II. Exchange Rates And Exchange Restrictions

International Monetary Fund
Published Date:
September 1948
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Exchange Stability and Exchange Rigidity

ONE of the purposes of the International Monetary Fund is “to promote exchange stability, to maintain orderly exchange arrangements among members, and to avoid competitive exchange depreciation.” At the time the Bretton Woods Agreement was under discussion, fears were expressed in many countries that membership in the Fund might impose upon national authorities control by an organization which would make a fetish of exchange stability and would regard any changes from the agreed par value (outside the 10 per cent limit on the total of all changes—for which Fund approval is not necessary) as highly abnormal and to be sanctioned only reluctantly and in the most unusual circumstances. There was at no time any justification for this view. The Fund Agreement makes it clear that the provisions for the regulation of exchange rates are not intended to impose upon the Fund the duty of perpetuating in the name of stability exchange rates which have lost touch with economic realities.

Stability and rigidity are different concepts. The Fund has never insisted on the maintenance of an exchange rate which was not suited to a country’s economy. On the contrary it has always recognized that an adjustment of exchange rates may be an essential element in the measures necessary to enable a country to pay for the goods and services it needs from abroad without undue pressure upon its international reserves. Stability implies that when exchange rate adjustments are necessary they should be made in an orderly manner and that competitive exchange depreciation should be avoided.

When the Fund was set up a major preoccupation of those who were concerned with international exchange policy was the avoidance of competitive exchange depreciation. This concern, which is reflected in the Fund Agreement, was based upon the conditions prevailing during that large part of the inter–war period which was characterized by unused resources and large–scale unemployment. During that period, countries not infrequently sought to protect themselves from the effects of deflation in other countries by exchange depreciation. At the present time, conditions are virtually the reverse and opinion has swung in the opposite direction. The major concern now is inflation and not deflation. Everywhere there is anxiety about the effects of rising living costs, and policies which appear to foster price increases meet with great social and political resistance. Nearly all countries are pressing on their resources and anxious to obtain their imports on the best terms of exchange.

Adjustment of Par Values

The tendency now is, therefore, to maintain exchange rates rather than to depreciate them. This has naturally led to a fear, which finds frequent public expression, that the prevailing level of exchange rates prevents certain countries from earning as much foreign exchange as they otherwise might and consequently increases the need for external assistance in order to maintain a given flow of imports. It is important, therefore, to consider the extent of the contribution to international equilibrium which might be made through adjustment in exchange rates. In this connection, one thing can be stated definitely at the outset. The countries which have been devastated by the war cannot be expected to balance their international payments at once, and no exchange depreciation, however severe, would enable them to achieve such a balance at a tolerable level of imports.

It is sometimes said that with so many countries of the world experiencing balance of payments difficulties, a solution could be found through simultaneous and widespread devaluation of currencies. This implies an oversimplified interpretation of present economic difficulties and attributes an exaggerated importance to exchange rate adjustment as a means of solving these difficulties. The unbalance of many economies throughout the world today is of too fundamental a nature to be corrected merely or even mainly by exchange rate adjustments. In countries where the primary cause of balance of payments deficits is the present limited export capacity, devaluation would not increase foreign exchange receipts, but would merely strengthen domestic inflationary forces. For some countries it is reasonable to expect that adjustments of other types will make it possible to maintain exchange equilibrium without any departure from the present rate. In others, an adjustment of the exchange rate may sooner or later be necessary. The proper course of action for each country will be determined by many different considerations, including the policies followed by other countries. Moreover, the question of timing of any change in exchange rates is all–important. The delicate problems of a satisfactory worldwide pattern of exchange rates cannot be solved by any mechanical rule, which would inevitably fail to take proper account of the special conditions of particular countries.

The appropriate timing of an exchange rate adjustment will depend upon a variety of factors. The relation to export opportunities, which was emphasized when the initial par values were announced, is still of great importance. So long as an exchange rate does not hamper a country’s exports, there is little to be said in present world conditions for altering it. There are indications, however, that in some countries the exchange rate is becoming a restraining factor on exports and that it is adding to the difficulty of earning convertible currencies.

The question of revising par values cannot be divorced from a consideration of internal financial problems and policies. An exchange rate adjustment undertaken by a country suffering from inflation might temporarily correct a price relationship which had begun to hamper exports, but without effective anti–inflationary measures the benefits of the adjustment would soon evaporate. Premature exchange rate adjustment might itself aggravate internal tendencies toward inflation and frequent changes of exchange rates would create distrust in the currency and hamper the orderly development of a country’s trade. In dealing with any concrete situation it will be necessary to take into account the necessity of restraining inflationary forces, particularly by achieving a balance or surplus in the national budget and bridging the gap between the volume of investment which is undertaken and the amount of its income the community is willing or able to save.

Although the Fund is not entitled to propose a change in the par value of a currency it has an obligation to keep the exchange rate situation constantly under review, and its views may properly find expression in its informal consultations with members. When an exchange rate is no longer appropriate the Fund will, of course, give prompt and realistic consideration to a member’s request for adjustment in the par value of its currency.

Fluctuating Rates

In the present abnormal conditions of the world it is difficult for some countries to abandon certain exchange practices which do not conform to the long-term objectives of the Fund. Many countries find it necessary to impose restrictions on current transactions, and where exchange restrictions are not imposed, imports are usually held in check by restrictions of other types. The view has been expressed that the necessity for these restrictions would disappear and international equilibrium would be restored if exchange rates were permitted to respond freely to the market forces of supply and demand. The fundamental conditions which would make possible the abandonment of trade and exchange restrictions are, however, entirely absent today in most of the world, and in fact very few countries are prepared to establish a genuinely free exchange market. The so–called free rates now in use in a number of countries do not obviate the need for restrictions on payments and transfers for current international business, as a system of genuinely free exchange rates would be expected to do. Under these “free” systems, the exchange proceeds derived from exports must, by law, be sold, and the purchase of exchange for imports is by law limited to licensed buyers. Other restraints on international payments and transfers are also retained. The exchange system is free only in name, and the rates quoted in these markets are not necessarily any more “realistic” than those quoted in countries maintaining fixed exchange rates.

Systems of fluctuating rates may, nevertheless, be unavoidable when prices are highly unstable. In China and Greece, which have so far not agreed a par value with the Fund, the rates at which the most important currencies are bought and sold are permitted to fluctuate, with a continuing depreciation of the national currencies. By managing the demand for exchange, the monetary authorities seek to bring about a rate of exchange that enables exporters to sell abroad despite the continuous rise in prices.

Italy is another member which has not yet agreed a par value and which is maintaining a fluctuating rate system. This system was the subject of a public statement by the Fund on December 4, 1947, which is reproduced in Appendix I.

It would be an empty gesture to insist on formal stability in an exchange rate without reference to actual economic conditions. Exchange stability is quite impossible for a country whose prices are still rising at a rapid rate; when there is no prospect that such movements will be checked a progressive depreciation of the currency is unavoidable. So far as it lies within its competence the Fund will do its utmost to promote the emergence of internal economic and monetary conditions favorable to the maintenance of stable exchange rates and at the proper time will not be remiss in urging upon governments the desirability of agreeing upon a parity. In the meantime, however, it is recognized that in certain exceptional circumstances, such as those of China and Greece, the temporary use of a fluctuating exchange rate is necessary to enable a country to prevent a breakdown in its trade.

The Importance of Orderly Cross Rates

The experience of a few countries with so–called free rates has recently directed attention to one aspect of exchange rate policy which has assumed considerable importance at the present time when nearly all currencies are inconvertible—the maintenance of orderly cross rates. When currencies are freely interchangeable, their values, in terms of each other, whether fixed or fluctuating, will as a rule be the same in exchange markets throughout the world. Any temporary divergence which may appear will be quickly eliminated by arbitrage operations.

With inconvertible currencies, however, transactions must, in the absence of credit arrangements, be balanced bilaterally, unless one trading partner is willing and able to use gold or acceptable currencies to liquidate its adverse balances with the other. If countries with inconvertible currencies do not cooperate to maintain agreed exchange rates, but permit the rate for each currency to be affected by the special circumstances of localized supply and demand or unilateral controls, the resulting cross rates will have little relationship to the parities agreed with the Fund and made effective in other countries, and the rate quoted for a particular currency will fail to reflect the overall international position of the country concerned.

The practical effects of deviations from an orderly pattern of cross rates are, of course, particularly serious when the country concerned plays a major role in international trade. In any country where the cross rates place a premium on the dollar, there is an inducement for traders to purchase goods from other countries for resale in the United States, and thus divert part of the dollar receipts which would otherwise accrue to the countries of origin. Export and import restrictions may limit the scope of such transactions, but it will be difficult to check them entirely when the goods diverted are raw materials which can be converted into manufactured goods for which the United States offers a market. To avoid further inroads upon their dollar resources by operations of this kind countries may be obliged to impose still more stringent trade restrictions.

Changes in the direction of trade in response to the movements of disorderly cross rates are likely to be determined by short–run considerations and local peculiarities which have little to do with the fundamental influences by which a new pattern of world trade should be determined. They will therefore merely add to the difficulty of restoring orderly balances of payments and the convertibility of currencies. For these reasons the Fund attaches great importance to the maintenance of orderly cross rates as a means of protecting its members and encouraging the appropriate reorientation of trade on a multilateral basis.

Multiple Currency Practices

Multiple currency practices have been used for a variety of purposes, including the correction of balance of payments dis–equilibria. Certain countries, particularly in Latin America, have used them as a means of restricting imports without resort to complicated administrative machinery and without giving the recipients of import licenses opportunities for large windfall profits. They have also had fiscal significance in some countries in which governmental revenue is derived in large part from indirect taxes.

The Fund has worked out guiding principles with regard to multiple currency practices. These have been communicated to its members in a memorandum, reproduced in Appendix II, which describes in detail its policy and jurisdiction. The memorandum emphasizes in particular that multiple currency practices, besides being in most cases restrictive practices, also constitute systems of exchange rates and as such are of special concern to the Fund.

The Fund has advised those of its members which engage in multiple currency practices of its interest in the unification of exchange rate structures. During the past year some members have undertaken to simplify or modify their multiple currency practices in a way which will facilitate establishment at a later date of a unitary rate of exchange. A number of countries with balance of payments deficits, however, have felt obliged to continue their multiple currency practices together with other restrictions on payments and transfers for current international transactions. Under the economic conditions now prevailing in many of those countries it is difficult to foresee an early termination of multiple currency practices. The Fund, however, is encouraging its members to bring about the economic conditions which would facilitate the removal of these practices as soon as practicable.

At present, the most important consideration is the termination in the countries concerned of domestic inflation. Until the abnormal demand for imports can be checked by other means, some countries may have to use penalty rates of exchange for this purpose. When their domestic inflation is halted these countries will find that costs soon creep up on prices and that a new exchange rate is necessary to encourage exports. It is this halting of inflation and the adjustment of local costs to prices that would offer the most favorable opportunity for eliminating multiple currency practices and establishing a new rate of exchange.

In view of their special circumstances the Fund did not take exception to proposals by some member countries to introduce multiple currency practices or to adapt existing ones to changing circumstances. A statement issued by the Fund following consultations with Chile on modifications of its multiple rate system is set forth in Appendix III. In the case of Ecuador the Fund agreed to a modification of the existing multiple currency system, as described in last year’s Annual Report. As a result of more satisfactory fiscal and credit conditions, the inflationary situation has shown a significant improvement and the demand for foreign exchange has been curbed, even though there is complete freedom to import and also to transfer capital at the effective exchange rates. If this improvement continues, conditions should eventually be established which would permit a unification of the exchange rate without the need for exchange restrictions.

Exchange Restrictions and the Convertibility of Currencies

All members of the Fund other than El Salvador, Guatemala, Mexico, Panama and the United States have notified the Fund that they are availing themselves of the provisions of Article XIV, Section 2 of the Fund Agreement, which provides that during the transitional period members may, subject to certain safeguards, maintain and adapt to changing circumstances exchange restrictions on payments and transfers for current international transactions.

In 1947 continuing balance of payments deficits forced many countries to impose or reinforce foreign exchange restrictions in order to deal with a persistent drain on reserves. Formerly, restrictions had in general been placed on imports of certain goods, i.e., luxury and non–essential items, rather than on imports from specific currency areas, but during the period under review the restrictions were imposed in most cases with the intention of reducing an existing or prospective United States dollar deficit, and safeguarding gold and United States dollar reserves. Under these circumstances, it has not been possible to effect any relaxation of exchange restrictions. However, the Fund is keeping the exchange control systems of member countries under review; wherever feasible, it will encourage the elimination of exchange restrictions on current transactions and may make representations to members for the withdrawal of particular restrictions whenever conditions appear favorable.

In 1947 a major attempt was undertaken to render convertible all sterling accruing from current transactions. By the terms of the Anglo–American Financial Agreement of 1945, the Government of the United Kingdom undertook, unless in exceptional cases an extension has been agreed with the Government of the United States, that after July 15, 1947 it would impose no restrictions upon payments and transfers for current transactions and would permit the current sterling receipts of sterling area countries to be used in any currency area without discrimination. During the months preceding that date the United Kingdom took a series of steps to extend the degree of transferability of sterling already existing and to fulfill its convertibility commitments; it announced from time to time the relaxation of certain wartime restrictions on the transferability of sterling. By July 15 these arrangements covered the greater part of the trading world, negotiations being unfinished with only a few countries. Convertibility for current sterling did not, of course, obligate the United Kingdom to remove all trade and exchange controls. Exports and imports were still subject to license and control was still exercised over capital movements and the large sterling balances which had accumulated during and immediately after the war.

From early July gold and dollar expenditure by the United Kingdom increased rapidly. In the two months July and August drawings by the United Kingdom on United States and Canadian credits were almost as large as in the preceding six months. But the acceleration in July was not wholly the result of the introduction of convertibility. Even prior to July the rate of dollar expenditure was rising sharply as a result of the growing deficit with the dollar area both of the United Kingdom and of the rest of the sterling area. For the year as a whole this deficit accounted for nearly 85 per cent of the net use of reserves and dollar credits by the United Kingdom, the greater part being attributable to the deficit of the United Kingdom itself.

So great was the drain on its exchange resources that the United Kingdom on August 21, 1947 withdrew the facility of freely transferring sterling from Transferable Accounts to American or Canadian Accounts, while at the same time eliminating Canadian Transferable Accounts. It may be noted that even after the suspension of the convertibility of sterling into dollars sterling remained transferable over a wide area.

The Government of the United Kingdom stated that the suspension of convertibility of sterling was of an emergency and temporary nature and was not to be interpreted as in any degree indicating a modification of its oft–expressed view as to the desirability of maintaining full and free convertibility of sterling for current transactions. As a long–run objective it was also stated that such convertibility is an indispensable element in British financial policy. The Government of the United Kingdom expressed its belief that it would be possible to work out in consultation with the Government of the United States and within the framework of the Anglo–American Financial Agreement and of the Fund Agreement a constructive policy which would be best suited to changes in the situation as they appear and which would lead towards the objectives laid down in both those Agreements.

The failure of the attempt to restore the convertibility of sterling does not in any way indicate that the free transfer–ability of the proceeds of current international transactions cannot or should not in time be attained. The economic advantages for all trading countries of being able to use the proceeds from their exports to any part of the world to pay for their imports from any part of the world are so great that there should be no abandonment of the objective of restoring a system of multilateral payments. The British experience does show, however, that the establishment of convertibility of currencies can succeed only when the underlying conditions are favorable to a system of multilateral trade and payments. Until the great trading countries, whose currencies are used in international payments, have restored a reasonably satisfactory balance in their current international accounts they cannot undertake the obligation of permitting free transferability of their currencies for current transactions. The members of the Fund which have taken advantage of the transitional arrangements do not for the most part have reserves adequate to enable them to meet large current deficits for even a short period, or to meet persistent deficits, even of a moderate size, for an extended period.

Multilateral Clearing in Europe

Since the war a large part of intra–European trade has been carried on under a network of bilateral payments agreements. These arrangements served a useful purpose in helping to restart trade in Europe, but as time went on their limits became evident, and an effort was made in 1947 to modify their structure to permit an extension of multilateral trade in Europe. Considerable assistance was afforded to European trade by the common practice whereby each partner to a bilateral agreement undertook to hold a limited quantity of the currency of the other, and thereby in effect granted credit. Her trading position in relation to other European countries resulted in Belgium becoming the main creditor under these agreements. Under these agreements and by credit arrangements of a similar nature, Belgium’s net creditor position vis–a–vis other European countries was increased during 1947 by about $170 million.

After the credit margins provided by the bilateral payments agreements were reached, however, balances had to be settled in gold or dollars. With the shortage of gold and dollar reserves in Europe, it was feared that trade would be forced more and more into bilateral balance by reduction of imports from the European surplus countries, and that this would adversely affect the flow of European goods essential for consumption and investment. Because of this danger, efforts were made in the latter part of 1947 under the auspices of the Committee on European Economic Cooperation to develop machinery for clearing European accounts. Belgium, France, Italy, Luxembourg and the Netherlands agreed in November 1947 to become regular members of a system of European multilateral compensation which would offset each month the balances arising from their mutual transactions, and thus reduce to a minimum payments in gold and convertible currencies. Other European countries have participated as “occasional” members and as such are entitled but not committed to take part in individual offsetting operations. The volume of transactions to which compensation machinery of this kind can be applied is dependent upon the balance of creditor–debtor relationships between the participants in the system. In view of the predominant creditor position of Belgium among European countries and the limited number of active participants in the scheme the scope for compensations has been narrow and the results actually recorded in the early months of the year have been meager.

Unless credit margins are increased or additional gold or dollars become available for settling balances in intra–European trade it will become increasingly necessary for certain European countries to seek to achieve a greater degree of bilateral balancing in their transactions with other European countries. This bilateral balancing can be attempted either by the deficit countries reducing imports from the surplus countries, even when such imports are urgently needed, or through pushing exports to the surplus countries, even when such exports are, not essential for consumption or investment. Developments along these lines would inevitably either reduce essential production in the surplus countries or encourage the continuance or expansion of nonessential production in the deficit countries.

The necessity of preventing a sharp decline in intra–European trade is clear. Any halt in the flow of essential consumption and investment goods would impede European recovery. Moreover the ultimate restoration of Europe’s payments position would be helped by substituting so far as is economically possible European sources of supply for goods that would otherwise have to be purchased in the Western Hemisphere. At the same time, while European trade is maintained and encouraged it should be gradually adapted to a pattern compatible with Europe’s future position as well as its present needs. If European payments were placed on a multilateral basis each country could import from other European countries goods which are most essential to its economy; in this way the necessary shift of European resources toward production and trade compatible with over–all balance in European payments and the general convertibility of European currencies would be promoted.

The Fund has consulted with the European countries studying the problem of intra–European payments. It has informed them of the Fund’s hope that an arrangement can be made for multilateralizing European payments and of its hope that a moderate rise in the credit margins of payments agreements can be made available by the European creditor countries as their further contribution to European recovery. The Fund has also indicated that it would not object to the use of its European currency resources in moderate amounts by ERP members eligible to draw on the Fund to assist in the multi–lateralization of European payments provided the conditions and purposes of the Fund Agreement relating to the use of its resources are met. In this connection the Fund referred to the decision on the use of its resources by ERP countries which is set out in Appendix IV. The Fund also indicated its willingness to place its advice and technical facilities at the disposal of its members in connection with the formulation and administration of any multilateral payments arrangements.

Par Values

Three members, namely, Lebanon, Syria and Australia notified the Fund during the past fiscal year of initial par values of their currencies which were agreed upon and published by the Fund. These par values were in conformity with the rates already prevailing in the countries concerned for some time previously. An initial par value for the Dominican Republic peso, which was introduced as the local circulating medium replacing at par the United States dollar notes which formerly circulated, was agreed with the Fund, and became effective on April 23, 1948.*

The only Fund member from whom an application was received during the year for a proposed change in par value was France. The proposed devaluation, however, was linked with the institution of a premium market for the dollar and certain other currencies readily saleable for dollars. This involved the introduction of a multiple currency practice and a discriminatory currency arrangement. The proposal was the subject of full and frank consultations between France and the Fund, at the end of which the Fund issued a statement which is reproduced in Appendix V.

The Fund agreed that a change in the par value of the franc was necessary and indicated that it was prepared to concur in a devaluation of the franc to a realistic rate which would be applicable to transactions in the currencies of all members of the Fund.

The Fund gave careful consideration to the proposed establishment of a market in United States dollars and certain other currencies, on which these currencies would be bought and sold at premium rates that would differ considerably from the new par value. The Fund explored various alternatives designed to meet, insofar as possible, the objectives of France, which were to reduce its dollar deficit by granting a premium on exports to, and by imposing a penalty on non–basic imports from, the dollar area, to encourage the repatriation of French assets held abroad, and to divert tourist receipts and other invisibles from the black into the “free” market.

The Fund could not agree, however, to the inclusion in a premium market limited to a few currencies, of any part of the proceeds of exports, as in its judgment this entailed the risk of serious adverse effects on other members without being necessary to achieve the trade objectives sought by France. The Fund felt there would be scope for competitive depreciation in the application by one country of a premium rate on exports to one area while other rates remained stable and other countries maintained the parities agreed with the Fund. Such a system, working in an important trading country, could lead to trade distortions by encouraging the diversion of dollar exports of other countries for re–export through France as a consequence of the disorderly cross rates and hamper the restoration of international payments based on multilateral trade. The Fund felt that a widespread adoption of such a system would result in exchange uncertainty and instability and produce a disrupted exchange situation from which all members of the Fund would suffer.

The French Government found that it could not accept the modifications suggested by the Fund and decided to go forward with its own proposals. Accordingly, the Fund considered that France had made an unauthorized change in its par value and had therefore become ineligible to use the Fund’s resources.

The plan for exchange adjustment was put into operation on January 26, 1948. Under the program the parity of the French franc was changed from 119.107 francs to the dollar to a new official rate of 214.392 francs, a devaluation of 44.4 per cent. A so–called “free” market began to operate on February 2, 1948, which dealt in United States dollars and Portuguese escudos. Only dealers authorized by the French Foreign Exchange Office may deal on the“free” market. The purchase of these currencies is strictly controlled by the authorities and limited to holders of import licenses or exchange authorizations. The supply side of the market consists of the repatriation of assets held abroad, tourist receipts and other invisible items and half of the proceeds derived from French exports payable in United States dollars and escudos. The other half of such export proceeds must be surrendered to the French authorities at the new official rate. While foreign exchange for certain essential imports payable in these currencies is provided by the French authorities at the official rate, the whole of the exchange for other licensed imports had to be purchased on the “free” market until March 30, 1948, when the exchange system was modified to permit importers to acquire half of the needed exchange from the French authorities at the official rate. All the exchange for other authorized French remittances to the dollar and escudo areas and for the conversion of free accounts in francs (restricted to residents in certain specified countries) must be purchased on the “free” market.

The “free” market rate for the dollar was at first about 311 francs, but since the beginning of April, it has been maintained at a level of 305–306, no doubt owing to the willingness of the French monetary authorities to intervene. The new arrangements did not prevent the continued existence of a black market in foreign exchange in which rates higher than those of the “free” market have been quoted.

Subsequent to the devaluation of the franc and the introduction of the new exchange system, some of the payments agreements into which France had entered were revised. Separate financial agreements were made with Belgium, Italy and Switzerland during March 1948. A “free” market was created for the Swiss franc in Paris and is similar to that for dollars. With Italy, a new franc–lira rate was agreed with the understanding that it would be subject to monthly review and change in line with the fluctuations of the “free” dollar both in Paris and Rome. With Belgium the agreement was more limited. It aimed at giving Belgian tourists in France benefits equivalent to the dollar premium in the “free” market and thus providing the French monetary authorities with Belgian francs which would otherwise have been disposed of on the black market.

Consultations between France and the Fund have not been interrupted. Discussions have taken place of the problems which have arisen out of the application and extension of the French exchange system.

The establishment of the initial par value for the Brazilian cruzeiro was announced by the Fund on July 18, 1948.

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