Why Did Europe Cooperate?

An important question remains. Many of the European economies had been keen to flex their newfound monetary muscle during the GAB negotiations to ensure they would have significant control over the new arrangement and, potentially, over US economic policy if a drawing were made. So why were they so quick to agree to US requests for swap arrangements? In essence, in agreeing to the swaps, they gave back everything they had gained in the GAB negotiations. Although it is true the arrangements eventually made the GAB redundant and diluted its power, they were not initially seen this way—at least from the European perspective. A key reason why the Europeans supported the swap arrangements has to do with the fact that they were viewed as only a "first line of defense” for the United States. If longer-term financing were needed, the Europeans expected the United States to convert any outstanding swap into a standby arrangement with the IMF or GAB.[1] Therefore, the Europeans did not initially think of the swaps as a mechanism that would almost entirely displace the need for the United States to seek IMF assistance, but only as the first of several steps the United States would progress through in correcting its own imbalances.[2]

Besides this, countries that partnered with the Fed stood to benefit from the swap lines in the future if their own economic fortunes changed.

As was the case with the GAB, it was clear from the outset that the United States was going to be a borrower in these arrangements—at least in the near term. However, there was no guarantee that those countries with balance of payments surpluses in 1962 would not find themselves in deficit within a few short years. Therefore, because the swap lines were reciprocal, opening up such an arrangement made dollars available to these countries as well (the value of this was not to be discounted for the European partners: after all, the dollar remained the key international currency despite its struggles). As one journalist at the time put it, "It is possible that the swaps will prove useful to some other country suffering a payments deficit and pressure on its currency. Indeed, American officials look forward to the day when they can come to the aid of some other central bank.”56 Swaps, then, naturally appealed to the European countries because they were a source of on-demand, flexible, unconditional credit. In one of several meetings with President Kennedy where the swap lines were discussed, Roosa makes this point, saying of the Europeans, "They are perfectly free to use these dollars if their balance of payments requires it.”57 In the end, this is exactly what happened. As Figure 3.2 indicates, the Fed became the primary provider of liquidity in the system not long after its creation.

A third reason the countries of Europe chose to cooperate with the Fed in the swap arrangement was the very real fact that there was a collective interest in maintaining a stable monetary system and the dollar-gold peg was the foundation of that system.58 In a sense, Europe faced a classic prisoner’s dilemma scenario where individual incentives push actors to consider actions that are collectively suboptimal. Individually, official dollar holders had incentives to defect and convert their dollars into gold given the constant fear that the United States would increase the dollar price of gold. However, if they all defected and rushed for the exits at the same time, they understood this would force dollar devaluation and bring about the unraveling ofBretton Woods. This would have been the worst outcome for everyone. What was needed was a system that would assure everyone the dollar could be defended against any serious onslaught, either by an a scale commensurate with IMF action. And it could take prompt action in more serious circumstances while IMF arrangements are being worked out. . . . [T]he System would not enter into long-term foreign exchange commitments . . it would not make arrangements under which the United States would acquire foreign exchange for a period of 3 to 5 years, as under IMF procedures. Federal Reserve foreign-exchange transactions and the proposed IMF arrangement would, therefore, complement each other. Both would play important roles in maintaining an efficient international payments system” (US House 1962, p. 91).

  • 56. New York Times 1964, p. 118.
  • 57. Naftali 2001, pp. 501-502.
  • 58. Eichengreen 2000, p. 7.

official source or private-market actors, thus reducing the incentive to defect. The swap arrangements helped to provide this assurance. In this case, the surplus countries had a very real incentive to provide easy credit to the United States. That is, "the potential lenders discovered that it was really in their interest to lend.”[3]

  • [1] Roosa felt that the only likely circumstance where the United States would have toconvert a swap line into an IMF standby arrangement is in the event of an "emergency situation,” that is, if the United States became involved in hostilities in Vietnam, and Europeancountries, in protest, attempted to convert dollar reserves into gold en masse (Naftali 2001,p. 502).
  • [2] Fed Chairman Martin described the use of the swaps in the same way beforeCongress: "The Federal Reserve would help to deal with minor pressures before they reach
  • [3] Stein 1965, p. 204.
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