Chapter

Change of Par Value

Author(s):
International Monetary Fund
Published Date:
January 1971
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The Articles of Agreement provide in some detail in Article IV for changes in the par values of the currencies of members. In the event of any change in par value, Article IV, Section 8, comes into play. The basic rule is that a member making a change in the par value of its currency must then adjust the Fund’s holdings of that currency so that, on the basis of the new par value, the holdings will correspond in gold value after the change to their gold value before the change. This obligation is confined to the Fund’s holdings of the currency at the date of the change.3 The obligation applies to all of the Fund’s existing holdings no matter what their origin may have been, and therefore there is no point in trying to trace the sources of these holdings even if it were possible to trace balances that are fungible and that result from a diversity of operations. The obligation of adjustment does not apply to any amount of currency that has been sold or disposed of in some other way by the Fund before the change in par value, even if that currency can still be identified in the hands of the recipient.

The effects of a change in par value under Article IV, Section 8, can be made clearer by means of certain examples. Suppose that member X has a quota in the Fund of $100 million and that the initial par value for its currency is parity with the U.S. dollar, i.e., 0.888 671 gram of fine gold per currency unit. X has to pay a subscription equal to its quota, of which 25 per cent is payable in gold and 75 per cent in its own currency.4 Article IV, Section 1, establishes the rule for computations by the Fund, including those relating to the payment of currency subscriptions. Under Section 1(a): “The par value of the currency of each member shall be expressed in terms of gold as a common denominator or in terms of the United States dollar of the weight and fineness in effect on July 1, 1944” (i.e., 0.888 671 gram of fine gold). Under Section 1(b): “All computations relating to currencies of members for the purpose of applying the provisions of this Agreement shall be on the basis of their par values.” Accordingly, X subscribes the equivalent of $25 million in gold and $75 million in its currency. The currency subscription will be in the form of 75 million units of the currency of X. On January 1, the Fund sells to Y the equivalent of $10 million from its holdings of X’s currency. On April 1, the Fund’s holdings of X’s currency amount to the equivalent of $66 million, as the result of the sale to Y and various other receipts and disbursements. On April 1, X devalues by reducing the par value of its currency by half, so that thereafter the par value of its currency is 0.444 336 gram of fine gold per currency unit. On these facts, X is required by Article IV, Sections 1 and 8(b)(i), to pay to the Fund another 66 million units of currency X. Thereupon, the Fund’s holdings of currency X total 132 million units, the gold value of which will continue to be equivalent to $66 million. X is not required to pay anything to Y in respect of Y’s purchase of currency X, even if Y can show that it retains some of this currency, and even though this currency in terms of gold will now be worth only half of what it was worth when purchased. Moreover, it will be seen from the next paragraph that when in due course Y terminates its use of the Fund’s resources by repurchasing from the Fund its own currency which it transferred to the Fund for the purchase of X’s currency, Y will have to use gold, special drawing rights, or currencies equal in gold value to the gold value of the purchase when made.

Repurchase by Y will work as follows. When Y made the purchase, it transferred the equivalent of $10 million in its own currency to the Fund. On the assumptions that the Fund’s holdings of Y’s currency were 75 per cent of Y’s quota before Y’s purchase and that there are no other changes in the Fund’s holdings of Y’s currency, Y will have to repurchase the equivalent of $10 million of the Fund’s holdings of its currency. If there has been no change in the par value of its currency, Y will have to repurchase the same number of units of its currency that it transferred to the Fund in return for the purchase. Y will have to repurchase with gold, special drawing rights, or the convertible currencies of other members. There is no legal requirement that a member must repurchase with the same currency that it purchased, but it may happen that repurchase has to be 5 or is made in this way. If Y uses currency X in repurchase, Y will have to transfer to the Fund twice as many units of currency X as it obtained by the purchase, because under Article IV, Section 1(6), the Fund will be basing all of its calculations on the new par value of currency X. Similarly, if some other member that purchased currency X or any other currency from the Fund has a repurchase obligation and uses currency X to discharge its obligation, it will have to repurchase its own currency on the basis of the new par value for currency X. If Y repurchases with gold or some currency other than currency X, the gold value of what is used to make the repurchase will be exactly the same, i.e., equivalent to $10 million.

Assume again the same quota and subscription for X, the same sale to Y, and the same devaluation of currency X. However, before the devaluation of April 1, X itself purchases various currencies from the Fund amounting to the equivalent of $34 million, so that on April 1 the Fund holds 100 million units of currency X, equivalent to $100 million. On these facts, X must pay another 100 million units of its currency to the Fund, which will then hold a total of 200 million units, but with a gold value remaining equivalent to $100 million. It will not be possible now for other members to use currency X in discharge of their repurchase obligations, because the currency of a member is not acceptable in repurchase when the Fund’s holdings of that member’s currency are at or above 75 per cent of its quota. X itself will have a repurchase obligation in due course to reduce the Fund’s holdings to 75 per cent of quota. Again, the repurchase obligation will be calculated on the basis of the new par value, and X will have to repurchase 50 million units of its currency with gold, special drawing rights, or the convertible currencies of other members on the basis that 2 units of currency X equal one U.S. dollar. Similarly, if the Fund sells currency X to other members in return for their currencies, this sale will be on the basis that 2 units of currency X are equal to one U. S. dollar. Thus, if Z purchases the equivalent of $20 million in currency X and the par value of Z’s currency is 4 units per dollar, Z will receive 40 million units of currency X and will transfer to the Fund 80 million units in its own currency.

Suppose now that, instead of devaluing its currency, X revalues it by adopting on April 1 a new par value of 1.777 342 grams of fine gold per currency unit, i.e., 2 dollars per unit of currency X. It is again assumed, to begin with, that X has a quota of $100 million, that it subscribed the equivalent of $75 million in its currency, and that the Fund sold currency X to Y in an amount equivalent to $10 million. As a result of this sale and other movements in the Fund’s holdings of currency X, these holdings amount, on April 1, to 66 million units, equivalent to $66 million. The Fund will now have to adjust these holdings by returning 33 million units of this currency to X. The 33 million units which the Fund retains will continue to have a gold value equivalent to $66 million. If, at the date of the revaluation of currency X, some identifiable part of the purchase by Y remains in Y’s reserves, Y will nevertheless not have to repay any part of it to X or to the Fund. Moreover, if Y repurchases in due course with currency X, the repurchase will be on the basis of the new par value for currency X, and hence Y will pay to the Fund fewer units of currency X than it had purchased.

These examples should demonstrate, first, that Article IV, Section 8, ensures that, in the event of a devaluation or a revaluation of a currency, the gold value of the Fund’s holdings of the currency will be maintained at the gold value they had before the change. Second, the financial relationship between the member making the change and the Fund will remain unaltered in the sense that the Fund’s adjusted holdings of the member’s currency will continue to represent the same percentage of quota after the change as before. It is important to emphasize this point, because many rights and duties under the Articles are measured in terms of percentage of quota. Third, the repurchase obligation of a member, whether it be the obligation of a member that changes the par value of its currency or the obligation of a member that uses that currency in repurchase, will be maintained in gold value and thus will not be increased or decreased in terms of gold value because of the change in par value.

A fourth generalization that can be made as to the operation of Article IV, Section 8, deserves special prominence for reasons that will be adverted to later. The provisions for the maintenance of gold value work in such a way as to maintain the gold value of members’ privileges to purchase the currencies of other members under the Articles (“drawing rights” in popular parlance). These privileges are based on the size of a member’s quota and the amount of the Fund’s holdings of that member’s currency. A member can purchase other currencies up to amounts which, in any period of 12 months ending with the purchase, increase the Fund’s holdings of the member’s currency by 25 per cent of the member’s quota, and it can purchase a total amount which will increase the Fund’s holdings to 200 per cent of quota.6 When a member makes a purchase, the calculations are made, as usual, in U. S. dollars of the weight and fineness in effect on July 1, 1944, which means, therefore, in terms of gold value. For example, if Y purchases an amount of currency X equal to 25 per cent of Y’s quota, Y will receive units of currency X equal in gold value at the date of purchase to the gold value of 25 per cent of Y’s quota. The gold value of Y’s quota is fixed, and hence any proportion of it is fixed in gold value. Although the par value of currency X or other currencies may change from time to time, Y’s ability to receive full gold value when it purchases currency X or any other currency will not be affected. Y will receive more units if it purchases currency X after it is devalued and fewer if it is revalued. The reassurance that Article IV, Section 8, gives to Y is that Y’s privileges are unimpaired in gold value by a change in the par value of currency X or of any other currency that Y may wish to purchase.

One aspect of the reassurance that the provision gives to a member is that it can face sales by the Fund of its currency to other members without fear of loss. If the Fund sells a member’s currency, the member can be considered to give indirect financial assistance to the purchaser, i.e., through the Fund. If the currency is used by the purchaser for making payments to the member, the latter forgoes the addition to its reserves that would have resulted from payments to it by the purchaser with some means of payment in lieu of the member’s currency purchased from the Fund. If the currency purchased from the Fund is converted by the member for the benefit of the purchaser, a transaction which now takes place quite frequently,7 the member gives up the foreign exchange used for the conversion. In return, the member receives certain benefits. If the amount that the Fund holds of the member’s currency is more than 75 per cent of the member’s quota, so that the member has potential repurchase obligations, the sale of its currency reduces these obligations pro tanto. Moreover, the reduction in the Fund’s holdings increases the amount of other currencies that the member itself may purchase thereafter without the necessity for a waiver of the 200 per cent limit.8 The effect of Article IV, Section 8, is that these benefits equal, and will continue to equal, the gold value of what the member gave up for them when the Fund sold its currency. In particular, the provision ensures that the gold value of the amount of the currencies of other members that it will be able to purchase will be maintained.

These effects have been particularly important in connection with the attitude of members toward the gold tranche. Normally, the gold tranche is equivalent to the amount by which the quota of a member exceeds the Fund’s holdings of the member’s currency.9 The amount of the gold tranche will then represent the amount of a member’s gold subscription to the Fund plus the net amount of the member’s currency that the Fund has disposed of or minus the net amount of the member’s currency that the Fund has acquired. Members have tended to regard the gold tranche in economic terms as the net amount of resources that they have transferred to or through the Fund, and, therefore, it is of peculiar importance to them that the value of the gold tranche is maintained in terms of gold. Because the Articles enable members to purchase an amount equal to the gold tranche without challenge,10 because the gold value of this amount is maintained, and because this value is safeguarded by maintaining the gold value of the currencies that members can purchase, members are increasingly regarding their gold tranches as a reserve asset.11

A fifth and final generalization that may be made is that the adjustment of the Fund’s holdings when changes in par value occur means that changes in the composition of its holdings as a result of its operations do not subject it to financial risk. The Fund’s resources revolve in the sense that the Fund sells to members, in return for the purchaser’s currency, the currencies of other members, and later the purchasing member repurchases its own currency with gold, special drawing rights, or the currencies of other members. The Fund will not sustain a loss as the result of exchanging any currency for any other currency. The operation of Article IV, Section 8, will ensure that the gold value of what the Fund receives will be kept equivalent to the gold value of what it parts with notwithstanding any change in the par value of either currency. It is equally true that the Fund will not make a profit as a result of any of these exchanges.

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