Tape 26 - Current Monetary Indication, Balance of Payments Deficit, Rush for German Marks / Paul A. Samuelson papers, 1933-2010 and undated / Duke Digital Repository

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Hello this is William Clark of the Chicago Tribune,

0:02

welcoming you again on behalf of Instructional Dynamics

0:05

to a visit with the eminent economist

0:08

Professor Milton Friedman of the University of Chicago.

0:11

Dr. Friedman is there any change in the story being told

0:14

by the monetary indicators these days?

0:18

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No I think the best conclusion is no change

0:20

in the sense that you are continuing to have a ratherly

0:25

slow rate of growth of the quantity of money

0:28

compared to the way it was growing last year.

0:31

This continues to forecast a slackening in the rate

0:33

of growth of the economy of GNP,

0:39

sometime around the third or fourth quarter.

0:42

It portends a slackening of inflationary pressure

0:45

which may come a little later of course

0:49

in the slackening in GNP because typically speaking,

0:51

prices don't move until after you've had some impact

0:56

on physical volumes.

0:59

Perhaps the only thing that might be noted

1:02

is that it is now about four to five months after

1:04

the sharp turn in monetary policy of last December.

1:10

And therefore you are beginning to get into the area

1:13

of where some of these effects oughta start showing up.

1:15

And there are some signs of these effects showing up

1:17

in the economy.

1:20

The people who are very close watchers of the detail figures

1:21

published each month by the Department of Commerce

1:26

and Business Cycle Developments, the leading indicators

1:29

and series of that kind are almost uniform in reporting

1:32

that there are the beginning signs of a possible slowdown

1:36

in economic activity.

1:42

Now, of course, there have in the past been false signals

1:44

from these leading indicators.

1:48

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M-hmm

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And so, nobody can be certain that this is a really

1:49

confirmed thing, but all you can say is that as yet all

1:54

of the evidence remains consistent with the forecast based

1:57

on earlier experience that the sharp slowdown

2:01

in monetary growth, if continued, as it has been up

2:04

to now, will in fact, produce slowing down in the rate

2:07

of growth in nominal GNP.

2:12

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Your position has been, I think, isn't it

2:16

that there's a possibility that the authorities are being

2:18

a bit too restrictive.

2:22

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Oh yeah, I think they are being, if I had to judge,

2:23

if I had to say on which side their going too far,

2:27

there's no doubt in my mind that if anything they're

2:30

being a little too tight.

2:33

This is a general difficulty of having patience.

2:35

You start that the Fed has moved and it feels, well now it's

2:39

stepped on the brake and nothing seems to be happening,

2:43

the figures don't show up, prices continue to soar,

2:46

there's some contradiction.

2:49

That there isn't really because you don't expect anything

2:50

to show up until six or eight or nine months

2:53

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M-hmm.

2:55

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But we had another sign of that recently,

2:56

Secretary Kennedy, made a statement that if you didn't have

2:58

signs soon that the inflation was being slowed down it would

3:03

be necessary to turn the screw another notch.

3:07

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Yes.

3:10

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Now I personally think it would be an extremely grave

3:11

blunder and a most unfortunate development,

3:15

if in fact, because of lack of patience for waiting to see

3:17

and get the results of the measures they have already taken,

3:21

if we fell into the trap that we have fallen into

3:24

so many times before

3:26

of overdoing the reaction.

3:28

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M-mm.

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As I say, in my opinion, if anything it's been a slight

3:30

overdoing so far but as of this moment the degree

3:32

of overdoing is not significant, is it?

3:35

The money supply over the first four quarters, four months,

3:38

of this year has been rising at the rate of something like

3:41

4% a year.

3:44

If I were doing it I would've made it more nearly 5 or 6%.

3:45

But it's not nearly the kind of switch that you had

3:48

in 1966 when you went down to 0%.

3:51

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M-hmm.

3:53

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So I think that if there is any overdoing

3:54

as yet it's mild and I hope it doesn't get any worse.

3:57

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(laughs) I see.

3:59

Dr. Friedman some people have been disturbed

4:01

in the last few days by the report

4:03

of a substantial deficit in our International Balance

4:05

of Payments for the first quarter.

4:09

I wonder if you would comment on the significance of that?

4:11

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Well the numbers are very funny.

4:14

And they're not nearly as clear as they look at first.

4:16

The headlines screech of a 1.8 billion dollar balance

4:20

of payments deficit.

4:24

The fine print in the article says, of course,

4:25

there's more than one way of measuring the deficit

4:29

and if you measure it on the official settlements basis

4:32

there is, in fact, a 1.1 billion dollar surplus.

4:35

Now what is the difference between this?

4:42

How is it that one way of looking at it has a

4:43

1.7 billion dollar deficit and the other way

4:45

of looking at it has a 1.1 billion dollar surplus?

4:48

Well the answer is that the second way of looking at it

4:52

treats as a deficit, only those changes in outstanding

4:55

claims on dollars.

5:01

Only those dollars balances, those increases

5:02

in dollar balances which are in the hands

5:04

of official agencies, of central banks of other countries

5:07

or treasuries of other countries.

5:10

Now, as a footnote, it's very important to distinguish

5:12

that part 'cause that's the only part of a dollar balance

5:16

in which we even have a nominal obligation

5:18

to provide gold at $35 an ounce.

5:20

As I emphasized in my last tape I don't think, in fact,

5:23

any central banks gonna ask for it but as a matter of record

5:26

it's interesting to note that in this quarter,

5:30

the potential legal claims on our gold supply

5:33

has gone down, not up.

5:37

The reason for the large increase in the deficit

5:39

is apparently that there are private individuals

5:41

and supposedly this is in considerable measure, banks,

5:44

that have wanted to have larger dollar holdings

5:47

and in order to get these dollar holdings

5:49

they have withdrawn, well,

5:51

consider a European who wants dollars,

5:54

Englishman, he takes sterling to his,

5:58

to the Bank of England, and he buys dollars with it.

6:00

This shifts the dollars from an asset of the Bank of England

6:03

to an asset of the individual.

6:08

That dollar transaction would show up in our accounts

6:10

as that much less, that much of a surplus on the official

6:13

settlement of accounts.

6:18

And there's no change so far as that was concerned

6:20

on the standard account.

6:22

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I see.

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I said the standard account showed a deficit

6:24

of 1.8 billion, the official settlements account showed a

6:26

surplus of 1.1, that means that something like

6:29

2.9 billion dollars, or close to 3 billion dollars

6:33

of additional dollars were accumulated in the hands

6:36

of non-official holders.

6:39

They've gotten 1.1 billion of that by withdrawing it

6:42

from their central banks and substituting

6:44

their own currency.

6:46

They got 1.8 billion of it by selling more

6:47

to the United States than they were buying

6:50

from the United States or by security transactions

6:52

which have the same effect.

6:56

Now, is this a cause for concern?

6:58

Personally I think it's no cause for concern whatsoever,

6:59

in the main I believe people have accumulated those dollars

7:03

'cause they wanted to hold larger dollar balances.

7:05

If they don't wanna hold that larger dollar of balances,

7:07

the first sign of that would be that they would turn

7:10

it back into the central bank because given our present

7:12

system of fixed exchange rates, nobody anywhere

7:15

has to hold dollar balances unless he wants to.

7:18

If he doesn't want to, it will show up in the form

7:21

of additional dollar balances at the central banks,

7:24

and therefore in my opinion from the point of view

7:27

of any real pressure on the dollar, the official settlements

7:29

balance from this point of view makes more sense

7:32

than the much more

7:34

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M-hmm.

7:35

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prudent and talked about

general liquidity balance.

7:37

So I do not see myself, any reason, on the basis

7:39

of this result to really be concerned about American balance

7:43

of payments problems.

7:46

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Doctor, we might switch for the moment from dollars

7:49

to German Marks and perhaps other European currencies too.

7:51

There's been a great deal of activity, of course,

7:56

revolving around the German Mark lately perhaps you'd

7:58

care to comment on the significance of that?

8:01

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Sure.

8:03

The disturbance of the European currency Markets

8:06

is certainly extremely remarkable.

8:08

It has as you quite realize, and recognize,

8:10

it's political in it's economic aspects.

8:13

The political aspect of it apparently

8:15

is a pull and haw, a see-saw between

8:17

the Social Democrats on the one hand

8:23

and the Christian Democrats on the other.

8:26

The Christian Democrats are the party of Kiesinger,

8:29

they are the party, it was the party

8:32

of Adenauer and Erhard.

8:33

The Social Democrats are the formerly socialist party

8:36

of Willie Brandt and you recall that a couple of years ago

8:39

they made the Grand Coalition and the two parties

8:43

together have been having a joint coalition government

8:46

which is running Germany.

8:49

But this fall, in September, there are elections coming up

8:53

and the coalition is giving every sign of falling apart

8:56

at the seams as the two major parties to the coalition,

8:59

each is trying to see how it can improve its own electoral

9:04

position and the chance of getting votes.

9:09

Well now the original run on the, the reverse of a run,

9:12

we usually talk about run on a currency,

9:18

I don't know how you describe a run into a currency.

9:20

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(laughing)

9:22

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Because what there was, was a rush,

9:23

I guess maybe a rush is the way to do it.

9:25

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That's a good way.

9:26

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A rush to buy Marks.

At any rate, the rush on the Mark,

9:28

came after the Economics Minister Mr. Schiller

9:32

who happens to be from the Social Democratic party,

9:37

the Socialist party, after he made a public statement

9:39

that it was desirable for Germany to revalue,

9:42

appreciate the Mark buy 6 1/2%

9:46

and the result of this was to cause a rush

9:49

of people trying to buy Marks and take advantage

9:51

of the opportunity to earn some, money.

9:53

However, when they got together int he government,

9:57

the Christian democrats, headed by Mr. Kiesinger,

10:00

were strongly opposed to re-valuing.

10:02

Underlying this, battle about the Mark,

10:04

is apparently, I'm no expert I should say,

10:09

on the German political or economic scene,

10:11

but my understanding is that underlying this

10:13

is the difference in the constituencies

10:16

to which they appeal.

10:17

The Christian Democrats are relatively strong,

10:19

the old line conservative party are relatively strong

10:23

both among the farming community and the exporters,

10:26

and both of these are opposed to an appreciation.

10:31

The farming community is opposed to it because under

10:33

the rules, I think I mentioned this earlier,

10:35

under the rules of the common market they have a price

10:37

fixing scheme just the same kind of foolishness we have,

10:40

apparently nobody can ever learn from anybody else.

10:43

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(laughs)

10:44

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Everybody has

to do it for himself.

10:45

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Yes you did mention that.

10:46

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And they have a price fixing scheme of this kind

10:47

under which the price is determined by in dollars,

10:49

and therefore if the Germans appreciate,

10:52

that is to say, if they make fewer Marks correspond

10:56

to a certain number of dollars, that lowers

10:59

the support price of agricultural product in Marks

11:03

and the German farmers are interested in Marks.

11:06

And so the government would either have to break

11:08

the common market agreement or do some kind

11:10

of a supplementary way or else the farmers would be hurt.

11:13

And this is a major reason why the Christian Democrats

11:15

have been strongly opposed to appreciating.

11:18

From the point of view of the Social Democrats

11:20

I suppose they regard that as an advantage,

11:22

this would alienate some of the constituency

11:24

of the Christian Democrats and I have heard stories

11:27

that in addition they thought it might be a rather clever

11:29

device for them to be in the forefront of an appreciation

11:32

because this would give a bonus to tourists.

11:36

That is if a German worker was gonna go on a vacation

11:38

to Southern France, he would be able to get more francs

11:42

with a given amount of Marks and therefore,

11:45

I understand that the question is in part,

11:47

desired by the Social Democrats to butter up

11:50

to potential tourists at the expense of the constituency

11:52

of the Christian Democrats.

11:56

Well you can see why this became a great political issue.

11:57

And it ended up with the Christian Democrats,

12:00

who are the senior partner in the coalition essentially,

12:02

overruling Mr. Schiller and coming out with

12:06

a firm statement that they were not going to appreciate

12:12

and that this was good for eternity.

12:16

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M-hmm.

12:17

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Well I do hope

that the eternity you and I experience is a little longer

12:19

than the one this is gonna be.

12:22

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(laughs)

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Because I don't believe that they,

12:23

well I as I said, I think I said last time

12:25

I'd be willing to give more than even money

12:27

that sometime within the next six months

12:30

the German Mark is going to be appreciated.

12:32

However, as I've been reading the papers

12:34

and the comments on this episode, there's one phase of it

12:36

and now I come to the economics as opposed

12:39

to the politics of it.

12:41

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M-hmm.

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There's one phase about the economics of it

12:43

which I believe is very widely misunderstood.

12:45

And that is, the very great difference that there is

12:48

between the position of a country which is experiencing

12:51

a rush into it and the position of a country which is

12:54

experiencing a run on it.

12:57

If we go back to the run cases, the cases of Britain

13:00

a couple of years ago when it was forced to devalue

13:04

or even the case of France right now,

13:07

which is subject to run or Britain now.

13:09

Both of these.

13:12

If we go back those cases, it is possible

13:13

for speculative runs on the currency essentially

13:18

to force a devaluation, whatever the country's desires

13:22

may be, because what does a run on sterling mean?

13:24

It means that people sell sterling and buy dollars.

13:29

In order to maintain the price of sterling the central bank

13:34

has to be prepared to accommodate everybody who wants

13:37

to sell the sterling.

13:39

The only way it can accommodate it is by using

13:43

up it's reserves of dollars.

13:45

But it inevitably has a limited reserve of dollars

13:46

and therefore there is necessarily a termination date.

13:49

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M-hmm.

13:52

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Now at the moment,

the French are at an extremely good position

13:53

to counter such a run and it is very likely

13:56

that they can hold it off until after their presidential

13:59

elections because they have very, very large reserves there.

14:01

They have large stocks of gold that they accumulated

14:05

during the de Gaulle's gold accumulating period.

14:08

They also have borrowing rights from the IMF and so on.

14:10

I've forgotten the exact number but it's something like

14:14

six to eight billion dollars that they can draw on,

14:16

automatically.

14:18

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M-hmm.

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So that they can, but that nonetheless is the limit

14:20

to them, they can't go beyond that.

14:22

Now consider the case on the other hand

14:24

of the German government.

14:26

The German government you have people wanting to buy Marks.

14:29

They come and they say we have dollars, we think

14:33

that if we buy Marks now we can later sell them

14:36

for more dollars, we wanna buy Marks.

14:39

Well, now Marks are something

14:42

that the German government prints.

14:43

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Hmm.

14:45

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It's got a printing press, I'm talking figuratively

14:45

of a printing press, it really isn't a printing press,

14:49

it's a I suppose a better analogy in the modern world

14:52

would be an accountant's pen.

14:55

Because what it really is, is a writing on a book

14:57

of the profit liability in Marks.

15:00

You come to a German commercial bank and say,

15:02

here's a hundred dollars I want 400 Marks

15:06

and the bank writes on the book 400 Marks,

15:08

it has a hundred dollars, it can now take that hundred

15:11

dollars to the German central bank

15:13

and the German central bank in its turn can create

15:15

the 400 Marks to provide the,

15:18

the commercial bank with the banking.

15:22

Well now given that Germany has a printing press

15:25

it can, in this sense, create an infinite amount of Marks

15:29

and so there is no technical reason why Germany

15:33

could not accommodate an indefinite inflow.

15:37

The stories are that there was a four billion dollar inflow.

15:40

What does that mean?

15:43

That means that Germany now has four billion dollars

15:44

that formerly were held by private individuals

15:49

and those individuals have a claim on Germany

15:52

of four billion dollars times the number of Marks,

15:55

which is roughly four Marks to the dollar

15:57

so they have roughly 16 billion Mark obligations.

15:59

Now if you just looked at it that way,

16:03

there's no reason that that situation couldn't sit there

16:05

indefinitely, the Germans can hold the four billion dollars

16:07

and the people who, the speculators could hold

16:10

the 16 billion Marks.

16:14

Now of course we have to go beyond that,

16:16

but I wanna go beyond but let me go back up a little bit.

16:20

In the case of the, of the devaluation.

16:23

The case of the British or the French,

16:28

the run as opposed to the rush,

16:30

as they get lower and lower down on reserves

16:34

they are driven more and more to a position

16:36

where they must devalue, even though it's very costly

16:38

to them to devalue, but they have nothing else to do.

16:40

The situation is almost the reverse for Germany,

16:43

as Germany goes more and more into this accumulation

16:46

of Marks, there's nothing, it doesn't add to the pressure

16:49

on them to appreciate it, in fact,

16:52

it's the other way around.

16:53

It makes it more costly for them to appreciate.

16:55

Because let's stop at that moment, let's suppose

16:58

here we are, the Germans have their four billion dollars.

17:00

The outsiders have 16 billion Marks.

17:05

If Germany appreciates, that means that Germany says,

17:09

instead of one Mark, instead of one dollar equaling

17:13

four Marks, one dollar will equal maybe 3.6 Marks,

17:16

it'll be a smaller number.

17:19

Let's go extreme, let's suppose, well let's say 3.6

17:21

that's alright, that would be a 10% appreciation.

17:24

That means that instead of a Mark costing 25 cents,

17:27

a Mark would cost something like 28 cents.

17:31

Now, from the point of view of the Germans,

17:36

they cannot now buy back those 16 billion Marks

17:39

for the four billion dollars they have.

17:42

They need more than four billion dollars to buy them back.

17:44

If they appreciated by 10% under this circumstance,

17:46

in effect, they are saying we will give the speculators

17:50

10% more dollars back than they gave us

17:53

and thus it would cost Germany 400 million dollars

17:56

to appreciate by 10%.

18:00

In the form of precisely paying the profit,

18:02

four hundred million dollar profit to the speculators.

18:06

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I see.

18:08

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Now, since Germany can so far as this part

18:09

of it is concerned, hold off more or less indefinitely,

18:12

there's no pressure in this score (mumbles),

18:15

if another four billion dollars aren't gonna come in,

18:19

well they can print 16 billion more Marks.

18:22

Why then, the more, the larger of the inflow of this kind,

18:25

the greater the cost to Germany of appreciating,

18:28

and therefore the greater temptation for Germany

18:31

to postpone it.

18:33

From this point of view what Germany would like

18:35

to do, and that's why she keeps making these strong

18:36

statements about eternity, if Germany can only persuade

18:38

the rest of the world, the speculators,

18:42

that there is going to be no appreciation

18:44

and induce them to withdraw that four billion dollars,

18:46

and put back in the 16 billion.

18:50

Then at that point she can appreciate

18:52

and not incur this particular cost of the speculative cost.

18:54

And that's obviously the tactic which Germany is following,

18:58

she is trying to establish a climate

19:01

in which people will withdraw their funds

19:04

and then permit Germany to appreciate.

19:07

-

Doctor in that case why should Germany ever appreciate,

19:11

what is the pressure for appreciation?

19:14

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Well the pressure for appreciation does not come

19:17

from this capital movement, the pressure

19:20

for appreciation comes from it's kind account.

19:23

Suppose for a moment that there were no speculative

19:26

movements in or out.

19:28

Then the situation is that, at the present time,

19:29

Germany is exporting more than she's importing.

19:32

Again, that's a, that's a shorthand.

19:36

That is Germany gets foreign currencies by exporting

19:39

goods or because people invest in Germany or because people

19:42

give money to Germany and Germany requires foreign exchange.

19:45

Because, I may, did I say foreign goods before?

19:50

I meant foreign exchange.

19:52

Germany acquires foreign, requires foreign exchange

19:53

in order to buy foreign goods, in order to invest abroad

19:57

and so on.

20:00

Now, independently completely of these speculative movements

20:01

for short run gains, Germany has been running a surplus

20:04

on current account.

20:07

That is to say, Germany has been acquiring more foreign

20:07

currency than she has been wanting to spend.

20:11

This means, in physical terms, that part of Germany's

20:14

resources have been used to ship out goods and services

20:18

without getting anything back in return.

20:21

So on a physical ground this is a strong

20:23

cost to Germany of maintaining a surplus

20:27

on current account.

20:31

On the financial side, this means that Germany,

20:33

German banks, German people are acquiring foreign exchange

20:38

which they are handing into the central bank for Marks

20:42

and this puts upward pressure on the money supply

20:44

which has to be counted by monetary operations type money

20:46

or the line.

20:50

Or to put it another terms, a combination of these

20:51

is to produce upward pressure on German prices.

20:54

Produce upward pressure because Germany is selling

20:57

much abroad and buying little, which makes physical volume

21:00

of goods available smaller than it otherwise would be.

21:03

Upward pressure because on the monetary side

21:05

it's tending to increase the quantity of money.

21:07

And consequently, the combination of these means

21:10

that it would be in Germany's economic interest

21:13

to appreciate as a way of avoiding these excessive exports

21:16

and deficient imports that she's now bearing.

21:21

That's on the current account.

21:24

But now that effect, while, it's always present,

21:25

is sort of a continuing steady one,

21:29

it's like a, like a low grade throb in your toothpaste,

21:32

not like in, a tooth, in your tooth if you've got a cavity,

21:36

not an acute one.

21:40

And as a result, from that point of view,

21:41

while it's in Germany's interest to appreciate

21:44

it isn't a case of having to do it today

21:46

or immediately, there's no reason why it can't

21:50

be put off some time.

21:52

And that's the, that pressure needs to be distinguished

21:53

sharply from this pressure of the speculative inflow.

21:57

Now with respect to this speculative inflow again,

22:01

the other part of it that's kind of interesting

22:05

is to look at it from the financial point of view.

22:07

I said technically speaking, there's no reason why Germany

22:09

can't hold on and the cost of appreciating,

22:13

while there are such large speculative balances

22:15

are very great, if you appreciate it by 10%,

22:18

four hundred million dollars.

22:22

-

M-hmm.

22:23

-

But it's even more extreme than that.

22:24

If we go and start looking at the form

22:26

in which these things happen.

22:28

The money which Germany gets in dollars,

22:31

she doesn't have to hold in the form of dollar bills,

22:34

or in the form of demand deposits.

22:37

In another story in The Wall Street Journal

22:39

about this episode was a very large increase

22:42

in the volume of U.S. Treasury securities held

22:45

for the account of others.

22:48

Now what that really means, underneath all that verbiage,

22:49

is in Germany, which has been acquiring claims

22:53

on U.S. banks by the people who have been buying the Marks,

22:56

has been saying to the Federal Reserve,

22:59

would you please buy Treasury Bills for us for them.

23:00

So a large part of this four billion dollars that I've been

23:03

talking about, Germany is earning something close to 6% on.

23:05

The Treasury Bill rate is now about 6%.

23:08

I say Treasury Bills, I don't know I'm not privy

23:10

to these secrets, maybe what Germany's been buying

23:13

has been long term bonds or I don't know what notes.

23:15

But I assume, I would be very, very surprised

23:18

if it were not Treasury Bills.

23:22

So Germany's earning 6% on these Treasury Bills.

23:23

On the other hand the people that have bought the Marks,

23:26

they of course are not holding these Marks in pieces

23:29

of paper they are holding them at deposits of German bank.

23:33

But the German interest rate is much lower

23:36

than the American interest rate.

23:38

The interest rate in Germany, I'm not sure what it is

23:39

on a comparable Treasury Bill but the discount rate

23:41

in the U.S. is 6% and in Germany, if my memory is right,

23:44

it's about 3%.

23:47

-

I see.

23:49

-

So here you have, in addition to everything else,

23:50

the Germans as it were are earning 5%

23:52

on the four billion dollars and they are maybe paying 3%

23:55

on the counterpart in Marks, so in addition

24:00

to avoiding the cost of appreciating they are right now

24:04

earning a nice interest sum.

24:06

And even that understates it because if we get

24:10

to the final complication, the one real problem Germany has

24:13

with this is how to prevent this temporary inflow of Marks,

24:17

this speculative inflow of funds.

24:21

Speculative inflow of dollars and accumulation of Marks.

24:24

How to prevent that from causing monetary expansion

24:27

in Germany.

24:30

Just as I was saying earlier that when Germany runs a

24:31

surplus on current accounts this adds to the Mark funds

24:34

available to commercial banks and now, if similarly,

24:37

let's say a speculator buys a thousand marks with $250.

24:42

The German bank, he puts it in a commercial bank.

24:48

The German bank takes the $250 to the Central Bank,

24:51

it gets a thousand Marks, now it thinks it's got excess

24:54

reserves and can lend it out and that, in and of itself,

24:56

would produce very strong inflationary pressure

24:59

in Germany.

25:02

So in order for this whole operation to be feasible,

25:03

the German Central Bank has to offset this inflationary

25:06

pressure.

25:08

Now it could do so by open market sales,

25:09

but in fact, and again I turn to what's,

25:11

I'm reading in the newspaper they've been

25:14

doing it a different way.

25:15

The Germans have announced that they are going to require

25:17

their commercial banks to keep 100% reserves behind

25:19

such foreign deposits.

25:22

Well now the effect of this will be

25:24

that you sterilize any tendency for this inflow of Marks

25:26

to increase the internal money supply in Germany.

25:31

But also, it means that German banks will not be willing

25:34

to pay any interest on these Marks.

25:37

And so the situation is going to be that Germany will,

25:39

as it were, be able to earn 5% on the dollars

25:43

and will essentially be paying 0% on the Marks

25:45

that the speculators are holding.

25:50

And this will offset, this or, this will be a,

25:53

an added advantage to holding it,

25:57

but I suppose I haven't made the calculation.

25:59

I guess it would take, no would take a very long time

26:02

before that would offset the cost of appreciating,

26:05

I was saying they could wait,

26:07

-

(laughs)

-

until they earned enough interest to pay them off.

26:08

But that would be two years because of the 5% interest

26:10

rate and if we talk about a 10% depreciation.

26:13

But at any rate, you see, the net effect

26:15

of these operations, is that Germany is in a position

26:17

to hold this for a very long time on capital account.

26:21

In a way what you have is therefore, a test of patience,

26:24

between the German government in being unwilling

26:27

to give the speculators a gain

26:30

and the willingness of the speculators

26:35

to hold on.

26:37

Now from the point of view of the speculators

26:38

it's not costless.

26:40

Because it turns out that from the point of view

26:43

of the speculators, if you're buying Marks,

26:45

you are sacrificing the interest you otherwise could earn

26:50

on your funds.

26:52

And let's say that's 5% a year.

26:53

Well, that's still profitable if you're gonna wait,

26:56

if you're gonna wait three months, let's say,

27:00

and you think there's gonna be an appreciation

27:02

of 10% in three months, the interest cost

27:03

will only eat up about 2 1/2%, which will leave you with

27:06

7 1/2% profit.

27:08

But in addition to that there are the costs of buying

27:10

and selling, in addition to that, there is the risk

27:12

that it maybe six months, it may be nine months.

27:14

So, on the whole, my conjecture would be

27:17

that the Mark balances will decline substantially

27:21

and that they may, maybe they'll decline substantially

27:25

enough so that the German government will be willing

27:28

to pay the price of appreciating and getting this

27:30

off the sly.

27:33

Now, I should, finally in completing this round up

27:34

about that situation, say that so far as the sterling

27:37

and the franc problem, it makes their problem

27:41

very much harder.

27:43

Because one of the, I talked as if it was only dollars

27:45

that was being used to by Marks, but in fact,

27:48

it's francs and sterling that have been used to buy Marks,

27:52

and so the counterpart of this on the part of the British

27:56

and the French is that you have people coming

28:01

to the Bank of England with, with sterling

28:04

buying dollars from the Bank of England,

28:07

using those dollars to buy Marks in, in Germany.

28:09

So, the final piece you need to add to this

28:14

is that the reports in the paper point out

28:16

that French and British borrowing from

28:19

the U.S. Federal Reserve Bank, has gone up substantially.

28:22

So a large part of what's happened, I don't know

28:26

how big a part, is that instead of the French

28:29

and the British having these dollar balances,

28:32

the Marks now have it, the Germans now have it.

28:34

That's why the U.S. is largely, independent,

28:37

is not very much affected by this whole kind of operation.

28:40

But it does put greater pressure on the French

28:44

and the English and therefore increases the probability

28:46

of the devaluation of one or another of these currencies.

28:49

-

Thank you very much Dr. Friedman.

28:52

Don't forget if you subscribers have questions

28:54

that you would like to hear discussed on this series

28:56

please send them to Instructional Dynamics Incorporated,

28:59

166 East Superior Street, Chicago, 60611.

29:03

This is William Clark, Dr. Friedman and I will be

29:08

visiting with you again soon.

29:10

Tape 26 - Current Monetary Indication, Balance of Payments Deficit, Rush for German Marks

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