1 High Time for a Broad Review
- James Boughton, Peter Isard, and Michael Mussa
- Published Date:
- September 1996
In addition to the regular sessions of the seminar, the two luncheons provided opportunity for further reflection on the “big picture” of the future role of the SDR.
The luncheon on the first day of the seminar featured a keynote address by the Managing Director of the Fund, the text of which follows.
It is a great pleasure for me to welcome all of you to this seminar. Although most of you come to the IMF from time to time, rarely do we have the opportunity to reflect upon some of the longer-term issues concerning the international monetary system—especially the directions in which the system might evolve and the possible implications for the SDR. Although the purpose of this seminar is more than just celebration, what could be a more fitting way to commemorate the fifty years since the inaugural meetings of the IMF’s Board of Governors than to gather together such a distinguished group to consider these issues so close to the heart of this institution’s purposes?
If it is fifty years since the first meeting of the Board of Governors, then it is also about a quarter-century since the first SDR allocation of 1970-72, and fifteen years since the last SDR allocation in 1981. A good time—or perhaps I should say, “high time”—for a fresh look at the issues surrounding the SDR, for a frank exchange of ideas, and, I hope, for a consensus to emerge on how to move the SDR debate forward. Indeed, this is what the Interim Committee had in mind when, at our suggestion, it requested “a broad review, with the involvement of outside experts, on the role and functions of the SDR in light of changes in the world financial system.”
Where does the policy debate stand and how might we move it forward?
From my vantage point, I see broad agreement on several important issues. First, the membership agrees on the need to maintain some role for the SDR in the international monetary system and on its usefulness in the Fund’s financial operations and structure. Second, there is broad agreement that all member countries should be included in the SDR system—a view that was voiced at the Naples summit and again at the Halifax summit last summer. Let us hope that thanks to your creative suggestions, we will not have to hear that for a third time from the Lyons summit next June. Third, there is also a very strong consensus that an SDR allocation is warranted—and, indeed, overdue—for the 38 member countries that have never received an SDR allocation, although views differ on the form that such an allocation should take.
Clearly, a large part of the controversy over SDR allocations in today’s global economy stems from the allocation criterion of “long-term global need.” Indeed, some members have questioned the existence of a long-term global need on several occasions, and, since 1981, no SDRs have been allocated. Yet since then, the global stock of non-gold reserves—acquired in many cases at significant cost to Fund members—has risen at an average annual rate in excess of 7½ percent, significantly more than even the largest allocations ever discussed by the membership. This cost to our members of acquiring reserves is a permanent reminder of the necessity of reaching a better common understanding of the potential contribution that the SDR could make in the supplementing of reserves.
In my view, there is, in fact, a growing global need for reserve assets in today’s expanding world economy. The controversy centers partly on how “long-term global need” should be measured, but more on how it should be met. The criterion of “global need” is, of course, essential, because without it, there could be a temptation to create more liquidity than is prudent and desirable. But with the global stock of nongold reserves standing at SDR 923 billion at end-1995, it is hard to make a convincing case that the modest amounts proposed for allocation to date would have a perceptible effect on global inflation. As long as there is a growing global need for reserve assets, some fraction of that need for additional reserves could be met by SDR allocations rather than by other reserve assets that countries must otherwise acquire. As noted at the time of the allocation during the third basic period, “the decision to allocate special drawing rights does not depend on the finding that the long-term global need cannot be met except by allocation.” On the question of how the long-term global need should be met, the point has been made that for most members of the Fund the cost of acquiring and holding international reserves is higher than the economic opportunity cost of providing such reserves through an SDR allocation, especially given the volatile nature of borrowed reserves.
I hope that this seminar will help clarify first some of the other pros and cons of allocating SDRs to meet a small share of the global need for reserves. In particular, I have in mind the situation of the roughly one-third of developing countries and countries in transition that have reserves equivalent to less than eight weeks of imports—well below the three months of import coverage often considered reasonable as a rule of thumb. Indeed, many of these countries’ reserve holdings are below that level. Many of these countries are pursuing strong reform programs supported by the Fund. However, to increase their reserve holdings beyond their current levels would require either expensive borrowing in the market—to which many countries do not have access—or a compression in domestic demand and imports that would be detrimental to their adjustment efforts. In this context, could a general allocation of SDRs help reduce the risk of setbacks in countries’ adjustment efforts and prevent the adverse spillover effects of a compression of imports on the world economy?
In looking for a way forward on the allocation question, perhaps we should take the opportunity of the debate on the eleventh quota increase—which will, in any case, require parliamentary approval in a number of countries—to revive the debate on an amendment of the Articles. A general allocation would go a long way to alleviating the inequity I referred to earlier—the fact that a large number of Fund members have not received an SDR allocation. To achieve greater equity, an amendment could provide for harmonization of countries’ net cumulative SDR allocations to quota. For example, this ratio could be set at the average ratio of cumulative net SDR allocations to quota for members that have participated in all previous allocations (17.4 percent) or at the same ratio of cumulative net SDR allocations to quota that the most favored Fund member presently enjoys (25.8 percent).
When looking to the best way of keeping the amount of SDRs allocated to a reasonable minimal proportion of world reserves, we could also examine the pros and cons of a more far-reaching amendment of the Articles to seek a more thorough rationalization of the basis for allocating SDRs to member countries in the future—by establishing the principle that, henceforth, each member’s cumulative net SDR allocations must bear some uniform minimum in relation to its quota.
As important as these current SDR issues are, we must also keep the larger picture in mind. It is frequently pointed out that the role of the SDR today is largely the result of the major changes that have occurred in the international financial system since the SDR was first introduced. Should we be surprised, then, if the many changes currently under way in the global economy also turn out to affect the SDR’s future role? Indeed, perhaps we should put aside—however briefly—the political and institutional constraints of the moment and consider how, in light of these changes, the SDR might help improve the functioning of the international financial system of the future.
Although the globalization of the international capital markets is already quite advanced, surely markets will continue to evolve in ways that we cannot fully foresee. Some have argued that the globalization of the international capital markets reduces the need for reserves. For the few countries with virtually unlimited market access, this is probably true. But what of other countries whose access is less assured? In the aftermath of the developments in Mexico last year, the private capital markets were significantly less accessible to a number of countries—in terms of both the availability of resources to meet their reserve needs and borrowing cost. Moreover, many countries have become vulnerable or are potentially vulnerable to sudden shifts in market sentiment regarding their creditworthiness for reasons largely beyond their own control. Their need for reserves has increased, at a time when the willingness of private markets to supply those needs has diminished. If these trends continue, could the case for the SDR as a source of additional liquidity become all the more compelling—particularly at times of tension in the system, when the role of the SDR as a safety net could become quite useful?
Second, the establishment of the “euro” is on the horizon now, although we have not yet seen how it will affect the international financial system or our monetary arrangements. With the eventual emergence of the euro as the major European currency, perhaps one day we will have a system dominated by the dollar, the euro, and the yen (or perhaps, who knows, a composite Asian currency). Under these circumstances, could the SDR play a useful role as a central monetary asset? This development would have the merit of being consistent with the common undertaking of our membership—I quote the Articles of Agreement—”of making the SDR the principal reserve asset in the international monetary system.” Not less important, it could, in some circumstances, provide the system with an anchor that could be of some utility at times of systemic crisis. If that is a possibility—however distant the prospect may seem today—shouldn’t we at the very least keep the door open for the role of the SDR to evolve, along with the evolution of the monetary system?
Among the ways to keep that option alive would be to develop a more important role for the SDR now. How might this be done? One means might be to expand its use beyond official holders, leading in time to the development of a private market and possibly the determination of the SDR’s value in that market, and helping to prepare for the day when it could serve as an anchor for the system. An additional means might be through regular SDR allocations of modest size to help meet a small proportion of the increasing global demand for reserves and by encouraging its use among other entities.
Finally, who can tell what new developments lie just over the horizon? Whatever their nature, I would venture that they too will have important implications for the international monetary system and the future role of the SDR. The international financial system has evolved considerably since the birth of the Bretton Woods institutions, and even since the introduction of the SDR. As the world continues to change in new and unforeseen ways, let us hope that we will have had the foresight to maintain a full range of instruments at our disposal—so that we will be able to deal effectively with whatever comes next!
On this note, let me thank you once again for your participation in this seminar. After so many debates of a more political nature, we did need these refreshing exchanges with experienced officials and eminent scholars who devote their attention and research both to the international monetary system and to the monetary instruments that could be needed in view of the risks of globalization.
Our ambitions for the seminar go beyond striking a political compromise on pending issues. The SDR has been conceived as a building block of a better monetary order. It has failed so far to deliver that. But it remains as a building block, and our membership will certainly not want to abandon—modest as they may be—the chances it represents for all those who believe that markets are not always right and are frequently slow in providing acceptable solutions to problems—particularly for those who do not have access, or for whom access is too costly. So let me tell you that we fervently look forward to hearing your views. Do not hesitate to be bold. And if your preference goes to the deep reform or even to the cancellation of the existing system, then be equally bold and imaginative in suggesting something more credible and efficient to replace it. Let us hope that, thanks to the insights and ideas that emerge from this seminar, Executive Directors will be able to report back to the Interim Committee with some new, pragmatic ideas that will attract the broad support of our membership and suggest a way forward on the issue of SDRs.
The guest of honor at the luncheon on the second day of the seminar was the Honorable Henry H. Fowler, who—as Secretary of the U.S. Treasury 1965-69—was instrumental in promoting the reform of the international financial system through the development of international reserve assets to supplement the U.S. dollar. Without his leadership, the SDR might never have come into existence. In June 1965, at the request of U.S. President Lyndon Baines Johnson, Secretary Fowler organized a “study group” of experts on monetary issues to develop a set of recommendations for the Government on possible reforms to the international financial system. The following month, he announced—in a widely reported major policy address to the Virginia State Bar Association—that the U.S. Government was prepared “to participate in an international monetary conference that would consider what steps we might jointly take to secure substantial improvements in international monetary arrangements.” Although no such formal conference was held, this shift in U.S. policy provided a new impetus to the ongoing discussions within the Group of Ten industrial countries and led directly to the eventual agreement on the creation of the SDR. The following is excerpted from Secretary Fowler’s informal remarks at the seminar luncheon.
Henry H. Fowler
It is a real thrill for me to be here, as I have always felt that one of the great rewards of being Secretary of the Treasury is to be the U.S. Governor in the IMF and the World Bank. I have always thought that these are two wonderful organizations, and even after I left office in 1969 I wanted to do everything I could to help them. As you know, I later became the [first] Chairman of the Bretton Woods Committee. I have a rule that I always get out of being Chairman after seven years, and when that time came [in 1989], I told my colleagues I was leaving, and that I had found a young man who would make a good replacement, named Paul Volcker.
I have enjoyed being present these past two days, to meet with this distinguished group of people from many parts of the world, to take a fresh look at what is going on, and to hear the exchange of ideas on the issues and the role of the SDR. It has been 15 years since the last allocation of SDRs, and I hope that this seminar is an advance indication of the renewed role of the SDR in the world financial system. I really bring the heartiest congratulations to Managing Director Camdessus and his talented staff for bringing this group together and providing a splendid forum for these various dignitaries to express their different points of view about how the SDR can be made more effective in the world in which we now live.
I really have not been so thrilled since I brought in the last fiscal surplus in the U.S. Treasury [in 1969]! I am proud of that, as I am about the work that I did on the SDR. I do not want to get into my feelings about the SDR or the International Monetary Fund, but I would like to give you something of the flavor of the old days when the SDR did not exist and was in the process of being born. I am not going to speak of my own activities in that regard, but I thought it might be interesting if I read a short excerpt from a memorandum to me from President Johnson. It is reprinted in his book, Vantage Point [pp. 597-8], and it is dated June 16, 1965. The President starts off:
It has become clear to me that we must develop policies, covering a considerable period in the future, with respect to the development of the international monetary and payments system and the role of the United States in the system. The actions we have taken to bring our payments into balance will, over time, put substantial pressure on reserves abroad and hence on international trade and the growth of the world economy. The Free World will need some way of systematically producing the additional liquidity which has been supplied by the payment deficits of the United States. This will require international agreements among the nations which are the primary sources of liquidity. I recognize that considerable study has been devoted to these issues by the Long-Range International Payments Committee, chaired by the Treasury. However, I believe that it would now be desirable to push forward with more intensive effort, so as to be fully prepared for full-scale negotiations when the time is ripe and right.
In the light of your leading responsibility within the Government for forward planning on international monetary problems, I should like you to organize a small high-level study group to develop and recommend to me—through you, and the other principals directly concerned—a comprehensive U.S. position and negotiating strategy designed to achieve substantial improvement in international monetary arrangements. The Study Group should consist of appropriate senior officials from the Treasury, the State Department, the Council of Economic Advisors, the Board of Governors of the Federal Reserve System, and the White House. I understand that you would have in mind that it would be chaired by the Under Secretary of the Treasury for Monetary Affairs.
Without attempting to lay down rigid terms of reference, the following are some of the questions I have in mind:
- What are the possible means of reducing the United States’ vulnerability to political and economic pressure through the threatened conversion into gold of any overhang of official dollar balances?
- What are the possible and feasible means of assuring that credit will be available to deficit countries in amounts and on terms—maturity, interest, and automaticity—consistent with the realities of the adjustment process in a world of fixed parities where sharp deflation is not an acceptable alternative?
- How can we assure that the amount of reserve assets will expand at a rate which will facilitate maintenance of full employment, reasonably stable prices, and expansion of world trade? Any revised or new system for creating reserves should insure against the instability inherent in a two-reserve-asset or multiple-asset arrangement in which one asset is judged to be absolutely safe in terms of convertibility into the other(s), whereas convertibility the other way is unavoidably judged more uncertain.
The President then concludes a little bit later:
I believe it would be useful for you also to establish a panel of consultants, consisting of people outside of Government with broad knowledge in this field, who would be available to you for counsel. This consultant group might also be relatively small and include people from the academic, banking, and business communities. It would be appropriate to include people formerly with the Government, such as Douglas Dillon, Robert Roosa, and Kermit Gordon.
I should like to receive a progress report on the work of the Study Group by August 2, 1965, and from time to time as appropriate. In addition, I shall expect periodically to meet with you and the other officials concerned to discuss the problems and prospects.
Lyndon B. Johnson
So I thought you might be interested in what LBJ felt about the SDR at that particular time! Again, it is a great pleasure to me; I cannot tell you how much I appreciate the opportunity to hear these commentaries. Much of it I do not yet understand, but I intend to read all of these papers in the weeks to come. Thank you very much.