Chapter 15. Preparing for an Evolving System
- International Monetary Fund
- Published Date:
- February 1996
THE ADOPTION OF FLOATING RATES by several members in February and March 1973 presented the Fund with several questions. What attitudes should the Fund take toward floating rates? How could it involve itself with the individual members that had introduced floating rates? Should the regime of central rates and wider margins that the Fund had introduced in December 1971 as a temporary device be abolished? Further questions arose with regard to the Fund’s operations and policies because the link between the U.S. dollar and gold had been severed and it appeared unlikely that gold would again have a prime place in a reformed system. How should the SDR be valued since its valuation in terms of gold was no longer appropriate? Should the SDR receive a higher rate of interest so as to make it a more attractive reserve asset? How should that interest rate be determined?
The Committee of Twenty, as noted earlier, purposely avoided dealing with questions such as these relating to the existing system until after September 1973 when it seemed fairly certain that they would be unable to agree on a reformed system. In the meantime, beginning in April 1973, while the Committee of Twenty was deliberating a reformed system, the Executive Directors, together with the Managing Director and staff, started to consider the questions arising out of existing international monetary arrangements. For the next several months, however, they were unable to provide answers. Progress on these matters depended on the outcome of the negotiations in the Committee of Twenty, since agreement on the features of a reformed system would make unnecessary or override any decisions taken with respect to the existing system.
After September 1973, H. Johannes Witteveen, the new Managing Director, returning from the Annual Meeting just held in Nairobi, came forward with suggestions to help resolve some of the problems in existing international monetary arrangements. In November and December 1973, the Executive Board took decisions on certain questions that they had been discussing earlier in 1973. These decisions permitted participants in the narrow margins arrangements of the ec to use their holdings of SDRs among themselves, pending a more basic decision on a new method for valuing the SDR, inaugurated a program of special consultations with selected members on their external policies, and ended the temporary regime of central rates and wider margins. These decisions, described in the present chapter, were in effect a holding operation until more basic decisions could be agreed. In this sense, they can be construed as measures preparatory to an evolving system. More basic decisions relating to existing international monetary arrangements were taken in June 1974. They are discussed in the next chapter.
SPECIAL CONSULTATIONS INAUGURATED
From May 1970 to February 1973 the Fund had initiated special consultations with four members—Canada, Italy, Japan, and the United Kingdom—that had already introduced floating rates. These consultations were supplementary to the annual consultations either under Article XIV that the Fund had been holding with its members since March 1952 or under Article VIII that had been initiated early in the 1960s. They were intended to make concrete the provision of the Executive Board decisions taken when these four members introduced floating rates. These decisions stated that the member would remain “in close consultation with the Fund with a view toward an early return to a par value and the maintenance of agreed margins.” Financial officials of each member were to discuss with Fund officials the actions being taken to facilitate resumption of par values.
After the breakdown of the par value system and the adoption of floating rates by most of the Fund’s largest members in February and March 1973, it was no longer sensible for the Fund to hold special consultations in order to urge members with floating rates to return to the par value system. If the Fund was to have any influence on exchange rates in the emerging system, the floating rates not only of Canada, Italy, Japan, and the United Kingdom, but now also of the United States, and the joint float of Belgium, France, the Federal Republic of Germany, the Netherlands, and other countries should be kept under review.
Taking its legal basis from the provision of the Articles of Agreement stating that members were obliged to collaborate with the Fund to promote exchange stability (Article IV, Section 4(a)), Mr. Schweitzer and the staff had as early as February 1973 begun to discuss how special consultations on exchange rate policy, supplementary to the usual annual consultations, might be held with all members with floating rates. As had occurred when the annual consultations on exchange restrictions under Article XIV were inaugurated in 1952, attention centered on developing a procedure that would elicit the kind of cooperation from members for consultations to be sufficiently frank and effective. The right procedure was by no means obvious. Although Fund staff could more readily and more frankly than in the past bring up the topic of exchange rates in their discussions with officials of members, these officials still considered discussions of their interventions in exchange markets highly confidential and sensitive. Officials of Western European members were willing to discuss exchange rate policy only on a confidential basis with the Managing Director or the Deputy Managing Director and one or two senior members of the staff. They explicitly stated their unwillingness to disclose their exchange rate policies to officials of other countries, including those on the Executive Board. Officials of Japan were reluctant to discuss exchange rate policy in any depth. Officials of the United States liked floating rates precisely because floating left determination of exchange rates in the hands of market forces; they believed that there was little to discuss with officials of the Fund.
These considerations implied that the Fund should use an informal and voluntary procedure for holding special consultations. The Managing Director, for example, might initiate discussions with officials of a member when he considered them necessary, and only one or two staff members would be included. Such informal and voluntary procedures, however, might put the Managing Director in the awkward position of having to negotiate holding special consultations. The very member whose policies the Fund believed were most in need of examination might reject participation in such consultations, leaving the Fund in an embarrassing and ineffective position. On the other hand, too formal a procedure for special consultations that mandated periodic consultations was likely to produce perfunctory discussions and convey the impression that the Fund wanted to arrange consultations only for their own sake.
Another procedural problem was that in making exchange rate decisions the authorities of members were heavily influenced by rapidly changing developments in other members and by exchange rate decisions taken by officials of other members. Hence, the Fund might have to conduct special consultations with several members concurrently, or even with officials of several members present at the same meeting.
In August 1973, when the Executive Directors discussed holding special consultations, they were unable to resolve these procedural problems. Although most Executive Directors recognized the vital importance of keeping the Fund active in the surveillance of exchange rates, few were ready to support the extension of special consultations to the major industrial members. Some Executive Directors, particularly those appointed or elected by Western European members and by Japan, objected that additional consultations with the Fund would impose a heavy burden on officials of members as well as on the staff of the Fund and would duplicate the regular annual consultations. Other Executive Directors objected that the Fund had no criteria by which to judge floating exchange rates and the Executive Board would consequently have considerable difficulty in evaluating the appropriateness of a member’s exchange rate policies. Mr. Beaurain explained that the French authorities objected to special consultations for France and the Federal Republic of Germany on the grounds that these members were observing the Articles of Agreement and did not need to be subjected to special discussions on their exchange rate policies. Because some kind of consultations on exchange rate policy more frequent than the usual annual consultations was essential to keep the Fund in the exchange rate field, Mr. Southard, as Acting Managing Director, suggested that the Executive Board return to the subject of special consultations later. The staff meanwhile should discuss informally with individual Executive Directors procedures that might be acceptable.
When Mr. Witteveen took over as Managing Director on September 1, 1973, he immediately explored ways of instituting consultations on exchange rate policy with the major industrial members. After two months of discussions with the staff and of informal discussions with a number of Executive Directors, Mr. Witteveen proposed to the Executive Board on October 31, 1973 that a few senior staff under his close direction periodically hold informal discussions for two or three days with high officials of each of a number of members that had a major impact on international currency relations. Staff would go to these members simultaneously. The list of members to be consulted in these special discussions would not be fixed. The first round, to begin in November 1973, would be held with nine members: Belgium, Canada, France, the Federal Republic of Germany, Italy, Japan, the Netherlands, the United Kingdom, and the United States. The results of the discussions would be summarized in a general way, without revealing the discussions with any individual member, in the world economic outlook papers, a semiannual review that was becoming a regular feature of the work of the Executive Board. At that time, the Managing Director would sum up for the Executive Directors the results of these discussions, “with due care to safeguard the confidentiality of information and views on matters of a particularly sensitive nature.”
The Executive Directors, increasingly aware that the Fund ought to take some action on the exchange rate policy of its larger members, welcomed the Managing Director’s proposal, commending him for his leadership and for finding a positive way for the Fund to play a crucial role in the exchange rate field “during the transition to the reformed system.” They took a decision concurring with his statement on the procedures to be used.1 Thus there was inaugurated a program of special consultations with members whose external policies had important repercussions on international currency relations. The term “external policies” was more encompassing than exchange rate policies, and included policies that had a direct impact on the balance of payments and thereby on exchange rates, such as controls on capital movements.
In the last two weeks of November 1973, one or two senior staff went to each of the nine members listed above and held confidential discussions with high-ranking financial officials. These discussions were in accordance with detailed guidelines worked out by the Managing Director and the senior staff of the various Area Departments, the Exchange and Trade Relations Department, and the Research Department. The results of the discussions were incorporated, in a general way, in the world economic outlook discussed by the Executive Board in the first week of January 1974.
A second round of special consultations with members whose external policies were of importance to other members was held in the same way in March and April 1974. In this second round, Belgium and the Netherlands were omitted and four developing members—Brazil, India, Iran, and Nigeria—were added. The subsequent world economic outlook review incorporating in general terms the results of these special consultations was taken up by the Executive Board early in June.
In this way a series of special consultations began which were held periodically, more than once a year. From 7 to 12 members were usually involved, although the members varied on each occasion. Canada, France, the Federal Republic of Germany, Japan, the United Kingdom, and the United States were always on the list. In the next few years—in addition to Brazil, India, Iran, and Nigeria—Algeria, Egypt, Kenya, Korea, Kuwait, Indonesia, Ivory Coast, Malaysia, Mexico, Pakistan, the Philippines, Saudi Arabia, Singapore, the United Arab Emirates, Uruguay, Venezuela, Yugoslavia, and Zambia were among the nonindustrial members with which special consultations were held.
The way in which special consultations were instituted parallels the way in which the annual consultations under Article XIV were instituted in 1952. The Fund began cautiously, confining its procedures and discussions to what it believed officials of member governments were ready to accept. Only a few members were involved initially, but gradually their number grew. The first round of discussions was experimental, but under the persuasion of the Managing Director and staff, discussions broadened.
Special consultations, referred to within the Fund as miniconsultations or as special “visits” in connection with the world economic outlook exercise, continued after 1978. Although they did not become a primary instrument by which the Fund carried out its operations and implemented its policies in the years covered here, special consultations greatly assisted the staff in preparing the World Economic Outlook. With up-to-date information on the economic situation of as many as a dozen members whose economies were critical the staff could much better evaluate the outlook for the world economy.
CENTRAL RATE DECISION REVISED
One of the Fund’s more formal responses to the evolving system was to revise in November 1973 the central rate decision that it had taken in December 1971.2 At that time, the Fund introduced the concept of a central rate because many members were not yet ready to establish effective par values but wanted nevertheless to maintain exchange rates within specified margins. Central rates were intended to be a de facto, although not a de jure, temporary substitute for par values, that is, in the period before observance of par values and maintenance of appropriate margins were resumed either in accordance with existing Articles of Agreement or with some amended Articles. An advantage of central rates was that they obviated the need for members to go to their legislatures for their establishment, since these rates were not par values agreed upon and fixed in relation to gold as a common denominator. It was thought that this advantage would be especially important for the United States.
After the introduction of widespread floating in the first three months of 1973, central rates for many members had become ineffective. Some members, such as Italy and Japan, that had declared central rates to the Fund no longer maintained margins around these rates. Several other members which had central rates and continued to maintain margins maintained these margins in relation to an intervention currency (namely, the U.S. dollar), but margins were no longer being maintained by the country issuing the intervention currency (that is, by the United States). Prescribed margins did not therefore result in exchange rate stability. The decision of a number of European members to maintain rates within margins only for transactions among their own currencies also resulted in deviations from the initial concept of central rates. In brief, members were deviating not only from the par value system specified in the Articles of Agreement but also from the alternative concept of central rates.
In July 1973, the legal staff recommended to the Executive Board that the central rate decision be revised so that members that wished to do so could have a meaningful central rate. For some members there was a psychological advantage in regarding themselves as maintaining a central rate rather than having no fixed rate at all. These members wanted the Fund’s central rate decision to be revised so that their currencies could continue to be regarded as following a central rate even if the intervention currency was floating. More explicitly, some of the members that used U.S. dollars to intervene in their exchange markets still wanted to be regarded as having some kind of fixed exchange rate. Under the revisions recommended by the staff, a member would be able to establish a new central rate, with or without wider margins, if it maintained a stable rate in terms of its own intervention currency or currencies. Moreover, a member maintaining narrow margins against an intervention currency would be deemed to be acting consistently with the central rate decision even if its intervention currency was the currency of a member that did not maintain rates within margins consistent with the decision.
When the Executive Board discussed these revisions in August 1973, most Executive Directors had no firm opinions. Mr. Wahl, however, stated that the proposed revision was unacceptable to the French authorities. The original central rate decision, he stressed, was meant to encourage stable exchange rates. The revisions now proposed by the staff would permit use of the term “central rate” even when a country’s intervention currency was floating, thereby making the concept of a central rate less meaningful. This diluted concept of a central rate, moreover, was to apply to participants in the European narrow margins arrangement, putting the arrangements for the French franc, which the French authorities regarded as consistent with the Articles of Agreement, in the same category as the dollar and the pound sterling, which the French authorities regarded as inconsistent with the Articles. Because of these objections and because of the intense debates going on in the Committee of Twenty in the last several months of 1973 over the desirability of fixed versus floating rates, it took two months before the Executive Board was able to take a decision even on this seemingly minor question. But in November 1973, the Executive Board approved the decision revising the central rate regime in the ways that the staff recommended.3
WHY THE SDR NEEDED TO BE REVALUED
When the SDR was created, its value was guaranteed and stated in terms of gold. It was made equivalent to 0.888671 gram of fine gold, the same as that of the U.S. dollar on July 1, 1944, when the original Articles of Agreement were drafted. (This continued to be the gold content of the dollar until May 8, 1972.) A link between the SDR, gold, and the U.S. dollar was thus established; an ounce of gold was equivalent to SDR 35, just as it was equal to $35. Transactions in SDRs, however, were made in currency rather than in gold: in exchange for SDRs, participants made available currency that was “convertible in fact.” It was therefore necessary for the Fund to have a method of translating the gold value of the SDR into values in terms of currencies. In other words, the SDR had to have a transactions price as well as a price in terms of gold. The Articles of Agreement, as amended in 1969, moreover, provided that a participant using SDRs should receive the same value in terms of currency regardless of the particular currency it received in exchange for SDRs. This provision was called the “principle of equal value.”4 To implement this provision, the exchange rates at which currencies were provided against SDRs had to be taken into account, and the Articles provided that the Fund establish a procedure for determining the relevant exchange rates.5 The Executive Board was to specify the procedures in the Rules and Regulations of the Fund. This arrangement meant that while the value of the SDR in terms of gold could not be changed without amending the Articles, the Executive Board could determine the method of valuing the SDR in terms of currencies.
Inasmuch as the relevant exchange rates needed to be determined before the start of operations in SDRs, the Executive Board in 1969 adopted Rule 0-3 of the Rules and Regulations. Rule 0-3(i) provided that the exchange rate in terms of SDRs for the U.S. dollar was to be the par value of the dollar, SDR 1 was to equal $1. Rule 0-3(ii) provided that for other major currencies representative rates would be used, rates selected from spot rates for the U.S. dollar actually prevailing in exchange markets and agreed between the member issuing the currency concerned and the Fund. In 1970 and 1971, the Executive Board took decisions on representative rates for a number of currencies.6 Since the rates for other currencies in exchange markets were fixed in relation to the par value of the dollar, the par value of the dollar was thus the base for determining the price, or value, of the SDR in terms of currencies.
When Rule O-3 was adopted, use of the par value of the U.S. dollar as such a base seemed entirely appropriate. The dollar was at the center of the international monetary system as it operated in practice. The United States legally maintained the value of the dollar at 0.888671 gram of fine gold by standing ready to convert dollar balances into gold. The majority of other Fund members maintained market rates within 1 percent either side of the par value of the dollar. In these circumstances, there was no important difference between a value for the SDR in terms of currencies based on par values and a value in terms of currencies based on actual exchange rates.
Basing the currency value of the SDR on the par value of the dollar was also based on the assumption, regarded as realistic in the mid-1960s when the features of the SDR were being considered, that the actual exchange rate for the U.S. dollar would at all times be equal to its par value. Should the United States decide to change the par value in terms of gold, the value of the SDR in terms of dollars and hence in terms of other currencies would accordingly change. The gold guarantee for the SDR ensured that the value of the SDR would be protected against a devaluation of the dollar; in the event of a devaluation, the SDR would be equal to more dollars than before the devaluation. When the new par value for the U.S. dollar was set in May 1972, the SDR became equal to $1.08571. When the second devaluation of the dollar took place in February 1973, the SDR became equal to $1.20635; (the reciprocal was $1 = SDR 0.828948, which was the way in which the Fund expressed the value of the SDR in terms of currencies for its operational and accounting purposes). Revaluations of currencies with respect to gold, which would make each SDR equal to fewer units of the revalued currency, were expected to be rare events; there had been only two revaluations of major currencies (of the deutsche mark and the Netherlands guilder in 1961) since the Fund was created, and in the mid-1960s there was little indication of further revaluations.
Another reason for basing the currency valuation of the SDR on the dollar was that such a single currency method of valuing the SDR was convenient and easy for the Fund to use. The alternative of valuing the SDR in terms of several currencies was complicated and at the time offered no special advantages.
When the SDR was created, it was assigned a rate of interest, but this was not regarded as one of its crucial features. The crucial features of the SDR concerned arrangements for its allocation, the amounts participants would hold and how they would transfer them, the Fund’s part in such transfers, and the uses the Fund itself would make of the SDR. No one was much concerned about the rate of interest.
The original rate of interest on the SDR was set at a low 1.5 percent a year, a rate already in effect in the Fund’s transactions and operations. It had been established in 1961 as the rate of interest that the Fund paid to claimants under the General Arrangements to Borrow and was the rate of remuneration paid to members on their net creditor positions, that is, on their super gold tranche positions in the Fund. (A super gold tranche position was defined as the difference between the Fund’s holdings of a member’s currency and 75 percent of the member’s quota when those holdings were less than 75 percent.) The rate of interest on the SDR was thus determined primarily in terms of its relation to the yields on other Fund-related reserve assets—the readily repayable claims arising out of borrowing by the Fund through the General Arrangements to Borrow and the super gold tranche. In addition, officials of the United States preferred a low rate of interest on the SDR in order to minimize its competition with the dollar as a reserve asset, since. U.S. officials tried to follow low interest rate policies on dollar-denominated assets.
A low rate of interest on the SDR was also regarded as adequate since nominal rates of interest on holdings of money instruments denominated in currencies were relatively low at the time, and it was assumed that the SDR, like gold, would maintain its value better than would holdings of currencies. The only reason for any rate of interest on the SDR (since gold bore no interest) was that Mr. Schweitzer and the staff and most Executive Directors believed that some rate of interest would offer central bank authorities a financial inducement to hold SDRs, rather than gold, in their reserves, thereby helping to launch the SDR as a reserve asset. Another provision of the Articles was that the rate of interest on the SDR had to be equal to the charges each participant had to pay on its net cumulative accumulation of SDRs. (The rate of interest and the charges paid were made the same so that a participant holding more SDRs than its net cumulative allocation received a net payment, and one holding less made a net payment.) The Fund wanted to keep these charges low.
The rate of interest on the SDR of 1.5 percent a year was specified in the Articles, but the Executive Board could raise or lower this rate, provided that it did not exceed the rate of remuneration and that an increase above 2 percent a year or a reduction below 1 percent a year was approved by a three-fourths majority of the total voting power.
Another Method Needed After Par Values Collapsed
The eruptions in the international monetary system which began on August 15, 1971 raised questions about the validity of the initial method of valuing the SDR. The United States no longer converted dollar balances into gold, raising the question of whether the gold value of the dollar was sufficiently meaningful for the SDR to be based on a fixed relationship with the dollar. From August 15, 1971 until the realignment of currencies four months later, narrow margins were not observed for most major currencies, market rates for several currencies floated, and several currencies began to appreciate vis-à-vis the dollar. These developments revealed clearly that a stable value for the SDR in terms of currencies based on par values, and especially on a par value for the U.S. dollar, did not necessarily mean a stable value for the SDR in terms of currencies based on their actual rates in exchange markets. Then with the onset in February and March 1973 of widespread floating, the value of the SDR, fixed in terms of the U.S. dollar, fluctuated widely in terms of other currencies. Such fluctuations in the currency value of the SDR occurred from one week to the next, as the value of the SDR in terms of currencies moved up or down depending on the strength of the dollar in exchange markets.
In addition, after August 15, 1971 some European financial officials increasingly opposed linking the value of an internationally created reserve asset to an individual currency and to the policies of its issuer, and many officials wanted to provide the SDR with stability of value in terms of currencies in general rather than in terms of only one currency. Those in the Fund were motivated by the belief that a stable value for the SDR in terms of currencies would help to get the SDR established as the main reserve asset of the reformed system.
After it became apparent that the SDR, as originally designed, did not necessarily have a stable value in terms of currencies, many officials came to center their attention on the interest rate on the SDR. They began to believe that this rate of interest should have some relation to market rates of interest. One consideration was that interest rates had risen substantially in the years since SDRs were established and 1.5 percent a year was now relatively very low. Beginning in early 1973, several Executive Directors urged that attention be given to raising this rate. It had also become evident that the SDR would have to have a higher rate of interest when, in the course of the Executive Board discussions for the reformed international monetary system in 1972, serious thought was given to the possibility of a substitution account, in which SDRs would be substituted for balances of reserve currencies. Schemes making mandatory the exchange of reserve currency holdings, on which members received higher rates of interest, for SDRs, which bore a lower rate of interest, would involve a severe loss of income for Fund members. A substitution facility could therefore never be adopted unless the rate of interest on the SDR was raised to be more comparable with the higher rates of interest prevailing on currency balances.
By early 1973, management and staff saw the necessity of relating the interest rate on SDRs to the interest rates prevailing for currencies. This led the staff to rethink the method of valuing the SDR. If the interest rate on the SDR was to be a function of market rates of interest on currencies, it seemed logical to value the SDR itself in terms of currencies. Indeed, the interest rate and the value—in effect the capital value—of the SDR together made up the effective yield on the SDR. By early 1973 the management and staff and several Executive Directors thus regarded the effective yield on the SDR as important. They believed that this yield was the crucial determinant of the willingness of central bank authorities to hold SDRs and that if the rules for holding and using SDRs were relaxed, as seemed likely, it would become even more critical.
Executive Directors Reject a Valuation Based on a Basket of Currencies
The management and staff suggested to the Executive Board in May 1973 that the valuation of the SDR be based on a specified package, or basket, of currencies, in which a number of currencies were combined with given weights, and that the interest rate on the SDR be linked to the average rate of interest on the currencies in the package. In suggesting to the Executive Board a basket of currencies for valuing the SDR, the management and staff were initially more influenced by the need to change the rate of interest on the SDR and to give this asset a satisfactory effective yield than by the need to change the valuation of the SDR itself. The need for an average rate of interest was based on the reasoning that it would not be desirable to make the yield on the SDR higher than that prevailing on any individual currency. Yet, it was also necessary to ensure that the effective yield on the SDR normally compared favorably with that on currencies in general. This was to avoid putting on members undue strain resulting from the rules for holding SDRs and to ensure that SDRs would eventually become the main reserve asset held in adequate amounts by central bank authorities.
The management-staff approach to the question of the interest rate for the SDR stressed comparability rather than equality: the interest rate on the SDR should be comparable to that on currencies but not necessarily equal. Since the SDR would fluctuate less vis-à-vis any currency than currencies did among themselves meant that the SDR was relatively attractive as a reserve asset and thereby could bear a somewhat lower interest rate than a holder could theoretically earn on a comparable portfolio of individual currencies.
The staff suggestion in May 1973 that the SDR be valued in terms of a basket of currencies met with immediate disagreement by the Executive Board. Several Executive Directors were concerned that any change in the method of valuing the SDR might prejudice the work of the Committee of Twenty with regard to the features of the SDR for the reformed system. Messrs. Dale and Wahl were, moreover, opposed to a valuation of the SDR using a basket of currencies. As the Executive Directors took up this subject on several occasions in the last six months of 1973, Mr. Dale expressed the same position in the Executive Board as Mr. Volcker was expressing in meetings of the deputies of the Committee of Twenty and Mr. Shultz in ministerial meetings of the Committee of Twenty. While the negotiations for reform were going on, U.S. officials did not seem to want to take any overt action that would break the tie between the dollar and the SDR or imply that the dollar was no longer the sole major currency of the international monetary system. Revaluation of the SDR in terms of a basket of currencies would inevitably cast doubt on the existing relationship between the dollar, gold, and the SDR and make other currencies virtually co-equal with the dollar.
Mr. Wahl, like French officials at meetings of the Committee of Twenty, did not want any valuation of the SDR which was not based on par values or which suggested that gold would have a reduced role in the reformed system. Mr. Kawaguchi, also taking the position adopted by Japanese officials at meetings of the Committee of Twenty, argued for an SDR valuation based only on “the strongest currencies,” defined as those which were appreciating in world markets.
Executive Directors also held different opinions on whether the rate of interest ought to be raised on the SDR, as did officials in the Committee of Twenty. While officials of European members and of Japan favored considerably higher rates of interest on the SDR than the existing 1.5 percent a year, officials of the United States and of developing members resisted any substantial increase in this rate of interest.
SPECIAL ARRANGEMENTS CONCERNING SDRs FOR EUROPEAN PARTICIPANTS IN THE SNAKE
Meanwhile, fluctuations in the value of the SDR in terms of currencies were beginning to cause problems. Intervention in exchange markets by participants in the narrow margins arrangement of the ec, effective in April 1972, entailed the accumulation by the central banks of these participants of the currencies of the other members. Thus these central banks had to settle their accumulated balances. Under the scheme, settlement of balances customarily occurred on the last day of the month following the month in which the balance appeared, and was to be made either in the currency of the creditor country or in gold, SDRs, reserve positions in the Fund, and foreign currencies. The scheme for settlements on this basis, however, almost immediately encountered operational difficulties. The sharp rise in the free market price for gold made deficit countries unwilling to use gold reserves to settle their net intra-European currency balances. They preferred to use SDRs. However, they were disturbed by the value at which they transferred SDRs among themselves. Their accumulated balances were expressed in units of account of the European Monetary Cooperation Fund and valued at the central rates or par values of the European countries concerned. The SDR continued to be valued on the basis of the par value for the U.S. dollar, that is, on the basis of the prospective par value of the dollar of $42.22 per ounce of gold following the second devaluation of the dollar in February 1973.
When officials of the ec countries raised the matter with the Fund in March and April 1973, their specific problem was this. ec currencies were being exchanged at fairly large premiums of 6–9 percent over the prospective par value of the dollar. Settlement of net balances in intra-European accounts through use of SDRs valued on the basis of the prospective par value of the dollar hence meant an overpayment by the ec debtor to the extent of this premium. France, in particular, was considerably in debt to the Federal Republic of Germany in intra-European accounts, and French officials were eager not to have to buy French francs with SDRs valued in this way. Hence, officials of the countries adhering to the ec snake arrangement requested the Fund to exempt them from the normal arrangements so far as transactions in SDRs between one another were concerned and to permit them to transfer SDRs on the basis of values determined by their own central rates or par values rather than by the par value of the dollar.
The Executive Directors debated the request on a number of occasions during the following months. U.S. officials opposed the change so as to avoid the implication that the par values or central rates for currencies of ec countries provided a better yardstick for measuring the value of SDRs than did the par value of the dollar.
Toward the end of 1973, a temporary solution was found to enable the countries in the snake arrangement to use SDRs in intra-European settlements while a new method for valuing the SDR was debated. On November 5, the Executive Board decided to permit a participant in the Special Drawing Account that used SDRs to purchase balances of its own currency held by another participant to employ the par value or central rate of the currency involved as an alternative to the valuation method under Rule O-3. All transfers of SDRs other than those in this category were to continue to take place at exchange rates based on market rates in accordance with Rule O-3.
This decision involved for the transactions concerned the suspension of the equal value provision of the Articles for 120 days starting November 6, 1973. (A period of 120 days was the maximum period for which the Executive Board could suspend the Articles.) This period was subsequently extended by the Board of Governors for an additional 240 days.7 This period enabled transactions in SDRs among the ec countries to take place at their par values or central rates until October 31, 1974, well beyond the deadline of July 31, 1974 that the Committee of Twenty had set for itself for agreement on the reformed system, including agreement on a new method for valuing the SDR. Until then, officials of the ec countries could make settlements among themselves in SDRs at what they considered a fair valuation for the SDR without violating the Articles of Agreement. This solution was accepted, but not without opposition. Some Executive Directors opposed it because they did not want to endorse departures from the principle of equal value, considered almost sacred, and because the solution involved the suspension of the operation of a provision of the Articles of Agreement. Nevertheless, this experience was to be a forerunner of the considerable liberalization of the provision for suspending the operation of provisions of the Articles made at the time of the Second Amendment.
The suspension of the equal value principle was a temporary, technical, and limited solution to the problem of the valuation of the SDR that the U.S. authorities could support. It preserved the existing role of the dollar as the link between the value of SDRs and the value of currencies in a broad area of transactions both in SDRs and in the Fund’s General Account; in particular, it did not affect the method by which the Fund determined the value of its holdings of gold and currencies. No doubt was cast on the validity of the existing relationship between the dollar, the SDR, and gold. No one could draw the conclusion that the par values or central rates of currencies of ec countries provided a better yardstick than the par value of the dollar for measuring the value of the SDR. Because the suspension was temporary, the action was not prejudicial to the outcome of negotiations on the question of how the SDR should be valued in the future. As an added safeguard, the Fund did not issue a press release announcing the decision so as to prevent the public, especially bankers and the financial press, from drawing wrong conclusions.
E.B. Decision No. 4076-(73/101), October 31, 1973; Vol. III below, pp. 484–85.
The central rate decision was described in History, 1966–71, Vol. I, pp. 557–59.
E.B. Decision No. 4083-(73/104), November 7, 1973; Vol. III below, pp. 485–87.
Article XXV, Section 8(a) of the Articles of Agreement as amended in 1969. These Articles are in History, 1966–71, Vol. II, pp. 97–141. Article XXV, Section 8(a) is on p. 127.
Article XXV, Section 8(b).
Rule 0-3, as adopted on September 18, 1969, can be found in History, 1966–71, Vol. II, p. 187. The representative rates agreed were described in History, 1966–71, Vol. I, p. 226.
Resolution No. 29–2, effective March 4, 1974; Vol. III below, p. 284