Effects of Various Types of Fund Reserve Creation on Fund Liquidity

1. In this paper, an attempt is made to arrive at a rough quantification of the possible effects of various techniques of reserve creation through the Fund on the Fund's own liquidity. The techniques considered are as follows:

Abstract

1. In this paper, an attempt is made to arrive at a rough quantification of the possible effects of various techniques of reserve creation through the Fund on the Fund's own liquidity. The techniques considered are as follows:

Summary

1. In this paper, an attempt is made to arrive at a rough quantification of the possible effects of various techniques of reserve creation through the Fund on the Fund's own liquidity. The techniques considered are as follows:

(a) extension of quasi-automatic drawing rights beyond the gold tranche for (i) all Fund members, (ii) members whose currencies are normally drawable, and (iii) other members;

(b) other changes in Fund policy leading to increased drawings; and

(c) Fund investment or acquisition of special assets with (i) the currencies of all Fund members, (ii) currencies that are normally drawable, and (iii) gold.

2. For purposes of comparison, the additional needs for Fund resources arising, respectively, from the several techniques of reserve creation are expressed in terms of the amounts of the currencies that are normally suitable for drawing, distributed in proportion to quota, to which the Fund would have to secure access (whether by subscription or by lines of credit) in order to cover the additional needs in question.

3. Such resources may be required to permit the initial increase in reserves. But, in any case, they will be required to enable the reserves, once created, to be transferred from country to country by way of drawings on the Fund. The amount of resources required for this latter purpose is assessed in this paper on the basis of past experience at periods of peak use of Fund resources. The proportion of normally drawable currencies that is likely to be currently usable at periods of peak use of resources is established also on the basis of past experience. In view of the inevitably uncertain character of these and other assumptions employed, the quantitative estimates finally arrived at must be regarded as highly speculative, and as throwing more light on the comparative than on the absolute cost of creating reserves by the different methods.

Introduction

4. If international claims, of whatever kind, are to be created and maintained, countries must be willing to hold them in the required amount. If the claims held are to be sufficiently liquid to merit the name of reserves, they must be usable in settlement of payments deficits. For this purpose they must be directly or indirectly transferable to other countries where they will either add to those countries' assets or reduce their liabilities. If the aggregate amount of reserves is to be maintained, only the first of these alternatives is open. But this means that at any time a sufficient number of countries must be willing, at least within limits or under prescribed conditions, to acquire amounts of the reserve claims in question over and above the amounts which they actually hold. These requirements are apt to give rise to financing problems, the precise nature of which will depend on the manner in which the reserves are created and the ways in which they can be used.

5. When reserves are created by the Fund, their creation will in some instances (though not in all) involve a use of Fund resources and may affect the Fund's own liquidity. For example, any expansion of gold tranche positions in the strict sense (i.e., any increase in the amount by which the Fund's holdings of a currency fall short of 100 per cent of quota) would by definition reduce the Fund's holdings of that currency and consume one type of Fund resources. Again, any accumulation of loan claims on the Fund, if carried out under pre-established lines of credit, would reduce the unused portion of these lines of credit and thus consume another type of Fund resources. Finally, any transfer of gold from the Fund to national reserves would involve the use of a third type of Fund resources. In all these cases, the Fund would acquire other assets—in the form of investments, certificates, or currency holdings in the credit tranches—in exchange for the assets that have declined or the liabilities that have been increased, but, as we shall see, the assets acquired are unlikely to compensate to any substantial extent for the resources that have been lost. Reserve creation by the Fund does not, however, always affect Fund resources in the manner described above. For example, if quasi-automatic drawing facilities were expanded, not by increasing the magnitude of gold tranche positions as at present defined but by extending such drawing facilities beyond the gold tranche into the credit tranches, the creation of reserve positions would, initially at any rate, involve no use of Fund resources.

6. The transferability of reserves created by the Fund in the form of reserve positions in the Fund1 is at present assured indirectly by the right which the holders possess of converting them into usable currency by drawing on the Fund when they consider that they need to do so for balance of payments reasons. The countries whose currencies are thus drawn acquire additional reserve positions (gold tranche positions or loan positions) as the reserve positions of the drawing countries decline. Reserve positions in the Fund are thus, in effect, transferred through the procedure of drawing. The possibility that this sort of transfer will be required increases the amount of resources, in the various currencies liable to be drawn, that the Fund needs to maintain unused as a safety margin, and thus enhances the Fund's need for access to such resources.

7. It would, of course, be possible for an international arrangement to be made between Fund members, providing for the direct transferability of loan claims on the Fund (though not of gold tranche positions), thus relieving the Fund pro tanto of any need to maintain resources for this purpose. In order to provide for transferability outside the Fund, however, countries would have to assume the same sort of obligations with respect to the acceptance of transfer as would—if undertaken vis-à-vis the Fund—provide the latter with the resources enabling it to ensure the transferability of reserve positions through the Fund. If the Fund is to be in a position to convert loan claims upon itself into useful currency upon demand, it may have to safeguard its own liquidity by negotiating lines of credit up to given amounts with countries whose currencies are apt to be drawn. Analogously, if the holders of such loan claims are to be in a position to transfer them directly to other countries when they so desire, the latter will have to assume obligations to accept transfer of these claims up to amounts similar to those of the lines of credit which they would otherwise have granted to the Fund. There seems no reason why countries should find it easier to undertake to accept direct transference of such claims at the will of the transferor than to undertake, in the form of lines of credit, to accept indirect transference through the Fund. Indeed, the contrary is probably true, since indirect transfers can to some extent be steered by the Fund in such a way as to ensure that countries are not asked to accept an inequitably large share of such claims, or to acquire them at times when it might be embarrassing to do so.

8. The liquidity of the Fund is neither a simple nor a measurable concept. On one interpretation, the Fund might be said to be illiquid only if it were uncertain of its ability to honor its obligations to holders of loan claims or to meet the legitimate needs of members that wished to draw in accordance with prevailing Fund policies. This, however, implies a definition of liquidity too broad and too easily satisfied to be helpful in the present context. In a more meaningful sense, the Fund may be said to be illiquid if it cannot be certain of carrying out the obligations described above save by departing from its policies on currencies to be drawn or on the supply of international liquidity, e.g., by reducing the reserves or worsening the reserve composition of countries in an insecure payments position, or by unduly curtailing the aggregate amount of reserve positions in the Fund. This definition makes it clear that Fund liquidity cannot be measured by any simple ratio between a definite class of “assets” and a definite class of “liabilities.” In a general way, however, it has to do with the balance between, on the one hand, countries' rights to repayment of loans, their unused rights to draw under stand-by agreements, and other unused drawing facilities in the various tranches, and, on the other hand, Fund resources in the form of gold, currencies that are deemed suitable for drawing, and unused lines of credit available in such currencies, together with any “other possibilities” that the Fund may have of inducing countries to supply currencies to the Fund in exchange for the acquisition of loan claims on the latter. The other possibilities include “resources” of an unquantifiable character, such as those that would arise, for example, from open-ended commitments of countries to hold claims on the Fund in proportion to their total reserves, or from the Fund's ability to attract purely voluntary deposits in appropriate currencies. In the following discussion, however, these possibilities will be ignored, and it will be assumed, in order to facilitate quantitative estimation, that any resources that the Fund may require to meet the needs of reserve creation are made available to it in the form of access, through lines of credit or borrowing arrangements, to currencies that are normally suitable for drawing.

9. In what has been said about Fund liquidity, the Fund has been treated as a unified financial entity. In some schemes for creating reserves through Fund investment, it has been suggested that all the resources required for the creation and subsequent transfer of reserve positions in the Fund should be provided separately from the ordinary resources of the Fund. In such cases, the concept of over-all Fund liquidity would be replaced by a concept of the liquidity of the Ordinary Department and of the Investment Department of the Fund, respectively.

10. The effect on Fund liquidity, or—in the event of compartmentalization of Fund resources—on the liquidity of the relevant Department of the Fund, of any given amount of reserve creation will depend partly on the particular method by which reserves are created, partly on whether or not the creation of reserves is associated with the provision of additional resources, and partly on what the liquidity situation of the Fund, or the relevant Department thereof, would have been in the absence of the reserve creation. Whenever, in what follows, reference is made to the additional resources “required” to finance any given act of reserve creation by the Fund, this is to be understood in the sense of what would be required in the absence of any associated provision for the supply of additional resources, and on the assumption that in the absence of such reserve creation the Fund would enjoy no excess of resources over and above what it should prudently maintain to meet its existing commitments and responsibilities.

11. The cost, in terms of Fund resources, of reserve creation through the Fund is examined below for a number of specific techniques of reserve creation. The order in which the various techniques are considered is determined by convenience. Extension of quasi-automatic drawing rights beyond the gold tranche is considered first because, for this form of reserve creation, the experience of the Fund provides some indication, however uncertain, of the drain on Fund resources that might be involved. Other techniques follow in the order that seems most apt to facilitate comparison with what has gone before.

Extension of Automatism Beyond the Gold Tranche

12. First, then, let us consider the case in which the Fund extends quasi-automatic drawing facilities beyond the gold tranche by a uniform proportion of quota for all members, thus creating reserves for all members that had not drawn within the credit tranches, and, for members that had so drawn, advancing the point at which repurchases would begin to reconstitute reserve positions. It is assumed that, in order that additional drawing facilities should not contract as quasi-automatic drawing facilities expand, total drawing facilities would be increased pari passu with the increase in quasi-automatic facilities.

13. Since the creation of reserves by this technique would call for no acquisition or segregation of assets by the Fund, no use of Fund resources would be involved at the initial stage. The expansion of drawing facilities, however, would create a probability that future drawings would be greater, by different amounts at different times, than they would otherwise have been, and this probability would create an additional need for Fund resources. An impression of the possible magnitude of the additional need arising from these elements in combination may be derived from the Fund situation in periods of heavy use in the past. At the end of 1957, when drawings were higher in relation to quotas than they had been before or have been since, drawings outstanding in the gold tranche amounted to 45 per cent of gold tranches (see Table 2, p. 183).

Table 1.

Summary of Numerical Estimates

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In the figures in column (2), no account is taken of any economy of resources that might result from the possibility of emergency realization of investments, nor of any economy of reserves that might be possible as a result of the policies referred to in row (5).

Table 2.

Drawings Outstanding in Various Tranches, All Fund Member Countries, End of Year, 1956–64

(Quotas and drawings in millions of U.S. dollars)

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14. When it is recalled that reserve creation by the Fund—in this case in the form of an extension of quasi-automatic drawing rights—would take place only as the need for reserves increased, it is not unreasonable to assume that in periods of strain the addition to quasi-automatic drawing rights might also be drawn upon to the extent of 45 per cent. On the other hand, despite the fact that the amount of conditional facilities would remain unchanged, conditionality would begin to apply only at somewhat higher levels of drawings, and it cannot be assumed that the amount of drawings within the conditional range would be unaffected by this shift. To assume this would imply that all countries which would otherwise have drawn within the old range of conditional drawing facilities would now increase their outstanding drawings to the full extent of the addition to total drawing facilities, which is most improbable. If we assume that these countries (which in 1957 accounted for over 36 per cent of total quotas—see Table 5, p. 186) would expand their drawings, in years of strain, to half the extent of the additional drawing facilities, it may be estimated that, in a year like 1957, drawings outstanding in the conditional range would decline by over 18 per cent of the amount of the extension of quasi-automatic, and total, drawing rights.2 One may conclude that 25–30 per cent would be a reasonable estimate of the proportion of any given extension of quasi-automatic drawing rights that might result, in periods of strain, in additional drawings outstanding.3

Table 3.

Drawings Outstanding in Various Tranches, Fund Member Countries of Normally Drawable Currencies,1 End of Year, 1956–64

(Quotas and drawings in millions of U.S. dollars)

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The countries are Austria, Belgium, Canada, France, Federal Republic of Germany, Italy, Japan, Netherlands, Spain, Sweden, United Kingdom, and United States. Italy and Spain are not included for the years 1957–58 since they were not fully subscribed members.

Table 4.

Drawings Outstanding in Various Tranches, Fund Member Countries Other Than Countries of Normally Drawable Currencies, End of Year, 1956–64

(Quotas and drawings in millions of U.S. dollars)

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Table 5.

Proportion of Fund Quotas Held by Members Whose Currency Holdings by the Fund Exceed 100 Per Cent of Quota, End of Year, 1956–64

(Quotas in millions of U.S. dollars)

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15. These additional drawings would, of course, subtract from the Fund's holdings of currencies which at the time in question were suitable for drawing on a net basis.4 Since, however, some of the currencies normally suitable for drawing would probably—because of the balance of payments situation—be unsuitable for drawing at that time, the Fund would have to make sure in advance that it had access to an amount of such currencies exceeding the maximum amount of drawings that might reasonably be expected to occur. By what proportion the addition to resources needs to exceed the amount of additional drawings for which provision is made depends on the currency distribution of these additional resources in relation to the possible variations in the set of currencies deemed currently suitable for drawing. If it is assumed that any additional resources in the form of currency subscriptions and lines of credit would be made available in proportion to quotas by countries with normally drawable currencies, past experience would indicate that as much as 50 to 60 per cent of these might, at some critical time, be currently unsuitable for drawing. If, accordingly, we assume that only 45 per cent of the additional resources would, in fact, be suitable for use at times of maximum drawings, then, in order to cover additional drawings amounting to 25 to 30 per cent of the extension of automatic drawing facilities, it would be necessary to provide additional currency resources amounting to approximately 60 per cent (=25to3010010045) of the amount of the extension of facilities. If, on the other hand, the additional resources were provided in the form of gold, which could be used to purchase any given currency, then, of course, only an amount equal to the anticipated amount of drawings—i.e., 25 to 30 per cent of the drawing facilities—would be required.

16. These estimates do not purport to cover the maximum needs that could conceivably arise. It is theoretically conceivable that all countries but one would draw to the full amount of the additional drawing facilities, so that, of course, all drawings would be in that single currency. A calculation on this basis would lead to fantastically high estimates of the additional resources required.

17. Having estimated the amount of additional resources, expressed in terms of a representative selection of normally drawable currencies, that the Fund might require for each unit extension of quasi-automatic, and total, drawing rights, the next step is to estimate the amount of additional reserves that would be created for countries by each unit extension of such drawing rights. On the assumption, previously adopted, that quasi-automatic drawing rights would be extended into the credit tranches for all members in proportion to quotas, and that total drawing facilities would be correspondingly increased, the initial effect of a small extension of this kind would be to increase reserve positions in the Fund for all those members whose currencies were held by the Fund in amounts not exceeding 100 per cent of quota.5 Other members would, in effect, receive an enhancement of their conditional drawing facilities, as well as a reduction in the amount of repurchase to be made before they would begin to reconstitute reserve positions in the Fund. Table 5 (p. 186) shows that, on the average, in the nine years 1956–64 some 77 per cent of Fund quotas were held by members of whose currencies the Fund held not more than 100 per cent of quota. Therefore, a small extension of quasi-automatic drawing rights for all members in proportion to quotas might be expected to effect an initial expansion in reserves to the extent of some 77 per cent. As the border line between quasi-automatic and conditional drawing facilities moved upward from the 100 per cent point, the percentage of reserves initially created by any further small increase in quasi-automatic facilities would tend to increase.6

18. In addition to this initial increase in countries' reserves, there would be a secondary increase resulting from the addition to actual drawings associated with the extension of drawing facilities. Not all of these additional drawings would create additional reserve positions in the Fund; some would merely transfer such positions from the drawing to the drawee country. Only additional drawings made by those countries—estimated above as holders of (100 − 77 =) 23 per cent of quotas—whose additional drawing facilities were of the conditional variety would count for this purpose. On the assumption that in an average year countries with drawings outstanding in the credit tranches would increase their outstanding drawings by one third of the amount of their additional drawing facilities—as against one half in a peak year—the secondary reserve increase might be roughly estimated at 8 per cent (=1323100) of the total addition to drawing facilities. This would raise the total addition to reserves resulting from the extension of quasi-automatic drawing facilities within the credit tranches to some 85 per cent of the additional drawing rights.

19. It is of interest, for its own sake and for its bearing on later sections of this paper, to consider the effects of extending quasi-automatic, and total, drawing facilities, not for all Fund members but for special categories thereof, e.g., members whose currencies are normally drawable, or other members.7 In both cases, drawing rights are assumed to be extended among the members of the category in question in proportion to quota.

20. The propensity of countries whose currencies are normally drawable to draw from the Fund is, even at times of strain, slightly lower than that of members in general. In the past, the gold tranche drawings of countries whose currencies are normally drawable amounted, at the maximum attained in 1957, to 42 per cent of their gold tranches (see Table 3, p. 184). It may be assumed that a similar percentage of drawings outstanding would obtain in the new additional range of quasi-automatic drawing rights. From this figure, a deduction of 17 per cent should be made, for reasons analogous to those explained in paragraph 14 and footnote 2, above, to allow for the probable decline in drawings outstanding in the range of conditional drawing facilities.8 This leads to an estimate approximating 25 per cent of the extension of quasi-automatic, and total, drawing rights for possible additional drawings by the countries in question, at periods of strain. To ensure the availability at all times of currently drawable currencies to this amount would call for additional resources in normally drawable currencies equal to some 55 per cent of the amount by which drawing rights have been extended (2510010045); see paragraph 15.

21. While the additional need for Fund resources associated with an extension of quasi-automatic, and total, drawing rights would be proportionately a little less for countries of normally drawable currencies than for members in general, the accompanying increase in reserves would be somewhat larger. The countries in question are less often than other members in the position of having drawings outstanding beyond the gold tranche, so that a higher proportion of the additional drawing rights accruing to them would be effectively of the quasi-automatic, rather than the conditional, type. On the experience of the past nine years, the average reserve creation from this type of extension of quasi-automatic drawing rights would amount to some 90 per cent of the amount of the extension.9 The cost in resources to the Fund for each unit of reserves created would, therefore, be slightly lower if the extension of drawing rights were confined to countries of normally drawable currencies than if it were applied to all members.

22. The opposite, not surprisingly, holds true for the case in which quasi-automatic, and total, drawing rights are extended exclusively for members whose currencies are not normally drawable. For such countries, gold tranche drawings outstanding amounted in 1961 (the year when their drawings in the gold tranche were greatest) to over 60 per cent of gold tranches (see Table 4, p. 185). On the other hand, in that year approximately 50 per cent of the quotas of the countries in question were those of countries that had drawings outstanding in the credit tranches. By the method employed in paragraph 14 and footnote 2, therefore, and assuming that countries with drawings outstanding in the credit tranches use, in peak years, one half of their additional drawing rights, one would arrive at an estimate for possible use of additional quasi-automatic, and total, drawing facilities for such countries of over (60502=) 35 per cent. When the usual multiplier, 10045, is applied, the Fund's additional need for resources in normally drawable currencies would amount to approximately 80 per cent.10

23. The reserve creation involved in extending quasi-automatic, and total, drawing rights to countries whose currencies are not normally drawn is much less than it is for countries of normally drawable currencies. On the average of the past nine years, only 61 per cent of the former did not have drawings outstanding in the credit tranches. If we assume that those that had such drawings outstanding would use, in an average year, one third of their additional drawing rights, the total reserve creation would be some 75 per cent of the addition to drawing rights.11

Changes in Fund Drawing Policies Other than Expansion of Automatic Drawing Rights

24. Reserve creation through a change in Fund drawing policies other than the expansion of automatic drawing rights would be the costliest of all the methods of reserve creation through the Fund in terms of resource requirement for each unit of reserves created. Such a change in Fund policies (e.g., an extension of average period of repurchase on Fund drawings) could not be deemed, in itself and in advance of any resultant addition to drawings, to constitute an enhancement of reserves or unconditional liquidity, though an increase in conditional liquidity might sometimes be involved. Additional reserves, in the strict sense, would arise only from the addition to drawings and hence to gold tranche positions and/or loan positions in the Fund. The amount of this addition to drawings and reserves would, of course, fluctuate over time, so that the largest amount of drawings, which determines the amount of resources required, would exceed the average of drawings and of reserves created. This largest amount of drawings must itself be multiplied by the usual ratio, 10045, to yield an estimate of the additional resources of normally drawable currencies that would be needed.

25. Over the last nine years the peak of drawings outstanding in the credit tranches exceeded average drawings by 45 per cent. On this basis, we may estimate the additional resources needed at (10045145=) 320 per cent of the average amount of reserves created by this technique. This result, however, may be misleading. Insofar as the change in drawing policies would involve an increase in conditional liquidity, and insofar as this increase in conditional liquidity was considered by members to be at least a partial substitute for reserves, there is a sense in which the change in policies could be said to be “creating” reserves. An upper limit to the resources cost for each unit of reserves created is, therefore, 320 per cent.

Across-the-Board Investment with Investee Currency

26. The resource requirements associated with other forms of reserve creation through the Fund can be estimated on the basis of those arising from the technique first discussed (the extension of automatism beyond the gold tranche). In order to facilitate comparison, it is convenient to begin with the case in which reserves would be created by the Fund's investing in all member countries, in proportion to quotas, using for this purpose its holdings of the currencies of the countries of investment.12

27. The immediate effect would be to deplete the Fund's stock of normally drawable currencies by an amount equal to its investment in the countries issuing them. At the present time, such countries account for 65 per cent of total quotas, so that the depletion would constitute some 65 per cent of the amount invested. It is assumed that the reserve positions thus created in the Fund would remain in their initial country distribution except to the extent that they were drawn upon from time to time to meet balance of payments difficulties, and later reconstituted. (The effect of such additional drawings is discussed below.) The need for additional resources to cover this initial drain of normally drawable currencies can, therefore, be estimated, without the use of any multiplier, at 65 per cent of the amount invested. This loss of resources is one that would have no counterpart in reserve creation through the extension of automatic drawing facilities. On the other hand, since the countries of normally drawable currencies would be relieved, to the extent of the investment, of the possibility that their currencies might be used by the Fund for future drawings, they could afford, without any new hazard to their reserves of gold and foreign exchange, to restore this possibility by providing additional resources, in the form of lines of credit or otherwise, to the Fund.

28. The amount of reserves, in the form of gold tranche positions or loan positions, initially created as a result of a small amount, x, of across-the-board investment of this sort would be the same as that initially created through an amount, x, of across-the-board extension of quasi-automatic, and total, drawing facilities. Indeed, each country would have the same addition to the same kind of unused drawing facilities—if not quasi-automatic facilities then conditional facilities of the first-credit-tranche type, or conditional facilities of the higher-credit-tranche type—in the former as in the latter case.13 It is, therefore, reasonable to suppose that the additional drawings resulting from the creation of reserves through across-the-board investment would be much the same in amount and distribution as those resulting from the extension of quasi-automatic drawing facilities. The loss of resources in the form of normally drawable currencies involved in the investment itself, amounting to some 65 per cent of x, would therefore be supplemented by an increased need for such resources amounting (as in the extension of automatism) to some 60 per cent of x.14 The total drain would, therefore, amount to some 125 per cent of x.

29. In this calculation, no account has been taken of the argument that insofar as investments were of a short-term character and repayable in drawable currency they might themselves be regarded, to some extent, as substitutes, from a Fund standpoint, for holdings of such currency, and thus as reducing the need for extra resources in the form of subscriptions or lines of credit. This argument cannot be accepted without important qualifications. If the Fund financed a drawing out of its currency holdings, the country whose currency was drawn would add to its reserve position in the Fund, though it might lose reserves, up to a corresponding amount, in other forms. If the Fund financed a drawing out of its gold stocks, the country whose currency was drawn and replenished with gold would maintain intact its total reserves of gold and foreign exchange. But if the Fund financed a drawing by realizing an investment, the country of investment would suffer an outright loss in reserves—a decline in liquidity by no means fully compensated by the decline in its investment liability to the Fund. Therefore, the Fund would have to be even more careful to confine such withdrawals of investment to countries in a strong payments position than it would be to confine drawings to the currencies of such countries. Its investments, no matter how liquid in form, would have to be regarded as imperfect substitutes, from the standpoint of the Fund's own liquidity, even for holdings of normally drawable currencies, and still more imperfect as substitutes for gold. Moreover, as the amount of reserves that had been created by Fund investment increased, the proportion of such investment that could be withdrawn with impunity would decline. Surplus countries that would find little difficulty about financing a small part of their surplus by the repayment to the Fund of an investment rather than by the accumulation of reserves (including reserve positions with the Fund) might find it intolerable to do so if the amount became too large. And, more generally, countries that would not mind losing a limited amount of reserves through the repayment of investments might have strong objections to losing large amounts.

30. For investee countries, the hazards to which they would be exposed—of having Fund investments withdrawn when they were in payments surplus—would, of course, be much more tolerable if they could rely on the investments being reconstituted should they move into a less favorable payments position. Such a policy, however, would import balance of payments considerations into the distribution of investments—a feature which should probably be kept out of the process of deliberate reserve creation, as far as possible.

31. The appropriateness of basing the Fund's own liquidity on the possibility of realizing investments at times of strain should also be considered in its bearing on the objective for which the investment was undertaken in the first place, viz., the creation of country reserves. If, at any time, it were deemed desirable to contract the over-all level of these reserves, the realization of investments would be unobjectionable, and a certain proportion of investments should always be kept in liquid form for this purpose. But realization of investment at other times would be more questionable. It might be argued that, if investments were sold only at times when the Fund required resources to finance an exceptional demand for ordinary drawings, no absolute contraction of country reserves need take place. All that would happen would be that reserves, in the form of Fund positions, would fail to expand as they normally do at periods of peak drawings. This, however, would mean giving up a valuable source of flexibility in the provision of reserves. Instead of reserves expanding when payments disequilibria and drawings on the Fund increased, existing reserves would be made to work harder—something that would be acceptable only up to a point.

32. We have seen (in paragraph 28) that both the initial creation of reserves and the consequential drawings would be the same in across-the-board investment with investee currency as in across-the-board extension of quasi-automatic, and total, drawing rights. This would also hold true of that part of consequential drawings which took place in the range of conditional drawing facilities. The secondary creation of reserves resulting from such drawings would, therefore, also be the same in the two cases. Total reserve creation from the type of investment now under consideration may, therefore, be put at 80 to 85 per cent of the amount invested (see paragraph 18).

33. Apart from the possibility of realizing investments in times of emergency, it would be of little importance from the standpoint of Fund liquidity in which countries the investments were made. Nor would it matter whether the investments were carried out in the currencies of the recipient countries, or in other currencies, across-the-board or selectively. All that would matter would be the set of currencies with which the investments were made. This is what would determine the currencies that would be withdrawn from the Fund at the time of investment, the countries that would acquire additional reserve positions in the Fund, and hence the magnitude of the potential drawings associated with the additional reserve positions. Again, if we may assume that each country's willingness to hold foreign exchange in its reserves is determined by the size of its over-all reserves (other than reserve positions in the Fund), the total amount of reserves created by a given amount of Fund investment with a given set of currencies would be much the same irrespective of which country receives which currency, and even irrespective of the geographical distribution of the investment. Admittedly, in the short run, the investment operations might alter the distribution of world reserves, and hence affect the aggregate holdings of foreign exchange. For example, if Fund investment were concentrated in less developed countries, which generally hold a high proportion of their reserves in the form of foreign exchange, the short-run effect would doubtless be to increase the share of these countries in world reserves and hence to increase world holdings of foreign exchange and world gross reserves. In the longer run, however, this effect would probably be negligible.

34. For these reasons, what has been said above regarding the resources cost and the reserve yield of “across-the-board investment with investee currency” would apply more generally to any investments that the Fund might carry out which involved the use of all member currencies in proportion to quotas. However, it is difficult to imagine in practice any scheme of investment other than the specific one examined in this section that would involve the use of such a wide range of currencies.

Investment with Normally Drawable Currencies

35. It now seems convenient to consider under a single head all types of Fund investment that might be made with currencies that are normally drawable from the Fund. The investments could be spread over all member countries, confined to countries of normally drawable currencies, concentrated in less developed countries, funneled through an investment institution such as the International Bank for Reconstruction and Development, placed directly, etc. All that is assumed here is that the currencies used for the investments would be of the normally drawable type and that they would be used in proportion to the quotas of the countries whose currencies they are.

36. Investment carried out exclusively with normally drawable currencies would cost the Fund more in terms of resources for each unit invested than would investment of the type considered in the preceding section. The reason is that the initial cost to the Fund, in terms of normally drawable currencies, would be 100 per cent of the amount invested, in contrast to 65 per cent. On the other hand, the need for resources to meet consequential drawings would be some 55 per cent, against 60 per cent of the amount invested (see paragraph 20). For reasons analogous to those set forth in paragraph 28, investment with normally drawable currencies, since it would improve the Fund positions of countries of those currencies, would give rise to much the same amount of consequential drawings as an extension of quasi-automatic, and total, drawing rights, confined to countries of normally drawable currencies. The amount of additional resources in the form of normally drawable currencies required for this type of investment may, therefore, be estimated at (100+55 =) 155 per cent of the additional investment, less whatever allowance is made for the possibility of liquidating the investment itself.

37. On the last-mentioned point, investments would, of course, generally be more easily realizable if made in countries of normally drawable currencies than if made in other, particularly the less developed, countries. However, as already pointed out, extensive resort to replenishment through the sale of investments would run counter to the Fund's role in relation to individual balance of payments situations as well as to any future role as a reliable provider of world reserves; and if a situation should ever arise in which any substantial proportion of Fund investments had to be liquidated to safeguard the Fund's own liquidity, it would be a sure sign that the practice was being abused.

38. If the countries of investment were different from the countries whose currencies were invested—e.g., in the present instance if investments were made in less developed countries—and if, therefore, the use of a country's currency might affect its reserves, it might be argued that the currencies invested should not be a fixed package, based on quotas, of normally drawable currencies, but rather should be a set of the currencies that were currently usable for drawings. This would increase the need for additional resources in the short run. In the long run, however, the various currencies that were normally drawable might be expected to take turns at being currently drawable; and if investment were a continuing process, the composition of the currencies used for investment, cumulated over time, should come to approximate the quota distribution of the countries in question. Thus, the total amount of resources required—expressed in amounts of the generally drawable currencies in fixed proportion to quotas—should not in the end greatly exceed what has been calculated above.15

39. For reasons analogous to those discussed in paragraph 32, the amount of reserves created by investment with normally drawable currencies would be the same as that created by an equal extension of quasi-automatic, and total, drawing rights confined to countries of normally drawable currencies. It would thus amount to approximately 90 per cent of the amount invested (compare paragraph 21).

Investment with Gold

40. Investment with gold would involve a substantially larger drain on Fund liquidity than investment carried out with currencies—even currencies that are normally drawable—though the drain relative to the amount of reserves created might well be somewhat smaller. What is here said of gold investment applies equally to the acceptance of gold certificates or other claims on gold in lieu of actual gold in quota subscriptions to the Fund, though the timing of the latter to coincide with an accrual of Fund resources would, of course, reduce the short-run significance of any effect on Fund liquidity.

41. Assume, once more, that the Fund invested in member countries in proportion to their quotas, that it acquired such investments in exchange for gold, and that the investments conferred claims to repayment in gold. The fact that investment was made with gold would mean that the initial loss of resources involved in a given amount of investment would be considerably greater than if the investment had been made with a package, based on quota proportions, of normally drawable currencies. It has been assumed above (paragraph 15) that up to 55 per cent of normally drawable currencies might, on particular occasions, be unsuitable for drawing. In order to be sure of having access at all times to at least $45 million of immediately drawable currencies, the Fund would, therefore, have to have at its disposal $100 million of a representative selection of normally drawable currencies. The same result would be achieved with only $45 million of resources in the form of gold. It follows that the loss of liquidity to the Fund involved in the investment of gold is equivalent, in terms of a representative selection of normally drawable currencies, to something like (10045=)220 per cent of the amount invested. Admittedly, in the case of gold investment, since no country would achieve any improvement in its Fund position, no liability to additional drawings would arise. However, this figure of 220 per cent of the amount invested, though based on the initial cost alone, is significantly higher than the 155 per cent which was estimated, in the preceding section, to be the total drain of resources, including that resulting from additional drawings, likely to be involved in investment with normally drawable currencies. This higher cost would in no way be compensated by any greater liquidity in the assets acquired by the Fund. As has already been pointed out, the degree of liquidity that the Fund can derive from the possession of nominally liquid assets depends on the extent to which such assets can be realized without severe damage to the reserve positions of the countries of investment. It follows that the realization of gold investments would be no easier (if anything, it would be more difficult) than the realization of currency investments, since the Fund would have to take account not only of the effect on the reserves of the investee country but also, in certain cases, of the secondary impact on the reserves of reserve center countries.

42. But if gold investment would be the costliest to the Fund for each unit of investment, it would also be the most productive of additional reserves to the world. This is because of the secondary impact referred to above. If the Fund added to national reserves by transferring gold to countries rather than by creating additional reserve positions in the Fund, some of the gold would be certain to be sold, sooner or later, to reserve centers in exchange for foreign exchange reserves. If it is assumed (1) that countries hold a fixed proportion of foreign exchange to gold in their reserves—and though the marginal propensity to hold foreign exchange probably differs from the average propensity, it is difficult to say whether it is higher or lower—and (2) that the addition to world reserves resulting from Fund investment would ultimately be distributed among countries in much the same proportion as existing reserves, it follows that gold investment by the Fund would give rise to additional holdings of foreign exchange in much the same proportion that total foreign exchange reserves now bear to total gold reserves, viz., about 60–65 per cent. These additional holdings of foreign exchange would constitute an addition to gross reserves over and above that resulting from the rise in countries' gold holdings, though to the extent that the increase in the liquid liabilities of reserve centers increased those centers' need for reserves, the rise in gross reserves would overstate the true increase in international liquidity.

43. When account is taken of the secondary impact of gold investment on world reserves, it appears that the liquidity cost to the Fund of creating reserves by means of gold investment, though greater per unit of investment, might be somewhat less per unit of reserves created than that of other forms of investment.

* * *

44. The numerical estimates appearing in various sections of the preceding text are brought together in Table 1 (p. 182).

45. All the figures quoted are, of course, highly uncertain and speculative and are dependent on the often arbitrary assumptions explained in the text. They probably throw more light on the relative than on the absolute amount of resources required, and reserves created, by the different techniques.

Incidences de la création de divers types de réserves du Fonds sur la liquidité de cet organisme

Résumé

Dans cette étude, l'auteur cherche à effectuer une quantification approximative des incidences possibles de diverses techniques de création de réserves par le Fonds sur sa propre liquidité. Les techniques étudiées sont les suivantes :

1) Extension au-delà de la tranche-or des droits de tirage quasi-automatiques en faveur a) de tous les membres du Fonds, b) des membres dont les monnaies sont normalement susceptibles d'être tirées, et c) des autres pays membres;

2) Autres modifications de la politique du Fonds menant à une augmentation des tirages; et

3) Placements du Fonds ou acquisition d'avoirs spéciaux au moyen a) des monnaies de tous les pays membres, b) des monnaies normalement susceptibles d'être tirées, et c) d'or.

Pour permettre les comparaisons, les besoins supplémentaires en ressources du Fonds provenant respectivement des diverses techniques de création de réserves sont exprimés en termes de montants des monnaies pouvant normalement faire l'objet de tirages, réparties proportionnellement aux quotes-parts, auxquelles le Fonds devra s'assurer l'accès (soit par souscriptions, soit par lignes de crédit) afin de pouvoir faire face à ces besoins supplémentaires.

Ces ressources seront peut-être nécessaires pour permettre l'augmentation initiale des réserves. Elles le seront, en tout cas, pour qu'une fois créées, les réserves puissent être transférées d'un pays à l'autre au moyen de tirages sur le Fonds. Le volume des ressources requises dans ce but est évalué d'après l'expérience acquise par le passé à des périodes d'utilisation maximale des ressources du Fonds. La proportion de monnaies normalement susceptibles d'être tirées qui seront, selon toute vraisemblance, couramment utilisables aux périodes d'utilisation maximale des ressources, est également déterminée d'après l'expérience du passé. Etant donné le caractère forcément incertain de ces hypothèses et de certaines autres qui sont également employées, les estimations quantitatives auxquelles on parvient finalement doivent être considérées comme hautement spéculatives et comme éclairant davantage le coêt comparatif que le coût absolu de la création de réserves par les différentes méthodes envisagées.

Efecto sobre la liquidez del Fondo surtido por diversas clases de creación de reservas por el Fondo

Resumen

En este estudio se procura hacer un cálculo cuantitativo aproximado de los posibles efectos que sobre la propia liquidez del Fondo surtirían diversas técnicas para la creación de reservas por medio del Fondo. Las técnicas que se examinan son las siguientes:

(1) La concesión de derechos de giro casi automáticos que superan al tramo de oro: (a) a todos los paises miembros del Fondo, (b) a los países miembros cuyas monedas normalmente pueden girarse, y (c) a otros países miembros.

(2) Otras modificaciones de la política del Fondo conducentes a que hay a un uso mayor de los giros; y

(3) Las inversiones del Fondo o la adquisición por éste de activos especiales, empleando para tal objeto (a) las monedas de todos los países miembros del Fondo, (b) las monedas que pueden normalmente girarse, y (c) el oro.

Para fines de comparación, las necesidades adicionales de recursos por parte del Fondo surgidas, respectivamente, de las distintas técnicas de creación de reservas, se expresan en términos de las cantidades de las monedas que por lo comun resultan apropiadas para hacer giros—repartidas en proporción con la cuota—a las cuales el Fondo tendría que lograr acceso (ya sea por subscripciones o por líneas de crédito) para poder cubrir las necesidades adicionales de que se trata.

Dichos recursos pueden necesitarse para posibilitar el aumento inicial de las reservas. De todas maneras se requerirán para permitir que las reservas, una vez creadas, sean transferidas de un país a otro mediante giros contra el Fondo. El monto de los recursos necesarios para este último fin se calcula basándose en la experiencia anterior durante períodos en que, se ha hecho el mayor uso de los recursos del Fondo. Asimismo, la proporción de las monedas normalmente girables que es probable puedan utilizarse corrientemente en momentos del mayor uso de dichos recursos, también se determina basándose en la experiencia lograda. En vista de la falta de certeza de que inevitablemente adolecen estas y otras hipótesis empleadas, es preciso considerar que las estimaciones cuantitativas que a la postre se obtienen son sumamente especulativas y que arrojan mayor luz sobre el costo comparativo de la creación de reservas mediante los diversos metodos, que sobre su costo absoluto.

*

Mr. Fleming, Deputy Director in the Research and Statistics Department, is a graduate of Edinburgh University. He was formerly a member of the League of Nations Secretariat, Deputy Director of the Economic Section of the U.K. Cabinet Offices, U.K. representative on the Economic and Employment Commission of the United Nations, and Visiting Professor of Economics at Columbia University. He is the author of numerous articles in economic journals.

1

Reserve positions in the Fund include gold tranche positions, any part of credit tranche positions that may be drawable on a quasi-automatic basis, loan claims under the General Arrangements to Borrow (GAB), and any similar loan claims, or deposits, that may be created. Reserves created by transferring gold from the Fund to national reserves are not included in this concept; such reserves are transferable outside the Fund without an effect on the Fund's liquidity.

2

This figure is arrived at as follows. A small extension of quasi-automatic drawing rights into the credit tranches, for all members, in a uniform proportion to quotas, if unaccompanied by any increase in drawings outstanding, would reduce drawings outstanding in the conditional range by approximately xaq, where q is the amount of total quotas, a the amount of the extension of quasi-automatic drawing rights as a proportion of quotas, and x the proportion of members, weighted by quota, that initially have drawings outstanding in the credit tranches. Again, a small increase in drawings outstanding, in a uniform proportion to quotas, by all members with drawings outstanding in the credit tranches, unaccompanied by any change in the relationship between quasi-automatic and conditional drawing rights, would increase drawings outstanding in the conditional range by approximately xbq, where b is the increase in outstanding drawings of countries initially having drawings outstanding in the credit tranches in proportion to the quotas of these countries. Assume now that the extension of quasi-automatic and total drawing rights, which is assumed to be proportionately small in relation to quotas, results in an extension of drawings, by countries initially having drawings outstanding in the credit tranches, that is proportionately half as great relative to the quotas of these countries. Then b equals a2, and the resultant decline in drawings outstanding in the credit tranches will be xq (a—b) = ½xaq. From Table 5 it will be seen that in 1957 x = 36.8 per cent, and ½x = 18.4 per cent.

3

A different, and almost equally plausible, set of assumptions about the effect on drawings of extending quasi-automatic and total drawing rights might have been (1) that countries that would have had no drawings outstanding in the absence of the extension would have no drawings outstanding in spite of it, but (2) that all countries with drawings outstanding (beyond the 75 per cent point) in the absence of the extension would, as a result of it, increase the drawings outstanding by 50 per cent of the amount of the extension for the countries in question. In 1957, as can be seen from Table 5, Fund members having quotas equal to more than 46 per cent of total quotas had drawings outstanding. The increase in drawings outstanding in a peak year, calculated by this method on the basis of the 1957 results, would amount approximately to one half of 46 per cent, say 23 per cent, of the amount of the extension of quasi-automatic and total drawing rights for all countries. However, when this method is adopted, the peak year is not 1957 but 1964. On the basis of that year's results, the increase in peak-year drawings outstanding would amount to almost 28 per cent.

4

To say that a country's currency is “suitable for drawing” means, in the present context, that its reserve and payments position is sufficiently strong to justify its being asked to take its fair share of the net creditor positions which are the counterpart of outstanding drawings. A currency not currently “suitable for drawing” might still be drawn as a matter of convenience, provided that its net position in the Fund is prevented from rising by concurrent repurchases with its currency or by other means.

5

If there were a substantial extension of quasi-automatic drawing rights, amounting to, say, x per cent of quota, beyond the gold tranche, members of whose currencies the Fund held between 100 and 100 + x per cent of quota would also increase their reserve positions, by some fraction of x per cent of quota.

6

It is assumed that outstanding drawings by the average member country would increase by less than the extension of quasi-automatic, and total, drawing rights.

7

For purposes of calculation, the countries whose currencies are normally drawable are taken to be the ten participants in the General Arrangements to Borrow plus Austria and Spain. There is nothing hard and fast about this classification, however, and over time the number of countries that might be considered as falling into this category has shown a tendency to increase.

8

This estimate is based on the assumption that countries of normally drawable currencies with drawings outstanding in the conditional range would increase their outstanding drawings by 50 per cent of the addition to their total drawing facilities. It may be thought that the proportionate use of additional drawing facilities would be somewhat smaller for this group of countries than was assumed in paragraph 14 for Fund members as a whole. But though countries of normally drawable currencies make less continuous use of their drawing facilities than do other members, the countries of that group which are at any time obliged to draw are perhaps more likely to be pursuing policies that make it easy for them to use their conditional drawing facilities than are other members in a similar Fund position.

9

Slightly over 85 per cent of the quotas of these countries are held by countries that are normally in the gold tranche (see Table 5, p. 186). If the countries holding the remaining 15 per cent added to their drawings in an average year to the extent of one third of the addition to their drawing rights, the increase in reserves resulting from drawings within the credit tranches would be 5 per cent of the total extension of drawing rights.

10

The relatively high cost in resources of extending automatism to countries whose currencies are not normally drawable did not fully affect the calculation for the cost of extending automatism to all Fund members because the peak drawings of the former class of countries over the past nine years (on which calculations were based) did not coincide with the peak year for countries of normally drawable currencies, which was also the peak year for Fund members as a whole (see Tables 2, 3, and 4, pp. 183–85).

11

61100+(1339100)=74100.

12

It is the last-mentioned point which is of primary importance. See paragraph 33, below.

13

As a minor exception, a country might have compensatory financing facilities restored in the investment case but not in the other.

14

Strictly speaking, this implies that the obligation to repurchase (or reconstitute loan claims) would somehow be extended below the 75 per cent point to an extent corresponding to the amount invested. Otherwise, the replenishment of currently drawable currencies through repurchase would be less—and their net use somewhat greater—for additional drawings resulting from investment than for additional drawings resulting from the extension of automatism.

15

What would greatly increase the need for Fund resources arising from investment would be any abandonment of the assumption expressed in paragraph 27, above, that reserve positions arising in the Fund as a result of investment would normally remain in their initial country distribution except to the extent that they were drawn on temporarily from time to time to meet balance of payments difficulties. Failing arrangements designed to bring about this result, the resources cost of currency investment by the Fund would tend to rise toward that of gold investment, discussed below.