Wm. C. Hood
The special drawing right was conceived in the 1960s and was formally provided for in the first amendment to the Articles of Agreement of the Fund, which took effect in 1969. The amendment authorized the Fund to allocate SDRs “to meet the need, as and when it arises, for a supplement to existing reserve assets.” Much has changed in the world of finance since that time: the gold exchange standard has been abandoned and replaced by a system of managed floating among major currencies, together with various forms of exchange rate pegging; the international capital markets have developed vigorously; the great inflation of the 1970s and early 1980s has swept the world and the convulsion induced by the dramatic increase in energy prices has been endured.
The world is now seeking a measure of stability after these turbulent events, as it wrestles with the unemployment and the debts that have been left in their wake. Many facets of our international arrangements have been undergoing reexamination. The role of the SDR is but one of them. While the SDR itself is not a prominent feature of current international monetary arrangements, participants in the conference maintained that the contemplation of its possible role leads to examination of many aspects of contemporary international economic relations and domestic policies.
The papers presented at the conference accordingly covered a wide range of topics—wider than can be reviewed in this rather brief exposition. A particular theme emerges from them, however, namely, that the future of the SDR as a world currency is neither imminent nor assured. It depends upon: (1) the achievement of more stable exchange rates than have characterized the world in recent years; (2) the development of SDR-denominated assets and liabilities in the private capital markets; and (3) the acceptance by national authorities of an enhanced central banking role for the Fund.
The papers presented at the Fund Conference have been collected in a book and have been published as International Money and Credit: The Policy Roles, edited by George M. von Furstenberg. Copies are available from the Publications Unit. See page 9 for ordering information.
Exchange rate instability
With the onset of inflation in the early 1970s and the pressures upon exchange rates induced by differences in inflation rates among countries, there emerged a general wish to direct national monetary policies toward restraining domestic price increases. The implication of this view was that less weight should be given to the purchase (or sale) of foreign currencies in order to stabilize the exchange rate, and, accordingly, exchange rates should be given greater freedom to move. This view provided the fundamental rationale behind the widespread adoption of floating rates in that period. The intimate relation between stability of a currency’s domestic value and its external value was recognized, of course. But it was felt that monetary policies could not adequately cope with domestic inflationary forces, and indeed might stimulate them, if they remained focused on the level of the exchange rate.
In the past decade of floating rates, there has continued to be a very considerable concern over what was regarded as excessive instability of exchange rate movements. The establishment of the European Monetary System was one response to this concern. (See the article by Horst Ungerer in the June issue.) The EMS was rooted in a wider range of concerns than simply the anxiety over instability of exchange rates among certain European currencies, but it did bring a degree of exchange rate stability among the currencies of participating countries. It also brought forth an important new composite currency unit, the European Currency Unit. A number of contributors to the Fund Conference noted the parallels and differences between the ECU and SDR and sought to link the implications of the experience with the ECU to the future of the SDR.
During one phase of the period of floating rates, especially when the U.S. dollar was comparatively weak, there was increased readiness on the part of official as well as private parties to diversity their holdings of reserves among major currencies. This trend was facilitated by the growing maturity of international capital markets. However, as the reserve status of such currencies as the German mark and the Japanese yen rose, fears developed that the switching of reserves from one currency to another might lead to unnecessary and unwelcome movements of exchange rates.
A substitution facility of the Fund was conceived as a response to this instability. The substitution account that was proposed by the Fund would have permitted official holders of dollars to exchange dollars for SDRs. An incidental, though not unimportant, contribution of the facility was felt to be a wider use of the SDR in the system and greater familiarity with its potential as a major international asset. The proposal that was most seriously considered would have permitted SDRs to be substituted for currencies on only one occasion and would have permitted only one currency, the dollar, to be presented for substitution. Under the proposal, there was no obligation upon official holders to use the facility, and private parties were not to be offered the opportunity to acquire SDRs through the facility.
These limitations on the operation of the substitution account seem now, with hindsight, more telling than they did in the late 1970s at the time the matter was under serious consideration. Then, the technical question of how to retain balance in an account whose assets and earnings were denominated in dollars and whose liabilities and expenses were denominated in SDRs seemed more forbidding. In any event, interest in the idea waned as the U.S. dollar strengthened and the view regained favor that more fundamental forces than diversification of the currency of reserve holdings determine the movements of exchange rates. This history was reviewed and commented upon in some of the papers before the Conference.
There have been other responses to the instability of exchange rates during the floating period, but they have not so far generated increased use of the SDR in the system. One has been the continuing practice of the authorities of intervening in exchange markets by making official purchases or sales of foreign exchange in order to bring at least temporary stability to exchange markets—”to maintain orderly conditions,” as the conventional phrase would express it. There has been remarkable interest in intervention in this period, an interest reflected in the Conference papers. While some countries have at times felt that official intervention was not normally productive or—worse—was counterproductive, the practice has nevertheless remained widespread.
The technical aspects of this matter, particularly the role of sterilized intervention versus unsterilized intervention, have been studied extensively. The former requires the authorities to reverse the effect upon their domestic monetary base of any purchase or sale of foreign exchange. Unsterilized intervention, on the other hand, allows the effects of official exchange transactions to flow through to the monetary base. Of course if a country’s purpose in adopting a floating rate is to permit monetary policy to focus primarily on domestic policy objectives, then extensive unsterilized intervention in the exchange market could frustrate this objective. The differences of official views on the merits of intervention have led to a special study of the matter by authorities of the major industrial countries that was released just after the Conference.
The continued practice of exchange market intervention has led to continued use of and need for official reserves. Attention was given to the demand for as well as to the supply of reserves in the papers before the Conference. On the demand for reserves there was considerable discussion of the difference, or more accurately the lack of difference, as revealed by econometric analysis, in the determinants of the demand for reserves in the period of widespread floating compared with the earlier period. On the supply of reserves, various papers commented upon the enhanced possibilities open to countries to augment reserves through borrowing from the greatly enlarged international capital markets. Indeed, reference was made to the latter’s apparent excesses in providing and later in threatening to restrict access to liquidity. It was also argued that the improvement in the liquidity of the international monetary system as capital markets evolved has diminished the pressure to provide liquidity in the form of SDRs.
A further response to the instability of exchange rates in this period of floating has been to try to achieve suitable coordination of policies among countries. One area in which this quest for coordination has been pursued has been the area of intervention policy just discussed. This has not been easy, since the fact that countries differed in their views as to the efficacy of intervention has led to feelings by the “interveners” that it would be helpful if the “noninterveners” would undertake matching actions and, to a lesser extent, feelings on the part of “noninterveners” that it would be better if their practice were more widely emulated. However, the quest for coordination ranges over a much wider area than exchange market intervention.
Floating and the SDR
Upon the abandonment of the Bretton Woods system of fixed exchange rates and the coming of freedom for Fund members to adopt the exchange arrangements of their choice, a lack of discipline was felt in the international monetary system. This was the discipline that came from the commitment to the fixed rate, and the consequent need to tailor policies, especially monetary policy, to defend it. An important effort has been made to replace this coordinating discipline with an undertaking to support surveillance over exchange rates conducted mainly through the Fund. Indeed, the Fund has been explicitly charged under its revised Articles to maintain such surveillance. The Conference did not dwell at length on the subject, but speakers pointed out that the emphasis on surveillance in the circumstances of the floating period has given an accent to the Fund’s activities that has not been conducive to the further evolution of the SDR as an international monetary asset, but rather the reverse.
For a good part of the period of floating rates, the world has suffered very high levels of inflation. Also in this period, the world’s balance of payments surpluses have been concentrated in the oil producing countries, and balance of payments deficits have been very widespread. Each of these features of the situation has had a negative effect upon the development of the SDR in the following ways.
At a time when, in its many surveillance activities, the Fund has been urging its members to resist inflation and establish domestic monetary stability, in the general international interest, it has seemed particularly inappropriate to undertake a new program of SDR allocations. Accordingly, when the time approached to consider an SDR allocation program for the so-called fourth Basic Period (beginning January 1, 1982 and lasting up to five years), there was no general consensus in favor of allocations and none has yet been made in this current basic period.
The prevalence of balance of payments deficits, many of them of a persistent structural character, has meant that the accent in the activities of the Fund has been upon the provision of conditional credit with very close surveillance of the economic programs of those member countries that are using the Fund’s resources. In this atmosphere, the creation of unconditional lines of credit, which would in effect be the result of SDR allocations, has seemed especially unsuitable. Equally, this atmosphere was not favorable to the idea of a formal link between the allocation of SDRs and the provision of aid to developing countries, and this subject has not been much pursued; indeed it was not an issue at the Conference.
For both of the above reasons, the period of floating, while it has generated concerns about the variability of exchange rates and led to an accent on surveillance in order to moderate the changes or levels of exchange rates thought to be excessive, has not favored expansion in the availability of SDRs in the system. However, now that more domestic stability is emerging, and the inflation rates of major industrial countries are converging at lower levels, rather more stress is being placed on examining ways of adapting the exchange rate system itself so as to induce more stability of exchange rates.
It is of course recognized that the stability of the system is threatened by factors other than disparities in inflation and interest rates among countries. An aborted recovery in the major countries resulting in increased pressure on the heavily indebted developing countries could, for example, disrupt the emerging stability. There is, however, growing interest in seeking to reinforce the emerging stability through greater commitment to exchange rate stability on the part of the major countries. It remains to be seen whether this will be best achieved by continued emphasis in monetary policy on domestic objectives or by renewed emphasis on exchange rates in determining policy. Perhaps the judgment will be that policy in reserve centers should remain focused on domestic objectives while other countries should give greater explicit weight to the exchange rate in their policy determinations.
Views in the Conference differed as to whether greater stability of exchange rates is more likely to emerge from a general calming of the system through the simultaneous achievement in many countries of greater domestic stability, or, after a period of breakdown in the present arrangements, from a general commitment to more or less fixed rates undertaken as a deliberate act of reconstruction. There was not much difference, however, on the view that the SDR would be more likely to evolve further in a system integrated through relatively fixed rates of exchange and exhibiting a high degree of stability, regardless of how such a system might be established.
Even in such a system, however, there is no guarantee that the SDR would flourish. Two reasons for this uncertainty were cited in the Conference materials, one broad and the other very specific. The broad reason was that to the extent that the SDR were to become a world money, widely held and widely used in international transactions, its appropriate management in the interest of world monetary stability would require some explicit centralization of control over monetary policy, that is, a shift of such control to the Fund from national monetary authorities. It was pointed out that general support for such a shift might not be forthcoming.
The very explicit reason the SDR might not flourish is that it would have to be felt generally by its potential holders and users that use of it was cheaper and more convenient than the use of some similar basket that might be made available by private issuers, or indeed than the use of a national currency. Doubts were expressed as to whether this condition could be met.
Preconditions for wider SDR use
There was a wide measure of agreement among the speakers who addressed the subject that, of the technical preconditions that would have to be met before the SDR could achieve the status of a principal monetary asset of the system, two were of special importance.
The first such precondition would be widespread use of SDRs, not only among official holders but also in the private economies of the world. A national currency becomes international only if it is widely used as a unit of account for the invoicing of trade and the denomination of debt and other contracts, and if there exist ample facilities for borrowing, lending, or depositing in that currency. Similarly, the SDR can only achieve status as a significant international money if it is widely used in the private sector. Of course, all those in the private sector who wish to pay for goods, deposit money, or obtain loans in SDRs need not have SDR accounts with the Fund. This is not required any more than that all users of U.S. dollars need to have accounts with a Federal Reserve Bank. But opportunities must be provided by national central banks and other financial institutions to enable financial transactions to be made in SDRs.
This line of thought leads to the second technical precondition for the graduation of the SDR to major currency status. There would have to be an “interface” between the SDRs issued by the Fund and those issued by the authorities or by private parties in individual countries. In more specific terms, there must be a network of clearing accounts. Thus, for example, national monetary authorities might provide SDR clearing accounts for banks within their jurisdictions, while the Fund would provide clearing arrangements for national monetary authorities.
The participants in the Conference felt that because it would take a considerable period of evolution for these preconditions to be met and for national authorities to be willing to cede the necessary central banking role to the Fund, a prominent role for the SDR as an international money was at best remote. There was, however, a general feeling that the creation of the SDR had been a major achievement and that it should be retained and developed. It was recognized that since its inception a number of major improvements in its characteristics and the provisions for its use had been made, which had improved its attractiveness as an official reserve asset. It was felt that further allocations should be made when times were propitious.
The Conference papers also reviewed a number of practical suggestions for steps that could be taken, as conditions warrant, to promote its more widespread acceptance and use. One would be to assist any body or organization, wishing to adopt the SDR as a unit of account, with the technical problems to which such adoption might give rise. Another would be to encourage the private issue of liabilities denominated in SDRs both by financial institutions and by others. Yet another would be for the Fund to take advantage of any available opportunity to extend the use of the SDR in its own activities and diminish its use of national currencies. The Fund should also continue to study the possibilities of financing its own lending activities through the issue of SDRs and should encourage the development of facilities in member countries that would match such an evolution in the Fund’s procedures.
Two New Packages in the IMF Occasional Paper Series
The Fund is making available two packages of papers from its Occasional Paper Series at substantial discounts from single-copy prices.
Package 2 includes the following seven recently published Occasional Papers:
No. 15. Hungary: An Economic Survey, by a Staff Team Headed by Patrick de Fontenay
No. 16. Developments in International Trade Policy, by S.J. Anjaria, Z. Iqbal, N. Kirmani, and L.L. Perez
No. 17. Aspects of the International Banking Safety Net, by G.G. Johnson, with Richard K. Abrams
No. 18. Oil Exporters’ Economic Development in an Interdependent World, by Jahangir Amuzegar
No. 19. The European Monetary System: The Experience, 1979-82, by Horst Ungerer, with Owen Evans and Peter Nyberg
No. 20. Alternatives to the Central Bank in the Developing World, by Charles Collyns
No. 21. World Economic Outlook (1983 edition), A Survey by the Staff of the International Monetary Fund
Package 1 includes the seven above-mentioned Occasional Papers plus all other Occasional Papers to be published through the end of 1983 (a minimum of five). Papers forthcoming in 1983 will include the Fund’s annual International Capital Markets survey; titles of the other forthcoming papers were not known at press time, but papers in the Series will continue to explore a variety of significant economic topics.
Package 1 (Nos. 15–26 +): US$46 (US$28 for university libraries, faculty members, and students)
Package 2 (Nos. 15–21): US$30 (US$18 for university libraries, faculty members, and students)
Advice on payment in currencies other than the U.S. dollar will be given on request.
For further information and to place orders, please write to: Publications Unit
International Monetary Fund
Washington, DC 20431 USA