11 Highlights of 1972 Through 1978
- Margaret De Vries
- Published Date:
- June 1986
The main developments in the Fund’s evolution in the seven years from 1972 to 1978 can be summarized under six headings: negotiations for a reformed international monetary system, the Second Amendment of the Articles of Agreement, development into an important lending institution, experiences with floating rates, developments in the SDR, and continued evolution as an international organization.
NEGOTIATIONS FOR A REFORMED SYSTEM
Plans for a reformed international monetary system were first developed by the Fund staff and discussed by the Executive Board in the first nine months of 1972. Thereafter, negotiations went on in the Committee of Twenty and covered virtually all features of a monetary system.1
Exchange Rates Undoubtedly, the most critical, and controversial, topic discussed was the nature of the exchange rates to be used in the reformed system. The Committee of Twenty, like the Fund staff and the Executive Directors, started from the premise that the exchange rate mechanism in the reformed system would be one of “stable but adjustable par values.” The countries of the European Community, particularly France, were eager to have a par value system, and they were supported by the Fund’s developing members. The authorities of the United States had been disturbed by the rigidity of exchange rates under the par value system in the late 1960s and 1970s but were willing—at least initially—to agree to another par value system, provided the new system had features to ensure its flexibility: (1) reserve currency countries should be able to change their par values more readily than under the previous system; (2) the Fund should be authorized to take the initiative in suggesting par value changes to its members; (3) substantially wider margins should be accepted; (4) some kind of objective indicators to suggest the need for changes in par values should be introduced; and (5) the Fund should have more power to approve temporary floating rates.
While nearly all members accepted the need for greater flexibility in the exchange rate mechanism, views were strongly divided as to how much and what kind. Extended arguments took place, for example, over a U.S. proposal for “reserve indicators.” Under this plan, changes in reserves would signal the need for balance of payments adjustment, especially through changes in exchange rates. Pressures might be applied against members that failed to adjust.
It was while these debates were going on in early 1973 that floating rates for the main currencies, especially for the U.S. dollar, were introduced. Thereafter, agreement on any par value system became elusive. Nevertheless, discussions continued. Then after the big jump in oil prices at the end of 1973, which led to massive worldwide payments imbalances, nearly everyone expected that floating rates would, in practice, continue indefinitely. In January 1974 the Committee of Twenty agreed that it was best in these circumstances to give up trying to negotiate a fully reformed system and instead to let a new international monetary system evolve out of existing arrangements.
The issue of exchange rates in the new monetary system was nevertheless not yet settled. While most monetary authorities admitted that circumstances permitted no alternative to floating rates for the main currencies in the foreseeable future, debates nonetheless persisted throughout 1974 and most of 1975 in both the Executive Board and the Interim Committee, the successor body to the temporary Committee of Twenty.2 The authorities of the United States and France, in particular, took opposing positions as to whether legal sanction could be given to floating rates in the amended Articles of Agreement, with the United States in favor and France against.
The amended Article IV on exchange arrangements was agreed to only after the authorities of the United States and of France, in intensive bilateral negotiations that went on from August to November 1975, reached a consensus on the likely future of the international monetary system and worked out a draft version of the Article. (J. de Larosiere, later to be Managing Director, served at the time as the principal negotiator for the French authorities.) The Article provides for freedom of choice in exchange arrangements, but members are subject to collaboration with, and surveillance by, the Fund. It also provides for introduction of a par value system when a sufficient number of members are ready.
International Liquidity A second critical feature of an international monetary system that was intensely discussed in the negotiations of 1972–74 was the management of international liquidity. The issue at the time revolved around the use of national currencies, particularly the U.S. dollar, as reserves in the international monetary system. It was argued that the use of a national currency as reserves gave the issuing country an unfair advantage, since it could run prolonged balance of payments deficits that would generate excessive liquidity on a worldwide basis. Various arrangements for reducing the use of national currencies in a reformed system were considered. Discussions centered on “asset settlement,” in which all countries would have to use primary reserve assets, such as gold or SDRs, to settle their international accounts. Asset settlement would thus eliminate the further injection of reserve currencies into the system. Considerable attention was given also to the idea of a “substitution account,” under which the Fund would distribute special issues of SDRs against balances of reserve currencies tendered to it by its members. A substitution account would thus reduce the existing supply of reserve currencies in the system. Many proposals were made as to how to implement a substitution account for reserve currencies, but no agreement was reached. In 1975, at the insistence of the developing members, the Executive Board, while considering draft amendments to the Articles relating to gold, discussed a possible substitution account for gold. Under the arrangement proposed, the Fund would exchange SDRs for some of the gold tendered to it by members. Existing stocks of gold, which also formed part of the supply of international liquidity, would thereby be reduced. A substitution account for gold was viewed as less controversial than a substitution account for reserve currencies, but agreement could not be reached even on this proposal.
Long after the Committee of Twenty concluded its work, H. Johannes Witteveen, Managing Director, continued to be concerned about the management and control of international liquidity in the international monetary system. As time went on, currencies other than the U.S. dollar and the pound sterling, such as the French franc, the deutsche mark, the Swiss franc, and the yen, were gradually also being used as reserve currencies, and Mr. Witteveen warned that this multicurrency reserve standard had the potential for injecting even more liquidity into the system. But he considered the huge amounts of liquidity that had come to be supplied by private capital markets as much more worrisome. In Mr. Witteveen’s view, the potential growth of international liquidity and the spectacular growth in international private credit so that countries could finance their balance of payments deficits by borrowing, made for a serious gap in the world’s anti-inflationary defenses. Therefore, in April 1978, shortly before leaving the Fund, he again proposed that a substitution account for reserve currencies be considered. (Financial officials held intensive discussions of a substitution account throughout 1979 and much of 1980, but again they reached no agreement.)
Reserve Assets A topic closely related to that of international liquidity also discussed by the Committee of Twenty was that of reserve assets. The Committee focused on the question as to whether the new asset, the SDR, was to be made the primary reserve asset of the reformed system. Eventually the Committee agreed that it was. Having so agreed, however, it still had to decide the more difficult questions involved in actually making the SDR the primary reserve asset. For example, what should be the role of gold in the system? Would monetary authorities be willing to hold the new and unfamiliar SDR in their reserves and to use it in their international financial transactions? How could the SDR be made a more attractive reserve asset so as to make it more competitive with the traditional reserve assets of national currencies and gold?
While all of these and other questions were examined in the negotiations for a reformed system, many of them remained unanswered when the Committee of Twenty completed its work in June 1974. Hence, as the many amendments that were to become the Second Amendment to the Articles of Agreement were hammered out in the course of July 1974 to March 1976, answers to many of these questions had still to be found.
SECOND AMENDMENT OF THE ARTICLES OF AGREEMENT
Since April 1, 1978, after the entry into force of the Second Amendment of the Articles of Agreement, the Fund has functioned under an almost wholly revised charter. Few provisions of the original Articles remained the same, and fundamental changes were made in several of the concepts of the original Articles. The entry into force of the Second Amendment, moreover, brought to an end the extraordinary period for the Fund that began on August 15, 1971, when the United States suspended official convertibility for the dollar. This period of nearly seven years was characterized by international monetary arrangements in which no members were performing their exchange rate obligations in accordance with the Fund’s Articles.
Negotiating the provisions of the Second Amendment was a complex and protracted process. It began on July 9, 1974, shortly after the Committee of Twenty completed its work, when the staff started to circulate drafts of individual amendments to the Executive Board. It continued until April 30, 1976, when the proposed Second Amendment was finally submitted to members for acceptance. It was to take nearly another two years for the required three fifths of the Fund’s membership—representing four fifths of the total voting power—to accept the Second Amendment, thus bringing it into force.3
The staff provided the Executive Board with drafts, redrafts, and explanatory memorandums for nearly two years. The Executive Directors discussed and negotiated individual amendments during 280 hours of debate at 146 sessions, seeking the guidance of the Interim Committee on issues that could be resolved only at the political level. The amended provisions of the Articles for two subjects—exchange rates and gold—were so controversial as to require separate negotiations by high-ranking officials of a few of the largest industrial members in forums outside the Executive Board and the Interim Committee. Thus, before the provisions on exchange rates could be agreed to, bilateral negotiations had to take place between the United States and France. Before the provisions in gold could be agreed to, a prolonged series of arrangements had to be worked out involving (1) the sale of one sixth of the Fund’s holdings of gold (25 million ounces), with the profits to be placed in a Trust Fund for the benefit of developing members; (2) direct “restitution” to members of another one sixth (25 million ounces) of the Fund’s gold, that is, the sale to them of gold at the official price of $35 an ounce; and (3) arrangements whereby central banks were free to enter into transactions in gold among themselves at mutually determined prices rather than at the official price.
In brief, the main objectives of the Second Amendment are to allow members to choose their exchange arrangements; to aim at a gradual reduction in the role of gold in the international monetary system; to make the SDR the principal reserve asset of the system; to modernize the Fund’s operations and transactions; to make changes and allow for possible future changes in the Fund’s organizational structure; and to give the Fund the capability to adapt to further developments in the international monetary system.4
DEVELOPMENT INTO AN IMPORTANT LENDING INSTITUTION
It was in the second half of the 1970s that lending to members became the Fund’s primary activity. Previously, much of the use of the Fund’s resources had been directed toward making the international monetary system function smoothly, or at least toward coping with threats to the system. To this end, for example, the Fund established the General Arrangements to Borrow and the SDR and engaged in strenuous efforts to help retain the par value system. The largest drawings were undertaken to restore confidence in the major currencies, particularly the pound sterling.
The enlargement of the Fund’s lending functions in the mid-1970s was a consequence of the collapse of the Bretton Woods system in March 1973 and the first round of oil price increases in December of the same year. Concerned that the big oil price rises and the resultant massive balance of payments deficits might, in the absence of structured monetary arrangements, lead to trade and exchange warfare and severe world recession as had been experienced in the 1930s, Mr. Witteveen took several innovative steps to increase the Fund’s lending activity and capacity. In January 1974, he proposed creation of a special temporary oil facility, which, in a departure from standard practice, was to be financed by borrowing from members. This 1974 oil facility was followed by another in 1975. Between September 1974 and May 1976, when the 1975 oil facility was terminated, 35 members drew a total of SDR 6.9 billion in 156 transactions under the two facilities.
The Fund took other steps after 1973 to help members finance balance of payments deficits. In September 1974, it introduced the extended facility to give medium-term assistance to developing members. In December 1975 it again liberalized the compensatory financing facility, this time substantially. It had introduced the facility in 1963 to provide financial assistance to members experiencing balance of payments difficulties resulting from export shortfalls that were temporary and due largely to factors beyond the member’s control, and had liberalized and extended the facility for the first time in 1966. In the liberalization of 1975, the maximum entitlement in terms of quota that a member might draw under the compensatory financing facility was increased, and the method of computing export shortfalls was changed so that calculated shortfalls would be larger and so that a member could receive assistance early in the shortfall year. In the years 1972 to 1978, the Fund also approved an increased number of stand-by arrangements, more than 100 in these seven years. Among the stand-by arrangements were unusually large ones approved for the United Kingdom and Italy, which were for 24 months and 18 months, respectively, instead of the usual one-year period. Many members also drew all or part of their reserve (formerly gold) tranche positions. Thus, in the seven financial years from May 1, 1971, through April 30, 1978, drawings totaled SDR 23.4 billion.
The Fund’s capacity to lend was enhanced by the two general reviews of members’ quotas in the second half of the 1970s, which led to a doubling of total quotas to SDR 60 billion from SDR 29 billion. The Sixth General Review went into effect on March 31, 1978 and was closely followed by the Interim Committee’s agreement in September 1978 to the Seventh General Review. In addition, in August 1977 a decision was made to establish a supplementary financing facility, also based on borrowing from members, to become operative when loan agreements totaling not less than SDR 7.75 billion were completed. (This facility went into effect early in 1979.)
The Fund provided still more assistance to the poorest developing members through a newly established Trust Fund, which was managed by the Fund. The Trust Fund was financed by the proceeds from the sale of some of the Fund’s gold holdings. Eligible members could apply for low interest loans that were to be repaid in ten equal semiannual installments starting five years from the date of the loan. The amount of loans made available through the Trust Fund was considerably larger than had been expected when it was inaugurated. For example, from July 1, 1976 to June 30, 1978, the first two years of its operation, 43 members received loans totaling SDR 841 million ($1,023 million).
As use of the Fund’s resources increased, “conditionality” became a familiar term in the international financial lexicon. (It refers to the conditions that the Fund attaches to the use of its resources.) Conditionality came under mounting and intense criticism in the second half of the 1970s. To help meet these criticisms, the Fund undertook a broad review of its conditionality in 1978, the first general review of the policy on use of its resources since 1968. This review resulted in new guidelines approved by the Executive Board in March 1979.
Taken together, these developments gave rise to complex changes in the Fund’s financing. A single policy on the use of resources was replaced by a range of policies. Conditionality, which ties the availability of resources to satisfactory economic programs, became the distinctive feature of the Fund’s financial activities. The use of resources was no longer undertaken in defense of a par value system but to promote effective and durable adjustment and restoration of the conditions for balanced and sustained economic growth.
EXPERIENCES WITH FLOATING RATES
Under the present system of exchange rates, some currencies float independently, some float jointly, and some are pegged, and as mentioned earlier, the amended Articles of Agreement permit members to apply the exchange arrangements of their choice, subject to collaboration with and surveillance by the Fund. This system is very different from the system of par values established at Bretton Woods in 1944. The new system, characterized mainly by floating rates for the main currencies, came into being on March 19, 1973.
Briefly what happened is as follows. As 1972 opened, financial officials inside and outside the Fund, encouraged by the agreement on exchange rates reached at the Smithsonian Institution in December 1971, tried to make these new rates viable. They experienced several setbacks, however, including the the floating of the pound sterling in June 1972. Then in early 1973, the U.S. dollar had to be devalued for the second time in 14 months, the Italian lira and the Japanese yen floated, the countries of the European Community (EC) introduced a joint float against the U.S. dollar, and the par value system finally collapsed. As described earlier in this article, efforts to introduce a reformed par value system were also gradually given up.
The par value system had worked smoothly for almost a quarter of a century, from the end of World War II until about 1970. This period, moreover, was one of unparalleled world economic prosperity. The Fund’s role in fostering this prosperity was to help its members attain realistic exchange rates, a progressive liberalization of their trade and payments from the tight restrictions that were one of the legacies of World War II, and eventual currency convertibility. Attainment of a liberal trade and payments regime was an important stimulus to the growth of world trade and international investment, which, in turn, was instrumental to world economic expansion.
In retrospect, it is clear that several unique circumstances helped to make the par value system work smoothly for nearly 25 years. First, the United States was willing to reduce its large stocks of gold to foster a better world distribution of reserves. Second, the dollar took on a special role as a transactions or vehicle currency, as an intervention currency, and as a reserve currency. Since prices in the United States remained stable, this “dollar standard” in place of the envisaged gold exchange standard was acceptable to other countries, which were willing to accumulate dollars. Third, the large industrial countries were able to effect balance of payments adjustment relatively easily by changing their macroeconomic policies and hence did not need to alter their exchange rates. Balance of payments adjustment was readily accomplished, partly because of the existence in industrial countries of unutilized capacity, including labor, which enabled countries to expand output and exports quickly and without inflation.
By the mid-1960s, however, the par value system was beginning to encounter trouble. Of the three problems, liquidity, adjustment, and confidence in reserve assets, that were identified, priority was given to solving the liquidity problem. With hindsight, it is widely agreed the adjustment problem received insufficient attention. Adjustment problems caused the system ultimately to collapse in 1973, and the need for adjustment continued to be the central issue facing many countries in the mid-1980s.
Since 1973 Fund members have used a variety of exchange arrangements. The vast majority, particularly the developing members, peg their exchange rates, either to a single currency—such as the U.S. dollar, the pound sterling, or the French franc—or to some composite (or basket) of currencies, such as the SDR. Most large industrial members have floating rates of one form or another. In Europe after 1973 most of the countries of the EC participated in the European common margins arrangement (“the snake”), in which they undertook to maintain margins of 2.25 percent between their own currencies but to float against the dollar. (The European Monetary System, with similar arrangements, went into operation in 1979.) Thus, Belgium, Denmark, France, the Federal Republic of Germany, Ireland, Italy, Luxembourg, and the Netherlands float their currencies against the dollar but not against each other under cooperative arrangements. Other industrial members of the Fund, such as Australia, Canada, Japan, New Zealand, the United Kingdom, and the United States, have fully floating rates, as do some developing members, such as Jamaica and the Philippines. Other industrial and developing Fund members, including Argentina, Costa Rica, Ecuador, India, Indonesia, Mexico, Nigeria, Pakistan, Spain, Sri Lanka, Turkey, and Yugoslavia have “managed” floating rates.
The Fund established guidelines for floating rates in 1974 and 1977 and, under its amended Articles of Agreement, has a mandate to “exercise firm surveillance” over the exchange rate policies of its members. But these guidelines and surveillance have been understandably hard to implement. Meanwhile, the new floating rates have proved to be much more volatile than had originally been expected. Flexible rates, moreover, have not insulated economies from the monetary policy actions of other countries, and central bankers have had considerably less independence in the pursuit of monetary policies than they had originally hoped. At times, too, crises have occurred in exchange markets. In the course of late 1977 and throughout most of 1978, for instance, rates for the U.S. dollar declined sharply, and the authorities of many countries asked the United States “to defend the dollar.” The U.S. authorities took a series of measures at the end of 1978 to bolster the currency, including a reserve tranche drawing on the Fund. These experiences with floating rates have prompted frequent calls for review by members and by the Fund of policies governing exchange rates, for possible coordination by industrial members of their monetary policies, and for a strengthening of surveillance by the Fund.
DEVELOPMENTS IN THE SDR
As described earlier in this article, in the negotiations of the Committee of Twenty for a reformed system in 1972–74, it was agreed that the SDR should become the principal reserve asset of the international monetary system and the Second Amendment of the Articles of Agreement so provided. The SDR still had some disadvantages, however, compared with gold and reserve currencies, and the Fund took several steps from 1972 to 1978 to enhance the SDR’s quality as a reserve asset. These steps included using the SDR as a unit of account in the Fund’s own transactions and reports, developing a new method of valuing the SDR in terms of a basket of currencies instead of gold, raising the interest rate paid on SDRs and calculating it so that it could move in line with market rates, reducing the obligation of members to reconstitute their holdings of SDRs, gradually extending the uses that could be made of SDRs by participants, and prescribing other institutions as holders of SDRs. Most significantly, in 1978 monetary authorities agreed to resume SDR allocations for a three-year period beginning in January 1979.
CONTINUED EVOLUTION AS AN INTERNATIONAL ORGANIZATION
The most visible and impressive changes in the Fund’s activities and policies during 1972–78, those relating to exchange rates, lending to members, arranging financing for the increased use of Fund resources, and amending the Articles of Agreement, are the ones just described. These activities, however, were not all that the Fund engaged in during this time. Numerous activities had gradually become part of its regular routine. These included preparing for new members, conducting annual consultations, providing technical assistance, training officials from member governments, gathering and dispensing a wide range of economic and financial information to members and to the public, putting out a range of publications, and collaborating on matters of common concern with an expanding number of international and regional organizations.
In the years 1972 to 1978 these activities became more complex and time consuming. For one thing, new members continued to join the Fund, including Romania and Hungary. Moreover, in 1976 the Fund decided that the Socialist Republic of Viet Nam should replace the Republic of South Viet Nam as a member. (In 1980 the People’s Republic of China assumed the representation of China in the Fund.) Thus, the Fund was adding to the number of members that regard themselves as being socialist or as having a centrally planned economy. As a result, it had to address at greater length than before the economic problems and policies of centrally planned economies.
The Fund also continued to broaden and adapt its annual consultations with each member, changing the topics discussed in accord with new circumstances. As in previous years, it concentrated on assessing a member’s monetary and fiscal policies and the effects of those policies on the member’s balance of payments positions and, where relevant, on the world payments situation. In consultations with industrial members, particular emphasis was placed on the need to control inflation and how best to do so, on the management of exchange rates, on balance of payments adjustment, and on ways to help alleviate the acute payments deficits of developing members. With developing members, consultations concentrated primarily on the financing of their balance of payments deficits, the prospects for their exports, the management of their domestic economies, and their mounting external indebtedness.
Consultations continued to provide the major vehicle through which the Fund dealt with new problems. For example, after April 1978, when the Second Amendment went into force, the new consultations under Article IV, which encompassed the consultations previously held under Article VIII and Article XIV, became the main vehicle for surveillance of all members’ exchange practices and policies.
The Fund increasingly furnished technical assistance to members in central banking, fiscal policy, statistics, and the drafting of monetary and banking legislation. It also increased its assistance in training officials—from finance ministries, central banks, and other government financial agencies—in economic and financial management.
During this period the Fund also developed a major project known as the World Economic Outlook. The Executive Board began to hold regular full-scale, although informal, discussions of recent trends in world economic developments and of the short-term and medium-term outlook for these developments based on comprehensive studies prepared by the staff. Gradually, too, the Interim Committee made reviews of the world economic outlook an important part of the agenda of all their meetings. In this way the Fund began regularly to express its views on the world economy on behalf of the international community.5
In the years 1972 to 1978 such issues as the external indebtedness of developing members, access to international capital markets, relations with commercial banks, and international trade policy all became of increasing concern to members. The Fund accordingly took on more responsibility for conducting studies and for assisting members in these areas. Furthermore, as the Fund’s work on members’ external indebtedness and international capital markets increased, so did the Fund’s relations with private commercial banks, especially as they became more deeply involved in the financing of the balance of payments deficits of non-oil developing members.
Finally, because of the severity and the pervasiveness of world economic problems after 1973, international and regional organizations with economic and financial responsibilities accelerated their activities. In the mutual quest for solutions and action, the Fund necessarily worked more closely than before with these organizations.
Note: This article was adapted from several articles written on the occasion of the publication of the History, 1972–78 and published earlier in a slightly different form in IMF Survey (Washington), Vol. 14 (August 26, 1985), pp. 257–66.
The creation of the Committee of Twenty is described on p. 127.
See article on pp. 158–67 for a description of the origin and work of the Interim Committee.
A member’s voting power is determined by the size of its quota in the Fund and the Fund uses a weighted voting system.
A fuller exposition of the provisions of the Second Amendment can be found in Joseph Gold, The Second Amendment of the Fund’s Articles of Agreement, IMF Pamphlet Series, No. 25 (Washington: International Monetary Fund, 1978).
Since 1980 the world economic outlook studies have also been made available to the public.