Abstract

Before the Second Amendment, the definition of a convertible currency under the Articles was, in effect, the currency of a member that had informed the Fund of its willingness to perform the obligations set forth in Article VIII, Sections 2, 3, and 4. The definition was an artificial one, which means that it had peculiar characteristics even after allowance is made for the fact that it was intended only for certain purposes of the Fund. Convertibility as a concept can be said to consist of three elements: use, exchangeability, and exchange value.66 Under the Articles, once a member gave notice that it was willing to perform the obligations of Article VIII, Sections 2,3, and 4, there was no retreat to the transitional arrangements of Article XIV, and this is still the legal position. One con-sequence before the Second Amendment was that a member’s currency remained convertible for the purposes of the Articles even though the Fund approved restrictions by the member on the making of payments and transfers for current international transactions. In short, the use and exchangeability of a convertible currency could be limited but the label of convertibility was not detached.

Compromise on Official Convertibility

Before the Second Amendment, the definition of a convertible currency under the Articles was, in effect, the currency of a member that had informed the Fund of its willingness to perform the obligations set forth in Article VIII, Sections 2, 3, and 4. The definition was an artificial one, which means that it had peculiar characteristics even after allowance is made for the fact that it was intended only for certain purposes of the Fund. Convertibility as a concept can be said to consist of three elements: use, exchangeability, and exchange value.66 Under the Articles, once a member gave notice that it was willing to perform the obligations of Article VIII, Sections 2,3, and 4, there was no retreat to the transitional arrangements of Article XIV, and this is still the legal position. One con-sequence before the Second Amendment was that a member’s currency remained convertible for the purposes of the Articles even though the Fund approved restrictions by the member on the making of payments and transfers for current international transactions. In short, the use and exchangeability of a convertible currency could be limited but the label of convertibility was not detached.

It must not be thought that because a currency remained convertible, balances of it purchased from the Fund could be used or exchanged notwithstanding these restrictions. On the contrary, balances to which the restrictions applied were not freed from them because the balances were sold by the Fund. Continuing convertibility meant in such circumstances that the Fund would go on accepting the currency in repurchase and would go on treating it as convertible in computations for the purpose of applying certain provisions of the Articles.

As for assured value, a member’s currency would not lose its legal character as convertible for the purposes of the Articles even if the Fund approved multiple currency practices under Article VIII, Section 3 or even if the member allowed its currency to float in violation of the member’s obligations under the par value provisions.67 Nevertheless, one view of Article VIII, Section 4 was that it was a prop of the par value structure. According to this view, the provision was intended to give members the assurance that if they obtained balances of the currencies of other members as the result of intervention, the official conversion of those balances could be obtained under Article VIII, Section 4. On this hypothesis, Article VIII, Section 4 should have been deleted from the Second Amendment.

The United States was willing to see the Articles modified in this way. In support of this position, it pointed out that no transaction had ever been carried out by reference to the provision. The system that had developed was one in which the currencies that had important roles in international trade and payments were U.S. dollars or convertible into U.S. dollars through the markets, while dollars accumulated by members could be converted into gold because of the free purchase and sale of gold that the United States engaged in with the monetary authorities of other members in accordance with Article IV, Section 4(b).68 Market convertibility under Article VIII, Section 2(a) and not the official convertibility of Article VIII, Section 4 had been a mainstay of the real system. Under this system, if members accumulated U.S. dollars or other reserve currencies, it was not because they centralized exchange transactions but because they intervened in the markets in support of par values. If members lost reserves, it was again the result of intervention and not official convertibility under Article VIII, Section 4. Intervention in the markets was made necessary by the exchange rate obligations in conditions of market convertibility under Article VIII, Section 2(a), as Robertson had foreseen.

The U.S. position was influenced less by the systematic relationship of Article VIII, Section 4 to the par value system than by its determination to avoid any impression that it might be willing in future to resume an obligation of official convertibility in any form. The United States had shaken itself free from all forms of official convertibility by the President’s announcement of August 15, 1971, and it had no intention of encouraging the belief that it might engage in the same or similar practices in the future.

The abrogation of Article VIII, Section 4 was resisted by some members. They hoped for the evolution of an international monetary system with more satisfactory ex-change arrangements and with symmetrical rights and obligations for all members.69 They did not expect that Article VIII, Section 4, with its limitations and obscurities, would be the instrument for achieving symmetry, but they hoped for some form of settlement with the use of reserves by reserve currency countries, and in particular the United States, if balances of these currencies were accumulated by other members. These ideas had been discussed exhaustively in the then recent past by the ad hoc Committee of the Board of Governors on Reform of the International Monetary System and Related Issues (the Committee of Twenty). The members that hoped for an evolution along these lines faced a dilemma: they could not sensibly insist on the retention of the provision (Article IV, Section 4(b)) under which the United States had undertaken the practice of the free purchase and sale of gold, and there was no prospect of reaching agreement on a provision that required “asset settlement” by reserve currency countries. Facing this dilemma, members entrenched themselves behind Article VIII, Section 4 and refused to see it abrogated in the absence of some substitute provision, because bare abrogation might suggest that they were reconciled to no evolution of the international monetary system or to an evolution not in accord with their preferences.

Attempts were made to find a compromise. One suggestion was that Article VIII, Section 4 might be replaced by a provision under which the Fund would have the power to approve, at some appropriate date, arrangements for the treatment of balances. Another suggestion was that Article VIII, Section 4 might be made dependent on the restoration of a par value system under Article IV, Section 4 and Schedule C of the Second Amendment or on a decision to make Article VIII, Section 4 effective in circumstances not defined in advance. Another proposal was that members would be deemed to be performing the obligations of Article VIII, Sections 2, 3, and 4 if they were issuers of a “freely usable currency” as defined by the Second Amendment70 or a currency that could be converted into a freely usable currency, and if, in addition, they imposed no restrictions, whether approved or unapproved by the Fund, on the making of payments and transfers for current international transactions.71

None of these or other proposed compromises was acceptable. In the end, the solution was the retention of Article VIII, Section 4, with the revision of the second sentence of Section 4(a) so that it now reads as follows:

The buying member shall have the option to pay either in special drawing rights, subject to Article XIX, Section 4, or in the currency of the member making the request.

The retention of Article VIII, Section 4, with this one amendment, was explained in the Report of the Executive Directors to the Board of Governors on the Proposed Second Amendment in the following passage, which was drawn largely from Pamphlet No. 14 (The Fund’s Concepts of Convertibility):

Convertibility Under Article VIII

14. Article VIII, Section 2(a) constitutes what has become the basic convertibility provision of the Articles of Agreement. The mechanism of convertibility under this provision is available to all parties, whether private or governmental, and under it holders of currency balances recently acquired as a result of current transactions must be allowed to transfer those balances through the exchange markets.

15. The basic convertibility mechanism of Article VIII, Section 2(a) was supplemented, in the original Articles, by another form of convertibility under Article VIII, Section 4 to which the monetary authorities of members, and only those authorities, could have recourse. This supplemental mechanism for monetary authorities was provided for by the drafters of the original Articles on the basis of certain assumptions about the character and operation of the monetary system after 1944, which has, however, developed in other directions. They assumed, for example, that conversions through the market might be moderate, but that governments might centralize all foreign exchange receipts, with the result that official balances might be enormous and conversion impossible without the use of the Fund’s resources.

16. The obligation of members to convert under Article VIII, Section 4 is a closely defined obligation and subject to certain conditions. One important condition is that the balances presented for conversion have been recently acquired as a result of current transactions, or that conversion of the balances is needed for making payments for current transactions. Another important condition is that the member asked to convert must be entitled to use the Fund’s resources. The theory of Section 4 is convertibility of official balances through the mechanism of the Fund, and a member is under no obligation to convert official balances of its currency, whether through the use of the Fund’s resources or with other assets, unless it can purchase from the Fund the currency of the member requesting conversion.

17. The world has not developed along the lines expected by the drafters of Article VIII, Section 4, and the convertibility mechanism envisaged in that provision has never been applied. Section 2(a) of Article VIII, and not Section 4, has provided the mechanism for conversion, and the Fund has supported this form of convertibility with its resources.

18. The second amendment has been agreed on the understanding that the situation as described above will continue to prevail, so that no obligation will be applied for a member so long as exchange markets for the currrency held normally serve this function. Members are, of course, free to agree to convert balances of their currency held by other members, as they have done on occasions in the past, or can, by agreement, transfer special drawing rights to other members for this purpose. It has been considered unnecessary, therefore, to attempt to modify the provision at this time, taking into account the fact that circumstances similar to those that the drafters of the original Articles had in mind might possibly emerge, thus justifying more reliance on the provisions of Article VIII, Section 4. Any study of a possible future modification of the provision could be undertaken more usefully in the light of developments in connection with exchange arrangements under Article IV.72

The main message in this extract is that the obligation under Article VIII, Section 4 is not to be applied as long as market convertibility is maintained. If circumstances were to change and market convertibility ceased to be as widespread and effective as it was at the date when the Report was written, so that there might be a need for official convertibility, Article VIII, Section 4 could be reconsidered in the light of the new circumstances.

Freely Usable Currencies: Official Exchanges

The compromise as described above was accompanied by the deletion from the Articles of the definition of convertible currencies and all mention of convertibility or conversion except in Article VIII, Section 4. These changes have been accompanied by the disappearance from the financial activities of the Fund of the distinction between the currencies of members that have undertaken to perform the obligations of Article VIII, Sections 2, 3, and 4 and the currencies of those members that have not yet taken this step. A new vocabulary has been coined in which the “exchange” of currencies is prominent. The former Article V, Section 7(b)(ii) has been abrogated together with all other formulas on repurchase.

A new concept has been introduced into the Articles by the Second Amendment: “freely usable currencies.” They are defined as follows:

A freely usable currency means a member’s currency that the Fund determines (i) is, in fact, widely used to make payments for international transactions, and (ii) is widely traded in the principal exchange markets.73

The Fund has decided that the U.S. dollar, pound sterling, deutsche mark, French franc, and Japanese yen are freely usable currencies, but this list may be changed by deletion or addition if the Fund decides that circumstances warrant changes in it.

Freely usable currencies have an essential role in enabling the Fund to use all currencies in the transactions it conducts through the General Resources Account. If the Fund sells a freely usable currency, it is assumed that the purchasing member, if it wishes, can exchange the currency in the market without affecting the exchange rate. The issuer of a freely usable currency sold by the Fund can require a purchaser that wishes to exchange it to engage in an official exchange. In that exchange, the issuer must provide a freely usable currency selected by the purchaser at a rate of exchange that is governed by the Articles. If the Fund sells a currency that it has not deemed to be freely usable, the issuer must exchange it, on the prompt request of the purchaser. The exchange is made in return for a freely usable currency selected by the issuer of the currency sold, and at the exchange rate that is required by the Articles. The issuer and purchaser may agree, however, on another procedure for an exchange.

The obligations as described above are confined to balances purchased from the Fund in contrast to the balances that are the subject of official convertibility under Article VIII, Section 4. Market convertibility under Article VIII, Section 2(a), however, relates to balances without limiting them to those that originate in transactions with the Fund.

Official Redemption

The Report on the Proposed Second Amendment notes that members are free to agree to convert balances of their currencies held by other members, without invoking Article VIII, Section 4, or can agree to use special drawing rights (SDRs) for this purpose. The Second Amendment contains a provision that recognizes the redemption of balances with resources drawn from the Fund. Under Article V, Section 3(a), a member may purchase currency from the Fund to help the purchaser solve its balance of payments or reserve problem. The currencies that the member may purchase are determined by the Fund in accordance with its policies on the selection of currencies suitable for sale because of the balance of payments and reserve position of the issuers and developments in the exchange markets, as well as the desirability of promoting over time balanced positions in the Fund among members.74 If, however, a member represents that it is proposing to purchase the currency of another member because the purchasing member wishes to redeem an equivalent amount of its own currency offered by the other member, the purchasing member is entitled to purchase the currency of the holder unless the Fund has given notice that its holdings of the currency have become scarce.75 Under this provision, if the two members agree on the redemption, the purchasing member is entitled to purchase the currency of the holder from the Fund even though at that time the Fund would not sell the currency in other transactions.76 Neither member is bound by the Articles to enter into such an agreement. The provision was inspired by the transactions with the Fund that had been entered into by members that had to make settlements under the “snake” arrangements.

The First Amendment provided for the official redemption of balances of a currency with SDRs. In the negotiation of the First Amendment, the United States protested that the right of a member holding SDRs to obtain currencies for them from transferees of SDRs designated by the Fund, when the member needed currencies because of its balance of payments position or because of developments in its reserves, was of no use to the United States. The United States did not support the U.S. dollar with other currencies. When the United States was in difficulties, pressure on the dollar might produce requests for the conversion of dollar balances with gold. The United States was interested, therefore, in a provision under which it would be able to redeem dollar balances with SDRs and not gold. The United States was unable to negotiate a right to redeem with SDRs any dollar balances that were offered to it, but it did succeed in obtaining a provision under which SDRs could be used if the United States and the holder of the balances agreed on this form of redemption. The provision was written in terms of any member whose currency was offered for redemption and not in terms of the United States alone.77 This special provision has been submerged in a broader provision of the Second Amendment under which members may agree on the exchange of SDRs for currency, and under which the currency may be that of the transferor of the SDRs or some other currency.78

66

Gold, Concepts of Convertibility, pp. 1–2.

67

For an economist’s view, see Ronald I. McKinnon, Money in International Exchange: The Convertible Currency System (New York, Oxford, 1979), pp. 4–7.

68

Gold, Concepts of Convertibility, pp. 33–37. Joseph Gold, Use, Conversion, and Exchange of Currency Under the Second Amendment of the Fund’s Articles, IMF Pamphlet Series, No. 23 (Washington, 1978), pp. 38–41. (Hereinafter referred to as Gold, Use, Conversion, and Exchange.)

69

Joseph Gold, “Symmetry as a Legal Objective of the International Monetary System,” New York University, Journal of International Law and Politics, Vol. 12, No. 3 (Winter 1980), pp. 423–77.

70

Article XXX(f).

71

For a more detailed account, see Gold, Use, Conversion, and Exchange, pp. 26–32.

72

Proposed Second Amendment to the Articles of Agreement of the International Monetary Fund: A Report by the Executive Directors to the Board of Governors (Washington, 1976), Part II, Chap. C, pp. 17–18.

73

Article XXX(f). See Gold, Use, Conversion, and Exchange, pp. 55–92.

74

Article V, Section 3 (a) and (d); and Rule O-10, in International Monetary Fund, By-Laws, Rules and Regulations, Thirty-Seventh Issue (Washington, January 1, 1981), p. 57.

75

Article V, Section 3(d).

76

Gold, Use, Conversion, and Exchange, pp. 36–38.

77

Article XXV, Section 2(b)(i) of the First Amendment.

78

Article XIX, Section 2(b) of the Second Amendment. Gold, Use, Conversion, and Exchange, pp. 41–45.

Keynes, Convertibility, and the Internationa Monetary Fund's Articles of Agreement
Author: Mr. Joseph Gold