Chapter Three. Current Situation and Problems

International Monetary Fund. External Relations Dept.
Published Date:
September 1950
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1. Spread of Restrictions

The history of the rise and spread of restrictions of the type now prevailing revolves around three landmarks of this century—the First World War, the World Depression and the Second World War.

The decades preceding the First World War are commonly referred to as the liberal era in international economic relations. Even during those years restrictions were present in some measure, but they differed profoundly from present practices. They did not undermine the unity of the world economy, because they did not interfere seriously with the adjustments of domestic prices and costs.

The principal purposes of the restrictions of that era were fiscal or moderately protectionist. Their most common forms were duties. Import duties and, for that matter, other taxes on international transactions, which are designed to provide fiscal revenue, are by their very purpose limited in scope. Since the tax tends to reduce the taxable base, there is a point beyond which an increase in rates reduces aggregate proceeds. This inherent limitation and the necessity for developing broader sources of revenue to meet the rapidly expanding financial requirements of governments have tended to diminish reliance on import duties and similar taxes on international transactions as the most important single source of fiscal revenue.

The extent of protection afforded domestic production varied considerably in time and from country to country. Generally speaking, however, the protection of those years affected only particular sectors of production and never attained the intensity of the interwar period.

The First World War had a far-reaching influence on the development of restrictions. During the war controls over foreign trade were considerably extended and comprehensive systems of restrictions made their first appearance. Some of these restrictions, particularly trade restrictions, were retained in some parts of the world to protect currencies and sectors of national production, and they survived in some countries, despite efforts to eliminate them, until the advent of the Great Depression made their removal impracticable. The First World War also generated forces which subsequently stimulated the more extensive use of restrictions. Like every great war, it accelerated the political, economic and social trends which had begun to show themselves in the preceding period. As the first conflict of truly global scope, it also had important effects of its own on the political and economic environment and gave rise to new political and economic outlooks. These changes tended to intensify protectionist tendencies and autarkic ambitions. The new conditions made it also increasingly difficult to submit to the consequences of deflationary correctives. On the other hand, the violent inflations, which beset some countries after the war, tended to make them very unwilling to adjust their rates of exchange downward, as currency devaluation was popularly associated with loss of purchasing power resulting from internal inflation.

When the Great Depression came, erratic capital transfers on an unprecedented scale and drastic declines in export volumes and prices made substantial balance of payments adjustments necessary. At the outset efforts had been made to undertake adjustments through deflationary processes. However, before long, it proved impracticable to carry the deflation to the extent necessary in view of the already unmanageable contraction which was the general experience at that time.

As an alternative to deflation, many countries sought relief by one or more devaluations of their currencies. These were, however, usually controlled changes of the exchange rate rather than currency adjustments of the freely fluctuating type. Many countries pegged their currencies to those of the leading international creditors, with central banks or special exchange stabilization funds intervening to stabilize the exchange rates. Such official operations in the exchange market required substantial reserves of gold and foreign exchange. The countries without sufficient reserves were, therefore, almost from the beginning of the depression compelled to rely mainly on restrictions in their international economic relations. Some inflation-sensitive countries, such as Germany, refused to devalue and resorted almost immediately to exchange restrictions.

The worldwide depression of 1929-33 was indeed the most conspicuous milestone in the development of restrictions. Many of the countries most immediately affected by capital flight, and subsequently by sharp declines in export volumes and prices, instituted exchange and trade restrictions. Restrictive practices, which had been previously applied in rudimentary form during the First World War, were rapidly developed and made more effective.

These restrictions were in the beginning applied as stop-gap measures to meet extraordinary balance of payments deficits. The contraction of economic activity all over the world created such staggering problems that neither ordinary balance of payments correctives nor the more traditional forms of restrictions promised effective relief. The newly introduced restrictions were thus originally devised to supplement or mitigate the effects of ordinary balance of payments correctives, but the unprecedented conditions then prevailing relegated the traditional remedies more and more to a secondary place. In fact, in many parts of the world restrictions became during the decade preceding the Second World War a major method of dealing with balance of payments deficits. They were widely used with the intention of avoiding or delaying the internal adjustments which could have brought the international accounts of the deficit countries into equilibrium, or with the desire of concealing from the public the magnitude of the adjustments which were required, as the leading importing nations suspended foreign purchases in the vain hope of curbing their domestic unemployment.

The result was the almost complete insulation of some national economies, particularly as countries soon discovered that exchange and trade restrictions were effective only when applied to the entire range of their international transactions. Whereas previous restrictions had been devised to provide fiscal revenue or to afford protection to limited sectors of the domestic economy, the restrictions applied in the Thirties were almost from the beginning intended to reduce the international payments of the deficit countries to levels consistent with their declining exchange receipts. Whereas earlier restrictions were generally of minor scope and took forms which were not overly destructive of the unity of world international economic relations, the characteristic of the new restrictions was that their application necessarily disrupted the traditional international mechanisms.

It was inevitable that countries applying restrictions in their international economic relations should in due course discover that these restrictions permitted them to pursue policies which would not otherwise have been feasible. Hence, when the original need for protecting balances of payments receded, they were reluctant to abandon these convenient devices, particularly in view of the worldwide political and economic disturbances which preceded the outbreak of the Second World War. Some countries maintained, for a variety of reasons, overvalued rates of exchange which necessitated the application of restrictions in their international economic relations. Others discovered that their internal expansion policies, which were designed to cure unemployment, required continued restriction of their international transactions. A few countries with undeveloped fiscal systems began to apply multiple rates of exchange for fiscal purposes. Many countries found that their restrictions gave them an international bargaining counter which was particularly effective under the conditions of increasing bilateralism of world trade and payments, which itself was a direct result of the spread of restrictions. Countries initially tended to use their international bargaining position to dispose of unsold exportable surpluses. They also sought later to attain improved terms of trade. Even creditor nations took in due time advantage of restrictive practices in their international economic relations, with a view to obtaining the release of assets blocked in debtor countries or to insuring the servicing of defaulted loans. Some countries even used restrictions to enhance their political power by imposing bilateral terms of trade and by building up autarkic regions; in some parts of the world restrictions as a result ultimately became an instrument of the aggressive policies which heralded the advent of another world conflict.

When the Second World War broke out, exchange and trade restrictions, in many cases still carried over from the depression years, were again used as an instrument of economic warfare. Most of the countries which had until then resisted the imposition of restrictions were compelled by the war to reconsider their position. After the end of hostilities, countries which did not require restrictions to cope with the balance of payments disequilibria resulting from the serious economic dislocations of the war, were rare exceptions. Restrictions have since then again served a variety of purposes.

2. Exchange Restrictions under the Bretton Woods Agreement

In tracing the spread of restrictions, it is not difficult to find valid reasons for their existence at any time of their varied history. They have always been applied with a view to satisfying the concrete needs implicit in prevailing policy objectives. However, policy objectives, in addition to being a reflection of current practical conditions, are also almost invariably a reflection of prevailing attitudes. Moreover, there is a tendency for restrictions to create conditions which require their continued use, or to persist even though the original need for them may have receded.

In subscribing to the purposes of the Fund, all member countries have agreed that restrictions on current foreign exchange transactions, which cover the broadest sector of international economic relations, even though they may be necessary under certain conditions, are undesirable in principle. The Articles of Agreement are thus a formal repudiation of restrictionism as a normal instrument of international economic policy. The adherence of members to this commitment as well as to the general philosophy embodied in the Articles of Agreement is indispensable for the eventual elimination of restrictions on their payments and transfers for current international transactions.

As part of the postwar arrangements for international economic cooperation, a number of international agreements were worked out and in most cases have already come into effect. It was anticipated that one of the common purposes of the international agencies established under such agreements and of their members would be to create such an economic environment that the collaborating countries would normally not need to pursue restrictive policies in their economic relations, once the transitional period of postwar adjustments had been terminated.

The Fund’s role in this undertaking is set forth in the Articles of Agreement, which, among the purposes of the Fund, cite in Article I(iv) that of assisting “in the establishment of a multilateral system of payments in respect of current transactions between members and in the elimination of foreign exchange restrictions which hamper the growth of world trade.”

When domestic measures cannot restore the payments position, orderly adjustments of exchange rates can be used to correct balances of payments which are in fundamental disequilibrium. But it is the task of the Fund to insure that no member manipulate its exchange rates in a manner which may unduly damage the interests of others. With stability in world economic activity, the need for alterations of exchange rates should arise infrequently and in response only to structural changes.

Departures from the principle of unrestricted current international payments under conditions of convertibility of member currencies would be exceptional and require in each case the approval of the Fund. On the other hand, every member country may protect itself against the serious disturbing effects which erratic international capital movements have had in the past on the international accounts of debtor and creditor nations alike. Article VI, Section 3 of the Articles of Agreement authorizes members to “exercise such controls as are necessary to regulate international capital movements,” provided they are not applied “in a manner which will restrict payments for current transactions or which will unduly delay transfers of funds in settlement of commitments.”

Restrictions can also be imposed under Article VII of the Articles of Agreement which provides that if one or several members are persistent creditors on international account and if it becomes evident to the Fund that the demand for the currencies of these members would seriously threaten its ability to supply them, the Fund shall formally declare such currencies to be scarce. After such a declaration is issued, members are authorized, after consultation with the Fund, to restrict current payments in the scarce currencies.

A wide gap still exists between the ultimate objectives of the Fund and the actual exchange systems of its member countries. Even though the framers of the Fund at Bretton Woods may have expected speedier progress, they never anticipated that the world as it emerged from the war would present such ideal conditions that the purposes of the Fund could be immediately accomplished.

Indeed, they clearly foresaw that because of the tremendous disruption of national economies, the distortion of foreign trade patterns and the disturbed international financial conditions, which were already in evidence at the time of the Bretton Woods Conference, the efforts required to improve national economies and international economic relations would have to be much greater than those following any previous conflict. It was, therefore, realized that the postwar economic relations would not be conducive to a rapid abandonment of restrictions. For that reason, the Articles of Agreement provided for a transitional period of postwar adjustments during which members may, without approval by the Fund, retain exchange restrictions on their current international payments, adapt them to changing circumstances, and even introduce new restrictions if their territory had been occupied by the enemy.1

The framers of the Fund considered it important, nevertheless, that during the transitional period members should not lose sight of the purposes of the Fund, and Article XIV, Section 2 of the Articles of Agreement provides therefore: “Members shall, however, have continuous regard in their foreign exchange policies to the purposes of the Fund; and, as soon as conditions permit, they shall take all possible measures to develop such commercial and financial arrangements with other members as will facilitate international payments and the maintenance of exchange stability. In particular, members shall withdraw restrictions maintained or imposed under this Section as soon as they are satisfied that they will be able, in the absence of such restrictions, to settle their balance of payments in a manner which will not unduly encumber their access to the resources of the Fund.” This provision, as well as other provisions of the Articles of Agreement, indicates clearly that the transitional period should not be protracted indefinitely, but provide the time necessary to overcome obstacles to the elimination of restrictions.

3. Postwar Developments

When the Fund began operations on March 1, 1947, only five members, El Salvador, Guatemala, Mexico, Panama and the United States, refrained from availing themselves of the transitional arrangements under Article XIV, Section 2 of the Articles of Agreement, and undertook immediately pursuant to Article VIII of the Articles of Agreement the obligation not to apply restrictions to their payments and transfers for current international transactions. No other members have to date formally joined their ranks.

However, four other members in the Western Hemisphere are extending very free treatment to their payments, even though they have not undertaken the obligations of Article VIII of the Articles of Agreement. Cuba has no quantitative restrictions on payments, and the tax of two per cent on all exchange remittances is obviously insignificant so far as its restrictive effect is concerned. Even payments for capital transactions are free. In the Dominican Republic U.S. dollars were for a long time the only legal tender. New national peso currency is now circulating, and no restrictions are applied to payments for imports, invisibles or capital transfers. A licensing system for foreign payments is formally in effect in Honduras, but licenses are freely granted. The only restriction on payments is a spread of two per cent between parity and the official selling rate for foreign exchange. Venezuela subsidizes exports of coffee and cocoa through preferential buying rates, applies lower buying rates to petroleum exports and subsidizes government imports through a preferential selling rate, but it applies neither quantitative exchange restrictions nor penalty selling rates of exchange.

The payments position of all the above countries has been strong throughout the postwar period. Belgium and Luxembourg are the only member countries which at the end of the war applied severe restrictions but have since made conspicuous advances toward convertibility of their currencies. These countries have not renounced the use of their exchange regulations, but their application has become increasingly more liberal. Restrictions on certain dollar payments continue, but Belgium and Luxembourg are relaxing these restrictions on all payments on current account, and are even extending generous treatment to capital transfers. The recent payments arrangements with Switzerland are further evidence of this trend. Since November 1949 trade between Belgium-Luxembourg and Switzerland and transfers of Swiss-owned capital in Belgium-Luxembourg have been freed from restrictions, thus placing the Belgian and Luxembourg francs on an equal footing with the U.S. dollar for Swiss residents and thereby providing a test of these currencies in a major free international exchange market. The currency of French Somaliland has been divorced from that of the rest of the French Franc Area and has been made fully convertible into U.S. dollars. This measure has been called for by the particular circumstances of that colony.

Since the establishment of the Fund, however, a few members have, because of their deteriorated exchange position, instituted or adapted restrictions over their current international payments on a significant scale. The exchange policy of Canada, which during the first postwar years was principally designed to prevent an outflow of capital, was revised in 1947. At that time, exchange for pleasure travel abroad was rationed, and certain imports were limited by quotas, individual licensing and prohibitions. Its reserve position having improved, Canada has since then again been relaxing the intensity of these restrictions. In 1947 and 1948 Uruguay, by extending the application of penalty selling rates, reoriented its multiple exchange rate system from one serving mainly the anti-inflationary purpose of discouraging an excessive inflow of foreign capital into one restricting more effectively certain foreign payments. The Union of South Africa, suffering from a heavy import surplus, which was roughly equally divided between Sterling Area and other currencies, imposed exchange restrictions on non-sterling payments in 1948. In mid-1949 the Union introduced import restrictions applicable to all imports, and revised its restrictions again effective January 1, 1950. The Philippine Republic found it necessary in December 1949 to impose restrictions both on current and capital transactions in order to arrest its heavy deficit. Ethiopia put into force toward the end of 1949 restrictions on all payments in order to cope with a balance of payments deficit and a decline in the value of its reserves resulting from the devaluation of sterling.

The development of United Kingdom policy was of particular significance in connection with changes since the war in the intensity of restrictions. By the end of the war the multilateral use of sterling had almost disappeared, wartime requirements having resulted in bilateral arrangements covering virtually all countries outside the Sterling Area and the so-called American Account Area, and sterling could not be transferred between the various areas except to a minor extent and by specific permission. United Kingdom policy from 1946 has consistently aimed at extending the transferability of sterling, at least for current transactions. Early in 1947 this process was formally begun by the introduction of the Transferable Account Area enabling sterling to be transferred automatically and freely for current transactions from any country within the area and also to any country in the American Account Area, i.e., into United States dollars. The formal restoration of the convertibility of sterling into U.S. dollars in July 1947 led to a heavy drain on the United Kingdom’s foreign exchange reserves and the facility of convertibility into United States dollars, available to Transferable Accounts by transfer to American Accounts, was suspended after a few weeks, and various changes were made in the list of countries to which the other Transferable Account arrangements continued to apply. In more recent years, the need further to economize foreign exchange resources, especially U.S. dollars and gold, has led to a tightening of the exchange and import policies of the United Kingdom, mainly by severer import licensing. On the other hand, the desire to reestablish sterling as a medium for international settlements has led to a constantly growing extension of multilateral payments in sterling allowed by administrative action of the Bank of England.

In many other countries, especially in Europe, restrictions followed not easily ascertainable trends. In some of the countries the tendency toward more or less restrictiveness has not always been consistent and has sometimes reversed itself. Generally, there was an inclination to relax restrictions on soft currencies, without a comparable relaxation of restrictions on hard currency payments. Some countries even tended toward intensification of restrictions on hard currencies. However, due to financial aid from the United States the restriction of dollar payments in Europe has not assumed as damaging proportions as would otherwise have been the case.

A number of countries in Latin America have maintained convertibility of their currencies throughout the postwar period. The trend in the other countries which have retained restrictions has varied according to the differences in the structure of their trade relations and other factors. In most such cases the trend was toward further restriction by raising effective selling rates of exchange, by shifting commodities from lower to higher selling rates or by extending quantitative restrictions, as the deterioration in the payments position and the depletion of reserves called for more cautious husbanding of foreign exchange resources. Latin American countries trading significantly with soft currency areas have also tended to favor payments in these currencies over those in U.S. dollars. On the other hand, a few countries in the Western Hemisphere have more recently commenced to abandon restrictive systems involving multiple rates and to unify their exchange rate structures. The case of Mexico is a practical example of a member which succeeded in maintaining the convertibility of its currency by a drastic exchange devaluation. Nevertheless, certain import restrictions had to be imposed in the process.

Many countries have entered into bilateral trade and payments agreements because they face particularly serious shortages of one or several foreign currencies, in most cases U.S. dollars, and because they prefer not to extend the required reduction of their payments in the scarce currencies uniformly to all their foreign payments, regardless of the availability of the foreign currencies involved. Bilateralism in international trade and payments contains significant elements of self-propagation, but it is sometimes the only alternative to restricting the foreign payments of a country to the lowest level which would be determined by the availability of the scarcest foreign currency.

Several member countries are linked with other members or non-metropolitan territories in broader currency areas. Preferential treatment is usually in varying degree extended to transactions within the same currency area. The French Franc Area links metropolitan France with its non-metropolitan territories other than French Somaliland. The Belgian Monetary Area includes Belgium and Luxembourg, in addition to the non-metropolitan territories of Belgium. The Sterling Area, which covers the United Kingdom, its non-metropolitan territories, six Dominions, and four countries which are not members of the British Commonwealth,2 is the most comprehensive currency area. Payments between the members of the Sterling Area enjoy a considerable degree of freedom, even though certain impediments have been erected between them. Import licensing is the rule, but it is more liberally applied to imports from within than from without the Sterling Area.

Plans are being discussed for a closer integration of a number of European countries into a regional scheme which would involve freer payments relations between these countries.

In general, progress toward unrestricted current transactions, which the Fund is committed to promote, is not as yet apparent, in spite of some improvements in the underlying conditions which justify hope for more visible progress in the future.

Balance of payments considerations are, of course, the most common motive for maintaining restrictions, but other factors also tend to sustain them. A not insignificant element of protectionism, and also of export subsidy, is involved in restrictions; they have been used as bargaining instruments in negotiating trade and payments agreements; and, in some instances, fiscal considerations are not negligible.

The main causes of postwar payments difficulties have been examined in some detail in the four Annual Reports of the Executive Directors of the Fund, and they are, therefore, only briefly reviewed here.

The most common disequilibrating factors since the world emerged from the Second World War have been disrupted production and distribution facilities, distortions of traditional foreign trade patterns, momentous changes in international indebtedness, the behavior of capital, and inflation. The extent to which these forces adversely affected particular countries varied considerably, but they all tended to add to the relative strength of the payments position of the United States.

The postwar disruption of production and distribution facilities, of course, affected most profoundly the countries which had suffered actual war damage. But even belligerent countries which did not suffer from war destruction had during the war shifted all available production to purposes closely related to the war. In some countries certain industries were overdeveloped to meet the extraordinary wartime demands, and the necessary postwar adjustments have involved strain on the economies of these countries. In the United States, the shift back from war to peacetime production was comparatively smooth. Because of its large domestic investments during the war, the absence of war destruction, and of a high level of investment during the postwar years, the United States was within a relatively short period of time able substantially to satisfy foreign as well as domestic demands.

After a slow start, the industrial production of other belligerent countries increased fairly rapidly and has now approached or exceeded prewar levels in most cases. In the major defeated countries, production is still lagging behind prewar, even though they have also registered conspicuous advances. The agricultural production of the former belligerents in Europe and Asia is somewhat less satisfactory and has left considerable gaps in world supply. In a number of countries, which have increased their aggregate output, expanded labor forces have been an important factor in their production gains. For these and other reasons, productivity has failed to increase sufficiently in many parts of the world to prevent a widening of the gap between their production standards and those of North America.

The dislocation of traditional foreign trade patterns was in part a result of the wartime disruption of production and distribution facilities. Another major source of distorted postwar trade patterns was the elimination of the defeated countries, particularly of Germany and Japan, as major markets and sources of supply. Their many prewar trading partners were compelled to search for alternative markets for their exports and, to an even greater extent, for new sources of supply of imports. In many cases, they shifted their imports to the United States, a development assisted by the financial aid which the United States made available to them.

Many countries of Europe, Asia and South America also sought to replace their disrupted trade with the major defeated countries through channels other than the United States. Since, however, their potential trading partners were beset with exchange problems similar to their own, an expansion of foreign trade of this kind necessitated the conclusion of a network of bilateral trade and payments agreements. In the more recent past, the situation has been improved by a revitalization of the German economy. On the other hand, the failure of East-West European trade to recover has introduced additional difficulties in the establishment of satisfactory postwar trade patterns. In the Far East, disturbances and subnormal production in China and other areas have delayed progress toward a satisfactory level and pattern of foreign trade.

Changes in international indebtedness have aggravated the payments problems of some important trading countries. During and after the war some of the victorious Western European countries were compelled to pay for part of their war imports by liquidating their foreign assets overseas. Defeated nations were deprived of some of their foreign assets at the end of the war. The United Kingdom was the largest single loser of foreign assets, and within less than forty years, it has passed from the position of leading international creditor to that of the largest international debtor. Some of these foreign debts are in the form of sterling balances which creditor countries are allowed to use up to varying limits for current imports from the sterling and dollar areas. In a few cases, particularly in South America, creditors have used their sterling balances to acquire former United Kingdom investments within their territories. Other debts of the United Kingdom are owed to the United States and Canada on account of war and postwar financial aid. Some other European countries have also been major recipients of United States and Canadian financial aid. The difficulties of these European debtors may increase when the obligation to make large remittances for the service and repayment of their debts places a further strain upon their exchange resources.

Long before the outbreak of the Second World War, capital began to seek sanctuary from political insecurity, exchange devaluation and currency inconvertibility by moving to countries which afforded better conditions. These tendencies are still evident. Many of these capital movements take place between soft currency countries, as capital strives to get into the best available place. Much foreign capital, however, seeks refuge in United States dollars and other generally desired currencies, and in gold.

Exchange restrictions, which have in many cases been devised to prevent the flight of capital, have also on occasions strengthened tendencies toward its escape. No control system is watertight, and funds are transferred abroad through illegal channels. Besides, many countries with restrictions have legalized or tolerated capital transfers through partial free markets at penalty selling rates. Legal or illegal private gold transactions at premium prices and dealings in banknotes also have permitted capital to escape the regime of exchange restrictions. The tendencies toward capital flight are almost invariably most pronounced in countries whose balance of payments position is such that they can least afford this additional drain on their exchange resources. To a large extent, of course, it is within the power of their responsible authorities to limit capital flight through appropriate budget and internal credit policies. If governments as well as central and commercial banking authorities acted with more restraint, the monetary liquidity would be lacking which is necessary for international capital transfers on a large scale.

Countries suffering from a flight of capital are essentially for the same reasons deprived of the benefit of an inflow of foreign capital. Exchange restrictions are of themselves a powerful deterrent to foreign capital investment even though favorable repatriation arrangements have been extended by some countries to importers of capital.

Because of domestic price and distribution controls, the monetary inflation generated by the war remained in many countries latent to a considerable extent until after the termination of hostilities. The postwar release of accumulated domestic purchasing power and the war-deferred demand gave rise in many parts of the world to pressure for imports on an unprecedented scale. The import demand was to a certain extent sustained by overvalued rates of exchange which made the prices of imported goods too attractive. The United States was the one major country which was in a position to supply the desired products.

A few countries are still confronted with runaway inflation, but conditions generally seem to indicate that the major forces of postwar inflation have been arrested in most countries. In many countries the remaining inflationary pressures result mainly from easy credit or the absence of firm budget policies and failure to establish appropriate methods of taxation. In some countries the economic development policies have for an extended period of time been accompanied by inflationary financing.

As productive resources were more and more fully utilized and the sellers’ market receded, the overvaluation of many currencies in relation to the U.S. dollar became more evident. Some countries adjusted their exchange rates before their membership in the Fund became effective. Others began to realign their currencies in 1947 and 1948 through floating rates of exchange 3 or, because of acute inflationary conditions, by changing their official rates of exchange from time to time.4 Two Latin American members of the Fund established new par values in December 1948 and June 1949, respectively.5 The changed conditions were most dramatically recognized in September, October and November 1949. During these months, there were alterations in the agreed par values of thirteen member currencies,6 in the official exchange rates or rates of analogous significance of six members without agreed par values,7 in most of the par values of non-metropolitan currencies, and in a number of exchange rates of non-members.8

Many inconvertible currencies have thereby been brought more in line with the U.S. dollar. There is reason to believe that the new rates of exchange will have beneficial effects on the payments position of the countries concerned. But the time that has so far elapsed is too short to permit an appraisal of the recent exchange adjustments, particularly so far as their effects on restraining payments in hard currencies are concerned.

4. Road to Relaxation of Restrictions

An appraisal of the factors underlying the current payments difficulties of nearly all member countries indicates that, though some of the postwar economic disturbances have been brought under control, others are still in evidence. More rapid and consistent improvement would be possible if the internal policies of members were more decisively oriented to the Fund’s objective of freeing current international payments from exchange restrictions, and if concerted international action were taken to alleviate difficulties which are beyond the exclusive control of the countries particularly affected by them. It is the intention of the Fund to extend increasingly its active cooperation and assistance to members in coping with obstacles of either type to currency convertibility.

Many members have entered into formal or informal consultations with the Fund concerning problems which are essentially within their own control. The Fund has on such occasions not limited its advice to the technical aspects of the measures under consideration, but has also weighed the merits of the contemplated policies from the point of view of their ultimate effects on the economies and balances of payments of members. The Fund desires to cooperate with its members even more closely in the future in devising policies which would help to improve their internal financial position and eliminate impediments to the establishment of more liberal international payments regimes.

Primary responsibility for the implementation of these policies rests, of course, with the member countries concerned. They alone can insure that restrictions are not applied for purposes other than the correction of balance of payments deficits. They alone can shape domestic credit and fiscal policies so as to curb inflation effectively and insure that maximum production and sales efforts are made to promote exports. And the initiative in adjusting the rate of exchange to the most appropriate level also rests with the countries immediately concerned.

Some exchange restrictions are not primarily motivated by balance of payments considerations. The protection of special sectors of domestic production undoubtedly plays a significant part in their application in some cases. It is, indeed, difficult at times to isolate protectionist from balance of payments considerations, because under prevailing conditions protectionism is frequently also a factor in balance of payments policy. This is particularly true when domestic production is protected from the competition of imports from hard currency areas. But many countries are protecting domestic production also from the competition of soft currency areas. There is a stronger presumption in such cases that protectionist motives are factors contributing to the maintenance of restrictions. In general, countries employing exchange restrictions for protectionist purposes must face the fact that more competition on a non-discriminatory basis in international economic relations is an important prerequisite for the resumption of multilateral trade and payments and for the international division of labor which multilateral trade serves.

In some countries exchange taxes and similar exchange devices incidentally serve fiscal purposes. The problem of replacing them with other taxes is in many cases difficult. If such restrictions were suddenly removed without corresponding reductions in government expenditures, additional inflationary pressures would be generated, with adverse effects on the exchange position of the countries concerned. The inter-relationship between fiscal interests and balance of payments problems points to the necessity of shaping fiscal policies so as not to interfere with the relaxation of exchange restrictions. Countries in which this issue is important should, therefore, make determined efforts to develop new sources of fiscal revenue. In a few exceptional cases the fiscal argument is advanced to justify the retention of exchange restrictions by countries in a relatively favorable payments position. The use of exchange restrictions for fiscal purposes is frequently the outgrowth of an extended historical process, but the Articles of Agreement do not sanction the application of restrictions under such conditions.

Every member has an obligation to observe restraints in its credit and fiscal policies, if its par value is to retain its economic justification. Under prevailing conditions, the Fund continues, therefore, to urge its member countries to practice restraints in their domestic policies in order to avoid inflation with its adverse effects on their payments position. The views of the Fund in this respect are not to be interpreted as an invitation to members to embark on damaging deflationary policies leading to a severe decline in employment. The importance of high levels of employment is stressed in the Articles of Agreement and has been borne in mind by the Fund in advising members on financial policies. However, this desirable objective has on occasion been advanced as a justification for inflationary policies which were, in effect, pursued for other motives. In seeking to attain and maintain satisfactory levels of employment, members should not lose sight of the necessity of safeguarding monetary stability and of arriving at acceptable international balance. The objectives of the Fund require, among other things, that the financial and economic policies of member countries should not disturb their payments position in a manner which will necessitate persistent recourse to restrictions. Monetary stability promotes a balanced growth of international trade which, in its turn, tends to contribute significantly to high levels of employment.

Some countries have not altogether succeeded in resisting the pressure for easy credit policies. Credit inflation invariably tends to sustain import demand at excessive levels, particularly when importers are permitted to finance foreign purchases by means of liberal bank credit. Such credit tends to be increased as the domestic prices of imports rise in response to inflationary forces and to the “scarcity” conditions resulting from restrictions, which are the almost inevitable consequence of an inflated import demand.

In some countries policies of economic development have been accompanied by inflation. The Fund is in full sympathy with the efforts of its member countries to speed the development of their latent resources. However, if monetary stability is to be safeguarded, the means employed to this end are necessarily of great importance, and there are inherent limitations to inflation-financed economic development. If, because foreign capital is not available in sufficient volume, the money incomes required for developmental investments have to be generated internally, the results are likely to be far less effective under conditions of full employment, when the requisite shift of factors into new enterprises will, at least in the short run, adversely affect production for export, than when there has been some unemployment and this undesirable consequence can be more easily avoided. Inflation can be avoided to the extent to which domestic savings, including those of governments and of public institutions, can be stimulated and directed into proper channels. An additional factor which may make inflationary financing ineffective is the likelihood that part of the entrepreneurial profits may be spent on consumption goods, many of them necessarily of foreign origin, instead of being continuously reinvested in the domestic economy. Even the unspent portion of profits may, exchange restrictions to the contrary notwithstanding, be transferred abroad rather than reinvested at home if, as is likely under easy credit policies, there is already sufficient liquidity in the domestic economy.

Experience has clearly shown that inflation undermines the exports of a country, not only by raising internal costs, but also by tending to shift products from export to domestic consumption. At the same time as inflationary impediments to exports are being removed, every country should also insure that the greatest possible effort is made to produce the goods which it can efficiently export and sell in the appropriate markets abroad.

If exports fail to move to foreign markets in adequate volume, the resulting disequilibrium in the balance of payments cannot be corrected by imposing or tightening exchange restrictions. The only alternatives are a reduction of domestic costs by a monetary contraction, or a reduction of the selling prices abroad by an exchange devaluation. A country might wish to avoid deflation and also to delay a change in its exchange rate by imposing or tightening exchange restrictions instead. These restrictions will, however, be effective in the long run only if accompanied by adjustments similar to those which would have been needed if exchange restrictions had not been tightened.

At the same time, some factors which have a bearing on the payments position of countries are of external origin, and no member can by itself control them. The success of export drives of deficit countries depends generally on the level of world economic activity, and more particularly, on the level of incomes in the surplus countries. The greater the confidence in the stability of demand in the surplus countries, the more readily the exporters of other countries will embark on the rather costly enterprise of launching their products in hard currency markets. The policies of surplus countries with respect to import duties, customs procedures and other impediments to imports are, of course, also of considerable consequence to countries desiring to enter hard currency markets. Surplus countries should modify their policies appropriately on their own initiative. However, the Fund, which recognizes the significance of the conditions and policies of the surplus countries, is prepared to enter into consultations with them whenever the situation requires it.

An improvement in the capital accounts of many countries, while not a prerequisite for the removal of restrictions from current international transactions, would strengthen their balances of payments and facilitate the removal of restrictions. For example, the accumulation of heavy foreign indebtedness by some countries raises problems which cannot be solved by the policies of the debtor countries alone. Similarly, the position of countries suffering from a shortage of capital could be considerably improved by an adequate inflow of long-term investment funds. In some cases the absence of such a capital inflow is the result of the atmosphere of general insecurity, but some countries could probably attract private foreign capital in larger volume if they insured more favorable treatment to foreign investments. For example, the relaxation of restrictions on the remittance of contractual invisible payments for amortization and earnings of foreign investments would be an important step toward inspiring confidence in the credit-worthiness of borrowing countries. The tax policies in borrowing and lending countries are also of consequence in this respect. The difficulties of attracting foreign capital are, of course, increased under conditions of general world insecurity on the one hand and of persistent monetary instability in borrowing countries on the other. As a rule, therefore, an adequate flow of private foreign long-term capital seems to depend on improved world security and confidence, on relatively liberal exchange regimes and on stable domestic financial policies in the borrowing countries. It is, of course, recognized that public funds of the capital surplus countries are, for one reason or another, likely to remain important as a source of foreign capital.

Some countries feel that they can more safely remove restrictions on an extensive scale as part of a program of concerted international action, because the maintenance of their restrictive practices is to a considerable extent a reflection of the policies of their trading partners. Countries with hard currency deficits and soft currency surpluses should not depend on surplus currencies becoming convertible as the solution of their payments problems, and they should, therefore, not slacken their efforts to increase their direct earnings of hard currencies. On the other hand, some countries are prevented from removing restrictions when the natural markets abroad for their exports are surrounded with restrictions or when restrictions abroad make it impossible for them to convert the exchange proceeds of their exports into the currencies required to pay for their imports.

Since member countries cannot in all cases be expected to act individually in relaxing their restrictions, international action is required to this end. The Fund provides machinery for consultation and collaboration, and it is the appropriate coordinating agency for the removal of the exchange restrictions applied by member countries.

Fully recognizing that the elimination of exchange restrictions is fraught with difficulties, particularly under prevailing economic conditions, the Fund does not anticipate that such action will normally be taken in one stroke. It is in any event unavoidable that, in relaxing restrictions, members be prepared to incur some risks in establishing patterns of international payments which alone can ultimately insure to them manageable balance of payments conditions at high levels of employment without recourse to restrictions. But the risks can be minimized without imperiling these ultimate objectives if exchange restrictions are gradually relaxed. Members proceeding in this manner can progressively test their balance of payments position and can time appropriately the next successive stages in the process of removing restrictions.

Restrictions can be gradually relaxed in three ways. They can be removed progressively by specified categories of international transactions; by specified foreign currencies; or by specified means of international payment.

Restrictions should normally be gradually relaxed by categories of international transactions, such as all imports or invisibles, or specified imports or invisibles. The relaxation of quantitative exchange restrictions in this manner will ordinarily involve a progressive reduction in the rate of rejection of applications for foreign exchange, until restrictions are eventually transformed into mere instruments for the administrative supervision of international transactions on current account. Where quantitative restrictions include outright prohibitions of specified transactions, the process of relaxation might involve the intermediate step of permitting, subject to license, transactions previously prohibited. The progressive elimination of cost restrictions is really a process of unifying the exchange rate structure. Gradual removal of composite restrictions involves both a step-by-step unification of the exchange rate structure and a progressive transformation of the restrictive elements of discretionary action into mere instruments of administrative supervision.

Efforts have also been made to relax restrictions by specified currencies, favoring payments in soft over those in hard currencies. Relaxation can take place under bilateral trade and payments agreements which exempt from restrictions certain international transactions of special interest to the parties to such agreements. Under many of these arrangements the differentiation by currencies is easily ascertainable, while in other instances the relaxation of restrictions is formally related to specified transactions, which tends to conceal the currency consideration. The formation of currency areas and regional payment arrangements is a broader method of relaxing restrictions by currencies. Under such arrangements, transactions within the currency area are normally less restricted than international transactions outside it. The Fund is giving close and continuous study to the implications of these methods of relaxing restrictions, especially with respect to their effect on the progress of members toward removal of restrictions on a global basis.

Some countries have in recent months removed restrictions from certain specified means of foreign payment, such as foreign or domestic banknotes. This may be a desirable form of relaxing restrictions but only in advanced stages on the road to convertibility; otherwise, it tends to create greater multiplicity instead of greater uniformity of effective rates of exchange. The elimination of restrictions on the repatriation of domestic banknotes, moreover, tends to increase the risk of capital flight.

The removal of exchange restrictions on an extensive scale has encountered serious obstacles in the postwar years. However, members should find the task less difficult in the future if the present trends of improvement in world economic conditions continue. It is the expectation of the Fund that members will take advantage of any such improvement to move in the direction to which they are committed under the Articles of Agreement. In the period ahead, the Fund should, therefore, take an increasingly active role in the relaxation of exchange restrictions.

To summarize, the Fund’s approach to the over-all problem of removing exchange restrictions must be influenced by two general considerations. The first is that, in many cases, relaxation has to be a progressive action over a period of time. The relaxation of restrictions necessarily involves uncertainties, but by a gradual program members can with the proper guidance realize the ultimate objectives without incurring any unnecessary risks. The Fund remains in close contact with the problems of member countries applying restrictions. It will assist them in working out policies designed to improve their financial position and advise them concerning appropriate procedures for relaxing restrictions. At the same time, the Fund will consult with countries in strong balance of payments positions concerning the policies which would most facilitate the removal of restrictions by deficit members.

The second significant consideration is that to a considerable degree the actions of members are interdependent. The ability of one member to eliminate exchange restrictions is often a function of the policies and actions of other members. This emphasizes the need for a concerted and coordinated program so that the policies and practices of every member will to the maximum extent assist, rather than frustrate, the efforts of those who are seeking to achieve freedom from restrictions.

In Article I of the Articles of Agreement, member countries have signified their intention to work together toward the multilateralization of international payments and the elimination of exchange restrictions which hamper world trade. They have established and recognized the Fund as the instrument for coordination and cooperation in the monetary field. The Fund feels that its individual consultations with member countries during the past three years have been fruitful in many respects and that their extension is desirable. The Fund expects also to contribute to the progress toward the relaxation of restrictions by initiating, encouraging and coordinating appropriate concerted action among its members.

The obligations of members with respect to the introduction and modification of multiple currency practices was laid down in the letter of December 19, 1947, which is reproduced in the Appendix.

Australia, Ceylon, India, New Zealand, Pakistan and the Union of South Africa; Burma, Iceland, Iraq and Ireland.

France, Italy, Lebanon, Peru and Syria.

China and Greece.

Colombia devalued by 10%; Mexico by about 44%.

Australia, Denmark, Egypt, Iceland, India, Iraq, Netherlands, Norway, the Union of South Africa and the United Kingdom devalued by about 30.5%; Belgium and Luxembourg by over 12%; and Canada by more than 9%.

Austria, Finland, France, Greece, Italy and Thailand.

The devaluations of Argentina, Burma, Ceylon, Hashemite Jordan, Ireland, Israel, New Zealand, Portugal, Sweden and Western Germany were the most significant adjustments of non-member currencies.

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