IN recent years, there has been increasing discussion in official, financial, and academic circles of the present international monetary system. This system comprises a spectrum of customary institutional and legal arrangements which govern the conduct of international economic transactions, the methods of financing deficits and surpluses in international payments, and the manner in which countries are expected to respond to such deficits and surpluses.
Characteristics of the System
IN recent years, there has been increasing discussion in official, financial, and academic circles of the present international monetary system. This system comprises a spectrum of customary institutional and legal arrangements which govern the conduct of international economic transactions, the methods of financing deficits and surpluses in international payments, and the manner in which countries are expected to respond to such deficits and surpluses.
In its widest sense, the international monetary system includes the broad network of banking and commercial practices through which day-to-day international transactions are undertaken. The pricing of international shipments, the extension of credit, and the settlement of accounts take place in terms of many currencies. Mainly, these are the currencies of Western Europe and the United States, and more particularly, within that group, the major “trading currencies,” i.e., the U.S. dollar, the pound sterling, and the French franc.
The predominance of the currencies of major trading countries is not surprising. A country with a very large world trade will develop a network of banking arrangements necessary for conducting that trade. The facilities and experience offered by these arrangements are then available to transact not only the trade and related payments between that country and its trading partners, but also those between other countries. The fact that a large trading country is also likely to have a well-established money market, and to be an important source of capital, further extends the use of its currency. For these and other reasons, such a country is likely to have long-established relation-ships with many other countries, causing them to look to it as the center of their own international financial arrangements. In a basic sense, therefore, the international monetary system tends to be founded on the currencies of a few countries which loom large in the total trade of the system.
In a narrower sense, the international monetary system is the complex of international rules and understandings which have evolved in an effort to ensure, by international agreement, a fair and efficient method of conducting international transactions. In this sense, the present system of international cooperation and consultation, which arose to a large extent from the 1944 Bretton Woods Conference, is in sharp contrast to that of the interwar period, particularly the 1930’s, when countries pursued their financial policies with little regard for, and little understanding of, the effects that these policies might have on other countries.
The present system comprises, to begin with, the provisions of the Articles of Agreement of the Fund, which are designed to foster the intercon-vertibility of currencies. It includes the par value system, under which a country is expected to maintain a fixed value for its currency relative to gold and to other currencies—alteration of the value being reserved to circumstances of fundamental disequilibrium and requiring consultation with the Fund and, in most cases, the Fund’s concurrence. It comprises also those provisions of the Articles of Agreement of the Fund and of the General Agreement on Tariffs and Trade under which restrictions on current payments and on trade are generally allowable only in situations of balance of payments difficulty and are subjected to international regulation. In addition, the concept of the international monetary system embraces all those de facto practical arrangements which give life and reality to the legal provisions. For example, the principal link between currencies and gold is provided by the fact that the United States freely buys gold from and sells gold to monetary authorities, at fixed prices, for the settlement of international transactions; moreover, the principal industrial countries act together through the Gold Pool to keep the price of gold close to par on the free market. All the main industrial countries other than the United States, and many other countries as well, stabilize their rates of exchange by buying and selling dollars on the exchange market, while a number of other countries achieve the same result by pegging on sterling or on the French franc. Although under the Fund Agreement countries are virtually free from obligations with respect to the control of capital flows, there has been a fairly widespread de facto liberalization of capital movements by the industrial countries.
Finally, the international monetary system covers the arrangements under which external reserves are held. At the present time, international reserves comprise not only gold but also such currencies as the dollar, sterling, and the French franc, gold tranche positions1 in the Fund, and claims resulting from loans made to the Fund under the General Arrangements to Borrow. Beyond these reserves, countries have access to the drawing facilities in the Fund in the credit tranches; these facilities, which are made available on condition that the drawing country maintains or adopts policies calculated to correct in due time the payments deficit in question, constitute “conditional” liquidity. In addition, there has been built up in recent years a network of bilateral mutual credit arrangements between the United States and a number of major industrial countries, under which each participant can draw on its partner for short-term accommodation in the form of a covered “swap.” Similar arrangements have been made on a number of occasions between the United Kingdom and other industrial countries.
Reserves and other forms of international liquidity make it possible for countries to finance their balance of payments deficits; and the volume, distribution, and manner in which these reserves are made available have obviously an important bearing on that aspect of the international monetary system which is concerned with the adjustment of such disequilibria.
The system as described thus combines two features that are complementary in character: the financing of imbalances and the elimination of imbalances. The task of managing the international system—which is an individual and common responsibility of all countries concerned—is, in a large measure, to strike a balance between these two features, and this has also necessarily been the primary and crucial task of the Fund as the international organization at the center of the system. It should be emphasized that the task can be lightened, and the performance of the system improved, insofar as countries see to it that major payments disturbances do not arise in the first place and are willing to cooperate to that end.
The task of international monetary management would be simpler if the objective were merely to finance payments imbalances, or, alternatively, to ensure that any disturbances in balance of payments equilibria were eliminated as quickly as possible. But it is not sufficient that deficits be financed; financing which is excessive in amount or in duration may constitute a distortion in the flow of real resources that should be avoided. Nor is it enough that international payments should be brought into balance without regard to the measures by which this is accomplished. Practically speaking, the aim must be the achievement of balance with the least possible sacrifice of the generally accepted objectives of economic policy, including full employment, an adequate and sustained rate of growth, maintenance of reasonable price stability, and the maximum degree of freedom in current international transactions. It is also important that distortions in the international flow of capital and financing be avoided.
In the world of today, national authorities place a higher priority than in earlier times on achieving specific objectives in the internal economy and are more willing to adopt economic policies to this end. Public understanding that marked unemployment and economic stagnation need not be suffered as conditions beyond the control of man is one of the most potent forces of the modern world. It is derived from, and it has stimulated, the development of techniques to influence the internal monetary situation and, beyond it, the national economy. The result has been that high employment and sustained economic growth have been established among the social goals that countries resolutely pursue, and every government seeks to equip itself with the tools of monetary and economic policy which will allow it to meet those goals. Countries reject the concept, implied in the gold standard, that deflation and economic stagnation, or inflation and overheating of the economy, must automatically be accepted in the interests of external equilibrium; and in many countries, the most pressing task of national financial authorities is to accommodate the public’s demands for high employment, economic growth, and price stability while maintaining external balance. Within any context of monetary and economic management, circumstances will arise in which countries, particularly when they suffer balance of payments disequilibria of a persistent character, will be faced with difficult choices among several external and internal policy objectives. Deficit countries that find themselves in such circumstances will need to choose whether to seek a solution to their problem in a degree of deflation or at least a slowing down of the rate of growth, in the adoption of measures to restrain payments for visible or invisible imports or capital transfers, in an adjustment in their exchange rate, or in some combination of these various broad policy approaches. Surplus countries may similarly find themselves forced to choose between inflationary pressure, the adoption of steps to restrain the inflow and promote an outflow of capital, and revaluation of their currencies.
Appraisal of the System
The international monetary system of today is thus a complex framework within which a very large number of countries seek to attain simultaneously, by a combination of policy instruments, an appropriate balance among a number of internal and external objectives. How well has the system served. to attain these objectives?
Any attempt at answering this question and thus appraising the performance of the system must start from the realization that the development of national economies individually and of the world economy as a whole cannot properly be attributed only to the workings of the international monetary system, even in the broadest sense of that concept. The physical and human conditions under which production proceeds, as well as a country’s own policies in many fields and the repercussions of the policies of other countries, have undoubtedly also had a major influence in determining the successes and failures of the past 20 years. These observations are particularly pertinent when one considers separately the experience of the developing countries and of the industrial countries; within each group there have been varying degrees of success. By and large, the developing countries, hampered by structural problems, notably the unsatisfactory development of their export earnings, have found it difficult to achieve simultaneously the goals of rapid growth and internal and external stability. Restrictions on imports and on payments for invisibles have often been resorted to, exchange rates have been depreciated, and internal imbalances have interfered with the expansion of the economy. This has, happily, not been the universal picture of the past 15 or 20 years, but it has been a common one. In recent years, however, there has been a growing awareness of the contribution which stability can make to sustained growth, and many developing countries are showing a determination to stabilize their internal and external economies to provide a sound basis for economic development.
The industrial countries have achieved a very high degree of success, as national governments have effectively pursued policies of full employment. Between 1950 and 1964, production in the industrial countries expanded at a rate of more than 5 per cent per annum, while the labor force grew by 1.3 per cent per annum; the large pockets of structural unemployment which at one time existed in most European countries, and which seemed likely to persist, were largely absorbed.
With respect to the objective of price stability, it must be noted that inflationary pressures continued to be felt, and the cost of living even in industrial countries increased over the same period by an average of 2.5 per cent per annum as countries found it difficult to reconcile full employment with price stability, a difficulty which is evoking attempts at establishing “incomes policies.” Great progress has been made by Fund members in the removal of barriers to trade and in shifting from bilateral to multilateral payments, and all the major industrial countries have now accepted the convertibility obligations of Article VIII.
These on the whole impressive results have been achieved with rather slight use in the industrial countries of the instruments of balance of payments adjustment that were provided for at Bretton Woods. With the exception of one large-scale and widespread devaluation in 1949, which was a part of the postwar readjustment process, there have been relatively few changes in agreed par values. Similarly, the instrument of quantitative restriction on imports, which was provided for in the GATT as a facility for meeting balance of payments difficulties, has in fact been practically abandoned by countries once they have succeeded in dismantling controls. Payments restrictions have similarly lost importance as a means of balance of payments adjustment, particularly since the widespread acceptance of Article VIII in 1961. Finally, restrictions on capital payments, which were not placed under the requirement of Fund approval as were restrictions on current payments, have been subject to a substantial dismantling, although this trend has recently been checked.
On the other hand, the instrument of monetary policy—or, more generally, internal financial policy—has been applied for balance of payments purposes far more generally than might have been anticipated at the time of the Bretton Woods Conference. This has been attributable in part to certain favorable features in the general economic environment. For example, the persistence of high demand and expanding output has in many instances enabled countries to correct their incipient balance of payments deficits by measures that have not gone beyond bringing about a temporary pause in the expansion of their economies. This has been conspicuously true of the industrial countries as a group, but there are numerous examples of the effective application of domestic financial policy among less developed countries.
A number of features of the international economy have given rise to considerable re-examination in recent years; these include the role of capital movements and the scope for price adjustment. Questions have furthermore been raised about the working of the system in terms of the manner in which international liquidity is created and the forms in which it is held. These issues are taken up below.
Role of Capital Movements
The Articles of Agreement of the Fund left control over capital movements almost entirely to the discretion of national governments. Later on, a view that had been dominant before 1930 began to gain ground, viz., the view that freedom of capital movements was highly desirable in itself, and moreover that the movement of short-term funds might be regarded as an equilibrating factor in international payments which would diminish the need for reserves. In fact, the period since the late 1950’s, especially after the main European currencies became convertible, has been characterized by a massive revival of capital movements among the industrial countries, in particular from the United States to Europe. The so-called Eurodollar market has become a large pool of short-term funds connecting the money markets of many countries and influencing them all. Long-term capital markets have also become more closely linked through direct investment, through dollar loans issued in European markets, and through other channels. As a result of these new developments, a large measure of international financial integration has taken place in a short span of years, and this has had important effects on the conduct of internal financial policy. Before currencies were convertible, countries could to a considerable extent follow independent monetary policies: the resulting differences in interest rates and in the tightness of money had relatively little influence in inducing movements of capital. At present, however, the scope for independent monetary policy is becoming increasingly narrow. In these circumstances more emphasis must fall on fiscal policy, and countries have, to a larger extent than previously, to bring their monetary policies into line with those of each other. Where countries have found the mobility of capital to hamper excessively the use of monetary policy for domestic purposes, they have tended to intervene to limit in some degree the freedom of capital movements. Massive movements of long-term as well as short-term funds from the United States to European countries have played a part in the persistent balance of payments problems of the former, while accentuating the difficulties which some of the latter have experienced in containing existing inflationary pressures. More generally, capital movements have frequently played a disequilibrating, rather than an equilibrating role, especially at times when there were thought to be prospects of exchange appreciation or depreciation on the horizon.
As a reaction to these developments in capital movements, several surplus countries have limited inflows of foreign funds, and certain deficit countries have discouraged the outflow of funds by fiscal measures (such as the Interest Equalization Tax imposed in the United States) and by more direct formal and informal measures.
The unexpected magnitude in recent years of capital movements between the main industrial countries, and in particular the continued substantial dependence of the world in general on the U.S. money and capital markets, thus confront the I international monetary system with a new area of problems, which are the more difficult to deal with since it is hard to judge the extent to which these capital movements are a response to a persistent and fundamentally sound tendency for capital to seek the highest real return, or how far speculative or other temporary factors or fiscal considerations play a role. Should these flows be considered as mere temporary phenomena and be financed by movements in reserves? Should it be expected that current account balances will be radically changed to accommodate them? Or should the flows in some way be limited by controls? There are no agreed answers to these questions, and it may take much study, discussion, and coordination of national policies to find a satisfactory practical solution.
Scope for Adjustment of Price Levels
Another element which, as has long been recognized, adds to the difficulties of managing the international monetary system is that changes in price levels cannot be counted upon as a quick or adequate equilibrating force between deficit and surplus countries. The social forces which are arrayed against deflation have been noted earlier. Modern conditions make it very difficult for deficit countries to force down their general price levels without giving rise to the danger of provoking substantial unemployment of labor and underutilization of plant. At best those countries may be able (as has the United States in the past few years) to maintain a fairly stable level of prices. On the other hand, there is an understandable feeling in surplus countries that any addition, through their payments surpluses, to inflationary pressures already present in their economies should be resisted. Thus, whether or not price adjustments played a large equilibrating role in the past, it is clear that in present circumstances large imbalances cannot be expected to be eliminated within a short period of time by reliance on differential price movements alone.
Role of Reserve Currencies
Currencies of the reserve centers form, next to gold, the largest component of countries’ reserves. Any rise or fall in the holdings of such currencies tends to result in a rise or fall in the gross reserves of the world as a whole. It is sometimes contended that this component in the world reserves total affords reserve center countries an undue and exceptional facility for financing balance of payments deficits, that its magnitude is determined by factors that have little to do with the world’s need for reserves, and that it constitutes an element of potential instability in the international financial system.
It is no doubt a fact that payments deficits and surpluses of reserve centers, being matched by corresponding surpluses and deficits of other countries, tend to be associated with rises and falls respectively in the value of currency reserves and hence of total reserves. So long as the center is strong and enjoys unquestioned confidence, some proportion of its balance of payments deficit may be met by an accumulation of liabilities to official foreign monetary holders. In the last six years as a whole, the United States has financed some 40 per cent of its deficit in this way, despite the growing awareness of the need to reduce this deficit. As far as the United Kingdom is concerned, however, outstanding sterling balances have tended to fluctuate without a clearly defined trend. Most of the financing of the U.K. deficits in the last decade has been provided by the Fund or, for very short periods, by special assistance from the monetary authorities of other countries. The ability of any reserve center to finance deficits by increasing its currency liabilities is in any event not without limit.
The gold exchange standard, however, involves more than the ability of a reserve center to finance its payments deficit. Reserve centers originated as places where the monetary authorities of other countries—for reasons of convenience, access to capital markets, etc.—decided to hold a substantial proportion of their reserves; and while reserve center countries have some advantages, they are also exposed to pressures when currency balances are transferred into other currencies or withdrawn in gold. These pressures may develop even when the reserve center is in external balance or in surplus. Whatever criticisms may have been expressed about the present system of reserve currencies, there has been no significant tendency for countries to transfer their reserves to potential new reserve centers; nor has there been any inclination on the part of any country whose currency might be thought of as an alternative reserve currency to welcome or to encourage any such development.
The practice of holding foreign exchange reserves, whatever its merits from the point of view of the reserve centers themselves, has the inevitable consequence that the supply of reserves comes to depend greatly on the balance of payments situation of reserve centers and the confidence in reserve currencies. It is important not to exaggerate the degree of instability that is likely to arise from this cause by looking at parallels drawn from earlier periods. The international monetary system has been managed much more effectively in the postwar than in the interwar period. Initial tendencies toward declines in reserves during the early postwar period were more than offset by massive aid financed by the main reserve center, the United States. During recent years, when the United States has been in deficit, the rate of reserve accumulation in other countries has deliberately been influenced by agreement on such specific devices as advance debt repayments and swaps. If the strengthening of the payments position of the United States that is now under way were to go so far as to threaten excessive pressure on other countries in general, there would be opportunities for corrective action on the U.S. balance of payments (e.g., by alteration or relaxation of measures to restrain dollar outflows from the United States) or on other countries’ reserves (e.g., by a build-up of a larger U.S. position in the Fund and a possible accumulation of foreign currencies as part of the U.S. reserves). Nevertheless, these possibilities of ad hoc mitigation do not entirely destroy the validity of some of the criticisms made of the system; nor do they justify delay in exploring other ways in which it may be possible, as the need may arise in the future; to supplement the growth of reserves in a more deliberate manner.
Types of International Liquidity
The subject of international liquidity was dealt with at considerable length in Part II of last year’s Annual Report, and some of its aspects can be dealt with more briefly here. As was there pointed out, a country’s external or international liquidity represents all those resources to which its monetary authorities have access for the purpose of financing balance of payments deficits. If there is too much international liquidity in the world, some countries are likely to pay too little heed to possible deficits and hence to tend to engage in overexpansive financial policies. As a consequence of this, other countries may find that surpluses develop on an excessive scale because balance of payments financing is too easy and cheap. If there is too little international liquidity in the world, deficit countries will have too little time to adjust in a desirable way to the disequilibria which develop, and will be forced to adopt unduly restrictive financial policies as well as to impose restrictions on trade and capital movements. As a result, the growth in world production and trade may be hampered and the prices of primary products depressed.
To what extent these various consequences will ensue depends in part on the composition and distribution, as well as on the quantity, of the international liquidity available. In the Fund it has been found useful to distinguish between conditional liquidity, which is available to a country in the form of credit facilities subject to the adoption of satisfactory policies looking toward balance of payments adjustment, and unconditional liquidity or reserves which are more or less freely at the disposal of the country. The Fund itself is much the largest provider of conditional liquidity in the form of drawing rights under the quotas. In the interest of maintaining economic activity at a high level and keeping international trade as free as possible from restrictions, while at the same time countering inflationary pressures, the supply of this type of liquidity should be adequate to meet all legitimate needs. It is for this reason that the Articles of Agreement provide for the periodic review of countries’ quotas in the Fund.
Ideally, countries’ needs for additional liquidity could be met by adequate increases in conditional liquidity. In practice, however, countries do not appear to treat conditional and unconditional liquidity as interchangeable. For various reasons, countries which have adequate real resources like to have the major proportion of their external liquidity at their free disposal. Even if conditional liquidity were expanded on a substantial scale, some countries might attempt—in preference to relying on these facilities—to increase their own reserves by adopting balance of payments policies which, from a broad international point of view, would have to be regarded as undesirable.
Potential Need to Supplement Growth of Reserves
Since the publication of last year’s Annual Report, the Fund has been devoting considerable attention to the problem of international liquidity. Its primary practical concern has, of course, been with the adaptation of conditional liquidity to world needs by way of the expansion of Fund quotas; this subject is dealt with at length in Chapter 4. In addition, however, it has been giving thought to the issues relating to possible inadequacies in the supply of world reserves, or unconditional liquidity, that might arise if the prospective trend of such reserves, based on the availability of monetary gold and any future increases (or decreases) in holdings of reserve currencies, were insufficient to satisfy the desire for owned reserves in an expanding economy. In fact, as indicated in Chapter 1, the current rate of expansion in reserves is substantially less than in the record year 1963, and it is unlikely to be of that order of magnitude in the immediate future. It is widely agreed that there is no urgent need for supplementing the volume of reserves, and that existing methods to create liquidity may suffice to meet the world’s need for a time. Nevertheless, it is important that further progress be made toward an international consensus about the way in which the international monetary system should develop, including possible new techniques whereby the existing methods of reserve creation could be supplemented, if and when necessary, and to the extent required.
Deliberate Reserve Creation
During the past year, studies as to possible new methods of creating reserves have been made both within the Fund and among the countries participating in the General Arrangements to Borrow.
A basic assumption of these studies has been that no change will be made in the price of gold in terms of currencies in general. This assumption corresponds to the endorsement of the established price of gold as one of the bases of the present monetary system, expressed by the responsible authorities of the principal industrial countries as indicated in the Ministerial Statement of the Group of Ten,2 an endorsement in which the Fund concurs. The arguments against a change in the price of gold, including the inequities it involves and the speculative movements to which it is likely to give rise, are well known and need riot be repeated here. The progress made in international monetary cooperation since the 1930’s should make it possible for the world to achieve a more deliberate control over the amount of reserves through international action and to avoid sudden changes in the relative value of different reserve media.
The studies mentioned above have focused mainly on the deliberate creation of reserves by collective international action in the light of an appraisal of the general need for reserves rather than on their creation in response to immediate needs of particular countries for balance of payments assistance. Compared with the existing mechanisms of reserve creation, this constitutes a new approach which raises a number of important issues, e.g., how to establish and measure general reserve needs, in what forms additional reserves should be made available, what role they should play in the international payments system, in which ways they should be created, how they should be distributed initially, and what institutional provisions should be made to ensure proper management of their volume and functioning. The question also arises as to the way in which, if conditions warranted, reserves should be reduced.
All these questions require a great deal of further study from the point of view of objectives as well as techniques. This Report can do no more than discuss them in a preliminary and general way and indicate what could be done by the Fund. It does not attempt to provide definitive answers or present concrete proposals.
Criteria of General Reserve Needs
Appraisal of general reserve needs is not something that can be carried out on the basis of precise criteria. Resort to qualitative judgment is inescapable. In particular, no close relationship exists between these needs and such simple indices as the value of international transactions. In the exercise of such judgment, attention has to be focused primarily on the nature of the reactions, particularly in the sphere of national policies, which it appears appropriate to encourage or discourage in the interest of sound development of the world economy with a minimum of monetary disturbance. Some of the consequences, or symptoms, of excess or deficiency in international liquidity were discussed at page 14 above. In the light of this analysis, the following appear to be the main criteria on the basis of which consideration should be given to an increase—or, on rare occasions, a decrease—in international liquidity: whether, in circumstances in which countries’ financial policies are likely to be influenced by the level of world reserves, it appears desirable on balance to enlarge the scope for an expansion of monetary demand or to influence countries in the direction of counter-inflationary action; whether, on balance, exchange rates are under undue pressure, or needed adjustments in exchange rates are being unduly delayed; and whether there are widespread restrictions in international transactions, or widespread tendencies to speculative capital movements that an expansion in world reserves could to some extent relieve. Some of these conditions might, of course, call primarily for a change in the supply of conditional rather than unconditional liquidity, or for other changes in the techniques of international cooperation, but they are all relevant in some degree to the question of reserve needs.
Types of Reserve Creation
Reserves may be created directly between countries, either unilaterally (as when one country acquires a reserve currency for gold) or bilaterally (as when two countries make a reciprocal, i.e., swap, credit arrangement or carry out an actual swap transaction). Plans for systematic reserve creation, however, have usually involved action through the intermediacy of an international institution. It may be convenient to distinguish two main techniques through which such an institution can create reserve claims: (1) by extending unconditional borrowing rights or drawing facilities to countries, and (2) by creating reserve claims on itself in exchange for value received, usually in the form of claims on countries. These countries can be either (a) identical with or (b) to some extent different from the countries that acquire reserve claims on the institution. Possibility (a), which has been envisaged in certain of the plans that are under consideration, is equivalent to a multilateral swap transaction or an exchange of claims between each participating country and the institution. Possibility (b) may be illustrated by analogy with the operations of a domestic banking system, which by lending to one set of customers in due course creates deposit liabilities vis-à-vis a somewhat different set.
Transferability of Reserves: Direct and Indirect
In order that a borrowing right or asset may be suitable for inclusion in a country’s official reserves, it must be available as needed to meet payments deficits; that is, it must be convertible virtually on demand into the currencies in which these deficits are incurred. One way to assure this is to transfer the reserve claim on the institution to another holder in exchange, e.g., for dollars or the currency of the purchaser. Another way is for the institution itself to convert or encash the reserve claim for needed currency. In this case, the reserve claim will, in effect, be transferable through the institution. This happens, for example, when a country with a gold tranche position in the Fund makes a drawing from the Fund—the position is transferred to the country whose currency is used.
If transferability, whether directly or through the institution, is to be ensured, countries must have certain obligations to accept transfer in the form of lines of credit or otherwise, although these obligations need not be unlimited. The nature of any limitations imposed on the acceptance of transfer will largely determine the usability of the reserve asset. For example, if countries undertake to accept transfer of the reserve asset in question only in a certain ratio to gold, or to gold and foreign exchange, then other countries will be able to use the asset to meet their payments deficits only in the specified ratio to gold, or to gold and foreign exchange, respectively. On the other hand, if the holder of the reserve claim is to be able to use it freely, other countries must be prepared to accept it freely. In practice, the more freely the reserve claim can be transferred at the will of the transferor, the more likely countries are to insist on a quantitative upper limit to their obligations to accept transfer.
The procedures that are at present applied with respect to the use and transfer of reserve positions in the Fund represent something intermediate between free transferability and a system under which such positions are held and transferred in a fixed proportion to other reserves. A member can draw on its gold tranche virtually at will on representation of a payments need. In regard to the currency drawn—and hence the country to which the reserve position is transferred—the drawing country consults the Fund, which strives to ensure an equitable distribution of reserve positions in the Fund in the light of the balance of payments and reserve positions of the countries whose currencies are considered for drawing. Over the long run, the reserve positions in the Fund of members whose currencies are suitable for drawing have, as a result of this arrangement, tended to approximate a uniform proportion of their total reserves. All this takes place within the framework of creditor limits set by the quotas and beyond these by commitments under the General Arrangements to Borrow.
Apart from these questions relating to the usability or liquidity of the newly created reserve claims, certain other attributes of these claims have importance, such as whether they enjoy a value-maintenance guarantee, whether they bear interest (or in the case of borrowing rights, whether their use costs interest), and what will happen to them in the event of liquidation of the scheme. These matters are important primarily as affecting the acceptability of the new reserve claims, but also because of their possible repercussions on countries’ preferences between holding gold and holding reserve currencies.
Distribution of Initial Reserve Increases
One of the most important questions to be asked with respect to any scheme for creating reserves would be how the initial increase in reserves would be distributed among countries. If reserves were created in the form of automatic access to credit, the initial increase in reserves would accrue to the countries which received such access. If reserve creation resulted from a purchase of assets by the institution, the initial increase would accrue to the countries whose liabilities the institution acquired, not necessarily to those that financed the operation by acquiring the newly created liabilities of the institution. For example, if the two groups of countries were separate and did not overlap, the countries whose liabilities the institution acquired would obtain additional reserves (initially in the form of balances in the currencies of countries of the other group), while the latter, though they acquired reserve claims on the institution, would probably lose reserves in other forms as a result of conversion.
A number of important considerations would enter into the decision as to the allocation among countries of any additional reserves that were to be created.
Any scheme of reserve creation would have to involve criteria to determine what countries would participate in the distribution of reserves and in what proportions. The countries participating in the distribution would be affected both directly, by having larger reserves at their disposal, and indirectly, because of the effect of increased reserves on the policies of other countries, which, as a result of easier liquidity conditions, would be induced to pursue policies that would increase their import demand and/or would be more willing to export capital or give aid. Countries not participating would be affected only in this indirect manner.
Whatever the initial distribution of reserves, the bulk of them would probably gravitate sooner or later to countries with a high propensity to hold reserves, such as the industrial countries and certain primary producers. To the extent that the initial distribution of reserves was confined to countries with a strong tendency to hold reserves, the effect of reserve creation on balance of payments surpluses and deficits, i.e., on the movement of real resources among countries, would be minimized, apart from short-run fluctuations. Conversely, where reserves were distributed directly to less developed countries (which on the whole have a weak tendency to hold and accumulate reserves), the creation of reserves would also involve a long-term movement of real resources from the more developed to the less developed countries. An important question to be considered is whether a mechanism which involved such transfers of real resources would be desirable.
Finally, although the likelihood of a reduction in reserves or liquidation of a reserve scheme might be remote, all participants would have an interest in the quality of the assets backing the claims that were created.
The foregoing discussion of various aspects of reserve creation has been conducted without reference to any specific institutional framework. The task of influencing the total level of world reserves could be carried out by a new institution or by an existing institution, such as the Fund. From a purely technical standpoint, it would in general be possible to attain through the Fund results similar to those that might be sought in other ways, although this might involve certain amendments of the Articles of Agreement.
It can reasonably be argued that a matter which is of concern to all countries should be handled in an institution that has been organized as an instrument of financial cooperation on a worldwide basis. This would, moreover, be one way of ensuring coordination between the function of providing individual countries with short-to-medium term balance of payments assistance on a conditional basis and any new function of influencing the aggregate supply of world reserves or unconditional liquidity.
Reserve Creation Through the Fund
As foreshadowed in last year’s Annual Report, the Fund has, during the past year, continued to study technical aspects that could arise in connection with any plans for the creation of reserves in the Fund. The Fund staff has also participated in the studies carried on within the Study Group on the Creation of Reserve Assets established by the countries participating in the General Arrangements to Borrow.
The Executive Directors have given some preliminary consideration to technical aspects of possible methods of creating reserves in the Fund. The two main ways, although not necessarily the only ways, would be the following: (1) the extension of quasi-automatic drawing facilities beyond the gold tranche into some part of the credit tranches, and (2) an operation whereby the Fund simultaneously would obtain special assets and assume additional liabilities.
One way of raising members’ reserve positions in the Fund would be by an Executive Board Decision on drawing policies under which the ratio of Fund currency holdings to quota up to which members can draw on a virtually automatic basis would be raised from the present 100 per cent to some higher percentage of quota. Such a Decision might apply to all members or only to such members as satisfied certain criteria.
It should be observed that unless the extension of automatic drawing facilities were accompanied by a corresponding extension of total drawing facilities, some contraction in the amount of conditional drawing facilities open to members would be involved. A mere substitution of unconditional for conditional drawing facilities would have disadvantages from the standpoint of the Fund’s ability to influence its members in the direction of the adoption of appropriate balance of payments policies. The contraction of conditional facilities involved would also reduce the value of the reserve increase to members themselves. This would apply particularly with respect to drawing facilities in the first credit tranche, which are available to any member that is making reasonable efforts to cope with its balance of payments problems. These consequences could be averted by extending the limits for drawing facilities of each type by the same amount that the limits for automatic drawing facilities were extended.
A second approach to an increased role of the Fund in the creation of international liquidity would be through an enlargement of the balance sheet totals of the Fund. The Fund would acquire assets other than the ordinary currency holdings which determine the drawing facilities available to members. In order to finance this acquisition, it would expand its liabilities by borrowing in one form or another. From the asset side of the balance sheet, this form of reserve creation may be described as the acquisition by the Fund of “special assets”3; from the liability side, and referring to the form which the additionally created reserves take, it may be described as the creation of loan claims on the Fund.
The liabilities to be created would have to be suitable for incorporation in countries’ reserves. The precise nature of these Fund liabilities (i.e., members’ reserve assets) would have to be worked out, but they could include at least the following: (1) the facility of the asset to be encashed for useful currency at least as freely as gold tranche positions or, alternatively, to be transferred directly to other members; (2) a goldvalue guarantee; (3) interest at a modest rate reflecting the gold value of the claim. It will be noted that claims under the General Arrangements to Borrow have these three characteristics.
Under either of the approaches to Fund reserve creation discussed above—the extension of automatism and the acquisition of special assets—reserves could be created on a more or less extensive basis, depending on the criteria to be applied for countries to be included.
Again, under either approach, suitable action would be required to enable the Fund, without impairing its own liquidity, to meet the additional claims on Fund resources (in the form of drawings or conversions) that would arise from the use of the reserves created.
The international monetary system as it exists today is sufficiently strong to allow of a calm and dispassionate consideration of the possibilities of amending and improving it. Even if there is no need for immediate action to create additional reserves, it is nonetheless important to consider well in advance the many problems of principle and technique that would present themselves if the necessity for such action should arise. The work that has been carried out in the Fund and, with the collaboration of the Fund’s staff, elsewhere has prepared the way for further advance toward an international consensus regarding both the major objectives of liquidity policy and the broad nature of the techniques to achieve these objectives. The Executive Directors have not, at this stage, attempted to reach a common view on the merits of the various possibilities indicated above. They intend, however, to devote further attention to these matters in the coming year.
A member’s gold tranche position is measured by the extent to which the Fund’s holdings of the member’s currency falls short of its quota. The polices governing drawings in the gold tranche are those set forth in Executive Directors’ 1952 Decision on Use of Fund’s Resources and Repurchase (Decision No. 102-(52/11); see Selected Decisions, PP. 21-24), and in the 1964 Decision on Procedure for Drawings in the Gold Tranche (see Appendix I, P. 123 and Selected Decisions, P. 49) under which the execution of requists for such drawings is expedited. All references to gold tranche drawings in the present Report should be understood in the light of these decisions.