J. Keith Horsefield
THE MEN WHO WROTE the Articles of Agreement of the International Monetary Fund in 1944 saw clearly that it should be a revolving fund; that is, whatever it paid out to its member countries should sooner or later be returned to it. Indeed, they were more specific than this. They devised arrangements that were designed to ensure that in normal conditions the Fund should hold an amount of each member’s currency that was equal to three fourths of its quota. A drawing, of course, increases the Fund’s holdings of the currency of the member making the drawing, and reduces the holdings of the currency drawn. After a drawing by Country A of Country B’s currency, therefore, the Fund would (other things being equal) have more of Country A’s currency than 75 per cent of Country A’s quota, and less of Country B’s currency than 75 per cent of Country B’s quota. So the founders imposed an obligation on Country A to repurchase its currency from the Fund down to the point at which the Fund’s holdings of that currency were again equal to 75 per cent of Country A’s quota. The currencies which Country A would use to make this repurchase might be expected to include that of Country B, since Country A obviously uses this currency; therefore the Fund’s holdings of Country B’s currency would be built up again toward 75 per cent of Country B’s quota.
Working Out the Details
That was the main idea, but of course it involved a whole string of secondary questions. As regards drawings, for example, it was necessary to prescribe which currencies Country A might draw from the Fund, and how much at a time. As regards repurchases the same questions arose, plus the further question, when should the repurchase become obligatory? Answering these questions, and especially those related to repurchases, produced some of the most complicated provisions in the whole of the Articles of Agreement. The questions with regard to drawings are answered in Article V, Sections 3 and 4; those with regard to repurchases in Article V, Section 7, and Schedule B. Even so, for reasons which we shall see in a moment, it was found necessary as the Fund grew up to superimpose a whole series of regulations to govern transactions.
Looking first at Article V, Sections 3 and 4, we find that to a large extent they are devoted rather to limiting the amount that a country may draw than to prescribing the currency that it may draw; behind these quantitative limitations lay a long series of discussions which are not relevant to our subject. The question which currencies a country might draw was disposed of in one magisterial clause. This sets out the first condition that a country must fulfill if it is to be allowed to draw from the Fund, and it reads as follows: “The member desiring to purchase the currency represents that it is presently needed for making in that currency payments which are consistent with the provisions of this Agreement.” Almost every word of this clause has had to be interpreted during the Fund’s lifetime, but all we need note at this point is that Country A, if it is to be allowed to draw Country B’s currency from the Fund, must represent that it needs this currency for making payments. This situation is, of course, most likely to arise if Country A has been trading with Country B and has run up a deficit in its balance of payments with Country B. It will then need some other currency than its own to settle its account with Country B, and what more natural than that it should pay over Country B’s own currency?
This was, indeed, the situation which the drafters at Bretton Woods had in mind. In 1944 world trade had very largely drifted into bilateral arrangements (see “What Does It Really Mean? Bilateralism in Payments and Trade” in Finance and Development, September 1968): Country A bought from Country B on the understanding that Country B would buy from Country A, and the idea was that if either A or B failed to sell as much to the other as it was buying from the other, it would come to the Fund and borrow enough of the other’s currency to settle the difference. In that way the drafters thought that all the Fund’s holdings of currencies could find employment, no matter how little they were normally used in international trade. Actually, the drafters were well aware that a very large proportion of the world’s trade was paid for either in dollars or in sterling. If Argentina bought from Brazil more than it sold to Brazil, it would make good the difference not in Argentine or Brazilian currency but in U.S. dollars. If Australia had a balance of payments deficit with India, it would make this good not in Indian rupees but in sterling. Realizing this, however, the drafters wanted to avoid drawings from the Fund being concentrated on dollars and sterling. But at the same time the drafters had a separate objective in view; they wanted to ensure that the Fund did not become a repository for currencies that were not exchangeable for gold. They therefore ruled that when the time came for Country A, which had drawn Country B’s currency from the Fund, to repurchase its own currency, it could offer to the Fund only such currencies as were exchangeable for gold. They called these “convertible currencies” and defined them as the currencies of countries that had accepted certain obligations, one of which was to exchange its currency for gold, on certain conditions. Before considering what difficulties this introduced we should look briefly at the repurchase obligations themselves.
Basically these required Country A to repurchase annually from the Fund an amount of its currency equal to one half of any increase during the year in the Fund’s holdings of its currency, plus one half of any increase, or minus one half of any decrease, in its own monetary reserves. The main idea was that a drawing from the Fund ought not to be used merely to build up a member’s own monetary reserves; if it was going to remain unused, it would be better for it to be unused in the hands of the Fund than in those of a member. If, therefore, Country A purchased dollars from the Fund with 100 units of its own currency, put these dollars in its reserves, and then finished the year with reserves increased by half this amount, the repurchase obligation required it to buy back 75 units of its currency—50 units as being half the increase in the Fund’s holdings of its currency, and 25 units as being half the equivalent of the increase in its monetary reserves.
But with what were the 75 units to be repurchased? The next rule was that (a) the part of the repurchase that was equivalent to one half of the increase in the Fund’s holdings of Country A’s currency should be repurchased in proportion to the amount of each currency, and gold, held by Country A in its reserves; and (b) that the part of the repurchase which was equivalent to one half of the increase in Country A’s reserves should be repurchased in each currency, and gold, in proportion to the increase in each of them during the year. Thus, if Country A’s reserves at the end of the year consisted of $200 worth of gold, $250 in dollars, and $50 worth of sterling (total $500), and if during the year these had increased by $20 worth of gold and by $30 in dollars, the repurchase obligation would work out like this: of the 50 units of A’s currency corresponding to one half of the increase in the Fund’s holdings, 20 would be repurchased with gold, 25 with dollars, and 5 with sterling. Of the 25 units corresponding to one half the increase in Country A’s reserves, 10 would be repurchased with gold and 15 with dollars.
These requirements were, however, subject to a number of limitations. In the first place, unless sterling was “convertible” (in the Fund sense), it could not be accepted by the Fund in a repurchase, so that 5 units of Country A’s currency would not have to be repurchased. To that extent, Country A’s obligation vanished (until next year, at any rate). Second, if the Fund’s holdings of U.S. dollars exceeded 75 per cent of the U.S. quota, dollars could not be accepted in repurchase either, so that another 40 units of Country A’s currency would remain unrepurchased. In that event, the only repurchase that Country A would have to make would be the 30 units repurchasable with gold. Third, if the Fund’s holdings of Country A’s currency were not above 75 per cent of its quota, it had no repurchase obligations at all. On the other hand, the Fund’s holdings of Country B’s currency might be above 75 per cent of Country B’s quota, e.g., because it had paid less than 25 per cent of gold in its subscription. To the extent that this was so, Country B would also have a repurchase obligation equal to one half the increase in the gold and acceptable currencies in its reserves.
Ensuring That the Fund Would Revolve
These references to 75 per cent will recall the statement made at the beginning of this article, that the main idea of the drafters at Bretton Woods was to ensure that in ideal conditions the Fund held 75 per cent of each member’s quota, no more and no less. But it will be seen that this idea got in the way of the other main thesis, that the Fund should be a revolving one. And this drawback was enhanced by yet another limitation, that if a member’s monetary reserves were less than its quota, it would have no repurchase obligation in any event. “Monetary reserves” were defined, for the purposes of the Articles, as a country’s holdings of gold and convertible currencies minus its official liabilities to other countries. If, therefore, the Treasury or central bank of a country owed to other Treasuries or central banks sums that were large in relation to its own holdings of gold and convertible currencies, it might draw and draw, and yet never incur a repurchase obligation. That was the situation of the United Kingdom in the Fund’s early years. And if a country held no gold or convertible currencies in its reserves it would not incur any repurchase obligation either. That was the situation in most countries of the sterling area at that time. The result was that a substantial part of the drawings made on the Fund during its early years did not involve the drawers in any repurchase obligations. True, they did involve the payment of “charges” (interest on outstanding drawings) which increased by ½ per cent every six months. But this was a frail reed to ensure the revolving character of the Fund compared with the original intentions of the founding fathers. (The main thing that went wrong, compared with these intentions, was that member countries failed to accept the obligations which would make their currencies convertible; the only countries with large quotas to do so before 1961 were the United States and—since 1952—Canada.)
What to do about this clash between the intentions of the Articles and the practical results of their provisions exercised the Fund for several years, being eventually resolved, in 1952, by a decision that made drawings conditional on an undertaking to repay them within three to five years. But that did not settle the question as to what currency should be used to make the repurchase.
Currencies to Be Used for Repurchases
For some years, however, this was not a real problem, because only one of the world’s major currencies, the U.S. dollar, was convertible (in the Fund sense) and therefore acceptable in repurchases. The very fact that it was convertible made it more desirable than other currencies (even apart from the fact that in the immediate postwar years U.S. goods were almost the only ones available in quantity, so that dollars were the curcency most needed for imports). As a result, Fund members were most reluctant to draw any currency except dollars, since they would have to repurchase with dollars. And as it was perfectly possible for them to “represent” that they needed dollars to make payments in dollars, something like 90 per cent of all drawings down to 1958 were made in dollars.
But then things changed, as the main European currencies gradually became more useful to buy commodities with, and therefore more desirable. And in February 1961 the situation was transformed by the acceptance of the obligations of convertibility by nearly every country in Western Europe. Thereafter their currencies, as well as U.S. dollars, could be used in repurchases. Consequently their currencies, as well as U.S. dollars, became acceptable in drawings.
The acceptance by these countries of convertibility also did away with almost the last remnants of the bilateralism which the founding fathers had regarded as the natural way to trade. Once a country’s currency is exchangeable for gold, and therefore, through gold, for any other currency, it becomes natural to regard balance of payments deficits as incurred against the world at large, and not against one particular country. Thus there was no longer any need to pick one particular currency with which to settle one’s deficits.
By 1961, therefore, there was a wide range of currencies in which a drawing would be perfectly acceptable to the drawer, and a wide range of currencies in which repurchases would be perfectly acceptable to the Fund. A small proportion of repurchases still became obligatory under the old rules, and for these the currencies in which the repurchase had to be made, and the amounts of each, were settled by the rules. But there were very many drawings that had to be repurchased under the five-years-maximum rule long before the repurchase obligations in the Articles would have made this necessary. Mainly this was the effect of the 75 per cent limits; the Fund’s holdings of sterling have been over 75 per cent of the British quota since 1964 and so sterling has never in that time been acceptable in repurchases, although it forms a large part of the reserves of a number of countries.
Consulting the Managing Director
In these circumstances something had to be done to decide which currencies countries should draw, and in which they should repurchase. Otherwise there would be no way of influencing drawings and repurchases toward the ideal situation in which the Fund’s holdings of each member’s currency equaled 75 per cent of the member’s quota. This problem, together with two others prompted by the coming of convertibility to European currencies, was posed by the Managing Director in February 1961. It took a long time to solve, but in July 1962 the Board of the Fund took a comprehensive decision.1 This recounted that since February 1961 member countries had been consulting the Managing Director about which currencies it would be best for them to draw, and went on to prescribe that such consultations should in future take place both for drawings and for repurchases. It then set out the principles which the Managing Director would adopt in making recommendations as to the currencies to be used.
As regards drawings, three factors were to be taken into account: the balance of payments of the countries whose currencies would be considered for drawing, their reserves, and the Fund’s holdings of their currencies. Accordingly, drawings would be directed toward the currencies of countries whose balance of payments was good, and whose reserves were in good shape, provided that the Fund’s holdings of the currency of that country were not being depleted too much. As regards repurchases, what would be watched would be the Fund’s holdings of each currency compared with that country’s quota, although some consideration would also be given to the country’s balance of payments. Put briefly, the idea would be for drawings to be concentrated so far as practical on the currencies of countries whose balance of payments was strong, and repurchases to be made so far as practicable in the currencies of countries whose balance of payments was weak. But overriding these considerations was the fact that the Fund could not accept in repurchases any currency of which its holdings were at or above 75 per cent of that country’s quota, nor the currency of any country that had not accepted the obligations of convertibility.
Budget for Drawings and Repurchases
From these general principles a regular procedure has been evolved, based on a quarterly forecast of the drawings that may be made in the ensuing quarter, and of the repurchases that may be expected during the quarter. A list is drawn up of countries whose balances of payments and reserves would permit them to provide assistance to other members. Partly to limit to manageable proportions the number of currencies handled, this list was originally a rather short one, confined mostly to countries with substantial reserves and sizable Fund quotas. Other countries have been added from time to time as their circumstances permit, until now more than 20 currencies are regularly considered. Among the different currencies thus available, drawings are allocated as explained below. If, however, the Fund’s holdings of a particular currency in the list should fall very low, its use in drawings will be limited unless the Fund can borrow more of that currency under the General Arrangements to Borrow or otherwise.
The budget thus worked out is discussed in advance by the Managing Director with the Executive Directors appointed or elected by the countries whose names are on the list and, subject to any modification introduced as a result of this consultation, the list is used as a guide when advising members what currencies to draw. However, ordinarily there is a last-minute consultation with the countries whose currencies are proposed to be used for any given drawing. Very large drawings, which cannot be accommodated under the budget, are the subject of separate arrangements and consultations when the requests for them are received. Very small drawings are usually met in the currency which the drawing country habitually uses for international trade purposes (usually the dollar, sterling, or the French franc). Intermediate-sized drawings are directed to the different currencies in such a way that by the end of the quarter these have been used in proportions corresponding to those in the budget. (This means that the currencies drawn in any particular drawing have no great significance.)
The budget for repurchases allocates those that are expected to fall due during the quarter among the currencies which the Fund can accept (i.e., convertible currencies of which its holdings do not exceed 75 per cent of the members’ quotas) roughly in proportion to each member’s “reserve position in the Fund.” By this is meant (a) the excess of a member’s quota over the Fund’s holdings of its currency, plus (b) any loans which it has made to the Fund (for example, under the General Arrangements to Borrow).
Drawings, of course, increase the reserve position in the Fund of the country whose currency is drawn, and repurchases made in that currency reduce its reserve position. If the currency drawn is later exchanged by the country that issued it for another currency or for gold, this will reduce the gold and foreign exchange reserves held by the country whose currency was drawn.
The general effect of drawings and repurchases, therefore, is to bring about shifts in the composition of members’ reserves between their reserve positions in the Fund and their official holdings of gold and foreign exchange. The procedure for selecting currencies for Fund transactions aims at equalizing the ratios between reserve positions in the Fund and the other components of reserves for every member whose currency is used for such transactions.
Special considerations led to the use of a different technique for effecting most repurchases during 1964-66. Fund holdings of U.S. dollars had risen to 75 per cent of the U.S. quota about the end of 1963, so that no more U.S. dollars could be accepted in repurchases. Many countries, however, were accustomed to using that currency in making their repurchases from the Fund, since it was the main currency in which they held their foreign exchange reserves. To allow the repurchase procedure to continue to function smoothly, the Executive Board accepted a U.S. offer of a “conversion facility.” Under this technique, the United States drew from the Fund currencies that the Fund was able to accept in repurchase. The United States then sold the currencies it had drawn to countries wishing to make repurchases; these sales were made at par against U.S. dollars. Since the currencies drawn in this way by the United States were promptly paid back into the Fund by the country making the repurchase, the position of the country whose currency was drawn was unaffected by the procedure, and it did not therefore matter which currency the United States drew. In fact, it drew a number of different currencies at various times. This technique was last used late in 1966, and currencies for subsequent repurchases have been chosen in accordance with the budget method described above.
The normal position for the Fund, as stated at the beginning of this article, would be one in which the Fund’s holdings of each currency were equivalent to 75 per cent of that country’s quota. But when some countries have drawings outstanding—and the total in recent years has amounted to the equivalent of several billion U.S. dollars—it follows that the Fund’s holdings of the currencies of other countries must fall below 75 per cent of quotas. In these circumstances the Fund’s aim is to equalize the ratio of reserve positions in the Fund to other forms of reserves. And that is the object of the procedure adopted for choosing currencies for drawings and repurchases.
Decision No. 1371-(62/36), reproduced in Selected Decisions of the Executive Directors and Selected Documents, Third Issue, pp. 33-39.