At the Annual Meeting in Rio, the Governors of the Fund agreed upon an Outline of a new facility, in the form of special drawing rights in the International Monetary Fund, intended to meet the need, as and when it arises, for a supplement to existing reserve assets. In this article the Economic Counsellor of the Fund gives an account of the discussions and of the Outline which they produced.
J. J. Polak
CONCERN about the adequacy of world liquidity is not a new feature of the international scene; it existed as far back as the end of World War I. A brief account, however, may begin in the late 1950’s, and note that since about 1958 the preoccupation with a prospective inadequacy of reserves, and accordingly with the need to do something about the international liquidity situation, has grown both in the universities and elsewhere.
Chapter 2 of the Fund’s Annual Report for 1967 shows that since about 1964 the world stock of reserves has remained practically stationary except for the results of some special operations. That stock now stands about as follows:
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Everyone interested in such matters is familiar with the reserve role of gold, dollars, and sterling; reserve positions in the Fund are probably less familiar. They are, in fact, automatic claims that countries have on the Fund as a counterpart either to their gold contributions or to the amounts of their currencies drawn by other countries. These reserve positions in the Fund constitute an already existing truly international component of reserves, guaranteed as to gold value, some of it (the loans to the Fund) interest earning, all of it usable to obtain convertible currencies. These reserve assets are in many respects the forerunners of the special drawing rights that are contemplated under the new facility.
The first component of the supply of reserves—gold—has not been flowing into official reserves in the last two years, owing in part to large speculative demands which were themselves fed by the uncertainty about the future of the international monetary system. There has been little increase in dollar holdings in recent years, as there has been little increase in sterling holdings for many years. Such increases in reserves as have taken place in the last two years are to a very large extent in the form of reserve positions in the Fund, and reflect Fund operations—including the large drawings by the United Kingdom—which are intended to be reversed.
In the absence of international action, there is not likely to be much increase in the stock of international reserves. While there may be some disagreement as to the seriousness of this for the short run, it would be hard to imagine that a rapidly expanding world economy would be possible in the long run on the basis of reserves that did not also expand.
The gradual recognition of a possible inadequacy of reserves led to the long process of international discussion and negotiation that ended up in the recent agreement on the Outline for a special facility. These discussions and negotiations took place both in the Fund and among the ten countries that had signed the General Arrangements to Borrow. Until September 1966 the Fund staff provided the main link between these two parallel sets of discussions. Then the decision was taken to organize Joint Meetings between the Executive Directors of the Fund and the Deputies of the Group of Ten. These Joint Meetings were considered by both sides to be extremely successful and they were particularly helpful in ensuring that the plan as agreed contains no discriminatory features and treats all Fund members on the same footing. By the end of the fourth and last Joint Meeting, which was held in Paris in June, 1967, most of the Outline was agreed in substance. There still remained, however, a few crucial differences among the industrial countries, which were finally resolved by two meetings in London of the Ministers and Governors of the Ten. The version of the Outline resulting from these meetings was approved by the Executive Directors of the Fund and submitted by them to the Governors at Rio.
How the General Principles Were Agreed
The product of all this effort can perhaps best be understood in terms similar to the way it was achieved, namely, first agreement on certain general principles which took until about the late summer of 1966, and then the elaboration of more specific provisions which took place during the ensuing 12 months.
The first major point of agreement was that if liquidity creation were to be effective in averting certain undesirable developments in the world economy, it was necessary to create the type of liquidity that member countries were anxious to hold, that is, unconditional liquidity. Until a few years ago there was a tendency to speak of international liquidity in general, without a sharp distinction between its two main categories, unconditionally available reserves, i.e., the kind of liquidity that countries can use without being subject to any commitments or discussion as to policy; and “conditional liquidity” such as the Fund provides in the credit tranches. It has become clear, however, from the discussions of recent years, that countries see important differences between access to such conditional credits and reserves available as of right; so that even an accelerated increase in credit facilities would not be regarded as an adequate substitute for a normal accrual of reserves.
This clear desire of the Fund’s member countries for the unconditionality of any newly created reserves is fully met by the Outline. A member country will be able to use the special drawing rights for which the Outline provides whenever it has a balance of payments or reserve need to do so, and the member’s judgment of need will not be subject to prior challenge.
One way to describe the major difference between the new facility and the present Fund system lies thus in the unconditional character of the new liquidity to be created, while the bulk of drawing rights in the Fund is conditional. Looked at from another angle, however—if one compares the new drawing rights with the present automatic drawing rights in the gold tranche—the striking difference is that the new drawing rights will be deliberately created in an amount considered necessary, while the present automatic drawing rights arise from gold payments and as the by-product of drawings by other countries, and disappear when these drawings are repaid.
As to the basic nature of the asset, agreement was gradually reached that any deliberate increase in reserves would have to be brought about in the form of an international reserve asset that derived its value from an international convention with respect to its acceptability. There has been little discussion of this recently; indeed it has been completely taken for granted for some time. Three or four years ago, however, there was some groping for the creation of additional reserve assets by a further extension of the reserve currency concept. It was suggested, in particular, that half a dozen or so currencies other than dollars or sterling should also perform the functions of reserve currencies. Traces of this approach can also be found in the early suggestions for a composite reserve unit, which would make the value of this unit to some extent derive from the market value of the underlying currency balances. The multiple reserve currency approach did not, however, find support, if for no other reason than that the position of a reserve center failed to appeal to countries that had so far been spared this particular blessing.
Although the discussions continued for a while in terms of a reserve asset “backed” by currency balances, it became increasingly clear that the essential value of the new asset derived from the obligation of participants to accept it, in much the same way as the value of domestic fiduciary money derives from its status as legal tender. The acceptance obligation was gradually made more precise, and the balances of their own currency by which countries were originally supposed to acquire the new asset were increasingly seen as immaterial to the plan, and in fact they were dropped when we drafted the Outline.
Another main point was that one could not possibly hope in international reserve management to follow the sensitive adjustments that are possible in domestic monetary policy in individual countries. The response of the world economy to the supply of reserves is too diffuse and too slow, and the problems of international decision-making are too difficult, to visualize any short-run international monetary management. All that is feasible, it was agreed, is to take care, as best one can, of the need for reserve increases over the long term, leaving the management of business cycles to domestic policy. This principle is reflected in the approach of the Outline where decisions on reserve creation are envisaged as being taken for a specific period ahead. This period would normally be five years, although there is a provision for changes within the period; it should be noted that the Fund’s quotas are also reviewed at five-yearly intervals.
The decision was reached that the new reserves should be allocated to all countries independently of their payments positions and on the basis of some objective criterion of economic size, for which in the end quotas in the Fund were selected. The suggestion made from many sides that the resources created should be brought into circulation in the first instance through development aid found little support in the industrial countries; nor could the original starting point of some of the latter countries, that allocations should be limited to strong currency countries, be maintained.
On each of these last three points—an international asset, decisions taken for a long period, and distribution across the board on the basis of quotas—the examination of alternative possibilities finally ended in agreement on essentially the same approach as that reflected in the Fund as it now operates.
The Specific Features of the Outline
Let me now turn from the more general principles to the specific features of the present Outline. Here we come to the specifics of what is in the text and, what is in some respects even more important, the specifics of what is not in the text. Among the latter, let me mention in the first place that the Outline does not contain any features of a discriminatory character: it embodies a fully universal approach.
The very title of the Outline refers to “Special Drawing Rights.” A great deal has been written on the difficult negotiations which ended up with this particular name for the new facility. Originally, there was indeed a clear distinction between those in favor of drawing rights in the Fund and those who wanted an entirely new scheme, which might or might not be linked to the Fund, for the creation of reserves, to which the name “units” came to be applied. The former had in mind a gradual extension beyond the gold tranche of the automaticity now applying in that tranche, with the additional currencies necessary for the exercise of these drawing rights being made available to the Fund under lines of credit. Those advocating units entertained a variety of novel ideas. As these two approaches were discussed over the years it became gradually clear that the essential thing was the particular collection of characteristics that one wanted to give to the new asset, some of which could be taken from the existing drawing rights in the Fund and others that might be defined in some different fashion. After all these characteristics had been sorted out and agreed, it became immaterial whether the resulting bundle of characteristics was called a drawing right, a unit, or anything else.
The “resources” of the new scheme do not consist of a pool of currencies or lines of credit; they consist in the obligation on the part of participants to accept drawing rights from other members in exchange for an equal amount of convertible currency. This obligation incidentally is set at twice a country’s allocation, which is superior to the liquidity structure of the Fund at present, where total drawing rights exceed total contributions (quotas). With this different financing structure, the “resources” of the new scheme and those of the old Fund must be kept separate. Indeed it is envisaged that the new drawing rights will be usable for certain payments that countries have to make to the Fund.
As has become the practice in the Fund as it now operates, a country that wants to exercise its drawing rights would normally ask the Fund against which other participant it should do so. The drawing country will then acquire currencies, not out of resources held by the Fund but in the form of convertible currencies to be delivered by the countries drawn upon, either directly or through the intermediary of the Fund. The rules by which the Fund will select the country or countries to be drawn upon follow basically the Fund’s existing practice on currencies to be drawn. Drawings will be directed to countries with sufficiently strong balance of payments and reserve positions, and they will be so allocated among these countries as to aim over time at an equal ratio of special drawing rights to total reserves. In the new facility this rule is complemented by a special provision permitting a reserve center that wants to buy balances of its currency held by another country to direct its drawing specifically to that country, provided that the latter agrees. In addition, the guidance rules are also to take care of reconstitution.
On the subject of reconstitution it may be said, by way of preface, that in practice few members are likely to be affected by this particular obligation. The new asset will have attractive features, including a guarantee of the maintenance of its gold value and interest remuneration. For these reasons, countries can be expected normally to want to retain the drawing rights allocated to them, to acquire additional amounts when they are in payments surplus, and, when they are in deficit, to use the new drawing rights only in conjunction with their other reserves. The latter idea is indeed reflected in the Outline, which refers to the desirability of countries pursuing over time a balanced relationship between their holdings of special drawing rights and other reserves. A member country that follows this principle in the management of its reserves would be unlikely to have to adjust its holdings of drawing rights as a result of the obligation to reconstitute. Should the obligation be incurred, however, it specifies that over a five-year period, a member’s average use is not to exceed 70 per cent of its average cumulative allocation; or, in other words, that its average holdings over this period should be at least 30 per cent of its average allocation. Those familiar with banking arrangements may see this as resembling an obligation to maintain a “compensating balance” of at least 30 per cent of a country’s allocation.
This concept of reconstitution is quite different from the repurchase rules that apply to drawings on the Fund. There is, in addition, a difference in technique in the sense that there will be no separate reconstitution mechanism, and reconstitution will take place only as a result of other countries’ drawings. If other countries do not want to draw, reconstitution may not come about.
It was agreed that decisions to create these assets would have to be taken with an 85 per cent majority of total voting power, which is more than the 80 per cent of total voting power that applies to quota increases in the Fund and, of course, much more than the simple majority of votes cast that applies to almost all other decisions in the Fund. The Outline shows, however, that the decision-making process is more sophisticated than the mere attainment of a large majority. What is foreseen in essence is a consultative procedure that is to ensure the broad support for any decision on reserve creation which is generally agreed to be necessary for it. This support is to be established through a process of consultation organized by the Managing Director. The Governors may vote on the allocation of drawing rights only on the basis of a proposal by the Managing Director. This proposal will, moreover, have to be concurred in by the Executive Directors before it can come before the Governors. The intention of the whole procedure is to arrive at these major decisions, once every five years, through a process of consultation that will ensure adequate support before an official proposal is made.
A special provision of the plan is that the first decision to allocate special drawing rights—what has been called the activation of the plan—will not be taken until certain special considerations have been met. This is in line with the concept of the plan as a “contingency plan.” In July 1966, the Ministers of the Group of Ten addressed themselves to this question of prerequisites for activation and defined them to include “the attainment of a better balance of payments equilibrium and the likelihood of a better working of the adjustment process in the future.” No attempt was made to define these activation conditions during the elaboration of the Outline. The Outline merely states that “special considerations applicable to the first decision to allocate special drawing rights… will be included in the introductory section of the Amendment and, to the extent necessary, in a Report explaining the Amendment.”
This article has outlined the main provisions in the present Outline and tried to give some impression of the way in which the new mechanism would work once it had come into effect. I trust that in the discussion of some of these rather detailed provisions we have not lost sight of the achievement in the field of international financial cooperation that is embodied in the Outline. International agreement on this facility is indeed the major event in international monetary affairs since Bretton Woods. It will add to the Fund a separate and major task, to supply the world with the amount of reserves that the international financial community will judge to be necessary—a task that may be relatively small to begin with, yet which may well be responsible for the major part of total world reserves before the end of the century.