IN ASSESSING THE STRENGTH of a country’s balance of payments and reserve position, it is generally not sufficient merely to take into account gains and losses of reserves over a past period. Prospective developments of the country’s balance of payments must be evaluated as well, which means that some projection, however informal its methodology may be, of the country’s balance of payments must be attempted. In making such assessment it has been found convenient to pay particular attention to those balance of payments components that tend to change only gradually in response to the relatively slow adjustment in the economic and financial structure of the country and of its trading partners to domestic developments or to policy measures designed to reduce balance of payments deficits or surpluses. Other components that are apt to change rapidly in response to more transitory stimuli, such as the effect of various instruments of monetary policy on short-term capital flows, changes in expectations wtih regard to spot and forward exchange rates or to the par value of the currency, and temporary financing or other disturbances, are considered less significant for longer term prospects.
A proper evaluation of a country’s balance of payments prospects would, of course, entail an analysis of many individual balance of payments components and the factors tending to influence them. However, for many objectives, it has been considered sufficient to base a quick assessment for the purposes of medium-term analysis or projections on fairly aggregative data that should show developments in a country’s basic competitive strength. This method has led to the development of the concept of the “basic balance,” a term that essentially applies to the sum of a country’s current account balance, its net unrequited transfers, and its net official and private long-term capital accounts.1 The concept of the basic balance was also resorted to as the balance of payments aggregate most appropriate for long-term analysis of developments in a country’s international reserves, or as a basis for careful long-term projections, component by component, of an individual country’s balance of payments position.2
The view that the basic balance can be taken as a broad indicator of a country’s balance of payments strength rests on the assumption that omitted items—i.e., essentially short-term capital movements and errors and omissions—will, in the longer run, tend to reverse their course relatively frequently, in such a way as to leave over the years only a small positive or negative net balance. To the extent that this assumption is warranted, reserve movements over somewhat longer term periods would tend to be determined by developments in the basic balance. Cumulation from year to year showing a net surplus or net deficit on the basic balance over a given period should roughly match the change in the country’s international reserves over the same period.
If, on the other hand, the omitted items, and in particular short-term capital movements, do not reverse themselves but exhibit trends of their own, the basic balance would be less adequate as an indicator of a country’s balance of payments strength than might have been supposed. Such trends in recorded short-term capital movements and errors and omissions could arise for a variety of reasons. Economies of scale in a few major international capital markets may generate persistent short-term capital flows in the same direction; intervention by monetary authorities to limit interest arbitrage through rationing of capital inflows may have similar results. Also, the basic differences in liquidity preference among various countries may cause a tendency for short-term capital to move predominantly in one direction, offsetting movements in the opposite direction in long-term capital flows.3 Some short-term capital outflows from reserve currency countries may be in response to a steady increase in private demand for working balances in such currencies, and may to that extent be a more or less permanent—i.e., nonreversible—feature of the reserve currency country’s balance of payments. Finally, the residual items entered as errors and omissions may reflect either a trend in recorded short-term capital flows, or movements in items belonging to the basic balance, or both.
The purpose of this article is to explore the longer run tendencies of the relation between the basic balance and reserve movements for selected industrial countries and to ascertain whether longer run trends have been exhibited by short-term capital flows, errors and omissions, or any of the balance of payments financing items that account for discrepancies between the cumulative basic balance and a country’s reserve level over a period of years. On the basis of this examination, the adequacy of the concept of basic balance for the purpose of assessing a country’s balance of payments strength may be judged.
I. Methods and Concepts
Inspection of annual balance of payments data, even if carried over a number of years, does not easily reveal the relation between the basic balance, short-term capital movements, and developments in a country’s international reserves. For instance, since short-term capital movements would rarely alternate in a regular pattern of inflows and outflows of roughly equal magnitude, it would be difficult to judge the question of whether or not these movements tended to fluctuate in such a way as to average approximately zero in the long run. Since the focus of this investigation is on the explanation of trends in international reserves, that is, in a cumulation of annual reserve movements, the balance of payments data used in this connection are conveniently shown as cumulative series, too.
Charts 1 and 2 show a comparison of each country’s reserve figures and alternative measures of the cumulative basic balance. If the cumulative basic surplus or deficit from the base year to a given year equals the rise or decline of reserves between these years, short-term capital movements and errors and omissions either were quantitatively unimportant or, if they were large in some years, they must have reversed their direction in such a way that outflows in some years were offset by inflows in other years. On the other hand, if there is a positive or negative gap between reserves and the cumulative basic balance, short-term movements and errors and omissions would have moved predominantly in one direction or another, and therefore would have affected reserves in the longer run.
Chart 1.Eight Industrial Countries: Reserves, Cumulative Basic Balances, and the Gap1 Chart 2.Reserve Currency Countries: Reserves, Cumulative Basic Balances, and the Gap
Sources: See the Appendix.
BB = cumulative basic balance; EO = cumulative errors and omissions; R = change in reserve level during the period; LCB = change in liquid liabilities to central banks and governments during the period (in the ten countries as a group, only the LCB of the United States and the United Kingdom are included); IMF = the International Monetary Fund’s holding, at the end of the year, of currencies by member countries in excess of their respective quotas; SC = cumulative short-term capital movements; Gap Adj.* (the United Kingdom’s adjusted gap) = gap between reserves and the cumulative basic balance, net of the change in liquid liabilities to central banks and governments during the period 1952–67;
The industrial countries examined are Belgium-Luxembourg, Canada, France, Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States. In each country, the base year for the cumulation of the basic balance has been chosen as early as data permitted after the end of World War II. For most of these countries it was possible to present the data for the whole postwar period, but for some countries consistent data could be carried back only to the beginning of the 1950’s. In order to facilitate the comparison between countries, alternative base years for cumulation were selected. In Table 1, the series for all countries begin in 1950. The only exception is the United Kingdom, in which the earliest available data start with 1952.
|1.||Changes in reserve level||–1,192||–3,328||–6,674||(–4,832)|
|2.||Cumulative basic balances||–12,360||–7,899||–11,627||(–4,326)|
|4.||IMF holding of currency in excess of quota||—||—||—||—|
|5.||Liabilities to central banks and governments||5,780||980||8,449||(5,863)|
|6.||Adjusted gap (3)–(4)—(5)||5,388||3,591||–3,496||(–6,369)|
|7.||Cumulative errors and omissions||3,940||934||–4,897||(–3,840)|
|8.||Recorded short-term capital (6)–(7)||1,448||2,657||1,401||(–2,529)|
|1.||Changes in reserve level||333||1,285||1,156||5,258|
|2.||Cumulative basic balances||641||844||909||4,882|
|4.||Cumulative errors and omissions||–400||49||216||8824|
|5.||Recorded short-term capital (3)–(4)||92||392||31||–5064|
For all the countries studied, the gap between the cumulative basic balance and reserves consists of recorded short-term capital movements and errors and omissions. Before 1959, short-term capital movements of most countries consisted of various official nonreserve flows (such as bilateral or regional payments agreements) in addition to private transactions. Since 1959, data on short-term capital movements include, with the exception of reserve currency countries,4 only net private transactions. The composition of the residual item of errors and omissions is still subject to considerable debate.5 It is generally believed that in some countries, such as the United States, Canada, and Germany, errors and omissions consist mainly of unrecorded short-term capital movements, though unrecorded elements belonging to the basic balances are also included; these unrecorded elements may be a more significant part of errors and omissions in other countries. In view of this ambiguity regarding the character of errors and omissions, Charts 1 and 2 show errors and omissions as a part of the cumulative basic balance and of cumulative short-term capital flows.6
In the principal reserve currency countries (the United States and the United Kingdom), cumulative short-term capital flows include liabilities to foreign monetary authorities. These liabilities are short-term capital of a special kind in that they are counted by creditor countries as reserves and are therefore shown separately from other recorded short-term capital flows. This separate treatment of the U.S. and U.K. liabilities to foreign monetary authorities is necessary when the combined short-term capital flows of the ten industrial countries are discussed.
The change in the reserve level, the cumulative basic balance, and the components of the gap for the two country groups—the European Economic Community (EEC) and the ten countries—are shown in Chart 3 and Table 2. This aggregative analysis is useful in that it affords some indication of trends in short-term capital flows between the members of the EEC or the ten major industrial countries, on the one hand, and the rest of the world, on the other.
Chart 3.EEC and Ten Countries as a Group, 1952–671
|Ten Industrial Countries|
|1. Reserve level (1951=0)||1,107||1,699||3,133||3,900||5,330||6,287|
|2. Cumulative basic balance||–406||–2,031||–1,756||–2,444||–3,434||–4,292|
|3. Gap (l)—(2)||1,513||3,730||4,889||6,344||8,764||10,579|
|4. IMF holdings of currency in excess of quota||49||17||—||—||329||527|
|5. U.S. and U.K. liabilities to central banks and governments||238||1,655||2,825||3,520||4,238||3,791|
|6. Adjusted gap (3)—(4)(5)||1,226||2,058||2,064||2,824||4,197||6,261|
|7. Cumulative errors and omissions||916||1,232||1,442||2,109||3,012||4,858|
|8. Recorded short-term capital (6)—(7) (other than in line 5 above)||310||826||622||715||1,185||1,403|
|1. Reserve level (1951=0)||910||2,237||3,637||5,146||5,566||5,844|
|2. Cumulative basic balance||471||1,643||3,083||4,772||4,861||4,902|
|3. Gap (l)—(2)||439||594||554||374||705||942|
|4. IMF holdings of currency in excess of quota||17||17||—||—||—||131|
|5. Cumulative errors and omissions||80||–64||–210||–383||–274||110|
|6. Recorded short-term capital (3)—(4)—(5)||342||641||764||757||979||701|
|–4,860 12,804||–6,601 13,598||–6,776 16,653||–5,873 17,129||–6,421 17,500||–7,459 19,526||–7,674 20,936||–8,303 22,639||–8,990 22,803||–11,088 25,930|
The cumulative basic balance and its four main components (i.e., the net current account, unrequited transfers, net private long-term capital, and net official long-term capital) are shown for the same ten countries and country groups in the Appendix, Charts 4 through 6. The cumulative method of presentation is used in the Appendix charts partly for the reason of comparability with charts in the text above, and partly because such presentation facilitates diagrammatical comparisons of the relative roles the basic balance components are playing in the long-term development of each country’s balance of payments position.7
Chart 4.Five Countries: Cumulative Basic Balance and Its Components1 Chart 5.EEC Countries: Cumulative Basic Balance and Its Components1 Chart 6.EEC and Ten Countries as a Group: Cumulative Basic Balance and Its Components, 1952–67
Sources: See pages 609–10, Statistical Sources and Notes.
II. Basic Balances and the Role of Short-Term Capital Flows in Individual Countries
The data on ten countries’ cumulative basic balances and reserve changes, shown in Charts 1 and 2 and Table 1, can be divided into two periods: the period before the achievement of external convertibility of major currencies and the liquidation of the European Payments Union (EPU) in 1959, and the period after 1959 which was characterized, at least initially, by greater freedom of international capital movements among industrial countries. Furthermore, a distinction should also be made between the role of the two balance of payments components in nonreserve currency countries and that in reserve currency countries.
In most of the eight nonreserve currency countries for which data could be compiled from the early postwar years, reserve movements follow fairly closely the cumulative basic balance from the late 1940’s to about 1958–59. For several members of the EPU some discrepancy occurred between these two series, but a major part of this discrepancy resulted from a different method of recording countries’ debits and credits vis-à-vis the Union. Thus, discrepancies between reserve movements and a cumulative basic balance, in the early and middle 1950’s in France, and between 1952 and 1957 in Italy, reflected balance of payments deficits of these two countries financed by debits to the EPU that were counted as official short-term liabilities.8 The relationship between reserve levels and cumulative basic balances was not affected in most countries by errors and omissions, since, again with the exception of reserve currency countries, this residual item was small.
The influence of private short-term capital flows on the long-term reserve position of the eight countries was minor before 1959. This was due largely to exchange controls on capital and current transactions that existed during that period. Even in Canada, which did not have exchange controls, private short-term capital flows did not follow a trend of their own but averaged out between 1946 and 1958 (see Chart 1). This may have resulted partly from the working of the flexible exchange rate system existing at the time in Canada. Since that country’s economic development is dependent substantially on private long-term capital inflow, short-term capital movements probably played an essential equilibrating role in financing surpluses and deficits in the current and long-term capital accounts.9
As can be seen from Table 1 and Charts 1, 2, and 3, during the precon-vertibility period an increase in international reserves for countries other than reserve currency countries could have been generated almost exclusively through surpluses in the basic balance. Thus, during that period, projections of cumulative basic balance could adequately express the expected development in these countries’ reserve positions.
For the two reserve currency countries the movements shown in Chart 2 were different. In both countries the cumulative basic balance was negative during the 1950’s (between 1952 and 1959 for the United Kingdom), while the trend of reserve levels was mildly declining in the United States and somewhat increasing in the United Kingdom. This gap between cumulative basic balances and reserves consisted in the United States of short-term capital inflows and increasing positive cumulative errors and omissions; in the United Kingdom it consisted of positive cumulative errors and omissions, balanced by a net outflow of short-term capital (basically in the form of decreasing sterling liabilities to foreign monetary authorities).
During the convertibility period, since 1959, reserve movements substantially exceeded the cumulative basic balance in most countries. The gap between these two cumulative flows consisted of items that hitherto had been thought of as too volatile to contribute to a longer term increase in reserves. Four of the ten countries covered in this paper experienced a persistent and substantial inflow or outflow of recorded short-term capital, while six countries had a sizable sustained increase or decrease in the cumulative errors and omissions items.10 A break in the trend for these items, which occurred in most countries after external convertibility of the major currencies became effective, is one of the significant developments in the structure of the industrial countries’ balance of payments. An increase in private short-term capital flows is a normal consequence of the newly acquired freedom in industrial countries to obtain foreign finance for various domestic and international transactions. A long-term trend in these flows meant that, depending on their direction, short-term capital movements could serve as an additional source of increase in, or of a drain on, industrial countries’ international reserves.
Opportunities opened by currency convertibility led to a development of closely linked foreign exchange and internationally oriented short-term capital markets, such as Euro-dollar and other Euro-currency markets. The resulting increase in the flexibility of short-term capital flows provided commercial banks and other financial institutions in industrial countries with alternative sources of funds and wider opportunities for placement of their own and borrowed resources. It is well known that, while these developments have reduced substantially the scope for independent monetary policies of individual industrial countries, they have also enabled the monetary authorities of these countries to use this increased flexibility of short-term capital movements either for the improvement of the country’s balance of payments position or for opening, under appropriate conditions, new possibilities to influence domestic liquidity. Finally, the new conditions for short-term capital movements during the period of currency convertibility have caused significant structural changes in enterprises involved in international finance. Considerable expansion of these enterprises’ activity in a number of countries opened a possibility for a sustained outflow or inflow of short-term capital.
This large variety of developments since 1959 in the structure and operations of institutions participating in international short-term capital movements, and differing responses of monetary authorities to these developments, have of course contributed to a fairly dissimilar pattern of short-term capital flow in individual countries. Therefore, it is useful to examine briefly some of the key factors that have caused sizable cumulative movements of short-term capital in a number of countries.
Among the nonreserve currency countries, Canada, Japan, and the Netherlands have experienced, since 1959, substantial inflows of short-term capital (see Chart 1 and Tables 3, 4, and 5) that resulted in an increase in their international reserves despite a decline, during the same period, in their cumulative basic balances. As can be seen from these tables, the substantial increase in commercial banks’ international operations was a major factor in the increased level of short-term capital flows, but the resulting net flows were different in different countries. In Canada, the banks’ operation consisted mainly of arbitrage in Euro-dollars and other funds between the United States and European markets, so that the size and direction of net flows fluctuated considerably. It is the expansion of the activity by Canadian finance companies and of their borrowing abroad that contributed mainly to a sustained inflow of short-term capital into Canada.11 In the Netherlands, international operations of commercial banks and the resulting short-term capital flows were influenced largely by anti-inflationary measures of the monetary authorities in 1961 and between 1963 and 1967. A domestic liquidity squeeze during these periods at first stimulated repatriation of banks’ assets from abroad and later, with the emergence of the Euro-dollar market, led to borrowing abroad for domestic liquidity needs. Both these policies have resulted, particularly since 1963, in a sustained inflow of short-term capital.12 In Japan, capital flows were influenced by substantial differences in domestic and foreign interest rate levels, on the one hand, and by the policy of monetary authorities to prevent excessive borrowing abroad by banks, on the other.13 However, since the authorities also relied on short-term capital flows as a stabilizing force in cyclical fluctuations of the balance of payments, periodic loosening of controls on borrowing abroad in the time of substantial basic balance deficits permitted a gradual build-up of Japanese banks’ and other institutions’ short-term liabilities abroad.14
|Change in Canadian dollar holdings of foreigners||108||17||127||–26||–9||16||11||42||0||21|
|Other capital movements|
|Bank balances and other short-term funds abroad (increase—)||–60||–124||–62||138||87||–239||–488||128||–556||–299|
|Canadian finance company obligations and commercial paper||25||71||61||94||111||97||219||52||138||–3|
|All other net liabilities (including errors and omissions)||23||346||147||79||89||154||228||169||194||–592|
|Total (net liabilities)||96||310||273||285||278||28||–30||391||–224||–873|
|Total (increase in net assets) Of which||–36||73||–40||8||237||82||74||197|
|Long-term bank loans, etc.||….||….||….||….||–17||–28||—||–64|
|Cumulative total (long-term bank loans excluded)||—36||37||—3||5||259||369||443||704|
|Import usance bills||288||530||–106||848||669||85||–284||975|
|Other (including bilateral payments agreements)||4||122||126||–207||17||10||39||–22|
|Total (net liabilities)||382||695||248||310||321||–340||–437||972|
In Italy, substantial swings in short-term capital flows that have occurred during the 1960’s have been influenced considerably by the policy of the central bank, which largely controlled the size of the commercial banks’ net foreign positions. Large capital inflows since 1962 have reflected the heavy borrowing abroad that was stimulated by monetary ease and liquidity needs in the expansionary economy, and they cushioned for a time the deterioration of Italy’s position on the basic balance. As a part of its anti-inflationary policy the central bank prevented further borrowing abroad by banks, and upon a substantial recovery of Italy’s current account, since 1964 (see Chart 5) has stimulated, through free cover on forward exchange, short-term capital outflows.15 Thus, the experience in Italy (and to some extent in the Netherlands) was consistent with the traditional role of short-term capital in the domestic and international adjustment processes, in that it would serve as a source of additional domestic liquidity in periods of expansion and, in its compensatory role, as a cushion for fluctuations in the basic balance.
Among reserve currency countries, the short-term capital flows of the United States have been of major importance since 1959, not only because they contributed greatly to the development of the Euro-dollar market but also because the forces influencing them affected the size and the direction of flows of other countries. International movements of major components of U.S. private short-term capital and their cumulative effects are shown in Table 6.16 Between 1960 and 1964 the balance on private short-term capital account swung into a substantial deficit that, on the cumulative basis, exceeded $2.5 billion. This change in the direction of net flows basically reflected a substantial increase in the volume of the U.S. short-term assets abroad in which commercial banks had a major share. The major effect of the voluntary restraint program since the beginning of 1965 has also been felt by the banks. Their foreign short-term assets decreased in the next two years, while their borrowing abroad has increased considerably since 1966.
|Private short-term assets abroad (increase—) Of which||–1,798||–388||–1,349||–1,556||–546||–785||–2,147||753||–418||–1,214|
|Other U.S. residents||—378||20||—354||—431||—222||—4||—623||—428||—334||—470|
|Short-term liabilities to foreigners other than official agencies Of which||3,244||3,046||217||1,260||102||615||1,664||273||2,677||1,864|
|To foreign commercial banks||…||1,206||140||586||—138||470||1,454||116||2,697||1,262|
|To foreign residents and unallocated1||…||…||—258||267||28||380||453||448||505||820|
|To international and regional organizations||…||…||335||407||212||—235||—243||—291||—525||—218|
|Total net private short-term assets (increase—)||1,446||2,658||–1,132||–296||–444||–170||–483||1,026||2,259||650|
With the appearance of a deficit on the short-term capital account in 1960, the errors and omissions item simultaneously changed sign and became consistently negative. These unrecorded “outflows” continued even after the voluntary restraint program became effective. Both cumulative deficits were financed (in the accounting sense) by the increase in liabilities to foreign central banks and governments, so that the gap between reserves and the cumulative basic balance fluctuated around the same level until 1965, but since then has risen significantly.
As can be seen, U.S. private short-term capital movements in the postwar period did not reflect cyclical or random fluctuations around the trend of the cumulative basic balance, or of the sum of the latter and the liquid liabilities to foreign official agencies. The turning points in the trend of short-term flows, in 1959 and 1965, were caused by exogenous institutional changes. Thus the substantial outflow of short-term capital after 1959 followed the convertibility in major industrial countries that revealed the effective yield differential on short-term assets in favor of some European countries and Japan and was facilitated by the development of the Euro-dollar market. The return flow of short-term capital since 1965 has been induced by the U.S. capital restraint program and only since 1967–68 has it possibly started to reflect international differentials in yields.
Restraints on both long-term and short-term capital flows that were introduced first by the United States and somewhat later by the United Kingdom were followed on the European continent by defensive measures aimed at undesirable capital outflows.17 Such competitive measures have had a considerable influence on the conditions for international short-term capital movements among industrial countries. Beginning with 1965, a more difficult access to some major money markets and other restrictive measures have generated in a number of countries a reversal of the direction of flows (see Charts 1, 2, 4, 5, and 6 and Tables 3, 4, and 6). This reversal was particularly noticeable in countries that have been closely associated with the U.S. money market. In Canada, which enjoyed a privileged position under the U.S. program to restrain capital outflows, the reversal has occurred only since 1966, and it narrowed considerably the gap between reserves and the cumulative basic balance. In Japan, the reversal of both short-term and long-term capital flows,18 which occurred in 1965, was also the result of the rigorous monetary and fiscal measures undertaken in 1964 for balance of payments purposes. The resulting rapid improvement on the current account permitted fairly smooth external adjustment without a substantial loss of international reserves. However, in 1967 sizable deficits on private and official capital accounts and on unrequited transfers were financed by an increase in nonmonetary and commercial bank net liabilities. Thus, at the end of 1967 the stock of net short-term liabilities to private foreigners again exceeded the size of Japan’s international reserves.
Finally, the cumulative errors and omissions are in some countries a key factor in the gap between reserves and the cumulative basic balance (see Charts 1 through 3 and Table 1). In Germany the cumulative errors and omissions have increased almost tenfold since 1959 and are the major components of the gap. They are generally ascribed to unrecorded short-term capital movements.19 In Sweden they reached $1.3 billion by 1967 and, recorded short-term capital playing only a minor role, actually exceeded the size of the gap. In the United Kingdom they are also sizable and are following a rising trend. Their meaning is debatable in both countries, and they probably only partly reflect unrecorded short-term capital flows.20 Among the countries with errors and omissions that have been consistently negative over a period of time, several studies of the United States found significant correlation of this item with short-term capital movements.21 In Italy, the main proportion of errors and omissions consists of unrecorded exports of banknotes, so that they may have been a substantial unrecorded outflow of short-term capital since 1960.22
Thus, it can be seen from this review that, as a result of differences in structural changes and in economic policies among industrial countries, their balance of payments developments during the convertibility period were not the same. However, these developments had as a common feature a much more significant role of short-term capital flows in contributing to the countries’ reserve positions. In a majority of these countries, short-term capital flows and errors and omissions have shown a positive or negative trend of their own, and this trend was not substantially changed in a number of them by recent restrictive policies concerning international capital movements. The effect of these trends and the differences in balance of payments developments are also demonstrated when the countries are shown as groups.
III. EEC and Ten Countries as a Group
Aggregate totals of reserves and cumulative basic balances for the EEC countries and the ten countries as a group are shown in Chart 3. The components of the gap between these totals are given in Table 2, while the components of the basic balances for the two country groups are shown in the Appendix, Chart 6. The series include the years 1952 to 1967, for which data for all ten countries are available.
In the EEC countries as a group the movements in reserves and in the cumulative basic balance were clearly very close during the whole period. A steep increase in both totals (which amounted during the 16-year period to $22.3 billion for the reserves and to $24.5 billion for the cumulative basic balance) resulted in a substantial redistribution of world reserves in favor of that region. Aggregate short-term capital flows appeared fairly small, so that reserves generally fluctuated around the trend of the cumulative basic balance. When measured, however, from the end of 1959, in order to eliminate substantial asymmetric adjustments resulting from the liquidation of the EPU,23 a gap representing an increase in net liquid liabilities appeared and reached $2.4 billion in 1964. Since 1965, however, there has been an outflow of short-term capital that resulted partly from restraints on capital flows in some industrial countries and partly from substantial outflows from Italy.
In the ten industrial countries as a group the series showing aggregates of cumulative basic balances and reserves diverge considerably during the period. While between 1952 and 1967 the group’s cumulative basic balance declined by $11.1 billion, aggregate reserves rose by $14.8 billion, so that the gap approached $26 billion. When liquid liabilities of the United States and the United Kingdom to foreign central banks and governments (which are counted as reserves elsewhere) and IMF credit tranche drawings by some of the ten countries are excluded, the gap is reduced by $14.3 billion, that is, by almost as much as the increase in total reserves of the ten industrial countries during the period. Recorded net short-term liabilities of the ten countries to the rest of the world were the main component of the remaining gap. These liabilities rose slowly to $2.3 billion at the end of 1959 and then their growth accelerated so that they reached $6.5 billion at the end of 1963. In the following years they fluctuated around the level of $6.3 billion but increased considerably in 1967.
This fairly sustained inflow of short-term capital into ten countries as a group is an interesting phenomenon, related mainly to developments of international activities in industrial countries’ money markets since the middle 1950’s and, more specifically, of Euro-currency markets in the 1960’s. A part of this inflow may have come from other advanced countries, such as Switzerland, and some of it consisted in placements of accumulated foreign exchange earnings by countries that export raw materials, such as petroleum producers in the Middle East and other regions. Thus, these long-term trends in movements of liquid funds of the ten industrial countries could be considered in relation to various components of the other countries’ basic balances or in relation to these other countries’ international reserves. In reference to a net private long-term capital outflow of over $18 billion from the ten industrial countries24 (of which $12 billion occurred in the 1960’s), these trends could reflect the operations in different maturities on international money and capital markets that accommodated substantial differences in liquidity preferences among regions. To some extent, these trends could also reflect placement on major capital markets of an excess of international reserve earnings by several Middle Eastern countries.
If cumulative errors and omissions are included as part of the movement in the 1952–67 short-term capital stock figures, the gap is not materially changed for the EEC countries, but it is considerably changed for the ten industrial countries as a group. The main short-term capital inflow into the latter would then have occurred by the end of 1960 and would have fluctuated around that level during the rest of the period. However, these results should be interpreted with considerable caution. It can be seen from Chart 3 that relatively small net movements of errors and omissions in the EEC countries are a result of substantial, but opposite, flows in Italy, on the one hand, and in Germany and the three other members, on the other hand. Furthermore, the U.S. errors and omissions dominate the movements in this item for the ten countries as a group. Thus, if in some countries errors and omissions include unrecorded flows belonging to components of the basic balance, netting out opposite trends in order to obtain an aggregate flow for a group of countries may introduce a substantial bias.
Greater freedom of capital movement since 1959 seems to have re-established the traditional role of short-term capital flows in offsetting fluctuations of the basic balance. Except in periods of destabilizing speculative activity in connection with serious payments crises, private short-term capital flows have tended, in a number of countries, to offset the effect on reserves of fluctuations, including cyclical swings, in the basic balance. This can be observed in Canada, Japan, Germany, Italy, the Netherlands, and the United Kingdom by comparing movements of the cumulative basic balance and the reserve level around their respective trends. As shown in Charts 1 and 2, the former fluctuations are larger in amplitude than the latter.
This compensatory role was made possible by an increase during the convertibility period in the responsiveness of international short-term capital movements to monetary stimuli and by a greater willingness on the part of the authorities to use monetary instruments for balance of payments purposes. The principal aim of some of these measures, such as forward exchange intervention and direct regulation of, or moral suasion with respect to, foreign asset holdings of commercial banks, was to bring about a temporary change in the payments position by directly influencing short-term capital movements. Other measures, such as discount rate changes and credit controls, were generally part of a range of policy measures aimed at controlling fluctuations in both economic activity and the balance of payments. Finally, in Canada between 1950 and 1962, compensatory short-term capital flows were an inherent part of the working of the adjustment process under the flexible exchange rate system. The fact that in all these instances stabilizing short-term capital movements responded more rapidly to policy measures or market stimuli than did real adjustments in the economic structure had a smoothening effect on the fluctuations of the over-all balance of payments.
However, as has been shown above, in the post-1959 period short-term capital flows contributed also toward a longer term change in the reserve position of many industrial countries. In some countries, a protracted inflow of private short-term capital contributed to an increase in reserves considerably in excess of the level of the cumulative basic balance. In the United States, a protracted outflow of private capital was much more than offset by an increase in liabilities to foreign monetary authorities. These patterns were influenced, inter alia, by differences in interest yields, developments in domestic financial markets, and the availability of funds in the various money and capital markets. Furthermore, in some instances anticyclical balance of payments measures by the monetary authorities (which often, as in Japan, caused alternating relaxation and strengthening of controls on capital movements) conflicted with a desire to restrain excessive inflows of short-term capital stimulated by interest rate differentials or other causes. In other instances, restrictive domestic credit policy, aimed at pursuing economic stability at home, provided an incentive for banks to obtain needed liquidity through borrowing abroad, or through the liquidation of foreign assets, and in this way generated a protracted inflow of short-term capital.
Nevertheless, some countries, such as Germany and France, were able through the use of direct measures and monetary instruments to restrain short-term capital flows that were deemed undesirable. This policy may help to explain the relatively small role played by recorded short-term capital movements in the EEC countries as a group.
For those countries in which the gap between the cumulative basic balance and the reserve level increased as a result of this long-term trend in flows of short-term capital, the basic balance may not be an adequate indicator of prospective developments in the reserve position. In countries that during that period experienced a sustained short-term capital inflow, the authorities may have oriented their balance of payments policies not only to the basic balance but may have taken into account these short-term capital flows as well.
Statistical Sources and Notes
All ten countries: International Monetary Fund, International Financial Statistics; reserves for Japan, 1947–51: International Monetary Fund, Balance of Payments Yearbooks.
Balance of payments data
1. Belgium-Luxembourg, Canada, France (franc area), Italy, Japan, the Netherlands, and Sweden: International Monetary Fund, Balance of Payments Yearbooks.
2. Germany: 1948–49, International Monetary Fund, Balance of Payments Yearbooks; 1950–67, Deutsche Bundesbank, Monthly Report, June 1968.
3. United Kingdom: Central Statistical Office, United Kingdom Balance of Payments, 1964 and 1968; liabilities to central banks and governments: International Monetary Fund, International Financial Statistics.
4. United States: U.S. Department of Commerce, Survey of Current Business, June 1968.
Adjustments and Notes
Balance of payments data for 1966 and 1967 include metropolitan France only. Transactions with the overseas franc area, amounting to a credit of US$253 million for 1966 and US$32 million for 1967, are included in errors and omissions (see International Monetary Fund, Balance of Payments Yearbook, Volume 19).
Adjustments are made in errors and omissions, and in private long-term capital movements, for export of Italian banknotes to Switzerland and Liechtenstein. It is assumed that the proportion of bona fide private long-term capital inflows from Switzerland and Liechtenstein have not exceeded, since 1960, the actual share of these two countries in the total net inflow in 1959. Amounts exceeding this share (i.e., $40 million in 1960, $212 million in 1961, $545 million in 1962, and $637 million in 1963) are assumed to consist of Italian funds accumulated in Switzerland and Liechtenstein through the export of banknotes and reinvested in Italy.
Reserves in 1966 and 1967 are adjusted by subtracting from the total the amount transferred from the dollar securities portfolio, i.e., $885 million in 1966 and $490 million in 1967. Since only the change in the level of reserves since the end of 1951 is taken into account, these amounts are considered as being part of U.K. reserves before that date.
Sources for liabilities to official holders: 1945–47, estimated from publications by the U.S. Department of Commerce; 1948–60, International Monetary Fund, International Financial Statistics; 1960–67, U.S. Department of Commerce, Survey of Current Business.
Liquidation of the European Payments Union
In order to take account of credits to and liabilities of the Union that were transformed upon its liquidation in 1959 into bilateral long-term debts, government long-term capital accounts of EPU members were adjusted by (1) increasing official long-term liabilities of debtor countries for the amount owed to the Union and (2) increasing official long-term assets of creditor countries for the amount owed to them by the Union.
Balances de base, flux de capitaux à court terme et réserves internationales des pays industriels
Le concept de la “balance de base” (à savoir la somme du compte courant net, des transferts sans contrepartie nets et des comptes des capitaux à long terme officiels et privés nets) a souvent été utilisé comme indicateur général de la situation de la balance des paiements d’un pays et a servi de base à des analyses et à des projections à moyen et à long terme des positions de réserve. Ceci suppose que l’évolution des postes omis (à savoir les mouvements de capitaux à court terme et les erreurs et omissions) accuse généralement des renversements assez fréquents et que les postes en question ne manifestent donc pas de tendances propres.
L’utilité du concept de la balance de base est vérifiée par une étude pour dix pays industriels importants des tendances à plus long terme du rapport entre les variations des réserves et la balance de base exprimées cumulativement. On a constaté que la libéralisation depuis 1958–59 des transactions en compte courant et de certaines transactions en compte capital a contribué à modifier le rôle des capitaux à court terme dans la balance des paiements. D’une part, la plus grande liberté des mouvements internationaux de capitaux a entraîné des réactions plus marquées des flux de capitaux à court terme aux stimulants monétaires et une disposition plus générale des autorités à utiliser les instruments monétaires à des fins de balance des paiements. D’autre part, la tendance des flux cumulatifs de capitaux à court terme et des erreurs et omissions qui est apparue clairement après 1959 dans un certain nombre de pays indiquait que ces postes (jusqu’alors considérés comme trop instables) ont contribué à la position de réserve à long terme de ces pays. Ce rôle inédit des mouvements de capitaux à court terme est l’un des éléments nouveaux significatifs de la structure des balances des paiements des pays industriels pendant la période de convertibilité. Une conséquence en est que la balance de base peut ne pas constituer un indicateur approprié de l’évolution future des positions de réserve des pays industriels.
Balanza básica, corrientes de capital a corto plazo y reservas internacionales de los países industriales
El concepto de “balanza básica” (es decir, la suma de la cuenta corriente neta, las transferencias netas sin contrapartida y las cuentas de capital netas a largo plazo, tanto oficiales como privadas) se ha usado con frecuencia como indicador general de la situación de la balanza de pagos nacional y ha servido de fundamento a los análisis y proyecciones a mediano y a largo plazo de la posición de reserva de cada país. Conforme a este punto de vista, las partidas que se omiten (es decir, los movimientos de capital a corto plazo y los errores u omisiones) tienden a cambiar de curso con relativa frecuencia y, por lo tanto, no muestran tendencias propias.
La utilidad del concepto de balanza básica se puso a prueba analizando lo sucedido en diez países industriales importantes en lo que respecta a las tendencias a más largo plazo de la relación entre los movimientos de las reservas y la balanza básica expresada en una forma acumulativa. De ese examen se desprende que desde 1958–59 la liberali-zación de la cuenta corriente y de algunas transacciones de la cuenta de capital ha contribuido a modificar la función que ejerce el capital a corto plazo en la balanza de pagos. Por una parte, la mayor libertad de los movimientos internacionales de capital hizo que aumentara el grado en que las corrientes de capital a corto plazo reaccionan ante los estímulos de orden monetario y que las autoridades estuvieran más dispuestas a usar instrumentos monetarios para fines de balanza de pagos. Por otra parte, a partir de 1959, en varios países se observó claramente cierta tendencia en las corrientes acumulativas de capital a corto plazo y en los errores u omisiones, lo que indica que estas partidas (que hasta entonces se habían considerado demasiado volátiles) han contribuido a la posición de reserva a largo plazo mantenida por dichos países. Esta nueva función de los movimientos de capital a corto plazo es una de las circunstancias significativas que han tenido lugar en la estructura de la balanza de pagos de los países industriales durante el período en que sus monedas han gozado de convertibilidad. Una de las conclusiones que puede derivarse de ello es que la balanza básica quizá no constituya un indicador adecuado de las futuras tendencias que presente la posición de reserva de los países industriales.
In statistical matter (except in the résumés and resúmenes) throughout this issue,
Dots (…) indicate that data are not available;
A dash (—) indicates that the figure is zero or less than half the final digit shown, or that the item does not exist;
A single dot (.) indicates decimals;
A comma (,) separates thousands and millions;
“Billion” means a thousand million;
A short dash (-) is used between years or months (e.g., 1955–58 or January-October) to indicate a total of the years or months inclusive of the beginning and ending years or months;
A stroke (/) is used between years (e.g., 1962/63) to indicate a fiscal year or a crop year;
Components of tables may not add to totals shown because of rounding.
To be published in January 1970
THE INTERNATIONAL MONETARY FUND, 1945–1965
Twenty Years of Internationa] Monetary Cooperation
Vol. I. Chronicle, pp. xviii + 663
Vol. II. Analysis, pp. xviii + 621
Vol. III. Documents, pp. vii + 549
This history of the International Monetary Fund provides the first comprehensive account of the Fund’s origins, formation, and evolution over its first 20 years.
Volume I starts with a description of the several different plans formulated in 1941–44 for an international monetary institution, leading up to a review of the proceedings at Bretton Woods. It then describes, year by year, the principal events in the Fund’s history. Extensive summaries of the discussions in the Boards of Governors and Executive Directors elucidate the arguments for and against the decisions which the Boards took.
Volume II briefly outlines the process of policymaking in the Fund, and its functions and objectives, and then treats systematically the formation of the Fund’s policies in three important fields—exchange rates (including gold); exchange restrictions; and the use of the Fund’s resources (including stand-by arrangements and stabilization programs). It concludes with a detailed study of the constitutional development of the Fund from 1945 to 1969.
Volume III reproduces most of the documents referred to in Volumes I and II, including early versions of the plans devised by Lord Keynes and Mr. Harry Dexter White which have not previously been published.
Volume I was written by J. Keith Horsefield; Volume II by Margaret G. de Vries, J. Keith Horsefield, Joseph Gold, Mary H. Gumbart, Gertrud Lovasy, and Emil G. Spitzer.
Price: $12.50 the set ($5 a volume if sold separately). Payment will also be accepted in most other currencies.
Address correspondence to
INTERNATIONAL MONETARY FUND
19th and H Streets, N.W.
Washington, D.C. 20431 U.S.A.
Mr. Hodjera, economist in the Special Studies Division of the Research Department, has degrees from the Graduate Institute of International Studies in Geneva and from Columbia University and has also studied at Oxford University. He has been lecturer at the City College of New York, Assistant Professor at Yale University, and Visiting Associate Professor at the University of Virginia. He has contributed several articles to economic journals.
For the use of the basic balance concept in the medium-term analysis, see the chapter, “World Trade, Payments, and Reserves,” in various issues of the International Monetary Fund’s Annual Report.
For the role of basic balance in the long-term analysis and projections, see Hal B. Lary, Problems of the United States as World Trader and Banker (National Bureau of Economic Research, 1963), and Walter S. Salant and others, The United States Balance of Payments in 1968 (The Brookings Institution, Washington, 1963).
For the development of this thesis, see Charles P. Kindleberger, Balance-of-Payments Deficits and the International Market for Liquidity (Essays in International Finance, No. 46, Princeton University, 1965), and Emile Despres, Charles P. Kindleberger, and Walter S. Salant, “The Dollar and World Liquidity—A Minority View,” The Economist, February 5, 1966, pp. 526–29.
In addition, some minor transactions, such as bilateral payments agreements of Japan (see Table 5) are included.
For various views on this point, see “Unrecorded Movements in the U.K. Balance of Payments: The ‘Balancing item,’” Bank of England, Quarterly Bulletin, Vol. II (1962), pp. 16–22; The Balance of Payments Statistics of the United States: A Review and Appraisal (Report of the Review Committee for Balance of Payments Statistics to the Bureau of the Budget, April 1965), pp. 85–91; Sven Grassman, ‘The Balance of Payments Residual,” Skandinaviska Banken Quarterly Review (1967: 2), pp. 43–50; John S. Smith, “Asymmetries and Errors in Reported Balance of Payments Statistics,” Staff Papers, Vol. XIV (1967), pp. 211–36.
The balance of payments for Canada, however, does not distinguish entirely between short-term capital movements and errors and omissions, so that the latter cannot be shown separately.
Cumulative presentation also permits inspection of yearly flows of various items, which are shown in the charts as slopes of the curves from one year to the next.
See Robert Triffin, Europe and the Money Muddle: From Bilateralism to Near-Convertibility, 1947–1956 (Yale University Press, 1957), pp. 180–87, and Bank for International Settlements, Annual Reports, Chapter VIII. Since credits to the EPU were counted by the member countries as reserves, a regional balance of payments surplus did not generate a discrepancy between reserve movements and a cumulative basic balance.
As can be seen from Chart 4, the structure of Canada’s balance of payments is quite unusual for a major developed country. The deficit on the current account was financed mainly by the private long-term capital inflow, while the other components of the basic balance played minor roles. For the equilibrating role of short-term capital movements during the period of flexible exchange rates, see Rudolf R. Rhomberg, “Canada’s Foreign Exchange Market: A Quarterly Model,” Staff Papers, Vol. VII (1960), pp. 439–56, and “A Model of the Canadian Economy under Fixed and Fluctuating Exchange Rates,” The Journal of Political Economy, Vol. LXXII (1964), pp. 1–31; also Paul Wonnacott, The Canadian Dollar, 1948–1958 (University of Toronto Press, 1960), pp. 128–39.
Movements of cumulative errors and omissions of the ten countries are shown in Chart 3.
See Table 3. It should be added that the component of short-term capital flows that includes errors and omissions (see item “All other net liabilities” in Table 3) was also quite large and, until 1967, consistently positive.
For a summary of a Dutch monetary policy during that period, see Samuel I. Katz, External Surpluses, Capital Flows, and Credit Policy in the European Economic Community, 1958 to 1967 (Studies in International Finance, No. 22, Princeton University, 1969), especially pp. 26–28, and Rodney H. Mills, Jr., “The Regulation of Short-Term Capital Movements: Western European Techniques in the 1960’s” (Board of Governors of the Federal Reserve System, Staff Economic Studies, 1968), especially pp. 15–16 and 32–33. See also Table 4. Until 1964, money supply and credit were controlled through changes in cash reserve requirements. These were later replaced by the policy on credit ceilings. To limit excessive borrowing from abroad, ceilings on net liabilities abroad by the banks were also introduced. (Each bank’s gross liabilities abroad could not exceed its gross foreign assets by more than 5 per cent.) However, large amounts of net foreign assets in the hands of commercial banks permitted them to undertake substantial borrowing abroad.
As can be seen from Charts 1 and 4, short-term capital inflows, which began in 1960, were followed until 1964 by increasingly heavy long-term borrowing abroad, mainly on the U.S. capital market. Such combined borrowing on both short-term and long-term capital accounts enabled Japan to maintain, or even slightly increase, its reserves between 1960 and 1964, despite a cumulative current account deficit of $2.1 billion.
For a detailed analysis of these fluctuations and the policy of Japan’s monetary authorities, see Hannan Ezekiel and Chandrakant Patel, “Fluctuations in Japan’s Balance of Payments and the Role of Short-Term Capital Flows, 1959–66,” Staff Papers, Vol. XIV (1967), pp. 403–32. As can be seen from Table 5, the main role in capital inflows was played by commercial banks, but after 1962 the contribution of the nonmonetary sector (mainly corporations with foreign interests) also became significant.
Katz, op. cit., pp. 18–22.
See Mills, op. cit., pp. 2–8 and 29–33, and Katz, op. cit., pp. 5–7, 41–42, and passim.
See Chart 4.
Deutsche Bundesbank, Monthly Report, February 1967, p. 27.
For Sweden, see Grassman, op. cit. In the United Kingdom, it is estimated that the trend in the cumulative balancing item reflects unrecorded current account, while the fluctuations reflect short-term capital movements. See “United Kingdom Balance of Payments in the Second Quarter of 1967,” Economic Trends, September 1967, p. xiv, and Central Statistical Office, United Kingdom Balance of Payments, 1966, p. 53.
Philip W. Bell, “Private Capital Movements and the U.S. Balance-of-Payments Position,” in Factors Affecting the United States Balance of Payments (compilation of studies prepared for the Joint Economic Committee, 87th Congress, 2nd Session, Washington, 1962, pp. 395–481); William H. Branson, Financial Capital Flows in the U.S. Balance of Payments (Amsterdam, North-Holland Publishing Co., 1968), pp. 150–51 and 175–76.
A substantial proportion of exported banknotes was, however, reinvested in Italy as a result of various incentives in the national fiscal system for investment from abroad. In order to account for this behavior, an adjustment was made in both errors and omissions and private long-term capital movements. For the method used, see the Appendix.
See pages 586–87 and the Appendix.
See Chart 6.