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Chapter 18: Convertibility and After (1959–61)

Author(s):
International Monetary Fund
Published Date:
February 1996
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The Formal Adoption by the major European countries of external convertibility for their currencies in December 1958 led on to their acceptance of the obligations of convertibility, in the Fund sense, in February 1961. Coincidentally there came about a marked increase in the influence which the Fund was able to exert, and in the degree to which its activities became central to the international monetary system. The present chapter, covering the two years from September 1959 to September 1961, will lay the foundation for the study of a more active period of the Fund’s whole history than any hitherto recorded; that period will be described in Chapter 19.

Membership, Board, and Staff

Five new members joined the Fund during the two years now being reviewed, all of them in 1961. Portugal became a member on March 29, Nigeria on March 30, Laos on July 5, New Zealand on August 31, and Nepal on September 6. The number of members was thereby raised to 73. There was in prospect, moreover, a sharp further increase in membership: from Africa alone the applications of seven countries had been received by the end of August 1961 and inquiries were in hand from eleven others. It was clear that in the near future the size of the Fund would be greatly enlarged.

Annual Meetings

The Fifteenth Annual Meeting of the Board of Governors was held in Washington in September 1960, and the Sixteenth in Vienna in September 1961. The latter was the first occasion on which there was simultaneous interpretation of the addresses delivered during the Meetings; it provided for the rendering of the speeches in English, French, German, and Spanish. At all subsequent Meetings simultaneous interpretation in English, French, and Spanish has been furnished.

The speeches made both in Washington and in Vienna—perhaps especially in Vienna—were notable for the implicit acceptance by nearly all speakers of the role of the Fund as a key factor in the international monetary system, rather than as an isolated instrument with a specialized function of its own. The developments within the Fund that influenced this change of attitude are discussed below.

Executive Directors

There was an unusual number of changes among the Executive Directors in the two years. In November 1959 Mr. J. M. Garland (Australia), who had been Alternate to Messrs. McFarlane and Melville from March 1949 to March 1951, was elected to succeed Mr. Callaghan. In March 1960 Mr. Walter Müller (Chile) was elected in the place of Mr. Herrera, who had resigned on being elected President of the Inter-American Development Bank. In August 1960 Mr. Paranaguá (Brazil) died.

The Eighth Regular Election of Executive Directors was held on September 30, 1960. Mr. Thorhallur Asgeirsson (Iceland) was then elected to succeed Mr. Asp, whose Alternate he had been for the two preceding years; Mr. Mauricio Chagas Bicalho (Brazil) was elected to fill the place vacated by Mr. Paranaguá; Mr. Guillermo Walter Klein (Argentina) succeeded Mr. Müller; Mr. José Antonio Mayobre (Venezuela) succeeded Mr. Gómez; Mr. Sergio Siglienti (Italy) succeeded Mr. Gragnani; Mr. Soetikno Slamet (Indonesia) succeeded Soemarno; and Mr. Gengo Suzuki (Japan) succeeded Mr. Watanabe. Messrs. Garland, Lieftinck (Netherlands), Saad (United Arab Republic, Egyptian Region), and van Campenhout (Belgium) were re-elected.

The increases in quotas recorded in the last chapter resulted in China being replaced by Germany as one of the five members with the largest quotas. This meant that China’s right to appoint an Executive Director passed to Germany, which appointed Mr. Guth (who had been elected in January 1959). Mr. Tann, who had been appointed by China in July 1950, was now elected by China. No country qualified under Article XII, Section 3 (c), to appoint a Director, and Mr. Rasminsky (Canada), who had been appointed by Canada in 1958 under the terms of this Section, was elected in 1960 by Canada and Ireland. There were no other changes in the groups electing Directors. However, in March 1961 Mr. Rasminsky undertook to look after Nigeria’s interests in the Fund, and in September 1961 Mr. Garland similarly undertook to watch those of New Zealand.

In the first nine months of 1961 there were three changes among the appointed Directors: Mr. David B. Pitblado (United Kingdom) succeeded the Earl of Cromer from January 19; Mr. I. G. Patel (India), who had been Alternate to Mr. Adarkar since December 1958, was appointed to succeed him from June 22; and Mr. Jashwantrai J. Anjaria (India) was in turn appointed to succeed Mr. Patel from August 1. Mr. Patel then became Alternate to Mr. Anjaria.

Staff

The prospect that a number of newly independent African states would join the Fund prompted the Governor for Ghana, Mr. K. A. Gbedemah, to suggest at the Annual Meeting, 1960, that the time had come for the formation of an African Department.1 In February 1961 Messrs. Saad and Slamet sent a memorandum to the Managing Director urging that effect should be given to this suggestion as soon as possible. Their memorandum added that it was essential that the new department should be headed by an African, and that the staff should be partly recruited from Africa in accordance with the arrangements in other departments.

Proposals along the foregoing lines were put to the Board by the Managing Director when presenting the budget for 1961/62, on April 10, 1961. The budget provided for an initial staff of 15 in the African Department. Mr. Jacobsson proposed that its sphere of activity should cover all African countries that should thereafter join the Fund, together with such of the existing members as preferred to be looked after by the new department instead of by those departments which had so far served them. It may be noted here that three countries which in 1961 were served by the European Department chose subsequently to be transferred to the African Department—Morocco in October 1963, Tunisia in November 1963, and Ghana in August 1964. South Africa, also looked after by the European Department, has preferred not to make a change, as have the four African countries served by the Middle Eastern Department, viz., Ethiopia, Libya, the Sudan, and the United Arab Republic.

Pending the appointment of an African, the new department was placed temporarily in the charge of Mr. Mládek. In August 1964 Mr. Hamzah Merghani (Sudan) was appointed Director.

Partly owing to the actual and prospective increase in membership, and partly because of the enhanced demands on the staff for consultations and for technical assistance, the number of Fund employees grew more in the fiscal year 1960/61 than in any previous year since 1948. On April 30, 1961 the staff numbered 474, of 52 nationalities; this compared with 451, from 51 countries, a year earlier.

The appointments of Mr. Jacobsson and Mr. Cochran, which were both due to expire in 1961, were extended until their seventieth birthdays, in February 1964 and July 1962, respectively. Later, Mr. Cochran’s appointment was extended to October 31, 1962, to cover the 1962 Annual Meeting.

Convertibility (Article VIII)

The previous chapter recorded the attainment in 1958–59 of external convertibility for 15 European currencies, and the introduction of corresponding arrangements in 15 other countries. It was noted that none of these 30 members had at that time accepted the obligations of Article VIII, Sections 2, 3, and 4, and none of their currencies was, therefore, convertible in the Fund sense. At the beginning of 1959 there were still only 10 countries that had taken the latter step—Canada, Cuba, the Dominican Republic, El Salvador, Guatemala, Haiti, Honduras, Mexico, Panama, and the United States. Nevertheless the Fund’s Annual Report for 1959 spoke of the progress made by the 30 countries as promising further advances toward the ideal visualized by the Articles of Agreement.2 This theme was taken up by a number of speakers at the Annual Meeting, 1959.

Article VIII and Article XIV

Even before the Annual Meeting, the staff had been already pressing on with an examination of the questions that would arise as members prepared to relinquish the privileges available to them under Article XIV and to accept instead the obligations of Article VIII, Sections 2, 3, and 4. It will be convenient at this point to summarize what those obligations are. Article VIII requires members not to impose restrictions on current payments (Section 2), to avoid discriminatory currency arrangements and multiple currency practices (Section 3), and to convert on request, under certain conditions, balances of their currencies held by other members into those members’ currencies or into gold (Section 4). It will be remembered that this last-mentioned provision occasioned much concern to the United Kingdom at Bretton Woods, as a result of which it was there limited to the conversion of balances recently acquired as a result of current transactions, or of which the conversion was needed to make payments for current transactions. The requirement in Section 4 is also subject to five other limitations designed to ensure, for example, that conversion cannot be demanded for balances built up from transactions that were contrary to the exchange regulations of the member asked to make the conversion.

Staff studies of the implications of these obligations showed that some clarification was needed before the Board could decide whether, and if so how far, to press members to accept them. This clarification took the form of two memoranda, one from the Legal Department and one from the Exchange Restrictions Department, presented to the Board in November 1959 and February 1960, respectively. The former provided definitions of key terms in the two Articles—“maintenance,” “adaptation,” and “introduction” of restrictions (Article XIV, Section 2); the phrase “making of payments and transfers for current international transactions” (Article VIII, Section 2); and the “notification” which members had to give to the Fund under Article XIV, Section 3, when they were ready to accept the obligations of Article VIII. The department explained that it was not possible for the Board to terminate the transitional period; the most it could do would be to express the opinion that conditions were favorable for the withdrawal of restrictions on the ground that, in its opinion, postwar transitional conditions had disappeared.

Discussing the effect of Article VIII, Sections 2, 3, and 4, when members decided to accept them, the memorandum made four points: (1) Members must perform the obligations of all three Sections and must dispense with the practices listed in Sections 2 and 3 unless these were specifically approved by the Fund. (2) Once a member had accepted the obligations of Article VIII, it could not retract from them—once under Article VIII, always under Article VIII. (3) The currency of a member accepting Article VIII could be used at once by other members to make voluntary repurchases. (4) However, such a currency would not be included in calculations of the monetary reserves of other members until the Fund’s financial year following that in which the acceptance of Article VIII took place, except that it would be included immediately in those calculations for the purpose of deciding under Article V, Section 8 (f), whether charges for the use of the Fund’s resources might be paid in currency instead of in gold.

The memorandum by the Exchange Restrictions Department addressed itself to the policy questions whether it was desirable to encourage more members to accept the obligations of Article VIII, and how the Fund should treat restrictions applied by such members after they had moved from Article XIV to Article VIII.

On the first of these issues, the memorandum suggested as a precondition for the Fund’s approval of a member’s moving to Article VIII that the member should be able to convince the Fund that it would terminate within a reasonable period any restrictions on current transactions which it was maintaining. The memorandum pointed out that the use of restrictions was still widespread. There were, however, a limited number of member countries, mainly in Western Europe, with favorable balance of payments and reserve positions, which were making little use of exchange restrictions (confined mainly to quantitative restrictions maintained for other than balance of payments reasons, and bilateralism). There should be little difficulty for the Fund in approving the few minor restrictions which these countries would wish to retain, subject to agreement on a timetable for their removal.

The second major problem discussed in the Exchange Restrictions Department’s memorandum involved the identification of restrictions. The most difficult technical problem was likely to be posed by quantitative restrictions on imports maintained by countries which automatically provided exchange for permitted imports. Certainly the Fund needed to know about such restrictions because it had to advise the GATT on them. However, about half the members of the Fund were not members of the GATT. The memorandum also pointed to the difficulty of distinguishing between controls on current transactions and controls on capital transactions, and to the problem of restrictions maintained by non-metropolitan areas. The latter had not so far been investigated, although an inquiry into restrictions in the sterling area was in progress.

Thirdly, the memorandum recommended that the Board should determine in advance which restrictive practices would need approval under Article VIII, in order that when concurring in a member’s decision to move to Article VIII the Fund would be able to specify which continuing restrictions it was approving. It would probably be unnecessary to include in such approvals any types of restriction which were in wide use but were unimportant in their effects. There might also be some restrictions over which the Fund’s jurisdiction was uncertain and which, therefore, it might not wish expressly to approve.

The memorandum went on to express the hope that members that had accepted the obligations of Article VIII would thereafter seek alternative ways of correcting their balances of payments, rather than reintroduce restrictions. For such members the Fund would need to lay down stricter criteria to determine whether restrictions were permissible; this would raise in an acute form the problem, which had already given trouble, of the lack of time fully to examine members’ proposals. Because of this problem it was suggested that approval given for restrictions should be for a limited time, say, a year. Eventually, the Fund’s close contact with members should overcome these difficulties, and in this connection the memorandum proposed that the Fund should hold annual consultations with countries accepting Article VIII as it was doing with countries under Article XIV.

These two memoranda were considered by the Board at two meetings in March 1960. Most of the views expressed by the staff were supported by the Executive Directors. The greatest measure of dissent was expressed by Mr. de Largentaye (France), who challenged in particular the concept of countries continuing under Article XIV. He believed that the privileges provided by Article XIV were limited strictly to the postwar transitional period, which he thought could not be said still to exist. Moreover, he considered that the terminology of Article XIV was a source of great legal complications. In these views, however, Mr. de Largentaye appeared to be a minority of one, although Mr. Southard (United States) shared his discontent with the perpetuation of the transitional period.

Apart from Mr. de Largentaye’s dissent, almost the only substantial differences of viewpont which emerged from the discussion related to the questions (a) whether it was necessary for a country accepting the obligations of Article VIII, Sections 2, 3, and 4, to have a par value—Lord Cromer (United Kingdom) and Mr. Guth (Germany) thought that it was, but Mr. Southard doubted this—and (b) whether consultations under Article VIII should result in conclusions. Mr. Guth and Mr. Southard thought that such consultations, if held, should not result in formal decisions or recommendations, but the idea that they would not yield the maximum benefit to members without such conclusions was expressed by Mr. Rasminsky (Canada) and Mr. Garland (Australia). At the end of the meetings, therefore, the Chairman proposed that the staff should draft a statement to be made along the lines of its memoranda and of the Board discussions. This would be brought to the Board for review in May.

For the next several weeks numerous attempts were made by the staff and by Executive Directors to formulate a decision on the transition from Article XIV to Article VIII which might express the views of the whole Board, and it was the seventh of these drafts which was brought before the Board on May 18. Four meetings were devoted to detailed consideration of the draft and to redrafting, and on June 1 the Board took its decision.3

After describing the improvement in balance of payments positions which had led to the achievement of external convertibility, the decision offered guidance to members that were considering accepting the obligations of Article VIII, Sections 2, 3, and 4. This was done in four paragraphs. The first paragraph described a “restriction on payments and transfers for current transactions” as one which “involves a direct governmental limitation on the availability or use of exchange as such.” The second recommended that before a member gave notice that it was accepting the obligations of Article VIII it should eliminate, as far as possible, restrictions which would require the approval of the Fund, and should satisfy itself that it was not likely to need to use such measures in the foreseeable future. Warning was given that, before approving the restrictions for balance of payments reasons only, the Fund would require to be satisfied that the measures were necessary and that their use would be temporary. Measures requiring approval which were maintained or introduced for other than balance of payments reasons should be avoided to the greatest possible extent. Nothing was said about the need to have a par value. The third paragraph stressed that consultations under Article VIII were not mandatory, but indicated that there was “great merit in periodic discussions between the Fund and its members even though no questions arise involving action under Article VIII.” This slight watering down of the proposal for annual consultations between the members and the Fund was introduced by the staff after discussions with Executive Directors who wished to emphasize that such consultations were voluntary.

The final paragraph referred to import restrictions for balance of payments reasons and urged members to continue to supply information about these to the Fund. Where members were also members of the GATT, this would enable the Fund to collaborate with the GATT in examining the members’ positions.

Following the decision of the Board just cited, steps were immediately taken by the staff to elucidate with the European countries likely to move to Article VIII what restrictions they maintained that would need to be approved by the Board.

Article VIII Achieved

The Annual Report for 1960 was in preparation when the Board took the decision described above. The Report reproduced the decision and commented that “The world is now closer to the attainment of a multilateral system of payments free from exchange restrictions than at any time since the beginning of World War II.”4 Reference to the subject was made by a number of speakers at the Annual Meeting, 1960—for example by Mr. Karl Blessing, Governor for Germany, who said, inter alia,

We fully endorse the conclusions expressed in the Executive Board’s decision. Some of us probably thought last year that we would attend this Annual Meeting already as new Article VIII members. Yet, as is true with other irreversible decisions, careful examination of all aspects of the intended step is certainly more important than a gain of a few months. Now, however, as the technical preparatory work has been completed with those countries which are likely to move first, the way is open for the acceptance of the formal obligations of Article VIII by these members in the next few months; and Germany is certainly prepared to take this step.5

Despite Germany’s readiness, the wish of the main European countries to move in concert delayed the completion of the necessary formalities for another five months. However, when on February 6 and 8, 1961, Belgium, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Peru, Sweden, and the United Kingdom came to the Board to announce their acceptance of the obligations of Article VIII from February 15, a swift response was possible.

The decisions of the ten members were welcomed with few reservations. Mr. Suzuki (Japan) criticized the discrimination widely practiced against his country, and he and some other Directors pointed out that some of the ten countries still had extremely complex trade regulations. Mr. Southard referred to the maintenance of exchange rates outside the permitted range of variation in Germany’s free markets for security transactions. He shared the view expressed by the staff that these constituted a multiple currency practice over which the Fund had jurisdiction, but he did not press the point as he knew that some Executive Directors differed from the staff on the matter. (It will be remembered that this issue was left open when the Board decided, on July 25, 1956, that members were free to control capital movements.6 It has not, in fact, ever been settled.) This said, the Board noted the intentions of the ten members to accept the obligations of Article VIII, Sections 2, 3, and 4, and approved the continuance of certain restrictions by Belgium, France, Luxembourg, and the Netherlands.

Six weeks later the number of countries moving to Article VIII was increased to 11, when Saudi Arabia also undertook the necessary obligations. This brought the number of members that had achieved convertibility in the Fund sense to 21. By the end of 1965 the number had grown to 27; Australia, Austria, Costa Rica, Jamaica, Japan, Kuwait, and Nicaragua had been added, but Cuba had dropped out, having left the Fund (as described in a later chapter). The list of “Article VIII” countries continues, of course, to grow as more members feel able to accept the responsibilities involved.

The first consultation with a member that had accepted the obligations of Article VIII was held in August 1961, with the United Kingdom. At the same time the Board discussed a British request for a drawing of $1,500 million, to which further reference is made later in this chapter. By the end of November 1962, consultations had been held with all 11 of the members whose currencies became convertible in 1961, except for Saudi Arabia, and in subsequent years they have been held with all other countries under Article VIII.

Inter-Central-Bank Cooperation

During the two years with which we are now concerned, the Fund continued to be consulted about numerous changes in exchange systems. Initial par values were approved for Italy, Uruguay, and Greece. New monetary units were introduced in Chile, France, and the Union of South Africa. There were devaluations of the currencies in Iceland (twice), Korea (three times), China, Costa Rica, Ecuador, Turkey, and Venezuela. Minor changes were sanctioned in a number of other countries; extensive changes in the exchange system of Cuba, which the Board decided needed its approval as multiple currency practices, led to a protest by the member and proved to be the first step toward a severance of relations between Cuba and the Fund.

The most significant change in exchange rates during the two years, however, was an increase of some 5 per cent in the par value of the deutsche mark, proposed on Saturday, March 4, 1961 (i.e., three weeks after the deutsche mark became convertible). As there had been no previous change in the par value of the deutsche mark, the revaluation fell within the 10 per cent permitted by Article IV, Section 5 (c) (i), without the Fund’s approval, and the Fund therefore merely noted Germany’s decision. Immediately afterward, the Netherlands felt it necessary to make a nearly equal revaluation of the guilder because of the close relations between that currency and the deutsche mark. This necessitated the approval of the Fund, since the Netherlands had devalued the guilder by more than 10 per cent in 1949; approval was given on March 6.

The two revaluations, of the deutsche mark and the guilder, created speculative expectations that other similar changes would follow, as a result of which considerable pressure developed on sterling. The central bank governors of the European countries, meeting at the Bank for International Settlements on March 12, 1961, found it necessary to issue a statement denying that any more changes were contemplated. They added that the central banks were cooperating closely in the exchange markets. A further statement issued a week later explained that the central banks were acting with a view to discouraging speculation and minimizing the repercussions of “hot” money movements on countries’ exchange reserve positions. Their cooperation was to take the form of holding each others’ currencies to a greater extent than previously, instead of converting them immediately into gold or into dollars, and of short-term lending of needed currencies. The statement concluded:

These procedures will be temporary, pending the evolution of more permanent techniques for dealing with the problems of international financial disequilibria, particularly short-term capital movements within the framework of, or through reform of, the International Monetary Fund.

From this so-called Basle Agreement much has stemmed, both as regards closer cooperation between central banks and as regards the supplementation of gold by alternative forms of international liquidity.

Assistance to the United Kingdom under the Agreement reached a peak of $900 million between March and July 1961. Most of this had been repaid by the end of September 1961, with the assistance of a drawing of $1,500 million from the Fund in August and September which is further discussed below.

Meanwhile, the United States, which took the lead in these inter-central-bank arrangements, had entered into large forward sales of deutsche mark; by mid-June its commitments reached $340 million, but as the spot dollar rate gradually rose these commitments were reduced, and they had been extinguished by the end of 1961. In July 1961 the United States similarly undertook forward sales of Swiss francs to offset the effects of a flow of hot money into Switzerland, which was raising the reserves of the Swiss National Bank far above traditional levels. It also undertook operations in Italian lire and Netherlands guilders.

Beginning in February 1962 the Federal Reserve System entered into systematic “swap” arrangements with other central banks. By February 1964 these totaled $2.05 billion, viz.: $500 million with the Bank of England; $250 million each with the central banks of Canada, Germany, and Italy; $150 million each with the Bank of Japan, the Swiss National Bank, and the Bank for International Settlements; $100 million each with the Bank of France and the Netherlands Bank; and $50 million each with the central banks of Austria, Belgium, and Sweden. From March 1962 through August 1963 the total amount of drawings on these lines of credit by the Federal Reserve System and the other central banks was $978 million, and the total amount repaid was $876 million, generally within six months. It was the countries cited in this paragraph (except for Austria and Switzerland) that later formed the Group of Ten.

Cooperation between central banks in connection with the London gold market is described in the next section.

Gold: Movements and Prices

The Price of Gold

From the time when the London gold market was reopened, in March 1954, until the autumn of 1960, the price of gold in that market did not vary beyond the limits set by the Fund ($34.65–35.35 a fine ounce), and indeed for most of the time it fluctuated within the narrower margins of the U.S. Treasury’s buying and selling prices for gold ($34.9125 and $35.0875, respectively). In October 1960, however, these limits were exceeded. On Monday, October 17, the price was $35,255 a fine ounce, which was approximately equivalent to the U.S. Treasury’s selling price plus transatlantic shipping costs. Thereafter it rose sharply, and on Thursday, October 20, the price at the “fixing” was equivalent to $36.55 a fine ounce, while strong buying demand pushed the price for some sales up to $41 a fine ounce.

That afternoon the U.S. Secretary of the Treasury issued a statement as follows:

The United States will continue its policy of buying gold from and selling gold to foreign governments, central banks and, under certain conditions, international institutions, for the settlement of international balances or for other legitimate monetary purposes at the established rate of $35 per fine troy ounce exclusive of handling charges. Treasury Secretary Anderson has stated many times in the past that it is our firm position to maintain the dollar at its existing gold parity.

Following this announcement the price of gold eased, but it was not until February 23, 1961, that it fell below the U.S. selling price. A contributing factor to the decline in February was a U.S. Executive Order dated January 14, 1961 prohibiting the purchase and holding of gold outside the United States by U.S. citizens and by corporations owned in the United States, and requiring U.S. residents to sell their existing holdings of gold, or of securities representing gold on deposit, by June 1, 1961. President Kennedy also declared firmly, in a Message to Congress on February 6, 1961, that the U.S. dollar would not be devalued.

Nevertheless, the demand for gold continued, and by the end of August 1961 had pushed the price up again to $35.20 a fine ounce. Until then the market had been supplied by the Bank of England, with the assistance of the U.S. monetary authorities. In October 1961 the latter proposed to the authorities in the United Kingdom and the European continent an informal arrangement to share the burden of intervention in the London market to keep price fluctuations within a reasonable range. This proposal was accepted, and the central banks of Belgium, France, Germany, Italy, the Netherlands, Switzerland, and the United Kingdom agreed, in case of need, to cooperate with the Federal Reserve Bank of New York in a sales consortium for the purpose of stabilizing the gold market. The “Gold Pool” thus constituted provided gold for the first time in November 1961. It remained in operation until March 1968, although France ceased to act in it in June 1967. The foregoing developments did not directly affect the Fund, although the philosophy behind the arrangements for the Gold Pool reflected the Fund’s policy of international cooperation to prevent the appearance of a premium price for gold.

Fund Investment

Meanwhile, however, the drain on the gold reserves of the United States continued. Net outward movements of gold from U.S. reserves during 1960 amounted to $1,669 million, of which some $550 million net was supplied to the United Kingdom. Just as in 1959, so in 1960 the decrease in the U.S. gold reserves was a factor predisposing the Board to consider favorably a proposal to increase the Fund’s investment of gold in U.S. securities. Such a proposal, for an increase in the investment from $500 million to $800 million, was made by the staff on November 22, 1960.

Recommending this measure to the Board, the staff pointed out that the expected considerable growth in Fund membership was bound to bring about a sizable increase in costs. The Fund’s operating income had declined over the three previous fiscal years and would drop very sharply indeed in 1960/61, while interest rates were appreciably lower than when the investment program was enlarged in the previous year; as a result, the rate of accumulation of reserves had slowed down. The staff urged that the Fund should have reserves of a size which the financial world would regard as appropriate, and that consequently there should be an acceleration in their growth, rather than a retardation. It therefore recommended the additional investment, in order that the resulting increase in the Special Reserve might give greater assurance that the General Reserve would be available, if necessary, for purposes other than meeting prospective deficits in the Fund’s annual budget.

These arguments were supported in the Board by all the Directors who spoke, and the proposal was approved without dissent.7 Mr. de Largentaye (France), who had opposed the investment of the original $200 million and the subsequent increase to $500 million, now said that on the legal basis of the Board’s earlier interpretations, the French Government was prepared to agree.

A further release of gold by the Fund to members’ reserves, in connection with a drawing by the United Kingdom in August 1961, is discussed in the next section.

Use of the Fund’s Resources: Precedents Set

During the year from October 1959 to September 1960 comparatively little use was made of the Fund’s resources, 13 members drawing a total of $247.25 million, while repurchases totaled $660.96 million. The following year, by contrast, was one of the most active that the Fund had known: 22 members drew a total of $2,503.68 million, and repurchases came to $596.32 million. In 1959–60 there was no drawing larger than $50 million, but in 1960–61 Australia drew $175 million, India $250 million, and the United Kingdom $1,500 million.

Stand-by arrangements followed a similar pattern. In 1959–60 there were 14 new or extended arrangements, for a total of $378.63 million; in 1960–61 there were 24 such arrangements, for a total of $1,459.88 million, including one for $500 million for the United Kingdom.

Some notes follow on drawings and stand-by arrangements that presented special features.

In February 1960 Iceland drew $2,812,500 (25 per cent of its quota) from the Fund, and was granted a stand-by arrangement for $5,625,000. Under this arrangement Iceland subsequently drew $4 million, including $800,000 in Danish kroner, the first time that this currency had been used in a Fund drawing.

In January 1961 Yugoslavia drew $45 million, of which it took $10 million in U.S. dollars and the remainder in five European currencies. This was the first occasion on which a drawing was so widely distributed between currencies, and anticipated the acceptance of the obligations of Article VIII by France, Germany, Italy, the Netherlands, and the United Kingdom in the following month. It also marked the first use of Italian lire in Fund drawings.

In February 1961 Chile drew $16 million in Argentine pesos and was granted a stand-by arrangement for $75 million. Thereby four precedents were established. The drawing was the first of a Latin American currency. It was also the first time that a member had drawn on the Fund for resources with which to terminate a bilateral agreement; the pesos drawn by Chile were used in partial settlement of the balance due to Argentina on a bilateral trade and payments agreement between the two countries, which had been wound up on January 31, 1961. Thirdly, the total made available to Chile in the drawing and stand-by arrangement, if fully utilized, would have raised the Fund’s holdings of Chilean escudos to 189 per cent of Chile’s quota; this was the first time that the Fund had accepted a commitment to increase its holdings beyond 175 per cent of a member’s quota. Fourthly, the discussion of the stand-by arrangement led to the discontinuance, as described below, of the clause permitting the Fund to give notice to terminate drawing rights.

The acceptance of the obligations of Article VIII, Sections 2, 3, and 4, by the principal European countries in February 1961 made it possible for the Fund to receive their currencies in repurchases, provided that the Fund’s holdings of these currencies did not exceed 75 per cent of the members’ quotas. Use was first made of this facility by Burma, which in February 1961 repurchased the equivalent of $4 million of kyats with sterling.

In August 1961 Japanese yen were drawn for the first time as part of a drawing of $250 million in six currencies by India.

Also in August, in connection with the drawing of $1,500 million by the United Kingdom, use was made of Article VII, Section 2 (ii), which enables the Fund to replenish its holdings of currencies by requiring the issuing members to sell them to it for gold. This was the first occasion on which the Fund undertook such replenishment of several currencies simultaneously. Gold was used to purchase the nine currencies drawn by the United Kingdom to the extent of $500 million, being apportioned so as to provide one third of the amount drawn of each currency. One of the currencies so purchased was the Canadian dollar, for which no par value existed at the time. This necessitated amending the comprehensive decision on fluctuating currencies taken in 1954 so as to include, in the transactions there discussed, the sale of gold by the Fund under Article VII, Section 2.8

Conditions for Stand-by Arrangements Again

The “Prior Notice” Clause

In connection with a stand-by arrangement for Paraguay, approved in August 1959, Mr. Saad (United Arab Republic, Egyptian Region) questioned the phrase “unless the Fund gives Paraguay prior notice to the contrary,” which was included in the stand-by arrangement as a limitation on Paraguay’s right to draw under the arrangement. On that occasion the Deputy General Counsel explained that because the ineligibility procedure in Article V, Section 5, was regarded as a severe sanction, two alternative provisions had been included in this and numerous other stand-by arrangements. One was a cross reference to an undertaking, usually given by the member in the letter of intent, that if it ceased to observe certain objective criteria it would not draw without consulting the Fund. The other was the clause permitting the Fund to give notice to terminate drawing rights, which might be done for reasons other than those which would bring into operation the undertakings in the letter of intent.

In February 1961 a reasoned study of the latter provision was presented to the Board by the Legal Department in response to questions by Mr. de Largentaye (France) in October 1960 and again in February 1961. The Legal Department recalled the provision which appeared in identical terms in paragraph 5 of the decision of October 1952 and paragraph 4 of that of December 1953 permitting the Fund to suspend a member’s drawing rights after

(b) a decision of the Executive Board to suspend transactions either generally (under Article XVI, Section 1 (a) (ii)) or in order to consider a proposal, made by an Executive Director or the Managing Director, formally to suppress or limit the eligibility of the member.

The memorandum referred also to the special provision for longer-term stand-by arrangements made in the decision of December 1953:

With respect to stand-by arrangements for periods of more than six months, the Fund and the member might find it appropriate to reach understandings additional to those set forth in this decision.

Finally, it recalled the discussion which took place in connection with the stand-by arrangement with Peru in 1954. The staff pointed out that for members with fluctuating rates, uncertain economic conditions, or complex stabilization programs, the feeling persisted that protective clauses were needed to see that improper use was not made of the Fund’s resources, and to give reasonable effect to the following clause in each stand-by arrangement:

In consideration of the policies and intentions set forth in the annexed letter, the International Monetary Fund agrees to a stand-by arrangement for the support of those policies and intentions.

The outcome had been protective clauses of the two types mentioned by the Deputy General Counsel in August 1959. That now challenged—providing that the Fund might give prior notice to terminate drawing rights—had been included in some thirty stand-by arrangements before it was questioned in October 1960, and in one instance the Fund had given notice under it.

The legal basis for the clause might be found in one of three provisions, viz., (1) the reference in the decision of December 1953 to “additional understandings” for stand-by arrangements of more than six months; (2) the authority given to the Fund by Article V, Section 4, to impose “terms which safeguard its interests” (since almost all stand-by arrangements necessitated a waiver under that Section); and (3) paragraph 5 (b) of the 1952 decision (4 (b) of the 1953 decision), quoted above. Of these three, the Legal Department regarded the third as the most appropriate, especially as it was felt that relations between the Fund and its members had progressed to a point at which Article V, Section 5 (Ineligibility to use the Fund’s resources), on which it was based, could be invoked without disturbing these relations. Since this Section read, in part, “Whenever the Fund is of the opinion that any member is using the resources of the Fund in a manner contrary to the purposes of the Fund,” reliance on it meant that the member’s eligibility could be withdrawn only if the member was actually using the Fund’s resources. However, it seemed probable that if a member was not “using” the Fund’s resources at all, any drawing which the member wished to make would fall wholly within the gold tranche, and so be permissible in any event under the Fund’s policies for such drawings.

The conclusion at which the Legal Department arrived as a result of this argument was that the “prior notice” clause might be safely omitted from future stand-by arrangements, being replaced by a requirement that a member to whom notice had been given under clause (b) above should consult the Fund before making any further drawing. The memorandum concluded that this new requirement should be substituted for the “prior notice” clause in the 17 current stand-by arrangements which contained that clause, except in the one with Yugoslavia. In this, the Fund’s right to give notice to the member suspending drawings was limited to certain objective developments in Yugoslavia’s stabilization program. It was felt that to withdraw this clause and rely on more general suspensory powers might be regarded as a retroactive measure detrimental to Yugoslavia’s interests.

The staff’s proposals were approved by the Board on February 20, 1961, except that as drafted they covered that part of clause (b) which referred to a general decision to suspend transactions under Article XVI; it was agreed that there was no need to provide for special consultation before drawings were resumed if the decision to suspend them were a general one taken under the terms of Article XVI. Accordingly the decision was taken to withdraw the “prior notice” clause (except from the Yugoslav stand-by arrangement) as proposed by the staff, but in place of it to add to clause (b) the sentence:

When notice of a decision of formal ineligibility or of a decision to consider a proposal is given pursuant to this paragraph, purchases under this stand-by arrangement will be resumed only after consultation has taken place between the Fund and the member and agreement has been reached on the terms for the resumption of such purchases.9

In consequence of the foregoing decision, the “prior notice” clause was not included in any subsequent stand-by arrangement. The next one approved, with Peru on February 27, 1961, contained only the usual undertaking, in the letter of intent, that Peru would consult the Fund before drawing further if it departed from its stabilization program in certain specific respects. This technique continued to be relied upon for stand-by arrangements with Latin American countries. It was not, however, appropriate where the letter of intent did not include quantified targets against which the achievement of the program could be measured. Such a situation arose shortly in connection with an arrangement for $100 million with Australia, approved on April 26, 1961. This was in addition to Australia’s drawing of $175 million. The staff agreed with the Australian Government that the letter of intent should include a phrase as follows:

Should any major shift in the direction or emphasis of policy become necessary during the currency of the stand-by arrangement the Australian Government would, at the request of the Managing Director, be ready to consult with the Fund and, if necessary, reach new understandings before any request for a further drawing is made.

Similar “major shift” clauses were included in the letters of intent annexed to stand-by arrangements approved for South Africa in July and for the United Kingdom in August, 1961.

Phasing

Another question about the terms of stand-by arrangements was raised by Mr. Jorge A. Montealegre (Nicaragua), Alternate to Mr. Mayobre, when a stand-by arrangement for $15 million with Guatemala was brought to the Board on August 11, 1961. This arrangement contained clauses providing (a) that not more than $5 million should be drawn within the first six months of the year for which the stand-by was granted, and (b) that not more than $10 million in all should be drawn (except to offset repurchases) without further consultation with the Fund and agreement on the terms on which the final $5 million would be made available. Mr. Montealegre took exception particularly to the second of these provisions. He felt that it detracted from the right to draw the $15 million of the stand-by arrangement and was in contradiction of the clause in the arrangement giving that right.

The General Counsel said that the provisions had been included in a number of stand-by arrangements without being questioned by the Board. In the present instance the staff felt that if it became necessary for Guatemala to draw as much as $10 million under the arrangement, its stabilization program might not be working out as well as expected, so that a fresh look at the problem would be beneficial. Asked by Mr. Saad whether it was usual to include such a clause in all stand-by arrangements for sums equivalent to the quotas of the countries concerned, the General Counsel said that this was not so: the terms of stand-by arrangements were varied according to the conditions and problems of the members to which they were granted.

Several Executive Directors supported the staff, and while others were doubtful whether the clause was necessary in the circumstances, it was decided to let it stand. It may be added that when this type of clause was again questioned in 1964, in connection with a stand-by arrangement for the Dominican Republic, the Deputy General Counsel informed the Board that it had been used on a number of occasions but was regarded as somewhat exceptional; it was not standard practice.

International Liquidity: The Problem Emerges

It will be recalled that in the report International Reserves and Liquidity, written in 1958, the staff had argued that the more rapid growth of world trade than of world reserves made it doubtful whether the Fund’s resources were sufficient to enable it to perform its duties under the Articles.10 The attainment of external convertibility for the main European currencies at the end of 1958 added a new dimension to the problem by giving rise to massive short-term capital movements.

We have already noted two facets of the Fund’s response to this situation. The first, a large increase in quotas, was recorded in the previous chapter; the second, the provision of access to its resources on an unprecedented scale, was described above. For the time being this was thought to be enough, especially as there were seen to be advantages in providing additional reserves on a conditional basis, as is done by the Fund, rather than unconditionally in the form of owned reserves. Nevertheless, international liquidity came to claim an increasing share of the Fund’s attention. We may here trace this development through the Annual Reports and Annual Meetings of 1960 and 1961.

The Annual Report for 1960 took an optimistic view of the problem. While official reserves (apart from those of the U.S.S.R. and the countries associated with it) had fallen in 1959 by an estimated $700 million, this was offset on the one hand by an increase of about $1 billion in the gold holdings of the Fund, and on the other by a large increase in the foreign exchange holdings of commercial banks. As a whole, the Report observed, world liquidity actually improved. If account were taken of the increase in the Fund’s holdings not only of gold but also of currencies suitable for international settlements, the growth in resources available through the Fund was several times that of the decrease in directly owned reserves.11

At the Annual Meeting, 1960, those Governors who referred to the matter expressed agreement with the Annual Report, and in his closing speech Mr. Jacobsson cited a consensus that there was “no lack of international liquidity.”12 This in fact remained the official view of the Fund for some time to come, but it was coupled both with an apprehension that the situation might not remain favorable and with an insistence on the important role to be played by the resources which the Fund controlled.

It was this last point which was mainly stressed in a brief reference to international liquidity in the Annual Report for 1961.13 The volatility of the situation had been enhanced by the acceptance early in 1961 of the convertibility obligations of Article VIII by the major European countries. Favorable notice was taken of statements that had been made at about the same time by the Prime Minister of Australia, the British Chancellor of the Exchequer, and the President of the United States, all of whom called attention to their countries’ drawing rights in the Fund as an integral part of their reserves. The Report pointed out that for all members of the Fund the aggregate of drawing rights was almost as large as the total foreign exchange components of their owned reserves.

Considerably more attention was paid to the problem during the Annual Meeting, 1961. Two or three Governors believed that, reinforced by the availability of the Fund’s resources, international liquidity was adequate to meet the world’s needs—one Governor (Mr. Holtrop, the Netherlands) even concluded that there had latterly been an oversupply of liquidity 14—but the more general view was that care would be needed to ensure that no lack of reserves developed. In this connection Governors generally welcomed proposals made by the Managing Director for studying arrangements for the Fund to borrow needed currencies, and for reviewing the use of the Fund’s resources to finance balance of payments deficits due to capital movements. These proposals form the main subject of Chapter 19.

Summary Proceedings, 1960, p. 117.

Annual Report, 1959, p. 30.

E.B. Decision No. 1034-(60/27), June 1, 1960; below, Vol. III, p. 260.

Annual Report, 1960, pp. 29–31, 122.

Summary Proceedings, 1960, pp. 64–65.

See above, p. 404.

E.B. Decision No. 1107-(60/50), November 30, 1960; below, Vol. III, p. 277.

E.B. Decision No. 1245-(61/45), August 4, 1961; below, Vol. III, p. 224.

E.B. Decision No. 1151-(61/6), February 20, 1961; below, Vol. III, p. 234.

See above, pp. 447–48.

Annual Report, 1960, pp. 60, 64–65, 67.

Summary Proceedings, 1960, p. 125.

Annual Report, 1961, p. 114.

Summary Proceedings, 1961, p. 113.

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