- International Monetary Fund
- Published Date:
- February 1996
In February 1973 the Research Department prepared a paper comparing the various proposals that had been suggested in the Committee of Twenty for achieving consolidation, convertibility, and asset settlement. The paper was revised to take into account the discussion in the Executive Board on this topic and is published as (A) below.
A second paper on the same topic, prepared in the Research Department in May 1973, analyzed the technical choices involved in choosing between alternative arrangements for achieving consolidation, convertibility, and asset settlement. This paper, as revised after discussion in the Executive Board, is published as (B) below.
(A) Approaches to Consolidation, Convertibility, and Asset Settlement
(February 28, 1973)
A number of proposals concerned with consolidation, and aimed at restoring some form of convertibility of official holdings of U.S. dollars into primary reserve assets or at introducing asset settlement for reserve currency countries, were advanced at the meeting of the Deputies of the Committee of Twenty in Paris. Four specific proposals, advanced by Italy, the United States, the United Kingdom, and the Federal Republic of Germany, will be described and compared in the present paper. The texts of these proposals are presented in the annex to this paper.
It may be helpful to preface the discussion by defining the principal terms that are used. “Consolidation” is used to refer to any operation by which the holders of reserves in the form of short-term currency assets exchange these for an alternative form of asset which does not constitute a liquid claim on the reserve center. Consolidation may take two forms. The first, known as “substitution,” involves the replacement of liquid reserve currency claims by liquid claims on the international community (SDRs) in the portfolios of reserve holders; the counterpart to this replacement is the acquisition of a claim on the reserve center by the Fund. The second, known as “funding,” involves the replacement of liquid reserve currency claims by illiquid reserve currency claims in a bilateral deal between the reserve holder and the reserve center: there might, of course, be a series of such bilateral arrangements pursuant to some internationally agreed principle.
The term “convertibility” is used in the present paper to refer to the right of official holders to obtain conversion of holdings of foreign exchange into other reserve assets. The holder of a convertible currency will be described as having a right to “request conversion,” and the issuer as having an obligation to “convert.” Under some arrangements there would be an obligation on those acquiring reserve currencies in excess of some limit to exercise their right to request conversion.
“Asset settlement” is defined as a system under which the payments imbalances of all countries, including reserve centers, are settled by the transfer of reserve assets (or else by the extension of negotiated credits) rather than by variations in outstanding reserve currency liabilities. It therefore places an obligation on the issuer of a reserve currency to ensure the actual conversion of its payments imbalances.
Balance of payments surpluses and deficits are to be interpreted as referring to the official settlements concept.
2. Description of Proposals
All of the proposals to be examined in this paper envisage the possibility of creating a substitution facility in the Fund. This could be done through instituting an account, which will be referred to as a substitution account, that would engage in one or more of three types of transactions.
(i) It would be entitled to sell specially created SDRs against outstanding holdings of reserve currencies. To the extent that such sales occurred, the account would obtain a claim against the reserve center.
(ii) It might engage in transactions with the reserve centers intended to secure asset settlement of the reserve currency countries’ imbalances. When a reserve center was in surplus (deficit), the account would buy (sell) its currency, in exchange for SDRs, in an amount that resulted in the reserve center gaining (losing) a quantity of reserve assets equal to its surplus (deficit).
(iii) It might be used to provide foreign exchange in exchange for SDRs to countries with a balance of payments need or to restore their working balances.
A substitution account could appropriately deal with other reserve currencies, e.g., the pound sterling, in the same way as with the U.S. dollar.
If it were decided to create a substitution account it would be necessary to agree on the terms on which the reserve centers would service the account’s assets. These terms would cover interest rates, possible amortization, and the unit in which the assets were denominated.
(a) The Italian proposal. The Italian proposal envisages the creation of a substitution account with all three of the functions listed above. Conversion would cease to be a bilateral matter between reserve holders and reserve centers. Instead, countries requesting conversion of reserve currencies would obtain SDRs from the account, and countries requiring foreign exchange for intervention to finance a deficit might obtain it from the account in exchange for SDRs. The account would sell (buy) SDRs to (from) a reserve center to the extent that the center’s surplus (deficit) had been financed by a reduction (increase) of its liabilities, thus securing full asset settlement. There would not normally be any restrictions on the composition of the reserve portfolio of individual countries, except by way of a gentleman’s agreement by the major reserve holders to a limited initial substitution of SDRs for reserve currencies.
Countries gaining reserves would do so initially by acquiring foreign exchange in the market, and there would be no obligation on them to request conversion of this foreign exchange into primary reserve assets. If the deficit countries were using SDRs to acquire foreign exchange from the account rather than running down their foreign exchange holdings, the account would lose foreign exchange and gain SDRs, resulting in what may be termed “deconsolidation.” (The same result would occur if it was the reserve center that was in deficit and therefore surrendered SDRs to the account.) As a result of such a process the account might exhaust its holdings of a reserve currency, thus making it impossible to reconcile freedom of portfolio choice with asset settlement. In such a situation it is envisaged that asset settlement would be maintained, and a renewed build-up of international reserves would be averted, by invoking the designation mechanism to designate certain countries to receive SDRs and provide the reserve currency. But this solution would be regarded as only a temporary one: such a revealed preference for reserve currencies would be taken as evidence that there was a need to make the holding of SDRs more attractive.
(b) The U.S. proposal. The U.S. approach to the problems discussed in this paper has not been cast in the form of a proposal comparable to the other proposals considered, but it is sufficiently well defined to justify providing a similar summary and analysis. It appears to envisage that if a substitution or analogous facility were to be created, its function would be limited to the first of the three possible roles of a substitution account and would be confined to arranging a once-for-all substitution of a part of existing reserve currency holdings by SDRs, at the option of the holder. The time limit on the use of the substitution facility would not diminish the freedom of choice of the holder, since the latter would normally be able to seek conversion of its holdings later, from the reserve center. However, a country whose holdings of primary reserve assets exceeded a “convertibility point” would lose the right to request conversion of holdings of foreign exchange in excess of that point. In addition, the issuing country would have the right to limit or prohibit other countries from adding to their holdings of its currency, thus compelling other countries to request conversion of any further balances of its currency that they might acquire, or to switch to another currency. It is not clear what would happen if a country were forbidden further accumulation of a currency when its primary reserves were above the convertibility point.
The U.S. paper envisages these arrangements being operated in conjunction with a system of multicurrency ceiling intervention. Under this system the participating countries when in surplus would acquire the currencies of whichever other participants were in deficit, so that the currencies of all participants would become to some extent “reserve currencies,” and the use of this term in connection with the U.S. proposal should be interpreted in this broader sense. The currency acquired in intervention could be used in one of three ways: (i) to acquire holdings of their own currency held by other participants; (ii) to hold in their reserves, provided the issuer acquiesced; (iii) to acquire primary reserve assets from the country whose currency was bought. There are reasons (which are discussed later in this paper) for believing that the operation of the U.S. proposal would be strongly influenced by whether or not a convention were established that countries acquiring foreign exchange in intervention should normally be expected to request conversion into primary reserve assets.
The U.S. paper mentions that designation would be superfluous under a system of ceiling intervention, but the designation procedure, or something akin to it, would presumably need to be retained to ensure that countries not participating in the multicurrency intervention arrangements were able to use their SDRs.
(c) The U.K. proposal. The U.K. proposal envisages that each country would agree to limit its holdings of each reserve currency to a prespecified level. Countries would be obliged to present any accretion of foreign exchange above this level to the reserve center, which would be obliged to convert it into primary reserve assets. In normal cases the limit would initially be set at no more than the country’s holdings of reserve currencies immediately before the scheme came into operation. On periodic settlements, countries would have the option either of restoring their holdings of reserve currencies by purchase against SDRs or of accepting a new and reduced level of reserve currency holdings which would become the new limit for future settlements. Countries would be permitted to exchange their reserve currency holdings for SDRs from the substitution account (either directly or indirectly through the reserve center, which would thereby become entitled to sell its currency to the account in exchange for SDRs up to the same amount), and initially substitution would be limited to the extent to which countries voluntarily availed themselves of this possibility. However, a country which subsequently ran a deficit and financed this by drawing on its foreign exchange holdings rather than settling in primary reserve assets would thereby also reduce the permitted maximum level of its foreign exchange holdings. A decline in total holdings of a reserve currency could thus result from (i) substitution of SDRs for the reserve currency, (ii) imbalances among other countries, insofar as deficit countries ran down their foreign exchange holdings while surplus countries were unable to add to their holdings because they were already at the permitted level, (iii) a surplus by the reserve center: in the last-mentioned case the reserve center would be entitled to acquire SDRs from the substitution account in an amount equal to its surplus, in exchange for its currency. The account would perform the first two of the possible roles of a substitution account. However, the scheme would also provide for controlled increases in permitted foreign exchange holdings where experience shows the permitted level to be inadequate to provide working balances.
(d) The German proposal. The German proposal was advanced by Mr. Pöhl in his statement to the Deputies of the Committee of Twenty during the afternoon of January 24, 1973. It envisages all countries agreeing to keep the main part of their monetary reserves in primary reserve assets, and to restrict foreign exchange reserves to a specified maximum needed as working balances. These maximum limits, which should be narrow ones, would be determined by the Fund according to “uniform principles.” The Fund would have the power to grant exceptions in the case of extraordinary developments. There would be an obligation to present foreign exchange in excess of these limits for conversion into primary reserve assets; there would be no right to request conversion of foreign exchange holdings so long as they were below the limits. The right to hold working balances would be limited to the intervention currency or currencies of the country concerned. All foreign exchange reserves should be held with the monetary authorities of the reserve center.
The system would require the consolidation of the existing reserve currency holdings in excess of working balances. Insofar as it was desired to change only the composition, and not the level, of reserves, this could be accomplished through substitution of assets in the Fund, such as SDRs, for reserve currencies. Any substitution facility created for this purpose would be limited to the first of the three possible roles of a substitution account. However, holdings of reserve currencies which originated in the abnormal capital flows of recent years should be regarded as only a temporary addition to world reserves and should be liquidated as and when the capital flows are reversed: this could be accomplished by the separation of such balances into bilateral accounts that would be used only to finance a reflux of capital to the United States. No details were presented on the method that would be used to establish when a country would be entitled to draw on such a bilateral account.
3. Comparison of the Proposals
A number of objectives have been mentioned as relevant in selecting arrangements regarding consolidation, convertibility, and asset settlement. It would appear that the following list, the order of which is not intended to imply any judgment on the relative importance of the different objectives, provides a reasonably complete coverage of the objectives that have been judged to be relevant:
(i) the avoidance of political tension arising from the decision as to whether to convert;
(ii) an equitable participation in the adjustment process by reserve centers;
(iii) the avoidance of undue pressure on deficit countries as a result of excessive surplus positions of some other countries;
(iv) the control of international liquidity;
(v) the provision of supplementary liquidity to meet abnormal situations;
(vi) the enhancement of the role of the SDR;
(vii) the possibility for reserve centers to participate on an equal footing in exchange rate flexibility;
(viii) freedom of portfolio choice in determining the composition of official reserves;
(ix) an equitable allocation of the benefits of reserve creation;
(x) the avoidance of a build-up of reserve currencies to the point of precipitating confidence crises.
These objectives are accorded different priorities by different countries, and this is one of the reasons underlying the differences between the proposals that have been advanced. The following analysis attempts to clarify the relationships between the different plans and the objectives that have been listed above. It does this by considering six features, each of which is first briefly related to the objectives. This is then followed by a discussion on a comparative basis of the extent to which each feature is represented in the different plans.
(a) Multilateral settlement
The proposal that conversion should be centered multilaterally in the Fund rather than continuing to be a bilateral matter between reserve holders and reserve centers is of relevance in connection with objective (i). It has been argued that the system of convertibility as it operated in the 1960s made decisions to convert or not to convert in part dependent on political considerations. The Italian plan seeks to prevent a repetition of this by making asset settlement mandatory and placing the responsibility for exercising conversion in the Fund. The German and U.K. proposals would tend to avert such a repetition by placing an obligation on countries to seek conversion of additional balances. The position under the U.S. plan would seem to depend on whether a convention was established providing that conversion should be expected in normal circumstances.
(b) Asset settlement
Asset settlement is relevant to objectives (ii), (iv), (vi), and (x), i.e., it is a method of ensuring that a reserve center in deficit participates in the initiation of adjustment, a means of avoiding an uncontrolled expansion of international liquidity, and it is necessary to ensure that future reserve growth is concentrated in SDRs and does not again lead to confidence crises. It is also relevant to objective (ix) so far as the future growth of reserves is concerned.
The Italian and U.K. proposals would both achieve full asset settlement by employing the substitution account for this purpose, although the Italian proposal might have to rely on the designation mechanism when the account ran out of currencies. The German proposal would achieve something close to asset settlement, but variations in working balances within the permitted limits would leave scope for some deviation. It is not fully clear to what extent the U.S. proposal would achieve asset settlement. If in practice the countries that participated in the multicurrency intervention scheme normally presented for conversion any balances of any currency acquired under that scheme, the U.S. plan would achieve asset settlement at least to the extent that any imbalances occurred among countries participating in multicurrency intervention. How far this would produce overall asset settlement would depend on the extent of the participation in multicurrency intervention and on the size of imbalances with the rest of the world. If, on the other hand, there were no presumption of conversion of balances acquired (e.g., because the countries that acquired balances in various currencies preferred, on account of a large interest differential, to hold these balances rather than acquire SDRs) operations under the U.S. plan would not approach asset settlement. Deficits might at least in part take the form of increases in currency liabilities, and there would be no assurance that surpluses of reserve centers would result in corresponding increases in reserve assets rather than in a rundown of reserve currency balances. Such a rundown could also occur independently of the accruing balance of payments position of the reserve center as holders of balances of convertible currencies changed their view on the relative attractiveness of various reserve assets.
Insofar as the U.S. proposal envisages the nonconversion of surpluses arising from temporary payments phenomena—for example, sudden or reversible speculative pressures—it provides an exception to asset settlement that is addressed to objective (v). The elasticity provided to the system in this manner might in some respects be similar to that provided by inter-central bank swaps in the past. The German plan recognizes that it might be desirable to allow the Fund to grant exceptions in the case of “extraordinary developments.” The Italian and U.K. proposals do not contain explicit suggestions as to how to meet this kind of need for elasticity. The possibility that this need might be met by some kind of facility in the Fund was mentioned in Chapter V of the reform report.† Any scheme that meets the need for this kind of elasticity will have to rely on discretion as to when the facility is to be utilized, which would tend to run counter to objective (i).
(c) Restrictions on the freedom of reserve composition
Asset settlement for the existing reserve centers is a necessary but not sufficient condition for the establishment of control over the volume of international liquidity (objective (iv)). It would also be necessary to prevent the accumulation of additional reserves on international markets (such as the Euro-dollar market) and in the form of additional currencies. Such measures would tend to run counter to freedom of portfolio choice, objective (viii). This would also be true of restrictions that arose from granting the issuing country the right to prohibit further accumulations of its currency, restrictions placed on the holding of primary reserves by means of convertibility points, and any use that was made of the designation mechanism.
The German proposal closely specifies the composition of each country’s reserve portfolio, and requires full initial consolidation. It would therefore tend to promote maximum control over the volume of international liquidity, at the expense of severely curtailing freedom of portfolio choice. The U.K. plan places a one-way constraint on the freedom of reserve composition: it involves no compulsory initial consolidation and provides freedom to switch into SDRs whenever desired, but any rundown of foreign exchange holdings not restored during periodic settlements would be irreversible and countries would also be prohibited from switching their reserves into new forms.
The U.K. plan would again bring the volume of liquidity under control, but at the cost of restrictions on the freedom of portfolio choice which, though minimal in the short run, might gradually become more onerous.
The Italian plan would again rely on voluntary initial consolidation and provide the freedom to switch into SDRs whenever desired. It would not permit countries to switch freely from SDRs to foreign exchange, but countries in deficit could continue to use SDRs or currencies as they desired. Countries in surplus would hold increments to their reserves in whichever form they might prefer (provided, however, that, if the substitution account should run short of currencies, their freedom would be circumscribed by the designation mechanism). Thus, the effective freedom of portfolio choice might be substantially greater than under the German and U.K. plans, but this might be bought at the expense of effective control of the volume of liquidity insofar as there was no constraint on the right to switch gradually into new forms of reserve media.1
The position under the U.S. plan would depend very much upon the conventions that were established. If countries were not normally expected to request conversion there would be no assurance that the volume of liquidity could be internationally controlled, but freedom of portfolio choice would be maximized (apart from the restrictions on countries in excess of their convertibility points and the obligation to accept SDRs when designated from countries not participating in the multicurrency intervention system). On the other hand, if countries were normally expected to request conversion there would be much greater certainty of controlling the volume of liquidity but much less freedom of portfolio choice. The element in the U.S. proposal that the country of issue should have the right to limit official holdings of its currency would provide a mechanism that could be used by a country that did not want to become a reserve center to prevent the switching of reserves into its currency. The U.S. proposal would also provide flexibility which could be used to allow some countries, e.g., the oil producers, to accumulate official balances for investment purposes without disrupting the normal operation of the system.
The U.S. proposal to limit the holding of primary reserves by establishing convertibility points is addressed to objective (iii); it is intended to ensure that reserve accumulations by a surplus country beyond some point would not endanger the reserve positions of deficit countries. The particular feature is related to the system of “ceiling intervention” proposed in the U.S. plan; the protection that it would provide would accrue to the particular countries whose currencies were purchased under the intervention scheme by the surplus country.
Restrictions on the freedom of reserve composition are also relevant to the exercise of exchange rate flexibility by reserve centers (objective (vii)). If the rest of the world were prohibited from adding to its holdings of a reserve currency, it would be unable to prevent a downward float desired by the reserve center. Both the U.K. and German proposals incorporate such a prohibition on adding to reserve currency balances. The U.S. plan would also enable a reserve center to secure a downward float by simultaneously prohibiting all other countries adding to their balances of its currency and declaring its currency temporarily inconvertible.
Substitution promotes objective (vi), the establishment of the position of the SDR, in the sense that it would reflect an enhanced commitment by the Fund membership to the use of SDRs in their reserves. At the same time, substitution, depending on the scale on which it takes place, increases the need to establish the SDR as a desired reserve asset, and unless accompanied by adequate steps in that direction, may tend to weaken the willingness of countries to hold SDRs. Substitution is also relevant to objective (vii), since reserve centers may find that their reserve role inhibits an active use of exchange rate policy. It should be noted that in the context of schemes involving asset settlement through the intermediation of a substitution account, substitution (or consolidation more generally) is not required to protect the reserves of a reserve center against the claims for conversion beyond the amount of any payments deficit of that center: the provisions of asset settlement provide that protection. In the context of the U.S. scheme, however, where asset settlement is not assured, large-scale substitution would help to provide such protection.
The German proposal goes furthest toward full, immediate, and compulsory consolidation, but it allows an element of choice between substitution and funding. The U.K. plan starts without any necessary substitution but provides for irreversible, though largely voluntary, moves in the direction of substitution. The Italian plan begins with a minimum initial substitution under a gentleman’s agreement but otherwise envisages substitution being entirely voluntary, and does not preclude subsequent deconsolidation. The U.S. plan provides for voluntary initial substitution accompanied by absence of a firm assurance against a renewed build-up of reserve currency balances. One effect of the inability of countries to replenish reserve currency holdings when in surplus (as proposed in the U.K. scheme) might be to make countries unduly reluctant to run down their reserve currency holdings, which could slow down consolidation.
Funding of reserve currency balances could be into long-term assets or into special bilateral accounts that could only be drawn on in specified circumstances, e.g., to finance a reflux of recent abnormal capital flows. The German plan provides for funding in the second of these forms. Such funding would promote objective (ix) by allowing any existing excess liquidity to be run down when return flows of short-term capital occurred, which would then make room for additional SDR creation. Funding would also reduce the amount of substitution.
(f) Amortization of existing holdings of reserve currencies
There are differing views as to the desirability of amortization. Insofar as such amortization took place over time and the consequent reduction in international reserves was made up by the issuance of additional SDRs to participants generally, some of the benefits of past reserve creation would be shifted from the reserve centers to participants as a whole (objective (ix)). In general, amortization would be possible to the extent that substitution had occurred. However, under the Italian plan any amortization would reduce the ceiling at which the freedom of reserve composition would have to be curtailed by invoking the designation mechanism. Under the U.S. plan, amortization might be negated by a renewed build-up of reserve currency balances. Neither of those problems would arise with respect to amortization under the German and U.K. plans.
4. Interchangeability of Features of Different Plans
It is apparent from the preceding discussion that there are conflicts between some of the objectives that have been listed. For example, full freedom of portfolio choice is incompatible with the establishment of control over the volume of international liquidity and the equitable allocation of the benefits of reserve creation. It has been suggested since the discussion in the Committee of Twenty that there is considerable scope for combining features from different plans with a view to constructing a system that would better reconcile the various objectives.
Mr. Ossola’s letter to the Deputies of the Committee of Twenty suggested that a provision that the issuing country be allowed to prohibit or limit holdings of its currency could complement the Italian plan. The Italian plan as first formulated provided no mechanism to prevent switches into new forms of reserve media. Even with the suggested addition international liquidity might still escape complete control: (i) if a new reserve center declined to utilize its right to prohibit additional holdings of its currency; and (ii) through switches into the Euro-markets where there is no “issuing country” to impose limitations. On the other hand, agreement by countries to forgo switching reserves into new forms would permit control of the volume of liquidity while still allowing free portfolio choice between SDRs and traditional reserve currencies.
Mr. Ossola’s letter also points out that the Italian proposal is consistent with bilateral funding as envisaged in the German plan. The same could no doubt be said of the U.K. and U.S. plans.
It is possible to envisage introducing a ratchet mechanism into the Italian plan, similar to that in the U.K. plan but on a global, rather than an individual country, basis, so as to prevent deconsolidation occurring. This could be done by using designation, rather than sale from the substitution account’s holdings of a reserve currency, to meet a participant’s need for currencies, either throughout or at least only after some specified small decline in the holdings of the account. This would have the effect of reducing free portfolio choice somewhat more than in the original Italian proposal.
Although only the U.S. plan specifically provides flexibility to accommodate the investment needs of (e.g.) the oil producers, it would be possible to introduce analogous arrangements into the other plans.
A number of other ways have been mentioned in which one could combine features of one plan into other plans. A feature similar to the “convertibility points” of the U.S. plan could be introduced into any of the other plans. The Italian and U.K. plans did not explicitly include proposals for providing “elasticity,” but both could be supplemented by a special facility in the Fund or swap facilities outside the Fund, and in the latter case either with or without Fund surveillance. All of the plans would be consistent with a system of multicurrency ceiling intervention provided its settlement arrangements were compatible with asset settlement.
ANNEX The Italian Proposal: Asset Settlement with Primary Reserves and Voluntary Consolidation of Reserve Currencies: A Unified Approach2
A Note by Mr. Rinaldo Ossola and Mr. Silvano Palumbo, Italy
For the second meeting of the Deputies of the Committee of Twenty, we circulated statements on the Program of Work, on the General Exchange of Views, and on the Adjustment Process. For the third meeting, we have thought it might also be useful to put down in writing our views on how asset settlement and voluntary consolidation of foreign exchange reserves may be joined together in a simple and effective manner. We shall, moreover, examine how gold could be voluntarily consolidated, and indicate what role the various reserve assets could play in the new system.
1. Over the last year, a consensus has emerged that the fundamental objectives of the international monetary system cannot be achieved without an effective adjustment process which requires, inter alia, that all countries settle payments imbalances with primary reserves, either owned or borrowed. Convertibility, or more generally, asset settlement, is thus generally considered an important instrument, although not the sole one, tor promoting the proper functioning of the adjustment process. It should also be noted that if reserve centers are no longer allowed to finance deficits and surpluses by increasing or decreasing their short-term liabilities, but are obliged to use primary reserves, international liquidity would be effectively brought under collective control.
In practice, of course, because of the special role of the dollar in the system, only the United States has been in a position of not having to finance imbalances with primary reserves. The issue is thus what is the most suitable arrangement for the dollar in the new system. The legacy of the past has been a huge overhang of dollar balances, both private and official. Quite clearly, in the short to medium term, the United States cannot be expected to be able to convert other than new dollar balances, because its ratio of primary reserves to liabilities is low.
This raises the difficult technical problem of distinguishing between “old” and “new” dollar holdings. If old and new dollars were commingled, even with equilibrium in the U.S. balance of payments, deficit countries could settle imbalances with dollars which would be new dollars for the surplus countries, but old ones for the world as a whole. Consolidation of old dollars, which would meet this problem, could be either arranged bilaterally between official dollar holders and the United States, or multilaterally through the Fund. In the first case, countries would acquire long-term bonds issued by the United States and denominated, presumably, in SDRs. Such an approach raises three distinct problems:
(a) If these bonds could be converted before maturity, bilateral decisions would continue to affect the level of international liquidity; if they could not be converted, countries would lose the liquidity of substantial portions of their reserves.
(b) Since countries would in any event still hold large amounts of old dollars in their reserves, the United States would not be assured of obtaining reserve assets, should it be in surplus, nor of being asked to convert only to the extent of its eventual deficit.
(c) More generally, a partial consolidation in U.S. bonds could well enhance the role of the dollar as a reserve instrument.
It should also be borne in mind that one of the major political difficulties of the former monetary system was that convertibility was bilateral. This meant that if a country did not ask for conversion, it was generally felt that pressure had been brought to bear by the United States; on the other hand, if it did request conversion, this was interpreted as a political decision rather than a purely economic one. The political ill feelings generated by such a system must be avoided in the future by making the whole convertibility process a multilateral one.
2. Consolidation of dollar balances through the Fund seems the best way to solve these problems. If it is mandatory—and it is most doubtful that all countries, or even a large majority, would agree to this—the level of working balances that each country would be allowed to hold would have to be determined. These balances would almost certainly be set at a fairly high level. As a result, there would still be substantial amounts of old dollars in circulation. The implications of this need not be belabored.
These considerations led us last July to propose a voluntary consolidation scheme, which was incorporated in the Executive Directors’ reform report as the so-called third approach (see Chapter III, pp. 35–40 [above]). This approach can be summarized as follows. A “substitution facility” would be established and the Fund would stand ready at any time to convert reserve currency balances into SDRs to whatever extent countries wish. With regard to the United States, the Fund would periodically determine, say at the end of each year, whether it had registered a deficit, a surplus, or equilibrium in its external accounts. If the United States registered a deficit, say, of $3 billion, the Fund would ask the United States to redeem that amount in primary reserve assets (such redemption could initially be only partial, as suggested in the reform report). If the United States had a surplus, it would be entitled to obtain SDRs from the Fund in exchange for dollars to the extent that the surplus had been financed by a reduction of its liabilities. If the United States were instead in equilibrium, no settlement would be required and the dollars presented to the Fund would all make for a reduction of U.S. liabilities to other countries. Through this facility the Fund would also stand ready to sell reserve currencies against SDRs, subject, of course, to the purchaser having a balance of payments need. It should be clear that, by consolidating dollar balances against SDRs, countries would be only changing the composition of their reserves, and that SDRs could be used in settlement of any obligations stemming from purchases of U.S. goods, services, and financial assets just as freely as dollars.
We do not think it likely that there will be a shift from the dollar as a vehicle currency, at least in the near future. But, in the longer run, the emergence of new vehicle currencies, say, a European currency, may well induce private holders to effect such a shift. Be that as it may, we think monetary authorities to which such dollars would be sold should be allowed to consolidate them in the same manner as any other dollar balances.
With such a facility, there would be little reason to limit voluntary transfers of SDRs among countries. Participants having a need to use SDRs could do so through the facility itself, thus doing away with the present cumbersome designation procedures. Nevertheless, the designation mechanism should be maintained as a back-up system should any difficulties arise.
It is most doubtful however that the above changes would be sufficient per se to induce countries to part with their dollar balances. SDRs will thus have to be made much more attractive than hitherto. In particular, two changes stand out as necessary. First, the rate of interest on SDRs should be brought in line with equivalent market rates. Second, the reconstitution provision should be abrogated so as to allow SDRs to be fully usable, thus eliminating the present connotation of credit from SDRs.
To give the facility sufficient room for maneuver from the beginning, a gentlemen’s agreement should be struck among countries having substantial balances of dollars, say, over $1 billion, that they would immediately consolidate at least 10 per cent of their holdings. This would, from the outset, place some $6 billion at the facility’s disposal. Nevertheless, should the facility’s dollar holdings be smaller than U.S. deficits, a temporary solution could be for the Fund to “designate” countries to consolidate dollars against SDRs to the necessary extent. However, such an approach would introduce an element of compulsion which could be undesirable if it were to be used often.
If this voluntary system led to the conversion of large amounts of dollar balances, so much the better. If, instead, only small amounts were consolidated, we would have to search for the reasons of such behavior and consider possible remedies. Most likely, the unwillingness of countries to acquire more SDRs would be accounted for by the SDR not having been made attractive enough.
This approach would tend to solve various problems at once. First, the United States would finance its payments imbalances with primary reserves through the intermediation of the Fund, even if only a portion of old dollars were consolidated. Second, there would be no need to determine the appropriate level of countries’ working balances. Third, asset settlement would cease to be bilateral because it would be the responsibility of the Fund, as representative of the whole community, to ensure asset settlement by the United States.
Such a consolidation scheme for reserve currencies would have other advantages. It would be essentially voluntary and thus quite flexible, something we think essential for the success of any new system. Moreover, the Fund would be placed at the center of the whole settlement process, thus enhancing its role in the new monetary system.
3. The facility’s reserve currency balances could become either a perpetual debt of the issuers vis-à-vis the Fund on which interest would be paid at market rates, or a debt to be amortized in accordance with agreed criteria. While amortization would initially entail larger annual service charges, it would eventually lead to the elimination of such commitments. As a result, there is little difference between amortizing or not.
It should be clear that requiring the reserve centers to amortize the facility’s holdings would require them to target a basic surplus of at least the amount of the annual service charge. Although such a transfer of resources may be viewed as appropriate, in the present circumstances it would inevitably raise other problems which would probably be best dealt with at a later stage. We thus feel that while, on balance, amortization may be desirable, its implementation should be deferred until the new system has been sufficiently strengthened to withstand additional strains.
4. Consolidation along the above lines would thrust additional tasks on SDRs and tend to increase substantially the amount of SDRs in circulation. Consequently, countries would be required to assume additional acceptance obligations. This, it is sometimes argued, would tend to “pollute” the SDR, that is to say, to make it a less desirable asset to hold. The alternative approach that has been suggested is to consolidate dollar holdings by creating special deposits in the Fund denominated in SDRs. We are certainly ready to discuss the respective merits of the two schemes, being fully conscious that there are valid reasons for different countries to prefer different portfolio mixes. It is indeed for this very reason that we have proposed an optional consolidation approach which would leave countries relatively free to determine the desired composition of reserves.
5. The system we are proposing should be viewed as a flexible one which would allow consolidation and asset settlement to start immediately. The functioning of such a system could be periodically assessed in the light of experience, which would also suggest what future measures, if any, are required.
It is likely that, over time, the dollar would practically cease to be a reserve instrument, at least for major countries, though it would continue to be the principal intervention currency. It is instead likely to remain a reserve asset for those countries which value highly the contacts such balances allow them to have with commercial banks in other countries. If the stock of old dollars is progressively converted into SDRs and new dollars are promptly withdrawn from circulation, and if world reserves are increased by allocating SDRs, this instrument will increasingly assume the reserve role hitherto played by the dollar.
Similarly, gold will also have a diminishing role as a reserve instrument. The consolidation facility we have proposed for reserve currencies could also be used for gold, as countries would be allowed to sell gold at the official price to the facility against SDRs. Countries would be more willing to avail themselves of this option if they could retain physical possession of the metal, simply earmarking it to the facility. Even with such an arrangement, however, we are not sanguine over the prospect of countries consolidating large amounts of gold.
It is thus likely that, for some time to come, countries will continue to be reluctant to “lose” their gold, viewing it essentially as some sort of national treasure. For those countries whose gold holdings are a small proportion of their total reserves, the virtual immobilization of gold poses few problems. For other countries, however, this could raise difficult problems, which to meet we have suggested “swaps” with the Fund of gold against SDRs. In this way, the gold portion of reserves could be used when in deficit and reacquired when in surplus. Furthermore, should the United States also be unwilling to countenance the loss of gold to settle payments imbalances, such swaps would place it in a position of immediately obtaining a supply of “usable chips” in the new asset settlement regime without first having to register a series of large surpluses.
The U.S. Proposal: Some Comments on the Nature of Reserve Assets in the Context of a Reformed International Monetary System3
The proposals for monetary reform outlined by the U.S. assume a generalized system of convertibility. Specifically, most countries will choose to establish and maintain central rates for their currencies, and as a corollary, will stand ready to convert officially held balances of their currencies into international reserve assets or into the currency of the country requesting conversion.
Such convertibility arrangements are dependent for their effectiveness and sustainability on other elements in the system and must be related to them. One indispensable requirement is equitable and effective “disciplines” for balance-of-payments adjustment by all nations, large and small, surplus and deficit. A related need is a means of assuring reasonable balance in the system as a whole between the availability of, and the requirements for, reserve assets. Thus, the system should be capable of reconciling the aggregate volume of reserves, in appropriate forms, with the amount of reserves that countries individually are able and willing to hold without producing generalized pressures (a) toward either inflation or deflation or (b) on either surplus or deficit countries.
The U.S. proposals set forth at the last Deputies’ meeting present a framework for meeting these requirements in the context of a system of general convertibility. The purpose of the present paper is to comment on the form, character, and role of reserve assets within such a system.
Today’s world is characterized by large imbalances both in reserve positions and in payments positions. A new system aimed at maintaining a broad equilibrium can become fully operational only after a transitional period during which the international balance of payments is brought into a better equilibrium; the heritage of the past, in the form of distortions in reserve holdings, is reduced or otherwise dealt with; and nations’ willingness and capacity for meeting the obligations of the system are demonstrated. In this connection, one important and pertinent transitional question is whether, and if so what, facilities should be introduced for consolidating or changing the form of pre-existing currency reserve holdings. The U.S. has suggested that careful study be given to proposals dealing with this matter, for example, by exchanging part of existing reserve currency holdings into a special issue of SDR, at the option of the holder. Such proposals will need to be studied in the light of the structure of the new system to be introduced, keeping in mind that such arrangements cannot substitute for effective machinery for payments adjustment and other features to assure the continuing stability of the system. For this reason, this paper, as well as our earlier paper on reserve indicators, focuses on the more permanent structure of the system and not on techniques for dealing with these transitional matters.
1. The Unit of Account for Currencies and Reserve Assets
Any system incorporating established exchange rates and reserve assets can usefully employ a “common denominator”—a unit of account, numeraire, standard or yardstick—to serve as the common expression of currency rates and as a common measure of the value of reserve assets. Although it is not necessary to use a particular reserve asset as the unit of account—an abstract unit is theoretically possible—it is convenient to do so. We anticipate greater reliance should and will be placed on the SDR (taking into account agreed changes in existing SDR provisions as touched upon later) as a reserve asset in the future. We propose that that same instrument serve as the unit of account of the system.
The usefulness of the SDR as the unit of account will be enhanced by the elimination of two potential sources of instability which have been particularly troubling with respect to gold and national currencies.
First, the system should not be subject to strains arising from private demands for the unit of account-reserve asset itself. The SDR has no commodity uses, and there are no plans, at least at present, for allowing the SDR to be held as a financial asset in private hands. The value of the SDR unit of account in terms of the generality of national currencies would not be affected by occurrences on often volatile commodity markets, nor dominated by a national decision to change the relative value of an individual currency.
Second, the aggregate needs of the system for official reserves would readily and equitably be met by changing the volume at the prevailing price rather than by increasing or decreasing the value of the SDR in terms of currencies generally. Provisions similar to those presently relating to uniform changes in par values would no longer be necessary, and speculative anticipation of such action would not be generated.
Elimination of potential disturbances from forces extraneous to the operation and technical requirements of the monetary system should enhance the effective operation of that system. A reserve indicator mechanism of the kind proposed by the United States, providing even-handed inducements to both deficit and surplus countries to adjust their imbalances by exchange rate changes or otherwise, would tend to maintain the “purchasing power” of the SDR against the generality of national currencies. We believe this result is broadly appropriate and equitable.
2. The Form of Reserve Assets
As discussed below, among the alternative forms of reserve assets, the U.S. supports an increasing reliance on the SDR as the primary source of world reserve growth over time; favors a progressive reduction in the role of gold; and envisages a much reduced but some continuing role for foreign exchange.
a. Currencies as reserves
The striking increase in the currency component of world reserves since the early 1950’s—from one fourth of total reserves then to two thirds today—can be traced in large part to two broad causes, neither of which should be operative in terms of the kind of system proposed. During most of the period, the Bretton Woods system provided no other practicable way to create the international reserves needed to accompany the unprecedented growth in trade and payments that the world experienced. Toward the end of the period—especially 1970 and 1971—the rapid acceleration in currency holdings was of a different character, and reflected the gross and unsustainable imbalances in payments that had arisen, accompanying heavy speculation, and the breakdown of the Bretton Woods system.
These sources of persistent and large reserve currency growth should not be operative in a reformed system of the type proposed. Nevertheless, official holdings of foreign exchange can provide some flexibility for those countries that wish to hold some amount of currencies in their reserves. In foreseeable circumstances, such holdings can also provide a needed element of elasticity for the system as a whole. For these reasons, while a build-up in foreign exchange holdings should not be encouraged as a part of the basic structure or design of the system, neither does the effective operation of the system require banning all holdings of foreign exchange in amounts larger than what might narrowly be defined as working balances.
Even in the framework of a system which effectively promotes broad payments equilibrium over time, nations will, for a variety of perfectly legitimate reasons, insist upon scope to run temporary surpluses at any given point in time—for example, to respond to sudden and reversible speculative pressures. It may be neither feasible nor desirable to provide enough primary reserves on an actual or contingency basis to finance such temporary surpluses in a manner that avoids unwanted adjustment pressures on the countries losing primary reserves. Indeed, if primary reserves were created on a scale larger than necessary to meet “normal” needs to take account of these situations, the risks of generalized inflationary pressures and lack of adjustment incentives would be evident. Yet, if reserves were not available through some mechanism, essentially short-term disturbances would undermine the desired stability of the system.
In practice, we believe there would be a great danger that a rigid system which prohibited foreign exchange holdings would break down under the normal pressures which can develop in a liberal world trading and payments order, when the level of international transactions is inevitably very large in comparison with the level of world reserves. Inability of the international reserve mechanism to adapt flexibly in periods of strain could seriously constrain the effort to move toward a more liberal trade and payments system.
At the same time, the system should not be dependent on large and growing official foreign exchange holdings as it sometimes was in the past. In the normal operation of the system, nations should have the right, and the system should have the capacity, to convert official currency holdings into primary reserves. A nation should not be compelled to hold currencies except in the exceptional instances in which its total reserve holdings are permitted to pass through a “convertibility point” (representing the maximum accumulation of primary reserves for that country justified in terms of the global availability of primary reserves).
The U.S. also envisages an important safeguard on the use of foreign exchange as reserves. The country of issue could limit or prohibit further accumulations of its currency by official institutions in other countries. This provision might be particularly helpful in a reformed system in which, as we envisage it, national currencies would be on a more equal footing, and in which there would be a greater number of national currencies purchased in the process of market intervention than in the past.
By such a limitation on currency accumulations, the country of issue could require another nation accumulating its currency either to convert further accumulations into primary reserves (SDRs, gold, imf position) or to switch into the currency of a third country, assuming the third country acquiesced. Future currency accumulations of foreign exchange in reserves would thus not occur in situations where either the holding country or the issuing country felt it was inappropriate.
b. Gold as reserves
We believe that the role of gold in the international monetary system will and should continue to diminish, and we would support orderly procedures to facilitate that process.
A declining role for gold is fully consistent with the long-term trend of monetary history. Governments long ago recognized the inadequacy of gold as a basis for national monetary systems, and in recent decades the dependence of the international economy on that metal has diminished sharply. With the supply of new gold both physically and geographically limited, with its commodity uses competing inevitably and increasingly with its monetary uses, and with residual noncommercial availabilities in no way related to the liquidity needs of a prosperous and expanding international economy, the world has naturally shifted toward other monetary assets.
The current situation—where speculative pressures on a thin and volatile commodity market have led to a price much higher than the official gold price—is evidence of the instabilities and tensions which are inherent in a system based on gold or other commodities. When the commodity price is substantially above the official price—as at present—there are proposals to raise the official price openly or covertly to the market price, and a consequent reluctance of central banks to use it in settlement. (The alleged effects of a “freezing” of gold at present are often exaggerated—excluding the U.S., total gold holdings of imf members represent less than one quarter of their total reserves, and only a very few of these countries hold as much as half of their reserves in the form of gold.) Such a change in the official price would represent a major increase in reserves—an increase bearing no relation to a considered international decision as to the appropriate level of reserves and capriciously and inequitably distributed among nations. Moreover, there is nothing to suggest that any new price is the “correct” price; and little prospect that any given price would remain satisfactory for any period of time in the sense of both achieving consistency with desired reserve totals and of being free from future uncertainty. In particular, any established monetary price for gold will either frequently be out of line with the price tendencies prevailing on the private market or, if the official community again tried to stabilize the private price, face the system with unpredictable and large fluctuations in levels of primary reserves.
In our view, the indicated course is to retain the present official price; to allow or encourage gold to flow out of reserves in an unhurried way; to seek cooperative multilateral arrangements for reducing the potential for instability and tensions resulting from the two-gold-price structure; and to shift toward greater use of SDRs for primary reserves.
Consistent with the reduced use of gold and the increased importance of the SDR as the central reserve asset, the official price of gold should be expressed in terms of SDRs (1 oz. equals SDR 35) rather than the reverse. The prohibition on purchases of gold for monetary reserves would remain, but arrangements should be developed by which official holders can sell gold in the private markets—in effect providing a one-way channel by which gold could move out of but not back into official reserves. Various approaches for such official sales of gold (including by the imf) in the private market should be examined with loss of gold to the system balanced by SDR creation.
c. SDRs as reserves
In a system envisaging progressively greater reliance on the SDR, use of the SDR should be freed from unnecessary restrictions.
Present imf provisions which provide for gold payments should be changed to envisage payments in SDRs as an alternative or substitute.
To facilitate an increased role for the SDR, that instrument should be freed of encumbrances of reconstitution obligations, holding limits, requirement of need, and designation procedures which would be unnecessary in a reformed system.
These special features of the SDR mechanism were considered necessary when that instrument was considered a subsidiary—or at least a new and untested—asset; when the appropriate role of gold, SDRs and reserve currencies was unsettled; and when inducements to adjust were inadequate. The need for such special features would be reduced or eliminated in a system in which limitations on imbalances, however financed, were enforced through adjustment mechanisms much more effective than the existing SDR provisions, and when SDRs come to play a more prominent role. Indeed, if the SDR is to play that role effectively, it must have maximum practicable utility, with only those restrictions on its use clearly necessary to the functioning of the system.
The reconstitution obligation was designed to preclude the permanent use of the whole of a country’s SDR allocation to finance a deficit. Motives for the provision varied. Some wished to draw a distinction between the usability of SDRs and other reserve assets. To some extent, it may have been felt that the provision would help induce adjustment pressures on deficit countries. Some were concerned that excessive use of SDRs in preference to other assets might impair confidence in the SDR in the early years.
This reconstitution obligation, applying to only one reserve asset whose relative share was not yet large among total reserves, did not have serious repercussions. However, as the SDR becomes the principal reserve asset, its usability relative to other assets needs to be assured, and a reconstitution provision is an inadequate substitute for an adjustment mechanism (such as the U.S. proposes) that gives effective incentives to both deficit and surplus countries. Confidence in SDRs will depend on a much wider and deeper array of factors than an artificial provision such as reconstitution.
There is a widespread view that the reconstitution obligation is inconsistent with the status of the SDR as an important international monetary asset, is operationally complex, and is unnecessary. The United States shares this view and believes that all forms of reconstitution obligation should be eliminated as part of a new system.
What is commonly called the “holding limit” in the SDR mechanism is in fact a positive—though limited—obligation for participants to acquire SDRs in certain specified circumstances, thus assuring [that] a seller of SDRs could find a buyer. The limit to this obligation is presently attained when a participant’s SDR holdings reach three times its net cumulative allocations.
The U.S. believes the holding limit can and should be eliminated in the context of the system it has proposed. The sale of SDRs to a country exercising its right of conversion of foreign exchange holdings should be capable of fully discharging the convertibility obligation, and the call for conversion should itself indicate a willingness to hold SDRs. If the intervention system in the reformed system is one of “ceiling” intervention (whereby the country whose currency is at the upper margin accumulates other currencies at their lower margin and—if it chooses—presents such currencies to the countries of issue for conversion into SDRs or other primary assets) the problem of assuring “willing” holders of SDRs would be handled more or less automatically.
The requirement that “need” govern a participant’s use of SDRs was designed to avoid sale simply for the purpose of changing the composition of a country’s reserve holdings, thereby pushing other countries toward their holding limits and indirectly giving rise to excessive demands for gold in a system in which the United States followed the policy of freely selling gold against dollars. Such safeguards appear less necessary in a system in which reliance on currency holdings will be reduced, conversion demands can be met through SDRs themselves, and appropriately designed reserve indicators provide equitable adjustment pressures.
Finally, the designation procedure was included in the SDR mechanism to give assurance to participants that a determined location would always be found for the transfer of SDRs which a participant wished to use (within the overall rules of the mechanism) in order to obtain an equivalent amount of needed currency. Together with the obligation on the part of other participants to provide such currency inherent in the “holding limit,” the designation procedure constituted the basic guarantee to participants that they could use SDRs to finance payments deficits.
If, as indicated earlier, the basic intervention obligation were one of “ceiling” intervention, SDR transactions would generally be of a type in which the demand for conversion itself expressed a willingness to hold SDRs, and no designation procedure would be essential. However, the need for some residual provision akin to designation should be examined in relation to transactions not arising from conversion demands.
A further question arises with respect to the interest rate on the SDR. The value of the SDR lies in the fact that it is a stable and widely usable asset with its volume under international control, free from private speculative influences and insulated from variations in the value of individual currencies. Interest does not appear an essential attribute of an ultimate “money” asset; it has no precedent either in gold internationally or in currency domestically.
The U.K. Proposal: A Possible Scheme of Asset Settlement4
1. The purpose of this paper is to set out in more detail the U.K. proposal which was the second of the three technical approaches to asset settlement described in the imf Executive Directors’ report on the reform of the international monetary system, transmitted to the Governors last August. It is hoped that the paper may assist the Deputies in making a comparative judgment between this and other approaches, as they have been invited to do in the Chairman’s annotated agenda.
2. The framework of this approach was conceived against the background of several objectives which were thought to be desirable, and it may be helpful to list them explicitly.
First, it is desirable that reserve movements of individual countries should correspond closely with their payments surpluses and deficits (subject to special arrangements to deal with short-term capital movements).
Secondly, with the objective of achieving control within fairly strict limits of future variations in the total amount of world liquidity, the supply of other reserve assets should be brought under control and the international neutral reserve asset (i.e., the SDR, modified as necessary) should be encouraged to play an increasingly dominant role.
Thirdly, within the constraints imposed by other objectives of the scheme, countries should be allowed some freedom in determining the composition of their reserve holdings.
Fourthly, some special arrangement may be desirable to provide reserve centres with the means of meeting any very large demands made upon them for conversion of existing reserve currency holdings; a similar arrangement may be desirable to prevent too rapid an absorption of world liquidity resulting from surpluses of reserve currency countries.
3. The technique proposed places obligations both upon reserve centres and upon other countries, both being necessary to match the transactions concerned. Reserve centres would be obliged to convert into SDRs any additional balances of their currency newly acquired by official holders in other countries, and these other countries would similarly be obliged to present to the reserve centres for conversion into SDRs any foreign exchange holdings newly acquired by them above some level previously specified. This level would not, in general, be higher than the country’s holdings of reserve currencies immediately before the new system came into operation, but there could be provision for controlled increases if these became necessary because the previous level of working balances in foreign currency had been shown to be inadequate.
4. Countries other than reserve centres which ran deficits could match them by a reduction in their holdings of reserve currencies. On periodic settlements, they would have the option either of restoring their holdings of reserve currencies by purchase against SDRs (which could be one mechanism of enabling reserve centres to earn SDRs); or of accepting a new and reduced level of reserve currency holdings, which would, however, become a new limit for future settlements. In the latter case, in order to preserve the facility for reserve centres to earn SDRs, they should be empowered to purchase them from the imf against their own currencies to the extent that official holdings of their own currencies had declined.
5. As an important extension of the substitution facility through the imf indicated at the end of the preceding paragraph, it could be arranged that countries would be free at any time, and to whatever extent they wished, to convert their holdings of reserve currencies into SDRs by a transaction either with the reserve centre or with the imf. The reduction in their holdings of reserve currencies which this would involve would establish, as in the case of reduction through a deficit, a new level of currency balances as a limit above which the obligation to present balances for conversion would apply.
6. Further extending the point in the last two paragraphs, it should be noted that the proprosed scheme does not depend on initial consolidation of reserve assets into SDRs by countries other than reserve centres, but does provide—at the choice of the reserve currency holder—a mechanism through which existing reserve currency assets could, either initially or at any subsequent time, be consolidated. The situation would be that any country choosing to consolidate could present its holdings of reserve currencies to the reserve centre or the imf and receive SDRs in exchange (on this latter choice, the reserve centre whose currency had been exchanged in this way would assume a liability to the imf). Although precise details would need to be worked out, in principle the interest on SDRs issued from the imf consolidation account would be serviced by interest received from currency balances held by the account.
7. Finally, it should be noted that the scheme could easily accommodate a situation in which a particular country, at some intermediate stage between settlements, might need access to foreign currency working balances, on the basis that any time the country in question could offer SDRs to the appropriate reserve centre, always providing that its total foreign currency balances did not exceed the limits which had been set.
The German Proposal: Statement of Mr. Karl-Otto Pöhl (Germany) on the Problem of Reserve Currencies and Asset Settlement5
I regard the control over the accumulation of reserve currencies as one of the essential elements of the reform. In order to achieve such control, it will not only be necessary to ensure the financing of payments balances with primary reserve assets. It will also be necessary to avoid the creation of additional foreign exchange reserves through the investment of official balances on international financial markets and in nondollar currencies. The liquidity creating effects of such practices are now well understood. The Fund’s Annual Report shows that these sources have contributed to world reserves the equivalent of SDR 9 billion in 1970 and SDR 7 billion in 1971.
It seems to me, therefore, that the introduction of asset settlement for dollar balances does not suffice; it would cope only partially with the problem. The other sources of reserves need to be dealt with as well. Of course, one could envisage creating a substitution facility for the U.S. dollar and prohibit, in addition, the accumulation of additional reserves on international markets or in nondollar currencies. I have noted with interest, in this context, the proposal of our American friends that a country should be allowed to “limit or prohibit further accumulation of its currency by official institutions in other countries.”
I wonder, therefore, whether a more formal approach could not be adopted, which would even more effectively prevent an undue expansion of exchange reserves.
This approach comes close to the concept put forward by our British and Dutch colleagues. It differs from these concepts mainly in that it envisages a faster replacement of reserve currencies by primary reserve assets. The essentials of such an approach would be the following:
All countries agree to keep the main part of monetary reserves in primary assets (gold, SDRs, imf positions) and to hold foreign exchange reserves only up to a specified maximum needed as working balances.
These maximum limits would be determined from time to time by the imf according to uniform principles. These limits would have to be rather narrow; otherwise there could still be disturbing fluctuations in the volume of foreign exchange holdings. In the case of extraordinary developments, the Fund might grant exceptions.
To the extent that the foreign exchange holdings exceed these limits, they would have to be converted into primary reserves. As long as they remain below these limits, there would be no right to convert.
The right to hold working balances would extend only to the intervention currency or currencies of the country concerned. Other currencies should not be held in the reserves. I would regard it as desirable to hold all foreign exchange reserves with the monetary authorities of the reserve currency country, and to exclude holdings on private markets and with private institutions.
Such an approach does require some limitation on the freedom to determine a country’s reserve composition. But some such limitation will, in my view, be necessary in any event if we are to achieve such control, and I would hope very much that we can agree to such limitation in the interest of the working of the monetary system as a whole. An important advantage of this approach, as I see it, would be the distributional aspect. The new liquidity would then be distributed according to the rules governing SDR allocations, whereas the alternative, the random expansion of foreign exchange holdings, leads to a very uneven distribution of new liquidity, which has been criticised by so many Deputies.
A final word on the overhang of existing reserve currency balances. Certainly, some form of “consolidation” is necessary if we want to reestablish the principle of asset settlement. If it is our aim to reduce substantially the foreign exchange component in monetary reserves there are strong reasons to exchange this overhang for Fund assets—either into SDRs or into a similar obligation of the Fund.
Special treatment could, however, be accorded to those balances which have their origin in the large capital flows of recent years. These balances should be regarded only as a temporary addition to world reserves; they should disappear when these flows are reversed. These balances, therefore, could appropriately be funded bilaterally: they would be separated from other foreign exchange assets with the provision that they should and could be used for intervention only when the capital returns to the United States. Such a treatment of these currency holdings would have two advantages: with the return flow of short-term capital, excess liquidity would be reduced, and additional room would be brought about for the distribution of newly created liquidity to allimf members on an equitable basis, that is, according to the rules governing SDR allocations.
(B) Technical Choices Involved in Arrangements Regarding Consolidation, Convertibility, and Asset Settlement
(May 16, 1973)
Four approaches to the problems of consolidation, convertibility, and asset settlement were suggested at the meeting of the Committee of Twenty Deputies in Paris and subsequently examined and discussed by the Executive Board. The resulting paper was essentially addressed to a comparison of the proposals advanced by Italy, the United States, the United Kingdom, and The Federal Republic of Germany. As a result, it tended to emphasize differences between these proposals. For purposes of further discussion it may be useful to examine the extent to which the different approaches merely adopt different techniques in pursuing similar aims. The present paper provides such an analysis of three of the principal areas in which proposals must be formulated.
1. Asset Settlement and Convertibility
Convertibility is, of course, a means to an end and not an end in itself. The main ends that most advocates of “convertibility” have in mind are those of providing asset settlement as a necessary condition for establishing international control over the global volume of liquidity, and limiting the borrowing powers of the reserve centers so as to increase the symmetry of the adjustment process. All the techniques that have been proposed could, with appropriate supplementary arrangements, lead to approximate or exact asset settlement for the deficits and surpluses of all countries.
(a) Under multicurrency intervention arrangements, asset settlement would be achieved, as between the countries included within the arrangements, provided that debit and credit positions arising under these arrangements were regularly cleared, i.e., provided that the right of convertibility was in fact exercised. Conversely, it would not necessarily be even approximately achieved if countries were able (either with or without the consent of the issuing country) to retain balances acquired in the course of intervention, or to request conversion of outstanding balances. The degree of approximation to asset settlement under this approach would also depend upon the relative importance of countries outside the scope of the multicurrency intervention system and on any arrangements for these countries of the type discussed below.
(b) Under a system of predominantly dollar intervention, there are two ways in which approximate asset settlement could be attained.
(1) The first involves an understanding that acquisitions of reserve currencies in excess of a specified level, e.g., working balances, would be presented for conversion to the reserve center, and that any needed replenishment of working balances would be achieved by the sale of primary reserve assets to the reserve center. This approach presupposes an initial reduction of currency holdings to agreed and relatively small working balances, if there is to be an assurance that surpluses of the reserve centers would lead to their acquiring reserve assets.
(2) The second method involves an arrangement under which a reserve center would sell SDRs to a substitution facility to the extent that its liabilities to foreign official holders increased, or buy SDRs from the facility to the extent that such liabilities decreased. This method does not require a large initial reduction in the holdings of reserve currency balances, although it would not preclude such a reduction.
The second approach would necessarily be run through the Fund, since it involves determination by the Fund of the size of the deficits or surpluses to be settled and their settlement via a substitution facility; it would thus involve “multilateral settlement.” It would, however, also be possible to organize multilateral clearing arrangements in the Fund under other proposals if this should be deemed desirable.
If multicurrency intervention arrangements were adopted and it were desired to prevent a limited participation in the system from eroding asset settlement, arrangements similar to either of those described in the context of a dollar intervention system could be adopted. That is, either countries outside the scope of the multicurrency intervention system might agree to limit currency holdings to working balances, as in (b) (1), or else a substitution facility might undertake transactions with reserve centers, as in (b) (2), to the extent that the currency holdings of nonparticipants changed. Conversely, if minor departures from asset settlement were deemed acceptable, this could be accomplished, under (b) (1), by excluding certain countries from the obligation to keep reserve currencies down to working balances, or, under (b) (2), by excluding certain assets from the definition of foreign official holdings of balances of the currency of the reserve center. The exclusion under (b) (1) could apply, for example, to nonmembers of the Fund, or to nonparticipants in the Special Drawing Account, or to countries with reserves below a certain level. The exclusion under (b) (2) could apply, for example, to long-term assets.
The extent of consolidation that is necessary would depend upon the form of the arrangements selected to establish asset settlement, but the technical form of the arrangements to permit consolidation could be essentially similar in any event. All of the arrangements would require the maintenance of some balances in intervention currencies, although with a multicurrency intervention system the participants’ needs might be restricted to balances acquired in ceiling intervention and held pending settlement, or to the minimal working balances required to operate floor intervention in conjunction with the right to draw on temporary financing facilities made available by other participants. Under all of the approaches, present holdings of currency balances could be reduced in two ways: (a) by funding, e.g., into long-term claims on the reserve center, or into bilateral accounts which could be drawn on only to finance specific flows, such as a reflux of capital to the reserve center; and (b) by substitution, i.e., by exchanging part of the remainder of currency holdings for SDRs, or possibly for other liquid assets issued either by the reserve center or the Fund.
Substitution into SDRs could be effected through the creation of a substitution account in the Fund. Such an account would acquire claims on the reserve centers with the reserve currencies that holders gave up in exchange for SDRs. One of the problems that would arise in creating a substitution account would be that of determining equitable terms for the valuation and servicing of the account’s claims on the reserve centers; this problem is not pursued further in the present paper. A second problem is that of deciding whether substitution should be (i) a once-for-all operation, (ii) open-ended but irreversible, or (iii) open-ended and reversible. A once-for-all operation would lead to a reduction in the stock of outstanding reserve currencies such as would be needed to introduce (b) (1). An open-ended and irreversible operation would provide a continuing opportunity for countries to exchange their reserve currencies for SDRs. An open-ended and reversible operation would permit them to obtain SDRs for reserve currencies, and also reserve currencies for SDRs (deconsolidation). A third area for decision is whether to use the substitution account as an instrument for establishing asset settlement, as under (b) (2). If this were done, it would raise the problem of defining the change in liabilities of the reserve center that should determine the size of the required transaction between the reserve center and the account. This could be approached either by taking the reserve center’s official settlements deficit or surplus, or by summing for all members the changes in their reserve currency assets. Apart from reporting errors, the two approaches differ in that the former would exclude, and the latter would include, the increase (decrease) in foreign official holdings of balances of the reserve currency in the Euro-currency markets.
3. Restrictions on the Freedom of Reserve Composition
If asset settlement were achieved through the restriction of reserve currency holdings of all countries to working balances rather narrowly defined, this would substantially restrict the freedom of reserve composition.
If asset settlement were established by means of a substitution facility, the restriction on the freedom of reserve composition as between SDRs and reserve currencies would be much less severe. Switches from reserve currency to SDRs would be accommodated by the substitution facility. Switches from SDRs to reserve currency would not, however, be entirely free unless the substitution facility were reversible and free from replenishment problems. With a nonreversible substitution facility individual countries would be able to increase their holdings of reserve currencies over time, e.g., by using their SDRs when in deficit and retaining the reserve currencies they acquired when in surplus. This would, however, be possible only to the extent that other countries or the substitution facility ran down their reserve currency holdings; moreover, any amortization that occurred would provide an alternative way in which the substitution facility’s reserve currency holdings would tend to be depleted. If reserve substitution were carried so far as to compel the substitution facility to replenish its stock of reserve currency, this could only be done by a process of designation which would to some extent impair the free choice of reserve assets. This restraint on the acquisition of reserve currencies might become more onerous as time progressed, especially if maximum total or national holdings of reserve currencies were subject to a ratchet mechanism, but any easing of the restraint would necessarily involve the modification of asset settlement and an equal reduction in the scope for creating SDRs consistent with the establishment of a desired total level of world liquidity. Establishment of a multicurrency intervention system as normally conceived would involve more severe restrictions on the freedom of reserve composition of the participating countries, though not of other countries.
Switches of reserves from one reserve currency to another would not in themselves change the volume of liquidity and therefore the potential for SDR creation, provided that imbalances between the reserve centers were settled in reserve assets. However, the fundamental conflict between freedom of reserve composition and removal of the instabilities caused by reserve switching would in this instance be manifested in the need that would arise for adjustment policies on the part of the reserve centers whose liabilities were changing.
It is a matter for consideration as to whether any explicit restrictions on composition should be imposed on the holding countries or should operate via the issuing country. It is difficult to see how one could completely avoid the holding countries accepting some limitation on their freedom of action, since in the case of the Euro-currency markets there is no “issuing country” that would be in a position to forbid further diversification into those markets. In addition, in the absence of full asset settlement between the reserve centers, the imposition of restrictions through the medium of the issuing country would make the volume of liquidity partially dependent upon the policies adopted by the issuing countries and their relations with reserve holders.
4. Other Features
Certain other features contained in some of the proposals are not logically dependent on the decisions made on the preceding questions and could be grafted onto whatever arrangements were adopted on the central questions. These include, for example, the measures selected to provide supplementary liquidity to meet abnormal situations, the introduction of convertibility points or similar arrangements to deal with excessive reserve increases, or special investment funds to insulate reserve accumulations of developing countries both from asset settlement and from the exercise of restrictions on excessive reserves.
Above, pp. 47–52.
A possible solution to this problem is mentioned in Section 4.
This proposal was originally circulated in a document to the Deputies of the Committee of Twenty.
This proposal was originally circulated in a document to the Deputies of the Committee of Twenty.
This proposal was originally circulated in a document to the Deputies of the Committee of Twenty.
This is the text of Mr. Pöhl’s statement to the Deputies of the Committee of Twenty on the afternoon of January 24, 1973.