W. John R. Woodley’s article on Multiple Currency Practices (Finance and Development, June 1966) explained the economic basis of these practices and outlined the Fund’s attitude toward them. This article, on the occasion of the twentieth anniversary of the Fund’s first general pronouncement on multiple exchange rates in December 1947, traces their dramatic decline over the last 20 years. It shows in particular how Fund policies were adapted to changing circumstances.
Margaret G. de Vries
ONE OF THE MOST immediate questions with which the newly born International Monetary Fund was confronted in 1946 was that of multiple exchange rates—used here as another term for multiple currency practices. Of the 40 countries that were members at the end of 1946, 13—all in Latin America except one—were using such rates.1 Although many members maintained exchange controls, to which the Fund was also opposed in principle, and also had inconvertible currencies while the Fund looked forward to widespread convertibility, the problem of multiple exchange rates was thought to require particular attention. Partly they were feared because of the competitive ways in which they had been used during the 1930’s. More important, because multiple rates are not merely restrictive practices but are in themselves rates of exchange, they can be a major source of exchange instability. And exchange rate stabilization and the attainment of fixed rates of exchange is, as has been stressed in the deliberations about multiple rates, a primary purpose of the Fund. In order to move toward this objective, the Fund had already, in late 1946, decided to set initial par values (see “Twenty Years with Par Values,” Finance and Development, December 1966). The mere existence of multiple exchange rates might not endanger exchange stability, but frequent changes and extensions of such rates could well undermine the whole par value system, and such changes are inherent in the use of multiple rates.
A Key Decision
For these reasons, among the key decisions of the Fund in its first year was that multiple exchange rates must be subjected, without delay, to special review. In December 1947, the Fund circulated to its members a general pronouncement, which came to be known as “the December 1947 Letter on Multiple Currency Practices.” This letter stated explicitly that member countries should as a minimum consult the Fund before introducing a multiple currency practice, before making a change in any of their multiple rates of exchange, before reclassifying transactions subject to different rates, and before making any other significant change in their exchange systems. Moreover, this statement of general principles on multiple currency practices stressed that early steps should be taken toward the removal of these practices, especially those which were clearly not necessary for the balance of payments position of a country, although problems of timing and practical alternatives had to be recognized.
Further Evolution of Fund Policies
In the next several years, there was a flood of specific instances of multiple rates for Fund consideration and action. The Fund began to work closely with the members concerned to see what progress might be made not only toward reducing but also toward the early removal of multiple rates.
However, as circumstances in individual countries were revealed in detail, an early termination of multiple exchange rates became more and more difficult to foresee. Very quickly it was apparent that much of the use of multiple rates was allied with the existence of domestic inflation: multiple rates usually resulted from balance of payments deficits which, in turn, were most often caused by inflation. Until inflation was brought under control, the removal of multiple rates would have necessitated, in their place, the introduction or tightening of quantitative restrictions on imports and payments. Inasmuch as quantitative restrictions are also a form of control and give rise to many difficulties on their own account, the replacement of multiple rates with such restrictions would achieve little. Moreover, many economists began to see multiple rates as performing economic functions that could not be done as well by quantitative restrictions.
It also became evident that countries were making widespread use of multiple rates not only for trading purposes but also for nontrade functions such as taxation. This meant that, in practice, the removal of multiple rates would, in many instances, require the introduction of some acceptable substitute measures to perform these tax and revenue-raising functions. Were the Fund to insist on the immediate discontinuation of multiple rates, members might be compelled to put into effect hastily devised tax substitutes, different in form but no better in fact than the existing systems of multiple rates. Much better substitutes could be devised, but these required over-all reforms of the fiscal systems and customs tariff schedules of the countries concerned. Such reforms first had to be carefully designed and then had to go through prolonged legislative procedures, both of which were time-consuming processes.
In these circumstances, the general principles outlined in the 1947 Letter could be put into effect only as varied by circumstances and adapted to the specific problems at hand. Accordingly, the Fund gradually evolved what was in effect a “case-by-case approach”; this meant that each case had to be decided on its own merits. Rather than insisting on a hurried elimination of multiple rates, the Fund offered guidance to its members by putting stress on the achievement of the basic underlying economic conditions which would facilitate such elimination as soon as practicable. Most important among these was the attainment of domestic financial stability. Members were also encouraged to avoid the use of many particular practices—such as auction systems, compensation arrangements, or “mixed rates”—which might unduly complicate their exchange rates or harm other countries. Furthermore, in order to keep exchange rates as stable as possible, the Fund urged that free market rates be limited to items other than trade such as capital or invisibles. This would help eliminate the most dangerous aspects of multiple currency practices and also help countries to exercise reasonable control over those retained. Within this framework, the Fund was able to agree to many multiple currency practices on a temporary basis, remaining in consultation with the member concerned.
Gradual Spread of Multiple Rates, 1947-55
In many respects, the 1947-55 period was a frustrating time for the Fund and for its members. In the eyes of some of the countries concerned, the Fund, in a world of extensive exchange controls and the continued inconvertibility of key currencies, appeared to be devoting excessive attention to the multiple rates of a few countries that had only a small share in total world trade. Yet some economists in academic and other circles, anxious for evidence of successful international monetary cooperation brought about by the new organization, frequently lamented the lack of progress, even in this field.
There was reason to lament; multiple currency practices actually increased among the Fund’s membership. Several countries which already had multiple exchange rates joined the Fund: Afghanistan, Argentina, Indonesia, Israel, Korea, the Syrian Arab Republic, Thailand, and Viet-Nam. Many existing members found it necessary to institute some such practice: the Republic of China, Greece, Finland, Iceland, the Philippines, Turkey, the United Arab Republic, and Yugoslavia. Thus multiple rates of the early 1950’s were no longer confined to Latin America; they had spread to Asia and the Middle East and, indeed, to Western Europe. Even France undertook in 1948 an abortive experiment with a free market for certain currencies, and during the early 1950’s a number of other Western European countries, while retaining unitary fixed rates for the great bulk of their transactions, felt compelled to open free markets for the sale of certain other bilateral currencies or currencies of the European Payments Union, or for particular capital flows.
By the end of 1955, the Fund had grown to 58 members, and 36 of these had some kind of economic device which the Fund considered a multiple currency practice. Although some of these practices were minor, very complex systems with many different rates had also gradually evolved in several countries.
Reasons for Their Extension
The increased use of multiple currency practices during these years reflected two distinct kinds of problems, each of which had given rise to different types of practices. One problem was what was commonly called at the time “the chronic world dollar shortage.” As a result of this, the currencies of the world had become divided into “hard” currencies, such as the U.S. and Canadian dollars, which were freely convertible into other currencies and, through the U.S. dollar, into gold at a fixed price of $35 per ounce; and “soft” currencies, such as the pound sterling, the French and Belgian francs, the deutsche mark, and the guilder, which were not freely convertible. While a country might have achieved over-all equilibrium in its balance of payments, surpluses in one currency (if it was inconvertible) could not be used to settle deficits in others (where convertible currencies were needed). This situation had led to the emergence, in Western Europe as elsewhere, of some multiple currency practices—such as limited free markets and broken cross rates—which aimed at increasing a country’s supply of “hard” currencies and decreasing its holdings of “soft” ones. Broken cross rates involved the sale of some currencies at discounts from their parity relations with the U.S. dollar.
The second problem was largely confined to the developing countries. Whereas a few Latin American countries had initially used multiple exchange rates to alleviate the depression-based problems of the 1930’s, these practices now seemed useful instruments to be used in efforts to cope with balance of payments problems generated by measures designed to stimulate economic development. Persistent balance of payments deficits, the need for protection of new domestic industries, the desire to differentiate various exports and imports, and the scarcity of adequate revenue techniques, had, in the absence of appropriate alternative measures, given rise to widespread use of multiple rates by developing countries in all regions. (For a description of the special payments and protection problems of development, see “Trade and Exchange Policies for Economic Development,” Margaret de Vries, Finance and Development, June 1967.) Selective exchange rate devaluation for particular exports and imports often seemed preferable to general devaluation, which would be inflationary, or would raise the cost of essential items, or would bring excessive profits to exporters, and might still not help significantly to solve the balance of payments deficit.
After 1955, however, there occurred a sudden and almost dramatic breakthrough in the multiple exchange rate war. In its Annual Report on Exchange Restrictions for 1956, the Fund was able to report great progress within a single year. A marked general improvement in the international payments situation was at its roots. The intensive postwar investment programs, especially in Western Europe, had borne fruit, and increases in production were coming forth. Increased supplies of goods, together with the improved domestic financial and monetary positions of Western European countries and the realigned exchange rates of 1949, brought the world dollar shortage to an end.
Within the next few years, the major industrial countries lowered or abolished many barriers to trade and payments and established the convertibility of their currencies. Multiple currency practices which distinguished between “hard” and “soft” currencies could be, and were, quickly removed. By 1958 the partial free markets and other special devices of a number of Western European countries had all been discontinued.
What was in some ways even more unexpected, although the Fund had been working closely with these countries over several years, was that several of the developing countries—Bolivia, Chile, Paraguay, and Thailand—which had long maintained complex multiple rate systems, abolished them in favor of a single fluctuating exchange rate at the end of 1955 and during 1956.
The time was ripe for an intensification of the Fund’s efforts to eliminate multiple rates. The countries employing them now, in their defense, placed greater emphasis on the practical difficulties of eliminating them than they did on any preference for them as against unitary rates for countries exporting primary products. In addition, the problem of multiple rates had taken on added importance: with keener competition in international markets, countries with unitary rates had been increasingly concerned that competitors using multiple export rates might derive unfair advantage in export markets.
The experiences of the Fund had shown that it was very much easier for a country to simplify its rate structure than to unify entirely. The stringency in internal monetary policies needed for simplification was significantly less than that needed for unification. The reserves required were lower if a simplified system included a fluctuating rate. And in a simple system with fixed rates, an exchange spread might absorb part of any internal monetary expansion, while such absorption was not possible with a unitary rate. In addition, Fund experience had shown that it was the complexity of multiple rates that had led to difficulties.
For these reasons, in June 1957 the Fund worked out a new decision on multiple currency practices. (This was reproduced as Appendix VI to the Fund’s 1957 Annual Report, pp. 161-62.) It urged countries to simplify their existing rate structures and offered to help them map out specific exchange systems. Simplification meant more than merely a reduction in the number of existing rates: emphasis was placed on a total of two or three rates which should be sufficiently realistic to maintain a satisfactory balance of payments with only a minimum of restrictions.
A simple system could include, where necessary, the temporary use of a widened free market or of a fluctuating rate as a step toward an eventual stable rate; over the years it had become evident that a floating-rate mechanism had a greater tendency to be self-liquidating than a series of fixed rates. Technical assistance could also cover the formulation, where appropriate, of substitute fiscal arrangements. Most important of all, where the exchange reform was sufficiently broad and accompanied by a domestic stabilization program, the Fund was willing to consider use of its resources to support stabilization efforts. Meanwhile, the Fund would be reluctant to approve changes in multiple rate systems which would make them more complex.
Accelerated Elimination of Multiple Rates, 1957-62
Following this new announcement, and with other countries encouraged by the success of those that had already unified their exchange systems, the next several years were to witness a further series of eliminations of multiple rates. Significantly enough, in 1959 the countries involved included Argentina, which in the 1930’s had been the founder of multiple rates in Latin America. Many other countries—Costa Rica, Iran, Jordan, Nicaragua, and Saudi Arabia—proceeded in a series of steps. In 1962 this group was joined by Yugoslavia, which in the mid-1950’s had the most complex system of all. Some countries—Finland, Israel, Spain, and Turkey—took the whole plunge at once, devaluing, eliminating multiple rates, and setting a new fixed rate.
These major reforms of the exchange systems were usually associated both with exchange devaluation and with internal policies designed to remove price distortions and to help bring inflationary pressure under better control. Frequently also, tariff changes, usually upward adjustments, were associated with exchange reform, and in some instances, fiscal reforms were also undertaken. Some countries temporarily applied taxes or surcharges to some imports in conjunction with a fluctuating rate. Thus, from 1955 to 1962, 8 Western European countries eliminated their various minor practices, and major systems of multiple rates were unified in 18 other countries. Hence, by the end of 1962, only 15 Fund members out of a total of 82 had multiple rates, in contrast to 32 out of 56 eight years earlier.
Figure 1 depicts graphically the change in the number of members with and without multiple currency practices at the end of 1947 and at the peak in 1954, and the decrease by 1962, as well as the latest position in August 1967.
Figure 1NUMBER OF FUND MEMBERS WITH AND WITHOUT MULTIPLE CURRENCY PRACTICES
(end of year figures)
Citation: 4, 4; 10.5089/9781616352882.022.A008
Subsequent Developments in Multiple Currency Practices, 1963-67
Developments in multiple exchange rates in the last five years have been of three types. First, additional countries which had long made use of multiple rates have continued to join the list of those which had considerably simplified or unified their exchange rates. In 1964-65 both Venezuela and Brazil substantially reduced their rate multiplicity. The Philippines, which introduced multiple rates in 1962, eliminated them in November 1965. And in 1965 Korea also replaced its series of rates by a unitary fluctuating rate. Second, some countries, such as Afghanistan, Colombia, and Indonesia, have continued to maintain complex systems and have not yet simplified. Third, some backsliding has occurred. Following the virtual unification of its exchange rate in 1956, Chile, for example, in 1962 introduced a dual market system which still continues. Some multiple rates have even sprung up in a few countries—for example, Ceylon and the Democratic Republic of Congo—where they had not been used before. If not multiple rates, then some other devices, such as import surcharges, advance deposit requirements, or special export bonuses, have also been introduced by several countries to deal with recurrent payments or fiscal deficits. Some of the countries which introduced these devices, such as Argentina, had eliminated multiple rates; while others, such as India and Pakistan, had not previously had them. Moreover, among the measures introduced by a number of industrial countries to reduce the outflow of capital were special taxes or markets with premiums for investment currencies. The latter was introduced, for example, in the United Kingdom.
In addition, some renewed arguments for multiple rates are advanced from time to time by economists as ways of solving some particular trade problem, especially for developing countries. Some now suggest—even for industrialized nations—that subsidies cum tariffs (another form of multiple rates) are a good compromise for those economists who favor either fixed or fluctuating rates.
Consequently, the issue of multiple exchange rates is not entirely at an end, and may never be. The nature of, and reasons for, the practices used differ, and the locale shifts. Nonetheless, despite some continued and other newly emerging problems, and the need for constant work by the Fund with all its members, the extent and complexity of multiple rates, in contrast to the position at the end of 1947, had been vastly diminished twenty years later. One of the great early aims of the Fund and its member countries, had, thanks to adaptibility and patience, come at least as near to accomplishment as, in 1947, could have been hoped for.
The Latin American countries were Bolivia, Brazil, Chile, Colombia, Costa Rica, Cuba, Ecuador, Honduras, Nicaragua, Paraguay, Uruguay, and Venezuela; the other one was Iran.