Chapter

“Supplement to Existing Reserve Assets”

Author(s):
International Monetary Fund
Published Date:
January 1971
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Most of the provisions dealing with special drawing rights have been added to the Articles in what amounts, in effect, to a separate chapter beginning with these words:

To meet the need, as and when it arises, for a supplement to existing reserve assets, the Fund is authorized to allocate special drawing rights to members that are participants in the Special Drawing Account.30

There is similar language in the first subsection of a provision that deals with the principles and considerations governing the allocation and cancellation of special drawing rights:

In all its decisions with respect to the allocation and cancellation of special drawing rights the Fund shall seek to meet the long-term global need, as and when it arises, to supplement existing reserve assets in such manner as will promote the attainment of its purposes and will avoid economic stagnation and deflation as well as excess demand and inflation in the world.31

In the language of these provisions, and particularly in the noun and verb “supplement,” there is great resonance.32

Professor Empson identified one form of ambiguity as follows:

An ambiguity of the third type, considered as a verbal matter, occurs when two ideas, which are connected only by being both relevant in the context, can be given in one word simultaneously.33

No fewer than four ideas are commingled in the language in which the word “supplement” is the central element. These four ideas may be summarized as follows:

  • (a) The statement that special drawing rights are a supplement to reserve assets is not equivalent to the statement that special drawing rights themselves are reserve assets.
  • (b) Special drawing rights have the characteristics that enable them to function as a supplement to existing reserve assets.
  • (c) Special drawing rights are a supplement to existing reserve assets because they can make up for any deficiency in the global stock of existing reserve assets.
  • (d) Special drawing rights are a supplement to as distinguished from a substitute for existing reserve assets.

These ideas are discussed in turn.

(a) The statement that special drawing rights are a supplement to reserve assets is not equivalent to the statement that special drawing rights themselves are reserve assets

International law contains no generally recognized concept of a reserve asset,34 although definitions of reserves for particular purposes can be found in various treaties, notably in the Articles of the Fund, and in the statute law of some countries. The practice of the Fund is as authoritative an international judgment on the content of the concept as can be found. This practice supports the view that an attempt at a generally acceptable definition of a reserve asset could not ignore at least two elements. First, a reserve asset can be used in support of the currency of the monetary authorities holding it when there are balance of payments difficulties. This implies that the monetary authorities can get prompt conversion of the asset into the currency they need. Second, a reserve asset can be used at will by the monetary authorities holding it. Before the creation of special drawing rights, reserve assets consisted of gold and certain currencies held in various forms, and there was growing acceptance of the Fund’s view that in addition the gold tranche and certain rights to repayment under loans to the Fund deserved recognition as reserve assets. During the discussions and negotiations of the 1960s that led to the creation of special drawing rights, it was clearly the preponderant view that there might be the need for a further reserve asset.

The 1964 35 and 1965 36 Annual Reports of the Executive Directors of the Fund discussed techniques for creating additional reserves but did not refer to the creation of new reserve assets. In part, this was because there were precedents for the two techniques that were discussed. One technique was an extension of the ability of members to make automatic and unconditional purchases from the Fund, and the other was investment by the Fund in member countries.37 The Ossola Report of May 31, 1965, which had been requested by the Group of Ten, distinguished between “new” and “additional” assets,38 but later these words were used indiscriminately. The 1966 Annual Report of the Executive Directors discussed automatic drawing rights that would resemble the traditional transactions of the Fund as one method of the creation of reserves but also discussed the “creation of a reserve in asset form—usually designated as a ‘reserve unit’”39 and “the creation of new reserve assets.” 40 The Deputies of the Ministers and Governors of the Group of Ten reported to their principals on July 8, 1966 that:

… we are agreed that at some point in the future existing types of reserves may have to be supplemented by the deliberate creation of additional reserve assets.41

Elsewhere in the Report it is clear that the reference to additional reserve assets contemplated new types of assets, and that the word “additional” was not being used in contrast to “new” as it had been at one time.42 This conclusion was echoed in a communiqué of a Ministerial Meeting of the Group of Ten in July 1966:

… it was agreed that, at some point in the future, existing types of reserves may have to be supplemented by the deliberate creation of additional reserve assets.43

In a communiqué of the Finance Ministers of the European Economic Community issued on April 18,1967, there is less certainty about technique. It refers to “any measures which may be taken to create additional reserves, or any alternative solutions adopted for the same purpose.” 44 This reference to alternative solutions reflected the existence of a minority view, apparent in earlier documents of the Group of Ten, that did not favor the creation of a new asset. This view was supported by a complex pattern of argument in which the main strand was the belief that an asset which could be awarded without being earned and which, in contrast to an instrument based on credit, could be used without any obligation of repayment might help to prolong the balance of payments deficits of countries, and particularly the reserve currency countries. An asset of this character, it was argued, might be used by the holder without the pangs that are induced by the need to use gold, and the result might be a weakening of discipline in the pursuit of the policies needed for adjustment.45

Even though the minority view was narrowly held, the absence of unanimity produced a subtle change in the language that had been employed for some time to indicate the objective of the negotiations. The change was made in the hope that it would promote consensus without embarrassment. At its Annual Meeting in September 1967, the Board of Governors of the Fund adopted a resolution approving the Outline that was to be the basis for the establishment within the Fund of a new facility “in order to meet the need, as and when it arises, for a supplement to existing reserve assets.” Similar language appeared in the first sentence of the Outline:

The facility described in this Outline is intended to meet the need, as and when it arises, for a supplement to existing reserve assets.46

The most striking contrast between this language and the language of earlier documents is the substitution of “a supplement to existing reserve assets” for the references to the supplementing of existing types of reserves with additional reserve assets. The language of the amendment permits but does not require the reader to accept the latter understanding. The change was a compromise which enabled each member at the time of the endorsement of the Outline to decide for itself, on the basis of whatever legal, economic, or political considerations it regarded as persuasive, whether special drawing rights were or were not going to be “reserve assets.” A similar freedom exists for each participant in the Special Drawing Account.

The freedom for individual response that the compromise permits was apparent in the comments on the Outline at the Annual Meeting of the Board of Governors at which it was approved. The Governor for the United States said:

While each country will make its own decision, it is expected that these special drawing rights will be treated as first-line reserves. The United States intends to dp so.47

The Governor for the United Kingdom made a similar statement:

… the United Kingdom intends to include the new drawing rights … in their front-line reserves. We hope that other countries will do likewise. When the new drawing rights are treated in this way it will be manifest that they are a supplement to existing reserve assets.48

The Governor for France expressed a different view:

The special drawing rights provision in no way constitutes a revolutionary step. These rights do not and cannot establish a new currency designed to replace gold. If such were the purport of the agreement, it is quite clear that France would not sign it. The plan provides for the possible extending of credit facilities. Such is the reform proposed, a limited but important one.49

Some translators of Petronius used to allow certain passages to remain in the “decent obscurity of the Latin.” Participants are entitled to rely on the decent obscurity of the Articles and are not bound to subscribe to any classification of special drawing rights. This was the position of the Governor for Italy in commenting on the Outline:

… the nature of the new special drawing rights is not nearly as important as the manner in which they will be used.50

The theme of his remarks was that they possessed the legal characteristics that could justify the recognition of them as reserve assets, but the view that was taken of them in practice would depend in the longer run on the way in which they were used.

The decision to establish the broadest possible basis for agreement by shunning the application of the term “reserve asset” to special drawing rights in drafting the amendment produced some formulations for which felicity cannot be claimed, although it can be maintained that there is compensation for any loss of that quality in the greater detail, and therefore greater precision, that had to be employed in lieu of the more compendious term. An even finer net was used in drafting the amendment than in drafting the Outline in order to filter out language that could prejudice the compromise. For example, one of the rules of reconstitution in the Outline was drafted as follows:

Participants will pay due regard to the desirability of pursuing over time a balanced relationship between their holdings of special drawing rights and other reserves.51

The words “other reserves” did not survive in the corresponding provision in the Articles:

Participants shall also pay due regard to the desirability of pursuing over time a balanced relationship between their holdings of special drawing rights and their holdings of gold and foreign exchange and their reserve positions in the Fund.52

It also followed that such expressions as “gross reserves” or “reserves” could not be used when those concepts would include special drawing rights. The following provision is an illustration of drafting designed to avoid that usage:

… a participant will be expected to use its special drawing rights only to meet balance of payments needs or in the light of developments in its official holdings of gold, foreign exchange, and special drawing rights, and its reserve position in the Fund, and not for the sole purpose of changing the composition of the foregoing as between special drawing rights and the total of gold, foreign exchange, and reserve position in the Fund.53

Two departures were made from an inflexible determination to avoid the language of reserves in relation to special drawing rights. There are contexts that refer to “holdings” of special drawing rights.54 Elsewhere in the Articles the word “holdings” is used to connote the ownership of reserve assets.55 A more important departure is the express inclusion of special drawing rights in “monetary reserves.” 56 That term is defined by the Articles for various purposes, including the calculation of obligations requiring a member to repurchase its currency from the Fund.57 It was decided that special drawing rights should enter into the calculations according to which the total of monetary reserves and increases in them are factors that determine the accrual of repurchase obligations. To achieve this end, it was unavoidable that the Articles would provide that a member’s special drawing rights are included in its “monetary reserves” for the purposes for which “monetary reserves” are relevant under the Articles. As a result, repurchases may be made in gold, the convertible currencies of other members, or special drawing rights. The inclusion of special drawing rights in “monetary reserves” was not controversial because of the acceptance of an overriding policy that they should affect the calculation of repurchase obligations. This policy seemed natural even at the time when there was resistance, which succeeded, to the further proposal that a member which had purchases outstanding in the credit tranches when the contemplated new reserve assets were distributed to it, should use those reserves in immediate repurchase.

The decision not to refer to special drawing rights as reserve assets left its mark on the Articles in other ways than those already mentioned. Great care was taken to avoid a vocabulary that suggested either the bringing into existence of new reserve assets or the transmission of reserve assets among participants in operations and transactions. This caution resulted in a less energetic terminology. For example, during the years of discussion and negotiation, it was common to refer to the undertaking as one concerned with the “creation” of a new reserve asset, with its “distribution” among or “issuance” to participants, and with “transfers” of it in operations and transactions. The word “creation” disappeared. Even the heading of the Outline referred to a facility “based” on special drawing rights. The “allocation” of special drawing rights was substituted for “distribution” and “issuance,” and “cancellation” was preferred to “recall.” “Transfer,” “transferor,” and “transferee” were avoided in favor of formulations involving the word “use.” 58 One of the most obvious of the many examples of this approach is the subsection in the Articles of Agreement which declares that:

A participant that provides currency to a participant using special drawing rights shall receive an equivalent amount of special drawing rights.59

The calculated debility of this language obstructs the forthright statement that a participant provides currency in return for a transfer of special drawing rights.

The rejection of a vocabulary based on reserve assets did not force the drafters to use language influenced by the competing theory of credit. In the discussions and negotiations, there were frequent references to debtor and creditor positions 60 in the proposed facility. It was easy to use these terms in connection with certain features of the facility that were proposed by some negotiators, such as reconstitution or the adjustment of voting power on the basis of a participant’s holdings of the new instrument. Other negotiators criticized these features precisely because they suggested a credit instrument. Even though some of these features, such as reconstitution, have survived, the language of credit has not.

Rejection of the terminology of both reserve assets and credit did not compel the drafters to follow a third course that might have been suggested by the expression “special drawing rights.” The drafters were not attracted by the language of the original Articles as it applied and continues to apply to the exchange transactions of the Fund conducted through the General Account. For example, a participant “uses” its special drawing rights “to obtain an equivalent amount of currency” 61 and does not “buy” 62 that currency or make a “purchase.” 63

Whether special drawing rights are or are not to be called reserve assets is no longer a question that provokes ardent dispute. At the Annual Meeting of the Board of Governors of the Fund in 1969, the Governor for France said:

… I wish to inform you of the reasons for which France has taken the decision to participate in the activation. of the SDR system. First, as the Managing Director of the Fund has so aptly reminded us, the system is now in existence: we have ourselves always considered that alongside conditional liquidities there was room in the modern world for a new reserve asset of an unconditional type, designed to supplement gold and foreign exchange in the holdings of the central banks. This was the purport of the proposal that we made for the creation of a collective reserve unit, or CRU.64

Under the legislation of almost 40 participants, special drawing rights are reserve assets for domestic legal purposes, but this number does not indicate the extent to which the conviction is held among participants in general that special drawing rights are truly a new reserve asset.

(b) Special drawing rights have the characteristics that enable them to function as a supplement to existing reserve assets

The word “supplement” in this second sense means that the characteristics of special drawing rights are such that holders can use them in much the same way as they can use existing reserve assets. The deliberate ambiguity of the Outline and the Articles on the question whether special drawing rights are to be considered reserve assets was not allowed to deprive them of the characteristics that would make them effective. That they should be endowed with these characteristics remained the objective even though opinion differed on what the characteristics should be.

The idea that an instrument of liquidity, and eventually special drawing rights as the chosen instrument, must have characteristics that would enable it to function satisfactorily appears in the discussion of characteristics in various reports and official pronouncements. Would the presence or absence of a particular characteristic be compatible with a “true supplement to reserves” 65 or affect the “quality” of special drawing rights,66 or help them to develop into a “true and proper reserve instrument”? 67 Thus, to cite one example, it was argued that linking the use of the new instrument to the use of reserve assets, and particularly gold, in fixed proportions “would compromise [its] standing as an independent and full supplement.” 68 The response was expressed in similar terms. On the contrary, a link of that kind would make the instrument “more convincing … as a supplement to monetary gold.” 69

Not all members attributed the same weight to all the characteristics on which agreement was reached.70 Some members were reconciled to certain characteristics because of the power of the Fund to vary particular provisions of the amended Articles without the need to resort to further amendment. One of the most important examples of these characteristics is the obligation of a participant to reconstitute its holdings of special drawing rights after using them.71 The rules as written into the Articles apply to the first basic period, but they may be altered or even abrogated for the second or any subsequent basic period by a decision of the Board of Governors taken by 85 per cent of the total voting power of participants. If there is no decision to adopt new rules or no decision to abrogate them, the rules in force continue to apply.

Sometimes it was said that the new instrument should be “as good as gold” or “goldlike,” and sometimes it was objected that a proposed characteristic would prevent the instrument from operating as a true supplement to gold. Ultimately, it was realized that the task was to agree on characteristics that would enable the new instrument to function satisfactorily however those characteristics might compare with any of the existing reserve assets. In the result, special drawing rights are an amalgam of characteristics which are not the same as those of any one of the existing reserve assets.72

(c) Special drawing rights are a supplement to existing reserve assets because they can make up for any deficiency in the global stock of existing reserve assets

The Fund is given the general instruction that in its decisions on the allocation or cancellation of special drawing rights, it “shall seek to meet the long-term global need, as and when it arises, to supplement existing reserve assets” in such manner as will promote the purposes of the Fund and will avoid certain dangers.73 The Fund is given the additional instruction to take certain special considerations into account, including a collective judgment that there is a “global need to supplement reserves,” before making the first decision to allocate special drawing rights.74 For the first decision to allocate, the word “supplement” can mean only “increase” and cannot include the idea of cancellation. The more general instruction, however, is to guide the Fund in all decisions not only on the allocation but also on the cancellation of special drawing rights. In this context, therefore, the word “supplement” applies to both allocation and cancellation. It follows that the global stock of special drawing rights is the supplement that may be increased or decreased in order that it will be appropriate to fulfill the purposes for which it is intended.

The authority of the Fund to allocate or cancel special drawing rights was intended to give the Fund the ability, by means of rational and concerted decision, to affect the volume of special drawing rights and “existing reserve assets” or, one might say, the total of the reserve assets available to participants. The degree to which the total volume can be affected by the exercise of this authority will depend on the proportion of special drawing rights to “existing reserve assets.”

The Articles do not define the “existing reserve assets” to which special drawing rights are to be a supplement. In the Report which accompanied the Managing Director’s proposal on the allocation of special drawing rights for the first basic period, the reserves that were considered were official holdings of gold and foreign exchange and reserve positions in the Fund.75 The adjective “existing” which qualifies “reserve assets” in the Articles does not restrict them to those types of reserves that were recognized at the time when the amendment became effective.

If any new reserve assets were to be recognized or old ones were to disappear, the words “existing reserve assets” would enable the Fund to take these developments into account in its subsequent decisions on the allocation or cancellation of special drawing rights. If, for example, the present types of reserve assets were deposited in an account and converted into a single form of unit, as recommended under some plans that have been advocated,76 subsequent decisions to allocate or cancel special drawing rights would be taken by regarding them as the supplement to the total of units in existence. If this development took the form of the issuance of special drawing rights against reserve assets, special drawing rights could continue to be allocated or canceled “to supplement existing reserve assets.” If that should happen, it would be possible to hold that the special drawing rights that had been allocated or issued before a new decision to allocate or cancel were the “existing reserve assets” to be “supplemented” under the decision. On that reading, the equivocation of the Articles in relation to the character of special drawing rights as reserve assets would seem to be eliminated. Alternatively, however, it would be possible for a participant to insist that there were no “existing reserve assets” but that it was still necessary to allocate more special drawing rights as a supplement to zero reserve assets.

The Articles do not include precise criteria for calculating existing reserve assets or for determining the volume of special drawing rights to be allocated or canceled so that the stock of reserve assets and the rate of growth in them will be satisfactory. In its decisions, the Fund must seek to meet “the long-term global need, as and when it arises.” The word “global” is another complex word. The need to be met is global because the facility is open to all members of the Fund that wish to participate and not simply to some limited class, such as the major industrial countries. In addition, the need is global because it is the need of the international monetary system as a whole and not the need of individual members as determined by their balances of payments.77

Although special drawing rights are an increment to existing reserve assets, it is not provided that they shall be the only increment and that there shall be no increases in the traditional reserve assets. Special drawing rights are a supplement to existing reserve assets and not the supplement. Nothing in the amendment, however, would prevent efforts to control the volume of existing types of reserve assets that might enter global reserves. For example, there is no inconsistency between the amended Articles and the Communiqué of March 17, 1968 in which the Governors of the Central Banks of the seven active members of the Gold Pool announced that:

… as the existing stock of monetary gold is sufficient in view of the prospective establishment of the facility for Special Drawing Rights, they no longer feel it necessary to buy gold from the market.

Indeed, the special considerations applicable to the first decision to allocate special drawing rights, which include “the attainment of a better balance of payments equilibrium, as well as the likelihood of a better working of the adjustment process in the future,” 78 imply that there will not be an excessive expansion of the currency component in the reserves of participants.

(d) Special drawing rights are a supplement to as distinguished from a substitute for existing reserve assets

It has been noted that special drawing rights could continue “to supplement existing reserve assets” even if more or less radical reforms in the international monetary system affecting present reserve assets were to be adopted. Nothing in the amendments to the Articles, however, requires the termination of the role of gold or reserve currencies as reserve assets as a condition of the allocation of special drawing rights. The Managing Director has stated this forcefully:

While special drawing rights will, I expect, eventually become a major component of international reserves, it is important at this stage to do nothing to undermine, and to do whatever is possible to strengthen, the traditional reserve components. The new facility is intended, when the need arises, to supplement, not to supplant, gold and foreign exchange. This is no more than common sense. Gold is a traditional means of international settlement and a point of reference for the values of national currencies. The value of special drawing rights is guaranteed in terms of a weight of gold. More than one half of all monetary reserves consists of gold, and it continues to be the basic element in the world monetary system. It is clear also that for many practical reasons countries will always need to hold foreign exchange in their reserves; and some may find it convenient to hold a larger proportion of their reserves in that form…. Once the facility for special drawing rights is operating effectively, however, the expansion of world reserves will no longer have to depend on the growth of official holdings of gold and foreign exchange.79

In brief, therefore, members may cease to hold other types of reserve assets if they wish and may agree among themselves to do this, but it is not a condition of the allocation of special drawing rights that they must eliminate other types of assets from their reserves. It is in this sense that special drawing rights are not intended to be a substitute for other kinds of reserves assets. In another sense, however, they would be a substitute. If members should decide not to hold certain reserve assets, either by reducing or by not expanding holdings of them, and special drawing rights were allocated to meet global needs, it could be said that special drawing rights were not only a supplement to existing reserve assets but also a substitute for those that might have been held had there been no allocations.

Another sense in which special drawing rights are not a substitute for existing reserve assets is involved in the rejection of the following proposal in the course of the liquidity debate:

A second proposal, by another member, envisages that a new reserve asset might be used not only in order to satisfy additional reserve needs but also to prevent the existing stock of reserves from shrinking. According to this proposal, there should be full freedom to convert any part of existing reserve currency balances into the new asset through a Trust Account, which would issue supplementary reserve units in return for them….80

Special drawing rights are allocated at the same percentage of quota to all participants under decisions of the Fund for basic periods,81 and there is no technique for issuing additional special drawing rights to a particular participant because it has made a deposit of currency.

Yet a third sense in which it can be said that special drawing rights are a supplement to existing reserve assets and not a substitute for them is the absence of a general principle permitting the conversion of them into existing reserve assets. It is beyond the scope of this pamphlet to discuss the uses of special drawing rights in detail, but two rules will illustrate the restraints on the conversion of special drawing rights. A participant can obtain currency for special drawing rights, but never gold.82 A participant is expected not to use its special drawing rights to obtain currency unless it has a need to use reserves.83 It should not use special drawing rights and substitute currency for them, or gold obtained with that currency, solely in order to change the composition of its reserves.

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