Fritz Machlup · 1978
Machlup’s commentary is a pointed post-Jamaica critique framed as a response to Dr. Slighton’s attempted defense of the 1976 Jamaica Agreement. His central claim is that the agreement should not be treated as a genuine reform of the international monetary system, because it fails to establish an adequate adjustment mechanism or a disciplined apparatus for controlling international liquidity. Slighton, in Machlup’s reading, effectively grants the strongest criticisms by acknowledging the agreement’s incompleteness.
“the good arguments of the prosecution were absolutely correct.”
The argument proceeds by separating simplified objections from serious economic criticism. Machlup does not deny that reserve creation is complex: additional reserves do not mechanically produce world inflation. His alchemist examples dramatize that reserves become inflationary only through the policies of those who receive them. The analogy to domestic money is explicit: money can be inert if held idle, but dangerous if it enables delay, spending, or intervention.
“if lots of money is created and given to certain persons who sit on it, nothing happens.”
This qualification sharpens rather than weakens the critique. The real issue is adjustment. Countries with ample reserves can postpone necessary correction, while countries that intervene by buying foreign exchange may expand their domestic money supplies. Liquidity and adjustment are therefore not separate problems but mutually reinforcing failures of the post-Jamaica order.
“The two things hang together.”
Machlup’s most important conceptual move is to challenge the idea that private markets can supply sufficient discipline under flexible exchange rates. In the U.S. federal funds market, banks can lend reserves to each other without changing the ultimate stock of reserves controlled by the Federal Reserve. Internationally, however, claims created in private or official markets may themselves be treated as reserves. Borrowing reserves abroad is therefore not merely a faster circulation of a fixed stock; it can enlarge the effective reserve base.
“In the international private market, there is no similar ultimate reserve of a limited size.”
From this follows his refusal to accept negotiability as the measure of monetary wisdom. If a sound system cannot be negotiated, the conclusion should not be that the negotiated settlement is sound, but that negotiation has failed. He treats “politically impossible” as a temporary educational condition rather than an analytic limit, recalling that dollar devaluation and flexible rates were once unspeakable in official circles.
“What is politically possible is a matter of education and a matter of making things understood.”
The constructive part of the commentary sketches three routes for controlling liquidity creation. First, increases in exchange reserves might be restrained through rules governing intervention in foreign-exchange markets. Second, gold reserves require active management, perhaps through a substitution account that exchanges gold for SDRs at a gradually declining rate, making early substitution attractive and gold holding increasingly costly. Third, SDR creation could be disciplined through arrangements resembling the Witteveen Plan, tying total reserves to required SDR holdings.
Machlup’s discussion of gold is especially striking. He rejects the notion that gold must remain a source of reserve expansion or rising value. Its scarcity, he argues, is politically manufactured by central banks keeping vast stocks off the market, much as the value of Picasso paintings would fall if large hidden stocks were suddenly sold. With cooperative official management, gold need not destabilize liquidity.
“gold, by wise management by the authorities and intelligent agreements among them, need not ever become a source of additional liquidity.”
The commentary insists that flexible exchange rates do not eliminate the governance problem of international money. Reserve accumulation, market borrowing, official intervention, SDR allocation, and gold management all remain institutional questions. Machlup’s argument is both critical and experimental: he condemns Jamaica as neither “a reform nor a good system,” yet urges economists and officials to risk proposing mechanisms that may initially appear impractical.
“out of foolish things, wise things may be distilled.”
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