Disruptions in Trade and Payments

This crucial issue was the focus of much of the discussion, and was addressed by several papers, including David Llewellyn’s round-up paper, G.G. Johnson’s review of multilateral surveillance, Tony Killick’s discussion of developing countries, Azizali Mohammed’s crystallization of Fund experience and practice, and Susan Strange’s comment. Vagaries of trade and payments are the pre-eminent “systematic” problem of international monetary arrangements. A world of n countries, and therefore n sovereign monetary and fiscal systems, needs workable methods for correcting payments imbalances—without such methods, crisis and chaos are inevitable. There are five main mechanisms available for correcting payments imbalances: the use of reserves; multilateral policy coordination; borrowing (or grants); the unilateral pursuit of price stability; and the Fund’s arrangements.

Sovereign reserves in finite quantity necessarily trigger correction in deficit countries once they are exhausted. This is the simplest and most crude device—a substitute for a system. (Michael Dooley’s important paper on reserves and liquidity is discussed in the section on reserves below.)

Multilateral policy coordination, including the (international) reconciliation of policy aims, is reflected in the sort of discussions that took place in the 1960s in Working Party Three of the Organization for Economic Cooperation and Development (OECD). Susan Strange was clear that, if such solutions to the problems that arise out of interdependence were ever possible, they are so no longer; in any case, they were open in practice only to the clubs of the rich nations. My own view is that if the Working Party has become less useful, it is because many countries it represents now set greater store by other mechanisms for ensuring policy compatibility at an international level, rather than because of any inherent problem with the Working Party as a device. (See the discussion of the fourth mechanism below, and the paper by Michael Dooley.) However, neither in practice nor in theory is it plausible to suggest the generalization of the approach of this Working Party to, say, all the Fund’s member states. That does not mean, however, that the basic insight underlying the Working Party approach—that one country’s deficit is another’s surplus—is incorrect or that it can be ignored.

The third mechanism is borrowing by deficit countries (preferably from non-state banks or corporations), or gifts between sovereign states. In practice, such sources of funds tend to be readily available when not needed, and in highly inelastic supply when needed.

To come to the fourth mechanism, both Michael Dooley and Tony Killick recognized that “equilibrium on the balance of payments” can be, in the view of some traditional economists, used as an appropriate policy target or even as an indicator for monitoring. I recall, however, the former Governor of the Bank of England who, in the context of some proposal for the control of capital outflows, commented, with perhaps unconscious prescience, that the balance of payments was an abstract concept which sensible people would not worry about if busybody statisticians did not insist on measuring it. The more modern version of that doctrine is that all countries should pursue steady and predictable monetary and fiscal policies appropriate to their own aims for price stability, and any resulting balance of payments deficits would be sustainable (perhaps even, in the terminology that Tony Killick carefully investigated, “viable”). If, today, overseas finance is not available to permit a deficit on yesterday’s scale, then that just means that the market estimate of likely returns on investment in the deficit country is lower today than yesterday, real expenditure must therefore be lower, absorption (in the old Fund sense) will be lower, and the deficit will fall.

Tony Killick, and, I suspect, several other contributors to the seminar, would object to this approach, emphasizing that international equilibrium in the balance of payments, or viability, or whatever, can be achieved at a range of different levels of global output, incomes, and employment. They would argue that the difference between a good and a bad adjustment mechanism is that the former will produce multilateral equilibrium at a higher level of income than will the latter. Bad adjustment mechanisms, like Joan Robinson’s invisible hand, work by strangulation; good adjustment mechanisms may still require a degree of international collaboration, and adjustment by surplus countries as well as by deficit countries.

The Fund’s mechanisms, or the resources and good offices of some or all of its members, associates, and sister organizations, were necessarily at the fore of the minds of all participants at the seminar. Whether the Fund is the first or the last resort (whether indeed the Fund has been “marginalized” as some suggested) the resources, rules, and procedures of the Fund’s operations remain crucial for much of the developing world. The question of whether those procedures work well, whether (and how) they can be improved, and the relationship between adjustment and other international relationships (aid, capital flows, or the oil facilities) occupied a major part of our time. The section below on the Fund’s operations reverts to these issues.

David Llewellyn’s paper, and in particular the oral introduction to its discussion, emphasized the “systematic” role of international monetary mechanisms in the ex post resolution of the necessary ex ante conflicts between national aims and policies. He evoked the well-known analysis that describes the function of the United States as the nth country, without balance of payments targets, enabling the aims of all the other n-1 countries to be reconciled. Perhaps that mechanism did, in the 1950s and 1960s, provide a stable background for the ten or twenty richest trading countries. But even in the heyday of the dollar standard the balance of payments adjustment problems of the poorer countries were frequently acute. And David Llewellyn pointed out the necessarily multilateral nature of the Fund’s procedures, requiring conscious and explicit rules of fairness and equity. That requirement remains, and is perhaps even more difficult to satisfy, in a world in which the nth country role of the United States has disappeared, and in which the rich countries can no longer be described as being engaged in a competitive hunt after a constant pool of reserve assets. In this world—a Michael Dooley world rather than a (Harry) Johnson world—the problems of the poorer developing countries appear even more starkly different from the problems facing their richer brethren.

The Role of Reserves

To set the scene for the central discussion of the modus operandi of the Fund, a brief reference to Michael Dooley’s paper, itself admirably brief and clear, is necessary. Traditionally, economists have seen a pool of reserves of constant (or, at any rate, of exogenously determined) size, available to be won by n countries in a zero sum game. If the international community can manipulate the size of the stock of reserves, it can influence global effective demand, and hence the level of output and prices. With output at its maximum, the rate of addition to world reserves determines the rate of inflation, and “it provides a nominal anchor to the system.”

For better or worse, Michael Dooley explained—and none at the seminar were inclined to challenge his conclusion—that “nominal anchor,” that constraint on domestic fiscal and monetary policies, no longer dominates behavior. Reserves are available in elastic supply to all rich countries. These countries are creditworthy, by definition, and can “rent” and use all the reserves they want. A new anchor has to be provided by each country separately.

What, as an apparent exception, of the United Kingdom in 1976? That, I suspect Michael Dooley would say, is the exception that proved the (new) rule: once the United Kingdom had acknowledged the new orthodoxy, and had found a new nominal anchor (in the form of sterling M3, reinforced by the Fund’s traditional anchor, domestic credit expansion), the turn-around in fortunes was rapid and complete. There may be from time to time a small trickle of other rich countries that use the Fund’s facilities, but only when they seem to be on the point of falling unexpectedly but helplessly from the heaven of perfectly elastic reserves to the purgatory where most Fund members live forever. In that purgatory, reserves are not available (or rather when they are available they tend to be used up once and for all). The year-to-year shocks that are necessarily encountered in the process of trade and development are then transmitted without the desired benefit of shock absorbers to domestic economies.

If I may elaborate on Michael Dooley’s dichotomy, the international system may be analyzed as one that “systematically” drains reserves from those countries for whom they are a valued scarce resource, to those countries for whom they are a freely available and readily purchasable “consumption good.” Two mechanisms ensure this process: the understandable and sensible propensity of poor countries to economize their inventories of reserves (as of everything else); and the Michael Dooley rule, which separates out the creditworthy from the rest.

It follows that there is just no point in traditional discussions of international reserve adequacy as if reserves were the common thread that held all countries together. In the new world, those who have reserves in free supply do not (and, for stability, must not) use excess reserves as a signal for domestic expansion, while those who need reserves cannot get them, save by gift or long-term loans. Such loans incur interest charges, which leads to the next topic.

Lending and Debt; Problems and Management

Stanley Please accepted the sense and justice of Tony Killick’s appeal for the symmetrical adjustment of deficit and surplus countries. But once Michael Dooley had signaled the disappearance of symmetry in the allocation of reserves, and now that international coordination among the richer countries has greatly diminished since its peak, how can we make the best of the present system? Neither the Fund nor the World Bank, Stanley Please reminded us, has much handle on the surplus countries, and domestic price stability (and intermediate targets for the money supply or budget deficits) rates higher in the preferences of the authorities in surplus countries than do considerations of balance of payments flows or reserves (and, alas, very much higher than considerations of the comity of nations, or the easing of other countries’ payments problems).

The adjustment problems caused solely or chiefly by the normal disturbances of trade flows, by worldwide cyclical fluctuations in the relative demand for different products, or by the imperfect coincidence of cyclical variations in different countries are well known and traditionally handled by the Fund’s normal procedures. They are common to advanced and developing countries, and well discussed in G.G. Johnson’s paper and in a note circulated informally at the seminar by Azizali Mohammed. I revert to these matters in the concluding section of this summary. The major problem that loomed over us at the seminar was the debt and payments problem of the developing countries—a problem of those countries but for the whole world.

The three papers on this topic laid down clear guidelines for the discussion, and were widely accepted. The debt problem was not universal—nearly half the debt, widely spread among countries great and small, was being serviced smoothly. Intergovernment debt was no less of a problem than debt owed to private banks—although the problems were different. The legal forms of U.S. banking regulations dominated the choice of solutions to the crisis: many options that might have been logical were not legally available, perhaps to the regret of non-U.S. creditors and to some of the debtors. The device of floating interest rates, though it had stimulated a large flow of funds in difficult times, had made debt service payments excessively sensitive to short-term changes in U.S. monetary policy. The “marginalization of the Fund” as a lender, much regretted by several members of the seminar, was not questioned; but the critical importance of the Fund’s surveillance during this period of crisis, its role as a “certifier of good housekeeping,” was widely recognized. There was no disposition to believe that the problems had all been solved.

But this general agreement on many aspects of the problem did not inhibit a widespread disquiet and some substantial divergence of views on what should now take place. At one extreme was a view—held in its pure form, perhaps, by no participant—that international debt was for rolling forward, not for repaying; the unprecedentedly large interest charges relative to redemption payments emphasized the importance of ensuring that a loan is “performing,” month to month, if default is not to be announced. Risks that can be swept under the carpet when nominal interest rates are low must be fully exposed to view when rates are high, and the alternative of adding interest to principal is neither acceptable to U.S. law nor easily reconcilable with a public insistence of all players in the game that all debts will eventually be settled.

The papers touched upon the delicate question of whether it would have been better for debtors and lenders if there had been some default, and some consequential bank failures. Perhaps too many of the participants in the seminar had practical experience of financial matters, and too many an understanding of the stark and unpleasant consequences of default for flows of good and services, for this issue to be lightly debated. David Lomax pointed out that some few bankers had felt the personal consequences of bad management or bad luck, and many others had learnt the lessons. But meanwhile many developing countries—only some of which had also erred in judgment—were being put through the wringer of adjustment that was necessary to convince world financial markets that the banks involved in new lending were making prudent investments.

Would the wringer have been less crushing if there had been a comprehensive settlement, led presumably by the governments of the rich countries themselves? This would have put into intergovernmental hands much (perhaps all, once one lender had dived for cover) of the mass of private sector loans. Most observers believed that a distinction should be maintained between commercial loans with broadly commercial terms and conditions and government gifts or loans on special terms. But whereas a bank can always appeal to market sentiment as the ultimate arbiter on the terms that it imposes, a government (or at least the government of a country in the more favored of the Michael Dooley groups) is freer of market pressures, and can be as unusurious as its electorate will permit. Some at the seminar spoke bluntly of the duty of creditor governments to behave in this way; others asserted, equally bluntly, that many governments of rich countries perceived no such duty.

Once again, the key role of the Fund, as an arbiter of sound policies whose judgment was listened to by the market, was in everyone’s mind. Would creditor governments allow easier terms to debtor governments than the market would permit private banks to offer? How free was the Fund to vary its standards? Nobody formulated this explicitly, but a simple analytical model of the process might be as follows. Economists and other specialists in the Fund form a provisional view on what might be called the maximum rate at which a debtor country can improve its current account, and hence meet debt service needs: this would most readily be defined as a rate of increase in net export earnings. When compared with existing obligations, this forecast projects a need for new borrowings. The “market” (which determines the standing and capacity of the banks to lend) personified in other professionals with training and backgrounds similar to those in the Fund, accepts the Fund’s judgment, and in particular, agrees that the maximum rate is consistent with current practice worldwide, and is sufficiently severe (from the creditors’ standpoint). The standard of maximum rates generally imposed, however, does hang rather from its own bootstraps, and the borrowers, at any rate, feel that it is more severe than it need be.

The proposition of those who believe the debt crisis should have been solved by intergovernmental action is, on this analysis, very simple: they assert that the debt service contributions required of the debtors over the next few years could, thereby, have been kept down. The Fund would have had, under that system, the same role of assuring sound, comparable policies among countries, but the absolute depth to which such policies bite could have been different—the policies could, in fact, have been softer.

This counterfactual proposition cannot be tested, but note that the harsher alternative also assumes an untestable counterfactual that may be inherently implausible. Is it possible that the maximum rate (imposed by international consensus) required for balance of payments improvement is also the minimum rate of improvement needed for long-term stability in the countries in question? The argument would be that to try to meet debt service commitments more slowly would be to risk incurring a greater overhang of debt in the future, which would bring its own problems. Long-run optimization—the avoidance of future disaster—might well, on this argument, require the highest possible quantum of debt service payments now, and the lowest possible carry-over of new debt in the future. All is for the best, perhaps in the best of all possible worlds! But we cannot know that this is true; it is, at the most, a hypothesis worthy of consideration. However the view was certainly expressed strongly at the seminar that the “solution” to the crisis in 1982–85 had been bought too dear in terms of social stability and economic progress in borrowing countries.

The Fund’s Operations

This section assembles the interlocking elements discussed throughout the seminar, with particular reference to G.G. Johnson’s paper on exchange rate surveillance, Stephany Griffith-Jones’ paper on the future of the Fund, and Loukas Tsoukalis’ paper on reform. A note tabled by Azizali Mohammed on Fund conditionality was also referred to widely, and there were important contributions both from formal commentators and seminar participants more generally.

Several themes intertwined, but three can be usefully separated. First, the allegation was made that there is a lack of symmetry between the Fund’s treatment of deficit and surplus countries. The plea entered to this charge is guilty, but inevitably so. The so-called Scarce Currency Clause has not been a serious constraint on surplus countries for at least a quarter of a century, and these have long been willing to accept international means of payment other than their own currency. For symmetry of treatment of rich and poor, or of the group of surplus countries compared with the group of deficit countries, it is not realistic to look to the Fund, but to a whole range of international monetary and economic institutions. Of the many challenges facing these bodies, symmetry, while important, comes several places down on the list.

The second broad theme was whether the rules of surveillance, in form or content, were unfair or unreasonable. I am reminded of a story current in London at the end of the 1960s about a Treasury official who, in the days after the devaluation of sterling, found two documents travelling separately but almost simultaneously across his desk, from in-tray to out-tray. The first was the preliminary interchange between the U.K. Government and the Fund on arrangements for the stand-by arrangement; the second was a slightly out-of-date copy of a telegram from London to the U.K. representative in Washington, instructing him, in forceful terms, to urge at the Fund Board Meeting that some third world borrower be treated strictly according to the rulebook on some alleged excess rate of domestic credit expansion. Strict conditionality always looks better when it is applied to someone else!

Some of the speakers at the seminar protested that the rate of adjustment required for deficit countries was too fast, too inconsiderate of long-term consequences, too careless of likely social effects, too excessively concentrated on monetary and fiscal instruments, and too credulous of the effects of exchange rate adjustment. But most of the seminar participants were uneasily aware of the necessary constraints upon the Fund’s freedom of action, and Azizali Mohammed’s patient exposition of both the methods used and the lack of available alternatives was given a respectful, if not warmly enthusiastic, hearing. I would comment that this type of argument cannot conclusively be examined in general terms; the only way to settle it is to look, in some detail, at individual cases. The trouble is that, after an agreement is made between the Fund and one of its “customers,” neither is enthusiastic about exposing details of the underlying argument to academic attention. Here the role of the economic historian could be great. Even in obsessively secretive countries like the United Kingdom it will not be many years before the full files of the 1960s are available for inspection.

G.G. Johnson and Loukas Tsoukalis and their commentators offered a number of illuminating comments on the exchange rate regime since the abandonment of fixed parities—a third relevant theme. There seemed to be a general acceptance that the present pattern of uncoordinated “floating” by the currencies of the rich countries, together with a regime of formal or informal pegging by many of the smaller or poorer countries, was far from perfect. It was hard to see any definable way in which “the markets” provided any useful substitute for explicit coordination between countries, very hard to see how further coordination could be achieved, and there was a fairly resigned acceptance of the rather appalling truism that the policies of most of the rich countries were far from optimal in isolation, quite apart from the fact that there was no serious attempt to achieve international consistency or coordination. Loukas Tsoukalis’ conclusion (attributed caustically to Richard Cooper) that material change might not be achieved until the next century, evoked little audible dissent at the seminar, but few of us actually welcomed it.

All these were important—nay essential—points for noting at a seminar on monetary adjustment. From the point of view of the editor three months later, and, I believe, for the reader a few months after that, the papers embodying this material make good and clear reading. But the main time at the seminar was spent hacking away carefully and persistently at a parallel set of challenges, concerned with the relationship between the Fund and intergovernmental loans, between the Fund and the private financial markets, between the Fund and the World Bank, and between the adjustment system and the flow of aid and loans to developing countries.

I.G. Patel spoke several times of the “marginalization of the Fund,” Loukas Tsoukalis wrote about the privatization of international reserves (quite consistent with Michael Dooley’s general thesis), and Marjorie Deane commented rather enigmatically that the Fund would have to disentangle itself from the private sector banks. What is the role of an international public sector bank, whose own capital base obstinately refuses to keep up even with inflation, let alone the expanding scale of operation in the financial sector of the world economy?

The Fund is not an international central bank. Attempts to equip it with its own international fiat money (the SDR), despite considerable progress in the first decade of the experiment, have run out of steam. Its role as a financial consultant—an issuer of certificates of good housekeeping—in the international loan crisis has given its analysts on the country desks a certain prominence, but that role will not last, or at least its present intensive phase will not. As for the developing countries, what they are short of at any time is (international) money. The purpose to which they will put that money, the reasons that have led to the particular pattern of need for money this month, the way that need for money might be satisfied, are all secondary issues. The Fund, because it appears only at moments of trouble, gets all the blame and none of the praise.

But the creditworthiness of borrowers is always an issue for banks. Domestically, there have certainly been periods (in London in the early 1920s or the early 1970s) when lenders have seemed ready to fall over each other in their eagerness to find a customer. Internationally, we seem to have had a similar experience closely connected with the rapid buildup of the oil surpluses of the oil producers and the problems created for the banks by that excess supply of short-term liabilities. Those periods of excess seem inevitably to bring stringency in their train, and this stringency often afflicts whole groups of persons and economic agents outside the ranks of those responsible for negotiating the original transactions.

Although all money is fungible, and all of it goes into the same pot and may be used for the same purpose, it is lent for different reasons, on different terms, often by different agencies. There seems to be at times a general disposition among developing countries, and economists learned in the affairs of developing countries, to expect the Fund to act as a “one-stop banker”—providing all lending for all purposes. That is not how the Fund sees itself, and not how many members of its Board require it to operate. There is a division of labor, the Fund would argue, among the Fund, the World Bank, governments, and the private banking system. In that division of labor, it falls to the Fund to deal with adjustment—the fine tuning of the system—while the streams of lending and borrowing are governed by other forces. The trouble with this paradigm is analogous to the problems that arise in dividing labor between a “finance ministry” and a “ministry of economic affairs” within any national government. He who holds the short-term purse strings also controls the longer-term path of the economic system. The agency of each individual government that deals with the Fund for stand-by arrangements or conditional finance of any sort, becomes necessarily during any period in which a country is “in the Fund” the dominant agency of government. And developing countries with persistent balance of payments problems tend to be “in the Fund” most of the time. Willy-nilly, therefore, the Fund often appears politically and socially as well as financially the determining force in economic development.

It is this contrast between how the Fund is perceived by the ordinary informed citizen in its client countries, and how it perceives itself and is perceived by the international financial community, that is a potent cause of tension. I recall nearly fifteen years ago setting out to find a monitoring device that would escape what seemed to me the obvious difficulty of the domestic credit expansion approach—an approach which I believed to be rather crudely monetarist, and requiring excessive interference in the general financial and monetary policy of client states. I was attracted by the notion of “the weighted budget balance” as a simple alternative forecasting device. But I soon began to encounter all the difficulties that Azizali Mohammed explained to us at Windsor, and I soon came to the conclusion that the only way to happiness was to avoid being “in the Fund” at all. That, of course, is a fine prescription for an advanced country with a large oil province and a highly developed financial sector. It is no comfort to poor countries with persistent balance of payments problems. As Tony Killick remarked at the seminar, “the need for monetary adjustment is negatively correlated with the ability to adjust.”

The complaint about the Fund’s treatment of the rich and the poor—that it is asymmetrical—is particularly strident on exchange rates. The Fund has very clear and straightforward views on exchange rates for developing countries with high inflation and balance of payments problems. Rates should not be allowed to get ludicrously out of line, and big gaps between actual and justified rates must be promptly corrected. These views are acted upon. But what are “our” views (as of March 1985) on the U.S. dollar? Are those views enforced, or enforceable? And is the pattern of institutional arrangements for a floating regime among the rich countries (discussed by G.G. Johnson and L.D.D. Price, with a wealth of analytical detail)—for example, the extent of forward market hedging that is available—remotely in accord with what professional opinion would require? Alas, there is some truth to this complaint. But surely this does not imply, where the Fund does have an influence, where its voice is heard, that it should speak in a way that is against the need for adjustment, which would inhibit the financial viability of the developing countries? The fact that we cannot do good everywhere should not stop us from doing good somewhere.

Frances Stewart made the point that bargaining or argument (between borrower and lender, between Fund staff and member country) need not be a sterile process. The give and play of argument, what Susan Strange called the “blood and guts of the business,” can change views and allow new considerations to be weighed, or institutional and economic factors to be introduced that may be equally important as the purely financial, short-term numbers game. Put delicately, no one wants to lend money on terms that, because of their excessive financial purity, ensure that the social and political system of the borrowing country would be so stressed that the outcome would be far worse than pure accountancy would predict. When some economists at the seminar complained about Fund conditionality, they could be read as advising the Fund that some conditions would be counterproductive. That is the sort of advice which should be heeded by lenders, and by “certifiers of good housekeeping,” as well as by borrowers.

A Concluding Remark

As Chairman of the discussion, the main lesson I learnt from the seminar was that the Fund is seen by some observers as the whole of the system, while the Fund sees itself merely as a component part. And that raises the crucial question with which I began: is there a system at all, or merely a number of component institutions, mechanisms, devices, which together do not add up to what is required?

International monetary adaptation in the developed world has coped remarkably well with the last 15 years of repeated incident; in the developing world, coping may not be enough, and the cumulating problems of food supply, of increasing trade protection against imports from developing countries, and of debt management may be judged by historians at the end of the century as having reached a point of real and interrelated crisis at this point in time. That looming fear was present at the seminar, and I must in all honesty report it.

I heard nothing, however, as one who has been away from direct involvement in these problems for seven or eight years, to convince me that there is a viable alternative set of mechanisms ready at hand. Loukas Tsoukalis and Stephany Griffith-Jones, pointing as they do to patient, detailed, incremental change, seem to me to have the balance right. There is, and should be, a sense of urgency among the experts, and it should be pressed. But what is urgent is a host of detailed improvements and developments, a determination to amend and adapt the system, not a bouleversement of what exists.