10 A New Universal and A New Regional Monetary Asset: SDR and ECU
- International Monetary Fund
- Published Date:
- December 1984
The SDR (special drawing right) of the International Monetary Fund (Fund) and the ECU (European Currency Unit) of the European Monetary System (EMS) established by the European Community (Community) have been created in order to improve international monetary arrangements. The name of the SDR was chosen to obscure what was being done when the SDR was invented. French politicians were fearful of any challenge to the supremacy of gold as a monetary asset. For this and other reasons, a compromise was reached that was intended to give the impression that the SDR was no more than an adaptation of what had been the traditional transaction of the Fund,1 which takes the form of a sale by the Fund to a member of the currencies of other members in return for the purchasing member’s currency. In popular language, the member was said to be exercising its “drawing rights.”
The similarity that justified baptizing the new monetary asset the SDR was that it could be transferred by a member to other members in return for currency. The differences between the traditional transactions of the Fund and the SDR were so numerous and substantial that the name SDR was always inappropriate and is even more inappropriate since the Second Amendment of the Fund’s Articles of Agreement, which took effect on April 1, 1978. The need for the original compromise has disappeared. The change is reflected in the terminology of the Articles. The First Amendment, which became effective on July 28, 1969, created the SDR but carefully avoided calling it a reserve asset, for the political reason already mentioned, even though the creation of a new reserve asset was the real purpose of the Fund’s membership in accepting the First Amendment. The Second Amendment has excised the circumlocutions of the First Amendment from the Articles, which now refer to the SDR as a reserve asset and provides, moreover, that members are to collaborate with the Fund and with other members to make the SDR the principal reserve asset in the international monetary system.2 The Fund, in its practice, tries as often as possible to use the acronym SDR and to avoid spelling out the words represented by the letters.
The name ECU was always a better coinage. The acronym is descriptive in associating the ECU with its geographical area and in describing the ECU as a currency unit. Moreover, écu in French means shield, and ECU can be understood to be a shield against monetary disorder. In addition, écu is also the name of a French coin, although it must be said that it is now obsolete.
The further comparison of the SDR and the ECU will be conducted under the headings of monetary reserve asset, portfolio asset, denominator, unit of account, and means of payment.
Monetary Reserve Asset
The SDR. The SDR came into being as a consequence of what can be called the Triffin dilemma. The par value system as regulated by the Fund’s Articles before the Second Amendment required each member to reach agreement with the Fund on a par value for the member’s currency defined in terms of gold as the common denominator of the par value system. Alternatively, the par value could be expressed in terms of the U.S. dollar of July 1, 1944, which had a fixed gold value, so that a member that chose this option was still expressing the par value of its currency in terms of gold, but indirectly. July 1, 1944 was selected as the date because the Bretton Woods Conference, at which the Articles were negotiated, terminated a few days earlier. The effect of establishing par values was to create fixed relationships, called parities, between any two currencies. Each member was bound to ensure that spot exchange transactions in its territories were not carried out at exchange rates outside prescribed narrow margins around the parity between the two currencies that were being exchanged.
The U.S. dollar had a central role in the operation of the par value system for a number of reasons, including the assumption by the United States of an undertaking that it would freely buy and sell gold for dollars, at prices closely related to the par value for the dollar, in transactions with the monetary authorities of other members. The United States would provide gold for dollars if the member holding them wanted to have them converted, and the United States would provide dollars for gold if a member needed them. Under a provision of the Articles that the United States had negotiated at Bretton Woods, this undertaking was deemed to constitute performance of the obligation of a member to maintain exchange rates for its currency in accordance with the prescribed margins. The undertaking of the United States to follow this practice was considered sufficient to promote the stability of the par value of the dollar in terms of gold. No other member undertook to follow the practice in support of its currency. Other members performed their obligations with respect to exchange rates by intervening in the exchange markets, if necessary, to buy and sell the U.S. dollar against their own currency. These members were held to be maintaining the effectiveness of the par values for their currencies in relation to the common denominator because the dollar was convertible into gold in accordance with the U.S. undertaking. Some members performed their obligations at an even further remove from gold, but nevertheless on the same theory. These members would buy and sell a currency, such as sterling or the French franc, for their own currencies. The theory held because these intervention currencies were convertible into the U.S. dollar, and the U.S. dollar was convertible into gold.
The members that held the dollar in their reserves as their intervention currency had confidence in the stability of the dollar because of the strength of the U.S. economy and because of the intention of the U.S. monetary authorities to maintain the par value of the dollar. Normally, these members preferred to invest their dollar holdings instead of requesting the conversion of them with gold by the United States.
The stability of the par value system in operation depended, therefore, on confidence in the U.S. dollar. The economist Robert Triffin argued that there was an inherent weakness in the system that could undermine this confidence. If the balance of payments of the United States was in repeated deficit, monetary authorities abroad would obtain more and more dollars by intervention and at some point would regard the additions of dollars to their reserves as excessive. Members would then begin to request conversion of their excess dollars into gold in accordance with the undertaking of the United States. The shrinkage in the gold holdings of the United States would spur other members that had refrained from requesting conversion to come forward before the U.S. stock of gold was exhausted or before the undertaking was withdrawn. The effect would be to destroy the par value system.
This development was only part of the dilemma that was foreseen. The other part began with the hypothesis that the United States would eliminate or substantially reduce the deficits in its balance of payments. The consequence of this success would reduce the infusions of dollars into the reserves of other members. A growing world economy created a growing need for reserve assets to be added to the monetary reserves that members held to support their currencies and for other purposes. Among these purposes was the sense of ease that members enjoyed in the pursuit of their policies because they could fall back on adequate reserves if the need arose, and the sense of confidence that lenders had that members held sufficient reserves to honor the obligations to repay their borrowings.
The dollar had become the main addition to the monetary reserves of members other than the United States. Gold was not produced in adequate amounts, the volume of production was unreliable, and most newly mined gold was not added to reserves because it went into the free gold market. The price of gold in terms of all currencies could have been increased under a provision of the Fund’s Articles of Agreement. This action was thought to be undesirable, for example, because it would be of special and undeserved benefit to such gold producers as the U.S.S.R. and South Africa and to those members that held gold because they had not exercised the restraint of other members and had obtained the conversion of dollars into gold. Another possible remedy if the demand for reserves was not being met was for the Fund to increase the volume of its assistance to members through the mechanism of its traditional transactions, or, in the language mentioned above, to increase the drawing rights of members. The disadvantage of this technique as a solution of the problem was that, to exercise these rights, members would have to meet the standards of the Fund’s conditionality for the use of its resources,3 but members wanted reserves that they could use unconditionally.
If the need for additions to reserves was not met, the consequences could be serious. Members might resort to exchange restrictions and protectionism to retain their reserves, and they might engage in competitive devaluation and similarly undesirable practices to draw reserves away from other members. The result would be a declining world economy, with dangers for national prosperity. The logical, but novel and arduous, alternative was to create a new reserve asset. It would provide the necessary increases in reserves, and it could be added to gold as an asset that the United States could use to convert foreign official holdings of dollars. The new asset could support both a growing world economy and the par value system. The SDR was the new asset. With the disappearance of the par value system and the freedom of members under the Second Amendment to choose their exchange arrangements and to determine the external value of their currencies, the SDR as the new reserve asset no longer supports a par value system, although it could resume this function if the par value system that is set forth in the Second Amendment were called into operation.4
The ECU. The ECU does not owe its existence to a desire to supplement the reserves of its members, at least in the first stage. The fundamental influences were the desire to create a European monetary identity and disillusion with the U.S. dollar as an anchor for Community currencies. The immediate influence was the wish to defend the members of the Community against the instability of exchange rates that has followed the disappearance of the par value system. This instability has followed the withdrawal by the United States on August 15, 1971 of its undertaking to deal in gold for dollars with the monetary authorities of other members, the final breakdown of the Smithsonian Agreement in March 1973 when members of the Community decided to float their currencies jointly against the U.S. dollar, and the legalization by the Second Amendment of the Fund’s Articles of the freedom with respect to exchange arrangements and exchange rates that has been mentioned above.5 Monetary anarchy followed by legalized unilateralism threatened not only the achievements but also the existence of the common market established by the Community.
Economic and monetary union has been considered an essential element in a broader cohesion within the Community. The Werner Plan of 1970 aimed at an economic and monetary union that would be completed by 1980.6 The narrow margins arrangement (“the snake”) was the most notable achievement of the Plan, but on the whole the Plan was a failure. After a period of little effort to achieve the broad objectives of the Community, the instability of floating exchange rates and fluctuations in them that did not reflect underlying conditions, as well as the tensions caused by a floating U.S. dollar, led to an initiative that surprised the world. The European Council, composed of the Heads of State or Government of Community members, issued a communiqué at Bremen after meetings on July 6 and 7, 1978, to which an annex was attached that outlined some main features of what became the EMS. The European Council adopted a Resolution on December 5, 1978 on the establishment of the EMS, which came into existence on March 13, 1979.
The Resolution refers to the discussion at Bremen of a “scheme for the creation of closer monetary cooperation leading to a zone of monetary stability in Europe.” Stability in the whole range of prices, exchange rates, interest rates, and other monetary variables was the aim. The Resolution dealt primarily with an initial phase of not more than two years, after which a final system was to be created, with the ECU at its center, that would provide for the creation of a European Monetary Fund, “as well as the full utilization of the ECU as a reserve asset and a means of settlement.” The first stage has been prolonged beyond two years and the final system has not yet been put into effect. Even the more modest proposal that uses of the ECU should be developed further in the period before the final system can be put in place has not been adopted. The ECU continues, therefore, to have its original characteristics and uses, but these are of central importance in the EMS. Indeed, the ECU has an emotional appeal in the Community as a unifying element that the SDR does not have in Europe or elsewhere.
The ECU, then, is centrally related at present to a particular exchange rate mechanism. The exchange rate arrangements of the EMS involve fixed but adjustable relationships among currencies. The ECU supports these arrangements and therefore resembles the SDR insofar as that monetary reserve asset was intended to support the par value system of the Fund’s original Articles. The SDR has no such intimate relationship with exchange rates at the present time. There is an indirect relationship with the looser provisions of the Articles on exchange arrangements, however, because an element in the criterion for the allocation of SDRs is promotion of the purposes of the Fund. The purposes include the promotion of exchange stability, the maintenance of orderly exchange arrangements among members, and the avoidance of competitive exchange depreciation.
The criteria that govern the amounts of SDRs that are allocated and the distribution of them are fundamentally different from the criteria that apply to ECUs.
The SDR. The Board of Governors of the Fund decides, by an 85 percent majority of the total voting power of members, whether to allocate SDRs. All allocations are made to all members of the Fund at rates expressed as the same percentage of members’ quotas. The Board of Governors is also empowered to take decisions, by the same majority, to cancel SDRs at the same percentage of the net cumulative allocations of all members (i.e., total allocations minus total cancellations for each member).7 The criterion for these decisions is expressed as follows:
In all its decisions with respect to the allocation and cancellation of special drawing rights the Fund shall seek to meet the long-term global need, as and when it arises, to supplement existing reserve assets in such manner as will promote the attainment of its purposes and will avoid economic stagnation and deflation as well as excess demand and inflation in the world.8
A reserve asset (or monetary reserve asset) can be defined as an asset held by monetary authorities, or by their fiscal agencies, with which, at their will, they can support the exchange value of the currency they issue, or an asset with which they can obtain such assets without legal impediment or undue cost. Patria can use a reserve asset in direct support of its currency by transferring the asset to Terra (i) in conversion of balances of Patria’s currency that Terra obtained by intervention in the exchange market, or (ii) in settlement of an obligation incurred as the result of advances by Terra of its currency for Patria’s intervention. Patria can use a reserve asset in indirect support by exchanging the asset for currency with which, again, Patria intervenes in the market.
The SDR as a “supplement” was not intended to dislodge any other reserve asset, such as gold or the U.S. dollar or other reserve currencies, from their status as reserve assets. If, however, an asset ceased to function as a reserve asset, or if its use was reduced in volume, SDRs could be allocated to fill any need for reserves that resulted from these developments. Members that receive allocations of SDRs do not transfer reserve assets to the Fund in return for the SDRs. Members are not even required to transfer their own currency to the Fund as a quid pro quo. The “backing” for SDRs is a set of obligations and not resources held by the Fund.
The criterion of “long-term global need” is not self-executing and has given rise to extensive but largely inconclusive debate. Allocations have not been made year after year in the way that some negotiators had hoped so that the SDR could become the main instrument for controlling the volume of global reserves in the interest of a better working of the international monetary system. Allocations were made in the seven years 1970 through 1972 and 1978 through 1981, for a total of approximately SDR 21.4 billion, but this total has represented a small and, most of the time, a declining proportion of total reserves. No cancellations have been made and most observers expect that they will not be made. A deterrent to agreement on additional allocations has been the expansion of currency holdings in reserves. Members have resorted to Euromarkets, in which abundant resources have been available, to increase or to maintain the level of their reserves.
The criterion of long-term global need was re-examined to justify allocations in the period 1978–81. The analysis arrived at the proposition that the need could exist, notwithstanding the high volume of global reserves, if members wanted more reserves because of the expansion of international trade and payments or for other reasons. Demand was evidence of need, but it was not necessary that all members should share in the demand. Furthermore, the criterion did not mean that allocations of SDRs were the only available means of meeting the demand. The borrowing of currency might be possible, but SDRs were a superior asset for members, because borrowing entailed obligations to repay or refinance, and repayment or refinancing might be difficult at the due date. SDRs would give members a greater sense of ease in managing their economies, and members might be induced to borrow less than they would in the absence of allocations. If members did borrow less, there would be less risk of an inflationary increase in total reserves that some members feared would be the effect of a combination of allocations and further borrowing. Nevertheless, the idea, which the Fund had considered earlier, of requiring the deposit in a Substitution Account of the equivalent in reserve currency of the amount of allocations, as a concomitant of allocations, was not entertained.
Some importance was attached to the language of the Second Amendment that expresses the objective of making the SDR “the principal reserve asset in the international monetary system.” 9 Sole reliance on the international capital markets for increases in the volume of reserves would not be compatible with this objective. A normative effect was given to the objective by understanding that a concept of quality, and not solely quantity, was involved in the criterion for allocations. The ideas worked out to justify allocations in the four years 1978 through 1981 have not been relied on in the subsequent years in which allocations have been absent.
The ECU. The invention of the SDR probably contributed to the creation of the ECU. If a reserve asset could be created for one purpose, another reserve asset could be created for some other purpose. The ECU differs from the SDR, however, in almost every feature of the SDR as explained above. The ECU is a regional asset because it is issued only to participants in the EMS. The SDR is a universal asset because it is allocated to all members of the Fund and because membership is not restricted to any particular class or classes of countries.
The volume of ECUs in existence is determined by a formula and not by the exercise of discretion. The formula involves no judgment about the need for reserves by participants or about the volume needed to promote the interests of the EMS. The central bank of each participant in the exchange rate and intervention arrangements of the EMS was required to contribute initially to the European Monetary Cooperation Fund (EMCF) 20 percent of the gold and 20 percent of the gross dollar reserves held by the central bank on February 28, 1979.10 Members of the Community are members of the EMS but are not compelled to participate in the exchange rate and intervention arrangements. The United Kingdom, as a member of the EMS but not a participant in the exchange rate and intervention arrangements, has exercised the option to contribute to the EMCF in accordance with the formula in return for ECUs.11
The EMCF credits all contributors with an amount of ECUs equivalent to their contributions. At the beginning of each quarter, a contributor adjusts its contribution so that it continues to represent 20 percent of the gold and of the U.S. dollar holdings of the contributor on the last working day of the preceding quarter. These adjustments take account of the changing price of gold and changes in the exchange rate for the dollar, as well as changes in the volume of holdings. The equivalent in ECUs of gold holdings is determined by the average of the prices, translated into ECUs, that were recorded daily at the two London fixings during the previous six calendar months, but the average price of the two fixings on the penultimate working day of the period in respect of which the adjustment is being made is applied if it is less than the average over the period. This maximum avoids the risk that gold will be valued in excess of the price on the penultimate day as a recent market price. The equivalent in ECUs of the U.S. dollar holdings is valued according to the market rate prevailing two working days prior to the value date for the renewed contribution. The volume of ECUs is hostage to the price of gold and the exchange rate for the dollar. The contrast is strong between this technique and the rational control of liquidity as the motive that inspired the creation of the SDR.
The quarterly adjustments can produce considerable variations in the total volume of ECUs in existence and in the ECU holdings of a central bank.12 Each central bank’s balance sheet shows its holdings of ECUs, but not the assets contributed to the EMCF, as part of the central bank’s reserve assets. The total volume of SDRs and the holdings of them by each member of the Fund are not adjusted in relation to any datum. Decisions to allocate or cancel SDRs affect individual and total holdings of them, but these decisions are taken for basic periods of five years, unless another period is chosen, but even different periods have not been, and are not likely to be, as brief as quarters.
The raison d’être of the SDR as stated in the Fund’s Articles is to supplement existing reserve assets when the global volume is inadequate. Allocations increase the reserve assets of each member. ECUs are not issued for this purpose. They are issued in return for other reserve assets, with the intention that the operation of the EMS, at least in its first stage, will not increase the individual or total volume of reserve assets. To avoid this result, neither the EMCF nor the depositors are free to use deposited assets, although in certain circumstances a swap can be reversed at the discretion of a depositor. A reversal would not increase reserves. The negotiators of the EMS wished to guard against the risk that increases in reserve assets might have inflationary consequences.
Two qualifications, however, must be noted. First, the issue of ECUs against gold is a de facto activation of gold as a reserve asset, which may reduce the need to accumulate or use other holdings of reserve assets. The fluctuating market price makes central banks reluctant to part with their gold in international settlements, so that gold is dormant in the reserves of most central banks. The activation of gold without finally disposing of it is undoubtedly one of the attractions of the ECU for participants. The attraction may seem greater to participants if the volume of their dollar holdings declines. Second, if a central bank values its gold at less than the price on the basis of which ECUs are issued, there is a statistical, although not real, increase in the central bank’s total reserves. Some of the central banks sterilize an amount equal to the discrepancy in order to offset the effect on domestic liquidity. If the Fund had required the deposit of reserve currency in a Substitution Account before issuing SDRs, the effect would have been comparable to the present effect on total reserves of the issue of ECUs.
If, at some future stage of development of the EMS, ECUs were issued by a European Monetary Fund without a corresponding contribution of reserve assets, the process would resemble the allocation of SDRs. The analogy would be valid even if the ECUs were issued against a participant’s own currency. The ECUs issued against a counterpart in the participant’s own currency would be comparable to allocated SDRs because the ECUs would increase the participant’s reserves.
The assets contributed to the EMCF are transferred under swap arrangements, of three months in duration, in return for ECUs. The swaps are renewable. They include some unusual provisions. The legal device of renewable swaps was adopted because of the reluctance of participants in the EMS to make final transfers of assets, in particular gold. In addition, one or more of the central banks may lack the legal authority to make final dispositions of the assets but may have authority to make spot sales of them coupled with forward purchases.
Other aspects of the contribution to the EMCF evidence the intention to avoid a final disposition. Each central bank concludes an agreement with the EMCF for delivery of the assets and for the right of the depositor to continue to manage the assets. Although the EMCF must be assumed to have ownership of the assets during the life of a swap, changes in the value of the assets and profits earned on them are for the account of the depositor. During the period of a swap, neither the EMCF nor a contributor is entitled to dispose of the deposited assets. The assets in the hands of the EMCF do not resemble the assets that the Fund holds in the General Resources Account and can dispose of in the transactions and operations conducted through that Account. The ownership of assets by the EMCF is subject to termination because, in principle, the quarterly swaps might be discontinued. They were established originally for two years, but the period has been prolonged. In addition, a contributor that suffers a decline in its U.S. dollar reserves is entitled to unwind a swap to the extent of the contributed dollars that it wishes to reacquire. It obtains the dollars it wants and returns an equivalent amount of ECUs to the EMCF.
The SDR. The value of the SDR under the First Amendment of the Fund’s Articles was defined as a fixed quantity of gold, which at that time was equivalent to the par value of the U.S. dollar. After the collapse of the par value system, the Fund decided that the value of the SDR would be equal to a basket of determined amounts of 16 currencies, and that the value of currencies in terms of the SDR would be based on the market value of the basket. Later, the basket was changed by eliminating 2 of the currencies and replacing them with 2 other currencies. As the result of a further revision, which took effect on January 1, 1981, the basket has been reduced to 5 currencies, as follows:
|Weight||Amount (in units|
|Currency||(in percent)||of each currency)|
The present Articles of the Fund provide that the method of valuation of the SDR shall be determined by the Fund by a 70 percent majority of the total voting power, but an 85 percent majority is necessary for a change in the principle of valuation or a fundamental change in the application of the principle in effect.13 Certain principles that govern the method of valuation have been set forth in a decision of the Fund.14 It declares that the value of exports and services is the criterion for the inclusion of currencies in the basket, and that shares in the basket are based on that datum together with the value of the holdings of a member’s currency by other members. The intention is to reflect the role of the currencies in international trade and other transactions and in finance. The Fund has announced also the principles that will guide any future changes in the method of valuation, so that changes will be made according to principles that are known and are consistent with the principles observed on earlier occasions. Furthermore, the timing of changes will be predictable. Objectives of stability in the composition of the basket and continuity in the value of the SDR in terms of currencies are among the considerations that have influenced the choice of principles. The decision will be applied at quinquennial periods beginning on January 1, 1986.15
The ECU. The value of the ECU also is determined by reference to a basket of currencies. When the EMS took effect, the basket was composed as follows, and so far it has not been changed:
(March 13, 1979)
|ECU 1 =|
(March 13, 1979)
This definition corresponded to the definition of the earlier European Unit of Account (EUA). That unit originally was made to equal one SDR in terms of currencies.16
The amounts of currencies in the ECU basket were to be reviewed, and if necessary revised, within six months after the EMS entered into force and at quinquennial intervals thereafter. The first review was completed in September 1979, but did not result in a revision. The amounts of currencies may be revised at any time if the weight of any currency, based on exchange rates, has changed by at least 25 percent and a review is requested. The parties that may request a review are not named, but it is possible that they include the Commission of the Community, as well as participants in the EMS.
Revisions “have to be mutually accepted,” which means perhaps that the agreement is necessary of all issuers of the currencies in the ECU basket. The drachma, the currency of Greece, the newest member of the Community, is not yet included in the basket. The Treaty of Accession under which Greece has entered the Community provides for the inclusion of the drachma when the ECU basket is revised or by the end of 1985 at the latest. Revisions are to be made “in line with underlying economic criteria.” The criteria for determining weights in the EUA basket were gross national product (GNP) and intra-Community trade.17 If they are applied to the ECU, they will differ from the criteria that determine shares in the SDR basket.
Among the differences between the methods of valuation of the SDR and the ECU are the inclusion of all Community currencies in the ECU (except the drachma for the time being) while only 5 of the 146 currencies of the Fund’s members are included in the SDR basket. Moreover, the number of currencies in the ECU basket will increase, while the number in the SDR basket has been reduced. Decisions to revise the SDR basket require majorities of the total voting power of the Fund’s membership, but apparently unanimity is necessary for decisions to revise the ECU basket.
A difference of outstanding importance between the two baskets is that the U.S. dollar and the Japanese yen are included in the SDR basket but not in the ECU basket. As a consequence, if the U.S. dollar is strong, the chances are that European currencies in the ECU basket will be weak. If both the dollar and the yen are strong, the prospects are even greater that the European currencies will be weak. In these circumstances, the ECU will be a less attractive monetary asset than the strong currencies. If the dollar is weak, or if both the dollar and the yen are weak, ECUs will increase in attractiveness. The incentive to use the ECU could be affected by its attractiveness from time to time.
Reviews and Changes. Similarities between the SDR and the ECU, apart from the valuation of each by reference to a basket of currencies, include revisions of the SDR and reviews of the ECU at intervals of five years. The transition to a revised basket must ensure that the exchange rate for each currency in terms of the SDR or the ECU immediately before and immediately after the change will be the same. These and some other features of the ECU seem to have been based on experience with the SDR.
In the brief existence of the ECU, the method of valuation has not been changed, but the method of valuation of the SDR has gone through four versions. The original version was related to gold and the other three to a basket of currencies. Although the changes can be considered successive improvements, the number of changes has been commented on unfavorably by one appellate tribunal in the United States in proceedings in which it was argued unsuccessfully that the Poincaré franc in the Warsaw Convention for the Unification of Certain Rules Relating to International Carriage by Air, 1929 should be applied on the basis of the SDR as the unit of account that has replaced gold.18
The SDR. Allocations of SDRs are made to all members of the Fund that become participants in the Special Drawing Rights Department. All present members have become participants. In addition, the Fund itself may hold SDRs in the General Resources Account of the General Department as the result of a range of transactions and operations between the Fund and members, but the Fund is not authorized to allocate SDRs to itself.
The Fund may decide, by an 85 percent majority of the total voting power, to permit certain entities to hold SDRs. These entities are nonmembers of the Fund, members that are nonparticipants in the Special Drawing Rights Department, institutions that perform functions of a central bank for more than one member of the Fund, and “other official entities.” The Fund, by decisions taken with a majority of the votes cast, may establish the terms and conditions (a) on which prescribed holders may be permitted to hold, accept, and use SDRs in transactions and operations with members of the Fund and with other permitted holders, and (b) on which members and the Fund, through the General Resources Account, may enter into transactions and operations in SDRs with prescribed holders. The Fund has no authority to permit private entities to hold SDRs. The Fund has borrowed currency from certain central banks that it had not prescribed as holders of SDRs, on terms that enabled the Fund to transfer SDRs in payment of interest and repayment of principal to the member whose central bank was the lender. The members make their own settlements with their central banks when the members receive SDRs under these terms of the Fund’s borrowing agreements. A similar procedure might be followed if the Fund were to borrow from private lenders, provided that the Fund reached the necessary agreement with the lenders and their national authorities.19
By the end of April 1983, the Fund had prescribed 13 entities as holders of SDRs. Among them were the following central banks and currency authorities:
Swiss National Bank, Zurich
Bank of Central African States, Yaoundé
Central Bank of West African States, Dakar
East Caribbean Currency Authority, St. Kitts
For these 4 entities, the SDRs they hold are reserve assets, with which they can support their currencies. The other 9 prescribed holders, which do not hold SDRs as reserve assets, are listed later in this Chapter.
Some of the 13 prescribed holders are international organizations or regional organizations, with a membership that sometimes includes nonmembers of the Fund. Some holders are Specialized Agencies of the United Nations, others are not. Some have adopted the SDR as their unit of account for all possible purposes, others have not. Switzerland is a nonmember of the Fund. These comments are made here for convenience, even though, as noted, not all prescribed entities hold SDRs as reserve assets.
The Fund has adopted standard terms and conditions for all prescribed holders of SDRs, under which these holders may enter into the same transactions and operations with each other and with members of the Fund that members may enter into with each other. This uniformity is intended to assimilate the SDR, as far as legally possible, to a currency. The standard terms could authorize transactions and operations between prescribed holders and the Fund, but so far the terms do not. The Fund has refrained from taking this action so as to demonstrate that a broad market can develop without involving the Fund. Under legal provisions, which are not confined to prescribed holders, the Fund may transfer SDRs 20 to prescribed holders as interest on their holdings of SDRs, as interest on loans to the Fund, and in repayment of loans.21
The ECU. ECUs may be held by the central banks of members of the Community, whether or not they participate in the exchange rate and intervention arrangements of the EMS, in accordance with the provisions of the legal instruments that govern the EMS. European countries with “particularly close economic and financial ties with” the Community may be allowed to participate in the exchange rate and intervention arrangements of the EMS as associate members of the EMS. Participation would be based on agreement among central banks. It would seem that European nonmembers of the Community entering into such agreements would be able to hold ECUs, in which event they would have some resemblance to prescribed holders of SDRs. Countries outside Europe could not be holders of ECUs, but no geographical limit applies to the Fund’s power to prescribe holders of SDRs. The provision that favors European countries is an echo of the participation of Sweden and Norway in the “snake” for certain periods. So far, no European country has entered into an agreement under the provision.
The SDR. Transactions in SDRs are defined by the Fund’s Articles as exchanges of SDRs for other monetary assets; operations in SDRs are defined as other uses of SDRs. Transactions and operations in SDRs can be classified as follows: 22
(i) A member of the Fund or a prescribed holder may transfer SDRs to another member or to a prescribed holder in exchange for currency by agreement between the two parties. These transfers are not subject to the rule of need as described in (ii) below.
(ii) A member is entitled to have the Fund designate another member to receive a transfer of SDRs and provide currency in return if the transferor has a need to use its SDRs because of its balance of payments or reserve position or because of developments in its reserves, and is not making the transfer for the sole purpose of changing the composition of its reserves. The Fund cannot refuse to designate a transferee even if the transferor does not have a need as defined, but the Fund can reverse the effect of the transfer if the transferor did not meet the test of need. The Fund can designate the earlier transferor to receive SDRs from a later transferor that requests a designation, even though the designation of the earlier transferor in the later transaction would not be made under the basic principles for designation.23 The obligation of the Fund to designate on request without challenge and the obligation of a member to accept SDRs when designated are the ultimate obligations on which the SDR scheme rests.
(iii) The Fund may transfer SDRs to a member that has a balance of payments or reserve need as described in (ii) above in return for the member’s currency. In these transactions, SDRs held by the Fund in the General Resources Account are among the general resources that enable the Fund to give effect to conditionality and to its efforts to encourage members to eliminate or avoid balance of payments maladjustments.
(iv) The Fund may accept SDRs or the currencies of other members in return for the currencies of other members or SDRs, in each case with the concurrence of the member whose currency is provided or accepted by the Fund. These transactions are not for the purpose of assistance to members in need as in (iii) above. Therefore, the member that is a party to a transaction with the Fund within category (iv) does not have to observe the test of need that applies to transactions under (ii) or (iii) above.
(v) The Fund may receive or transfer SDRs in settlement of numerous obligations between the Fund and its members. For example, a member may transfer SDRs to the Fund in partial settlement of an increase in subscription or in discharge of a repurchase obligation by which the member terminates an outstanding use of the Fund’s general resources. The Fund may transfer SDRs to a member, for example, as remuneration for use of the member’s currency in transactions conducted through the General Resources Account or in repayment of loans by the member to the Fund. The use of SDRs in discharge of obligations is mandatory under some provisions, but there is authority to use currency as an alternative.
(vi) The Fund, by a 70 percent majority of the total voting power, may permit operations in which members or prescribed holders of SDRs may engage by agreement with other members or with other prescribed holders on such terms and conditions as the Fund establishes. The Fund has permitted the following categories of operations so far: direct settlements of financial obligations, loans, pledges, transfers as security for the performance of financial obligations, swaps, forward operations, and donations. The Fund cannot compel members to use SDRs in operations between members.
(vii) The Fund can require a member to sell its currency to the Fund in return for SDRs if the Fund deems it appropriate to replenish its holdings of the currency in the General Resources Account.
Nonofficial entities cannot hold SDRs. It follows that the categories of transactions and operations listed above are confined to transactions and operations to which members and official entities are parties. It follows also that, even though SDRs are reserve assets for members and some official entities, SDRs cannot be used for direct intervention in the exchange markets.
The ECU. The uses of ECUs are more limited than the uses of SDRs, although the central banks of the EMS may agree to transfer ECUs to one another, but not to other entities, against U.S. dollars, Community currencies, or gold. It has been noted above that, for the purpose of meeting a decline in the holdings of dollars in its reserves, a central bank may obtain dollars against ECUs from the EMCF between periodic adjustments of the central bank’s contribution of reserve assets, initially by unwinding a swap transaction pro tanto. Neither transaction can be entered into for the sole purpose of changing the composition of the transferor’s reserves. There is no procedure for designating a transferee of ECUs on the request of a central bank wishing to transfer them that corresponds to the designation procedure for SDRs.
It would seem that if a participant transfers ECUs for the sole purpose of changing the composition of its reserves, the participant is in breach of its obligations. There appears to be no procedure for challenging a transfer or the unwinding of a swap before the transfer or swap is made. If a member of the Fund requests the designation of a transferee of SDRs, the transfer cannot be challenged before it is made on the ground that the transferor is making the transfer solely for the purpose of changing the composition of its reserves. Moreover, the transfer is not a violation of the transferor’s obligations. These principles have been included in the Articles in order to enhance the characteristics of SDRs as reserve assets.
SDRs and ECUs are dissimilar in this aspect of use, but are similar in another aspect. Holders of the two assets have only limited rights to have them converted into currency by the issuing institution. A member of the Fund can obtain the currency of another member for SDRs from the Fund only if the Fund agrees and the other member concurs. The EMCF is bound to unwind a swap and provide U.S. dollars only in the specified circumstances. In the normal operation of both plans, the holders of SDRs and ECUs have no claims against the issuing institution that compel it to provide currency in exchange for the asset it issues.
The unwinding of a swap would not give a central bank dollars in exchange for the ECUs that it had received against gold. Such an exchange would not be an unwinding of the swap. Most ECUs have been issued against gold. On the date of the next adjustment after the unwinding of a swap to get dollars, the central bank’s reserves of gold and of dollars would have to be made without allowance for the interim unwinding. The bank, however, may have expended and not restored the dollars it obtained in the unwinding, so that the adjusted deposit of dollars would be smaller than the preceding deposit. Nevertheless, the principle of reinstituting a deposit at the full level of 20 percent resembles the obligation that formerly required members of the Fund to reconstitute their holdings of SDRs after use so as to maintain a certain average level of holdings.
Participants in the exchange rate and intervention arrangements of the EMS must ensure that certain margins around parities are observed in transactions for the exchange of their currencies, as discussed below. Participants are obliged to intervene in the exchange markets in whatever amounts are necessary when the limit of a margin is reached in exchange transactions. Participants may intervene within the margins, but only with the approval of the participant whose currency is to be used in intervention. Participants may intervene also in non-EMS currencies within or at the limits of a margin. As in the case of the SDR, ECUs cannot be used for direct intervention in the exchange markets, because nonofficial entities are not permitted to hold ECUs. This limitation applies even though the ECU is at the center of the exchange rate and intervention arrangements of the EMS.
A so-called very short-term facility has been established for financing intervention at the limits of margins, in accordance with which participants make available reciprocal lines of credit in their own currencies in unlimited amounts. The currencies are made available bilaterally and not through the EMCF. Intervention takes place with these currencies. Claims and debts arising from the use of this facility are recorded in ECUs in the books of the EMCF at the exchange rates on the day when intervention occurs with the use of currency obtained under the facility. Settlements of claims and debts arising from the use of the facility must be made 45 days after the end of the month in which intervention took place. Extensions of this period are possible, automatically or by agreement with the creditor central bank, according to certain provisions. A debtor central bank is entitled to make an advance repayment at any time in the currency of the creditor, or on a monthly settlement date in accordance with the rules on the means of settlement that must be observed at the due date.
The obligatory means of settlement at the due date are, first, the debtor’s holdings of the creditor’s currency. Central banks may hold working balances of Community currencies within the limits laid down by the Committee of Governors of the Central Banks. As a result, if a debtor obtains the creditor’s currency in the market because of developments in exchange rates, the debtor repays the creditor before the date for settlement. A limit on working balances may be exceeded only with the consent of the central bank whose currency is held. Next in the order of the means of settlement are ECUs. They may be used to settle all or part of the remaining debt, but a creditor is not obliged to accept ECUs in excess of 50 percent of the claim that is being settled. The remainder of a debt is settled by transferring other reserve assets in accordance with the composition of the debtor’s reserves denominated in SDRs and in currencies at the end of the month preceding the settlement.24 The debtor and creditor central banks are permitted to reach agreement on some other form of settlement. Settlements of a substantial proportion of total claims and debts arising under the facility have been made in accordance with bilateral agreements.
If a debtor central bank no longer possesses ECUs and wishes to obtain them for making settlements, it must apply in the first instance to the central banks that are net accumulators of ECUs (i.e., the central banks that are holding ECUs in excess of the equivalent of their contributions to the EMCF) or “possibly” to the EMCF. If the ECUs are provided by the EMCF, the debtor central bank obtains them against an equal percentage of the gold and dollar assets held by the debtor. This provision somewhat resembles the Fund’s authority to sell SDRs, if it agrees, to a member that requests them in return for the currencies of other members (category (iv) of the Fund’s transactions and operations listed above), but the transactions in ECUs referred to in this paragraph must be for the purpose of settling indebtedness under the very short-term facility. Another difference is that the Fund’s Articles do not include any formula that governs the currency composition of a member’s payment for SDRs.
Distribution of Holdings
The distribution, use, and holding of SDRs and ECUs are subject to various provisions that are intended to protect the equilibrium of the two schemes.
The SDR. An unwilling recipient of SDRs can refuse to accept them under a decision of the Board of Governors to make allocations if the Governor for the unwilling member did not vote in favor of the decision and the member notifies the Fund in writing before the first allocation under the decision that it does not wish to receive SDRs under the decision. The idea is that an unwilling holder can be an embarrassment in the operation of the scheme.25 The member may withdraw the notice, if the Fund consents, and receive subsequent allocations.
A similar idea that there should be reasonable freedom for members to hold or not to hold SDRs partly explains the provision that a member cannot be compelled to hold more than 300 percent of the net cumulative allocation of SDRs that it has received. A further purpose of the provision is to avoid a maldistribution of SDRs. Again, however, a member’s freedom is recognized by permitting it to reach agreement with the Fund to hold more than this volume of SDRs.
The attempt to avoid the maldistribution of SDRs and harm to the SDR scheme if members systematically disposed of their holdings of SDRs, or systematically amassed SDRs from other members, was among the objectives of a provision requiring members to reconstitute their holdings of SDRs after use. The rules for reconstitution made it mandatory for members to maintain a certain average proportion of net cumulative allocations over time. The Fund has exercised a power to abrogate reconstitution, because of the widespread objection among members that the obligation was inconsistent with the character of the SDR as a reserve asset.
The objective of achieving a desirable distribution of SDRs is evident in the provision that deals with the designation of a member by the Fund to receive a transfer of SDRs if designation is requested by a transferor. One of the principles of designation is that the Fund must designate transferees in such manner as will promote over time a balanced distribution of holdings of SDRs among them.
Members of the Fund may not engage in certain transactions for the sole purpose of changing the composition of their reserves. The explanation of the word “sole” is that all uses of SDRs have the effect of changing the composition of reserves. A member’s request to the Fund for designation of a transferee is not challengeable even if the member is transferring SDRs in disregard of the expectation that it will not use SDRs solely for the purpose of changing the composition of its reserves. It has been noted, however, that the Fund may reverse the effect of the transfer by the special designation of the transferor, which then becomes a transferee, in a later transaction initiated by another transferor.
The principle that a member of the Fund should not transfer SDRs for the sole purpose of changing the composition of its reserves applies to transfers to designated transferees but not to transfers by agreement between members or to transfers the Fund agrees to accept from a member in return for the currency of another member provided by the Fund with the concurrence of that other member. The principle does apply to transfers of ECUs by agreement between central banks and to the transfers to the EMCF a participant is entitled to make on an interim unwinding of a swap to restore dollar holdings. It follows that SDRs may be transferred more freely than ECUs.
The ECU. An unwilling holder of ECUs has less freedom than an unwilling holder of SDRs. A participant in the ECU scheme must make the required contribution, must receive the equivalent in ECUs, and must make the quarterly adjustments. There is no provision comparable to the one that allows a member of the Fund to refuse allocations of SDRs. In the settlements of claims and debts under the very short-term facility, however, a creditor cannot be compelled to accept ECUs in excess of 50 percent of the claim that is being settled, but apparently a willing creditor is permitted to accept more. One reason for the limit of 50 percent is the protection of persistent creditors within the EMS, because they may need to use other reserve assets in settlements with non-EMS countries. The other 50 percent of a debt, therefore, is to be settled in reserves other than ECUs.26
Participants in the EMS have no obligation to reconstitute their holdings of ECUs after use, but they must adjust their contributions of assets to the ECMF at quarterly intervals if developments in gold and dollar holdings make adjustment necessary. If adjustments are made, participants’ holdings of ECUs will be affected.
If a debtor no longer has the ECUs it needs for settlement, it must apply in the first instance to the central banks that are net accumulators of ECUs. The objective of this provision is similar to the objective of achieving a desirable distribution of SDRs in the designation procedure of the Fund. When a member requests the Fund to designate a transferee of SDRs, one of the principles of designation is that the Fund must designate transferees in such manner as will promote over time a balanced distribution of holdings of SDRs among them.
EMS members may not engage in certain transactions for the sole purpose of changing the composition of their reserves. The right of central banks to transfer ECUs to one another against U.S. dollars, Community currencies, SDRs, or gold, and the right to meet a decline in dollar holdings by obtaining dollars against ECUs between periodic adjustments of contributions, are subject to the qualification that the transactions are not for the sole purpose of changing the composition of reserves. This principle resembles the one that applies to certain transfers of SDRs, but the principle applies to transfers of ECUs by agreement but not to such transfers of SDRs.
Interest and Charges
Both the SDR and ECU schemes provide for the payment of interest to and charges by participants.
The SDR. The Fund pays interest at the same rate to each holder of SDRs (whether a member, prescribed holder, or the Fund itself) on the amount of the holder’s balance of SDRs. The rate of interest is established by the Fund by decisions taken with a 70 percent majority of the total voting power. The present interest rate is the sum of the average yield or rate on each of five selected instruments that are denominated in the five currencies of the SDR valuation basket and that are available in the five domestic markets. The yield or rate of interest on each instrument in the interest rate basket is multiplied by the number of units of the currency of denomination in the valuation basket and the value in terms of the SDR of a unit of the currency as determined daily by the Fund, subject to rounding. The averaging is based on the yields and rates for the 15 business days preceding the last 2 business days of the last month before the calendar quarter for which interest is calculated.27
All members pay charges to the Fund at the same rate on their net cumulative allocations of SDRs. The rate of charges is equal to the rate of interest. The effect is that members that have held fewer SDRs than their net cumulative allocations pay a net amount of charges on the average excess of net cumulative allocations over holdings. Other holders pay no charges because they receive no allocations. The net amount of charges is equal to the net amount of interest received by members whose average holdings of SDRs have exceeded their net cumulative allocations, together with the interest received by other holders of SDRs. Interest and charges accrue daily, and the difference between charges and interest, or interest in the case of holders other than members, is credited or debited, as is appropriate, to the accounts of holders promptly after the end of each financial year of the Fund.
The ECU. Central banks that hold fewer ECUs than the ECUs they have received from the EMCF in return for their contributions pay interest to the EMCF on the shortfall. The EMCF pays interest to central banks whose holdings exceed the ECUs they have obtained from the EMCF in return for their contributions. These central banks receive interest from the EMCF on the excess. The amount of interest paid or received by central banks is calculated on the basis of average daily balances and is paid monthly. The rate of interest is determined by a fixed formula and not according to decisions taken in the exercise of a discretionary power such as the Fund has to establish the interest rate on holdings of SDRs. The formula for the ECU is the same as for the interest paid by debtors and to creditors under the very short-term facility: the average of the official discount rates of all Community central banks, weighted in accordance with the weight of their currencies as derived from the central rates of the currencies in terms of the ECU. The average is calculated once a month on the basis of the discount rates ruling on the last working day of the month. The resulting rate applies during the following month to all amounts outstanding under the very short-term facility. Accrued interest is paid in ECUs on each monthly settlement date or, between settlements, when a debtor makes an advance settlement of its debt. The interest rate on holdings of ECUs has been below market rates. There has been no change in the formula, but progressive improvements have been made in the formula for the SDR.
Ties Between SDR and ECU
The Resolution of the European Council of December 5, 1978 establishing the EMS declares that the “EMS is and will remain fully compatible with the relevant articles of the IMF Agreement.” This declaration was formulated as one of both fact and intention.
Effect on Allocations. In an examination of the ties between the SDR and the ECU, a question that arises immediately in relation to this declaration is whether members of the Community would be less likely to vote in favor of allocations of SDRs because holdings of ECUs are available to them. Under present arrangements, ECUs do not represent a net addition to the reserves of members of the Community, although ECUs are substituted for inactive gold. Therefore, members of the Community might not regard ECUs as meeting the need that can be met by SDRs as a supplement to reserves and not a substitute for them. If, however, ECUs were issued in the future without a counterpart in reserve assets, these ECUs would be a net addition to reserves. The attitude of members of the Community might then be different, but ECUs, however issued, would still be a regional asset that lacked the liquidity of SDRs. ECUs can be used at the present time only in intra-Community transactions. Once again, then, members of the Community might not regard ECUs as equivalent to SDRs in meeting their needs. It is possible, of course, that the geographical limitation on the holding and use of the ECU might be whittled away in time, with a consequent increase in liquidity, but it is hardly likely that the regional connection would be abandoned.
ECUs can be affected in another way because of the regional character of the ECU. It is not inconceivable that all members of the Community might face simultaneous balance of payments difficulties with the outside world. In those circumstances, the volume of ECUs might be reduced because of the termination of swaps and the reduction of the reserve assets on the basis of which contributions to the EMCF are calculated. Within so large a community as the present 146 members of the Fund, surpluses are always likely to equal deficits. In any event, the volume of SDRs can be reduced only by a decision of the Fund to cancel some proportion of them in order to promote the purposes of the Fund and to avoid excess demand and inflation in the world.
Effect on Role of SDR. The effect of the EMS on the allocation of SDRs and, therefore, on the role of the SDR in the international monetary system is not the only conceivable issue of compatibility with the Articles of the Fund that could arise. So far, there has been no suggestion of incompatibility, but the SDR has not become the principal reserve asset in the international monetary system and the EMS has not progressed beyond its initial stage. Neither the SDR nor the ECU has achieved a position in which the issue could arise of a threat to the central reserve asset by a regional reserve asset.
Other Relationships. One tie between the SDR and the ECU that has been mentioned already is that the creators of the ECU have taken account of experience with the SDR. This experience has been used by the Community both in applying some features of the SDR and in rejecting others as premature or as unsuitable for a regional asset.
Some provisions governing the ECU take account of the existence of the SDR, not as an influence on the characteristics and uses of the ECU, but for the purpose of regulating the business activities of the EMS. Contributions to the EMCF do not include SDRs. The EMCF has legal personality but has not been prescribed by the Fund as an official entity that can hold SDRs. The central banks of the EMS, however, can transfer ECUs in exchange for SDRs between themselves as central banks of members of the Fund, although the rules of the EMS provide that these transfers should not be made for the sole purpose of changing the composition of reserves. Furthermore, SDRs can be used to settle debts under the very short-term facility. To the extent that settlement is not made with the creditor’s currency or with ECUs, the settlement is to be completed with currencies and with assets denominated in SDRs in the proportions in which the debtor held them on the relevant date. Assets denominated in SDRs include both SDRs and the debtor’s reserve position in the Fund, both of which the debtor can use without challenge by the Fund. The debtor can decide with which of these two assets within the category of assets denominated in SDRs, or in what proportions, it will discharge the amount of its debt that must be settled in assets denominated in SDRs.28
The Fund has taken cognizance of the ECU in its decisions authorizing members of the Fund to enter into operations in SDRs not otherwise authorized by the Articles. For example, SDRs may be used in the settlement of financial obligations that are denominated in one of various ways, including “another unit of account that is composed of currencies and is applied under an intergovernmental agreement.” The decisions authorizing certain other operations include the same formulation. The drafters of this language had the ECU in mind.29
A possible tie between the SDR and the ECU would be a change in the method of valuation of the SDR according to which the ECU would replace the three European currencies in the SDR basket. This change would raise numerous issues. One of them would be the desirability of permitting the method of valuing the SDR to be affected by decisions of the Community on the method of valuing the ECU.
The drafters of monetary arrangements pay much attention to provisions for liquidation. The drafters may not regard liquidation as likely, but they will be aware that potential participants in the arrangements will pay attention to rights in liquidation as aspects of the quality of rights while the plan is in operation.
The SDR. In the case of the SDR, the drafters were concerned that, if a member should default in the settlement on liquidation of the scheme, there should be an equitable sharing of the burden among participants, and that a participant should not bear a greater proportion of the risk because it held more SDRs than its net cumulative allocation. The SDR might be considered to have an inherent weakness during its daily life if liquidation would produce inequities.
The system of liquidation of the Fund under the original Articles was regarded as less than optimal for the SDR scheme because, under the original Articles, members would be ranked, for the purpose of receiving assets in settlement, on a scale in which the largest creditor in proportion to quota would be first and the largest debtor in proportion to quota would be last, with all other members in positions between them according to the same principles. The burden of default by a member, therefore, would be borne not by all other members according to a criterion applicable to all but only by those members above the defaulter on the scale. The higher a member would be on the scale, which meant the greater its creditor position in proportion to quota, the greater would be its risk, because, in effect, all members had claims against those below them on the scale and owed obligations to those above them. If there were more members lower on the scale, the greater was the risk that there might be a defaulter among them.
The system of liquidation for what is now the Special Drawing Rights Department is different. Each member would be bound to pay the Fund, in installments, an amount in prescribed currencies equal to the member’s net cumulative allocation, and the Fund would use these receipts to redeem the SDRs held by members. The Fund would redeem SDRs held by the member that held the largest amount in proportion to net cumulative allocation until this proportion was reduced to the next highest proportion. The next redemptions would bring the proportions held by these two members down to the third highest proportion. The process would be continued until all members held the same proportion in relation to their net cumulative allocations, at which point subsequent redemptions would be made at the same proportion in relation to the net cumulative allocations of all members. The effect would be that if a member defaulted, the burden would be shared by all members, in proportion to the same criterion of net cumulative allocation, and that a member would not be at greater risk because it held SDRs in excess of its net cumulative allocation.
The ECU. The system for liquidating the ECU scheme is simple. The net users of ECUs would have to raise their holdings of ECUs to the amount they had received in return for their contributed assets. The net users would have to obtain the necessary ECUs from the net accumulators, which would have to reduce their holdings to the same norm. All the swaps could then be unwound by the return of ECUs to the EMCF and the receipt of contributed assets from it. It will be apparent that this system makes no provision for default. In the small and uniform membership of the Community, default was unthinkable.
SDRs may be held by entities that do not issue a currency and therefore do not hold SDRs as reserve assets to support a currency. These entities hold SDRs as part of their portfolio of assets and use the SDRs for their own purposes, whatever they may be, and in accordance with the terms and conditions prescribed by the Fund. SDRs held in the General Resources Account can be considered part of the Fund’s portfolio of assets with which it conducts transactions and operations through that Account in accordance with the Articles. The Fund holds these assets not to support a currency that it issues but to support the currencies that its members issue.
Nine of the 13 entities that the Fund has prescribed so far as holders of SDRs would hold SDRs as part of the portfolios of assets with which the entities conduct their activities. The 9 can be classified as follows:
Intergovernmental monetary institutions
Bank for International Settlements, Basle
Andean Reserve Fund, Bogotá
Arab Monetary Fund, Abu Dhabi
Intergovernmental development institutions
Asian Development Bank, Manila
International Bank for Reconstruction and Development (World Bank), Washington, D.C.
International Development Association, Washington, D.C.
Islamic Development Bank, Jeddah
Nordic Investment Bank, Helsinki
International Fund for Agricultural Development, Rome
The terms and conditions on which prescribed holders have been permitted to hold SDRs and to use them in transactions and operations have been standardized by the Fund. The underlying policy has been to avoid the existence of different characteristics and uses for SDRs, and therefore different kinds of SDRs, subject to the consequences of the fact that prescribed holders are not members of the Fund. One consequence of this caveat is that prescribed holders do not have the benefit of the procedure by which the Fund designates transferees of SDRs on the request of members wishing to make transfers.
Provisions governing the EMS contemplate that in some circumstances the EMCF may receive ECUs from participants, but the EMCF does not hold ECUs in its portfolio of assets for purposes comparable to those for which the Fund holds SDRs in its General Resources Account as the result of transactions and operations with members. Moreover, there are no provisions under which countries and entities, other than participants in the EMS, and certain European countries if agreements were reached with them, may hold SDRs in their portfolios. If agreements were reached with eligible European countries, or if under some future amendment of the EMS other countries or entities were permitted to hold ECUs, it is likely that a policy of avoiding different categories of ECUs would be observed.
A denominator can be defined as a standard of measurement. It is often called a “unit of account,” but it is useful to distinguish between two concepts. The word denominator can refer simply to a standard for expressing value, while the words “unit of account” can refer to the combination of a standard of value and obligations to make payments in accordance with that standard.
Both the SDR and the ECU function as denominators. They then express quantities valued according to the Fund’s method of valuation of the SDR and the Community’s method of valuation of the ECU, respectively. The Fund and the Community make widespread use of the SDR and the ECU as denominators in statistical and accounting presentations, but numerous other official and private entities make a similar use of the SDR and the ECU. For example, legislation in the United Kingdom places a limit expressed in SDRs on the total of official export guarantees, facilities, and loans expressed in non-sterling currencies and SDRs.
Exchange Rate Regulation
The SDR and the ECU are denominators when used to regulate exchange rates. Members of the Fund are free to choose their exchange arrangements and to determine the external value of their currencies, in contrast to the former par value system in which only the maintenance of a par value in terms of gold as the common denominator was permissible. On December 31, 1982, of the 146 members of the Fund, 15 30 pegged their currencies to the SDR, but with variations in the margins they applied for exchange transactions. Four other members 31 pegged their currencies to the SDR with wide margins but did not always observe them because of a policy of maintaining a relatively stable relationship with the U.S. dollar. No industrial member’s currency fell into either category. If, however, the Fund were to call into existence the par value system that is regulated by the Fund’s Articles, the SDR probably would be the common denominator of that system.32
The ECU as a denominator of exchange values is in strong contrast to the SDR. The ECU is at the heart of the exchange rate and intervention arrangements of the EMS, and the members of the Community that adhere to those arrangements must conform to a closely regulated regime. It is unlikely that the objective of a zone of monetary stability in Europe could be realized without such regulation. Furthermore, the currencies of the EMS include a number that have major roles in international trade and payments. Among these currencies are two of the five in the SDR basket. The number would be increased from two to three if the United Kingdom joined the exchange rate and intervention arrangements.
Each participant establishes a central rate for its currency in terms of the ECU as the common denominator. As a result, a bilateral exchange relationship is created between each pair of currencies. Participants must ensure that margins of 2.25 percent above and below the bilateral relationship are observed in spot exchange transactions between the two currencies involved in the transactions. When a currency reaches the upper or lower limit of the margin against another currency, the central bank of each of the issuers must intervene in the other’s currency. Margins of 6 percent are permitted for currencies that were not in the former narrow margins arrangement (the “snake”), which was replaced by the EMS. The wider margins must be reduced gradually as economic conditions permit. Italy applies the wider margins. The United Kingdom, which did not participate originally, may participate in the arrangements at a later date.
Central rates can be changed. Adjustments are “subject to mutual agreement by a common procedure” involving all participants in the arrangements and the Commission of the Community. Whether or not “mutual agreement” means unanimity as a legal requirement, adjustments appear to have been made by consensus. The adjustment of the central rate of a participant’s currency modifies all other central rates in an opposite direction, because change by a participant affects the value of the fixed number of units of its currency in the ECU and therefore affects the values of all currencies in relation to the ECU.33
ECU as “Divergence Indicator”
The ECU performs another role as a denominator. The EMS arrangements include a “divergence indicator.” In the negotiation of the EMS, a controversy developed between those who wanted intervention margins to be established around bilateral relationships derived from central rates in terms of the ECU (the parity solution) and those who wanted the margins to be established around the central rates in terms of the ECU (the basket solution). An objection made to the basket solution was that one currency might rise to the limit of its upper margin without another currency sinking to the limit of its lower margin. The obligation to intervene would rest on the issuer of the former currency only. Moreover, the issuer of that currency would not know which currency to buy when intervening. The issuer of the currency it decided to buy would become an involuntary debtor in the settlement that would follow the intervention. The supporters of the basket solution countered the argument by contending that, while it was true that under the parity solution two currencies always reached the intervention limits at the same time, it was impossible to decide which issuer was responsible for that situation.
The negotiators of the EMS reached a compromise. The obligation to intervene is based on the parity solution, but the divergence indicator is based on the basket solution. The purpose of the divergence indicator is to establish which currency has moved out of line with the average exchange rates for the other EMS currencies. The ECU has a value in terms of a currency that is equivalent to the sum in that currency of the number of units of each currency in the ECU basket on the basis of their central rates. The prescribed margins around bilateral parities make it possible to calculate the maximum permissible appreciation above or depreciation below the ECU value of a currency as described in the preceding sentence. This maximum deviation is reached when a currency is at its bilateral limit of plus or minus 2.25 percent against all the other currencies.
When the deviation in the market rate of the ECU in terms of a currency reaches 75 percent of this maximum deviation, the currency is at its divergence threshold. A number of adjustments are made, however, in the calculation of the divergence threshold. One of them takes account of the fact that even when a currency appreciates or depreciates by the full 2.25 percent against all other currencies, the variation in the ECU rate for the currency will be less than 2.25 percent because the value of the number of units of the currency in the basket is fixed in terms of that currency and does not vary. One consequence is that the larger the weight of a currency in the ECU basket, the less will be the influence of changes in the exchange rates of other currencies on the rate of the ECU in terms of the heavy currency, and the more will be the influence of movements in the exchange rate of the heavy currency on the ECU value of currencies with lighter weight. In the absence of adjustment, the lighter currency would reach its threshold sooner than the heavy currency. To achieve equity, an adjustment is made that neutralizes the weight of a currency in the calculation of its divergence threshold. The formula for the threshold of a currency, therefore, can be stated as follows:
0.75 x 2.25 x (1 minus the weight of the currency in the ECU basket)
Adjustments in this formula are made for the currencies of Italy and the United Kingdom. The formula produces a lower threshold for the heavy currency and broadly the same degree of probability that each currency will be the first to reach its threshold. The threshold can be crossed by a strong currency or by a weak currency. The result may be the greater symmetry that the supporters of the basket solution had wanted.34 The indicator, however, has not worked with complete efficiency in certain circumstances.35
A presumption arises that the issuer of the currency that crosses its threshold of divergence will take adequate corrective measures, although there seems to be some difference of opinion about what is meant by the presumption. The corrective measures can be diversified intervention, measures of domestic monetary policy, other measures of domestic policy, or a change in central rate. Diversified intervention may mean intervention in a number of currencies, so as to spread the impact more broadly than would result from intervention in a single currency. If, “on account of special circumstances,” the measures mentioned above are not taken, the issuer must explain the reasons to the other participants.36
Unit of Account
The SDR and the ECU as units of account are standards of value in accordance with which obligations must be settled. This formulation applies to two situations. In one, the unit of account determines the amount of the settlement in all circumstances. In the other, the unit of account governs the maximum amount of the settlement and, therefore, determines the amount of the settlement only if the criteria for establishing the amount of the obligation would produce an amount equal to or in excess of the maximum. A contractual obligation defined as a certain number of SDRs or ECUs is an obvious example of the first kind. A treaty establishing a limit on liability for harm in terms of the unit of account is an example of the second kind.
The function of the SDR or the ECU as a unit of account does not require that obligations must be settled with SDRs or ECUs. The function of SDRs and ECUs as means of payment is discussed in Means of Payment below. To say that the SDR or the ECU is the unit of account but not at the same time the means of payment is to say that the amount of the settlement is calculated in accordance with the value of the SDR or the ECU as a reserve asset, but that settlement is made with means of payment other than SDRs or ECUs. The value of the SDR and of the ECU is announced daily by the Fund and by the Commission of the Community, respectively.
Settlement of Intraorganizational Obligations
The SDR. The SDR is the unit of account of the Fund on the basis of which numerous obligations are settled between the Fund and its members. The Articles state when the SDR must be the unit of account for obligations in or arising under the Articles. Even when the use of the SDR as the unit of account is not mandatory, as in agreements for borrowing by the Fund, the policy of the Fund has been to contract on the basis of the SDR as the unit of account. This policy is followed because most of the Fund’s activities are conducted on the basis of the SDR as the unit of account, so that the use of another unit of account might result in a loss (or a profit) as the result of a variance in exchange value between the SDR and the other unit of account when translated into the SDR. For example, if the Fund were to borrow a currency on the basis of the currency as the unit of account for repayment, it nevertheless would have to sell that currency to its members through the General Resources Account on the basis of the SDR and receive repurchases (repayments) from them on the same basis.
The ECU. The ECU is the unit of account for the settlements required by the EMS, but the use of the ECU in this way goes far beyond the EMS and has spread throughout the activities of the Community. The ECU as a unit of account for settlements under the exchange rate and intervention arrangements of the EMS is a function that has no counterpart in the case of the SDR.37
Use by Noncreator Organizations and Under Treaties
That the SDR or the ECU functions as the unit of account in the organization that created it as a reserve asset is not surprising. What is surprising is the increasing use made of them as units of account in activities not involving the creator organization. There are manifold reasons for this development, and they are not the same in all activities. A widespread reason is that the SDR or the ECU is normally more stable in exchange value than the individual currencies in the basket and may be more stable in real value. The SDR and the ECU may have these advantages over other units of account. Publication of the value of the SDR and the ECU in terms of currencies by the creator organizations is a considerable convenience. Indeed, when the SDR or the ECU serves as a unit of account outside the Fund or the Community institutions, all that is intended is that the value of the SDR or the ECU shall be as determined by the Fund or the Commission of the Community.38 Other provisions or decisions of the Articles or Community law that regulate the characteristics and uses of the SDR or the ECU are not applicable simply because the SDR or the ECU has been chosen as the unit of account.
The SDR. The SDR is the unit of account in a growing number of treaties and in the activities of a growing number of international organizations.39 The purposes for which the SDR is chosen as the unit of account range from central to marginal purposes in the operation of these treaties or in the activities of these organizations.
Some treaties have been, or will be, amended to adopt the SDR as the unit of account in place of an earlier unit of account defined in terms of gold, such as the Poincaré franc or the Germinal franc. In some organizations or in the operation of some treaties, the SDR has replaced gold as the former unit of account by interpretation or by administrative decision. Some organizations have decided to apply the SDR as their unit of account before their constitutive treaties have been amended for the purpose, because the SDR is the unit of account of the central organization of the international monetary system. Another justification for these decisions has been the action taken by the Fund, when it adopted the basket method of valuation of the SDR in lieu of gold, to ensure that the value of the SDR in terms of all currencies was the same immediately before and immediately after the transition. This identity of value gave support to the argument that the SDR is the official and direct successor to gold in present circumstances, in which gold no longer has an official price.
The treaties in or under which the SDR is the unit of account do not always regulate universal activities. Similarly, the organizations in which the SDR is the unit of account are not always universal in membership. In some regional organizations that apply the SDR, the explanation may be that the organization has relationships with countries or with other entities, whether official or nonofficial, outside the region. Since the collapse of the par value system, no unit of account other than the SDR has been adopted for the purposes of an organization or treaty that is open to universal membership or to universal adherence. No Specialized Agency of the United Nations that has adopted a new unit of account has chosen one other than the SDR.
Many treaties or proposed treaties that have been negotiated limit the liability of governmental or private entrepreneurs in some activity for death, damage, loss, or injury to maximum amounts in terms of SDRs. These treaties have been entered into to protect the entrepreneurs from ruinous damages, to deter “forum shopping” by claimants, and to prevent unfair competition among countries. The traditional technique to achieve these objectives has been agreement on the limits of liability to be observed wherever suit is brought. In the past, the limits were expressed in terms of gold so as to detach recoveries from the fate of individual currencies. The United Nations Commission on International Trade Law (Uncitral) has recommended to the General Assembly of the United Nations that the SDR should be the preferred unit of account in universal treaties to limit liability. The recommendation, which recognized a practice that already had been followed widely, has been endorsed by a resolution of the United Nations.40 A reservation has been made in favor of gold as a secondary monetary unit for the benefit of nonmembers of the Fund if they allege that they cannot apply the SDR under their domestic law. The U.S.S.R. seems to have abandoned the contention that its law prevents application of the SDR.41
The SDR is a unit of account in treaties limiting the liability of entrepreneurs whether or not they are signatories to the treaty, and most often they are not. For entrepreneurs that are not signatories, the SDR is the unit of account that determines the obligations of entities that do not select it for themselves.42 An analysis has shown that when entities have chosen the SDR as their unit of account, the obligations have been entered into between international organizations; international organizations and members; international organizations and nonmembers; international organizations and private parties; states (or public entities); states and private parties; and private parties.43
In the private sector, banking and finance are fields in which the SDR has been adopted as a unit of account, although there has been less use in commerce. Financial instruments and banking facilities expressed in SDRs have been developed that parallel those expressed in currencies. A growing number of assets expressed in SDRs have become available in numerous financial centers, so that it becomes possible to match SDR assets with SDR liabilities.44 Furthermore, the reduction of the SDR basket of 16 currencies to 5, for which there are active financial and exchange markets, enables obligors, such as banks accepting deposits expressed in SDRs, to cover their risks more easily by depositing the component currencies in other banks or entering into forward contracts. The Fund did not reduce the number of currencies in the SDR basket specifically in order to encourage the use of the SDR as a unit of account outside the Fund, but the Fund was not unaware that this consequence might follow. The view is widely held that a greater private use of the SDR as a unit of account will enhance the role of the SDR as a reserve asset in the international monetary system and that enhancement of the SDR as a reserve asset will have a reciprocal effect by broadening the use of the SDR as a unit of account. On this view, the Fund would be legally justified in taking whatever action is within its powers for the specific purpose of encouraging a broader use of the SDR as a unit of account throughout the world.
The ECU. In the Community, the ECU is the unit of account in the management and transfer of assets among Community institutions. For these purposes, the institutions hold accounts expressed in ECUs. The borrowings and loans expressed in ECUs entered into by the European Investment Bank in dealings with private entities have had no counterpart in financial activities of the Fund denominated in SDRs, although the Fund is empowered to borrow in the market. The regional character of the ECU does not preclude adoption of the ECU as the unit of account in transactions in which a nonregional entity is a party. Three loans expressed in ECUs have been raised for the benefit of Canadian and U.S. borrowers.
Less use has been made of the ECU than of the SDR as a unit of account in treaties. It was to be expected that the ECU as a regional asset would have a role in treaties only if the Community was a contracting party or if the contracting parties were regional.
The ECU is in common use in banking and finance. In these fields developments are similar in character to those involving the SDR. If parties are contemplating the use of a unit of account, the risk against which they are seeking protection will affect their choice. If the competition is between the ECU and the SDR, the composition of the baskets will have a bearing. If the risk has a purely European complexion, the inclusion of the U.S. dollar and the Japanese yen in the SDR basket will tell against the selection of the SDR. But the SDR will be a more serious candidate if the risk is not confined to Europe.
Transactions in small amounts by the public at large are a newer and expanding development in the use of the ECU as a unit of account. So far, there is no parallel use of the SDR. Since the beginning of 1982, banks in Belgium and Luxembourg have accepted fixed-term deposits subject to a trifling minimum, have offered demand savings accounts for amounts of 20 ECUs or more, and have provided other banking services for private persons of small means.45 The spread of services such as these is thought in the Community to be important for the future of the ECU.
Business transactions are beginning to be expressed in the ECU as the unit of account. This development has led exporting firms to obtain ECU cover pending settlement in currencies to protect themselves against exchange risk.
The strongest contrast between the SDR and the ECU as units of account is less in the facilities and instruments in which the units of account are appearing than in the measures the institutions and members of the Community have taken, and continue to take, to promote the widespread use of the ECU as a unit of account and means of payment. This subject is discussed in the next Section. There is no official policy in the Community or in countries outside the Community to promote the SDR in this way. Governments have no obvious inducement at present to encourage parties to use the SDR instead of the national currency or other currencies as a unit of account.
Means of Payment
Both the SDR and the ECU are means of payment in accordance with the legal instruments that govern them. That is to say, to use the terminology applicable to currencies, the SDR and the ECU are, to some extent, currencies of payment as well as currencies of account. This analogy does not mean that the SDR and the ECU are currencies, but that they can be used in the settlement of obligations without prior exchange for currency with which to make the settlement.
The SDR is a means of discharging obligations between the Fund and its members, and in the operations that members and prescribed holders of SDRs are permitted to engage in with other members and with other prescribed holders.
Growth in the variety and volume of banking facilities and financial instruments in which the SDR is the unit of account might tend to encourage the willingness of parties to contract on the basis of a term that assets (rights, claims) expressed in SDRs would be accepted in discharge of liabilities expressed in SDRs. Some major loan agreements have provided that if at any time during the period of the agreement a sufficient development has occurred in the international banking system to enable SDRs to be treated as a currency, subsequent repayments of, and payments of interest on, the tranche of the loan expressed in SDRs are to be made in assets expressed in SDRs. (Under the agreements, the development referred to is defined to mean that assets expressed in SDRs can be transferred, lent, and otherwise dealt in without the need for the satisfaction of obligations in U.S. dollar equivalents.) Furthermore, even if this development has not occurred, any bank participating in the loan can give notice at any time of its willingness to accept repayments and interest in the form of assets expressed in SDRs.
On March 13, 1981 Morgan Guaranty Trust Company announced that its Brussels office had established a system that enables clients to open currency accounts (or demand deposit accounts) expressed in SDRs. The holders of accounts can borrow and lend in SDRs and can receive and make payments in SDRs. Morgan Guaranty stated that the establishment of this first facility for SDR settlements reflected the expectation that the use of the SDR for commercial transactions and obligations would continue to increase. The service would be available to governments, central banks, other banks, and corporations that open accounts in the Brussels branch of Morgan Guaranty. Euroclear and Cedel are facilities for similar transactions in ECUs.46
The ECU, it has been seen, is a means of payment in the settlements required by the EMS. Participants in a par value system will insist on settlement obligations, but it is not essential that a new asset must be created as a means of settlement. A new asset was not created for the purposes of the par value system under the original Articles of the Fund.47 The volume of use of ECUs in settlements has fluctuated. The delay in reaching the next phase of the EMS and the provisions requiring a net user to obtain ECUs in liquidation may deter the use of ECUs in settlements and may explain recourse to other forms of settlement. In the first three years of the EMS, more than half the volume of intervention was conducted in non-Community currencies, principally the U.S. dollar. Some central banks prefer to intervene before the limit of a margin for exchange rates is reached, because they want to narrow the fluctuation of exchange rates. Moreover, early intervention can prove to be more economical in the use of reserves, and intervention in non-EMS currencies within the margins avoids the necessity to request the consent of an EMS member whose currency might otherwise be used. Consent, even if forthcoming, can be too long delayed to permit an effective response to changing conditions in the market.
The policy of institutions and members of the Community to encourage as broad a use as possible of the ECU as a unit of account and means of payment has been referred to already. The ECU is composed of all the Community currencies (except the drachma at the present time) and is treated, therefore, as subject in principle to the regulations governing both the national currency and foreign currencies in member states of the Community that impose monetary or foreign exchange restrictions. In some member states, the component of the national currency in the ECU has been caught by the rules imposed under domestic monetary policy, which may prohibit certain operations (for example, loans to nonresidents) or may restrict operations (for example, by applying credit controls, ceilings on the growth of the money supply, compulsory reserves), while the foreign currencies as components in the ECU have been subject to foreign exchange restrictions.
To clear the way for the use of the ECU as a unit of account, and also as a means of payment, most members of the Community have taken, in varying degree, two sets of measures:
(i) Members have lifted restrictions on the use of the national currency insofar as it is a component in the ECU, so that to this extent the national currency can be regarded as a nonresident’s currency and treated as a Eurocurrency. Commercial banks can then deal with nonresidents in respect of the component in the ECU represented by the national currency.
(ii) Members have permitted ECUs to be shown as such in the accounting returns that must be submitted to the competent monetary authorities by financial operators dealing in ECUs instead of requiring the component currencies to be shown. This permission simplifies the management of operations and reduces the costs of using the ECU as a unit of account.
If these measures were taken in full by all members of the Community, the ECU would no longer be recognized as a basket of currencies but would be a means of payment comparable to a foreign currency, and all operations in ECUs would be subject only to national regulations applicable to operations in foreign currency. The measures actually taken range from a preferential status for the ECU in Italy at one extreme, through treatment more or less comparable to foreign currency in other countries, to a virtual ban on operations expressed in ECUs in the Federal Republic of Germany. The Bundesbank takes the view that denomination in the ECU is equivalent to indexation. As a legal consequence, the use of the ECU is prohibited between residents, and in banking operations with nonresidents the Bundesbank’s authorization is required but is not readily forthcoming. Where all the measures to treat the ECU as if it were a foreign currency are not taken, the ECU is in an inferior position to national and foreign currencies because the ECU is treated as both. On April 20, 1983 the Commission of the Community sent a communication to the Council in which the Commission pointed out that financial integration in the Community could not make genuine progress unless members help to develop the role of the ECU by recognizing it as a foreign convertible currency. The Commission recommended that transactions by residents of the Community in securities denominated in ECUs should receive privileged treatment.
The ECU is bought and sold on both the spot market and the forward market, with maturities up to 12 months, against any convertible currency, although so far the European currencies and the U.S. dollar have been the main currencies. The development of these currency transactions was inspired by the hope that the ECU would become a means of payment. The practice now is for subscribers to an ECU-denominated issue to effect payments in ECUs and for the borrower under an ECU-denominated loan to receive ECUs in an ECU account. It is possible to buy ECUs, subject to the national regulations that have been mentioned, to have them transferred to another bank, to hold them on fixed-term deposit, to use them for settling business transactions or for purchasing long-term securities, and to obtain forward ECU cover.
The growth in the number, variety, and volume of facilities and instruments expressed in ECUs, which makes it possible to discharge ECU liabilities with ECU assets, reduces the need for cover in the form of the currencies that compose the ECU basket. If the latter form of cover were necessary, the process would be more complicated for the present 9 currencies in the ECU basket than for the present 5 currencies in the SDR basket, and would become even more complicated with the inclusion of other currencies in the ECU basket. When the Fund considered the reduction of the number of currencies from the 16 that had composed the basket, numbers like 9 or 11 were among those that were considered, in part because of the possible political advantage of having more than a small number of currencies in the basket. One reason for deciding finally on 5 was the simplicity of arranging cover against exchange risk, even if cover could be arranged only in the modest number of component currencies.
The progress that has been made already in the establishment and growth of facilities and instruments expressed in ECUs in banking and finance has induced some national authorities and some commentators to refer to the ECU as a de jure or a de facto currency and not simply as an asset that is treated for some purposes as if it were a currency.
Some Concluding Observations
A similarity between the SDR and the ECU is that they have not yet realized the hopes with which they were created and that the future of both, at least as reserve assets, is unclear. The SDR has been improved as a reserve asset; the ECU, so far, has not. There continues to be a disposition to improve the SDR as a reserve asset; the ECU as a reserve asset is standing still. At the present time, the use of the SDR in the markets is not increasing and is even declining, while the ECU is making progress. The SDR is the favored unit of account in a growing number of treaties.
The SDR as a Reserve Asset
The SDR was invented as a reserve asset at a time when an ordered regime of exchange arrangements was in existence. The SDR could serve its original purpose if a new order were achieved. The contrast between the former and the present law relating to exchange arrangements may explain why the First Amendment of the Fund’s Articles did not refer to the objective of making the SDR the principal reserve asset in the international monetary system, while the Second Amendment, under which the Fund’s regulatory authority is less evident, does refer to that objective. It seems that the weaker the international monetary system becomes, the more necessary it is to emphasize the role that the SDR should play in a stronger system. By implication, the modest role of the SDR in current conditions should not justify neglect of the SDR at the present time.48
It was never made clear what was intended by the language of the Second Amendment that refers to the objective of making the SDR the principal reserve asset in the international monetary system.49 The United States was content to accept the language after explaining that in its view the language did not mean that the SDR was to predominate in volume among reserve assets. It was not expected that the SDR would become the principal reserve asset by substituting SDRs for dollars or gold. Efforts to include provision for a Substitution Account in the Second Amendment were rejected.50 The United States preferred the word “principal” to other adjectives because the word seemed more obviously to leave room for reserve assets other than the SDR. The United States concluded that it had protected the role of the U.S. dollar as a reserve asset and at the same time had achieved a compromise with European members. They had advocated the reference to the SDR as the principal reserve asset. They had taken the language from the Outline of Reform of the Committee of the Fund’s Board of Governors on Reform of the International Monetary System and Related Issues (the Committee of Twenty).51 The Outline had contemplated an international monetary system in which the Fund would exercise an extensive regulatory authority. The origin of the language helps to explain the European advocacy of it. The language symbolized the hope of European members that a more orderly international monetary system would evolve even if it could not be negotiated in 1974. The SDR was the only existing nonnational asset on which such a system could be based. The SDR would make it possible to avoid restoring a system based on a national currency and flawed for that reason.
Nobody can claim that the SDR is closer to the status of the principal reserve asset now than it was when the drafting of the Second Amendment was completed in 1976 or when it became effective in 1978. Some commentators question whether so important a role for the SDR is necessary when members of the Fund have such broad freedom to choose their exchange arrangements and to manage the external value of their currencies. Nevertheless, two comments deserve to be made even though they do not dispose of questions raised about the future of the SDR.
First, the express objective of making the SDR the principal reserve asset has had normative effects, even if there is less order now in international monetary arrangements and even if achievement of the aim is at best a distant possibility. The objective was relied on as part of the case for the decision to allocate SDRs in the four years 1978 through 1981, and the objective has had an even more obvious influence in bringing about the improvements in the characteristics and the extensions of the uses of the SDR that have been made in recent years.
Second, the SDR has undergone substantial development in response to the change that has occurred in the international monetary environment. Originally, the SDR was seen to function as an alternative to gold when gold was the paramount reserve asset in the international monetary system. There were frequent references to the character of the SDR as “gold-like” or to the ambition that it should be “as good as gold.” In present conditions, the SDR is seen as an alternative to reserve currency. The characteristics and uses of the SDR as a reserve asset now more closely resemble those of reserve currencies. SDRs can be used in numerous transactions or operations, are freed from the close control of the Fund, can be used even to change the composition of reserves, need not be recovered after disposition, and earn a full market-related rate of interest. Gold has never been a model for the ECU even though most ECUs have been issued against the deposit of gold.
The improvements that have been made in the SDR have not freed it from criticism as a reserve asset. The central banks that responded to a questionnaire from the nonofficial Group of Thirty pointed to a number of drawbacks of the SDR.52 Among these disadvantages were the limited obligation of members to accept SDRs, the designation rules,53 the absence of authority to use SDRs in intervention, the prohibition on the holding of SDRs by private entities,54 lack of a range of maturities, “lack of anonymity,” 55 and a yield lower than the average return on liquid assets held by central banks in the markets of the currencies that compose the SDR basket.56 For many countries, the composition of the SDR was deemed to be incompatible with the pattern of their trade or external debt. Some commentators foresee no important advance in the status of the SDR as a reserve asset unless a universal and symmetrical obligation of the official convertibility of currencies (“asset settlement”) with SDRs is instituted by international agreement.57
Some of these criticisms could be met, without great strain, by changes of a technical character under the present powers of the Fund. The powers are broad enough to encompass improvements in the characteristics and extensions in the uses of the SDR beyond those that have been made already. Some changes advocated by critics would require amendment of the Articles, although somewhat complicated and indirect procedures might be arranged that would meet some of the shortcomings on which the critics dwell. Whether or not members agree that further allocations of SDRs are needed, there is widespread agreement that the SDR will not be an important reserve asset in the future, much less the principal reserve asset, unless SDRs become a much larger proportion of total reserves than they are at present. To promote the reputation of the SDR, however, it should not be allocated simply to help members pay their subscriptions to the Fund when quotas are increased.58
Most improvements in the SDR as a reserve asset that might be made would have no direct effect on the SDR as a means of payment outside the Fund. Commentators agree that only an increased use of this kind will enhance the status of the SDR as a means of payment in the world. The proposition is really a tautology: an increased use is indispensable for an increased use. Academic attention is being devoted to possible clearing arrangements for the settlement of financial obligations expressed in SDRs. Ideas advanced for this purpose foresee, in addition, arrangements that would link SDRs as reserve assets and other assets expressed in SDRs by means of arrangements that would clear private payments expressed in SDRs. The arrangements would provide for movements in official holdings of SDRs without relying on the private ownership of SDRs, which is precluded by the present Articles.59
The SDR was created as a reserve asset, and that concept is still dominant. Decisions taken under the present Articles for the exclusive purpose of fostering the use of the SDR in the private sector might be considered an abus de pouvoir. This objection would not be valid if the argument were accepted that decisions to promote the use of the SDR in the private sector would improve the SDR as a reserve asset and would not be for the exclusive benefit of private interests. So far, the Fund’s decisions on the SDR have been directly and clearly related to improvement of the SDR as a reserve asset. The Fund has not called upon its members to take action under their laws to promote the use of the SDR in the private sector.
The ECU as a Reserve Asset
Insofar as the ECU is a product of the instability of exchange rates, the ECU might seem to have a doubtful future if a more ordered international monetary system were to evolve. Even in such conditions, however, the ECU, in its present or in an improved form, is likely to be maintained not only because the tendency in international monetary arrangements is to add and not to take away but also because the ECU would continue to be a symbol of European aspirations.
Numerous proposals have been discussed within the Community for improving the ECU as a reserve asset, particularly when it seemed that the final phase of the EMS would not be realized after the initial two years. An improved ECU seemed a worthy, though less ambitious, project at that time. Unanimous ratification by members of the Community would be required for any amendments of the Treaty of Rome that would be considered necessary to change the law relating to ECUs. Amendments of the Fund’s Articles require acceptances in accordance with the specified majorities of members and total voting power. It is an open question whether it is more difficult to reach agreement under a rule of unanimity in a small community than it is to achieve a large majority among numerous countries.
There is leeway under existing treaty provisions for improvements in both the SDR and the ECU. Changes in the present decisions relating to the ECU that do not require ratification by members of the Community under their constitutional procedures could be made by the Community organ that is empowered to make the changes. Probably, unanimity would be necessary for these changes. Decisions relating to the SDR under existing provisions of the Fund’s Articles can be taken with a majority of the votes cast, or with a special majority of the total voting power if specified by the Articles.
Differences of opinion exist among members of the Community on the question whether some of the changes in the ECU discussed below can be taken without amendment of the Treaty of Rome. The Commission has taken the position that many changes are possible under Article 235 of the Treaty:
If action by the Community should prove necessary to attain, in the course of the operation of the common market, one of the objectives of the Community and this Treaty has not provided the necessary powers, the Council shall, acting unanimously on a proposal from the Commission and after consulting the Assembly, take the appropriate measures.
Most members of the Community agree with the Commission, but the need for amendment of the Treaty of Rome is asserted by members in which domestic monetary order is based on the constitution and the central bank’s independence from the government. These members consider it desirable for political reasons also to involve legislatures in successive stages of the development of the EMS.
Many possibilities exist for improving the ECU, and much work has been done for this purpose in Community bodies. Some potential changes in the ECU appear to be more radical than others. There are no objective tests, however, by which to recognize what would be regarded as more important modifications. A power to issue ECUs without any deposit of reserve assets as counterpart probably would be considered fundamental. Another change that might seem important would be to make intervention by a participant obligatory if its currency crossed the threshold of divergence.
The present limit of 50 percent on the amounts of the ECUs that creditor central banks can be compelled to accept in settlements could be raised or the limit could be abrogated. Restraints on transfers of ECUs between central banks, such as the condition that they must not be motivated solely by the desire to change the composition of their reserves, could be abolished. A net accumulator of ECUs could be allowed to mobilize its net creditor position at any time. The rate of remuneration on holdings of ECUs could be increased by relating it to interest rates in the markets.
Another possible change would be removal of the restraints, perhaps in certain circumstances and up to a specified limit, on intra-marginal intervention in Community currencies, with the consequences that participants would have assured access to the very short-term facility and would make more extensive use of ECUs in settlements for interventions. This change would eliminate or reduce the need for the swaps that have been the subject of bilateral agreements to finance intramarginal intervention. Creditors have had the option of accepting ECUs in settlement of these swaps. The change might have the effect of reducing intramarginal intervention with U.S. dollars, which has tended to interfere with the development of a common policy toward the dollar and to enhance its role in the operation of the EMS.
A procedure for the designation of transferees of ECUs, comparable to the Fund’s procedure for SDRs, might be considered an improvement. As an alternative, or in addition, the EMCF (or its successor) might be required, on demand, or on demand in case of a participant’s need, to exchange ECUs for other reserve assets, but this change would imply that the EMCF would own assets without the encumbrances on them created by the present system of swap arrangements. If the convertibility of ECUs into other reserve assets were not assured, participants could not be certain that they would be able to obtain reserve assets for settlements outside the Community, and they would be unlikely to agree that the limit of 50 percent for the mandatory acceptance of ECUs in settlements under the EMS should be raised or eliminated.
The technique of transferring the ownership of assets to the EMCF could be either sales to the EMCF or contributions to its capital. The latter technique would imply a residual right in the contributor. The choice between the two techniques might be particularly important in relation to gold, but it is likely that a workable arrangement would be difficult to negotiate whichever technique were selected. If swaps were retained, the proportion of reserves in gold and in U.S. dollars to be deposited with the EMCF as counterpart against ECUs might be increased if participants were to be entitled to have the EMCF convert ECUs into other reserve assets. Whether or not larger deposits were mandatory, they might be permitted on the request of a participant.
Lengthening the period of swaps, or the period over which averages are taken to determine contributions to the EMCF, would be among the numerous techniques for reducing fluctuations in the volume of ECUs. Adjustments in volume might be based not on changes in the value of the total of a participant’s gold (and dollar) holdings from time to time but on changes in the value of the amount it had contributed to the EMCF on some chosen date. A formula that valued gold without reference to the market price would be open to the objection that a fixed official price for gold was being established in defiance of the Second Amendment of the Fund’s Articles.
An alternative procedure would be periodic decisions by the EMCF to determine the total stock of ECUs that would be outstanding. The determined amount could be matched by an equivalent contribution of assets to the EMCF, or the stock of ECUs and the volume of contributions could be detached from each other. If the latter course were followed, the amount of the contributions would depend on the needs of the EMCF for financing its activities, whatever they might be. Either procedure would require the exercise of judgment, according to whatever criteria were considered appropriate, that would resemble the discretion exercised by the Fund in deciding whether to allocate or cancel SDRs and in what amounts.
A wider holding of ECUs outside the Community might increase the liquidity of ECUs and provide nonmembers of the Community with an opportunity to diversify their reserves without affecting exchange rates, but a wider holding might undermine the character of the ECU as an instrument of cohesion among members of the Community. If ECUs were held by central banks outside the Community, the central banks might obtain the ECUs as the result of issues by the EMCF against contributions or as the result of transactions with members of the Community. The possible holders could be broadened beyond countries with particularly close economic and financial ties with the Community.
A major reason for the failure so far to reach agreement on improvements in the ECU, apart from the normal difficulties of compromise between potential creditors and potential debtors, is disappointment in the degree of convergence that has been achieved in the policies of Community members.60 A greater convergence that would help to bring about similar economic conditions in member countries and, therefore, greater integration in the Community was one of the major objectives of the EMS. According to one view, the exchange rate and intervention arrangements of the EMS are responsible for less variability in the exchange rates of participants’ currencies than would have occurred in the absence of the EMS. Some observers have concluded, in addition, that there has been less variability in these exchange rates than in the rates for other currencies. This favorable verdict is challenged by others who take account of the seven rounds of changes in central rates in the period of four years up to March 21, 1983 and the increasing frequency of these rounds. To this challenge, the reply has been made that the EMS should be thought of as neither a fixed nor a floating system but as a system managed by agreement among participants. Whatever conclusion is reached in this debate, the benefits of the EMS have not been sufficient to quell the disappointment produced by the modest progress made toward the convergence of policies.
As a result, even a modest list of recommendations by Community bodies for improvements in the uses of the ECU has failed to receive unanimous support. Objections have been expressed to some proposed changes because other improvements were not being proposed. An observed equity in the rights and obligations between creditors and debtors helps to explain the resistance so far to proposed improvements. It may be that there is a broader explanation: there are limits to so-called improvements in the characteristics and extensions of the uses of both the ECU and the SDR as reserve assets if the proposed improvements are not accompanied by a strengthening of the EMS and of the international monetary system into which an improved ECU or SDR would be fitted.
The present stasis reached by the ECU as reserve asset has not produced a similar condition in the private markets. There, the dynamism in developing the ECU is attributable to initiatives by private entities, the institutions of the Community, and individual members of the Community. Some impediments may exist to an even broader use of the ECU in the markets. The absence of uniformity among members in the measures they apply in relation to the ECU and disquiet because, in principle, the ECU can be subjected to two categories of control may be among the impediments. The negative attitude to the use of the ECU under the law of the Federal Republic of Germany may be another deterrent.
Differences in attitude, not necessarily determined by legal considerations, may be troublesome. The greater propensity of the private sector in countries with weaker currencies, because parties undertake less risk on the basis of the ECU than on the basis of a strong currency, may create less confidence in the use of the ECU in other countries. The uncertain future of the EMS and the ECU because of delay in instituting the final phase may give cause for concern.61 This uncertainty has induced the Community authorities to give assurances to private banks that the value of the ECU in terms of currencies will continue to be published whatever happens.62
Notwithstanding these difficulties, the use of the ECU has progressed to a point at which a group of leading European banks have developed a formal plan for a clearing system that would replace the present informal arrangements. According to reports, the location of the system and the entity that would operate and back it were problems.63 The Bank for International Settlements has been approached as the favored entity.64
A Final Comment
Both the SDR and the ECU have emerged as efforts to bring international monetary affairs under a greater degree of control. The international monetary system, however, is now subject to less control than in the past and national monetary authorities have resumed more autonomy. In these conditions, the SDR has achieved less than was hoped for it as a reserve asset, although the Fund pays much attention to improving the quality of the SDR and activating its use. The ECU is associated with an attempt at a greater degree of control of regional monetary matters as part of a broader integration. The attempt was inspired by the decline in international control and by the belief of countries in the region that the new conditions imposed disadvantages on them. The failure to bring about a more satisfactory convergence of policies, which would imply greater restraint on national autonomy, is responsible for the present standstill in developing the ECU as a reserve asset.
The current state of the international monetary system and of the EMS as a regional system leads private entities to find safeguards for their individual interests. The SDR and the ECU as denominator, unit of account, and means of payment have obvious advantages over private composite units, although probably not all the advantages in all circumstances. The institutions and members of the Community encourage private uses of the ECU because it is an expression of the ambitions of the Community. The Fund pursues the task of improving the SDR, but members of the Fund have not emulated members of the Community in encouraging use of the SDR, perhaps because making the SDR the principal reserve asset in the international monetary system seems to be a distant prospect at best. Perhaps, too, parties contract on the basis of the ECU when they wish to avoid the impact of the U.S. dollar, while parties that do not take this attitude prefer the dollar to the SDR, especially when the dollar is strong. These differences in official and private attitudes are not the whole explanation of the greater use of the ECU than the SDR or of the small proportion of business conducted on the basis of both of them in comparison with total business.
This view of what has happened so far is not a hopeless one. It is true that unforeseen political and economic events have had adverse effects on reforms. But reforms do take place. The SDR and the ECU are among the most surprising reforms on which agreement has been reached. The agreements have not been abandoned, and they may come to play a larger role in the future. Meanwhile, there is a determination not to squander the achievements of such strenuous intellectual effort and such hard bargaining.
Supplemental Note to Chapter 10
1. On the naming and renaming of the SDR, see in addition to the pamphlet cited in footnote 1, Joseph Gold, “Special Drawing Rights: Renaming the Infant Asset,” International Monetary Fund, Staff Papers, Vol. 23 (Washington, July 1976), pages 295–311. The article has inspired an international correspondence in which suggestions for renaming the SDR are still made. A correspondent from Geneva has suggested “Maya,” which is drawn from the Sanskrit of the Vedas, and which is said to mean both money and the propelling force behind all materialistic activity. The word is recommended for the further reason that it is elegant and easy to pronounce, neither of which qualities can be claimed for such other suggestions as “Spedrar” (an acronym of special drawing rights) or “Drotis” (alleged to be an Anglo-Saxon rearrangement of “droits”).
The Executive Board, hemmed in by the terminology of the Articles that prevents a new name, adopted a new rule on July 26, 1983, to recognize that the expression “SDR” was taking on a life of its own and to encourage the process of depriving the expression of the quality of an acronym. Rule B-6 of the Rules and Regulations provides that:
SDR refers to the special drawing right of the Fund. The term “SDR” (or “SDRs,” as appropriate) shall be adopted as standard usage in Fund documents, correspondence and publications where a reference to special drawing rights is intended, provided that if the text is in a language in which a different usage has become established, that usage may be retained.
The rule cannot amend the usage of the Articles, but it expresses the hope that members for which English is not the native language can use “SDR” instead of an acronym derived from the translation into the native language of the English words represented by the three letters.
2. A more substantial decision taken on the same date (July 26, 1983) amended Rule T-l of the Rules and Regulations on the frequency with which the excess of charges on allocations of SDRs over interest on holdings of SDRs is debited, or the excess of interest over charges is credited, to the accounts of each holder, in each case in SDRs. Before the amendment, these net debits or net credits were made annually after the end of the Fund’s financial year on April 30. The effect was that the interest income on holdings of SDRs was less than the interest members received on successive investments in the instruments in the SDR interest rate basket. The discrepancy was created by the compounding of the interest received on the instruments, normally at quarterly intervals. The amended Rule T-l provides for the quarterly crediting and debiting of interest and charges on holdings and allocations of SDRs. A change in accounting procedures was made at the same time.
3. On the attitude of nonmembers to use of the SDR as the denominator or unit of account in treaties, see Section VI, paragraph 4 of the Supplemental Note to Chapter 1. On reconstitution, see Section IX, paragraph 2 of the same Supplemental Note. Discussions of clearing arrangements for SDRs are referred to in Section IX, paragraph 4 of the same Supplemental Note.
4. See Section VI, paragraph 2 of the Supplemental Note to Chapter 1 for a provision on SDRs in Public Law 98-181 of the United States (November 30, 1983).
5. For a list, as of the date of publication, of the new treaties or the amendments of treaties in which the SDR is or will be the denominator or unit of account, see Joseph Gold, “The SDR in Treaty Practice: A Checklist,” International Legal Materials, Vol. 22 (1983), pages 209–13.
6. For an evaluation of the proposal referred to in footnote 49, see J. Carter Murphy, The International Monetary System: Beyond the First Stage of Reform (Washington: American Enterprise Institute for Public Policy Research, 1981), pages 187 and 191–94.
7. For an analysis of the criteria for allocations of SDR that would justify further allocations, and for a proposal on the reintroduction of an obligation of reconstitution, see John Williamson, A New SDR Allocation? (Washington: Institute for International Economics, Policy Analyses in International Economics, No. 7, 1984).
8. The case referred to in footnote 18 was appealed to the Supreme Court of the United States and decided by it on April 17, 1984 (Trans World Airlines, Inc. v. Franklin Mint Corp. et al. 52 LW 4445).
9. On December 15, 1983, the Fund prescribed the East African Development Bank, Kampala, as a holder of SDRs. This organization is added to the category of intergovernmental monetary institutions under the heading “The SDR” in the Section entitled “Portfolio Asset.”
10. On concurrent methods of valuation of the SDR, which is referred to in footnote 38, see Floating Currencies, Gold, and SDRs: Some Recent Legal Developments, IMF Pamphlet Series, No. 19 (Washington, 1976), pages 56–57; SDRs, Gold, and Currencies: Third Survey of New Legal Developments, IMF Pamphlet Series, No. 26 (Washington, 1979), pages 7–8; SDRs, Currencies, and Gold: Fourth Survey of New Legal Developments, IMF Pamphlet Series, No. 33 (Washington, 1980), pages 1517; SDRs, Currencies, and Gold: Fifth Survey of New Legal Developments, IMF Pamphlet Series, No. 36 (Washington, 1981), pages 15–17; Decisions Nos. 6843-(81/75) and 6863-(81/81), Selected Decisions, 10th (1983), pages 178–79 and 206–207.
11. The Commission of the European Community addressed a report to the Council on March 2, 1984 on Five Years of Monetary Cooperation in Europe (COM (84) 125 final). The use of the ECU as a reserve asset is discussed as follows:
The ecus received by central banks in exchange for gold and dollar contributions are not put to extensive use. As an asset, they are precarious, on the one hand, because they are created by means of a temporary swap system with no indication as to what may happen after the transitional stage, and, on the other, because the volume in existence is unstable given that it depends on volatile variables: the price of gold and the exchange-rate of the dollar. Their attractiveness as an asset is further circumscribed by their limited acceptability (creditors are under no obligation to accept ecus except in settlement of a claim maturing under the very short-term financing facility and only up to 50 % of that claim); accumulated creditor positions in ecu are not convertible; and the yield is low (being an average of official discount rates). For all these reasons, ecus are only used on a small scale even in cases where debtors are explicitly entitled to do so. A new type of operation has, nevertheless, been introduced with swaps between ecus and national currencies being utilised in order to mobilise available ecus. In practice, however, the ecu is considered not so much a reserve asset as a means of credit that will eventually have to be settled using other assets.
From 1979 to 1983, about 80% of very short-term financing operations were unwound without recourse to the ecu through offsetting or advance repayments with creditor currencies. The cumulative amount of settlements in ecu is in the order of 2 000 million ecu over the whole period. This figure compares with a total ecu stock of 53 000 million at end-1983. Voluntary transactions have resulted in net repurchases of ecu, which is also indicative of central banks’ efforts to hold down the level of net ecu balances.
On the private ECU market, the report contains the following passage:
The ecu is becoming increasingly popular with private operators in a role that is quite independent of its rôle in the system and the official circuit. The short-term ecu market (interbank market and short-term transactions) is at present estimated at 10 000 million ecu; the volume of long-term issues totals 3 300 million ecu—making the ecu the currency unit with the third largest share in euro-market borrowing in 1983; outstanding medium-term syndicated bank credits amount to about 2 000 million ecu.
This may be a promising development both for European monetary cohesion and for the resistance of the EMS to external shocks. Freer use of the ecu in commercial and financial operations in Europe could contribute to convergence, affecting both interest rates and financial integration. More extensive international use of the ecu for invoicing, settlement, borrowing and investment would also help to reduce the impact of external shocks, and spread it over the entire set of Community currencies.
To date, the ecu’s r61e on the markets has developed more or less spontaneously, with the varying discreet approval of the member States. But the ecu market has grown so large that a more uniform response to market needs is now required of the member States.
See also Horst Ungerer with Owen Evans and Peter Nyberg, The European Monetary System: The Experience, 1979–82, IMF Occasional Paper, No. 19 (Washington, 1983); Jean Paul Abraham, Filip Abraham, Yvonne Lacroix-Destree, “EMS, ECU and Commercial Banking,” Revue de la Banque, 48th year (2/1984), pages 5–25; Frank Moss, “The Private Use of the ECU: Its Implications for National Monetary Authorities in EEC Member States,” ibid., pages 41–64.
The Istituto Bancario San Paolo di Torino issues an ECU Newsletter.
12. A communication of the Commission of the European Community to the Council dated May 24, 1984 (COM (83) 274 final) has recommended that the Council adopt the following draft resolution:
The Council considers that the development of the role of the ECU is an important part of the internal consolidation of the EMS and the affirmation of its external role.
It has noted the Communication of the Commission in the matter and, particularly, the suggestions made to facilitate the treatment and promotion of the use of the ECU. The relevant authorities have expressed their intention to take all the measures necessary to ensure that ECU operations are treated, in the context of their internal regulations, as foreign currency operations.
13. Dr. Leonhard Gleske, of the Directorate of the Bundesbank, discussed the attitude of that central bank to the ECU in Wirtschaftswoche of March 9, 1984, from which discussion the following excerpts are quoted:
Q.: Recently, praise has been expressed even by the Bundesbank for the European Monetary System. Will the Bundesbank now be able to go so far as to recognise the ECU as a currency?
A.: Things are not so simple as that. Certain restrictions exist in Germany, but only as regards incurring ECU-denominated liabilities, whereas every resident is free to purchase and hold ECU-denominated claims. In this respect, things are quite different in France and Italy. Under their foreign exchange regulations these countries restrict the holding of ECUs by residents.
Q.: But why does the Bundesbank then continue to have such reservations vis-à-vis the ECU? After all, the ECU is becoming increasingly important.
A.: An ECU market has developed quite spontaneously, certainly. As a currency for denominating loans, the ECU has become quite important after the dollar and the Deutsche Mark. It has gained in weight considerably on the international markets. The restriction as regards incurring ECU-denominated debt may be disadvantageous for German banks in the one or the other respect. But our interpretation of the law does not allow us to simply declare that the ECU is a currency. It lacks essential characteristics to qualify as a currency. It is not legal tender in any country. Nor is there an institution that is responsible for it. Other countries treat it de facto, for instance under their foreign exchange regulations, as a foreign currency.
Q.: How, then, does the Bundesbank see the ECU?
A.: Under our system of law we can consider the ECU to be a kind of indexation clause. Such clauses determine the value of liabilities which must be settled in Deutsche Mark. Under Section 3 of the German Currency Act such liabilities can be incurred only with the approval of the Bundesbank.
Q.: The Bundesbank has, after all, repeatedly permitted indexation in the case of long-term rental and leasing contracts. Why are things different in the case of the ECU?
A.: One of the principles of our practice in granting permission has always been not to approve of indexation clauses for financial transactions. For us, the question arises as to what precedents would be created for the spreading of such indexation clauses for financial transactions if the ECU were allowed to be used under Section 3 of the Currency Act. Concern rightly exists at disregarding the standards for granting approval that have been applied for over 35 years.
Q.: Some observers believe that the Bundesbank is worried about a new strong currency arising next to the dollar and the Deutsche Mark and that this is why it is so hesitant.
A.: We are not worried about the ECU being able to compete with the Deutsche Mark. In 1961 we generally allowed debt to be incurred in foreign currencies. Since then, all residents have the possibility to conclude contracts with other residents in US dollars, French francs, etc. And I am confident that, so long as we pursue a policy that keeps the Deutsche Mark stable, we do not need to fear competition either from other currencies or from the ECU.
Q.: The ECU is a kind of symbol of the EMS, is it not?
A.: I would not go that far. It is true that many people see the ECU as a kind of symbol. Symbols can be important in political life. But we must see things very soberly from the point of view of monetary policy. The ECU is a unit of account that has advantages for many transactions, such as contracts between importers and exporters. In such cases the ECU can be a suitable instrument for sharing the exchange rate risk involved without having to hold long discussions as to whether it should be borne by the buyer or the seller. This also applies to the ECU as an investment currency. But it would be an illusion to believe that the ECU could become a kind of vehicle for pushing ahead with the monetary integration of Europe.
14. On the United Kingdom and the EMS, see paragraph 2 of the Supplemental Note to Chapter 9.
15. In the original version of this Chapter, it was said that the EMCF does not have legal personality. Dr. René J.H. Smits of the Netherlands Bank pointed out to me that the EMCF was given legal personality under Article 1 of Regulation (EEC) No. 907/73 of the Council of April 3, 1973. The text of the Chapter has been corrected. It does not necessarily follow that the EMCF is at present empowered to hold SDRs under Community law.
Note.—This essay was published originally in Österreichische Zeitschrift fiir Öffentliches Recht und Völkerrecht, Vol. 34 (Vienna, 1983), pp. 117–72.
Joseph Gold, Special Drawing Rights: The Role of Language, IMF Pamphlet Series, No. 15 (Washington, 1971).
Article VIII, Section 7; Article XXII.
Joseph Gold, Conditionality, IMF Pamphlet Series, No. 31 (Washington, 1981); Manuel Guitián, Fund Conditionality: Evolution of Principles and Practices, IMF Pamphlet Series, No. 38 (Washington, 1981).
Article IV, Section 4, and Schedule C.
For a detailed account of the past, present, and possible future law of exchange arrangements, see “Developments in the International Monetary System, the International Monetary Fund, and International Monetary Law Since 1971,” Chapter 1 of this volume.
Michel Vanden Abeele, “L’ECU, une monnaie politique?” Revue de la Banque (Brussels, 2/1979), pp. 357–70; J. van Ypersele de Strihou, “Le nouveau système monétaire européen,” Revue de la Banque (Brussels, 2/1979), pp. 247–68; Horst Ungerer, “European Monetary System Has as Objectives Greater Economic Stability, Policy Convergence,” IMF Survey, Supplement: The European Monetary System, Vol. 8 (Washington, March 19, 1979), pp. 97–100.
On allocations and cancellations, see Article XVIII.
Article XVIII, Section 1(a).
Article VIII, Section 7; Article XXII.
Agreement between the Central Banks of the Member States of the European Economic Community laying down the operating procedures for the European Monetary System, March 13, 1979, in EMS Texts. This compilation should be referred to for most of the legal provisions relating to the ECU. Another valuable compilation is the Compendium of Community Monetary Texts (1979), issued by the Monetary Committee of the Community. The basic documents relating to the EMS are reproduced on pages 39–85 of this Compendium.
The privilege of a member of the EMS that enables it not to participate in the exchange rate and intervention arrangements and not to receive ECUs has some similarity to the option of a member of the Fund not to participate in the Special Drawing Rights Department.
When the EMS took effect, ECU 23.3 billion was issued. The amount was increased to ECU 27.4 billion when the United Kingdom made its contribution. Subsequent amounts were ECU 49.7 billion in April 1981, ECU 38.1 billion in July 1982, and ECU 41.9 billion in December 1982.
Article XV, Section 2.
For considerations that have guided all decisions but have not been included in a decision, see Joseph Gold, SDRs, Currencies, and Gold: Fifth Survey of New Legal Developments, IMF Pamphlet Series, No. 36 (Washington, 1981), p. 4.
For details, ibid., pp. 1–4 and 93–96.
H. Joly Dixon, “The European Unit of Account,” Common Market Law Review, Vol. 14 (Netherlands, 1977), pp. 191–208.
Ibid., pp. 195–96.
Franklin Mint Corporation et al. v. Trans World Airlines, Inc., 690 F. 2d 303 (2nd Cir., 1982).
Joseph Gold, SDRs, Currencies, and Gold: Fourth Survey of New Legal Developments, IMF Pamphlet Series, No. 33 (Washington, 1980), pp. 12–13.
Joseph Gold, SDRs, Currencies, and Gold: Fifth Survey of New Legal Developments, IMF Pamphlet Series, No. 36 (Washington, 1981), pp. 21–26.
Decision No. 6864-(81/81), Selected Decisions, 9th (1981), p. 178.
The listed examples of transactions and operations are not intended to be exhaustive.
Article XIX, Section 5(a) (i).
This formula excludes the compulsory use of gold, but the creditor and debtor central banks may agree to settle with gold at an agreed price.
A member may terminate its participation in the Special Drawing Rights Department at any time by giving notice in writing to the Fund at its principal office, and the termination becomes effective on the date the notice is received. There is no express provision that authorizes a participant in the ECU scheme to withdraw before liquidation of the scheme, but the absence of such a provision may not be decisive.
Wolfgang Rieke, “The Functioning of the ECU,” in Group of Thirty, Reserve Currencies in Transition (New York, 1982), p. 53.
For details, see Joseph Gold, SDRs, Currencies, and Gold: Fifth Survey of New Legal Developments, IMF Pamphlet Series, No. 36 (Washington, 1981), pp. 14–20 and 93–98.
The procedure for a transfer of SDRs in a settlement is obvious: an agreement between the two members. The procedure for the use of a reserve position in the Fund is less obvious and an explanation may be desirable. A reserve position can consist of (a) a readily repayable claim under a loan by a member to the Fund and (b) a reserve tranche position in the Fund’s General Resources Account. A reserve tranche position entitles a member to use the Fund’s general resources without challenge in amounts not exceeding the reserve tranche. A readily repayable claim can be assigned if the loan agreement provides for assignment. The reserve tranche can be used by purchasing SDRs from the Fund; the SDRs are then transferred to the creditor central bank. Alternatively, the debtor central bank can purchase the creditor central bank’s currency from the Fund if that currency is appropriate for sale by the Fund under its policies. The Fund’s Articles permit transactions to meet a need because of developments in reserves (which include developments because of the settlement of obligations), even though the member does not have a balance of payments deficit. The purchase by one member of another member’s currency from the Fund is likely to reduce the first member’s reserve tranche position and to create an equivalent position for the other member.
Joseph Gold, SDRs, Currencies, and Gold: Fourth Survey of New Legal Developments, IMF Pamphlet Series, No. 33 (Washington, 1980), pp. 105–109. A decision is taken on how to calculate in SDRs a debt denominated in ECUs, see Annual Report, 1982, p. 90.
Burma, Guinea, Guinea-Bissau, Iran, Jordan, Kenya, Malawi, Mauritius, Sao Tome and Principe, Seychelles, Somalia, Vanuatu, Viet Nam, Zaire, and Zambia.
Bahrain, Qatar, Saudi Arabia, and United Arab Emirates.
Article IV, Section 4; Schedule C. The use of the SDR was not made compulsory, in order to provide flexibility if the method of valuation of the SDR in force at the time was considered unsatisfactory for the purposes of the par value system.
The European Monetary System: Problems and Prospects, a study printed for use of the Joint Economic Committee and the Committee on Banking, Finance and Urban Affairs, 96th Cong., 1st Sess. (November 1979).
“The European Monetary System,” European Economy, No. 3 (Belgium, July 1979), pp. 65–111.
European Economy, No. 12 (Belgium, July 1982), p. 41.
Jean-Jacques Rey, “Some Comments on the Merits and Limits of the Indicator of Divergence of the European Monetary System,” Revue de la Banque (Brussels, 1/1982), pp. 28–37.
The Fund may determine under Article IV, Section 4 that the conditions exist for calling into existence the par value system spelled out in Schedule c. Among the conditions are “arrangements for intervention and the treatment of imbalances.” The settlements that would be involved in the treatment of imbalances, including the role of the SDR, are not described.
The parties are free, however, to apply not the SDR as valued currently by the International Monetary Fund but as valued by it at some earlier date. For this and other variants, see Joseph Gold, “Development of the SDR as Reserve Asset, Unit of Account, and Denominator: A Survey, The George Washington Journal of International Law and Economics, Vol. 16 (Washington, 1982), pp. 7-10.
Joseph Gold, “The SDR in Treaty Practice: A Checklist,” International Legal Materials, Vol. 22 (Washington, January 1983), pp. 209–13.
Report of the United Nations Commission on International Trade Law on the Work of Its Fifteenth Session, General Assembly Official Records, 37th Sess. Supplement No. 17 (A/37/17).
Robert C. Effros, “Unit of Account for International Conventions Is Considered by UN Commission on Trade Law,” IMF Survey, Vol. 11 (Washington, February 8, 1982), pp. 40–41.
An obligor would be able to forbear from relying on the limit and could settle on some basis more favorable to the obligee.
Joseph Gold, “Development of the SDR as Reserve Asset, Unit of Account, and Denominator: A Survey,” The George Washington Journal of International Law and Economics, Vol. 16 (Washington, 1981), pp. 4-7.
Dorothy Meadow Sobol, “The SDR in Private International Finance,” Federal Reserve Bank of New York Quarterly Review, Vol. 6 (New York, Winter 1981–82), p. 29; Lawrence de V. Wragg, “Commercial Transactions in SDRs: Some Documentation Considerations,” Business Law Review, Vol. 2 (October 1981), p. 315, and “Documentation of the Commercial Special Drawing Right,” International Finance Law Review (February 1983), pp. 22–26; Orren Merren, “The SDR as a Unit of Account in Private Transactions,” International Lawyer, Vol. 16 (Summer 1982), p. 503; “Le Marché des certificats de dépôts en D.T.S.,” Agence Economique et Financière, year-end ed. (December 1981), pp. 118–20; and Joseph Gold, see footnote 43 above.
The discussion of the uses of the ECU is based principally on “Private Use of the ECU,” Bulletin of European Commerce, Vol. 15, pp. 82–86; and Pierre Guimbretière, “Le marché de l’écu,” Revue du Marchè Commun, No. 259 (August-September 1982), pp. 388–97.
“The second innovation [in 1981] was the decision by the two primary European clearing institutions, Euroclear and Cedel, to adapt their systems to accept assets denominated in SDRs, notably Eurobonds and floating rate notes. By this means, secondary markets could develop in these instruments which would increase their liquidity and attraction to potential investors.
“The third innovation was an agreement in January  by seven leading banks in London to provide a secondary market in SDR CDs and floating rate CDs. The banks were Barclays, Chemical, Citibank, Hong Kong and Shanghai, Midland, National Westminster, and Standard and Chartered. Using practices already in existence for United States dollar CDs as their guide, the banks further agreed to try to standardize the procedures for transactions in SDR CDs” (Sobol, op. cit. (see footnote 44), p. 37).
Under the First Amendment, settlements with SDRs became possible, although not obligatory, largely for the benefit of the United States (see Article XXV, Section 2(b)(i) of the First Amendment). The original Articles provided, however, that the Fund’s resources could be used for settlements to perform the obligation of official convertibility (Article VIII, Section 4). On the present law relating to this obligation, see Joseph Gold, Use, Conversion, and Exchange of Currency Under the Second Amendment of the Fund’s Articles, IMF Pamphlet Series, No. 23 (Washington, 1978), pp. 26–32.
The U.S. Commission on the Role of Gold in the Domestic and International Monetary Systems recommended that the United States and the International Monetary Fund should not dispose of their stocks of gold. Some members of the Commission subscribed to this recommendation for a reason similar to the reason noted in the text for preserving a role for the SDR. The role of gold in the international monetary system might change again and become central (Report to the Congress of the Commission on the Role of Gold in the Domestic and International Monetary Systems, Vol. 1 (March 1982), pp. 14–15 and 19–20).
During the drafting of the Second Amendment, the Managing Director (Mr. Witteveen) gave an illustration of a “central” or “main” role for the SDR without making it the only reserve asset or the largest component in reserves. Members could be required to hold SDRs in fixed proportions to other reserve assets. By varying the volume of SDRs or the proportion of holdings of SDRs to other reserve assets from time to time, the Fund could use the SDR to control the total volume of official liquidity (IMF Survey, Vol. 4 (Washington, October 28, 1975), p. 315). A similar proposal for the holding of Collective Reserve Units (CRUs) and gold was made in the Ossola Report, pars. 34–37.
Joseph Gold, “Substitution in the International Monetary System,” Case Western Reserve Journal of International Law, Vol. 12 (Cleveland, Ohio, Spring 1980), pp. 295–302. See Chapter 3 of this volume.
Outline of Reform, pp. 8 and 24.
How Central Banks Manage Their Reserves (New York: Group of Thirty, 1982), pp. 19–20.
It is not clear whether the criticism is that there are designation rules or that they are not sufficiently comprehensive.
Opposition was expressed to private holding, however, on the ground that it would undermine the collective management of reserves (How Central Banks Manage Their Reserves (New York: Group of Thirty, 1982), p. 20).
Apparently because uses become known.
Another criticism related to the criterion of balance of payments need for the use of SDRs, but the criterion applies only to transactions in which the Fund designates the transferee and not to transactions entered into by agreement between members.
Christopher McMahon, ‘The Long-Run Implications of the European Monetary System,” in The European Monetary System: Its Promise and Prospects, ed. Philip H. Trezise (Washington: Brookings Institution, 1979), p. 86.
Allocations for this purpose might appear to be motivated, in part at least, by a desire to overcome the difficulty that the Fund cannot allocate SDRs to itself. Moreover, an effective reserve asset, unlike gold at the present time, is one that is used actively in support of the currency of the holder. The Fund has recognized the undesirability of engrossing too large a proportion of the stock of SDRs. For example, it has not prescribed transactions and operations between itself and “other holders” (i.e., holders other than members) under Article XVII, Sections 2 and 3, so that the use of SDRs will be encouraged among members and other holders. Moreover, the Fund has adopted a policy on sales of SDRs that is designed to reduce the Fund’s holdings to a specified level (see, Annual Report, 1982, p. 134), although the decision also seeks to maintain that level so as to meet certain needs of the Fund. Another objection that might be made to allocations of SDRs primarily for the purpose of enabling members to pay subscriptions for increases in quota would be that SDRs were intended to be assets that members could use unconditionally, but transferring them to the Fund would mean that they then could become available to members only in transactions to which conditionality applied.
Warren L. Coats, Jr., “The SDR as a Means of Payment,” International Monetary Fund, Staff Papers, Vol. 29 (Washington, September 1982), pp. 422–36.
For a study of the experience, and proposals for the development, of the EMS, including the ECU, see Commission of the European Communities, Documents relating to the European Monetary System, European Economy, No. 12 (Belgium, July 1982).
Peter Dreyer, “European Currency Unit Facing Doubtful Future,” Journal of Commerce (May 24, 1982), p. 6A.
Alena Wels, “Private Markets Aid Evolution of the ECU,” Journal of Commerce (January 25, 1983), p. 4A; John Wyles, “ECU Bank Clearing Move,” Financial Times (January 10, 1983), p. 24. The private banks that have constituted a working party on clearing arrangements are Lloyds, Crédit Lyonnais, Istituto Bancario San Paolo di Torino, Kredietbank, and Morgan Stanley. The European Investment Bank also has been involved according to some reports. All interested banks would be invited to join an Association of ECU Clearing Banks.
Alena Wels, op. cit.
“BIS Eyes Request That It Handle Issues Denominated in ECUs,” Journal of Commerce (February 23, 1983), p. 4A.