8 Highlights of 1966 Through 1971
- Margaret De Vries
- Published Date:
- June 1986
The years 1966 through 1971 were extremely important ones in the evolution of the Fund. They were filled with turbulence and fundamental change in the international monetary system, which affected the functions and activities of the Fund. Three main developments stand out—creation of the SDR, substantially increased use of resources, and the onset of severe crises in the Bretton Woods system.
CREATION OF THE SDR
The SDR, a novel feature of the international monetary system, was established in the Fund on August 6, 1969, after the First Amendment of the Articles of Agreement had gone into effect and after a sufficient number of members had deposited the necessary instruments making them participants in the new Special Drawing Account.
Controversies, debates, and negotiations had gone on for more than a decade. In brief, in the late 1950s and early 1960s a few economists, mainly outside official circles, became concerned about the special role of the U.S. dollar in the international monetary system, particularly its increased use as the prime reserve of the system. They began to discuss the problem of international liquidity and to propose the creation of a new reserve unit to supplement the use of gold, the supply of which was insufficient, or of national currencies, such as the U.S. dollar. One proposal, for instance, made in 1962 and 1963 was that a collective or composite reserve unit (CRU), consisting of a stated proportion of the leading currencies, be created by a group of industrial countries and used as exchange between their monetary authorities.
The start of the official discussions that led to the eventual creation of the SDR was probably the announcement by President John F. Kennedy to the Board of Governors on September 30, 1963 at their eighteenth Annual Meeting, held in Washington, that the United States “stands ready to support such measures as may be necessary to increase international liquidity.” At that time, the Group of Ten—the finance ministers and central bank governors of the ten countries participating in the Fund’s General Arrangements to Borrow1 stated their intention to examine the topic of international liquidity. Simultaneously, Pierre-Paul Schweitzer, Managing Director, announced that the Fund as well was intensifying its study of international liquidity. Five years to the day after President Kennedy’s statement, President Lyndon B. Johnson, on September 30, 1968, announced to the Board of Governors, at their twenty-third Annual Meeting, again in Washington, that the United States was among the first to accept the proposed First Amendment to the Articles of Agreement, which established in the Fund the mechanism for creating the SDR. Almost another year went by before a sufficient number of members had accepted the First Amendment, permitting it to become effective on July 28, 1969, and not until August 6, 1969 did the required number of members deposit the necessary instruments of participation in the Special Drawing Account, permitting the SDR to come into existence.
The period from 1963 to 1969 was filled with discussions and negotiations about whether any new reserve asset was needed at all and about the specific features required for such an asset. For years, the concept of creating a reserve asset, and even the term itself, was repugnant to some national authorities, who preferred something more comparable to international credit, such as drawings on the Fund. There were also sharp differences between the monetary authorities of the industrial countries who favored expansion of the supply of world liquidity through the introduction of a new reserve asset and others, mainly the six original members of the European Community (EC),2 who wished to see, first, the elimination of the balance of payments deficits of the United Kingdom and the United States. The EC countries were concerned that, if new sources of balance of payments financing were available, the United Kingdom and the United States, which were under less pressure to correct their balance of payments deficits because their currencies were held as reserves by other countries, would pursue domestic fiscal and monetary policies that would aggravate world inflation. Accordingly, progress in the discussions often hinged on the status of the balance of payments of these two reserve currency countries, as well as on the levels of world reserves, especially of gold. Meanwhile, study groups were set up to examine proposals for deliberate reserve creation.
As a result of their differing viewpoints, by September 1965 the authorities of the countries of the Group of Ten could agree only to draft a contingency plan for reserve creation—that is, a plan that could be used if a supplement to world reserves was ever needed. Thus, it was necessary to work out both the provisions of such a contingency plan and the method of implementation.
In 1966 Mr. Schweitzer took an important initiative by proposing arrangements for reserve creation that would operate through the Fund and include all Fund members. Not only did he propose these arrangements to the Group of Ten but he also spoke out repeatedly against the limited participation then being favored by the Group of Ten and strongly advocated a worldwide arrangement.
Determining the features of the new reserve asset and the method of allocation took the better part of two years. The Deputies of the Group of Ten met nearly every six weeks, while the Fund’s Executive Directors and management and staff met regularly and discussed intensively all the relevant issues. Then in an unprecedented move, the Fund’s Executive Directors held four joint meetings with the Deputies of the Group of Ten to exchange views and facilitate agreement on a plan.
The most crucial question concerned the number of countries entitled to receive the new asset. Undoubtedly, the most significant outcome of the long negotiations was agreement on a plan that included all Fund members, both developing and industrial countries. But there were other important questions as well: How was the new asset to be financed? What rules would govern its use? Would the new asset be subject to repayment? In finding answers to these questions, the basic issue was whether the new instrument would be a genuine reserve asset, freely usable and not subject to repayment, or whether it would more closely resemble credit, subject to rules for its use and to repayment obligations. Some countries—mainly the United States and the United Kingdom—preferred to shape the new reserve in such a way that it would be readily accepted in place of gold; other countries—most notably France—were eager to retain gold as the heart of the international monetary system and strongly preferred that the new unit be more like credit than like money. The SDR that finally emerged was a compromise—what the General Counsel of the Fund called an alchemy, a blend of both a reserve asset and a credit.
After the specific features of the SDR had been decided on, the difficult question of what voting power would be required for the entry into force of this plan and for any decision to create SDRs thereafter had to be answered. The majority of 85 percent of the total voting power of the Board of Governors was agreed on, and as part of the compromise, at the insistence of the EC countries, it was agreed that certain changes in the Fund’s rules and practices regarding its regular resources would also go into effect.
Thus, the principal elements of a plan entitled “An Outline of a Facility Based on Special Drawing Rights in the Fund” gradually took shape over a four-year period. The Board of Governors approved the Outline at the Fund’s twenty-second Annual Meeting in Rio de Janeiro on September 29, 1967. It remained to incorporate the plan into the Fund’s machinery, and for this it was necessary to translate the general terms of the Outline into the precise language required for an amendment to the Articles of Agreement. This First Amendment took the form of 13 new Articles and 4 new Sections, plus other substantial changes in the Articles. As the drafting in the Fund proceeded, once again a meeting of the Group of Ten was called to permit the industrial countries to settle their differences. A proposed amendment to the Articles was, nonetheless, drafted within a few months, and the Board of Governors approved it in May 1968.
The First Allocation of SDRs Much work still had to be done both by the Managing Director and the staff and by the Executive Directors before the first allocations of SDRs could be made. Again there was discussion of the question of how the need for supplementing world reserves should be determined. In brief, the decision to allocate SDR 9.5 billion over a three-year period beginning January 1, 1970, which was approved by the Board of Governors at the 1969 Annual Meeting, was based on a determination that the world reserve situation existing at the time was tight.
Before SDRs could actually be allocated and put into use, other important and difficult decisions also had to be made: How should the principles governing transfer of SDRs between participants in the Fund’s new Special Drawing Account be implemented in practice? How far should the Fund go in exercising its authority to accept SDRs in place of gold or members’ currencies in its General Account? The first issue, which had come up in many previous discussions, was the degree of ease or of constraint to be placed on transfers between participants. Again, some Executive Directors were concerned that a few industrial members would have to hold the bulk of the SDRs, while other Executive Directors were afraid of making the use of SDRs so restrictive that they would not become fully accepted as reserves. With regard to the second issue, it was clear that the Fund’s acceptance of the SDR in its operations and transactions in the General Account would help to establish the new unit but there was the danger that the Fund itself might hold excessive amounts of SDRs. The Executive Directors had to weigh the various factors, and in taking the necessary decisions, they played a unique role in the successful launching of a new reserve asset.
The SDR became an accepted reserve asset even more quickly than its advocates had dared to hope. By the time of the 1970 Annual Meeting, in Copenhagen, Mr. Schweitzer was able to state that “in my judgment, the experience up to now with the operation of the special drawing rights facility has been highly successful, and it can be stated that the SDR has become established as a reserve asset.” And after the middle of August 1971, when the United States suspended convertibility of officially held dollars into gold, monetary officials began to suggest giving the SDR an increasingly prominent role in the international monetary system.
INCREASED USE OF THE FUND’s RESOURCES
The economic and financial circumstances of the years from 1966 to 1971 presented challenges to the Fund with respect to the use of its general resources, and the Fund responded in various ways.
One, the compensatory financing facility, which had been introduced in 1963, was extended and liberalized in September 1966 for the first time. This liberalization and extension came about largely as an offshoot of the discussions that led to establishment of the SDR. When it appeared that a new scheme for deliberate creation of reserves might be limited to a few large industrial members, several monetary authorities suggested that the Fund liberalize the use of its resources by its developing members. Subsequently, in 1967–68 and again toward the end of 1971, despite the tremendous boom in commodity markets that was then getting under way, use of the compensatory financing facility increased. The need for compensatory financing had become so great that, as 1971 came to a close, officials from developing members were recommending further liberalization of the facility. (These recommendations were forerunners of the more extensive changes in the facility enacted in December 1975.)
Two, the Fund introduced a buffer stock financing facility. During the years 1966–71 one way in which developing members sought assistance was to ask the Fund and the World Bank to do a joint study of the stabilization of prices of primary products. After extensive examination in 1969, the Fund took a decision to introduce a facility especially for financing contributions to international buffer stocks of primary products.
Three, the Fund took a more active part in helping members finance their balance of payments deficits. Drawings on the Fund were significantly higher in 1966–71 than in any previous period since the Fund commenced operations in 1947. Several industrial members experienced severe balance of payments deficits in the late 1960s, and many developing members continued to have large deficits. In 1968 and 1969, especially, substantial drawings from the Fund took place, as first the pound sterling and later the French franc came under severe pressure and the United Kingdom and France each came to the Fund for a stand-by arrangement.
In the 1966–71 period, the Fund approved two stand-by arrangements for the United Kingdom. The first, approved in November 1967 in conjunction with the devaluation of the pound sterling, was intended to create confidence in the new rate of $2.40 for the pound. The amount was $1.4 billion, which at the time equaled the largest transaction in which the Fund had ever engaged—the drawing by the United States of May 1965.
The stand-by arrangement of November 1967 was negotiated in an atmosphere of crisis, following intensive discussions. Some Executive Directors, especially those for developing members, supported the proposed stand-by arrangement for the United Kingdom but believed that the terms were not as strict as those used by the Fund for many developing countries. They therefore requested a review of the Fund’s policies on the use of its resources under stand-by arrangements. After completing the review, the Executive Directors adopted guidelines in September 1968 to ensure uniform and equitable treatment in standby arrangements for all members.
The improvement in the U.K. balance of payments expected after the devaluation of the pound sterling did not materialize for some time. Hence, in June 1969, the United Kingdom requested another stand-by arrangement, this time for $1 billion. Under the terms of this stand-by arrangement, the Fund required, for the first time, that quarterly reviews of the British economy be conducted before each drawing. The procedure of reviews prior to full use of the arrangement was used again for the two-year stand-by arrangement for the United Kingdom approved in January 1977. In the course of 1969 a vast improvement in the balance of payments of the United Kingdom got under way, and by the end of 1971 it was able to repay nearly all of its debts, including that to the Fund.
The stand-by arrangement of $985 million that the Fund approved for France in September 1969 followed strictly the form of the September 1968 decision. France’s balance of payments objective, to achieve equilibrium within less than a year, was realized, so that France was also quick to repay its debt to the Fund. In addition to the stand-by arrangements for these two industrial members, the Fund approved stand-by arrangements during 1966 through 1971 for many developing members, several of whom had more or less continuous support from the Fund.
As the stand-by arrangement became the primary vehicle through which members made use of the Fund’s resources, and as stabilization programs were usually a prerequisite for a stand-by arrangement, what is called “financial programming” gradually became one of the Fund’s major activities. Financial programming consists of agreement between the Fund and a member on monetary, fiscal, and other policies in that country to produce a desired balance of payments result. The Fund’s keen interest in the stabilization policies of a member asking for a stand-by arrangement led to the development of new techniques for quantifying monetary targets, as well as the economic concepts and analysis underlying such quantification. Thus, the Fund was a pioneer in formulating analysis and methodology for the monetarist economics increasingly being used by economists and central bankers in the 1970s.
The fourth way in which the Fund responded in 1966–71 to members’ increased need for its resources was to enlarge its resources, especially through a third round of general increases in quotas following the Fifth General Review of Quotas. The Fifth General Review, which became effective in 1970, necessitated the resolution of many very difficult questions. How large should the increase in quotas be? This question was unusually difficult to answer because the general increase in quotas was coming up at the same time as the first allocation of SDRs was expected. Some industrial members took the position that if the increase in quotas was sizable, no SDR allocations need occur. At the very least, the magnitudes of the amounts involved in the two exercises were interrelated. Another question was, How much of the enlargement in quotas ought to be in the form of a general increase, available to all members, and how much in the form of special increases available to individual members? The positions of industrial and developing members on these questions differed markedly.
The discussion of quotas in the 1966–71 period was intense. Members were making greater use of the Fund’s resources, and their quotas determined how much they could draw. Also, as problems of the international monetary system were of increasing interest and gaining importance, members became concerned about their relative voting positions in the Fund, which were also determined by their quotas. The first allocation of SDRs was about to begin, and the size of the allocation was determined by the member’s quota. For all these reasons, some of the largest members, such as France, Italy, and Japan, were insisting on larger quotas to reflect their strong economic positions in the world economy. At the same time, the developing members argued that the so-called Bretton Woods formula traditionally used to calculate quotas worked seriously to their disadvantage and asked for a review of the formula. Quotas thus became a contentious and controversial issue.
CRISES IN THE BRETTON WOODS SYSTEM
Although the use of flexible rates for most major currencies actually emerged in March 1973, some officials fix the date for the collapse of the Bretton Woods system as August 15, 1971, when the U.S. authorities suspended the convertibility of officially held dollar balances into gold. And many monetary experts have, in retrospect, cited 1971 as historically significant in the same sense as 1931, the year when the United Kingdom suspended convertibility of the pound sterling: the U.S. action of 1971 meant that the international monetary system could no longer function in the same way.
The collapse of the Bretton Woods system did not appear imminent at the start of 1966. In fact, as late as the end of 1967—especially after the devaluation of the pound sterling—it seemed to many monetary officials that the problems disrupting the smooth functioning of the international monetary system were being alleviated. The deficits of the United Kingdom and the United States were already being greatly reduced. Moreover, after years of deliberation, the SDR had finally been created and it was hoped that this new mechanism for reserve creation could substitute for the losses in reserves in the form of pounds sterling or U.S. dollars that would accompany the elimination of the U.K. and U.S. deficits.
Signs of impending trouble, however, were on the horizon, even at the end of 1967. A flight from the dollar into gold occurred almost immediately after the devaluation of sterling, as speculators feared that the dollar, too, might be devalued. In early 1968 the long-standing arrangement in which gold was bought and sold in one market for all transactions (private as well as official) at a fixed, officially maintained price of $35 an ounce—unchanged since the early 1930s—collapsed. Two separate markets were established for gold transactions, one for official transactions at $35 an ounce and one for private transactions at a price to be determined in free markets. Subsequently, there was a gradual rise in the free market price to levels many times the official price.
Then, in January 1970, even before the first SDRs could be allocated, the international monetary system was subjected to further strain. The French franc came under pressure and so did the deutsche mark, and short-term capital flows became even larger. Hence, in the two years after the devaluation of sterling, not only was the single official price for gold abandoned and a two-tier gold market set up but also the French franc was devalued and the deutsche mark revalued. Then, from May 1970 to May 1971 floating exchange rates were introduced for the Canadian dollar, the deutsche mark, and the Netherlands guilder. Short-term capital movements had been so mobile and volatile, and the magnitudes involved so large, that par values could no longer be defended. Nor could they be changed in an orderly way. Finally, on August 15, 1971, came the U.S. suspension of convertibility. The United States itself had balance of payments deficits that were exceedingly large in relation to the size of its official gold holdings. Two pillars of the Articles of Agreement—the par value system and the gold convertibility of the dollar—crumbled.
After four months of difficult negotiations, the ministers and central bank governors of the Group of Ten, meeting at the Smithsonian Institution in Washington in December 1971, reached agreement on the realignment of their currencies. New fixed rates were introduced for the major currencies, except for the Canadian dollar. Immediately thereafter, the Fund’s Executive Board adopted a decision on a temporary regime of central rates and wider exchange rate margins. The magnitude of the crisis, however, had generated a consensus on the urgent need for a thoroughgoing reform of the entire international monetary system.
Note: This article has been adapted from articles written on the occasion of the publication of The International Monetary Fund, 1966–71: The System Under Stress, Vol. I, Narrative, by Margaret Garritsen de Vries, and Vol. II, Documents, edited by Margaret Garritsen de Vries (Washington: International Monetary Fund, 1976), and published earlier in a slightly different form in IMF Survey (Washington), Vol. 6 (April 18, 1977), pp. 114–21.
Belgium, Canada, France, the Federal Republic of Germany, Italy, Japan, the Netherlands, Sweden, the United Kingdom, and the United States.
Belgium, France, the Federal Republic of Germany, Italy, Luxembourg, and the Netherlands.