IMF History (1966-1971) Volume 1

Chapter 27: A Temporary Regime Established (December 18–31, 1971)

International Monetary Fund
Published Date:
February 1996
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Immediately After the Smithsonian Agreement, the Managing Director cabled all the Fund’s members (1) to let them know the new exchange rates for the currencies of the ten countries participating in the agreement, (2) to inform them that the United States was expected in the next few months to propose to the Fund a new par value for the dollar, based on a price for gold of $38 per troy ounce of fine gold, and (3) to alert them to a forthcoming decision by the Executive Board regarding exchange rates.

Consideration of Central Rates

The last point had reference to action that had been in preparation for some weeks. The Executive Directors had begun in the first part of November 1971 to consider the immediate impact that a new series of exchange rates for the major industrial countries would have on the par value system. It appeared probable that, whatever realignment of rates was eventually worked out, monetary officials would agree, for the time being, on the use of margins somewhat wider than the existing maximum limits of 1 per cent on either side of par. In addition, since the United States could not propose a change in par value until after the Congress had acted, and since some other countries also needed legislation in order to establish new par values, there would be an interval in which several members might wish to communicate to the Fund central rates of exchange around which margins would be maintained, rather than new par values.

The Executive Directors had addressed themselves to the two questions of wider margins and central rates as part of a temporary regime that would come into effect after a currency realignment had taken place. They had been considering the possibility that a central rate of exchange could be communicated to the Fund by any member that did not maintain rates for spot exchange transactions based on a par value, but declared its intention to maintain rates for these transactions within maximum margins from a communicated central rate for its currency expressed in terms of the U.S. dollar.

Central rate was not a term used in the Articles of Agreement. Moreover, under the existing Articles, the Fund lacked the authority to substitute wider margins for those specified in Article IV, Section 3. However, the legal basis for a temporary regime of wider margins and central rates, according to the General Counsel, was Article I (iii) and Article IV, Section 4 (a), relating to the basic purposes of the Fund and to members’ obligations to collaborate with the Fund in order to promote exchange stability, to maintain orderly exchange arrangements, and to avoid competitive exchange alterations. According to the General Counsel, in situations in which members did not observe Sections 3 and 4 (b) of Article IV, it was Section 4 (a) of Article IV that was the main provision under which the Fund and members could collaborate in order to do their utmost to preserve the objectives of the Articles. Collaboration under Section 4 (a) would minimize the harm that might flow from the breach of obligation, but it would not mend the breach.

When the Executive Directors first discussed the possibility of such a regime, in mid-November 1971, some members of the Board had difficulty with the idea of central rates rather than par values. Mr. de Vries, for example, indicated that the Netherlands authorities had difficulties with the suggestion that after realignment had taken place central rates rather than par values would be established: central rates might be too flexible. Mr. Viénot argued that dollar convertibility ought to be re-established and objected to central rates on the grounds that they would pave the way for a general floating of exchange rates. He insisted also that margins should not exceed 2½ per cent. Mr. Suzuki, too, stated that the Japanese authorities favored an early return to a system of par values. The central rate regime might be a prelude to a more permanent departure from the par value system. Much discussion turned on what rules would apply for a member’s intervention in the exchange markets within its territories.

Further revisions by the staff and discussion in the Board clarified the character of a regime that could be introduced as a temporary one and led to an understanding of the conditions and safeguards that would apply. Central rates were to be rates regulated by the Fund in order to ensure that the purposes of the Fund were protected to the maximum extent possible in conditions of nonobservance of other exchange rate provisions of the Articles. The gold equivalent of a central rate was to be regarded as if it were a par value for certain purposes without, however, having the legal validity of a par value.

Decision Adopted

By December 18, 1971, the date of the Smithsonian agreement, the Executive Directors were ready to go ahead with a decision. They met that Saturday evening and took a decision entitled “Central Rates and Wider Margins—A Temporary Regime.”1 The decision was intended to enable members to comply with the Fund’s primary objectives “to the maximum extent possible during the temporary period preceding the resumption of effective par values with appropriate margins in accordance with the Articles.” Practices that members could follow that would be consistent with the obligation of Article IV, Section 4 (a), as well as with Resolution No. 26-9 adopted by the Board of Governors at the 1971 Annual Meeting, were specified in some detail.2

Under the decision, a member was deemed to be acting in accordance with Article IV, Section 4 (a), and Resolution No. 26-9 if it took appropriate measures “to permit spot exchange transactions between its currency and the currencies of other members taking place within its territories only at rates within 2¼ per cent from the effective parity relationship among currencies as determined by the Fund, provided that these margins may be within 4½ per cent from the said relationship if they result from the maintenance by the member of rates within margins of 2¼ per cent from the said relationship for spot exchange transactions between its currency and its intervention currency.” An intervention currency was defined as the currency that a member indicated to the Fund that it stood ready to buy and sell in order to perform its obligations regarding exchange stability. A member that availed itself of wider margins was to notify the Fund and would then be subject to certain rules regarding multiple currency practices and discriminatory currency arrangements and regarding intervention in the exchange markets within its territories.

A member that was temporarily not maintaining rates based on a par value for its currency but was maintaining a stable rate as the basis for exchange transactions in its territories could communicate that rate to the Fund. If the Fund found that this rate was not unsatisfactory, the rate was referred to as a central rate. The member could then maintain margins around that central rate. A central rate for a member’s currency could be communicated to the Fund in gold, units of SDRs, or another member’s currency.

Rates Communicated

In the weeks that followed, members began to notify the Fund of their actions, and the Fund acted on these notifications as necessary.

Par Values Unchanged

By December 31, 1971, 24 members and 1 nonmetropolitan territory had decided to maintain unchanged the par values of their currencies; such action meant that the currencies of these members were appreciated vis-à-vis the dollar by 8.57 per cent from the par values existing on May 1, 1971. These countries included France and Spain as well as the United Kingdom and most members of the sterling area, such as Australia, Iraq, Ireland, Jamaica, Malaysia, New Zealand, and Nigeria.

The complete list and the par values maintained are given in Table 18.

Table 18.Par Values Maintained Unchanged as of December 31, 1971
MemberPar Value in U.S. Dollars per Currency Unit1
Gambia, The0.521143
Libyan Arab Republic23.04000
New Zealand21.21600
Saudi Arabia0.241269
Sierra Leone1.30286
United Kingdom22.60571
United Kingdom:
Hong Kong0.179143

Represented an appreciation of 8.57 per cent in terms of the U.S. dollar from the rates in effect on May 1, 1971.

Member availed itself of the wider margins of up to 2¼ per cent.

Represented an appreciation of 8.57 per cent in terms of the U.S. dollar from the rates in effect on May 1, 1971.

Member availed itself of the wider margins of up to 2¼ per cent.

Par Values Changed

Changes were made in the par values for the currencies of 10 members and 2 nonmetropolitan territories. The par values for the shillings of Kenya, Tanzania, and Uganda and for the Zambian kwacha were altered so that they all remained in line with the U.S. dollar. In terms of the U.S. dollar, the South African rand, also used by Botswana, Lesotho, and Swaziland, was devalued by 4.76 per cent, the Yugoslav dinar by 11.76 per cent, and the Ghanaian new cedi by 43.88 per cent. Revaluations occurred for the Surinam guilder and for the Bahamian dollar.

Details are given in Table 19.

Table 19.Par Values Changed, December 18–31, 1971
MemberNew Par Value in U.S. Dollars per Currency UnitPercentage Change in Terms of U.S. Dollars1
South Africa1.33333−4.76
United Kingdom:
Bahama Islands1.03093+3.09

The percentage change in the amount of U.S. dollars required to purchase a unit of national currency, calculated on the basis of the par values in effect on May 1, 1971.

Member availed itself of the wider margins of up to 2¼ per cent.

The percentage change in the amount of U.S. dollars required to purchase a unit of national currency, calculated on the basis of the par values in effect on May 1, 1971.

Member availed itself of the wider margins of up to 2¼ per cent.

Central Rates Established

Central rates were established for the currencies of 28 members and of 1 nonmetropolitan territory. The majority also availed themselves of the wider margins. Members that set central rates included Belgium, the Federal Republic of Germany, Italy, Japan, the Netherlands, and Sweden.

Details of the central rates established are given in Table 20.

Table 20.Central Rates Established, December 18–31, 1971
MemberCentral Rate Expressed in U.S. Dollars per Currency Unit1Percentage Change in Terms of U.S. Dollars2
Dominican Republic1.0000000.00
Germany, Federal Republic of30.310318+13.58
Netherlands Antilles0.558659+5.35

Central rates are here expressed in U.S. dollars even though some members communicated them to the Fund in other terms.

The percentage change in the amount of U.S. dollars required to purchase a unit of national currency, calculated on the basis of the par values in effect on May 1, 1971.

Member availed itself of the wider margins of up to 2¼ per cent.

Includes the changes in par values between May 1, 1971 and December 18, 1971.

Central rates are here expressed in U.S. dollars even though some members communicated them to the Fund in other terms.

The percentage change in the amount of U.S. dollars required to purchase a unit of national currency, calculated on the basis of the par values in effect on May 1, 1971.

Member availed itself of the wider margins of up to 2¼ per cent.

Includes the changes in par values between May 1, 1971 and December 18, 1971.

Rates of Other Members

The overwhelming majority of the Fund’s members kept their exchange rates unchanged in terms of their intervention currency, and did not avail themselves of the wider margins. Many such members used the French franc as their intervention currency and kept their rates fixed in terms of French francs. Thus, Cameroon, the Central African Republic, Chad, the People’s Republic of the Congo, Dahomey, Gabon, Ivory Coast, the Malagasy Republic, Mauritania, Niger, Senegal, Togo, and Upper Volta retained the relationship between the CFA franc and the French franc at 50 to 1, yielding an appreciation in terms of dollars from 277.710 CFA francs per U.S. dollar to 255.785 CFA francs per U.S. dollar, the same appreciation as that of the French franc in terms of the dollar. Algeria similarly maintained its exchange rate fixed in terms of French francs, thus also appreciating its currency by 8.57 per cent in terms of the dollar.

The Republic of China, El Salvador, Iran, Liberia, Nepal, and Thailand all had had effective par values prior to August 15, 1971, and they continued to keep their exchange rates unchanged in terms of dollars. This meant that they devalued in terms of gold to the same extent as the United States was expected to do. Many other members that did not have effective par values prior to August 15, 1971 likewise kept their exchange rates unaltered in terms of the U.S. dollar. Some of these members had free exchange markets for at least part of their transactions, where exchange rates might change according to the new realignments. These members included Argentina, Brazil, Chile, Costa Rica, Ecuador, Egypt, Indonesia, Korea, Lebanon, Pakistan, Paraguay, Peru, the Philippines, the Sudan, the Syrian Arab Republic, Viet-Nam, and the Yemen Arab Republic.

The Executive Board took a blanket decision on December 23, 1971 affecting primarily the members mentioned in the preceding paragraph. The Board agreed to the changes in exchange rates that they had made and approved the multiple currency practices involved. The countries concerned all had membership resolutions, or exchange rates already approved by the Fund as pre-par value rates, that specified as fixed the number of currency units to be maintained per U.S. dollar. Hence, their rates in terms of dollars had already been approved by the Fund. The Fund now deemed to be approved any change in the gold equivalents of such exchange rates that resulted from the country’s continuing to maintain the same number of currency units per U.S. dollar.3 This decision meant that these members did not individually have to seek the Fund’s approval for the changes in their exchange rates, which, while unchanged in terms of dollars, were necessarily depreciated in terms of gold.

The Fund’s Operations Restored

To facilitate the resumption of the orderly conduct of the Fund’s operations after the decision taken on December 18, 1971, the staff submitted to the Executive Directors, on December 22, some proposals for valuing the Fund’s holdings of currencies and for determining the exchange rates that would be applicable in the Fund’s operations. There was preliminary discussion of these proposals by the Executive Directors at two informal sessions on December 23, which led to further refinements of technical points by the staff. Then, on January 4, 1972, the Executive Board took a decision that would apply until the new par value for the U.S. dollar became effective.

There were several elements to the decision. Within a reasonable period after a member established a central rate for its currency, the Fund would adjust its holdings of the member’s currency in accordance with the central rate. If the member was availing itself of wider margins, the adjustment of the Fund’s holdings of a currency that was involved in a transaction with the Fund was to be based on the ratio of the representative rate for the member’s currency in the exchange market to the effective parity relationship between that currency and the member’s intervention currency. And participants in the Special Drawing Account that used SDRs were enabled to obtain against them amounts of foreign exchange that corresponded to the prospective par value of the U.S. dollar based on a price for gold of $38 an ounce, rather than on the par value of the U.S. dollar based on a gold price of $35 an ounce.4

World Payments Situation at the End of 1971

As 1971 drew to a close, it was uncertain whether, and to what extent, the new exchange rates would redress the imbalance in world payments. That imbalance had not only persisted but had become much worse. The overall U.S. balance of payments deficit on official settlements for the year had come to $30 billion, three times the size of that of 1970. The trade surplus of 1970 had turned into a $3 billion deficit, and the current account had now also shifted into a deficit of somewhat less than $1 billion. The 1971 U.S. basic balance was in deficit by $9.3 billion, compared with the $2.5–3 billion of the preceding few years.

In contrast, Japan had an overall balance of payments surplus in 1971 of more than $7 billion and a current account surplus of $5.8 billion, unprecedented in that country’s postwar history. The overall surplus of the United Kingdom had also shown a tremendous rise, second only to that of Japan, reaching $6.5 billion, which was $3.5 billion larger than it had been in 1970. The Federal Republic of Germany’s overall surplus had declined from that of 1970 but was still $4.5 billion, and France also had a large surplus, of $3.5 billion.

International Monetary Reform—The Next Step

The system of par values had been suspended. The U.S. authorities were not converting foreign official holdings of U.S. dollars into gold or other reserve assets. Thus, two key features of the international monetary system that had been designed at Bretton Woods a quarter of a century earlier no longer existed. The need for international monetary reform, or, as a minimum, measures to improve vastly the functioning of the international monetary system, were on everyone’s mind. The resolution taken by the Board of Governors at the 1971 Annual Meeting had provided the official blessing for a study of monetary reform, and the Executive Directors had begun consideration of many issues.

The spectrum of topics to be considered in discussions about monetary reform had already become wide. Should greater flexibility of exchange rates be provided for, and, if so, how great and by what techniques? How should the relative responsibilities for correcting future imbalances be apportioned between deficit and surplus countries? What measures should be used to reduce disequilibrating capital flows, and, in particular, to what extent should resort be made to capital controls? Should the substantial amounts of dollars held in foreign official reserves be converted into some other form of international reserve asset, such as the SDR? What should be the position of gold in any future monetary system? These were fundamental questions, and it was likely that some years would pass before international monetary reform would be achieved.

A Backward Glance

Although what is commonly called the Bretton Woods system did not collapse entirely until the early months of 1973, at the end of 1971 it was already evident that the regime of par values was in jeopardy. Economists, financial officials, and monetary historians looked backward, as well as forward, endeavoring to seek explanations for the breakdown of the system that had served so well at least until 1965, if not a year or two longer.

In retrospect, it is clear that the developments in the international monetary field and in the world’s exchange markets that placed the par value system under stress were a direct reflection of the basic changes in the world economy that had been gradually evolving since the end of World War II. Over time the world had become integrated, economically and financially, and a true “world economy” had developed. Not only had international trade expanded to unprecedented levels but production, too, had become international: giant multinational corporations could shift production from country to country, depending on changes in costs or other circumstances. A progressive internationalization of banking operations had taken place, making it possible, among other things, for large and potentially disruptive short-term capital movements suddenly to cross national boundaries.

There had been other changes in the world economy as well. Instead of the widespread unemployment that had been feared when the Fund was created, inflation had persisted as the key problem for nearly all countries and had eventually reached historically high rates; to make matters worse, inflation coexisted with unemployment and danger of recession. World economic circumstances became subject to frequent changes, making economic forecasting very difficult. World economic power had become distributed among a number of countries. And as shortages of natural resources began to make themselves felt, an awareness developed that there could be limits to economic growth.

These changes in the world economy made it much more difficult for central bankers and economic policymakers, including those in the international economic institutions established after World War II, to achieve the four principal objectives of economic policy that, for the previous twenty-five years, had been their goal: full employment, price stability, economic growth, and balance of payments equilibrium. And the international monetary system that had been designed to help achieve those objectives inevitably broke down.

E.B. Decision No. 3463-(71/126), December 18, 1971; Vol. II below, pp. 195–96.

The resolution is reproduced in Vol. II below, pp. 331–32.

E.B. Decision No. 3504-(71/134), December 23, 1971; Vol. II below, p. 215.

E.B. Decision No. 3537-(72/3)G/S, January 4, 1972; see Annual Report, 1972, pp. 87–88. When the United States established a new par value, on May 8, 1972, this decision was replaced.

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