Nature of monetary reserves

Monetary reserves may be defined narrowly or broadly. The most useful type of definition depends upon the purpose intended to be served. If the purpose is statistical or legal, the definition must, before all else, be precise. When the broader implications of reserves are taken into account, however, a precise definition is not possible without a loss of realism.

Some items are included in the term “reserves” by universal agreement. Beyond these, potential items shade away imperceptibly from those whose reserve character is almost as clear as those conventionally included in reserves to those which are scarcely reserves at all. A similar hierarchy exists for items which might be considered as deductions from reserves. Because of the essentially arbitrary character of all cutoff points, narrow definitions of reserves fail to give a true picture of the relative international liquidity of different countries. Precise reserve computations are also subject to discontinuous changes in time, as portions of a country’s assets move into or out of the categories formally characterized as “reserves”, or as portions of a country’s liabilities are formally allowed, or cease to be formally allowed, as deductions. Consequently, when the purpose is to consider the over-all “deficit-financing power” of different countries or regions, as is true for this paper, it is desirable, in principle, to treat the concept of reserves broadly, even though only narrow and particular concepts can be measured and compared.

Viewed in this manner, the monetary reserves of a country³ may be defined as the assets which its authorities have available to meet payments to other countries. The nature and ownership of these funds may be quite varied. The two tests of the reserve, or near-reserve, character of any item which may be in doubt are, first, its availability to the monetary authorities of the country in case of need and, second, its acceptability by potential creditors.

Gold and currencies readily convertible into gold held by monetary authorities meet both of these tests perfectly and so form the core of the monetary reserves of most countries. Very short-term securities of countries with convertible currencies or private securities or bankers’ acceptances of unquestioned credit and short maturity payable in such currencies and held by the monetary authorities of other countries meet both tests about equally well. The same is true of gold and convertible currencies or of any of the above-mentioned assets held by commercial banks or other financial institutions in countries where such institutions are considered to be part of the “official family” and are closely accountable to the monetary authorities.

Other items that meet only one of the two tests may, depending on the country and the time, be equivalent to reserves as defined above, and for some purposes could be included in reserves. In any event, their availability in financing a deficit is an important factor in any consideration of the adequacy of reserves. For example, gold and convertible currencies and short-term securities held by others than the monetary authorities and their “official families” may in some countries and at some times function in much the same way as reserves. The holders may themselves use such assets to meet payments abroad, or they may sell such assets to the monetary authorities when required to do so by law or when induced to do so by financial considerations.

Apart from such assets, whose reserve character is diminished only by the fact that they are not held by the monetary authorities and their “official families”, there are assets held by the monetary authorities which can perform the deficit-financing function, although not so widely or so readily as gold and convertible currencies, including short-term securities. These assets include inconvertible currencies, credit balances in bilateral or multilateral payments agreements (as EPU), and debt-type securities (other than those already mentioned) payable in foreign currencies, whether convertible or inconvertible, and having an international market.

While access to foreign exchange under predetermined conditions cannot be regarded as reserves, such rights do perform some of the functions of reserves and affect the standard of adequacy of reserves. Standby agreements and the provisions for drawing needed currencies from the International Monetary Fund, the right to incur debit balances with the EPU or under bilateral payments agreements, and established lines of credit against which a foreign currency may be drawn all provide means of meeting balance of payments deficits.

Some countries include stocks of silver and precious stones in their monetary reserves under the provisions of their national laws. These assets are not reserves in the meaning of the term used here, because they are not readily salable at an approximately predetermined price. They may, nevertheless, be salable abroad and could be used to secure additional foreign exchange when necessary. This may also be true of other commodities readily salable in international markets and of equity securities similarly salable. The possession of such assets by the monetary authorities or by others may affect the level of what may be regarded as adequate reserves, even if they are not included in a definition of reserves.

Monetary reserves, however they may be calculated, may be stated at their full gross amount or they may be stated “net” after subtraction of liabilities on account of which near-term payments may have to be made to foreigners—as, for example, short-term debts of the government, the monetary authorities, or the banking and business communities, debit balances in clearing accounts, or foreign holdings of national currency.

As already noted, when it is necessary to give precision to the concept of monetary reserves, particular items (positive and sometimes negative) must be selected from the broad variety of reserve and near-reserve items just enumerated. Thus, a calculation of a member’s monetary reserves pursuant to specified standards is necessary to determine its obligation, if any, to repurchase its currency from the Fund. Such calculations are based on the definitions of terms in Article XIX of the Fund Agreement. Reserve comparisons in which the need for precision is primarily statistical, rather than legal, present similar problems. Thus, data on movements of monetary reserves are presented in the Fund’s annual Balance of Payments Yearbook, and data on their amount in its monthly publication, International Financial Statistics. Similarly, statistical comparisons of monetary reserves on several alternative bases are presented later in this paper. Each presentation or comparison helps in the understanding of over-all reserve adequacy. But any single basis of comparison can, at best, give only an approximation of the “real” amounts of the reserves actually available to the monetary authorities of each country in case of need.

The concept of adequacy

Adequacy of reserves depends on the prospective problems that confront a country and, therefore, will differ from country to country and from problem to problem. No amount of reserves can be adequate to finance a chronic or continuing imbalance in a country’s payments. Therefore, the problem of reserve adequacy can be discussed meaningfully only for those countries prepared to take appropriate measures to balance their external accounts over an entire cycle—but which may, nevertheless, encounter substantial payments deficits in some years, or even occasionally for several years together.

It is obvious that this fundamental assumption of a strong and balanced payments position over the course of a cycle, which is essential for determining the adequacy of reserves for the only purpose for which reserves can ever be adequate, that is, to meet temporary needs, is not generally or even widely met by the situation currently prevailing. Some countries have failed to establish their exchange rates at appropriate levels, and other countries have been so concerned over assuring full employment or rapid economic development that their monetary policies have been too expansionist to enable them to bring their international payments into balance without severe exchange and import restrictions. Unless such countries are prepared to moderate their monetary policies, and, if necessary, readjust their exchange rates, they will be under steady pressure in their international payments, and they will necessarily find that their reserves are inadequate to establish and maintain multilateral trade without widespread and continuing restrictions and discriminations.

While satisfactory fiscal and monetary policies are indispensable to establishing a strong payments position, it does not follow that a country with noninflationary fiscal and monetary policies and an appropriate exchange rate will inevitably have a strong payments position. The international payments position of a country is affected not only by its own policies, but also by those of the countries with which it trades. An inflationary fiscal or monetary policy or an unsatisfactory exchange rate in another country may cut off the flow of imports from customary sources and force the country to seek other sources of supply. And a restrictive import or exchange policy in another country with inflationary fiscal or monetary policies or an unsatisfactory exchange rate may make it difficult for a country with sound policies to maintain its exports and to earn the gold, dollars, or foreign exchange which it could secure under better conditions. No doubt, with severely rigorous policies and a far-reaching shift in the pattern of production, a country may offset the effects of bad policies of its trading partners. But that is a costly step which countries will seek to avoid as long as there is hope of securing better policies elsewhere.

It must be pointed out, furthermore, that the magnitude of the task of establishing a strong payments position which confronts countries with a tendency toward deficit in their international accounts will be importantly affected by the policies of countries with a tendency toward surplus. This applies most clearly to the commercial policies of the surplus countries. The deficit countries want to buy—and, in some cases, desperately need—the exports of the surplus countries; but, as the deficit countries have no monetary reserves to spare, they can pay for the exports of the surplus countries only with their own goods. If the surplus countries place or maintain onerous trade barriers on the receipt of these goods, the effect must be a general lowering of the level of world trade to the mutual impoverishment of both groups of countries.

Particular attention should be called to restrictions of the “escape clause” or “peril point” type—which, in effect, serve notice on countries endeavoring to increase their sales in the markets of the surplus countries using them, or endeavoring to break into such markets with new types of goods, that success in such efforts may result merely in an increase in trade barriers sufficient to restore the earlier (low) trade volume. Where such attempts involve substantial investment in specialized plant or equipment or specialized inventories or involve substantial advertising, the value of which would be lost if the attempts should fail, the existence of “escape clause” or “peril point” provisions may often be a sufficient obstacle to prevent serious attempts at materially increasing sales from being made at all.

In addition to policies with respect to trade barriers, the surplus countries’ policies with respect to stockpiling may make an important difference in the situations of countries with serious balance of payments problems. Changes in stockpiling policies, which may mean relatively little to the surplus countries pursuing them, may make a vital difference in the economies, and even in the social and political orientation, of hard-pressed raw material producing countries.

The investment policies of the surplus countries can also do much to ease the payments problems of underdeveloped countries. A flow of capital on a commercial basis from regions where it is relatively abundant to those where it is relatively scarce—and, consequently, of high productivity—is justified by investment considerations alone and is in the mutual interest of both the lending and the borrowing countries.

But most important of all are the policies of the surplus countries with respect to their domestic levels of activity. Experience has shown that, in the United States in particular, the level of industrial activity is a far more important determinant of import volume than is commercial policy. Even a moderate slump in the United States would place a substantial strain on the economies and balance of payments positions of other countries, particularly producers of raw materials. Some fluctuation in U.S. business volume is inevitable, and countries exporting to the United States must allow for it in their calculations of what they can “afford” to import over a normal cycle. But they cannot and should not be expected to make similar provision for a period of severe depression and mass unemployment in the United States. Just as no amount of reserves can be adequate to sustain a chronic deficit due to their own inappropriate policies, so no practicable amount of reserves can be adequate to maintain convertibility without discriminatory exchange restrictions in the event of a major depression in the United States. Provision against this contingency can be made only by the United States itself through domestic and international policies aimed at preventing the occurrence or continuance of the depression.

Let us consider a country which has established a balanced payments position. That is, through a period covering prosperity and depression—but not a deep or prolonged depression—its receipts are adequate to meet its payments. The exchange rate is correct, the monetary policy is correct, and restrictions and discriminations continuing throughout the cycle are not needed to shore up the payments position. For such a country, what is an adequate level of reserves? Four standards, each more rigorous than the preceding, can be suggested:

• 1. Enough to enable a country in bad years, by resort to restrictions, to maintain its external debt payments and to purchase the goods and services necessary to avoid hardship to its population or dislocation to its economy and the possible emergence of an exchange crisis, i.e., to permit a reasonable distribution over time of the payments which it can afford to make over the entire cycle;

• 2. Enough to maintain currency convertibility, barring a severe depression, but with occasional necessity to resort to trade and exchange restrictions for balance of payments purposes;

• 3. Enough to maintain currency convertibility, barring a severe depression, but without the necessity for occasional resort to trade and exchange restrictions;

• 4. Enough to maintain currency convertibility, even through severe depressions (but not through prolonged periods of international deflation such as occurred in the thirties), without either the necessity for occasional resort to trade and exchange restrictions or the necessity for resorting to domestic deflationary policies for the purpose of restraining imports, even if this involves a substantial drain on reserves.

It may be helpful to list some of the principal factors which must be taken into account in determining the “adequacy” category in which a given amount of reserves (expressed as a proportion of its trade) may place a country pursuing appropriate exchange rate and domestic financial policies. Without attempting to arrange them in order of importance (which would, in any event, vary greatly from country to country and from time to time), these factors may be listed as follows:

• 1. The normal seasonal variation in the country’s imports and exports and in the service items in its balance of payments;

• 2. The extent to which the volume of its imports and exports is subject to extraordinary variation because of natural or other factors, e.g., crop failures, political or economic changes elsewhere, etc.;

• 3. The variability in the prices of its imports and in the prices of and demand for its exports;

• 4. The extent to which the country is dependent on imported raw materials, equipment, and essential foodstuffs to avoid dislocation of its economy or undue hardships to its population;

• 5. The size of its inventories of export goods and their components, and of import goods and their products, and the extent to which these inventories could be compressed without hardship in the event of pressure on the country’s reserve position;

• 6. The extent, if any, to which the country may expect adverse changes in its reserve position to be offset by “equilibrating” movements of short-term credit;

• 7. The prospect that the supply of reserves can be supplemented by grants-in-aid or long-term loans from other countries;

• 8. The extent to which the use, for international purposes, of actual holdings of reserve-type assets may be prevented by legal or other restrictions.

The first three factors (each dealing with variations in the amount and value of a country’s imports and exports) and the fourth (dealing with its need for imports) are the most fundamental in the list, and can be altered by the country itself only by basic changes in the structure of its economy.

The fifth factor deals with inventories. It has already been suggested that stocks of goods readily salable on international markets might be considered to have an important bearing on the adequacy of a country’s holdings of the more conventional type of reserves. When used in this sense, the concept of inventories may be enlarged to include both stocks of materials entering into the production of export goods and import goods and their derivative products. All such inventories permit either exports to be expanded for a while or imports to be contracted for a while, in case of necessity, thereby easing strains on reserves. The reciprocal relationship between inventories and reserves appears most clearly during periods when reserves are being run down to build up inventories or during periods when reserves are being increased or maintained only at the expense of inventory run-downs. In such cases the combined changes in holdings of reserves plus inventories may give a better clue to a country’s real external position than either of these quantities taken separately.

The sixth factor enumerated above is short-term credit movements. At one time short-term credit movements were extremely important as means of supplementing the reserves of individual countries, and so as means for making smaller amounts of reserves go further. In the environment which has prevailed during most of the period since the beginning of the depression of the thirties, however, short-term credit movements have been, on the whole, of a disequilibrating rather than of an equilibrating character for most countries—although they still operate to the advantage of countries with substantial amounts of mobile capital, in the event of temporary stringencies in their payments positions. It should be noted in this connection that there has been a great shrinkage during the past generation in the amount of one of the most important types of short-term international credit; bankers’ acceptances created for the purpose of financing international trade, the outstanding amount of which ranged between the equivalent of $2 billion and $3 billion in the late twenties, have now very largely disappeared.

The seventh of the enumerated factors is the prospect that the balance of payments receipts of a country from other sources will be supplemented by long-term loans or grants-in-aid from other countries. Long-term loans are an important factor affecting reserve positions. Throughout most of the nineteenth century and well into the twentieth century, the United Kingdom and some other European countries were fairly consistent exporters of capital. When these countries were confronted with reserve stringencies they could often adjust their positions merely by cutting down on the outflow of long-term capital or by ceasing to export capital altogether. The capital exported by Europe was an important factor in the economic development of the newer countries. Long-term capital flows were not necessarily happy as far as their effects on the year-to-year reserve positions of the newer countries were concerned, however, as these countries often adjusted their levels of imports, exports, and reserves to an expected inflow of long-term capital and then suffered reserve crises whenever such inflows were suspended. But those newer countries with strong credit positions were often able to replenish their reserves in time of need by floating long-term loans for that purpose. The long-term capital movements brought about by such loans were decidedly equilibrating in character for the newer countries. Unfortunately, the possibility of floating such loans is much less today than it was even a few years ago, and the necessity of maintaining reserves is correspondingly greater.

The possibility of a deficit country receiving a grant-in-aid is principally a post-World War II development. Most grants-in-aid during the postwar period have been for the purpose of meeting balance of payments deficits arising from the physical devastation and disruption of trade and financial relationships caused by the war. Countries still in need of such grants are clearly in too weak a payments position to fall within the orbit of any of the categories of reserve adequacy used in this paper. Their problems are payments problems, not reserve problems. More recently, however, most grants have been for defense purposes. Such grants may be considered as part of the mechanism for financing the cost of a mutual defense system in which each country contributes resources, human and material, in proportion to its ability and situation. It seems proper, therefore, that the prospect of receiving such grants should be taken into consideration, along with other types of prospective balance of payments receipts, in determining the adequacy of the reserves of the recipient countries.

The eighth, and last, factor enumerated above is the extent to which the use for international purposes of the reserve-type assets actually held by the monetary authorities is restricted by law or custom. The laws of many countries require that the authorities hold reserve-type assets equal to a stipulated proportion of the outstanding currency or some other objectively determined criterion. The effect of such laws is to reduce the adequacy for international purposes of any given amount of total holdings of reserve-type assets. The same effect may be produced in the absence of law if the climate of public opinion in a country is such that the holding of some minimum amount of gold or of other reserve-type assets is considered a practical necessity by the monetary authorities.

Reserves and confidence

The discussion thus far has proceeded on the implicit assumption that reserves are meant to be used and that, except as qualified in the immediately preceding paragraph, all reserves are, in fact, available for use. Neither of these assumptions is strictly true in a world in which uncertainty is, and will continue to be, a major factor in all economic calculations. In practice, if they are to fulfill their functions efficiently, reserves must be considerably larger than would be indicated by any reasonable evaluation of the probabilities of their actual use.

Assume, for example, that $500 million is the most pessimistic estimate of the amount of reserves which a country might reasonably need to meet an existing current account deficit before the deficit would either halt of its own accord or could be halted by the adoption of appropriate policies. (It is assumed, for convenience, that capital transfers are controlled and that this control is tolerably well enforced.) Assume, also, that the country’s reserves are of just the amount necessary to meet the maximum expected deficit—namely, $500 million. This amount, despite its superficial appearance of adequacy, will prove inadequate if the pessimistic possibilities are actually realized. This follows from the fact that, in spite of prior estimates, no one will know how far the adverse balance of payments will actually run; consequently, if reserves run low, traders will lose confidence in their adequacy and will take steps to protect their positions. These steps—such as stockpiling beyond ordinary requirements, expediting payments for imports, and delaying the receipt of payments for exports—will involve additional reserve drains which would not have occurred at all if reserves had been truly adequate. As a consequence, a reserve run-down which would have amounted to only $500 million if reserves had been, say, $1 billion, may result in a serious exchange crisis if reserves are actually only $500 million.

It follows that, in order to avoid the intermittent imposition of trade and exchange restrictions, reserves must be larger than any allowable current account deficit in order to maintain confidence and so hold down outpayments to the actual amount of the deficit. To secure the required confidence, it is necessary that there always be available, even at the very bottom of the cycle, a substantial volume of additional reserves which are uncommitted and available for immediate use.

Confidence, however, is a two-way street. Just as larger reserves promote confidence in a country’s situation and so may make their use unnecessary, so confidence in a country’s situation—and in its willingness to pursue appropriate policies—reduces the amount of reserves necessary to sustain this confidence. In the long run, the effect of “underlying” confidence upon the amount of necessary reserves is probably more important than the effect of adequate reserves upon confidence. The classic example, of course, is the United Kingdom before World War I, when London was the undisputed financial center of the world and operated on a minimal reserve base. At that time, other countries were able to hold a large portion of their reserves in sterling with full confidence in the universal acceptability of sterling which made it the practical equivalent of gold.

Over-all evaluations of reserve adequacy

The factors that determine the adequacy of reserves are not, in practice, precisely measurable. Basically, therefore, the adequacy of reserves is a matter of judgment—depending on the country, on the time, and on the purpose for which the reserves are intended. Furthermore, the prevalent opinion of the international business community concerning the adequacy of each country’s reserves is itself a factor in determining their “real” adequacy—so that, in one sense, the reserves of a country are not adequate until the public thinks that they are adequate. Such opinions, it should be noted, are likely to be based as much on the trend in a country’s reserve position as on its absolute amount; a moderate reserve position, well maintained, is likely to give an impression of greater adequacy than a large reserve position which has been rapidly declining, with no end clearly in sight.

That the adequacy of reserves cannot be precisely measured gives rise to the corollary that significant decisions depending in part upon reserve adequacy—e.g., decisions to impose or to relax exchange restrictions, to tighten or to relax monetary and fiscal policies, or to alter exchange rates—are based on the opinions of the relevant authorities, national and international, concerning this adequacy. The opinions of these authorities are seen most clearly by their actions in the field of international financial policy. For example, the decision of the Canadian authorities in late 1951 to eliminate all exchange controls expressed more clearly than words their opinion that their payments position had become strong and could be maintained strong, with their level of reserves, by appropriate monetary policies and a fluctuating rate of exchange—an opinion amply justified by the developments of the succeeding period.

It is much more difficult to draw conclusions from the actions of the authorities in the fields of monetary and fiscal policy. This is because actions in these fields are often determined with greater reference to their domestic than to their international effects. For example, the restrictive actions of the U.S. monetary authorities in 1951 and 1952 (which commenced during a period of heavy gold outflow) were undertaken for purely domestic reasons and not because of anxiety concerning the adequacy of the international reserves of the United States. Such inferences may be drawn more reasonably, however, with respect to actions in countries where international trade comprises a larger proportion of total activity. For example, it is probably not inaccurate to say that the relaxation in the rigor of monetary policy in the Federal Republic of Germany, Belgium, and the Netherlands during 1952 reflected in large part a lower degree of concern by the authorities in these countries with respect to the adequacy of their monetary reserves.

Reserves and total resources

An adequate reserve position permits both the monetary authorities and the private traders of a country to look ahead and to plan their affairs with confidence. When reserves are inadequate, a country’s foreign trade may be subject to sudden starts and stops, as restrictions are imposed or relaxed, or its exchange rate may fluctuate sharply. In whatever way imports are suddenly restricted below the level suited to the economy under a strong payments position, the result may be a serious dislocation of the economy.

It must not be overlooked that reserves are real resources from the point of view of the countries holding them, and the holding of reserves is only one of the possible uses competing for the limited amount of resources at the disposal of each country. In a rich country, or in a country in which there is little prospect of economic development, the maintenance of an adequate reserve position may necessitate no practical sacrifice. In a poor country, however, or in one in which the tempo of economic development is greater than can be accommodated by available resources, the maintenance of an adequate reserve position may be at the expense of urgently needed industrial or agricultural equipment, or may even entail some hardship due to shortages of food or of other consumers’ goods which might have been imported by using a portion of its reserves. It is inevitable, therefore, that poor and dynamic countries are tempted to sacrifice their reserve positions in favor of other uses of their real resources which they consider more urgent. This may often be sound policy. Indeed, such a transfer of resources would occur as a result of the operation of natural economic forces in the absence of state intervention, as it is of the essence of economics so to economize on scarce resources that the last unit employed in each use has an equal utility. If a country can improve its over-all position by transferring a portion of even an inadequate supply of reserves to some yet more urgent use, it is fully justified in doing so. On the other hand, countries may underestimate the real losses incurred because of inadequate reserves and so may tend to hold less reserves than they should, in their own interest.

In this respect, the reserves of countries have been compared with those of individuals. The monetary reserves of individuals (principally cash balances) serve much the same purposes as those of countries. They protect the individual’s consumption from fluctuations in the amount and timing of his income, permit him to minimize his total outpayments by taking advantage of cash discounts, and allow him to prevent unfavorable developments in his situation from being magnified in their consequences because of the lack of adequate finances for dealing with them promptly. But, for individuals as well as for nations, monetary reserves are only one of a number of possible uses of resources competing for priority. Consequently, wealthy persons or persons with relatively few undertakings (although their incomes may fluctuate but little) are more likely than poorer or more active persons (although their incomes may fluctuate widely) to provide fully for reserves.

Therefore, it is normal to find, both for wealthy or more settled persons and for wealthy or more settled nations, that reserves are much larger in proportion to the apparent need for them than are the reserves of poorer or more dynamic individuals or of poorer or more dynamic nations. This tendency, at least on the international level, is often described as a “maldistribution of reserves”. However, a high degree of maldistribution is normal and would reassert itself even if the reserves were redistributed—for, the poorer or more dynamic countries would apply part of their newly acquired reserves to higher priority uses, and the reserves disposed of in this way would return to the more wealthy or more settled countries. Of course, it does not follow that any given degree of maldistribution of reserves is compatible with a stable structure of world payments. An extremely high degree of maldistribution can, however, be corrected by appropriate changes in monetary and fiscal policies in low-reserve countries. The adjustment can be made gradual, although protracted, if the newly mined gold is added to the reserves of the countries with the greatest reserve deficiency. But the period of adjustment can be shortened and its unavoidable cost in terms of deflationary pressure on the economy can be lightened by liberalization of commercial and external investment policies on the part of high-reserve countries.

Interaction of reserves and policy

As already noted, reserves and policy interact on one another, the strength of the interaction varying with the importance of foreign trade in a country’s total economy. Restrictive policies result in the accumulation of reserves, while adequate reserves tend to modify and soften policies. When world-wide inflationary and deflationary pressures are in balance, this interaction between reserves and policy tends to work out well and promotes a well-balanced distribution of the available reserves among the trading countries of the world in the light of their preference for reserves and other types of investment.

If no fundamental change in the basis of monetary standards is assumed, the world supply of reserves may be increased (1) by additions to the volume or value of the world monetary gold stock, or (2) by the creation of new international assets and contra-liabilities of such a character that the creditors will consider their asset holdings as part of their reserves, but the debtors will make no corresponding deduction of their liabilities in the calculation of their own reserve positions. Aside from changes in the world supply of reserves, all reserves gained by one country must be at the expense of another. Some year-by-year increase in the total stock of reserves is necessary in order to maintain an expanding volume of world trade and stable prices. An expansion of this magnitude in the world stock of reserves tends to promote sound policies, and countries pursuing sound policies tend to secure an appropriate share of the total available reserves. Indeed, a country can be said to have a strong payments position only when it is acquiring such an appropriate share of newly created reserves. On the other hand, a too rapid increase in the world stock of monetary reserves tends to promote inflationary policies generally and in individual countries, while an increase of less than the optimum amount (or a decrease) tends to promote deflationary policies.

These observations are, of course, true only when a number of years are taken into consideration. In a single year, or even for several years, characterized by general expansionary psychology, a stationary stock of reserves (or even a declining one) may be compatible with expanding trade and price stability. On the other hand, in a year, or series of years, characterized by general deflationary psychology, an extraordinarily large expansion in reserves may be necessary to support price stability and a continuing expansion in world trade.

Finally, it should be noted that the response of a country to an increase in its reserves or to an improvement in its balance of payments position is not likely to consist wholly in a relaxation or elimination of trade and exchange restrictions. It may consist wholly—and will probably consist partially—in a relaxation of its domestic fiscal and monetary policies. A general improvement in reserve positions during a time of world-wide inflationary pressures is likely, therefore, to reinforce those pressures.

Reserves and the growth of world trade

The necessary increment to reserves, if inadequacy of reserves is not to hamper the growth of multilateral trade, will depend primarily on the rate at which trade can grow. This in turn depends in large part on the growth of production throughout the world. Support of an appropriate rate of growth in world trade depends on the annual increment to the world’s monetary gold stock and on other types of reserve assets created by national monetary systems and through the instrumentality of international agencies.

Newly mined gold is the principal source from which increments to gold reserves must be made. Unless this gold is in large part accumulated by the monetary authorities, it will not be effective in enabling countries to meet their needs for reserves. The increment to monetary gold stocks has been low in most postwar years. Monetary and exchange policies that leave doubt as to the future value of national currencies tend to divert newly mined gold into private hoards rather than into central holdings. Furthermore, little will be accomplished in securing adequate reserves for most countries for the future if all newly mined gold is regarded as an easy means of meeting continuing balance of payments deficits. Under such conditions, the newly mined gold will simply be concentrated in the reserves of a very few creditor countries, while the reserves of the rest of the world will be inadequate. A basic condition for adequate reserves in the long run is the maintenance of monetary and exchange policies that will enable countries not only to balance their international payments, but also to add part of the newly mined gold to their monetary reserves.

Adequacy of particular types of reserves

As already noted, assets are useful for reserve purposes only to the extent that they are acceptable for the external payments which the reserve holding country must meet. Before the depression of the thirties—when most currencies were convertible either through the medium of buying and selling prices for gold or foreign exchange maintained by the monetary authorities of the issuing countries, or by the purchase and sale of exchange in the market place—most currencies could be held for reserve purposes, subject to the qualification that holdings of currencies with fluctuating exchange rates involved greater risk than holdings of currencies with fixed exchange rates. Since the onset of the depression, and particularly since the end of World War II, a large number of currencies have become inconvertible and can no longer be legally exchanged (either officially or through the market place) by the monetary authorities of the countries holding them for such other currencies as they may need to meet their external payments. As a consequence, the reserve problem—which once could be viewed as a whole—has tended to break into fragments, and a country may now be short of reserves in some currencies but have a surplus of them in others.

Reserves and the spread of depression

A function of reserves upon which considerable emphasis was placed in the planning for the postwar period is that of preventing the spread of depression from one country to another. A depression in any country will tend to reduce its imports, as these are related more or less closely to its national income. Hence, a depression in an important country will tend to reduce substantially the exports of other countries. If these countries maintain their imports, they will deplete their monetary reserves; if they do not, the exports of other countries will be reduced further and so the depression will tend to spread in an ever widening circle. One of the principal purposes of the International Monetary Fund is to combat this mechanism for the international spread of depressions.

The amount of reserves necessary to prevent the spread of a depression depends upon the duration and intensity of the depression in the country of primary origin and the importance of that country in world trade. Even a minor depression in an important trading country, such as the United States, may have serious consequences in some other countries. If the depression is deep and protracted at its point of origin, the amount of monetary reserves necessary to prevent its spread may become indefinitely large. If such reserves should be supplied entirely by the Fund and be subject to reasonably firm undertakings with respect to their repayment in the foreseeable future, they might not be able—however large the amount available—to check the spread of a severe depression, because many countries would probably contract their imports (and so other countries’ exports) substantially, rather than pile up large debts which they saw no prospects of repaying. The problem presented by such conditions is referred to later in this paper (pp. 219–21).