Chapter 4 The Fund and International Liquidity
- International Monetary Fund
- Published Date:
- September 1964
The Fund as a Source of Liquidity
ONE of the most important functions of the Fund is to help its member countries by making funds available to them in accordance with the provisions of its Articles of Agreement. The Fund possesses a stock of gold and of member countries’ currencies from which members may draw needed currencies in exchange for their own. Such drawings are to be repaid as reserves recover or, at any rate, under existing policies, within three to five years. The Fund is thus a source of short-term or medium-term finance and as such its operations affect the distribution and composition of international liquidity. Moreover, since members can count on having access to the Fund in accordance with established policies and procedures, unused drawing facilities in the Fund constitute a form of international liquidity. Drawings within the gold tranche (i.e., those that do not raise the Fund’s holdings of the currency of the drawing country above its quota) are available on a virtually automatic basis. Such drawing rights may be considered as part of a country’s reserves, and are so presented in the reserve statistics published by the Fund. Drawings beyond the gold tranche, however, are conditional, in greater or lesser degree, on the adoption by the drawing countries of policies designed to ensure the temporary character of their payments problem, and designed also to eliminate or reduce the member’s reliance on exchange restrictions or certain other exchange practices. The amount which a member can draw on a conditional basis is normally limited to the equivalent of its quota. The Fund can, however, waive this quantitative limitation when this is justified, and has declared its willingness to do so in connection with the special facilities recently established for the compensation of export fluctuations.
When a member draws from the Fund, the country whose currency is drawn experiences an improvement in its Fund position. In most cases this will be a gold tranche position, and the improvement will carry with it an increase in drawing rights that are virtually automatic, and hence in reserves as presented in the statistics published by the Fund. Where, as will often be the case, the drawing member is utilizing its drawing facilities in the credit tranches, the net result of the operation will be to reduce aggregate conditional drawing facilities and to increase aggregate reserves.
At present the Fund contributes on a small scale to unconditional liquidity and is a large contributor to conditional liquidity. Gold tranche positions stand at about $3.9 billion. However, much the greater part of these positions are a consequence of gold contributions made by members; and since such contributions have often been associated in part with purchases of gold from reserve centers, they have brought about a reduction in countries’ holdings of gold plus reserve currencies that has exceeded the amount of gold tranche positions acquired. The Fund’s net contribution to unconditional liquidity is, therefore, only a small fraction of that suggested by the total of gold tranche positions. In sharp contrast, the conditional drawing facilities, in the credit tranches, now total about $14 billion.1
As discussed in the preceding chapter, members can use the Fund only to meet balance of payments problems that are temporary in character, and such use is to contribute to the achievement of the purposes stated in the Fund’s Articles of Agreement. In exercising its responsibilities with respect to these purposes, and specifically in making financial resources available to its members, the Fund must continuously keep two considerations in mind: on the one hand, it must act according to standards which are sufficiently definite to be predictable; and on the other hand, it must take into account the unique set of circumstances that characterizes the economic position of any particular country at any particular time. The Fund has had a rich operating experience in evolving general criteria and in making the detailed judgments necessary to apply them to particular cases. Member countries, having given the Fund the central role in the international monetary system, can adapt this role to changing circumstances.
Fund Quotas and Quota Increases
An increase in quotas is the normal way to make it possible to expand the operations of the Fund and to enable it to play a greater role in the provision of international liquidity of a more or less conditional kind.
Quotas play three main roles in the Fund. They are the basis for the magnitude of drawing facilities which members can expect to enjoy. Subject to any borrowing the Fund may undertake, they determine the magnitude of the resources in gold and currencies on which the Fund can rely—though the composition of these resources may be subsequently affected by the Fund’s transactions and by any use of gold to replenish the Fund’s stock of currencies. Thirdly, they determine the relative voting rights of members.
In accordance with the Articles of Agreement, the Fund makes a review of quotas every five years and as a result of this review may propose a general or a selective adjustment of quotas, or both. However, there is nothing to prevent the Fund from proposing a general adjustment of quotas—which need not be a uniform proportional adjustment for all members—at times other than the quinquennial review, and indeed the general increase in quotas in 1959 was undertaken as a result of a special review of quotas requested by the Board of Governors in 1958. Finally, the Fund can at any time consider a member’s request for a change in its quota.
It is appropriate in connection with this discussion of international liquidity to note that the next quinquennial review of quotas by the Executive Board is scheduled for 1965, and to describe certain considerations affecting the desirability of a general increase in quotas and of an adjustment of relative quotas.
The first consideration is that in a world in which income and trade have expanded rapidly and are expected to continue to do so, the need for the type of liquidity provided by the Fund, like the need for international liquidity in general, may be expected to grow.
Beyond this, insofar as there is some prospect that the rate of growth in the need for international liquidity will outstrip that in the supply, there is a case for relying on the type of conditional liquidity provided by the Fund to assist in filling the resulting gap. This would have the beneficial effect of increasing a type of liquidity that is associated with the adoption of measures that will help to correct payments disequilibria without prejudicing the general prosperity.
A number of other considerations may be mentioned that may be of particular importance for certain individual countries or groups of countries.
(1) The variability of capital flows has increased since 1959. This has tended to aggravate balance of payments deficits and surpluses and therefore to increase the amount of resources needed to finance them. Short-term bilateral arrangements are proving very useful in reducing the impact of these problems; but these arrangements are on the whole limited to the industrial countries, and even in those cases the Fund may have to be brought in if the problems prove to be more than short run.
(2) Account must be taken of the policies that countries follow with respect to the accumulation of reserves. As already noted, each country’s accumulation and level of reserves will be affected by the availability and predictability of resources that can be obtained in case of need, principally from the Fund, but also under bilateral or regional arrangements. There is every reason to believe that the reserve behavior of countries will continue to show widely different trends. Some countries clearly assign great importance to increasing their reserves, but many countries have difficulties in doing so and attach importance to increasing their Fund quotas rather than their owned reserves.
(3) Countries have varying ability to round out resources provided by the Fund with resources obtained elsewhere to meet a given balance of payments problem. In a number of instances certain countries, in particular less developed countries, have found that the amounts available from the Fund in connection with stabilization plans endorsed by the Fund were inadequate, and that additional resources were difficult or impossible to obtain. This problem has been accentuated as more countries have drawings outstanding in the higher credit tranches.
Following the decision of the Executive Board on the Compensatory Financing of Export Fluctuations, a number of quota increases have been granted to primary producing countries with small quotas when these were deemed relatively low. These increases were related to the Bretton Woods formula,2 revised to give more weight to trade and variability of trade and relatively less weight to national income and holdings of gold and foreign exchange. For other countries, similar adjustments might appropriately be considered in individual cases.
In the case of countries whose currencies have been actively drawn, particular account has to be taken not only of their own need to draw on the Fund to finance potential payments deficits, but also of their ability to provide resources for the Fund when experiencing payments surpluses. This fact need not significantly alter the criteria which it is appropriate to use in such cases. The same structural characteristics which cause a country to have relatively large short-term to medium-term payments deficits may cause it, at other times, to have relatively large short-term to medium-term payments surpluses. However, in the case of certain industrial countries one should also bear in mind their special needs and their special abilities to provide resources, which arise out of the large-scale movements of short-term and portfolio capital between these countries, especially since the restoration of convertibility.
In examining the desirability of quota increases, the liquidity of the Fund itself is also an important consideration. The amount of assistance which a member can obtain from the Fund is not simply a function of the size of its quota but reflects a judgment by the Fund of what is appropriate in the light of the member’s payments problem and the measures it is proposing to take to deal with that problem. A general expansion in quotas will therefore not of itself bring about a proportionate increase in drawings, but will increase the Fund’s stock of gold and currencies relative to the calls that are likely to be made upon them and enhance confidence in the Fund’s ability to meet all justifiable requests for drawings. Provision of adequate resources, enabling the Fund to meet needs with a margin of safety, may also reduce those needs by marshaling the resources and demonstrating the international cooperation that could deter speculation.
The preceding considerations lead to the conclusion that there is a case for an increase in Fund quotas. The Fund should therefore proceed to an early examination of this question in detail. This examination should encompass the magnitude of a general and virtually uniform quota increase, the need for special additional increases for individual countries in the light of the considerations mentioned earlier in this chapter, the timing of such increases, and other relevant considerations. Under the Fund’s normal practice, the Executive Directors would begin the quinquennial study of quotas at the end of this year with a view to reaching a conclusion by the end of 1965. There would be advantage in considering quotas as promptly as possible after the Annual Meeting of the Board of Governors. If, having regard to views expressed by Governors, the Executive Directors find that increases in quota are desirable, they could submit an appropriate proposal to the Board of Governors for action.
Quota Increases and the Fund’s Gold Policies
When any member’s quota is increased it is obliged to add to its subscription to the Fund an amount equivalent to the increase in its quota. Of this additional subscription, 25 per cent is normally made in gold and the remainder in the domestic currency of the member in question.
The payment of gold to the Fund has implications both for the liquidity of the Fund itself and for that of member countries. For the Fund, gold is an asset which can be used at any time to replenish its holdings of any currencies needed for its operations. Through its holdings of gold, the Fund can assure its members that they will be able to draw, in accordance with the Fund’s policies, even though its holdings of currencies suitable for drawing are low; and the Fund’s gold holdings also assure members that the Fund will not feel obliged to sell their currencies in situations where their own position is not strong enough to stand such sales.
When gold is subscribed to the Fund by a member whose outstanding drawings do not exceed 25 per cent of its previous quota (i.e., which has not previously used up its gold tranche drawing rights), the member in question will experience a change in the composition, rather than in the amount, of its reserves: the decline in its owned reserves of gold will be compensated by an equivalent increase in its gold tranche position in the Fund, the value of which remains constant in terms of gold, and which when needed can be drawn upon virtually on demand. In addition, the member will also gain an enlargement of its conditional drawing facilities roughly equal to its increase in quota. However, where quota increases are obtained by countries that have substantial drawings outstanding, the payment of gold will involve a decline in reserves proper, and the entire improvement in the member’s liquidity will take the form of conditional drawing facilities.
In both of these cases there may be repercussions on the holdings of reserve currencies and, therefore, on total world reserves. For example, members who hold the great bulk of their reserves in foreign exchange might have to acquire any gold they subscribe to the Fund by converting holdings of reserve currency. Even if the member held substantial amounts of gold and acquired additional gold tranche positions in the Fund in exchange for its gold subscription, it might feel inclined to obtain at least part of the gold subscribed by way of conversion. These conversions would reduce the gold stocks and thus adversely affect the reserve positions of the reserve center countries.
The problem of striking a proper balance between the need for gold of the Fund and the need for gold of its members is not an easy one. The Fund has twice made use of its gold stocks to replenish its holdings of currencies. In 1957, the Fund acquired $600 million of U.S. dollars for gold, and in August 1961, on the occasion of the sale of $1.5 billion in currencies to the United Kingdom, the Fund purchased for gold the equivalent of $150 million of U.S. dollars and $350 million of the currencies of eight other industrial countries. The Fund now holds $2.3 billion in gold. In addition, the Fund has in its Gold Account an amount of $800 million invested in U.S. Government securities for administrative purposes; the Fund is entitled to reacquire the amount of gold that it sold to the United States for the purpose of this investment.
The adequacy of the Fund’s holdings of gold should be considered in relation to the fact that the two members with the largest quotas have almost $7.5 billion of drawing facilities unutilized—though it is very unlikely that these would be drawn simultaneously to the full extent—whereas the balances in currencies of other main industrial countries available to the Fund amount to some $2.0 billion in holdings plus $3.0 billion under the General Arrangements to Borrow.
The preceding discussion suggests that it would be desirable for the Fund’s gold holdings to increase when quotas and the Fund’s resources in currencies increase. In the past, 25 per cent of all increases in quotas has been paid to the Fund in gold. In present circumstances, however, it may be desirable to consider whether measures should be adopted to mitigate the repercussions of gold payments on the gold reserves of the contributing members and of the reserve centers that may be affected. There are several methods within the Articles by which this might be done, such as a reduction of gold payments by members with low reserves where permitted by Article III; an offsetting of gold payments by measures within the Articles to move gold into members’ holdings; and special drawings in connection with gold payments. If measures such as these were considered inadequate, others could be devised which might require an amendment of the Articles of Agreement. All such approaches are deserving of further study.
General Arrangements to Borrow
Insofar as quota increases provide balances in currencies likely to be drawn by other members, they meet to some extent the Fund’s need for additional resources that is now covered by the General Arrangements to Borrow, which were negotiated under the authority of Article VII. To that extent quota increases reduce the Fund’s dependence on borrowed resources. There is much to be said for the view that the Fund should conduct its financial operations as much as possible with resources on which it can count permanently without question. But whatever action is taken with respect to quotas, it would probably be desirable for the Fund to have certain stand-by arrangements under which additional amounts of currencies could quickly be borrowed in the event of need. Until thinking about quotas has progressed further, it is too early to be specific about amounts or conditions for future borrowing arrangements. These matters can be considered when the General Arrangements to Borrow, which expire in October 1966, come up for review in the course of 1965.
Potential Further Contribution by the Fund Toward the Supply of Unconditional Liquidity
As stated above, the Fund, under present policies, is primarily a source of liquidity which is linked to the fulfillment of the conditions inherent in the Articles. The Fund creates unconditional liquidity only as a by-product of drawings, and in amounts that are small compared with total quotas.
In practice, members that follow policies that are consistent with the Articles of Agreement have found that they can rely on obtaining financial assistance when needed, and as more and more members have occasion to draw on the Fund and acquire familiarity with its procedures their willingness to use their conditional drawing rights may be expected to grow, thus economizing their demand for reserves.
If, however, it were considered that the international monetary system was moving into an era in which the supply of unconditional liquidity tended to fall short of the need for it, notwithstanding some expansion of the Fund’s conditional drawing facilities, there are various possible ways whereby the Fund might enhance its contribution to the supply of international liquidity of a more or less unconditional kind. As has already been mentioned, the provision of unconditional liquidity has not hitherto been a principal preoccupation of the Fund, although the increased role attributed to gold tranche positions in recent years can be seen as a step in that direction. In the period ahead increasing attention may have to be given to the need for and the desirability of further moves along these lines. During the last year, some of the technical aspects of these problems have been analyzed but they require further study. The techniques described in the following paragraphs are presented, therefore, only to suggest the range of technical solutions that might be found, without attempting at this stage to decide whether they fall within the existing Articles. Member countries will ultimately have to decide whether it is necessary and desirable to move in the direction of the creation of unconditional liquidity on an international scale, and, if so, to what extent and in what manner the Fund could be used to this end.
One possible approach that would deserve study, in the light of the purposes of the Fund, would be to make members’ access to some portion of the credit tranches more assured than it is at present. Such action might be carried to the point at which it would be tantamount to raising members’ unconditional liquidity in the Fund, and in that event each subsequent increase in quotas would increase the amount of unconditional liquidity thus provided.
A second technique, which is, of course, closely related to the Fund’s gold policy in connection with quota increases, discussed above, would substitute for a portion of the gold subscription to the Fund an alternative method of payment, e.g., by means of gold certificates. This would pro tanto have the effect of providing a member with a gold tranche drawing right without a corresponding reduction in its gold and foreign exchange reserves.
Another approach that might be envisaged could take a variety of forms. Its essence would be the purchase by the Fund of assets, other than the currencies which it acquires in connection with drawings, for the purpose of enhancing members’ international liquidity. Such action, whatever its precise form, may conveniently be designated by the generic term of Fund “investment.”
The creation of reserves in the form of gold tranche positions as a result of drawings takes place in response to balance of payments disequilibria. Investment operations, on the other hand, could be undertaken on the initiative of the Fund, with a main purpose of creating liquidity, and not necessarily in response to a particular balance of payments need. In considering operations of this kind, attention would have to be paid to the nature of the investment and the principles on which investments would be made. Investments might take place in all member countries or on a selective basis. They might be made in currency or in gold; in the former case, countries’ reserves would increase in the form of claims on the Fund, in the latter case, by additions to their gold holdings.
Any acquisition of assets by investment would tend to put a strain on the Fund’s resources and create a need for additional resources. Investment would be likely to require an extension of the Fund’s own resources derived from subscriptions or of borrowing by the Fund beyond what would otherwise be necessary. Borrowed resources might be provided under negotiated lines of credit, by “deposits” according to suitable criteria, or in other ways. Investment and any borrowing necessary to finance it might be handled separately or they might be arranged in a single operation.
In order that the Fund’s investment should in/fact increase unconditional liquidity, it would be essential that members treat the resulting liquid claims on the Fund as reserves. As indicated above, a country’s gold tranche drawing rights—which increase as the Fund reduces its holdings of a country’s currency—already possess characteristics which permit them to be considered as part of a country’s reserves. Claims arising from loans made to the Fund under the General Arrangements to Borrow are intended to have the same liquidity as gold tranche positions. Claims on the Fund arising from other kinds of borrowing by the Fund might have similar characteristics.
The types of operation that have been very sketchily indicated in this section would require careful consideration from many points of view before any decision could be reached as to whether it would be appropriate for the Fund to undertake such operations. It is the intention of the Executive Directors to give these matters further study in the period ahead.
Drawing facilities in the Fund are available to be used to meet balance of payments deficits; they cannot, in the nature of things, be used by all countries at the same time. The same qualification attaches to any other totals of international—or, for that matter, domestic—liquidity.
In its original form this formula combined a member’s national income, reserves, imports, exports, and export variability, with certain weights attached to each. The formula was used at the Bretton Woods Conference in 1944 as a help in the determination of countries’ initial quotas.