12 The Emerging System as of Mid-1975
- Margaret De Vries
- Published Date:
- June 1986
In August 1971 the Bretton Woods system that had prevailed since 1945 collapsed. Not only was official gold convertibility for the U.S. dollar, which many considered the linchpin of the Bretton Woods system, suspended but another basic tenet of the system, par values agreed with the Fund, also became inoperative. No longer were actual exchange rates in world markets necessarily related to par values. Nor could the financial operations of the Fund be conducted in their normal way. It was obviously imperative that the international monetary system that had served so well for a quarter of a century be reformed.
By August 1975, efforts had been going on for four years to redesign and obtain agreement on a new international monetary system, or at least on some features of a new system. Agreement proceeded slowly and at times it was nonexistent. Critical features of the new system were still being debated. Nevertheless, it seemed worthwhile to take stock of what had been achieved so far. By looking at the trends of the previous four years and giving them some historical context, some of the advances toward a future international monetary system could be discerned more readily than by centering attention on the events taking place from day to day or from one meeting to another in which monetary authorities were continuously engaging.
EFFORTS AT AGREEING ON A NEW SYSTEM
By August 1975 there had been several stages to the efforts to reconstruct the international monetary system. In September 1971 the Board of Governors requested the Executive Directors to study and report on the measures needed. In preparation for the Executive Directors’ consideration, the Fund staff prepared a comprehensive sketch of a reformed system. After months of discussion, in August 1972 the Executive Directors sent their report Reform of the International Monetary System to the Board of Governors. This report did not prescribe a new system; rather, it clarified the issues involved that would have to be further discussed before the features of a new system could be agreed.
The reform process then moved into a second phase with the establishment of the Committee of Twenty, formally the ad hoc Committee of the Board of Governors [of the Fund] on Reform of the International Monetary System and Related Issues. This committee was established in 1972 as a temporary committee specifically to negotiate a reformed international monetary system. After two years of intensive work, the Committee of Twenty ended in June 1974, abandoning efforts to introduce immediately a whole new international monetary system and opting instead for a system that would evolve over time out of the prevailing arrangements. It issued both an Outline of Reform indicating the general direction in which the Committee believed the international monetary system should evolve and a list of interim measures to be adopted immediately and to serve during the evolution to the new system. The latter included the formation of an Interim Committee of the Board of Governors on the International Monetary System, which was, among other things, to carry on the efforts for monetary reform by advising the Board of Governors on the supervision, management, and adaptation of the monetary system.
In the year after its formation, the Interim Committee met three times. One of its main initial tasks was to consider proposed amendments of the Articles of Agreement and advise the Executive Directors on these proposed amendments, that is, a Second Amendment of the Articles, a First Amendment having been completed in July 1969. Meanwhile, the regime of exchange rates that had existed since March 1973, in which industrial members either floated their currencies independently or as a group, was generally considered as a transition to a new emerging system, the specific features of which had not yet been agreed.
Debates over the Existing Arrangements From the middle of 1975, the existing regime of floating rates for the main currencies, and what to do about it in the future, was the subject of heated disputes, mainly between the monetary authorities of the Fund’s large industrial members. On the one hand, monetary authorities of some members, especially of the United States, stressed the usefulness of floating rates in appropriate circumstances and the fact that many of the dangers first thought likely to result from floating rates had not materialized. They credited floating rates with preventing major crises in foreign exchange markets, such as those that had characterized the last years of the par value system. They stressed, too, that any system of fixed exchange rates would probably have been impossible in the turbulent economic circumstances of the severe payments imbalances brought about by the quadrupling of oil prices late in 1973, the historically high rates of inflation in many countries throughout most of 1974, and the widespread recession that began late in 1974 and continued well into 1975. The U.S. authorities emphasized, too, that the most serious dangers of a destructive depression after the sharp rise in oil prices had been avoided and that international money markets supplemented by some official mechanisms were successfully recycling funds from countries with oil-related surpluses to those with deficits. Also, the Fund had found ways to effect its regular financial transactions even with exchange rates for the major currencies floating.
On the other hand, monetary authorities of most of the countries of the European Community (EC), especially of France, held diametrically opposite views. They argued that floating rates themselves might be a source of the inflation that was already a worrisome problem and might quicken the transmission of inflation from one country to another. They argued also that floating exchange rates were not bringing about as much adjustment in countries’ balances of payments as might have been expected and, indeed, might not be doing much beyond compensating for the differences in their rates of inflation. Most important, in their view, fixed exchange rates ought to be an immediate major objective for all countries. Since countries had to defend fixed rates by adhering to strict monetary and fiscal policies, it was only with fixed rates that inflation could be controlled. And stable prices were essential for a stable international monetary system.
There was yet another problem with the prevailing exchange arrangements. They were not in accord with the Articles of Agreement. For that reason, as well as for a number of other reasons, amendments of the Articles had become essential. But here again U.S. and French officials held opposing views. U.S. officials insisted that floating rates be made legally permissible, while French officials insisted that the amended Articles authorize only another par value system.
The problem of agreeing on amended Articles was complex also because agreement on some features of a new monetary system was a prerequisite for the solution of other features; the need for solution of which was becoming urgent. For example, until those provisions of the Articles of Agreement requiring payments in gold of 25 percent of any increases in quota were amended, the increases in members’ quotas in the Fund that were being considered in the Sixth General Review of Quotas could not become effective. Yet the Fund urgently needed more money.
While the debates on exchange rates continued, progress nevertheless was being made on some features of a new monetary system that had previously been under dispute. Progress was apparent, for example, with regard to SDRs, gold, and the special needs of developing members.
TOWARD AN SDR STANDARD
By mid-1975, several developments and decisions had moved the system toward an SDR standard.1 Historically, the twentieth century had seen, in succession, a gold standard, a gold exchange standard, and for all practical purposes, a dollar standard. A key question was, What was to be the standard for the new system? In July 1969 a facility for SDRs had been introduced into the Fund and allocations of SDRs to members had been made in each January of 1970, 1971, and 1972. The existence of the SDR provided the international community with a new international reserve asset that could serve as a standard in the new international monetary system.
Movement in the direction of agreement by the international community to an SDR standard had been much faster than could have been envisaged even a few years before, when the SDR itself had been the subject of heated controversy. Before an SDR standard could be agreed on, it was necessary for officials to agree that the role of gold in the international monetary system should be reduced and on how to achieve that reduction. Such agreement was not easy to obtain. Gold had played a central role in the international monetary system for centuries. The existing stock of monetary gold was large. Moreover, only a few years earlier prominent monetary officials and economists had been advocating that gold be restored to what was called its rightful place as the primary reserve asset of the monetary system and that its official price be raised to augment the world’s supply of liquidity to avoid altogether the need to establish an SDR facility. Finally, just as on the subject of exchange rates, so, too, on the subject of gold, did the authorities of the United States and France hold opposing views, and both held adamantly to their views. U.S. authorities wanted gradually to phase the use of gold out of all international monetary arrangements. French authorities went so far as to argue for a return to the use of gold as the sole or at least the primary asset in international financial transactions. As a minimum, its use ought to be continued along with any other primary asset, such as the SDR.
Agreement on Gold in June 1975 Against this background, the agreement of the Interim Committee in June 1975 at their third meeting, in Paris, on a number of general principles about gold was significant. The Committee agreed that the objective should be to enhance the role of the SDR as the principal reserve asset of the international monetary system, and consequently, to reduce the role of gold. The Committee agreed also to abolish the official price of gold and to abrogate obligations to use gold in payments between the Fund and its members.
The Interim Committee agreed, moreover, on what to do about the Fund’s large holdings of gold. It agreed that the major part would remain in the Fund for the time being, but some would be returned to all members at the official price at which they first paid gold to the Fund (the official price in the Articles of Agreement was still SDR 35 an ounce). Another portion would be sold at market prices (either to members or in the market, an issue yet to be decided), with the objective of using the profits from these sales for the benefit of developing members, in general, and of low-income developing members, in particular. The exact amounts of the Fund’s gold to be used in these different ways still had to be determined. Also still to be determined were how and when these arrangements were to be implemented and yet to be agreed was how central banks and governments would use their gold reserves. As John N. Turner, then the Finance Minister of Canada and Chairman of the Interim Committee, pointed out in a press conference given jointly with the Managing Director, H. Johannes Witteveen, at the conclusion of this Interim Committee meeting, there was still work to be done on these questions concerning gold, both at the political and technical levels. Nonetheless, the principles of a solution about gold were taking shape.
Agreement on gold was hastened by the pressure of economic events after 1973, especially the large increase in payments deficits after the oil price rise of late 1973. Because central banks had been able to exchange gold with each other only at the official price of $35 an ounce and had been reluctant to sell in any large quantities in the private market, where prices were approximately four times higher than the official price, their gold reserves had been virtually immobilized. Few transactions in gold had been taking place. The United States, for example, as of December 31, 1974 had permitted private citizens to hold gold for the first time since 1934 and had been selling gold from its official holdings to private buyers on an auction basis, but the amounts were very small.
The countries of the EC were especially eager to reach some agreement about transactions in officially held gold. Many of them, facing massive balance of payments deficits, wanted to be able to use their gold reserves for financing payments deficits, but were unable to do so until their central banks were freed from obligations to deal only at the official price for gold and were permitted to buy and sell gold at prices more closely related to those in the private market. On the other hand, the monetary authorities of other Fund members, especially of the United States and of many developing members, feared that permitting central banks to buy and sell gold at the much higher prices prevailing in private markets would unduly swell the supply of existing international liquidity and could open the door to international uncontrolled increases in liquidity in the event of future rises in the market prices of gold. These members were concerned also that revaluing the world’s supply of gold at higher prices would inevitably make gold the effective primary reserve asset. Developing members, who held little gold, also feared that if international liquidity was so enlarged, future allocations of SDRs would be reduced.
These disagreements made it difficult for officials of various countries to act together to devise arrangements that would simultaneously ensure the gradual reduction in the role of gold in monetary reserves, preserve its usefulness as a reserve asset during the phase-out period, and be equitable as between holders and nonholders of gold. But the pressure of economic circumstances was building momentum toward finding a solution and, as described above, by June 1975 consensus was finally emerging on the principles of a solution.
Other Factors Accelerating an SDR Standard Worldwide inflation and the continuation of floating exchange rates in 1974 and 1975 were additional factors accelerating the movement toward an SDR standard. To give the SDR, and with it the value of members’ positions in the General Account of the Fund, a higher degree of stability than belonged to any single currency in a floating rate world, the Fund, as of July 1, 1974, valued the SDR in terms of a basket of 16 currencies instead of the U.S. dollar, as it had done previously. Since 1972 the Fund had been using the SDR as a unit of account in its own exports and transactions, and gradually some of the Fund’s members had begun to express their exchange rates in SDRs. The use of the SDR was also spreading to commercial transactions. (For instance, by April 1, 1977, worldwide airline passenger fares, cargo rates, and other air transport transactions were being quoted in SDRs instead of in dollars or the pound sterling; the first Eurobonds to be denominated in SDRs had been issued and successfully sold; and tolls for the use of the reopened Suez Canal were being quoted in SDRs instead of Egyptian pounds.)
The Interim Committee, in June 1975, also took other actions that helped move the international monetary system toward an SDR standard. The Executive Directors were asked to study the establishment of a gold substitution account through which members would be able to exchange a part or all of their gold holdings for SDRs which would be issued by the Fund especially for this purpose. In addition, the Committee agreed that in the future when members’ quotas were increased they would be given an option to pay the 25 percent of the increase in quotas in SDRs, or in the currencies of certain other members, or in their own currencies, instead of gold. The Committee also agreed to several improvements in the Special Drawing Account to make the SDR a better reserve asset. For example, the Fund, through the General Account, was to be authorized to purchase SDRs from and sell them to members in exchange for the currencies of other members, and SDRs were to be given priority among the assets the Fund may accept and use. Thus, by the middle of 1975, it was already quite clear that the SDR was going to become the principal reserve asset of the international monetary system, and, indeed, under the Second Amendment of the Articles in 1978, it became so.
SPECIAL NEEDS OF DEVELOPING MEMBERS
Another important development in international monetary relations taking place at the time was the increasing attention being given to the special needs of developing members. Although the developing members stood to gain indirectly from anything that improved the emerging international monetary system, they were looking for compensating features of international monetary reform that would be particularly beneficial to them. As of 1975 the authorities of developing members continued to support strongly a link between SDR allocations and the provision of finance for economic development. That link had been rejected in the 1960s when the SDR was created and again in the deliberations of the Committee of Twenty in 1972–74. In the absence of agreement on an SDR and development finance link, and because of the universal recognition that the non-oil exporting developing members in particular had been most adversely affected by higher prices of oil and food, by the general inflation in industrial members, and by the depressed demand for their exports as a result of the 1974–75 world recession, an increasing number of measures of special benefit to developing members were being agreed on. For instance, the oil facility, while open to use by all members, was expected to be of most use to developing members. In September 1974, the Fund had also introduced the innovative extended facility for medium-term assistance. In addition the Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries (the Development Committee) had been established in October 1974.
In June 1975, the Interim Committee carried still further the idea of assisting developing members. As noted above, the Committee accepted the proposal of Mr. Witteveen that some portion of the Fund’s gold be sold and the profits used to assist developing members. In addition, it was agreed that there would be a Subsidy Account in the 1975 oil facility, out of which payments would be made to those developing members regarded as most seriously affected by the rise in prices for oil and food to help them meet the cost of using the oil facility. Further improvements were also being sought in the Fund’s facility for compensatory financing of export shortfalls and for assisting members in connection with their contributions to international buffer stocks. (In December 1975, a considerable liberalization of the compensatory financing facility was agreed.) Active consideration was also being given to a special Trust Fund to be administered by the Fund to provide additional highly concessional resources to meet the balance of payments needs of low-income developing members for the next few years. Developing members, moreover, were raising important questions concerning their relative quotas in the Fund, and hence their voting strength compared with that of the industrial members.
PROSPECTS FOR THE EXCHANGE RATE MECHANISM
Thus, as of August 1975, exchange rates remained the all important unsettled issue. As noted above, the sharp differences of view among the monetary authorities of the industrial members concerning the nature of any future exchange rate system, or even concerning a suitable pattern of exchange rates among the major currencies, persisted. These differences of view notwithstanding, there seemed to be movement in what is more generally termed the adjustment process. The trend seemed to be toward international monetary arrangements that would be applied flexibly to the circumstances of individual members. Increasingly, the adjustment process that seemed to be emerging from the discussions of monetary authorities in 1974 and the first half of 1975 was one that permitted members much greater flexibility in altering their exchange rates than they had had under the par value system. At the same time it was becoming increasingly recognized that exchange rates would more than ever have to be a matter of international concern and subject to international surveillance. To a greater extent than in the past, it was being recognized that floating rates were legitimate and useful in certain circumstances. But it was also being emphasized that they needed guidelines. Indeed, the Executive Board had agreed on such guidelines in June 1974. Furthermore, the adjustment process that was emerging from the intensive discussions about the international monetary system was clearly one in which monetary authorities had moved considerably away from the idea implicit in the operation of the Bretton Woods system, although not inherent in its original specification, that the main brunt of balance of payments adjustment should fall on members with balance of payments deficits. It was becoming abundantly evident that in the future members with payments surpluses would also be expected to make adjustments, including changes in their exchange rates. Added evidence that the adjustment mechanism of the newly emerging system was to be more flexible than that of the par value system was to be found in the absence of any distinction in the Outline of Reform between fundamental disequilibrium and other types of balance of payments disequilibria.
At its June 1975 meeting the Interim Committee again did not agree on a particular exchange rate mechanism, and it reiterated its agreement that provision should be made in the amended Articles of Agreement for stable but adjustable par values and the floating of currencies in particular situations, subject to appropriate rules and surveillance of the Fund in accordance with the Outline of Reform. Nonetheless the Committee made some progress. It renewed the commitment of monetary authorities to the past obligations of members to cooperate with the Fund and with other members in order to promote exchange rate stability and to maintain orderly exchange arrangements. And, going further than monetary authorities had done previously, the Committee agreed that members should pursue exchange policies that contribute to adjustment and that the Fund should adopt policies “to enable members to act consistently with their basic obligations whatever their exchange arrangements might be.” Unlike its predecessor the Committee of Twenty, the Interim Committee was thus contributing directly to the adjustment process through periodic exchanges of views on how adjustment was working and what should be done to facilitate it.
In effect, the trend as seen in mid-1975 seemed to be both toward flexibility of exchange rates and toward what Mr. Witteveen called “stronger machinery of international decision making.” Most important of all, monetary authorities ardently hoped—and expected—that now that the disputes about gold were at last being resolved, those about exchange rates would also soon be resolved.
Note: This article was written just prior to the fourth meeting of the Interim Committee, in August 1975, as background for an understanding of the forthcoming meeting, and was published earlier in a slightly different form in IMF Survey (Washington), Vol. 4 (August 25, 1975), pp. 241, 249–52. At their August 1975 meeting the Committee took important decisions that finally resolved the gold problem and set the stage for secret bilateral negotiations between France and the United States to settle the last big remaining area of dispute, that of exchange rate arrangements. This article reveals well the debates that preceded eventual agreement on how the international monetary system should evolve.
The standard of an international monetary system is determined by the nature of the primary reserve asset of the system and by the unit of account in which international transactions are specified.