- Michael Ainley
- Published Date:
- September 1984
The General Arrangements were established against a background of widespread, and growing, concern about the adequacy of official sources of international liquidity, in general, and the disruptive effects of short-term capital movements, in particular. The return to external convertibility of the major European currencies in 1958, and of the Japanese yen in 1961, followed by the elimination of exchange restrictions and the relaxation of capital controls in these countries, had a dramatic effect on the international trade and payments system established at Bretton Woods. These developments created the conditions for larger and more frequent transfers of short-term capital between countries, in response not simply to interest rate differentials but also to anticipated changes in par values and other speculative factors.
The two major reserve-currency countries, the United States and the United Kingdom, were particularly exposed to such transfers because of their balance of payments problems. Sterling was subject to periodic pressure in the exchange markets; and the growing payments deficits of the United States were also exacerbated by large capital outflows accompanied, at times, by flights from dollars into gold.
1. Short-Term Expedients
The increasing volatility in the exchange markets, continuing large payments deficits in the United States, and the accumulation of sizable official and private holdings of dollars prompted a series of responses by the major industrial countries in 1961–62. In March 1961, for example, immediately after large revaluations of the deutsche mark and the guilder, the central banks of the major European countries, meeting at the Bank for International Settlements (BIS) in Basle, agreed to cooperate closely in the foreign exchange markets to discourage speculation and to minimize the repercussions of speculative movements on their foreign exchange reserves. More specifically, the central banks agreed to hold each other’s currencies to a greater extent than before, instead of converting them immediately into gold or dollars, and to provide short-term loans to assist each other when their currencies were in difficulty because of speculation.
The Basle Agreement, as it was called, was followed, in February 1962, by the establishment of systematic swap facilities at the U.S. Federal Reserve with the central banks of the United Kingdom, Canada, the Federal Republic of Germany, Italy, Japan, Switzerland, France, the Netherlands, Austria, Belgium, Sweden, and the BIS. These swaps, which totaled more than US$2 billion by February 1964, were heavily used throughout the 1960s, particularly by the United Kingdom, as a reversible, short-term defense against exchange market disturbances. At the same time, the major central banks, led by the Federal Reserve, moved to coordinate their policies on short-term interest rates and on intervention, in forward as well as spot markets, with the aim of preventing, or at least reducing, speculative capital movements.
Speculation at this time was not confined to currencies but included gold, the second main source (with the dollar) of official liquidity and reserves under the gold exchange standard. Intense speculation regarding a possible rise in the official price of gold, then US$35 an ounce, led, in October 1961, to the creation of the London “Gold Pool” by the major central banks. Under this arrangement, the central banks of Belgium, France, the Federal Republic of Germany, Italy, the Netherlands, Switzerland, and the United States agreed, informally, in cases of need, to share with the Bank of England the burden of intervening in the London gold market to keep the market price of gold at, or close to, the official price. This informal sales consortium, which provided gold to the market for the first time in November 1961, remained in operation until March 1968, when a two-tier gold market, separating the free market from the official market, was introduced.
These arrangements were ad hoc financing mechanisms to deal with short-term crises. They did not address the underlying problems in the Bretton Woods system, problems which stemmed from the heavy reliance on the dollar as the main source of international liquidity; from the reluctance of countries to change par values until the last minute; and from the delays in adjusting domestic policies, particularly among countries with persistent deficits. This is where the Fund, and ultimately the GAB, came in. It was not without significance that the Basle Agreement of March 1961 concluded that
These procedures [for closer exchange market cooperation] will be temporary, pending the evolution of more permanent techniques for dealing with the problems of international financial disequilibria, particularly short-term capital movements within the framework of, or through reform of, the International Monetary Fund.4
2. The Fund’s Response
Before 1961, the Fund’s response to the more rapid growth in world trade and to the problem of large short-term capital movements was twofold. First, a large general increase in quotas (50 percent) was agreed in 1959, with provision for special increases for countries like Canada, the Federal Republic of Germany, and Japan to reflect their growing economic importance. Second, the Fund allowed members access to its resources on a then unprecedented scale. The period 1960-61 was, for example, one of the most active in the Fund’s history. Twenty-four standby arrangements were approved for a total of approximately US$1,500 million, including one of US$500 million for the United Kingdom.5
However, despite a consensus at the Fund’s Annual Meeting in 1960 that there was “no lack of international liquidity,”6 it became increasingly apparent that the Fund should do more. The continuing large shifts in the balance of payments positions of the major countries were expected to lead to even greater demands on the Fund. But, even after the quota increase in 1959, the industrial countries in strong external positions had relatively small Fund quotas. The Fund’s holdings of their “lendable” currencies were low. By contrast, the external positions of the United States and the United Kingdom, the two reserve currency countries with the largest quotas, were not strong; and these two countries were the most vulnerable to capital outflows.
The obvious solution of a further increase in Fund quotas, with selective increases for “strong” countries, was considered impracticable so soon after the 1959 increases, and because it would have been a further drain on members’ reserves. There were, therefore, doubts, both inside and outside the Fund, whether its resources were sufficient to deal with the potential problems of the two reserve centers. These doubts were especially marked with regard to the United States, given its very large quota and the possibility that its drawings could have limited the Fund’s ability to assist other members in difficulty. Indeed, the February 1961 statement by President Kennedy to Congress that the United States might wish to use the Fund’s resources was the most important immediate reason for the Fund’s decision to supplement its currency holdings with a borrowing arrangement.7
3. Radical Reform
The General Arrangements were thus a response to the needs of the time. There was, however, no shortage of proposals designed to remedy the perceived defects in the international monetary system. The more radical ideas came from outside the Fund. They included the Triffin Plan, under which the Fund would become an international central bank for central banks authorized to create money in accordance with international liquidity requirements; and the Stamp Plan, under which the Fund would create a new form of credit certificates which could be used to meet both the needs of industrial countries for additional liquidity and of developing countries for additional foreign capital. Economists such as Roy Harrod and Jacques Rueff went further, arguing that the shortage of international liquidity could be solved by doubling or even tripling the official price of gold. Milton Friedman proposed abandoning the par value system and replacing it with freely flexible exchange rates that could reduce, if not eliminate, the need for central banks to hold reserves.8
Other less radical plans, such as those of Edward Bernstein, looked ahead to broadening the base of the gold exchange standard through a system of “multiple reserve currencies” in addition to dollars and sterling. The Fund staff also explored various possibilities, including that of inviting deposits of gold or currencies from surplus members which could be used, if necessary, to replenish the Fund’s holdings of particular currencies.9
Although none of these ideas was adopted, and many were too extreme for the financially orthodox countries, they marked the beginning of the long debate on the adequacy of international liquidity, and of the Fund’s lending facilities, which continued throughout the 1960s. It culminated in the creation of the special drawing rights facility within the Fund in 1969.
4. The GAB
The General Arrangements themselves were something of a halfway house between the temporary financing expedients established by central banks and the wholesale reform proposals outlined earlier. If they were part of the “ingenious devices for creation of international liquidity”10 devised to keep the system going, they were also something more. The General Arrangements were within the Fund’s framework, and therefore at the center of the system; and they provided support over the medium, and not just over the short, term.
The General Arrangements were created after extensive preparatory work by senior Fund staff members, which included a number of informal discussions with national officials. They were first put forward by Per Jacobsson, then Managing Director, in February 1961 as part of a pragmatic package of measures aimed at strengthening the Fund’s resources in the aftermath of convertibility.
The package had three related elements. The first was clarification of the principle that members could, in certain circumstances, use Fund resources to meet balance of payments deficits that went beyond the current account and were attributable, in whole or in part, to capital transfers.11 Clarification was needed because of a 1946 interpretation of the Fund’s Articles of Agreement by the Executive Board that limited the use of the Fund’s resources to the financing of deficits “on current account for monetary stabilization operations.”12 This interpretation, which reflected U.S. concerns after World War II that Fund resources not be wasted in financing capital flight from members maintaining overvalued currencies, was overly restrictive. It ignored the provisions of the Articles, and Article VI in particular, which allowed the Fund to finance capital transfers, for example, where a capital outflow was not deemed to be “large or sustained.” Although the interpretation had been virtually forgotten, the position had to be clarified before the Fund could establish a borrowing arrangement specifically designed to deal with problems relating to short-term capital movements.
Accordingly, the Executive Board re-examined the 1946 interpretation and decided, in July 1961, that it did “not preclude the use of the Fund’s resources for capital transfers in accordance with the provisions of the Articles, including Article VI.”13 This did not mean that the Fund would allow its resources to be used irrespective of a member’s circumstances or of the volume of a capital outflow. But it gave the Fund flexibility in deciding what constituted “large or sustained” capital outflows under Article VI; and it removed a potential obstacle in the way of setting up the GAB.
The second element of the package involved the establishment of new guidelines for the selection of currencies to be used in financing members’ transactions with the Fund. Prior to 1961, little use had been made of any currency except the U.S. dollar in drawings on the Fund. Even when the currencies of the major European countries became convertible, in the Fund sense, under Article VIII in February 1961, it did not automatically follow that these currencies would be used in Fund drawings. Most members kept their foreign exchange reserves in U.S. dollars, pounds sterling, or French francs and preferred to draw one of these currencies if they were in balance of payments difficulties.
The new guidelines, which were adopted in July 1962 after extensive discussion by the Executive Board, ensured that drawings from, and repayments to, the Fund would take place in a broad range of currencies. The Fund would select currencies for drawings, through quarterly operational budgets, from a list of countries in strong balance of payments and reserve positions whose currencies could be converted into the currency directly needed by the drawing member. Very broadly, drawings would be allocated among these countries in proportion to the size of their gold and foreign exchange reserves. The guidelines reflected the important principle that reserves should flow, through the Fund, from countries with strong balances of payments to countries with weak ones.14
The third element of the package was the proposal that the Fund establish a mechanism ahead of need under which it could borrow currencies to finance large drawings. The idea of a comprehensive borrowing arrangement had the advantage over more radical schemes in that it was within the limits of what was politically feasible, although only just, and did not require an amendment of the Fund’s Articles of Agreement. It could be, and was, implemented quickly under the replenishment provisions of Article VII.15
The list of participants was agreed within a few months. It was based on a number of economic and financial criteria drawn up by the Fund staff. These included quota size, level of reserves, actual or prospective balance of payments surpluses, and the Fund’s likely needs for particular currencies. The list had been more or less finalized by August 1961, when the Fund used the currencies of the eventual participants to finance a US$1,500 million drawing by the United Kingdom. The choice of the ten GAB participants led, significantly, to the formation of the Group of Ten, which quickly developed a wider role in examining and coordinating positions on international monetary problems in the 1960s. It also determined, a little later, the composition of the Organization for Economic Cooperation and Development’s (OECD) influential Working Party 3 (WP3) on economic and financial issues.
In practice, drawing up a list of participants was not quite so straightforward. France had to be persuaded that the Fund really needed additional resources at that time. Japan was almost left out, because of temporary balance of payments difficulties, and was included only on the “strongest advice” of Jacobsson.16 Canada and Sweden had doubts, as late as November 1961, whether they should participate at all. Austria, which the Fund staff had viewed as a possible participant, was not included.
Inevitably, the final version was a compromise, political as well as financial, agreed after “much diplomacy and involved negotiations.”17 In the process, Jacobsson’s idea of a global fund which would be available to finance drawings on the Fund by all members was lost. Some of the European countries invited to participate were critical, and France in particular, according to Jacobsson, regarded the proposal as “a trick of the Anglo-Saxon nations.”18 These countries were especially concerned about the persistent balance of payments weaknesses of the United States and, to a lesser extent, of the United Kingdom. They wanted to ensure that any additional resources made available to the Fund would be on-lent on conditions no less stringent than those applicable to ordinary drawings. They insisted on having real control over the use of the borrowed funds, and this was subsequently reflected in the voting provisions of the Baumgartner letter.19 Their bargaining position was strong, since they did not expect to have to use the Fund’s resources in the foreseeable future.
In contrast, countries like the United States and the United Kingdom, which sympathized with Jacobsson’s plan, were in a weaker bargaining position, since they did expect to draw on the Fund and wanted its resources increased. The United States wanted to get some kind of Fund borrowing arrangement in place and was therefore prepared to consider alternative proposals more acceptable to the European critics. This was reflected in a Franco-U.S. proposal, in November 1961, for a Special Resources Facility within the Fund. Under this scheme, the decision to allow use of Fund resources, if borrowed funds were involved, would have been made by the lending countries, and not by the Fund. Similarly, the choice between using Fund resources or borrowed resources would have been made by the borrowing country, not the Fund. The proposal was, understandably, rejected by Jacobsson, since it would have impaired the Fund’s authority and was inconsistent with the Articles of Agreement; but it demonstrated very clearly the limits to cooperation between the major industrial countries and the Fund.
The General Arrangements to Borrow, which were finally agreed by the Group of Ten in December 1961 and approved by the Fund’s Executive Board in January 1962, were, therefore, different from Jacobsson’s original proposal. The credit lines established were highly contingent commitments. They could not be drawn on automatically by the Fund. They could be used only in exceptional circumstances with the concurrence of the Group of Ten, collectively, and the individual consent of prospective creditors.
Equally significant, the credit lines could be called on only to finance drawings on the Fund by the participants. In other words, they were for the exclusive use of the Group of Ten. In addition, the amount available to the Fund at any one time was always less than the overall total of US$6 billion. At each activation, the credit line of the prospective GAB beneficiary had to be deducted from the total; and the amounts which could be drawn from the other credit lines depended on the balance of payments and reserve positions of the participants.
The General Arrangements also differed from other Fund decisions, and subsequent Fund borrowing arrangements, in two other important ways. First, they included a provision for periodic renewals of the credit lines. They have since become a more or less permanent arrangement, in contrast to the Fund’s temporary borrowing, for more specific purposes, under the 1974–75 oil facilities, the 1977 supplementary financing facility, and—more recently—the enlarged access policy. Second, important amendments to the GAB required not only a decision by the Executive Board but also the agreement of all ten original participants. It is this last provision which helps to explain the GAB’s remarkable resistance to change over the past 20 years.