Published by EH.Net (June 2013)

Carol M. Connell, Reforming the World Monetary System: Fritz Machlup and the Bellagio Group.? London: Pickering & Chatto, 2013.? xi + 271 pp. $99 (hardcover), ISBN: 978-1-84893-360-6.

Reviewed for EH.Net by Herbert Grubel, Department of Economics, Simon Fraser University.

Carol Connell is Professor of Finance and Business Management at Brooklyn College.? Her book?s main focus is on the achievements of Fritz Machlup, a legendary personality who was a member of a group of economists who fled Austria during the 1930s and who for many years taught economics at Princeton University.? The material in the book is based on the study of Machlup?s letters and other documents archived at Stanford University.? The author writes with exemplary clarity in a superb analytical framework.

Machlup was keen on research methodology, which is one of Connell?s professional interests as it applies to decision making in business.? As a result she discusses in some detail how Machlup imposed his methodological ideas on the deliberations of groups of academics, officials and business leaders concerning the problems faced by the international monetary system starting in the late 1950s.? He insisted that conference participants present their views on current problems and spell out the assumptions they used reaching them.? He then encouraged participants to discuss and challenge each other?s views and assumptions, expecting the group to arrive at a clear understanding of the problems faced by the international monetary system at the time.? Out of this understanding was expected to emerge a solid set of recommendations for changes in policy and institutions.

These discussions started in 1964 at meetings held in Bellagio, at a Villa owned by the Rockefeller Foundation, overlooking beautiful Lake Como in Italy.? The leading personalities and intellectual driving forces behind the initial Bellagio group meetings besides Machlup were Robert Triffin and William Fellner, who both had great influence on my professional development and interests as my teachers at Yale (1958-62).? Connell meticulously lists all of the participants at the Bellagio group meetings and a number of other groupings of individuals that emerged later.? The list of participants reads like a Who?s Who of the international economics establishment of the period 1950-80.

The problems of the international monetary system in the 1950s had their roots in the decision made at Bretton Woods in 1944 to create a collective institution that centered on fixed exchange rates in an effort to avoid a repeat of the chaos caused by competitive devaluations during the Great Depression of the 1930s.?

In this system, dollars convertible into gold provided the world central banks with liquidity needed to deal with temporary payments imbalances.? Triffin in a 1960 book argued that this system resulted in a dilemma.? The supply of liquidity depended on continuous U.S. deficits, which were unsustainable as they decreased the ratio of the country?s gold holdings over the dollar obligations held by foreigners.? If the U.S. stopped running deficits, the supply of reserves would dry up.? If the price of gold were raised, countries would no longer be willing to hold dollars because of the risk that future price increases would result in financial losses.

The solutions needed to deal with this dilemma in principle were identified by Machlup?s groups as ?adjustment, liquidity and confidence.??? The specific recommendations surrounding adjustment involved a wide range of ways in which exchange rates could be made flexible.? Milton Friedman was the dominant proponent of totally freely floating rates.? Adjustable pegs with and without bands, crawling pegs and other variants were advocated by different people.?

The solution to the liquidity problem similarly elicited many different suggestions involving such arrangements as multiple currency reserves, ex ante agreements among central banks to provide liquidity to each other and the expansion of IMF resources in the form of Special Drawing Rights.? No solutions were offered to speculative capital flows in the wake of confidence lost in countries? ability to maintain an official exchange rate.? After she presents the gist of all of these ideas for reform, Connell concludes ?These were exciting days to be an economist.?

The author considers what influence the work Machlup and his committees had on public policy.? She provides quotes from prominent economists and officials suggesting that the influence was substantial.? However, the professional consensus about the need for greater exchange rate flexibility was also driven by a paradigm shift away from reliance on all-knowing policy makers to the increased use of market signals and from Keynesian demand management and the Philips Curve concept to monetarism and its emphasis on price stability.

There is no doubt that the present international monetary system works better than it did in the period when Machlup did his work, not because of the adoption of any one of the grand reform schemes discussed in many of the meetings he had organized.? It works better for the practical reasons that the world has accepted the non-convertibility of dollars into gold and that if a country no longer wishes to accumulate dollar reserves, it can always use national policies to stop running payments surpluses.? The United States in essence is pursuing the policy of ?benign neglect? proposed by Gottfried Haberler at the height of the international financial crisis in the late 1960s.? The IMF is a useful forum for discussion and source of intelligence, but the system works acceptably well without its exercise of power over national policies envisaged by utopian planners in the past.

The flexible exchange rate system has allowed countries the freedom to pursue domestic economic policies without external restraints, but it has given rise to the most pressing problems of our era ? irresponsible politicians running unsustainable budget deficits.?

Herbert Grubel, Professor of Economics (Emeritus) at Simon Fraser University, is the editor of World Monetary Reform: Plans and Issues, Stanford: Stanford University Press (1963) and of The International Monetary System: Efficiency and Practical Alternatives, Penguin Books (first edition 1969, fourth and final edition 1987).

Copyright (c) 2013 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator ( Published by EH.Net (June 2013). All EH.Net reviews are archived at