Chapter

Chapter 1 Developments in the World Economy

Author(s):
International Monetary Fund
Published Date:
September 1972
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General Survey

The main features of world economic developments in 1971 were a continuation of slow output growth coupled with inflation and the succession of currency crises, involving capital movements and foreign exchange reserve increases of unprecedented magnitude, that led to the December 18 realignment of major currencies. During the first half of 1972 the picture with respect to certain aspects of these problems improved significantly. However, the period around the middle of the year, marked by the floating of the pound sterling, was characterized by renewed unrest in the foreign exchange and gold markets and by an intensification of exchange controls as difficult problems of dealing with currency flows were faced by the authorities of a number of major countries. Further, it was abundantly clear that great challenges remained for the longer run.

Among the foremost of these challenges are the collective task of improving and reforming the international monetary system and the national tasks of improving the management and performance of the main industrial economies. The importance and urgency of international monetary reform were underscored by developments in the first half of 1972, when periodic outbursts of speculation signaled continued weakness of market confidence in the international monetary system, notwithstanding the major step toward restoration of international payments equilibrium that had been taken in December 1971 with the realignment of major currencies. Also fundamental is the consideration that reform of the system cannot prove effective unless it is accompanied by satisfactory policies in the larger industrial countries, which have had a record of economic instability since the mid-1960s and now must endeavor to control inflation while at the same time achieving satisfactory levels of employment and rates of economic growth. Enduring solutions of the problems in the fields of international monetary reform and national economic management would be to the benefit of all countries, developed and developing alike.

At the beginning of 1971 the international monetary system, already strained by conditions of fundamental imbalance in key currency relationships, was under additional pressures emanating from differences in the cyclical positions, financial policies, and credit conditions of the North American and European industrial centers. Yield-induced flows of short-term capital, occurring against a background of chronic basic deficit in the U. S. balance of payments and of continuing surplus in the external accounts of Germany, Japan, and several smaller industrial countries, were joined in the second quarter of 1971 by speculative movements in anticipation of possible changes in parities. The tremendous upsurge in capital flows led in early May to the floating of the deutsche mark and action in the exchange field also by four other members of the Fund.1

The respite provided by these changes in exchange rate policy proved brief. As the fundamental weakness of the U. S. balance of payments—and corresponding strength of other countries’ positions—became more apparent during the next few months, speculation was resumed at an accelerating tempo. A widespread feeling that price inflation in the United States was not being brought under control, even at a time of high unemployment and sluggish economic growth, contributed to an ebbing of confidence in the dollar. On August 15, the U.S. Administration responded to this combination of adverse circumstances by initiating dramatic and far-reaching changes in its domestic and international economic policies.

The action taken by the United States on the external front removed one of the foundation stones of the international monetary system as it had operated since World War II under the Bretton Woods Agreement. No longer were the U. S. authorities prepared to convert officially held dollars into gold or other reserve assets. In response to this action by the United States, nearly all countries ceased to ensure that exchange transactions would be related to par values. These moves set in motion a process of appreciation of most major currencies against the dollar in the weeks following August 15.

Generally, however, the extent of the appreciation was limited by official intervention in the exchange market or by measures taken to curb capital inflows. During this period, strong upward pressures on exchange rates and/or increases in reserves were sustained by the continuing basic deficit in the U. S. balance of payments, as well as by additional capital flows reflecting market sentiment that further exchange rate adjustments were probable. In these circumstances, further large accumulations of dollars in official holdings took place.

These increases in official foreign exchange reserves, like the capital flows underlying them, were unevenly distributed among countries.2 For many national monetary authorities, however, severe difficulties were posed by the extraordinary expansion of reserves during 1971, immediately following the substantial increase that had taken place in 1970. Except where it could be adequately countered by neutralizing policy actions, the expansion tended to generate excessive domestic liquidity and thus to complicate the problems of containing inflationary pressures. The result was a proliferation of measures intended to discourage capital inflows or encourage outflows.

In view of the clearly unsatisfactory nature of the exchange rates, exchange arrangements, and related expedients introduced after August 15, consideration was soon given to their replacement by a more viable regime. The interim of about four months before negotiating efforts came to fruition was a period of general uncertainty and confusion. Although it was clear that most exchange rates were moving in the right direction, in view of the evident overvaluation of the dollar, judgment as to the suitability of the emerging exchange rate pattern was rendered difficult by such factors as varying degrees of official exchange market intervention, the temporary import surcharge that had been imposed by the United States on August 15, the various restrictions on capital movements instituted by other countries, and cyclical influences on trade positions. The unprecedented character of the situation presented serious problems not only for the major industrial countries most immediately involved but also for the developing and other primary producing countries, which were apprehensive of the adverse effects of exchange rate fluctuations, the accompanying uncertainties, and the U. S. surcharge.

By mid-November there was widespread concern that continuation of the prevailing situation would threaten to produce severe economic effects—that a prolonged period in which exchange rates continued to float without guidelines for their regulation or for reconciliation of conflicting national objectives, and in which restrictive practices increased, would breed hesitation in private and public planning, procurement, and investment, with deflationary consequences. The desire to avert such a constrictive development in the world economy was high among the considerations that led to the Smithsonian Agreement of December 18, 1971, providing for a realignment of exchange rate relationships among major currencies as the first essential move to eliminate the disequilibria in international payments. The most important aspects of this realignment were the depreciation of the U. S. dollar in terms of gold and of special drawing rights (SDRs) and the appreciation (in the same terms) of the Japanese yen and the deutsche mark, as well as the Netherlands guilder and the Belgian franc. There was little or no change in the gold or the SDR value of other major currencies, and the Canadian dollar continued to float.3 This pattern of changes had the overall effect of leaving the value of the SDR (and of reserve positions in the Fund) approximately unchanged in relation to major currencies in general.

In addition to the pattern of exchange rate changes, the Smithsonian Agreement had several other important aspects. These included an understanding among the participants with respect to consideration of long-term reform or improvement of the international monetary system, a provision for temporary wider margins of exchange rate fluctuations, and agreement by the United States on an immediate removal of its temporary import surcharge. On the same day, December 18, the Executive Directors of the Fund adopted a decision providing for a temporary regime of wider margins and central rates. Under this, exchange rates in transactions between a member’s currency and its intervention currency can move within margins of 2¼ per cent on either side of the parity relationship between them as indicated by par values or central rates, and as a result maximum margins of 4½ per cent are possible in relation to other currencies.

The realignment of exchange rates among the major countries was quickly followed by adaptations of the exchange rate policies of many other countries, whose authorities, in making their decisions about adjustments of their own exchange rates, had to weigh a number of complex considerations. The decisions actually made by developing countries resulted, on the average, in a moderate depreciation of their currencies in relation to those of the developed countries.

For several months after the realignment, market confidence remained vulnerable to even minor shocks emanating from the flow of economic and political news. Moreover, the reflux of speculative capital to the United States that was widely expected to follow the realignment was deterred by both international differences in interest rates and a variety of special factors, including the initial pattern of market exchange rates within the newly widened margins and lack of public appreciation of the lags with which the intended effects of exchange rate changes are felt. In the absence of such a reflux, the continuing basic deficit in the U. S. balance of payments resulted in further additions to foreign official dollar holdings in the first quarter of 1972. Nevertheless, a calmer exchange market atmosphere emerged toward the end of that period; it prevailed until mid-June, when the pound sterling came under downward pressure.

Heavy outflows of short-term capital led to a large and accelerating loss of net U. K. reserves, precipitating the decision by the U. K. Government on June 23 that for the time being the pound sterling would be allowed to float. The U. K. authorities, in announcing that decision, expressed their view that there was nothing in the country’s current economic situation to justify the short-term capital movements that had given rise to the floating, which they emphasized was temporary. As a result of subsequent exchange market developments, the pound fell from around US$2.58 just before the float to a range of US$2.42—2.45 in the first half of July.

In response to the action on sterling, 15 member countries that have close trading and financial ties with the United Kingdom and whose currencies were pegged to the pound decided to maintain that peg, thus allowing their currencies to float with sterling. (See Appendix Table I.1.) However, a number of other countries with currencies previously pegged to the pound sterling abandoned such a peg and maintained the existing relationship to gold or the U. S. dollar. Actions slightly variant from these were taken by a few other sterling area countries. Still other members of the area, having already pegged their currencies to gold or the U. S. dollar, maintained that relationship.

Table I.1Exchange Rate Changes, August 13, 1971-July 31, 1972(Expressed in terms of currency units per SDR)
Rate onRate Established December 18, 1971-Rate Established
August 13, 1971May 8, 1972May 9-July 31, 1972Date Central
Rate or New
ParParCentralParCentralPar Value
MemberCurrencyvalueOther 1valuerateOthervaluerateOtherEstablished
Afghanistan2afghani45.000048.85713no change
Algeriadinar4.93706no change4
Argentina2peso4.0000055
Australia *dollar0.892857no change in par value
Austria *schilling24.750025.2971no change12/22/71
Barbadosdollar2.00000no change in par valuefloating6
Belgium *2franc50.000048.6572no change12/21/71
Boliviapeso11.875012.89293no change
Botswanarand0.7142860.814286floating612/21/71
Brazil2cruzeiro5.2500056.3845
Burma *kyat4.761905.80717no change12/27/71
Burundi *franc87.500095.0000no change12/30/71
Cameroon2franc277.710no change4
Canadadollarfloating
Central African
Republic2franc277.710no change4
Ceylon2rupee5.952376.462593floating6
Chad2franc277.710no change4
Chile2escudo12.210017.154355
China, Republic of *new Taiwan dollar40.000043.4286no change5/8/72
Colombia2peso18.500021.8771no change
Congo, People’s
Republic of the2franc277.710no change4
Costa Rica2colon6.625007.192863no change
Cyprus *pound0.416667no change in par value
Dahomey2franc277.710no change4
Denmark *krone7.500007.57828no change12/21/71
Dominican Republicpeso1.000001.0857171.085715/9/72
Ecuador2sucre25.000027.14293no change
Egypt2pound0.34824255
El Salvadorcolon2.500002.71429no change5/8/72
Equatorial Guineapeseta70.0000no change4
Ethiopia *dollar2.50000no change in par value
Fiji1dollar0.8708364floating6
Finland *markka4.199974.45143no change12/20/71
France *2franc5.55419no change in par value
Gabon2franc277.710no chanse4
Gambia, Thedalasi2.08333no chanse in oar valuefloating6
Germany, Federaldeutsche
Republic of *markfloating3.49872no change12/21/71
Ghana *new cedi1.020411.97403512/27/71
Greece *drachma30.000032.5714832.57145/19/72
Guatemalaquetzal1.000001.0857131.085715/10/72
Guineafranc247.000no change4
Guyanadollar2.000002.171439floating64/ 5/72
Haitigourde5.000005.4285610no change4/12/72
Honduraslempira2.000002.1714372.171435/15/72
Icelandkrdna88.000095.5429895.54295/ 9/72
Indiarupee7.500007.90321floating612/20/71
Indonesia2rupiah378.000450.571
Iranrial75.750082.2428no change4/29/72
Iraq *dinar0.357143no chanse in nar value
Irelandpound0.416667no chanee in oar valuefloating6
Israel *pound3.500004.5600084.560005/17/72
Italy *lira625.000631.342no change12/20/71
Ivory Coast2franc277.710no change4
Jamaicadollar0.833333no chanse in par valuefloating6
Japan *yen360.000334.400no change12/20/71
Jordan *dinar0.3571430.38775411no change5/ 8/72
Kenya *shilling7.142867.75509no change12/22/71
Khmer Republic2riel55.541955
Koreawon255.00055
Kuwaitdinar0.357143no change in par value
Laos2kip240.000651.428
Lebanonpoundfloating
Lesothorand0.7042861.0814286floating612/21/71
Liberiadollar1.000001.08571no change5/8/72
Libyan Arab Rep. *dinar0.357143no change in par value
Luxembourg *2franc50.000048.6572no change12/21/71
Malagasy Republic2franc277.710no change4
Malawikwacha0.833333no change in par valuefloating6
Malaysia *dollar3.06122no change in per value
Mali2franc555.419no change4
Maltapound0.4166670.406504floating12/26/71
Mauritania2franc277.710no change4
Mauritiusrupee5.555555.5555512floating65/24/72
Mexicopeso12.500013.5714913.57145/10/72
Morocco *dirham5.06049no change in per value
Nepal *rupee10.125010.9929 310.992910.99295/13/72
Netherlands *guilderfloating3.52281no change12/21/71
New Zealand *dollar0.892857no change in par value
Nicaraguacórdoba7.000007.600037
Niger2franc277.710no change4
Nigeria *pound0.357143no change in par value
Norway *krone7.142867.21500no chante5/8/72
Oman1rial Saidi11.94285/11/72
Pakistan *rupee4.761901.0857113no change4/5/72
Panamabalboa1.00000
Paraguay2guaraní126.000136.8003no change
Peru2sol26.815055
Philippines2peso529.5857no change12/22/71
Portugal *escudo28.7500no change in par value
Rwanda *francl00.000no change per value
Saudi Arabiariyal4.50000no change4
Senegal2franc277.710no change in par valuefloating6
Sierra Leoneleone0.8333333no change in par value
Singapore *dollar3.061227.51881147.518816/1/71
Somalia *shilling7.14286
South Africarand0.7142860.814286floating612/21/71
Spain *peseta70.0000no change in par value
Sudan2pound0.3482420.3780923no change
Swazilandrand0.7142860.814286floating67/21/71
Sweden *krona5.173215.22545no change12/21/71
Syrian Arab Rep.2pound2.1914855
Tanzania *shilling7.142867.75509no change12/22/71
Thailandbaht20.800022.5828no change5/ 8/72
Togo 2franc277.710no change4
Trinidad and Tobagodollar2.00000no change in par valuefloating 6
Tunisia *dinar0.525000no change in par value
Turkey *2lira15.000015.2000no change12/22/71
Uganda *shilling7.142867.75509no change12/22/71
United Kingdompound0.416667no change in par valuefloating6
United Statesdollar1.000001.08571no change5/ 8/72
Upper Volta 2franc277.710no change4
Uruguay 2peso7.4000055
Venezuela 2bolívar4.4850055
Viet-Nam 2piastre80.000055
Western Samoa 1tala
Yemen Arab Rep.rialfloating
Yemen, People’s
Dem. Rep. of *dinar0.4166670.416667no change1/12/72
Yugoslavia *dinar15.000018.4571no change12/21/71
Zaire *zai’re0.5000000.542856no change12/24/71
Zambia *kwacha0.7142860.775509no change12/22/71

Member is availing itself of wider margins of up to 2¼ per cent on either side of the parity relationship, based on par values or central rates.

Exchange rate under membership resolution or provisional rate for Fund computations.

Member maintains multiple currency practice and/or dual exchange market.

Member maintained unchanged parity of exchange rate with U. S. dollar.

Member maintained unchanged gold content of currency, or parity of exchange rate with French franc, pound sterling, or Spanish peseta.

Exchange transactions in the market differ from par value, exchange rate under membership resolution, or provisional rate for Fund computations.

Floating with the pound sterling; Botswana, Lesotho, and Swaziland continued to be linked with sterling as a result of their use of the South African rand as domestic currency.

Central rate effective December 21, 1971.

Central rate effective December 20, 1971.

Central rate effective December 22, 1971.

Central rate effective December 23, 1971.

Central rate effective December 29, 1971.

Central rate effective December 28, 1971.

Central rate effective December 24, 1971.

Central rate effective January 9, 1972.

Member is availing itself of wider margins of up to 2¼ per cent on either side of the parity relationship, based on par values or central rates.

Exchange rate under membership resolution or provisional rate for Fund computations.

Member maintains multiple currency practice and/or dual exchange market.

Member maintained unchanged parity of exchange rate with U. S. dollar.

Member maintained unchanged gold content of currency, or parity of exchange rate with French franc, pound sterling, or Spanish peseta.

Exchange transactions in the market differ from par value, exchange rate under membership resolution, or provisional rate for Fund computations.

Floating with the pound sterling; Botswana, Lesotho, and Swaziland continued to be linked with sterling as a result of their use of the South African rand as domestic currency.

Central rate effective December 21, 1971.

Central rate effective December 20, 1971.

Central rate effective December 22, 1971.

Central rate effective December 23, 1971.

Central rate effective December 29, 1971.

Central rate effective December 28, 1971.

Central rate effective December 24, 1971.

Central rate effective January 9, 1972.

During the second quarter of 1972 the private market price of gold, after having risen from about $42 an ounce at the time of the Smithsonian Agreement to a range of about $48-49 an ounce from early February to the end of April, increased rapidly from early May to early June, when it briefly exceeded $65 an ounce. After falling back to somewhat above $60 an ounce in the middle weeks of June, the price rose again toward the end of the month and remained above $65 an ounce during the first half of July. These price movements appear to have reflected a variety of factors. On the supply side, where the level of current production was somewhat reduced, the marked improvement of South Africa’s balance of payments after the end of 1971, together with changes in sales by some other suppliers, resulted in a substantially lower volume of gold sales on the free market. Demand, however, was strong, as the surge in speculative demands for gold during the first half of 1972—reflecting uncertainty about the future role of gold and uneasiness regarding the stability of currency relationships—was superimposed on a generally buoyant underlying trend of industrial, artistic, and traditional hoarding demands.

A new factor in the operation of exchange markets after December 1971 was the maintenance by a number of countries of wider margins within which their exchange rates could fluctuate. The rates emerging under these arrangements tended to deter or encourage capital movements in particular instances. However, the period since the introduction of wider margins has been too brief, and too strongly affected by special circumstances, to permit generalization about the impact of these margins on the management of capital flows by national monetary authorities. A development of even more recent origin (April-May 1972) was the agreement by members and prospective members of the European Economic Community to limit fluctuations of their currencies in relation to each other to 2 ¼ per cent, thus reducing by one half the maximum range that would be associated with maintenance by the countries concerned of margins of plus or minus 2 ¼ per cent in relation to the U. S. dollar.4 This agreement, accompanied by special arrangements for intra-EEC settlements of balances resulting from official interventions, was an important step toward implementation of the plan for monetary union of the EEC countries.

An additional factor in the operation of exchange markets emerged toward the end of July, when it became known that the United States had intervened in its exchange market for its own account. The U. S. authorities indicated that they might from time to time initiate such intervention in circumstances where they considered it would produce useful effects and that foreign currencies needed for this purpose might be obtained through the swap arrangements between the United States and certain other industrial countries. It was emphasized, however, that no basic change in policy toward international monetary reform was involved.

In the nonfinancial sphere, expansion of output in the industrial countries during 1971 had proved unexpectedly weak. Economic recovery proceeded at a moderate pace in the United States, where demand management policy—in view of the substantial gap between output and productive capacity that had opened up in the endeavor to curb inflation—had turned expansionary during 1970; and the slowdowns in Japan and Europe were still running their course. This sluggishness of the industrial economies depressed the growth of world trade and had a particularly dampening influence on the prices of commodities exported by many primary producing countries.

At the same time, import costs of the primary producing countries were raised by the continuing inflation of prices in the industrial countries. Progress toward abatement of inflation in the latter countries was considerably less than had been expected by national authorities at the beginning of the year, even though the degree of slack and unemployment—while differing substantially from country to country—was on average probably greater by the latter part of 1971 than at any previous time since the early postwar period.

As of mid-1972 the short-run economic outlook appeared more hopeful than it had at the turn of the year. It indicated a sharp pickup in the overall rate of output growth in the industrial countries from 1971 to 1972, along with some subsidence in the average rate of inflation. Nevertheless, the reduced rate of inflation would still be high in comparison with past experience, and countries faced the prospect of continuing difficulties in reconciling their objectives for growth and employment with those in the field of prices.

The rest of this chapter reviews recent world economic developments in broad outline, focusing mainly on changes in output, prices, and world trade, and on the evolution of the balance of payments situation. It also includes a discussion of two important matters bearing on the international adjustment process: (1) principal aspects of the economic impact of the currency realignment and (2) the role of the major industrial countries in supporting the realignment while its intended effects emerge. The subject of international liquidity is dealt with in Chapter 2. This Report does not address itself to the issues of improving and reforming the international monetary system, which will be the subject of a separate report by the Executive Directors to the Board of Governors.

Trends in Economic Activity

Growth of output on a world-wide basis 5 in 1971 was again markedly below the long-run average. According to available estimates, the increase in volume of total output both from 1969 to 1970 and from 1970 to 1971 was well inside the 3-4 per cent range, compared with the 5 per cent average annual rate of expansion that prevailed over the 1960-70 decade (Table 1).

Among the industrial countries the continuation of relatively slow growth of output in 1971 was compounded of a recovery in the United States and Canada and a deceleration almost everywhere else. On the continent of Europe, the overall increase of 3½ per cent was as much as 2 percentage points below the 1969-70 rise in real gross national product (GNP). For the United Kingdom the increase of only 1 per cent in 1971 followed two successive years of below-average growth in total output. In Japan the 6 per cent rise of real GNP in 1971, after a slowdown in the latter part of 1970, was quite low in historical perspective and brought recessionary conditions.

The primary producing countries as a group also sustained a reduction in the growth of total output from 1970 to 1971. This occurred in most of the 12 countries classified in “more developed areas” and in three of the four broad areas comprised of less developed countries. Among these areas, only the Middle East (where several of the major oil-producing countries are located) had a higher rate of economic growth in 1971 than in the preceding year. The growth rate moved distinctly lower in Africa, Asia, and the Western Hemisphere.

The rise in total output of the less developed countries in 1971, although somewhat below that in 1970, was still above the average for the decade of the 1960s. As shown in Table 1, output expansion in the developing countries during the second half of the decade was considerably higher than in the first half, and lifted the overall decade average to 5½ per cent. However, growth rates over the decade were very uneven among this large and heterogeneous group of countries. Growth tended to be strongest for countries with relatively high levels of per capita GNP; for countries with relatively low levels, and accounting for two thirds of the population in the developing world, the average annual growth of real GNP during the 1960s was only about 4 per cent on an aggregate basis and 1½ per cent on a per capita basis.

Although in many individual countries production has been affected by special or localized developments, the general course of world output in recent years has been dominated by the combined growth rate of the seven major industrial countries represented in Chart 1. As may be seen, this growth rate declined from 1968 to 1970 and then, because of cyclical recovery in the United States and Canada, moved upward in 1971 and advanced sharply in the first half of 1972.

Chart 1.Changes in Output of Selected Groups of Industrial Countries, First Half 1968-First Half 1972

(Percentage changes in real GNP from preceding half year, seasonally adjusted at annual rates)

Throughout most of the world, output changes in 1971 were accompanied by strong inflationary pressures. Although of varying intensity, these pressures generally constituted a problem of some years’ duration. Taken together, the industrial countries experienced a combined price rise (as measured by GNP deflators) of 5½ per cent from 1970 to 1971—not far below the exceptionally high rate of 6 per cent from 1969 to 1970 and more than double the average annual rate for the first part of the 1960s, before inflation became a serious problem (Table 2). In the primary producing countries, for which price performance can best be gauged by the available data on consumer prices, the increases in such prices from 1970 to 1971 averaged 9 per cent for both the more developed and the less developed groups and were markedly higher than the increases from 1969 to 1970.

Table 2.Price Increases in Industrial Countries, 1960-71(Percentage changes in GNP deflators)
Annual Average1Change from Preceding Year
1960-701960-651965-7019671968196919701971
Canada3.11.94.13.43.54.84.13.5
United States2.71.44.13.24.04.85.54.7
France4.54.14.82.84.87.95.75.5
Germany3.53.63.41.21.63.57.37.7
Italy4.55.53.53.01.54.16.76.5
United Kingdom3.73.14.23.72.83.57.811.0
Japan5.05.44.75.32.84.16.74.4
Average, seven major countries 23.22.44.13.23.54.76.05.5
Other industrial countries 2,34.44.14.84.42.94.26.47.0
All industrial countries 23.32.54.13.23.44.76.05.6
Source: National economic reports; secretariat of the Organization for Economic Cooperation and Development; and Fund staff estimates.

Compound annual rates of change.

Weighted average of percentage changes for individual countries, with their respective GNPs, converted to U. S. dollars at 1970 exchange rates, used as weights.

Austria, Belgium, Denmark, Luxembourg, the Netherlands, Norway, Sweden, and Switzerland.

Source: National economic reports; secretariat of the Organization for Economic Cooperation and Development; and Fund staff estimates.

Compound annual rates of change.

Weighted average of percentage changes for individual countries, with their respective GNPs, converted to U. S. dollars at 1970 exchange rates, used as weights.

Austria, Belgium, Denmark, Luxembourg, the Netherlands, Norway, Sweden, and Switzerland.

Conditions of slow growth combined with inflationary tendencies were thus widely prevalent in 1971. With respect to the large industrial economies, underutilization of economic resources was particularly great in the United States, Canada, the United Kingdom, Japan, and Italy. In the other industrial countries, where the post-1967 boom generated inflationary pressures later than in North America, the drop in the rate of output growth from 1970 to 1971, in response to actions taken by the authorities to repress inflationary tendencies, served generally to eliminate excess demand, but the degree of economic slack that emerged was still comparatively small. Among the more developed group of primary producing countries, the recent phenomenon of depressed economic activity coincident with rising prices was evident in the Southern Hemisphere countries of Australia and New Zealand and in the European countries of Ireland, Finland, and Spain; in several other European countries, including Yugoslavia and Portugal, there was an intensification of inflationary pressures simultaneously with higher economic expansion.

Alleviation of the widespread problems of slow growth and price inflation will depend crucially on the trend of developments in the large industrial countries, and especially in the United States. Major shifts in domestic economic policy—in conjunction with the balance of payments decisions noted above—were launched by the U. S. Administration on August 15, 1971, when a comprehensive incomes policy was inaugurated with a 90-day freeze on wages, prices, and rents, and when a set of fiscal measures was proposed with the aim of stimulating more rapid expansion of the economy.

The current economic prospect in the industrial countries may be depicted briefly as follows.

  • —A substantial rise in the rate of output growth from 1971 to 1972 seems clearly indicated for these countries as a group. According to the pattern based on projections by national authorities, this result would stem primarily from sharp gains anticipated for the relatively depressed U. S., Canadian, and U. K. economies on the strength of expansionary policies in force.6 In the other industrial countries (i.e., continental Western Europe and Japan), projected output expansion is below longer-term trends and, consequently, there would be a general tendency to build up slack in resource utilization—as happened during 1971. However, within this latter group of countries, conditions are by no means uniform. The degree of economic slack and the strength of inflationary forces vary considerably among the countries; in a few of them, even on the basis of present policies, the rate of GNP expansion may accelerate markedly in the latter part of 1972.

  • —Although the overall price rise in the industrial countries from 1970 to 1971 was almost as high as that in the preceding year, some lessening of price and cost increases in the course of 1971 can be discerned. During 1972 the continuing effort to abate inflation should be aided by a combination of several circumstances: the lagged effects of the reduction in demand and cost pressures achieved by restrictive financial policies, the rapid productivity gains that are characteristic of the earlier stages of cyclical recovery, and some contribution by incomes policy (especially in the United States) in moderating wage and price increases. According to the official economic projections of the industrial countries, better price performance is expected, particularly in three countries: the United States, Germany, and the United Kingdom. In these and all other industrial countries, the overall price increases expected for 1972 would still be above the rates generally typical in the past.

Industrial countries in general thus face a situation in which pressures of excess demand have been eliminated, unemployment has increased, and policies of renewed expansion are being pursued. At the same time, cost-push forces are still strong in a climate of deep-rooted inflationary psychology and widespread inflationary expectations based on the experience of recent years. The strength, or importance, of the foregoing elements differs markedly among countries, primarily because of prevailing differences with respect to the current stage of stabilization programs and to cyclical positions. Nevertheless, such a combination of elements poses a very difficult situation for the conduct of economic policy throughout the industrial world.

To help deal with this situation, many countries have made use of incomes policy 7 as a supplement to the instruments of demand management. The need that various countries have felt for measures of incomes policy—now and in the past—stems from the capacity of business firms and labor groups in many instances, because of imperfect competition, to push up money incomes at rates exceeding the economy’s long-term productivity growth. This feature of current economic life often makes it very difficult for fiscal and monetary policies, used by themselves, to stop a strong wage-price spiral without costly economic and social effects. However, incomes policy has had a mixed record of effectiveness; and, indeed, it is most difficult to establish standards or criteria in this field, and to build up a body of doctrine. In part, the difficulty arises because of the very wide range of possibilities that exist with respect to the form and functioning of an incomes policy.8 Also important in this regard are the constraints on incomes policy inherent in the social and political setting of individual countries—in the attitudes of labor and industry, the prevailing institutional arrangements, and the scope for government leadership in the determination of price and wage movements.

One reason why many countries turn to incomes policy, or come back to it, is their disappointing experience in relying solely on demand management policies. Since the mid-1960s, when inflation again became a problem in the industrial countries, serious difficulties have been found in the application of such policies. In the United States, Canada, the United Kingdom, and other countries, costs and prices have registered pronounced increases that showed only small response to the relatively high margin of unused resources in the economy. Analysis of the differences between country forecasts and actual developments in recent years indicates that relationships between demand/cost pressures and rates of price increase have been rather seriously misjudged in the formulation of economic policy.

Some types of problems that have often hampered demand management—such as the widespread failures to apply corrective policies promptly or to use the fiscal instrument more effectively—cannot be avoided through the adoption of incomes policy. But an increasing number of countries, particularly in the past year, have had recourse to incomes policy in the belief that it may be helpful in carrying out a task that fiscal and monetary policies proved incapable of handling alone.

The greater attention that incomes policy has been attracting under prevailing conditions is, in essence, part of an active re-examination of economic policies in general. At a time when early restoration of financial stability in the industrial countries would be highly desirable, following their record of financial instability since the mid-1960s, these countries face the new and difficult situation of resuming the pursuit of expansionary policies while the rate of price increase is still too high. An obvious question of importance is whether wider application of incomes policy—supplementing a careful adaptation of the fiscal and monetary instruments—could prove useful in preserving or extending the progress in the fight against inflation that countries have achieved during recent years by means of restrictive demand management policies.

World Trade

The development of world trade in 1971 was marked by a below-average rate of growth in volume, for the first time since 1967 (Table 3). The 1970-71 advance of roughly 5½ per cent was considerably lower than the average rate of increase over the decade of the 1960s, and it fellfar short of the exceptional rates of expansion in 1968 and 1969. These facts are illustrated in Chart 2, which also shows the role of prices in maintaining the high rates of advance in the value of trade as the growth in volume terms decelerated steadily from its 1968 peak, broadly in line with the output changes described in the preceding section.

Table 3.World Trade, 1960-71(Percentage changes in U. S. dollar value and in volume)
Annual AverageChange from Preceding Year
1960-7011968196919701971
Imports
World 2Value9.511.513.914.611.5
Volume8.412.511.49.05.8
United StatesValue10.022.98.510.814.1
Volume8.421.65.33.58.3
CanadaValue8.913.714.51.815.7
Volume7.59.111.7-3.29.6
United KingdomValue5.26.55.38.910.5
Volume4.610.62.25.83.5
GermanyValue11.416.123.719.615.2
Volume10.518.318.014.110.9
Other industrial Europe 3Value11.19.519.517.110.5
Volume10.110.417.911.32.7
JapanValue15.511.415.725.74.4
Volume14.713.015.919.51.8
Primary producing countries
More developed areasValue10.04.813.818.89.1
Volume9.46.611.813.35.4
Less developed areasValue6.58.89.811.812.0
Volume5.49.96.77.77.0
Oil exporters 4Value5.511.49.910.218.0
Volume4.512.56.86.212.9
Other countriesValue6.88.39.712.310.5
Volume5.79.46.68.15.5
Exports
World 2Value9.511.914.614.811.6
Volume8.212.910.99.25.7
United StatesValue7.79.59.713.72.1
Volume5.67.96.37.5-1.1
CanadaValue11.219.49.416.68.8
Volume9.816.46.610.85.5
United KingdomValue6.26.814.19.915.4
Volume4.814.510.33.65.2
GermanyValue11.614.316.917.714.2
Volume9.516.012.18.46.7
Other industrial Europe 3Value11.113.118.115.812.6
Volume9.714.114.610.86.5
JapanValue16.924.223.320.824.3
Volume16.424.118.014.017.0
Primary producing countries
More developed areasValue8.94.915.512.39.7
Volume7.79.010.78.46.7
Less developed areasValue7.39.812.111.811.0
Volume6.99.88.98.75.0
Oil exporters 4Value7.610.78.511.930.0
Volume8.99.113.311.49.9
Other countriesValue7.49.114.311.51.5
Volume6.110.17.17.63.0
Source: International Financial Statistics and Fund staff estimates.

Compound annual rates of change.

For coverage, see Table 1, footnote 6.

Austria, Belgium-Luxembourg, Denmark, France, Italy, the Netherlands, Norway, Sweden, and Switzerland.

The oil exporters included here are Iran, Iraq, Kuwait, Saudi Arabia, other producers in the Persian Gulf area, Algeria, Indonesia, the Libyan Arab Republic, the Netherlands Antilles, Nigeria, Trinidad and Tobago, and Venezuela.

Source: International Financial Statistics and Fund staff estimates.

Compound annual rates of change.

For coverage, see Table 1, footnote 6.

Austria, Belgium-Luxembourg, Denmark, France, Italy, the Netherlands, Norway, Sweden, and Switzerland.

The oil exporters included here are Iran, Iraq, Kuwait, Saudi Arabia, other producers in the Persian Gulf area, Algeria, Indonesia, the Libyan Arab Republic, the Netherlands Antilles, Nigeria, Trinidad and Tobago, and Venezuela.

Chart 2.Growth of World Trade, 1960-71

(Percentage changes in exports from preceding year)

The acceleration of foreign trade prices in recent years reflected primarily the pervasiveness and intensity of inflationary forces in the main industrial countries. In contrast to the tendency from the mid-1950s to 1968 for average prices of internationally traded goods to rise only slightly, they showed a marked upturn in 1969 and advanced quite sharply in 1970. Their further advance from 1970 to 1971—by about 5½ percent, measured in U. S. dollars—was even some what larger, but it included two special elements: (1) an unprecedented increase of more than one fifth in the average unit value of petroleum exports, on the basis of new agreements negotiated between the exporting countries and the international oil companies toward the end of 1970 and in the early months of 1971; and (2) the adaptation of prices to the appreciation of several major currencies in the period of floating during 1971. This latter influence may have accounted for as much as 2 percentage points of the increase in the average unit value of exports (expressed in U. S. dollars). The rise in export unit values in terms of SDRs was smaller in 1971 than in 1970 —a result consistent with the occurrence of some easing in cost and price pressures in a number of the industrial countries, although these pressures still constituted a serious problem for policy.

The principal reason for the slower growth of world trade in 1971 was undoubtedly the cyclical slowdown of economic activity in continental industrial Europe and in Japan; in this group of countries, accounting for almost one half of world trade, the total volume of imports rose by 4½ percent in 1971 (over 1970), compared with a rise of 13 per cent in the previous year. Import expansion also fell off sharply in the more developed group of primary producing countries but (as discussed below) was well maintained in the less developed group. In addition, strikes at U. S. docks, the temporary surcharge on U. S. imports, and the general sense of uncertainty that pervaded the international community may in combination have been a significant deterrent to foreign trade in 1971 or at least may have caused a postponement of transactions until 1972. The main counterforce to the rather pervasive tendencies toward slower trade growth in 1971 was the resumption of a substantial rate of increase in import volume in the United States as domestic economic activity picked up after the 1969-70 recession.

Developments in 1971 were in line with the experience of prior years, when the course of world trade was also governed in important respects by cyclical changes in aggregate demand and imports in the main industrial countries. Following the 1966-67 recessions or slowdowns in a number of these countries, the generalized upswing in economic activity induced an unusually strong and sustained upsurge of import demand. This was attributable partly to the fact that differences among the industrial countries in the phasing of cyclical developments generated a tendency for them to succeed each other as principal sources of incremental demand for internationally traded goods. In its early stages, during 1968, this wave of import expansion reflected mainly the surge of demand in the United States. Subsequently, during 1969 and 1970, the principal impetus to growth of world trade emanated from European and Japanese import demand. Then, when the rise in such demand slumped in 1971, trade growth was supported by the renewal of sizable import expansion in the United States, as well as in Canada. The economic recovery currently proceeding in those two countries is still providing the main stimulus to the advance of world trade in 1972, as the increase of imports in most other parts of the industrial world continues at a below-average pace.

The easing of international trade growth in 1971 induced by cyclical developments in the industrial countries had widespread manifestations. The rate of export volume expansion fell substantially below the long-term average in the industrial countries as a group and in the less developed countries exclusive of the major oil exporters, whose experience in 1971 was extraordinarily favorable. In the group of more developed primary producing countries, export growth eased in 1971 but remained near the annual average for the 1960s.

Among the industrial countries, the sharpest contrasts in trade developments in 1971 were those recorded for the United States and Japan. U. S. exports increased by only 2 per cent in value (and declined somewhat in volume), whereas the value of U. S. imports went up by 14 per cent. Japanese exports continued to surge in 1971, with the advance of 24 per cent matching or exceeding the exceptionally high rates of the three preceding years. At the same time, Japanese imports rose by only 4 per cent in 1971, in contrast to the spurt of 26 per cent in 1970. Although these U. S. and Japanese trade results were affected by cyclical and special influences, the sharp deterioration in the already weakened U. S. position and the huge advance in the enlarged trade surplus of Japan reflected a major imbalance in the exchange rate structure.

The growth in value of exports from the more developed primary producing countries decelerated from about 12½ per cent in 1970 to 10 percent in 1971, reflecting mainly a decline in the volume gain. The Southern Hemisphere group (Australia, New Zealand, and South Africa) experienced some acceleration of the rise in total export earnings, but there was a considerable reduction in the expansion of such earnings of the European group, despite maintenance of high export growth rates by Spain, Turkey, and Ireland. The expansion of imports into the more developed primary producing countries fell off substantially in 1971, when the rate of increase in value—9 per cent—was only half the previous year’s rate.

For the less developed countries, 1971 was a year marked by generally weaker gains in export volume, sagging average prices for primary products other than petroleum, and a very uneven distribution of changes in export values and trade balances. One factor—operative only for about four months toward the end of 1971—that probably had a dampening effect was the temporary U. S. import surcharge. The inhibiting influence of this was felt chiefly, insofar as the less developed countries were concerned, by those whose exports include high proportions of manufactured products.

A major factor working in the opposite direction in 1971 was the influence, upon a number of oil exporting countries, of the unprecedentedly large increases in petroleum prices. Although there was a slight dip in the rate of growth in the volume of the oil exports from developing countries in 1971, the total value of such exports rose by some 30 per cent. The benefits of this exceptional rise in export proceeds were centered, of course, in a small number of countries, chiefly in the Middle East and in Africa.

Because of the lesser intensity in demands of the industrial countries for primary products, the average unit value of all nonpetroleum exports of the developing countries actually declined somewhat from 1970 to 1971; and the rate of expansion in the volume of such exports, already reduced from its 1968 peak, fell off sharply. In terms of total value, the exports of developing countries other than the oil exporters appear to have risen by only about 2 per cent in 1971—by far their smallest increase since 1967. Since in 1971 there was a further substantial rise in the prices of imports in dollar terms, the purchasing power of export earnings for less developed countries other than oil exporters apparently suffered an overall net decline—stemming from substantial decreases for countries primarily exporting metals or food and agricultural materials, partly offset by increases for countries exporting manufactured products.

The relatively unfavorable experience in 1971 for countries exporting food and agricultural materials—although not those exporting metals—was in line with comparative export performance over the 1960s. This showed that, in general, developing countries with the highest rates of export growth were exporters of petroleum, metals, or manufactures. Such trends were in conformity with the growth of world import demand during the period. However, factors other than external demand—including notably the character of national economic policies—would have to be taken into account in an assessment of the export performance of individual developing countries.

The trade balances of many less developed countries other than petroleum exporters, already deteriorating somewhat in 1971, may come under further pressure in 1972 because of the terms-of-trade effects of the realignment of currencies. (See the discussion below on “Impact of the Realignment.”) Import unit values may rise faster than export unit values for developing countries that do not export petroleum or otherwise command a strong position in the formation of prices for internationally traded goods. Such a result would reflect the relative inelasticity of the demand for imports in those countries, in combination with the realignment-related rise in supply prices of the imported goods, expressed either in dollars or in the currencies of the importing countries. Most developing countries do not have adequate capacity, in the short run, to replace through domestic production any significant proportion of the imports of capital equipment and intermediate manufactured products that currently dominate their commodity imports. The actual extent to which the developing countries will suffer pressure on their trade balances in the short run will depend crucially on the extent of the pickup in demand for their exports occasioned by the current economic upswing in the industrial world.

Study of cyclical fluctuations in the external trade of less developed countries over the past dozen years or so yields two main findings. First, in light of the historical experience, the 1970-71 change in exports of developing countries other than oil exporters was broadly in line with what could have been expected on the basis of weakening economic activity in the developed countries. This is true of both the volume and the unit value of those exports. Second, despite this slowdown in exports, growth in the dollar value of imports into less developed countries was sustained at a historically high rate in 1971. Outside the Middle East, there was a general deterioration of trade balances from 1970 to 1971 in the major regional groupings of developing countries.

Most of the cyclical volatility in the total value of developing countries’ exports over the years is attributable to fluctuations in the unit value. (See Chart 3.) In terms of percentage changes in annual data, variations in the industrial output of developed countries usually translate into concurrent but much larger variations in market prices of commodities. These, in turn, give rise to fluctuations of smaller amplitude—and sometimes with a lag, even in annual data—in the unit values of the exports of developing countries.9 This process can be followed in the data shown in the first and second panels of the chart.

Chart 3.Less Developed Countries: Merchandise Trade and Related Variables, 1960-71

(Percentage changes from preceding year)

1 Composite index, with individual countries weighted according to value of imports from less developed countries.

2 From National Institute of Economic and Social Research ; does not include petroleum.

Rates of growth in the value of developing countries’ imports have typically paralleled the corresponding changes in exports. Notable divergences between import and export growth occurred in 1963 and, to a lesser extent, in 1969 because of abnormal increases in commodity prices. But in 1971, when imports turned out to be exceptionally high, the “gap” between import growth and export growth for less developed countries excluding oil exporters had no precedent in the previous 12 years (fourth panel of the chart). Of particular note, in the 1962-65 export cycle the second year of deceleration in export earnings —that is, 1965—witnessed a parallel slowdown in import expansion as countries adjusted their spending to the external situation, whereas in 1971, also the second year of a slowdown in exports, a parallel import adjustment did not occur.

There are perhaps two main explanations for this difference. The first is that the real cost of adjustment would have been higher in 1971 than it was in 1965. Import prices, over which the developing countries have little influence, were rising in 1971 at a rate of 4—5 per cent, compared with only 1 per cent in 1965. Thus, if the less developed countries (excluding oil exporters) had adjusted the growth of their imports in value to that of their exports, their imports in volume in 1971 would have shown no increase, or perhaps a small decline.

The second explanation is that the financial need to adjust may well have been less strong in 1971. Official reserves provide some evidence to this effect. Largely because of the influence of short-term capital movements, the reserves of less developed countries other than the oil exporters (as defined in Table 3) increased from $10.4 billion at the end of 1968 to $13.5 billion at the end of 1970 (including the equivalent of $0.7 billion in SDR allocations), after having risen by an average of only $0.4 billion per annum over the ten-year period from 1958 to 1968. The spurt in reserves during 1969 and 1970 was a development that must have affected the stance of trade, exchange, and development policies in many of these countries as they faced a darker export picture in 1971.

Balance of Payments Developments

The currency crises that dominated international payments developments during 1971 had their roots in a long period of imbalances in payments relationships among major industrial countries. Although the proximate causes of the severe difficulties in managing reserve positions and exchange rates that erupted in May and again in August of that year could be found in explosive movements of capital, it was largely because these occurred against a background of chronic imbalances that they went beyond the scope of containment by internal means available to national financial authorities.

Evolution of Payments Situations in Major Industrial Countries

At the heart of the disequilibrium in international payments relationships has been the deficit in the basic external accounts of the United States. Prevailing for many years, it has long been accompanied by a deficit in the overall U. S. balance of payments except during periods of exceptionally tight U. S. monetary conditions, such as 1966 or 1969, when it was temporarily masked by favorable movements of short-term capital. For more than a decade, the balance of payments problem faced by the U. S. authorities had been one centered in a current account surplus much too small to cover the combined net outflow of long-term capital and government aid to other countries. From the mid-1960s onward, this problem was compounded by a progressive weakening of the U. S. current account, stemming mainly from deterioration of the trade balance. The deterioration became quite substantial after 1967, being interrupted only briefly in 1970 by an unusual combination of domestic and foreign cyclical conditions. Official programs of restraint on outflows of U. S. capital were utilized throughout these years in an endeavor to limit the overall balance of payments deficit of the United States.

The counterpart of the persistent U. S. deficit on external transactions was found during recent years in rather widespread surpluses of other countries. To a considerable extent, the distribution of these varied from year to year with shifts in economic conditions and in the trade and payments fortunes of particular countries. Among the major industrial nations, however, two stood out—even prior to 1971—for the size of their trade surpluses and the strength of their overall payments balances. These were Germany and Japan, both of which gained reserves very rapidly after about the end of 1969. Although their combined holdings at that time represented only some 28 per cent of total reserves held by industrial countries other than the United States, the two countries accounted for well over half of the extraordinary growth in that total over the next two years. Rising overall payments surpluses for the United Kingdom and France in 1970 and 1971 were also noteworthy (Table 4). For these two countries, however, the surpluses followed periods of severe balance of payments weakness. With specific reference to 1971, when the overall U. S. balance of payments deficit on official settlements approximated $30 billion, compared with $10 billion in 1970, the industrial countries that absorbed the bulk of the counterpart were Japan, with a surplus of more than $10 billion, the United Kingdom ($6½ billion), Germany ($4½ billion), and France ($3½ billion). Japan’s overall surplus was the one that showed the most striking improvement from 1970 to 1971. It rose by $9 billion, partly because of a $4 billion increase in the current account balance and partly because of the inflow of short-term capital in reflection of the unsettled international monetary situation.

Table 4.Industrial Countries: Balance of Payments Summaries, 1969-71(In billions of U.S. dollars)
Balance on
TradeServices

and

private

transfers
Current

account
Capital

Account

Balance 1
Allocation of

SDRs
Overall

Balance 2
Canada19690.9-1.6-0.70.80.1
19703.0-1.71.30.20.11.6
19712.3-1.80.40.30.10.9
United States19690.70.10.72.02.7
19702.10.12.2-12.90.9-9.8
1971-2.92.1-0.8-29.70.7-29.8
France1969-1.2-0.5-1.70.6-1.1
19700.7-0.20.51.40.22.1
19711.8-0.71.22.10.23.4
Germany19695.2-2.42.7-5.7-3.0
19705.8-4.21.74.30.26.2
19716.1-4.81.33.00.24.5
Italy19690.52.12.6-3.1-0.5
1970-0.41.71.3-0.90.10.5
19710.32.02.3-1.30.11.1
United Kingdom1969-0.31.81.5-0.31.2
19701.91.90.80.43.1
19710.72.02.83.40.36.5
Japan19693.7-1.42.3-1.50.8
19704.0-1.82.1-1.10.11.1
19717.9-1.86.14.10.110.3
Other industrial countries 31969-2.63.20.6-0.30.3
1970-3.93.6-0.32.30.32.2
1971-3.94.30.42.00.32.7
Total, industrial countries19697.01.18.1-7.60.5
197011.3-0.610.7-5.92.37.1
197112.31.313.7-16.02.0-0.3
Source: Data reported to the International Monetary Fund and staff estimates.

This balance is computed residually, as the difference between the overall balance (less SDR allocations) and the current account balance; it includes official transfers and net errors and omissions, as well as recorded capital movements. Because of asymmetries in national balance of payments statistics resulting from placements of official reserves in the Euro-currency market, the net outflow of capital from industrial countries is understated by the following amounts (according to estimates given in Table 7): $2.2 billion in 1969, $7.3 billion in 1970, and $5.4 billion in 1971. See Annual Report, 1971, page 82, footnote 1, for further explanation.

Overall balances are measured by changes in official gold holdings, in SDRs, in reserve positions in the Fund, in foreign exchange assets, in use of Fund credit, and, where data are available, in liabilities to foreign monetary authorities, including those arising from “swap” transactions.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

Source: Data reported to the International Monetary Fund and staff estimates.

This balance is computed residually, as the difference between the overall balance (less SDR allocations) and the current account balance; it includes official transfers and net errors and omissions, as well as recorded capital movements. Because of asymmetries in national balance of payments statistics resulting from placements of official reserves in the Euro-currency market, the net outflow of capital from industrial countries is understated by the following amounts (according to estimates given in Table 7): $2.2 billion in 1969, $7.3 billion in 1970, and $5.4 billion in 1971. See Annual Report, 1971, page 82, footnote 1, for further explanation.

Overall balances are measured by changes in official gold holdings, in SDRs, in reserve positions in the Fund, in foreign exchange assets, in use of Fund credit, and, where data are available, in liabilities to foreign monetary authorities, including those arising from “swap” transactions.

Austria, Belgium-Luxembourg, Denmark, the Netherlands, Norway, Sweden, and Switzerland.

Table 7.Sources of Reserve Change, 1962-711(In billions of SDRs)
Annual Changes in1962196319641965196619671968196919701971Memo Item

Outstanding

Totals at the

End of 1971
1.Gold Reserves
Monetary gold0.40.80.70.2-1.6-0.70.10.3-0.1
Gold transactions by IMF, BIS, and European
Fund (sales +)0.10.1-0.10.8-0.90.20.10.1-2.2-1.0
Countries’ gold reserves0.40.90.61.0-0.9-1.4-0.60.2-1.9-1.136.1
2.Special Drawing Rights
Allocation of SDRs3.42.9
IMF holdings of SDRs (increase —)-0.3-0.2
Countries’ SDR holdings3.12.85.9
3.Reserve Positions in TMF
Use of IMF credit-0.40.10.41.6-0.51.20.3-0.8-1.9
IMF gold transactions (inflow +) 20.10.1-0.1-0.31.00.1-0.41.60.4
IMF transactions in SDRs (inflow +)0.30.2
IMF surplus (increase —)-0.1-0.1-0.1-0.1-0.1-0.1-0.1
Reserve positions in IMF-0.30.10.21.20.9-0.60.70.21.0-1.36.3
4.Foreign Exchange Holdings
a.U. S. dollars
U. S. deficit on official settlements 32.71.91.51.3-0.23.4-1.6-2.710.730.5
U. S. reserve assets (including foreign exchange)
used in transactions with countries-1.5-0.4-0.2-1.2-0.8-0.10.91.3-3.0-3.1 4
(i) Official claims on United States 51.11.51.40.1-1.13.4-0.8-1.57.7627.4 446.7
(ii) Identified official holdings of Euro-dollars 7.........0.10.70.41.20.74.90.2 49.3
b.Official sterling holdings-0.10.40.5-0.9-0.1-1.3-0.50.80.51.57.2
c.Official deutsche mark holdings80.10.10.10.8-0.4 41.0
d.Official French franc holdings 9-0.1-0.10.1-0.1-0.20.20.20.8
e.Foreign exchange claims arising from swan credits and related assistance0.4-0.30.70.91.2-0.1-2.2-0.7
f.Correction for effect nf realignment nn stock of reserves10-4.3
g.Unidentified Euro-currencies and residual 11-0.40.4-0.90.4-0.2-1.30.61.52.45.28.0
Countries’ holdings of foreign exchange0.62.31.4-0.60.22.11.71.214.329.072.9
Total reserve change0.63.42.21.60.20.11.91.616.529.4121.3
Source: International Financial Statistics, and Fund staff information and estimates.

Adjusted reserves. See footnote 1,Table 6.

Including gold subscriptions and effect of IMF gold deposits and gold investments.

Unlike the other components of reserve growth, the deficit is already in a flow dimension and therefore is not expressed as a change from the previous year. The U. S. deficit is shown before allocations of SDR 0.9 billion in 1970 and SDR 0.7 billion in 1971.

Excluding the estimated impact of the realignment on the value of amounts outstanding at the time of realignment.

Includes claims on the United States denominated in the claimant’s own currency, i.e., Roosa bonds.

Excludes SDR 0.4 billion in respect of reduction in IMF gold investment.

Fund staff estimates. See Table 10.

Estimates of claims on the Deutsche Bundesbank and, for 1969-71, on German commercial banks, provided by the German authorities.

Estimates provided by French authorities, supplemented in the earlier period by Fund staff estimates.

For explanation see page 25.

Includes asymmetries arising from the fact that data on U. S. and U. K. currency liabilities are more comprehensive than data on official foreign exchange holdings shown in International Financial Statistics.

Source: International Financial Statistics, and Fund staff information and estimates.

Adjusted reserves. See footnote 1,Table 6.

Including gold subscriptions and effect of IMF gold deposits and gold investments.

Unlike the other components of reserve growth, the deficit is already in a flow dimension and therefore is not expressed as a change from the previous year. The U. S. deficit is shown before allocations of SDR 0.9 billion in 1970 and SDR 0.7 billion in 1971.

Excluding the estimated impact of the realignment on the value of amounts outstanding at the time of realignment.

Includes claims on the United States denominated in the claimant’s own currency, i.e., Roosa bonds.

Excludes SDR 0.4 billion in respect of reduction in IMF gold investment.

Fund staff estimates. See Table 10.

Estimates of claims on the Deutsche Bundesbank and, for 1969-71, on German commercial banks, provided by the German authorities.

Estimates provided by French authorities, supplemented in the earlier period by Fund staff estimates.

For explanation see page 25.

Includes asymmetries arising from the fact that data on U. S. and U. K. currency liabilities are more comprehensive than data on official foreign exchange holdings shown in International Financial Statistics.

Table 10.Official Holdings of Euro-Dollars and Unidentified Foreign Exchange Reserves, 1964-71(In billions of SDRs)
19641965196619671968196919701971
Identified official holdings of Euro-dollars 1
Ten industrial countries 20.50.51.01.01.81.74.12.6
Other industrial countries 30.30.20.30.50.50.50.80.9
Total, industrial countries0.80.81.41.52.32.24.93.5
More developed areas0.30.30.30.30.40.51.41.4
Less developed areas0.20.40.40.70.91.62.94.4
Total, primary producing countries,0.50.60.70.91.32.14.25.8
Total 11.31.42.02.43.64.39.29.3
Unidentified official holdings of Euro-
currencies and residual sources of reserves 4-0.6-0.2-0.4-1.7-1.10.42.88.0
Source: Fund staff information and estimates.

Fund staff estimates based on information supplied by 58 countries

Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, and the United Kingdom.

Austria, Denmark, and Norway.

Includes asymmetries in data on reserves and liabilities: see footnote 11 of Table 7.

Source: Fund staff information and estimates.

Fund staff estimates based on information supplied by 58 countries

Belgium, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, Switzerland, and the United Kingdom.

Austria, Denmark, and Norway.

Includes asymmetries in data on reserves and liabilities: see footnote 11 of Table 7.

For Germany the overall payments surplus in 1971, while still quite sizable by comparison with the overall balances of most other countries, represented an appreciable shrinkage from the $6 billion surplus recorded in 1970. This stemmed chiefly from a reduction of net capital inflows, contrasting both with Germany’s absorption of a disproportionate share of the capital movements stemming from the U. S. deficit in 1970 and with the rise in capital inflows received by so many other countries in 1971. The floating of the deutsche mark in May 1971 and the succession of measures adopted by the German authorities to restrain the inflow of foreign funds were largely responsible for this contrast.

Apart from Japan, the country showing the largest increase in its balance of payments surplus from 1970 to 1971 was the United Kingdom, where the rise amounted to about $3½ billion. It reflected both current account gains and increases in capital inflows, as did the much smaller rise ($1¼ billion) in the French surplus. Italy’s overall surplus rose by about $0.5 billion, reflecting a substantial recovery in its current account, while the Canadian surplus subsided somewhat in 1971, following a sharp rise in 1970.

During 1968 and 1969, the underlying weakness of the U. S. balance of payments, as well as the strength of various other countries’ payments positions, had been camouflaged by the prevalence of credit conditions inducing abnormal flows of foreign capital into the United States. With the onset of recession in the U. S. economy, however, the previously tight U. S. monetary policy was relaxed early in 1970. U. S. credit conditions eased and U. S. interest rates fell sharply. These developments, occurring at a time when boom conditions in most Western European economies, as in most Western European economies, as well as in Japan, brought a dramatic reversal of the 1968—69 capital flows, and international capital movements dominated changes in overall payments balances of the industrial countries during both 1970 and 1971.

Although current account changes in the payments balances of the major industrial countries in 1971 were generally dwarfed by huge movements of speculative capital, some of the current account changes themselves were larger and more disequilibrating than any of those occurring in 1970. This is true, in particular, of the 1970-71 swings in the U. S. and the Japanese current accounts. The former swing was negative by some $3 billion, while the latter was positive to a degree (about $4 billion) unprecedented in Japan’s postwar experience. None of the changes in current account balances of other industrial countries from 1970 to 1971 even approached the order of magnitude of the Japanese and U. S. changes, and a number of them were smaller than corresponding changes a year earlier.

During 1970 and the early months of 1971, the flow of capital from the United States to other industrial countries, while abnormally large in comparison with any prior movements of funds, reflected primarily the responses of financial market participants to the shift in comparative monetary conditions and interest rate levels. The U. S. outflow took the form chiefly of repayments by U. S. banks of depository funds that they had borrowed abroad during 1968 and 1969. However, as these large flows proceeded against the background of underlying imbalance in the global payments structure, they were progressively rein-forced by shifts of other types of capital in anticipation of, or hedging against, possible changes in exchange rates for major currencies. A contributing factor was the spreading realization that the modest improvement of the U. S. current account in 1970 had been a temporary manifestation of favorable conjunctural circumstances, and that the tapering off of the European boom, together with the commencement of a domestic economic up-swing in the United States itself, was again exposing the fundamental weakness of the U. S. current account.

Both in the unprecedented movements of capital to the United States in 1969 and in the even more massive movements of funds out of that country in 1970 and 1971, as well as in the rising volume of flows among other countries, the mechanism of the Euro-currency market was an important factor in the fluidity of capital movements and the speed of responses to new influences or market expectations. Available evidence shows that the growth of the Euro-currency market during 1971, estimated by the Bank for International Settlements at some $14 billion, was about the same as that of the previous year. However, the rise of dollar deposits in the market slowed somewhat, while that of non-dollar currencies accelerated. As in 1970, the ease of U. S. monetary policy brought about a sharp reduction in the net indebtedness of U. S. banks and other residents to the Euro-currency market, whereas Euro-currency borrowing by Europe and other parts of the world increased. An important change in the operation of the market was the cessation by major industrial countries, early in 1971, of placements of official reserves in Euro-currency deposits. Such placements had previously contributed to the velocity of international movements of funds and had tended to pyramid reserve holdings based on a given volume of U. S. liabilities.10 Although the monetary authorities of many primary producing countries apparently increased their placements of official reserves in the Euro-currency market in 1971, as indicated in Chapter 2, the overall net growth of official Euro-currency reserve holdings was substantially reduced in that year and shifted into non-dollar forms.

The acceleration of speculative international movements of funds in the second quarter of 1971 led to the floating of the deutsche mark and related changes in the exchange field in early May. Subsequently, when such movements were resumed on a far larger scale after only a brief lull, the mid-August suspension of convertibility of the U. S. dollar into gold or other reserve assets ensued, along with numerous other changes in national exchange rate policies. Continuing uncertainties about currency relationships caused further large movements of capital throughout the remainder of the third quarter and much of the fourth. However, because of the gradual emergence of a new exchange rate pattern and the eventual adoption of the December 18 agreement on realignment of exchange rates, as well as the spread of official restraints on capital movements, the shifts of funds in the fourth quarter of 1971 were a good deal less massive than those of the third quarter. They subsided further in the first five months of 1972, though not without an occasional revival of exchange market pressures, especially in early March. Shortly after the middle of June, a stronger revival of such pressures led to the floating of the pound sterling.

During the opening months of 1972, international interest rate differentials remained generally such as to discourage major reflows of funds to the United States, even if confidence factors had been more propitious than they were. Short-term security yields in the United States were lower than at any time since 1963; and U.S. interest rates on long-term bonds, while still relatively high by pre-1969 U. S. standards, were well below the corresponding long-term rates in most other major industrial countries. Around the turn of the first quarter, however, U. S. interest rates firmed somewhat, while a further easing of interest rates became evident in Europe, where there were reductions in the central bank discount rates of Germany, France, Italy, and several other countries. In April and May some firming of exchange rates for the dollar suggested a distinct abatement of earlier speculative pressures. However, evidence of any sizable reflux of speculative capital to the United States remained largely inferential, and the dollar was again weak in the exchange markets during the weeks immediately following the sterling float.

At mid-1972 the prospects for early achievement of better balance in the distribution of over-all payments surpluses and deficits among major industrial countries appeared to rest very largely on the evolution of capital movements in the aftermath of the huge disturbances of the prerealignment period. The realignment itself, as noted below in the discussion of the international adjustment process, could be expected to produce changes in countries’ current account balances only gradually, with much of the impact extending considerably beyond 1972. Meanwhile, the cyclical positions of key economies were such as to exert disequilibrating influences on the current account balances of Japan, Italy, and the United States during 1972. Consequently, although there was a possibility that current account balances would begin to shift in appropriate directions before the end of the year, there was little prospect for redress of the large recent payments imbalances through changes in current accounts from 1971 to 1972. Instead, prospects for avoidance of further major overall payments imbalances in 1972 seemed to depend largely on partial reversal of the speculative capital flows that created such massive disturbances during 1971. Such a reversal would require an improvement in market confidence and the emergence of financial conditions in the United States and other major industrial countries that would not provide yield incentives for placement or retention outside the United States of funds that would otherwise tend to be held in that country.

External Payments of the Primary Producing Countries

In the main, the huge shifts in overall payments balances in 1971 occurred among the industrial countries. Some of the counterpart of the U. S.deficit, however, was to be found also among the primary producing countries. Both the more developed and the less developed members of that large group shared—though by no means evenly —in a substantial expansion of their combined balance of payments surplus (Table 5). Inclusive of SDR allocations totaling the equivalent of about $1 billion, it rose to roughly $8 billion in 1971, compared with $4 billion in 1970 (when SDR allocations were somewhat larger). The increase reflected an unusually sharp expansion of capital inflows, much of it in short-term or unidentified forms, as the current account deficit of the primary producing countries rose again in 1971. For the less developed countries other than oil exporters, the rise in their combined current account deficit exceeded that in their net capital inflow.

Table 5.Balance of Payments Summary, 1969-71(In billions of U. S. dollars)
Balance on
TradeServices

and

private

transfers
Current

account
Capital

Account

Balance 1
Allocation of

SDRs
Overall

Balance 2
Industrial countries19697.01.18.1-7.60.5
197011.3-0.610.7-5.92.37.1
197112.31.313.7-16.02.0-0.3
Primary producing countries1969-3.2-5.1-8.39.81.5
1970-5.9-5.2-11.114.31.14.3
1971-6.8-5.3-12.219.41.08.2
More developed areas1969-3.91.8-2.12.1
1970-5.82.7-3.14.10.31.3
1971-6.54.0-2.45.80.23.6
Less developed areas19690.7-6.8-6.27.71.5
1970-0.2-7.9-8.010.20.83.0
1971-0.4-9.4-9.713.60.74.6
In the Middle East19690.8-1.6-0.80.4-0.4
19701.2-2.1-0.90.90.10.1
19713.5-3.8-0.32.50.12.3
In Africa19692.6-2.50.80.8
19702.3-2.5-0.11.00.21.0
19711.5-2.2-0.71.60.11.0
In Asia1969-3.40.3-3.13.60.6
1970-3.8-0.1-3.94.20.30.6
1971-4.1-0.3-4.44.90.20.8
In the Western Hemisphere19690.7-3.0-2.42.90.5
19700.1-3.2-3.14.00.31.2
1971-1.2-3.2-4.44.60.30.5
Total, all countries19693.7-3.9-0.22.21.9
19705.4-5.8-0.48.43.411.4
19715.5-4.01.53.52.97.8
Memorandum:
All countries in less developed areas excluding oil exporters 3
1969-3.9-1.8-5.87.01.2
1970-5.6-2.7-8.39.80.72.2
1971-8.5-2.8-11.211.70.61.1
Source: Data reported to the International Monetary Fund and staff estimates.

For definition, see Table 4, footnote 1. Because of asymmetries in national balance of payments statistics resulting from placements of official reserves in the Euro-currency market, the global summations of net capital inflows and overall balance of payments surpluses are overstated, and the net outflow of capital from industrial countries is understated, by the following amounts (according to estimates given in Table 7): $2.2 billion in 1969, $7.3 billion in 1970, and $5.4 billion in 1971. See Annual Report, 1971, page 82, footnote 1, for further explanation.

For definition, see Table 4, footnote 2. See also footnote 1 above.

The oil exporters covered in this table are Algeria, Indonesia, Iran, Iraq, Kuwait, the Libyan Arab Republic, the Netherlands Antilles, Nigeria, Saudi Arabia, Trinidad and Tobago, and Venezuela.

Source: Data reported to the International Monetary Fund and staff estimates.

For definition, see Table 4, footnote 1. Because of asymmetries in national balance of payments statistics resulting from placements of official reserves in the Euro-currency market, the global summations of net capital inflows and overall balance of payments surpluses are overstated, and the net outflow of capital from industrial countries is understated, by the following amounts (according to estimates given in Table 7): $2.2 billion in 1969, $7.3 billion in 1970, and $5.4 billion in 1971. See Annual Report, 1971, page 82, footnote 1, for further explanation.

For definition, see Table 4, footnote 2. See also footnote 1 above.

The oil exporters covered in this table are Algeria, Indonesia, Iran, Iraq, Kuwait, the Libyan Arab Republic, the Netherlands Antilles, Nigeria, Saudi Arabia, Trinidad and Tobago, and Venezuela.

More developed primary producing countries.

These countries accounted for nearly half of the combined surplus of the whole primary producing group in 1971 and for a considerably larger proportion of the annual increase in that surplus. Together, the more developed primary producers have now had a substantial overall balance of payments surplus in each of the past four years except 1969, when stringent credit conditions in international financial markets curtailed tempo-rarily their use of foreign capital. In 1970 a resurgence of capital inflows to such countries was partly absorbed by the financing of an enlarged current account deficit, but the further substantial rise in capital inflows in 1971 coincided with some shrinkage of the combined current account deficit. It thus gave rise to an aggregate overall surplus of about $3½ billion for a group of countries whose combined payments surplus had not previously exceeded $l½ billion in any calendar year. The result was an unprecedented expansion in the international monetary reserves of a number of these countries.

For the more developed primary producing countries in the Southern Hemisphere, the 1971 improvements in overall balances stemmed largely or wholly from increases in net inflows of capital.

Such inflows were especially marked in the case of Australia, where, over the final three quarters of the year, a modest decline in the current account deficit under slack conditions of domestic demand also contributed to a sharp expansion of official reserves. There was a considerable further rise in South Africa’s current account deficit in 1971, although the overall payments deficit, while still large, was a little lower in 1971 than in 1970. Reduction of the country’s international reserves therefore continued during 1971 at a pace that gave rise to concern on the part of the authorities and led to imposition of quantitative restrictions on imports. Devaluation of the rand in December 1971 (by about 5 per cent in relation to the U. S. dollar) was followed by a turnaround in South Africa’s reserve position in early 1972. Another change in South African exchange rate policy came in June, when the authorities allowed the rand to float with sterling in view of the close financial relationships with the United Kingdom, the uncertainties created by the sterling float, and the importance of maintaining a stable exchange rate between the two currencies.

The European primary producing countries also received larger net inflows of capital in 1971 than in 1970, but the improvement in their combined current account was a more important factor in raising their aggregate overall payments surplus. Spain accounted for the bulk of the current account improvement, as its exports and net receipts from tourism again rose sharply while its imports reflected slackened growth in domestic economic activity. Slower domestic expansion, however, was not invariably associated with current account improvement. In Finland, for example, it was associated with a current account deterioration and, indeed, was caused in considerable part by a drop in foreign demand for Finnish exports. Conversely, strong expansion of Turkish exports in 1971 contributed to the strength of domestic economic growth, as well as to the maintenance of a sizable balance of payments surplus.

Most of the other European countries in the primary producing group had current account deficits of some size, but all of them were able to obtain inflows of capital or aid (including unrecorded capital flows) large enough to provide ample financing of these deficits and to increase their overall payments surpluses from 1970 to 1971. The only European primary producer not showing a balance of payments surplus in 1971 was Yugoslavia, where a poor harvest resulted in a large current account deficit.

Less developed countries.

For this group of countries, the overall surplus reached $4½ billion (including SDR allocations of the equivalent of $0.7 billion) in 1971, compared with $3 billion (including a slightly larger amount of SDR allocations) in 1970. These figures present a contrast to earlier annual surpluses, which totaled less than $1 billion in the middle 1960s and only a little over that amount as recently as 1968.

However, two features of the large overall payments surplus of the developing countries in 1971 deserve special emphasis. One is the degree to which it depended—in view of a substantial enlargement in the current account deficit—on an unusually sizable increase in inflows of capital, and especially of capital in short-term or unidentified forms. The second special feature, noted more fully below, is the extent to which the 1971 rise in the overall surplus was centered on a limited number of major oil exporting countries.

According to estimates still based in part on fragmentary and preliminary information, the current account deficit of the developing countries was about $9½ billion in 1971, compared with $8 billion in 1970 and $6-7 billion in each of the three preceding years. The rise in this aggregate deficit from less than $5 billion per annum in the middle 1960s reflected primarily an increase in net payments for international services, including earnings on foreign investments; there was little change in the combined trade balance of the developing countries as recorded for balance of payments purposes.

As in all other years since the mid-1960s, the overall current account deficit of the developing countries was more than covered in 1971 by net inflows of capital and aid. Indeed, such flows rose considerably faster than the current account deficit, as they did in 1970. However, recorded net inflows of private long-term capital rose only moderately from 1969 to 1971, and increases in receipts of official capital and aid accounted for less than one fourth of the apparent rise in total capital inflows during that period. The remainder stemmed from a sharp swing in movements of short-term funds and unidentified capital, which had been held back in 1969 by the prevalence of tight conditions in financial markets of major industrial countries.

This pattern of change in the financing of the current account deficit of the less developed countries contrasted with concurrent changes in the financing of the much smaller current account deficit of the more developed primary producing countries. For the latter group, the upswing in movements of short-term and unidentified capital formed only two fifths of the 1969-71 rise in the total flow of capital to these countries. Their collective net receipts of official capital and aid remained small, and three fifths of the rise in capital inflow to the more developed primary producing countries reflected a doubling of private long-term flows.

The aggregate rise in the overall payments surplus of developing countries in 1971 was unevenly distributed among regional groups. The great bulk of it was centered in the Middle East, which was the only region having a decrease in its current account deficit and the one with by far the largest rise in capital inflows. The other principal regional groups of developing countries showed comparatively small changes in their respective overall payments balances. It was in the Western Hemisphere that the sharpest deterioration of trade and current account balances occurred, and this deterioration was not matched by the increase in flows of capital and aid. For the Asian and African regions, the increases in current account deficits were smaller and were covered by increases in financial inflows. Receipts of SDR allocations have become important elements in the overall balances of many developing countries, especially in Asia and the Western Hemisphere.

The relatively favorable balance of payments experience of developing countries in the Middle East in 1971 stemmed mainly from the effect on their trade balances of the oil price increases noted above in the review of world trade developments. Several African and Western Hemisphere countries were also beneficiaries of renegotiated agreements between the international petroleum companies and the major oil exporting countries. Taken together, the whole group of developing countries in this category accounted for three fourths of the aggregate balance of payments surplus of all less developed countries in 1971, compared with only one fourth in 1970 and lower proportions in the late 1960s.

In general, developing countries not directly affected by revisions of the international petroleum arrangements fared much less well with respect to balance of payments changes over the past year or so. Their combined surplus of $1 billion in 1971 was substantially lower than that in 1970, and only the relatively favorable development of their capital accounts prevented more of them from slipping into overall payments deficit at a time of sagging demand for primary products in many of the industrial countries.

Certain less developed countries whose exports include relatively large proportions of metals were particularly affected by the sluggishness of economic expansion in the industrial areas. The overall payments position of these developing countries, after having been in surplus over a period of several years prior to the recent slow-down, swung into deficit in 1971. Asian, African, and Western Hemisphere countries whose principal reliance for export earnings is placed on food and agricultural materials did not have a much more favorable experience. Only through the support provided by SDR allocations were their combined reserve holdings prevented from declining. The balance of payments experience of less developed countries exporting substantial amounts of manufactured goods was more varied, depending on the distribution of their exports among principal markets in the industrial world, the character of those exports, and the domestic situations of the exporting countries.

Among the developing countries of the Western Hemisphere not exporting oil, Brazil accounted for disproportionately large shares of both the current account deterioration and the rise in capital inflows for the whole group in 1971. That country, whose economic programs have been supported by a flexible exchange rate policy, has for several years been in a phase of strong domestic growth and of accelerated inflows of capital. In late 1971 steps were taken to lengthen the maturity of this financing, much of which had been in the form of short-term and medium-term loans. Brazil’s overall surplus in 1971, as in the two previous years, far exceeded that of any other developing country in the Western Hemisphere, where surpluses and deficits of the other countries not exporting oil totaled close to zero in 1971, after showing a moderate preponderance of surpluses in 1970. The payments situations of a number of Western Hemisphere countries were adversely affected by the price declines for important export products, such as coffee and certain metals, or by the impact of inflationary domestic demand conditions upon imports, augmented by rising import costs. In several instances, the prevalence of such demand conditions could be traced chiefly to application of excessively expansionary financial policies.

Other examples of weakness in balance of payments positions exacerbated by expansionary fiscal and monetary policies emerged in Africa. There, too, a number of countries were vulnerable to the cyclical downturn in world market prices for industrial raw materials, as well as to the drop in coffee prices. Aside from the very large surplus of the Libyan Arab Republic, which accounted for the bulk of the regional surplus in 1971, the collective balance of payments experience of African developing countries was thus not particularly favorable. Even with the supplement of SDR allocations, their combined reserve increases were smaller in both 1970 and 1971 than in 1969. Moreover, the two largest surpluses after that of the Libyan Arab Republic were those of Algeria and Nigeria, both of which were also beneficiaries of petroleum price developments. On balance, the payments positions of the remaining African countries were moderately in deficit for 1971, after having been substantially in surplus for the two previous years. This deterioration reflected larger increases in current account deficits than in capital inflows.

The developing countries of Asia, like those elsewhere, felt the impact of slack world demand and softening prices for primary products. In addition, some of them were strongly affected by natural calamities or active military hostilities, and a few found their imports subject to strong pressures of domestic demand. Their combined current account deficit rose considerably in 1971 for the second consecutive year, and their receipts of long-term capital and aid again changed little. Nevertheless, their overall balance of payments surplus was not only maintained, but somewhat enlarged, by considerable buoyancy of short-term capital inflows.

The overall payments surplus of the Asian region in 1971, as in 1970, was concentrated in Singapore, the Republic of China, India, and the Philippines. For India there was some decline in the payments surplus as the trade deficit rose again to meet the strains of refugee relief and defense requirements in a period of slackened growth in nonagricultural output, but the foreign exchange position remained generally satisfactory. Singapore’s increasing overall surpluses in the past two years materialized despite a large increase in the current account deficit; they reflected very sharp expansion of capital inflows, almost entirely—on a net basis—in short-term or unidentified forms.

In the Middle East the spurt in receipts from petroleum exports raised the area’s trade surplus to $3½ billion—several times the size of previous annual trade balances since 1965. However, there was also a very sharp deterioration of the net balance on international service transactions, strongly affecting the accounts of Saudi Arabia, Iran, Iraq, and Lebanon. Consequently, the 1970-71 improvement of the area’s aggregate current account was fairly moderate, although it did interrupt an upward trend in the regional current account deficit from 1967 to 1970. Aside from the surge in export earnings, the major contribution to the increase in overall payments surpluses of Middle Eastern countries in 1971, according to the preliminary statistics available from national sources, came from a marked upswing in inflows of short-term or unidentified capital. These went particularly to Saudi Arabia, Lebanon, and Israel and may have reflected the influence of various currency developments upon incentives to repatriate funds.

International Adjustment Process

The preceding section of this chapter elaborated the well-known fact that the international adjustment process had functioned under difficulties for a number of years prior to the events of August 15, 1971 and the ensuing realignment of currencies in December. This section deals with two key aspects of the new situation that has now developed with respect to the adjustment process: (a) the economic impact of the 1971 currency realignment and (b) the role of national policies in supporting the realignment and rendering it effective under the general conditions that can presently be envisaged for the next year or so.

Impact of the Realignment

The effects of the 1971 currency realignment may be assessed with respect to (1) the trade and current accounts, and the balances of payments generally, of the major industrial countries that participated in the December 18 Smithsonian Agreement; (2) countries’ official reserves; (3)the debt and debt service of developing countries;and (4) the trade of developing countries.

Studies by the Fund staff, summarized briefly below, cover the impact of realignment on major features of the external position for both the industrial and the developing countries. But for the latter group of countries it should be borne in mind that the really fundamental question in this context concerns the degree to which the realignment will be successful in causing economic policies in the main industrial countries to be less encumbered than heretofore by balance of payments difficulties—difficulties which in the past contributed to a financial instability that had distinctly adverse effects on the developing world.

1. The new currency values agreed upon in December 1971 were intended to be suitable for a situation in which the major industrial economies would have returned to conditions of high employment. The estimation of equilibrium exchange rates in an exercise such as the recent realignment is, of course, subject to a margin of error; however, it can be expected that the realignment will, in due course, lead to the restoration of international payments equilibrium—unless its intended effects are blunted or frustrated by inappropriate national policies.

The qualification “in due course” refers mainly to the inevitable lags in trade volume adjustments to be induced by the currency realignment. Because of these lags, not before 1973 can the equilibrating influence of the realignment make itself strongly evident, and its full impact will probably not be apparent until even later. In the interim, the terms-of-trade effects of the realignment, which precede its impact on trade volume, will be dominant; and these effects will be perverse because of their tendencies (a) to increase the current account surpluses of Japan, Germany, and other countries whose relative exchange rates appreciated (by raising the dollar prices of their exports more than the dollar prices of their imports) and (b) to increase the current account deficit of the United States (by raising its import prices more than its export prices). Furthermore, cyclical developments in 1972 can be seen to have a disequilibrating influence on major current account positions. Such developments, as reflected in the trends of GNP discussed earlier, will tend to bolster import growth in the United States relative to that of other major countries; in addition, the prevailing cyclical conditions—in general, relatively unfavorable to export expansion—may be expected to affect exports of the United States more severely than those of most other industrial countries, which will benefit from the pickup in the U. S. market itself. However, both the realignment effects and the cyclical influences should become more favorable in the period ahead. Insufficient public appreciation of this prospect, and of the period of time required for its realization, may have postponed the emergence of market confidence in the new exchange rates.

2. With the aid of special information supplied by member countries on their foreign exchange holdings by currency of denomination, it has been estimated that the overall value of countries’ reserves increased from $ 125 billion to $ 131 billion —i.e., by about 5 per cent—because of the currency realignment. The world price level of international transactions, for which reserves provide the means of financing any net imbalances, could also be expected to increase in terms of U. S. dollars as a result of the realignment. Based on import prices, the average amount of that expected increase was calculated at 7.4 per cent over the level prevailing immediately before May 1971. After the occurrence of this price increase, reserves would have commensurately less potential for financing imbalances, and this loss of “purchasing power” because of the realignment out-weighs the total revaluation gain, producing a net loss in real terms of 2.3 per cent of the total value of reserves.11 Such calculations indicate that the net percentage loss in purchasing power of reserves was about the same for the developed areas and for the less developed areas.

3. The external debts of developing countries, like their reserve assets, have been subjected by the 1971 currency realignment to both a revaluation effect and a price effect. The former raised the U. S. dollar equivalent of most non-dollar debt or debt service payments, but did not affect the nominal value of dollar debt (in terms of the U. S. dollar as the unit of account). On the other hand, the increase in U. S. dollar prices resulting from the realignment tends to reduce in real terms both the dollar-denominated debt and the U. S. dollar equivalent of most other outstanding debt. Similar considerations apply to interest payments on external debt.

For the total of outstanding debts, as covered in basic data provided by the World Bank,12 the revaluation effect is estimated at a little more than $2 billion, or about 4½-5 per cent (depending on assumptions made in cases of unknown currency composition of liabilities) of the outstanding debt. Further, the average increase in debt service payments (likewise valued in U. S. dollars) is also estimated at roughly 4½ per cent.

These nominal changes in debt and in debt service flows may be “deflated” to discount the average increase in prices of developing countries’ exports expected to result from the 1971 currency realignment, and thus to gauge debt changes in real terms from the standpoint of the volume of exports necessary to meet external debt commitments. Accordingly, the outstanding long-term external public debt of developing countries as a group was reduced in real terms by an estimated 1-1 ½ percent as a result of the currency realignment, and the real value of annual debt service payments was also reduced by about 1½ per cent.

The foregoing estimate of the net decline in outstanding debt in real terms attributable to the realignment—roughly $500 million—is of the same order of magnitude as the estimate (above) of the net loss in purchasing power of reserves held by developing countries as a group. Therefore, the combined external balance sheet position of these countries does not appear to have been greatly affected in real terms by the currency realignment. Also worth noting is the fact that there alignment, according to estimates of consequential changes in both debt items and export values in nominal terms, apparently did not have a substantial effect on the average ratios of either debt or debt service payments to the exports of developing countries.

4. The exchange rate decisions that were made by the developing countries in reaction to the 1971 realignment of major currencies reflected two main tendencies. One of these was a propensity to maintain traditional exchange rate relationships with the major industrial countries predominant in their respective combinations of trading partners. The other was a rather strong tendency for countries to resolve doubts in favor of maintaining exchange rates against the U. S. dollar, thus depreciating their currencies in relation to those of most industrial countries other than the United States and to currencies in general.

For the developing countries as a group, in their trade with all developed areas, the result was an average effective depreciation of roughly 4½ per cent. Since the changes, in terms of gold or SDRs, in the parities or central rates of the industrial countries, weighted by their shares in world trade, sum to very close to zero, it may be assumed that the weighted average effect of the same changes on the effective rates of the developing countries was also small, so that the effective depreciation they achieved was over-whelmingly the result of the depreciation of their currencies in terms of gold.

On the basis of reasonable (although necessarily uncertain) assumptions regarding such relevant factors as the price elasticities of demands for and supplies of goods traded by the developing countries, the effective depreciation of 4½ percent may be expected to generate shifts in price relationships that involve a deterioration of roughly 1 per cent in terms of trade, but which may eventually bring about a larger rise in total export values than in total import values. The price changes stemming from the realignment may lead to an expansion of 1½-2 per cent in the volume of developing countries’ exports and to a decline of somewhat more than 2 per cent in the volume of their imports. These estimated volume changes, in combination with the estimated price changes underlying them, would imply—before any allowance for indirect effects—an eventual improvement in the collective trade balance of the developing countries equivalent to about 2½-4 percent of the group’s combined exports. Such an improvement, amounting to roughly $1½-2 billion, would be fairly sizable when viewed in the perspective of past actual changes in the trade balance of the developing countries as a group.

Role of National Policies

The effectiveness of the adjustment process in the period ahead will be greatly influenced by the degree of success achieved by the main industrial countries in handling the problem, discussed earlier, of controlling inflation while fostering renewed economic growth. Beyond this basic proposition, the character of policies oriented more directly toward the external sector will also have an important bearing on the adjustment process.

Through the realignment of exchange rates, forces have been set in train to change the current account balances of some of the main industrial countries in such manner as to improve the structures of their balances of payments and to facilitate management of the overall positions. Hence, the short-term outlook for current account balances does not seem, in general, to call for major changes in national policies, even though the balances projected for 1972 in several important instances are clearly out of line, for cyclical or other temporary reasons, with medium-term national objectives. However, the short-range prospects do have certain policy implications, noted below, from the standpoint of the international adjustment process.

Since changes in current account balances from 1971 to 1972 are not expected to contribute materially to the alleviation of international payments disequilibrium, the immediate prospect for avoidance of further major overall imbalances depends on the evolution of capital flows, especially those to and from the United States. There is every likelihood that the United States will have a substantial payments deficit on the basic accounts in 1972; at the same time, analysis of the 1971 U. S. capital outflow, much of which was speculative, indicates the potentiality of a large reflow of short-term or unidentified funds to the United States, through a combination of interest rate and confidence factors. The conjuncture of cyclical forces indicated by the GNP projections discussed earlier is in fact conducive to an upward movement of U. S. rates relative to those in other major centers, and such a pattern has begun to develop in recent months. Depending on the evolution of these influences, a sizable U. S. payments deficit on an overall basis could be avoided in 1972.

But the fact remains that future developments with respect to short-term capital flows and to exchange market conditions cannot be predicted with any confidence. This was shown anew by the sudden outbreak of speculative pressures on sterling in June, and by the ensuing weakness of the dollar as exchange markets became disturbed once again after calm had returned to them during April and May. Therefore, it is imperative for policies of the major industrial countries to give attention to the international adjustment process and, more specifically, to support the realignment by seeking to ensure that the international payments situation develops satisfactorily over the short run. The implications with respect to national policies would appear to be as follows:

  • —Countries that have slack in resource utilization, large current account surpluses, and high reserves and that are projecting a near-term output growth below potential should earnestly consider the adoption of more expansionary policies. Within this group of countries (Japan and various continental European countries), the constraint upon adoption of such policies would stem mostly from a concern about exacerbating inflationary pressures. However, to the extent that the countries in question found it possible to follow a more expansionary course, this would be helpful—beyond its domestic effects—not only to the balance of payments situation among the industrial countries but also to the exports of the developing world. Insofar as feasible, policies of expansion in this group of countries should be so conducted as to bring down short-term interest rates.

  • —The current GNP projections of the United States for 1972 imply that expansion will be strong enough to absorb some of the present substantial slack and reduce unemployment at least moderately, but not so strong as to risk launching an excessive boom that would trigger a resurgence of inflation. Achievement of a satisfactory, non-inflationary rate of growth by the United States is, of course, in the interest of the rest of the world, and is a prime continuing U. S. responsibility with respect to the appropriate functioning of the international adjustment process. In the near future, it would be helpful to the adjustment process if U. S. monetary policy were to exert upward pressure on short-term interest rates without, however, incurring undue risks of affecting the general level of U. S. rates to such an extent as to have a retarding effect on economic growth.13 Further, if at some point in the current expansion the U.S. authorities should feel a need to apply additional restraint, international considerations indicate that this should come at least in part through monetary policy.

  • —Pursuit of such policies by the main industrial countries—reflecting a concern for the effect of their policies on others and on the international system in general—would be likely to have a decisive positive effect on market confidence. This, indeed, is a major independent reason why these policies are needed.

These actions and related responses were described in the Annual Report, 1971, pages 37-38 and 133-41.

Distributional aspects of the recent expansion of international reserves are discussed, along with compositional changes and other important characteristics, in Chapter 2.

Although formal action establishing a new par value of the U.S. dollar, based on an official price of $38 an ounce for gold, was not completed until May 8, 1972, the U.S. Administration committed itself in the Smithsonian Agreement to seek—following negotiations on certain short-term issues relating to trade arrangements—congressional approval of a 7.89 per cent devaluation of the dollar against gold.

With the floating of their currencies late in June, the United Kingdom and Ireland suspended their participation in this special EEC arrangement; at about the same time, Denmark also suspended its participation in the arrangement.

For the coverage and the classification of countries used in this Report, see the list of countries and footnotes 3-6 in Table 1.

For the United States, which accounts for one half of total GNP in the industrial countries, the output projection involves a real GNP growth of 6 per cent from 1971 to 1972 and of 7 per cent from the fourth quarter of 1971 to the fourth quarter of 1972.

Consisting of wide variety of possible measures-ranging from moral suasion and voluntary guidelines to compulsory arbitration and direct controls- to affect the movement of wages and prices in the public intrest.

Including the question of whether and for what peroid of time such policy can be applied to advantage without engendering a risk of undue rigidities that hamper long-run efficiency and growth.

Both characteristics-the smaller amplitude and the lag-stem largely from variations in the rate and timing of deliveries at particular prices, together with the importance in commodity trade of preferential arrangements and of contracts involving prices that differ from market quotations. These factors vary from one commodity to another.

For an explanation, see AnnualReport, 197Lpage 82, footnote 1.

This percentage would be the same if the calcula-tions had been carried through in terms of gold, SDRs, or any other unit of account, rather than in U. S. dollars.

These data for developing countries refer to the outstanding external public (or publicly guaranteed) debt with a maturity of more than one year.

There should be, as indicated above, a natural tend-ency for U.S. short-term rates to rise in the course of1972, under the influence of federal budget financing anda revival of private demand for goods and services.

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