Journal of Management History

Reforming the world monetary system: How Fritz Machlup built consensus among
business leaders and academics using scenario analysis
Carol M. Connell,
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JMH
17,1 Reforming the world
monetary system
How Fritz Machlup built consensus among
50 business leaders and academics using
Downloaded by Universitas Islam Negeri Maulana Malik Ibrahim, UIN Maliki At 19:18 03 September 2018 (PT)

scenario analysis
Carol M. Connell
Department of Economics, Brooklyn College, City University of New York,
Brooklyn, New York, USA

Abstract
Purpose – The purpose of this paper is to examine Fritz Machlup’s method and use of scenario
analysis in the policy discussions around exchange rate solutions to balance of payments problems.
Design/methodology/approach – The qualitative research on which this paper is based is the
sociohistorical biographical approach, based on a close examination of published works and archival
materials.
Findings – What makes Machlup unique is his focus on the impact to an economic system of discrete
human actions, each set of actions associated with a change in exchange rate policy and the operations
and institutions necessary to implement it. Impact on the system was evaluated in terms of three
values – balance of payments adjustment, liquidity and confidence. In his use of a system’s approach,
his focus on change and adjustment to change, and most particularly his focus on human action,
Machlup is also distinctively Austrian.
Research limitations/implications – This is the first paper generated from the author’s far larger
planned study of Fritz Machlup and the Bellagio Group.
Practical implications – The collaborative exploration of alternative futures by senior teams has
become increasingly important to strategic planning by governments and corporations.
Originality/value – The story of the Fritz Machlup’s contribution to exchange rate regimes,
international trade and the balance of payments has remained largely untold.
Keywords Exchange rate mechanisms, Monetary policy, Balance of payments, International economics
Paper type Research paper

Journal of Management History
Vol. 17 No. 1, 2011
pp. 50-65
q Emerald Group Publishing Limited
1751-1348
DOI 10.1108/17511341111099529
Nearly a half-century before the financial crisis of 2008, there was another time when
reforming the world monetary system was on everyone’s lips and many academics and
policy makers were developing and attempting to promote plans for its reconstruction
before illiquidity, speculation and loss of confidence brought the system to a predicted
ruin. This paper examines Fritz Machlup’s contribution to exchange rate regimes,
international trade and the balance of payments during the 1960s, a story that remains
largely untold. The paper begins with a brief review of the scenario analysis literature,
focusing on the role of Austrian economists in its development and importance to
strategic planning (first section) and then discusses Fritz Machlup’s background and
methodology (second section). The historical context and politics of balance of payments
problems and alternative exchange rate regimes as a solution to these problems is
discussed in the third section. The fourth and fifth sections focus on the use of scenarios
in the conferences Fritz Machlup organized for academics and business leaders
 to discuss the impact of exchange rate change on the stability of the world financial Reforming
system. Finally, the sixth section addresses the impact of Machlup’s scenarios approach. the world
monetary system
The scenario analysis literature
Scenario analysis attempts to capture the nonlinearity, complexity and unpredictability
of turbulent environments, macroeconomic and corporate, by incorporating techniques
for eliciting and aggregating group judgments. If this sounds very much like the nature 51
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of strategic planning itself, that is because the collaborative exploration of alternative

futures by senior teams has become increasingly important to strategic planning by
governments and corporations[1]. Nevertheless, as a method of strategic planning in
corporations, scenario analysis has been adopted but not understood by a number of
introductory text books. Scenario analysis is not an assessment of best case/worse case,
not an exercise in creative wish fulfillment, and not a tool for deducing correct strategies.
As Loasby (2002) reminds us, however secure the logic, human design is fallible. The
future remains uncertain; at best scenario analysis allows us to explore alternative
hypotheses and embody them in artefacts and institutions that form the premises for
decision making (Loasby, 2002).
With its emphasis on uncertainty and the fallibility of human action, Austrian
economics is particularly relevant to scenario analysis and strategic planning, and its
contribution has received renewed attention from Jacobson (1990, 1992), Loasby (2002),
Salerno (1994), Nicholai Foss (2007) and Klein (2008), among others. Jacobson (1992)
argues that the Austrian emphasis on “the market process” and “entrepreneurial
discovery,” the importance of “unobservable factors” (culture, luck, customer satisfaction
in Jacobson’s view and entrepreneurial judgment and vision in mine) and the existence of
“strategic windows,” limited periods when corporate capabilities are aligned to pursue
unexplored opportunities have been incorporated into the resource-based view of the
growth of the firm. Foss calls these unobservable factors “beliefs” or “expectations,”
including the expectations that managers have about the behavior, beliefs and actions of
others – managers and policy makers – who are engaged in the game (Foss, 2007, pp. 1-3).
In a discussion of the equilibrium states of Austrian analysis, Klein (2008, p. 172) notes
that Mises’ considered the ideas of a final state of rest and that of an evenly rotating
economy to be:
[. . .] “imaginary constructions” [. . .] hypothetical scenarios that do not obtain in reality, but
are useful in economic reasoning, allowing the theorist to isolate the effects of particular
actions or circumstances, holding all else constant.
Aligica (2007) finds the roots of scenario analysis in the methodological individualism
and uncertainty of Menger, Mises and Hayek. Proops and Safonov (2005, p. 59) track
the use of alternative futures to Bohm-Bawerk at the turn of the century, arguing the
Austrian approach was significantly different from the dominant neo-classical
approach in that the former is empirically oriented, so the prime aim is to represent
activities observed rather than preconceptions about human behavior and human
motivation. In contrast with Bohm-Bawerk, Machlup’s model was designed not to put
the assumptions of economic theory to empirical test, but only the predicted results
that are deduced from them, empirically verifying the results by observed data. In the
following section, we will examine Fritz Machlup’s background and the methodology
he created for understanding the impact on change on economic systems.
 JMH Fritz Machlup: background and methodology
17,1 Fritz Machlup’s lifelong interests in monetary economics, methodology and knowledge
were shaped by his Austrian economics roots. Machlup’s 1923 University of Vienna
dissertation on the gold-exchange standard, Die Goldkernwahrung, was supervised by
Ludwig von Mises and published in 1925. It was followed by Die neuen Wahrungen in
Europa in 1927, a book in which he described the adoption of the gold-exchange
52 standard by one country after another, as well as his work on the transfer problem, the
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price of gold and the theory of foreign exchanges, all three of which were reprinted in
International Payments, Debts and Gold (Machlup, 1964b). While Machlup has generally
been classified as a “neoclassical” economist, Langlois and Koppl (1991) and Koppl
(1992) have positioned Machlup far from the neoclassical mainstream. While a key
problem for Machlup, as for Mises (1936) and Hayek (1945) and others in the Austrian
tradition, was how economic actors adapt to unanticipated change, Machlup’s
unconventional version of marginalism produces a process story appropriate for
analyzing adjustment to exogenous change using a four-step adjustment model in which
steps 1 (initial equilibrium) and 4 (final equilibrium) are methodological devices in a
mental experiment designed to analyze causal connections between a disturbing change
(step 2) and an adjusting change (step 3). To verify that a disturbing change has
produced the predicted or desired adjusting change, Machlup designed a mental
“machine” to put the predicted results to empirical test (Machlup, 1978, p. 143). While the
model consists of many parts, all of which represent assumptions or hypotheses of
different degrees of generality, the so-called fundamental assumptions are a fixed part of
the machine; they cannot be changed without changing the character of the machine.
All other parts are exchangeable (Machlup, 1978, p. 148)[2]. The exchangeable parts of
Machlup’s model are a series of disturbing (inputs) and adjusting (outputs) changes
caused by a sequence of individual actions and reactions that must be explained or
accounted for in terms of the knowledge, preferences and expectations of the individuals
doing the acting. Hence, the knowledge, preferences and expectations of the actors must
provide sufficient cause for their actions and seem reasonable and understandable in
commonsense terms (Koppl, 1992, p. 303). In the conferences Machlup would organize
around balance of payments problems and exchange rate regimes, causal connections
between disturbing changes (change in exchange rate regime, in this case) and adjusting
changes (effect on payments balance/imbalance, liquidity increase/decrease and
confidence increase/decrease) would become essential to a comparison and evaluation of
the viability of the alternative exchange rate systems under discussion.

International payments problems: context, alternative exchange rate

regimes and their advocates
Setting out to examine alternative exchange rate scenarios, Fritz Machlup was fully
aware that the viability of each depended of its ultimate effect on balance of payments
adjustment, liquidity and even the confidence-in-the-system factor. This meant an
examination of the assumptions underlying each exchange rate regime, recognizing and
weeding out value judgments and political biases and the precise meshing of institutions
and operating systems to support the regime. At the time Machlup began his study, the
Bretton Woods financial order – with its intricate web of rules and institutions –
provided choice fodder for analysis. The fixed exchange rates of Bretton Woods’ gold
exchange standard affirmed the primacy of domestic economic goals, which included
 the maintenance of full employment over strict balance of payments concerns; hence, the Reforming
Bretton Woods order failed the adjustment test. Stability in exchange rates required the world
stability in prices of goods traded between countries, but inflation or deflation in
different nations would necessarily force shifts in exchange rates; the foundation of monetary system
the Bretton Woods order, however, was a fixed gold-exchange rate. In addition, the
agreement was faulted in its ability to provide liquidity to the system through the
transfer of reserve assets from debtor to surplus countries. The universally accepted 53
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asset – gold – was in the control of a handful of countries, and a primary one, Russia,
was outside the system entirely. When sterling was deemed less than fully convertible in
1947, the US$ was left as the sole reserve currency or currency accepted for international
payments. With the USA running persistent deficits, the entire balance-of-payments
system was inherently unstable. The USA and Europe shared a common fear: because
central bankers could cash in dollars for gold at any time, one day the ratio of dollar
liabilities to American-held gold might increase to a level that might cause a loss of
foreign confidence in the dollar and a run on the US Treasury gold window (Greider,
1987). American and European policy makers shared a common history: the global
recession turned depression had unleashed monetary chaos and devaluations, which
unleashed beggar-thy-neighbor policies and economic nationalism, which produced
dictatorships, which unleashed world war (Gavin, 2004, p. 14).
Ever since 1950, the USA, through its purchases, investments (direct and indirect
foreign direct investment), loans and aid, had put at the disposal of foreign countries
more dollars than these countries had used for their purchases in the USA. US Presidents
Dwight Eisenhower, John F Kennedy and Lyndon Johnson considered US payments
deficits a problem as critical to US security as the nuclear threat. Kennedy calculated
that US payments deficit in 1962 was equal to the cost of maintaining US troops in
Europe and weighed the advantages of eliminating the deficit by recalling the troops or
negotiating with the French as the USA had with Germany to pay for the troops via
US armaments purchases, thus allowing the USA to use the cash received to retire the
deficit. Cold War Presidents were concerned that the Soviet Union might pursue an
alliance with Germany or that France might pursue an alliance with Germany, pushing
the USA out of European affairs. Along with some European colleagues, US policy
makers and economists more than happy to exchange the dominant reserve currency
position for a basket of reserve currencies backed by gold. Others wanted to eliminate
gold completely and set exchange rates free to float (Solomon, 1977).
Four major exchange rate policy alternatives emerged, each with its advocates.
The multiple currency approach, first introduced by Friedich Lutz of the University of
Zurich, would have replaced the dollar as reserve currency with a basket of currencies,
each convertible to gold on request. At the same time, others were suggesting that a
semi-automatic gold standard should replace the current gold-exchange regime. Jacques
Rueff, close advisor to French President Charles de Gaulle, believed that international
deviation from the gold standard was behind the global financial meltdown. In 1961,
he encouraged de Gaulle to take steps to end the dollar’s role as an international reserve
currency. Similarly, Michael Heilperin, a professor at the Graduate Institute of
International Studies in Geneva, proposed a “managed” form of gold standard (just as
the pre-1914 standard had been a system of managed gold-linked currencies). In two
phases, the plan called for nations to pay all future external deficits on current account
in gold, and later doubling the price of gold to $70 per ounce. Increasing gold’s price
 JMH was also the basis of a proposal to “fix” Bretton Woods by Sir Roy Harrod of Oxford
17,1 University. Unlike Rueff and Heilperin, he did not propose to eliminate existing dollar
(and sterling) balances from official monetary reserves, but contended that doubling the
price of gold would raise reserves by $40 billion and allow participating countries to
expand domestic credit in pursuit of higher growth and full employment.
Among those taking a broader view altogether – the creation of a world central bank
54 could create international reserves and make the banking system shock proof, therein
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multiplying the capacity of the world monetary system – were, of course, John Maynard
Keynes and Robert Triffin of Yale. Keynes had called for the creation of an International
Clearing Union and a new international currency, while Triffin supported an extended
role for the IMF as central banker, acting not as the lender of last resort but as guarantor.
Finally, a fourth policy scheme proposed a system of flexible or “floating” rates,
adjusting to market conditions. Harry Johnson of the University of Chicago focused on
the threat to international liquidity by the conversion of national currencies into gold at a
fixed rate, and the reality that gold supplies were insufficient to meet the demands of the
monetary authorities to increase their holdings. Richard Caves, Milton Friedman,
Gottfried Haberler, Albert Hahn, George Halm, Friedrich Lutz, James E. Meade and
Egon Sohnen were among those making similar arguments.
Fritz Machlup’s goal was to bring together several of the economists whose plans on
international monetary reform had been widely discussed – especially those with
notoriously divergent views – to consider the assumptions underlying their plans and
the impact of those plans on payments adjustment, liquidity and confidence. In fact,
while all of the economists invited to participate in the series of conferences Machlup
planned were academic economists, nearly all were former members of the International
Monetary Fund, Bank of International Settlements, Organization of Economically
Developed Countries, Federal Reserve – or were advisors to the heads of their national
governments (Table I).

The Bellagio Group conferences: origins, process and ground rules for
scenarios, the scenarios and their lessons
Origins
The idea for series of conferences exploring the impact on payments adjustment,
liquidity and confidence came to Fritz Machlup and his colleagues Robert Triffin and
William Fellner as they sat at a press conference called by the Annual Meeting of the
World Monetary Fund in Washington, DC on October 2, 1963. Then Secretary of the
Treasury and a Governor of the International Monetary Fund Douglas Dillon announced
at the launching of two studies on “the outlook for the functioning of the international
monetary system,” one to be undertaken by government economists of the Group of Ten;
the other study was to be made by International Monetary Fund economists. As
“academic economists” whose potential contribution was being ignored, Machlup,
Fellner and Triffin felt challenged to embark on a study themselves, involving
economists who had widely divergent views, with no problem or proposal considered
“out of bounds” (Machlup, 1964a, p. 6). Funds for an initial series of four conferences
were donated by the Ford and Rockefeller Foundations.
The first conference was described by Machlup as an experiment designed to
isolate the assumptions underlying the major policy recommendations to determine
where the policies diverged. With only ten members and five observers, this conference
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Member
Prof. Arthur L. Bloomfield
Prof. Lester Chandler
Prof. Alan C. L. Day
Prof. Pierre Dieterlen
Prof. Leon Dupriez
Prof. William J. Fellner
Prof. Alberto Ferrari
Prof. Gottfried Haberler
Prof. Albert Hahn
Prof. George Halm
Sir Roy Harrod
Prof. Michael Heilperin
Mr Fred Hirsch
Prof. Harry G. Johnson
Prof. Fritz de Jong
Prof. Peter B. Kenen
Prof. Charles Kindleberger
Prof. Kioshi Kojima
Dr Alexandre Lamfalussy
Prof. Friedrich Lutz
national affiliations
institutional and
Group members, their
Attending Bellagio
Table I.
Nation
Institution Former public policy role represented
University of Pennsylvania Federal reserve USA
Princeton Federal reserve USA
University of London UK
National Center of Author with Charles Rist of The Monetary Sin of the West (Rueff, 1949) France
Scientific Research
University of Louvain National Bank of Belgium Belgium
Yale University Council of Economic Advisors USA
University of Rome Secretary General, Bank of International Settlements Italy
Consorzio di Credito per le Opere Pubbliche
Harvard University Federal Reserve, National Bureau of Economic Research USA
University of Frankfurt Banker, Bankhaus L. Albert Hahn Germany
Fletcher School of Law Doctoral mentor of C. Fred Bergsten, who became a member of the senior USA
and Diplomacy staff of National Security Council under Richard Nixon
Oxford Economic Advisor to Harold Macmillan, Conservative Prime Minister in UK
1957-1963. Consultant, International Monetary Fund
Institut Universitaire Academy of International Law, The Hague Geneva,
de Hautes Etudes Switzerland
Internationales
The Economist Senior Advisor in the Research Department of the IMF UK
University of Chicago USA
University of Groningen Labor Party of Groningen The Netherlands
Columbia University President Kennedy’s Task Force on Foreign Economic Policy, the Review USA
Committee on Balance of Payments Statistics and the Economic Advisory
Committee of the Federal Reserve Bank of New York
MIT Federal Reserve, Bank of International Settlements USA
Hitotsubashi University Pacific Free Trade agreement proposal in 1966, leading to the Japan
establishment of both the Pacific Economic Cooperation Council and to
APEC
Banque de Bruxelles Banker, Banque de Bruxelles General Manager, Bank of International Belgium
Settlements
University of Zurich President, Mont Pellerin Society, 1964-1967 Switzerland
(continued)
Reforming
monetary system
55
the world
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56
17,1
JMH

Table I.
Nation
Member Institution Former public policy role represented

Prof. Fritz Machlup Princeton Founder, Mont Pellerin society USA

Prof. Burton Malkiel Princeton Protégé of Machlup; later, Member of Council of Economic Advisors USA
Prof. Hans Moller University of Munich Germany
Prof. Robert Mundell McGill University Adisor to United Nations IMF, the World Bank, the European Commission Canada
and several governments in Latin America and Europe, the Federal
Reserve Board, the US Treasury and the Government of Canada
Prof. Jurg Niehans University of Zurich Swiss Diplomatic Corps Switzerland
Prof. Bertil Ohlin Handelshogskolan Minister of Commerce (1944-1945) in Sweden’s wartime government; Sweden
leader, Liberal Party in Sweden from 1944 to 1967, and member of the
Riksdag (parliament) from 1938 to 1970
Prof. Jacques Rueff Cousul for Economic Economic Advisor to French President Charles de Gaulle France
and Social Affairs
Dr Walter Salant Brookings Institution Treasury Department, Securities and Exchange Commission, Commerce USA
Department in the 1930s, and, in the 1940s, the Office of Price
Administration, senior staff member for international relations on the
President’s Council of Economic Advisers from 1946 to 1952, consultant to
NATO and in the Treasury Department in the Kennedy and Johnson
Administrations
Prof. Tibor Scitovsky University of California OECD USA
Prof. Egon Sohmen University of the Saar In late 1960s, with Herbert Giersch, wrote a defense of flexible exchange Germany
rates, submitted to the Saarbrucken Government and drawing the support
of 100 economists in Germany when it went public
Prof. Robert Triffin Yale University Federal Reserve, IMF USA
Dr Pierre Uri Atlantic Institution Aide to Jean Monnet French Reconstruction Plan, which was part of the France
Schuman Plan that created the European Coal and Steel Community
 was held at Princeton, December 18 and 19, 1963. As Machlup argued in his letter of Reforming
invitation to Roy Harrod: the world
Presumably, we all use the same logic. Hence, if we arrive at different recommendation we monetary system
evidently differ in the assumptions of facts or in the hierarchy of values. To identify and
formulate these assumptions would, I believe be a major step toward a better understanding
of the present conflicts of ideas[. . .] (Fritz Machlup Papers, Box 43, folder 10).
57
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Scenario building – process

At a second conference, held from January 17 through January 23 at the Villa Serbelloni
in Bellagio, on Lake Como in Italy[3], advocates of each of the four alternative exchange
rate regimes were asked to enumerate the positive assumptions associated with his plan
and the reasons he preferred his plan to alternative systems. The inquiry took the form of
hearings: one or two protagonists were asked to submit to cross-examination by the rest
of the group. On the basis of notes taken during these sessions, drafting committees
worked every night on the formulation of statements of assumptions made in the
advocacy of each major policy system. In the weeks that followed, members were asked
to state their positions concerning each of the assumptions listed. Revised versions of the
lists of assumptions were discussed during the third conference in Princeton, March 21
and 22. Further revised and re-edited lists of assumptions were again distributed, this
time with questionnaires inviting answers on each assumption before the fourth and last
conference, again held at Villa Serbelloni in Bellagio from May 29 through June 6, 1964.
The task of this conference was not only to determine the final versions of the lists of
assumptions on the basis of which different approaches to a satisfactory monetary
system could be advocated, but also to write a report of the conference results.
While no transcript of the actual conference conversations exists (unlike later
conferences where a transcription was provided by several of the business leaders),
economist Robert Triffin acknowledged “Each of us had to defend his proposals against
the criticisms of other participants and to explain why he could not agree with their own
proposals” (Triffin, 1978, p. 149).

Scenario building ground rules – getting at fundamental assumptions

From the outset, Machlup posited four common sources of disagreement in the expressed
opinions of reputable economists: logical fallacies, semantic confusion from ill-defined
terms, different hunches “about essential but unavailable information, particularly the
unpredictable responses of central bankers and other decision makers to future problems
and developments” (Triffin, 1978, p. 148). Additionally, value judgments and political
attitudes were especially important to Machlup who urged participants to frankly state
what their recommendations would be if the constraints of “political feasibility” were
removed. Machlup warned against confusing political assumptions with value judgments.
Most important to the examination of exchange rate regimes and their impact on
payments adjustment, liquidity and confidence, Machlup hoped that the reasons for
disagreement on balance of payments, liquidity and confidence issues could be isolated
and classified according to a variety of separate categories, leading to a common
understanding of the kinds of imbalances, liquidity or confidence problems that could be
adjusted using exchange rates and the kind that could not. The conferees were asked
to classify the many different possible causes of payments imbalance into a few major
 JMH types, distinguished by the frequency with which they were likely to occur (Machlup,
17,1 1964a, pp. 43-5).
Given the ground rules discussed above, advocates for each exchange rate proposal
developed a set of assumptions which, if accepted as pertinent, correct and realistic would
justify the adoption or adaptation of a particular system and rejection or modification of
the others. Assumptions covered three questions (Machlup, 1964a, pp. 71-4). In what
58 respects are the present-day system and the three other proposed systems inferior to the
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one under consideration? What are the essential arrangements which characterize the
system? What are some of the necessary conditions for the system to work in the intended
fashion? What potential modifications to the system might you make? The lists of
assumptions concerning the four systems were uniformly organized under headings
roughly corresponding to the questions posed above so that they could be compared by
all the economists attending.

Lessons
Advocates of the four major policy proposals – semi-automatic gold standard,
centralized international reserves, multiple currency reserves and flexible exchange
rates found they shared assumptions about the prevailing gold standard, holding it
unsustainable because since it required a progressive increase in the ratio of the liquid
liabilities of reserve-currency countries to their gold holdings which threatened the value
of the reserve holdings of other countries, undermining confidence in the stability of the
system.
Advocates of centralizing international reserves and replacing a single reserve
currency with multiple currency reserves (disturbing changes) policies found that their
shared assumption, gold-exchange standard in the one instance and semi-automatic
gold standard in the other, were based on the same haphazard approach to gold
production and did not ensure against excessive or deficient holdings, leading to
liquidity problems (adjusting change). They also shared the assumption that, under
existing and foreseeable circumstances, the adjustment mechanism would fail to work
fast enough to enable countries to finance their deficits with available international
reserves and borrowing facilities (adjusting change), with the result that satisfactory
growth of world trade and capital movements could not be reconciled with full
employment and stable prices (adjusting change). While in all other respects the policies
diverged in terms of arrangements, institutions and operations, centralized reserves and
multiple currencies advocates were in complete agreement that domestic and
international stability were mutually dependent on full employment, stable prices,
responsible adjustment with inflation/deflation depending on surplus/deficit country
status and avoidance of tariffs/trade controls.
Further, the comparison of the four scenarios and the systems effects of their
underlying assumptions encouraged economists to reach consensus on the requirements
for any acceptable exchange rate regime (Machlup, 1964a, pp. 101-2):
.
Because balance of payments disturbances differ substantially in source and
duration, the differences between them necessitate different responses.
.
Persistent adjustments of payments imbalances should be initiated promptly
with the smallest loss of income and employment and, to this end, interim
financing should be available.
 .
The financing of reversible disturbances requires the use of official reserves and Reforming
reserves should be expanded to meet needs. the world
.
The protection of the large outstanding foreign-exchange component of the monetary system
world reserve pool against sudden or massive conversion into gold should be a
high priority.
.
There was broad consensus on the importance of exchange rate change as a
preferred method of adjustment. 59
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Exploring scenarios with corporate leaders – the Burgenstock conferences

In 1968, with new funding from the Ford Foundation for two closely timed conferences –
one in Oyster Bay Long Island and one in Burgenstock, Switzerland, Fritz Machlup
extended the scenario exercises to include a group of practitioners, drawn from
international corporations, including many international banks, active in
foreign-exchange dealings, as well as academic economists (most of whom had been
attendees of the Bellagio Group conferences). The practitioners were largely bankers,
but they included as well representatives of international corporations IBM, Standard
Oil Company and Olivetti, companies with an active foreign exchange department.
In a report to the Ford Foundation on the selection of business leaders to join the
Burgenstock conferences, Fritz Machlup said that he had chosen them because of the
major forward exchange issues that would influence their support or rejection of
changes to the existing system (Table II).
In preparation for the first conference, Machlup had commissioned a poll of industrial,
banking and government-services firm leaders. Five questions were asked: have you
experienced problems or difficulties which can be ascribed primarily to the system of
fixed change rates? Do you feel that a different system allowing for wider fluctuations or
for periodic and systematic increases or decreases in parities would facilitate your
operations? Would you prefer a system allowing wider trading ranges? Would you prefer
a system in which demonstrably overhauled currencies would be devalued or revalued
fractionally over a period of time (the “crawling peg” concept)? Would you prefer a
system with no fixed parities, based on floating rates? With a general distaste for
uncertainty and change, the overwhelming response of business leaders to all questions
was “no,” (no change to the existing system), but this status could change dramatically as
a result of rigorous conference discussion (Fritz Machlup Papers, Box 285).

Scoping the problem

Machlup opened the first conference with a talk on the definition of terms and the need
for clarity. He then put up a 2 £ 2 matrix for the discussion of nine scenarios for
exchange rate flexibility, including unmanaged and managed rates with unlimited and
limited variability and with varying degrees of discretionary action by national
authorities, international agreement or fixed formula (Table III).
At the outset, the group began with several questions about classification. Professor
Lundberg asked if “passive” intervention be judged simply from the size and direction of
reserve changes? Several European conference members noted that the close relationship
between central banks and government made this kind of intervention more difficult to
track. Swiss banker Max Ikle observed that as long as the dollar is exchangeable into
gold, it cannot be considered to be “managed.” George Chittenden of Morgan
Guaranty Trust then asked if the intention of the group was to assume a continuation
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60
17,1
JMH

Table II.

affiliations
their institutional
conference members,
Attending Burgenstock
Academic Institution Corporate Institution

Prof. Francis M. Bator
C. Fred Bergsten
Prof. Richard N. Cooper
Prof. William Fellner
Prof. Milton Friedman
Prof. Herbert Giersch
Prof. Gottfried Haberler
Prof. George Halm
Prof. Harry G. Johnson
Prof. Peter Kenen
Prof. Albert Kervyn
Prof. Erik Lundberg
Prof. Friedrich Lutz
Prof. Fritz Machlup
Prof. Robert Marjolin
Prof. James E. Meade
Prof. Robert Mundell
Dr Peter Oppenheimer
Dean David W. Slater
Prof. Egon Sohmen
Prof. Thomas D. Willett
Harvard University W.F. J. Batt
National Security Council James W. Bergford
Economic Growth Center George H. Chittenden
Yale University Michel Fribourg
University of Chicago Edward R. Fried
University of the Saar David L. Grove
Harvard University Dr M. W. Holtrop
Fletcher School, Tufts University Mr Tadashi Iino
University of Chicago Dr Max Ikle
Columbia University David J. Jones
Universite catholique de Louvain Dr Lawrence Krause
Stockholm School of Economics Emil Kuster
University of Zurich Dr Helmut Lipfert
Princeton University Ake Lundgren
University of Nancy Stephen Marris
Cambridge University Donald B. Marsh
University of Chicago Guiliano Pelli
Oxford University Edwin A. Reichers
Queen’s University, Canada Paolo Rogers
University of the Saar Dr Robert Roosa
Harvard University Lars-Erik Thunholm
Dr Merlyn N. Trued
C.M. Van Vlierden
John H. Watts III
Pierre Haas
Westminster Bank Ltd
The Chase Manhattan Bank
Morgan Guaranty Trust Company
Continental Grain
National Security Council
IBM Corporation
De Nederlandsche Bank
Mitsui Bank Ltd
Eidgenossische Bank
Standard Oil Company of New Jersey
Brookings Institution
J. Henry Schroeder Banking Corp.
Westdeutsche Landsbank Girozentrale
Scandinaviska Banken
OECD
Royal Bank of Canada
Swiss Bank Corporation
First National City Bank
Olivetti
Brown Brothers Harriman
Scandinaviska Banken
Inter-American Development Bank
Bank of America
Brown Brothers Harriman
Banque de Paris et des Pays Bas
 Reforming
Limited variability
Unlimited variability Around parity At parity the world
Unmanaged Freely flexible (floating) Intervention at edges n/a
monetary system
only
Managed a. By discretion of national Intervention within a. By discretion of national
authorities band also authorities 61
b. By international agreement b. By international
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c. By discretion of interest cooperation

authority c. By fixed formula Table III.

of the dollar-gold relationship. Professor Harry Johnson responded that there were two
systems to consider: one in which gold is the numeraire and other currencies move,
perhaps in terms of a key currency, but finally with respect to gold; and two, without gold
or any non-currency numeraire. Stephen Marris of OECD and Robert Roosa of Brown
Brothers Harriman then suggested the group assume first that the discussion be based on
a continuation of the fixed gold-dollar relationship; later, the group could consider the
implications of relaxing the assumption.
Fritz Machlup intervened to limit the scope of the problem: our task is to try to find an
international currency technology which could improve the present degree of rate
stability. Machlup then suggested that the group begin a series of individual opening
comments, beginning with the bankers and businessmen, in alphabetical order.
George Chittenden argued that he would vote for maintaining the system as is, having
served world trade and investment well thus far. The only missing ingredient, in his view,
was the lack of sufficient pressure on governments to accept the discipline of the system
when its signals were contrary to domestic political desire. Disagreeing with Chittenden’s
claim that the current system was working well, IBM’s Chief Economist David Grove said
that the present resistance by officials to change had led to interventions, political
stresses between countries and controls with more frequent and more disruptive crises,
followed by illiberal controls. Seconding dissatisfaction with the present system,
Dr Holtrop of Nederlandsche Bank noted that pressures to make appropriate internal
corrections or to change the currency rate seemed to be stronger and more effective
during times of crisis than during times of surplus, hence the system is asymmetrical.

Wider bands, limited variability

Wider bands had limited appeal for the corporate participants. W.F.J. Batt of
Westminster Bank argued that, if currency bands were wider and important currencies
could fluctuate by several percent, bank customers would desire a much greater amount
of forward cover, without which rates could skyrocket. More importantly, banks would
be in the position of finding and matching buyers and sellers, difficult given their limited
capacity for two-way forward exchange. Ake Lundgren of Scandinaviska Bank said
there were two major discrepancies in the current system: first, that creditor countries do
not hew to the rules and wider might encourage deficit countries to react less quickly to
inflation and impose an inflationary bias on the system; second, that wider bands would
change the liquidity picture with currency rate fluctuations tending to enlarge customs
or border hurdles for trade, reducing the level of trade and contradicting the goals
of General Agreement on Tariffs and Trade. Donald Marsh of the Royal Bank of Canada
 JMH agreed that forward markets might well be weak under wider bands, but in his
17,1 experience with Canada’s floating rate period of the 1950s, forward cover was not a
problem, and many large firms did not have currency exposures. On the other hand, in
the first quarter of 1968, under fixed rates, a real difficulty in providing forward cover
occurred. Marsh suggested turning the emphasis around: instead of fixed rates with
fluctuating reserves, the authorities would keep reserves at a fixed level and let rates
62 float freely, the precise opposite of the Bretton Woods system, with International
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monetary Fund oversight.

Bank of America’s Van Vlierden said he was worried about widening the bands
because trade was not the primary motivator in international transactions, but instead
direct and portfolio investment were more dynamic. In his view widening bands would
create disproportionate demands for forward contracts and the present commercial
banking system could not meet it. George Chittenden then commented that there was no
pure speculation in the world’s foreign exchange markets, instead what appears to
government officials and economists as “speculation” simply is commercial banks
running scared. IBM’s David Grove countered that it should not be concluded from the
problems in the present banking structure that wider bands would not work, but only
that institutional changes might have to be made. Emil Kuster argued that there was
also the possibility that the volume of foreign exchange transactions might shrink with
wider bands if underlying trade shrank from greater uncertainty about exchange rates.
Conference Co-Chairman Robert Roosa (formerly Assistant Treasury Secretary, now a
partner of Brown Brothers Harriman) then summarized the discussion and invited the
academics in the group to comment.

Floating rates, unlimited variability

Focusing the group now on alternative flexible exchange rates with unlimited variability,
Machlup raised the question for discussion: if totally fixed currency rates are impossible,
as they obviously are, how often should changes occur in different situations – on a
ten-year frequency or daily? Where in this spectrum is the optimum for any country?
Machlup asked the group to consider a second question: how would one go about effecting
a transition from fixed rates to a system of “gliding adjustments” or a wider band? And
finally, he posed a third question: should peg adjustment be discretionary or based on a
formula? Stephen Marris of OECD asked whether more flexibility would be useful for the
“dilemma” case where adjustment indicated for external equilibria is disfunctional to
internal economic needs: how would greater flexibility affect adjustment? Professor
Mundell pointed out that part of the world moved with the economic center of gravity,
e.g. the USA, Japan and Latin America. Others like the UK and Germany do not or cannot
so move and so their policies to not match. The problem is how to adjust for this
mismatch. Central banks could conceivably run the entire monetary system, taking the
uncertainty away, but the tendency in monetary management today is toward
decentralization, so institutional change may be necessary and the problem is how to get
it. Professor Bator commented that had it not been for USA’s unwillingness to correct its
balance of payments, we would have more controls on trade and funds and no foreign aid.

Managed flexibility – public policy impact

When Donald Marsh asked whether the foreign exchange rate was in fact a policy target,
Professor Johnson puts the question to the group: did they believe the exchange rate
 to be a relevant instrument for affecting the composition of the balance of payments, Reforming
or was it to be used for hoodwinking the public into accepting other economic objectives? the world
Dr Holtrup said automatic peg ideas only invite intervention via other financial routes
by authorities who are frustrated by automaticity. Robert Roosa agreed that asking monetary system
governments to submit themselves to automatic exchange rate regimes was similar to
asking them to subject themselves to a fixed gold standard: they would need to express
their policy aims through other parallel means. Pushing forward, Fritz Machlup noted 63
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that economists had taken for years as given its imminence of collapse and, therefore,
now accepted as undeniable the need for major reform in the present structure.
After some discussion about the politics of arguing effectively for modification of the
present system, Fred Bergsten introduced a detailed summary of the headings which the
group had discussed to date. The method of assigning papers to be presented at the next
conference was then discussed. Conference attendees made their choice of topic,
committing themselves to the research and preparation necessary. The conference
papers prepared by Burgenstock members were presented and discussed at a follow-up
conference in Burgenstock Switzerland. Both papers and comments were collected into a
volume published by Princeton University Press in 1970 as Approaches to Greater
Flexibility of Exchange Rates: The Burgenstock Papers, edited by George Halm.
Understanding the potential impact they had on public policy, a number of the
practitioner conferees (David Grove, Max Ikle, Tadashi Iino, Ake Lundgren and
Donald Marsh) sought also to publish versions of their work in professional journals.
By the time the conference ended, the conferees had arrived at an unexpected consensus
on smaller and more frequent exchange rate changes by widening the range within
which exchange rates respond to market forces and permitting a more continuous and
gradual adjustment of parities.

Conclusion: scenario analysis at the Bellagio and Burgenstock

conferences – the value of method
For a methodologist like Fritz Machlup methods shaped thinking; they provided a lens
for interpreting and making sense of data, and scenario analysis was a method that
made sense not only of alternative versions of future events, but of their underlying
assumptions and the impact of those assumptions on economic systems. Because
Machlup redirected conferees to think of the systems effects of balance of payments
adjustment, liquidity and confidence (issues closely related to the stability of the
system), conferees confronted the assumptions underlying their preferred exchange rate
regime to discover whether the impact of exchange rate change on each of these
problems was positive, negative or null, removing value judgments and political
considerations from consideration.
Before the Jamaica Agreements of 1974-1976 essentially made system reformation a
non-issue and made all rates flexible (without gold back-up), the Ford and Rockefeller
Foundations had supported 17 additional conferences for academics, policy makers and
business leaders in the USA, Europe and the developing world under the “Bellagio
Group” umbrella (1963-1971) and five conferences under the “Burgenstock” umbrella
(1969-1971), bringing the disciplined exploration of alternative scenarios and their
consequences for policy, management and institutional decisions to a far larger
audience.
 JMH Notes
17,1 1. Scenario analysis is linked to methods like Delphi (a nonquantitative forecasting method
based on aggregated responses to a series of questions administered to a group of panelists
who are experts in their respective fields), first used in 1944 for a US defense department
project undertaken by the RAND Corporation, and cross-impact analysis, first pioneered at
General Electric by Ian Wilson in the 1950s, a complex technique that plots the impact of
64 economic, geopolitical and cultural changes on corporate decisions. Nevertheless, what we
think of scenario analysis is most frequently associated with Herman Kahn and the team of
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Pierre Wack, Ted Newland and Napier Collyns used scenario-driven planning at the Royal
Dutch-Shell Group of Companies during the 1973 energy crisis.
2. Machlup’s “fixed part of the machine” is strikingly similar to Imre Lakatos’ “hard core” of
scientific research programs (Langlois and Koppl, 1991, p. 88). Here, the purpose of the model
is to provide an “invisible hand,” a genetic explanation of a process, involving social (rather
than natural) phenomena, that unfolds in time. The story provides a plausible mechanism
whereby the displaced activities of individuals aiming at particular ends, and not at the
phenomenon in question, nevertheless result in the occurrence of the phenomenon (Koppl,
1992, p. 295).
3. Attendees of the first four conferences would be known variously as the Group
of 32 Economists and the Bellagio Group, taking their name from the Ford Foundation’s
conference center in Bellagio, Lake Como, Italy.

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Dreyer, J. (1978), Breadth and Depth of Economics: Fritz Machlup: The Man and His Ideas,
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Klausinger, H. (2006), “‘In the wilderness’: emigration and the decline of the Austrian school”,
History of Political Economy, Vol. 38 No. 4, pp. 618-64.
Knudsen, C. (2004), “Alfred Schutz, Austrian economists and the knowledge problem”,
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Machlup, F. (1947-1983), Papers, Hoover Institution Archives, Stanford, CA.
Machlup, F. (1965), “Why economists disagree”, Proceedings of the American Philosophical
Society, Vol. 109 No. 1, pp. 1-7.

Corresponding author
Carol M. Connell can be contacted at: CConnell@brooklyn.cuny.edu

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