iraq (New York: Oxford University Press, 2009), 142-5. 142 Thomas B. McCabe, “The Role of Central Banking in Our Free Enterprise Society,” Address by Thomas B. McCabe before the Alabama Dinner of the American Newcomen Society, Birmingham, Alabama, December 12, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/bog_members_statements/mccabe _19501212.pdf (accessed April 14, 2013). 454

needs while at the same time safeguarding domestic political economic freedoms.

Federal Reserve officials viewed voluntary measures of credit restraint as beneficial but insufficient.143 Board of Governors Chairman Thomas McCabe wrote to Federal Reserve

System member banks urging them to voluntarily restrain expansion of bank credit. He framed this voluntary measure not merely as economically beneficial but also as directly contributing to the nation’s foreign policy goals. He argued that forgoing potentially inflationary lending made a “definite contribution to the defense effort” and claimed that what bankers lost in investment returns was a “small price to pay for the defense of the dollar,” which he believed was “of paramount importance.”144

While the Federal Reserve recognized the benefits of voluntary restraint to the nation’s defense effort, it continued to believe that this must be supported by expanded regulatory authority. Central bankers cast their arguments in favor of greater power over credit in a way seemingly designed for a political discourse charged with concern over the degeneration of American society into a regimented garrison state. Policymakers argued that a program of credit restraint maximized “individual choice and initiative” and should therefore appeal to “all who prize a high degree of freedom in economic and political life.” According to Matthew Szymczak of the Board of Governors, credit restraint limited sources of inflationary purchasing power without “direct Government

143 Thomas B. McCabe, “Our Common Defense,” Address by Thomas B. McCabe before the National Association of Supervisors of State Banks, Boston, Massachusetts, September 21, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/bog_members_statements/mccabe _19500921.pdf (accessed April 14, 2013). 144 Thomas B. McCabe, “Federal Reserve Statement on Defense Loan Policy,” Letter to All Member Banks of the Federal Reserve System, November 17, 1950, reprinted in the Federal Reserve Bulletin (December 1950), 1582. 455

intervention in a single decision” while still leveraging the freedoms and efficiencies of the market system, making it more responsive and less cumbersome than other forms of economic control.145 Marriner Eccles similarly warned that an “extensive system of direct controls” was not only less efficient but more apocalyptically threatened the

“eventual destruction of the very foundation of social and economic life that we are seeking preserve in our defense against Russian Communism.”146 He made similar comments privately to the Board of Governors. In a discussion of war finance measures he cautioned that without proper credit and fiscal policies the nation would have no choice but to accept a “garrison state through direct controls and a regimented economy.”147 Eccles continued to press this idea into 1951, telling an audience that the

United States must adopt “domestic economic policies” that ensured the “preservation of our free democratic institutions.” He further equated the defense of the dollar with the

“defense of the free nations of the world.” This required credit and monetary measures, rather than “direct controls” which attacked only the symptoms rather than the sources of inflationary pressure.148 Without the proper mixture of policies the United States might not only lose to the Soviets but also undermine its own freedoms in the process.

145 Matthew Szymczak, “Monetary Policy in a Free Economy,” Address by M. S. Szymczak before the School of Banking, University of Wisconsin, Madison, Wisconsin, August 29, 1950, reprinted in the Federal Reserve Bulletin (September 1950), 1112-17. 146 Marriner Eccles, Address of Marriner S. Eccles, Member of the Board of Governors of the Federal Reserve System, at Banquet of the 17th Biennial Congress of the Cooperative League of the USA, Chicago, Illinois, October 12, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19501012.pdf (accessed April 12, 2013). 147 Federal Reserve System Board of Governors, Meeting Minutes, October 3, 1950, FRASER, http://fraser.stlouisfed.org/docs/meltzer/min100350.pdf (accessed April 10, 2013). 148 Marriner Eccles, Address of Marriner S. Eccles at a Luncheon of the Executives’ Club of Chicago, Chicago, Illinois, March 2, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19510302.pdf (accessed April 13, 2013). 456

McCabe similarly associated the Federal Reserve’s management of credit with a

“Jeffersonian” defense of “the rights of individuals against the encroachment of an all powerful State.”149 To the extent that bankers cooperated with this program of anti- inflationary credit restraint it limited the need for “compulsion.”150 McCabe continued to emphasize this view into 1951, referring to the Federal Reserve as the “last bulwark of the private enterprise system” and warning that the United States should be careful of the financial measures it adopted in prosecuting the Korean War and the larger Cold War in order to avoid destroying “the very society” America was “struggling to preserve.”151

The Federal Reserve became highly assertive in expressing its views about the relationship between political and economic policy, going so far as to voice opinions about not just the amount but the type of defense spending commitments the nation should undertake. During the Second World War, as previously noted Chapter 1, the

Federal Reserve defined its job as simply providing the financial stability necessary to facilitate political and military victory over the Axis. The indefinite nature of the Cold

War, however, meant that central bankers increasingly expressed concerns about how the

149 Thomas B. McCabe, “The Role of Central Banking in Our Free Enterprise Society,” Address by Thomas B. McCabe before the Alabama Dinner of the American Newcomen Society, Birmingham, Alabama, December 12, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/bog_members_statements/mccabe _19501212.pdf (accessed April 14, 2013). 150 Thomas B. McCabe, “Inflation and the Banking System,” Address by Thomas B. McCabe before the National Credit Conference of the American Bankers Association, Chicago, Illinois, December 14, 1950, FRASER, http://fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/bog_members_statements/mccabe _19501214.pdf (accessed April 14, 2013). 151 Thomas B. McCabe, “The Role of the Federal Reserve in Wartime,” Address by Thomas B. McCabe before the American Academy of Political and Social Science, Philadelphia, Pennsylvania, January 26, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/federal%20reserve%20history/bog_members_statements/mccabe _19510126.pdf (accessed April 14, 2013). 457

political and military commitments of the United States affected the nation’s financial stability, and thereby its ability to secure those ends. A drastically different reading of the international context meant that the Federal Reserve became more vocal in expressing these concerns, a stark reversal from the 1941-1945 experience.

Marriner Eccles, in the same early January statement in which he called for greater flexibility over interest rates, intensifying the conflict with the Treasury and leading to the 1951 accord, argued that the United States must reconcile itself to the fact that it could “never expect to defeat Russia on land” and that the nation would be “bled white and destroyed economically as well as militarily” should it “attempt to do so.”

Furthermore, he asserted that the United States must guard against an expensive long- term defense program that “we cannot maintain indefinitely without regimentation or inflation” or the risk of a military conflict. Instead, the former Fed chairman believed that the United States should devote its manpower resources to producing goods while leveraging its technological, naval, and aviation superiority rather relying upon “land armies in Asia or Europe.”152 Eccles again stressed the long-term nature of the Cold

War, arguing that the “Kremlin’s hope” was that through American “failure to control inflation” the country would “accomplish the destruction of our own economic and political system and make the conquest of the United States both cheap and easy.” In order to prevent such a disaster from coming to pass, he argued, the United States needed to husband its manpower and financial resources and avoid becoming “further embroiled

152 Marriner Eccles, “Preparedness Against Both War and Inflation,” Statement by Marriner S. Eccles before the Joint Committee on the Economic Report on its hearings on the President’s Economic Program, January 25, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19510125.pdf (accessed April 12, 2013). 458

with land armies on the continent of Europe or Asia.” Finally, he couched his warnings in a call for greater credit restraint, asserting that the United States through

“regimentation or further inflation” risked the “destruction of our capitalistic democracy” and suggesting that the nation must respond not only with fiscal measures but also with

“restrictive monetary and credit policies” to forestall such a disaster.153 In this way, he rhetorically linked the call for greater Federal Reserve autonomy over monetary and credit policy with the defense of American values of liberal democracy and free market capitalism. Thus, central bank policy was depicted as fundamentally in line with the nation’s larger Cold War goals and its self-identification as leader of the free world.154

Nor was Eccles alone in arguing that the United States should leverage its economic and technological advantages through the employment of air-atomic power to counter communist conventional military strength.155 Indeed, his position reflected many of the conservative critiques of the national security program and seemed, from that perspective, to offer the best chance for securing the nation’s defense while also avoiding the regimentation of citizens and the economy associated with a garrison state.156

The significance of Eccles’ position becomes clear when viewed within the continuum of central bank policy dating back to the Second World War. During that earlier conflict the Federal Reserve urged a variety of anti-inflationary measures but at

153 Eccles, Beckoning Frontiers, 479-80; Marriner Eccles, Address of Marriner S. Eccles at the 58th Commencement of the Utah State Agricultural College, Logan, Utah, June 4, 1951, FRASER, http://fraser.stlouisfed.org/docs/historical/eccles/eccles_19510604.pdf (accessed April 13, 2013). 154 The role of American political economic ideals and their role in legitimizing Cold War foreign policy is explored in John Fousek, To Lead the Free World: American Nationalism and the Cultural Roots of the Cold War (Chapel Hill: University of North Carolina Press, 2000). 155 Melvyn P. Leffler, A Preponderance of Power: National Security, the Truman Administration, and the Cold War (Stanford: Stanford University Press, 1992), 16. 156 Hogan, Cross of Iron, 99-101, 120-1. 459

the same time limited these critiques to technical measures pertaining directly to monetary or credit policy and ultimately chose to subordinate its own anti-inflationary preferences to the needs of war finance. Indeed, for much of the Second World War

American policymakers, not just in the Federal Reserve but throughout the government, tended to adjust war finance policy to meet the demands of the military rather than alter military plans to accommodate financial needs.157

The Fed’s outspokenness during the Korean War was therefore at once a dramatic shift and a rather natural progression. Central bankers remained sensitive to how developments abroad affected domestic credit conditions. In the case of the Cold War,

Fed officials recognized that the likelihood of open-ended commitments created an ongoing potential for inflationary disruption that differed from the Second World War experience. Similarly, they realized that failure to maintain domestic price stability limited the nation’s efforts to fulfill these foreign obligations, and therefore affected prospects for international peace and prosperity. Policymakers’ arguments for a more vigorous anti-inflationary effort, and their highlighting of the long-term challenge of the

Soviet Union represented sincere efforts to serve the country’s ultimate foreign policy objectives. In this way, the Fed’s position reflected similar stances taken during the

Bretton Woods negotiations, the British Loan talks, and discussion about the Marshall

Plan. The fact that the Federal Reserve demonstrated a growing awareness of the continuing political, security, and economic challenge from the Soviet Union well before

157 Gregory Hooks, Forging the Military-Industrial Complex: World War II’s Battle of the Potomac (Chicago: University of Illinois, 1991), 228-36. 460

the outbreak of the Korean War only reinforces this point. Central bankers had come to realize that the communist challenge was not going away even after the end of the war in

Korea. Therefore, while the Federal Reserve called for policies that enhanced its own autonomy and authority, these proposals were made with full understanding of how they fulfilled America’s foreign policy goals, at least as central bankers understood them.

Conclusion

The Federal Reserve’s assertion of greater autonomy over interest rates during the

Korean War and the conclusion of the 1951 Fed-Treasury Accord represented yet another in an the central bank’s ongoing concerns with international affairs. Despite the different stance taken by the Fed toward interest rate pegging during the Korean War, in a critical way it represented continuity with the Second World War experience. In both cases central bankers supported the policy they believed necessary to aid the nation in meeting and defeating a fundamental challenge to the American system of liberal democracy and free market capitalism. In the Second World War this meant subordinating concerns over inflation in an effort to secure victory over the immediate threat posed by the Axis powers. Almost a decade later central bankers interpreted this as limiting the inflationary implications of Korean War finance in order to sustain the nation’s long-term challenge to Soviet communism. That the Federal Reserve interpreted its role in the same way despite the different time scales posed by international challenges is testimony to the 461

keen interest and understanding central bankers demonstrated in the realm of foreign affairs, an arena of policymaking scholars have heretofore largely neglected.

At the same time, the Fed’s attentiveness to international developments and their implications for domestic financial stability was not episodic, merely emerging during periods of intense international conflict. Indeed, one of the reasons the Federal Reserve supported the creation of the NAC and paid close attention to international negotiations first over the creation of the Bretton Woods institutions and later the British Loan and

Marshall Plan was because of an ongoing concern with foreign developments. The NAC had been intended to extend a Federal Reserve voice into the management of the international economy, motivated by central bankers’ awareness of the links between domestic and international developments. The NAC and Bretton Woods, however, had been intended for the peaceful and cooperative international system many had hoped would come after the defeat of the Axis. As Soviet-American tensions increased, and as the size of America’s international commitment grew and came under the auspices of a newly emergent Cold War bureaucracy in which the Federal Reserve was not fully represented, central bankers resorted to assertions of traditional central bank power to exert influence. In many ways the fight to create the NAC and the fight to exercise greater control over the pattern of rates were one and the same. They both represented efforts by the Federal Reserve to ensure its voice was heard in policymaking and to help ensure that the means undertaken in pursuit of the nation’s foreign policy goals did not undermine the country’s ability to achieve its desired ends. According to Allan Meltzer, the 1951 Fed-Treasury Accord resulted in a restoration of the central bank’s traditional 462

role of independence “within the government.”158 Federal Reserve officials pursued this independence not merely to be able to play an active role in stabilizing monetary policy, however, but also to ensure that monetary policy aided the pursuit of the full range of

American goals, political and economic, both at home and abroad.

158 Meltzer, History of the Federal Reserve, Vol. I, 713. Conclusion

During the nearly ten years between the Federal Reserve’s pledge to uphold a supportive monetary and credit program at the beginning of the Second World War and the restoration of greater nominal flexibility to yields on government securities with the

1951 Fed-Treasury Accord during the Korean War, central bank policy and policymaking exhibited an important mixture of change and consistency. Federal Reserve policy, while not guided by a single master plan, nevertheless reflected a fairly consistent set of beliefs about the necessity of both domestic and international economic stability and prosperity as a foundation for political peace. During the Second World War these beliefs largely reflected the perceived lessons of the interwar period. As tensions with the Soviet Union increased, however, central bankers evolved their views based upon the perception of the swiftly emerging bipolar security competition composed of both immediate dangers and long-term challenges. Central banker policymaking similarly exhibited active and reactive tendencies in response to a rapidly changing environment. Hemmed in by traditional, large government agencies such as the Treasury and State Departments, as well as the potential influence of newly emerging multilateral bodies in the International

Monetary Fund (IMF) and the World Bank, Federal Reserve officials fought to secure a voice in foreign policy decision making. Recognizing the interdependence of domestic and international economic developments, Federal Reserve officials actively participated, to the extent possible, in crafting the IMF and World Bank, while seeking permanent

463 464

representation in their operation by proposing and securing a seat on the National

Advisory Council on International Monetary and Financial Problems (NAC). Fed policymakers continued to support international commitments after the war, such as the

British Loan and the Marshall Plan, to the extent that these programs revived foreign prosperity without unleashing domestic inflationary pressures that threatened the sustainability of America’s own postwar reconversion. On the domestic side, central bankers called for fiscal and credit policies to ease price pressure while refraining from challenging the Treasury’s debt management program and continuing to accept the need to maintain stability in the market for government securities. Ultimately, however, as the

Cold War divisions hardened, and America’s military commitments grew, correspondingly shrinking Fed influence and increasing inflationary pressure, central bankers reacted by asserting greater autonomy over an area where they had previously conceded it in the interest of supporting war finance, yields on government securities.

A number of important conclusions can be derived from the Federal Reserve experience between the Second World War and the Korean War. The debates and decisions that took place during this period offer new insights not only into the nature of

America’s Cold War foreign policy but also the role of the Federal Reserve System in both domestic and international relations. They also offer a point of reference against which scholars might examine the role of central bankers and the interactions between monetary policy and American foreign relations, such as the supposedly accommodative policy of the Federal Reserve during the Johnson administration and the Vietnam War, the potential tensions between the Volcker Fed’s fight to contain spiraling inflation and 465

the Reagan administration’s military deficit spending programs as the Cold War reached its terminal phase, and the way easy Fed policies and the so-called Greenspan Put helped create a veneer of widespread prosperity at the beginning of the twenty-first century while the nation simultaneously embarked on a global war on terrorism. Each of these episodes lies beyond the scope of this work, and the assertion is not that they each reflected a precise replaying of the events or beliefs of 1941-1951. Rather, they are instances when financial and monetary issues intersected with domestic and international political economy, and reference to the early Cold War era may serve as a useful touchstone for more detailed examinations of these later events.

This dissertation has attempted to further widen the scope of interest in the Cold

War specifically, and the foreign policy more generally, to include the central bankers of the Federal Reserve System. In this way it endeavors to bridge a gap in the existing scholarship. In recent years historians have shed light on the direct and indirect influence that a variety of non-traditional actors have exercised over the nation’s international relations. These include non-governmental charity and humanitarian organizations, artists and filmmakers, as well as civil rights activists and the families of American military personnel stationed overseas, to name just a few. This dissertation demonstrates that the Federal Reserve represented yet another interested party in the formation and execution of American foreign policy. Learning from the interwar experience, Federal

Reserve officials recognized that the scope and duration of both the nation’s foreign commitments as well as the sustainability of the global economy held real implications for achieving a prosperous and peaceful international order and domestic environment. 466

Furthermore, even when the Federal Reserve accepted measures it knew increased inflationary pressure, those decisions were based on a relatively sophisticated understanding of long-term gains versus short-term costs. Thus, central bankers backed

American efforts to finance the Second World War effort on relatively easy terms and supported large amounts of foreign assistance in the form of the British Loan and the

Marshall Plan knowing that these efforts might create price distortions, but judging the risk to be lower in comparison to an Axis victory or postwar European economic stagnation. Additionally, the Fed’s interest was persistent over the entire period even when its actual influence was relatively low and reflected an appreciation for the fact that domestic and international conditions were entwined on an ongoing basis. The Fed’s interest in foreign affairs was not episodic, and by demonstrating so this dissertation helps expand existing interpretations of American history that often minimize or ignore central bankers, particularly following the emergence of the New Deal. Thus, even in periods of low influence, groups like the Fed maintained a deep a concern for American foreign policy and attempted to influence it, even if only at the margins.

Additionally, this dissertation sought to demonstrate how the intersection of ideas and bureaucratic structures shaped the course of policy and policymaking. The interwar period molded the Fed’s response to the war and postwar worlds. The legacy of the breakdown of economic prosperity led to the rise of autocratic and autarkic regimes, and ultimately to the outbreak of war, informing the Fed’s support to revive international partners in liberal cooperative economic relationship. At the same time, the Fed remained cognizant of the central role of the American economy, making it necessary to 467

guard against domestic inflationary distortions that might transmit disruptions outward and similarly undermine the return of prosperity. Fed officials further acted within a constrained policymaking environment, first having lost influence because of the perceived failings of global central bankers during the 1920s and 1930s and then ceding significant autonomy to the Treasury as part of the Second World War financing program. Part of the story of 1941-1951 is how and why the Fed first accepted this constraint on its ability to manage domestic credit and monetary conditions, and eventually its effort to restore this lost autonomy.

Throughout the period in question the Federal Reserve’s efforts were not about gaining independence per se, but rather independence within the scope of the Roosevelt and Truman administrations’ previously articulated policy goals. First, support for war finance, the Bretton Woods institutions, and the creation of the NAC were intended to support the Roosevelt administration’s wartime goal of defeating the Axis as a military and ideological threat while establishing the conditions necessary to avoid a repetition of the interwar political-economic breakdown. Central bankers believed the NAC served this goal not by allowing the Fed to challenge or subvert administration policy but rather by providing another mechanism to better execute its own institutional responsibility in the service of those goals. Second, Federal Reserve support for postwar recovery and reconstruction programs dovetailed with the desire for a peaceful and prosperous postwar order as well as providing American allies with the ability to resist perceived Soviet pressure. As the Cold War challenge became increasingly defined in terms of military strength guided by new bureaucracies, such as the Defense Department, over which the 468

Fed had no influence, central bankers shifted tactics, culminating in a push for the restoration of traditional monetary powers, and breaking free of the wartime pledge to support yields on government securities. Once again, however, central bankers understood this not as a rejection or challenge of the Truman administration’s policy, but rather as the means to support the immediate fiscal demands of the Korean War while ensuring the long-term economic stability necessitated by the ongoing Soviet threat.

An important relationship between the Federal Reserve and the larger American government emerged between the Second World War and the Korean War. In a way the central bank existed almost like an orbiting satellite compared to the government. Its unique institutional structure made it independent and distinct compared to executive departments such as the Treasury, yet it remained fundamentally tethered, as if by gravity, to movements of administration policy. At times the Federal Reserve exhibited weaker autonomy, sometimes by choice such as its support for yields on government securities during the Second World War, and sometimes by circumstances, such as in comparison to the Treasury’s dominance in shaping the Bretton Woods institutions. At other times the Fed demonstrated greater autonomy, such as its campaign for greater flexibility in interest rates during the Korean War. In either case, however, its actions were guided by a desire to support administration policy, at least as central bankers understood it. Bibliography