Fund Transactions and Reserve Creation, 1951–73

In the period following World War II international reserves have been created by the balance of payments deficits of the United States, the inflow of gold into official reserves, members’ transactions with the International Monetary Fund, and, more recently, the allocation of special drawing rights (SDRs). This paper analyzes the extent to which transactions with the Fund’s General Account have contributed to the growth of international reserves during the period 1951–73, using the framework described by J. Marcus Fleming in 1964.1

Abstract

In the period following World War II international reserves have been created by the balance of payments deficits of the United States, the inflow of gold into official reserves, members’ transactions with the International Monetary Fund, and, more recently, the allocation of special drawing rights (SDRs). This paper analyzes the extent to which transactions with the Fund’s General Account have contributed to the growth of international reserves during the period 1951–73, using the framework described by J. Marcus Fleming in 1964.1

In the period following World War II international reserves have been created by the balance of payments deficits of the United States, the inflow of gold into official reserves, members’ transactions with the International Monetary Fund, and, more recently, the allocation of special drawing rights (SDRs). This paper analyzes the extent to which transactions with the Fund’s General Account have contributed to the growth of international reserves during the period 1951–73, using the framework described by J. Marcus Fleming in 1964.1

The paper first examines the direct impact on world liquidity of members’ transactions with the Fund. It then deals with the effects of the introduction of the SDR facility on gross and net reserve creation in the Fund’s General Account. Next, it analyzes the effects on liquidity of the conversion of currencies purchased from the Fund, as well as of foreign exchange transactions undertaken by members in order to make repurchases with the Fund. Furthermore, an attempt is made to measure the effects of purchases from the Fund by member countries for the purpose of acquiring balances of their own currency from other member countries. Finally, the effects on liquidity of transactions between participants in the Special Drawing Account are briefly investigated.

I. Direct Liquidity Impact of Members’ Transactions with the Fund

A member has the right to draw other members’ currencies automatically from the Fund to the extent of its gold tranche position. Gold tranche positions arise in the first place from the members’ gold subscriptions; they are extended pro tanto when net sales by the Fund reduce its holdings of a member’s currency below currency subscription.2 While meeting demands by members for activation of their conditional drawing rights, Fund transactions may thus lead to an increase in the unconditional liquidity of other members.3 Members’ unconditional liquidity may also be increased by loans extended to the Fund under the General Arrangements to Borrow, or bilaterally.4

reserve positions and net reserve creation

A member’s unconditional drawing rights on the Fund reflecting the above operations is called the reserve position in the Fund (RPF). The sum of all members’ reserve positions in the Fund does not represent an equal sum of net creation of reserves. To determine the volume of net international reserves created in the course of Fund transactions, the members’ gold payments to the Fund—net of general gold deposits placed with members or gold sales by the Fund to members—should be subtracted.5 Similarly, as is shown later in this paper, the effects of conversions of the currencies drawn must also be taken into account in calculating the Fund’s net reserve creation.

The central relationship for analyzing reserve creation by the Fund is that between the Fund’s holdings of a member’s currency (Hi) and the member’s quota (Qi). If the Fund’s holdings of the ith member’s currency exceed the member’s quota (Hi>Qi), the ith member is indebted to the Fund, that is, it has made net use of its credit tranches in the Fund. If, on the other hand, its quota exceeds the Fund’s holdings of its currency (Qi>Hi), the ith member has a gold tranche position in the Fund.6 For Qi>Hi gold tranche positions in the Fund (GTP) are:

GTP=Σi=1n(QiHi)(1)

where n is the number of Fund members for which Qi is greater than Hi.

It is now fairly easy to calculate total reserve positions in the Fund (RPF):

RPF=Σi=1n[(QiHi)+BLi+GABi](2)

where BLi and GABi are, respectively, the outstanding bilateral loans and loans to the Fund under the General Arrangements to Borrow by the ith member.7 Subtracting the Fund’s bar gold holdings (BG) from equation (2) provides the amount of net reserve creation (NRC) in the Fund’s General Account.8

NRC=RPFBG=Σi=1n[(QiHi)+BLi+GABi]BG9(3) 9

special financing facilities of the fund

The analysis thus far has not taken into account the amendment of the Executive Board Decision establishing the compensatory financing facility.10 Since this amendment, purchases under the compensatory financing facility no longer reduce pro tanto the member’s gold tranche position.11 Therefore, in calculating a member’s unconditional drawing rights, the Fund’s holdings of the member’s currency should be reduced by the amount of drawings under the compensatory financing facility. Equations (2) and (3) must thus be modified as follows:

NRC=Σi=1n[Qi(HiCi)]+BLi+GABi(4)
NRC=Σi=1n{[Qi(HiCi)]+BLi+GABi}BG(5)

where Ci is the amount of Fund holdings of the currency of the ith member due to compensatory financing drawings.

No such adjustment is required for drawings under the buffer stock financing facility 12 that reduce pari passu a member’s gold tranche position (if any), so that the above analysis does not need to be modified. Of course, since both the buffer stock and the compensatory financing facilities increase conditional drawing rights of the members, they may lead to larger drawings and consequently to higher reserve positions in the Fund for some members.

So far no mention has been made of transactions with the Fund’s General Account conducted in special drawing rights rather than in gold or members’ currencies. The following section is devoted to an analysis of transactions with the General Account involving SDRs, before turning to the impact of the currency composition of drawings and repurchases.

II. SDR Transactions Between Fund Members and the General Account

A new form of unconditional reserve asset was introduced with the creation of the Special Drawing Account for members of the Fund participating in the SDR scheme. While SDR allocations undoubtedly represent liquidity creation, only a relatively small number of SDR transactions are related to the General Account and therefore fall within the scope of this section.

basic uses of SDRs

SDRs may be used essentially in three ways: (1) in “designated transactions,” (2) in “voluntary transactions,” and (3) in operations between members and the General Account.

The first two types of transactions take place between participants in the SDR scheme and do not involve the General Account; therefore, they will not be dealt with here. However, since their overall effects on world liquidity have features similar to those of General Account operations, such transactions are dealt with in the Appendix.

This section deals only with the third type of SDR transactions—those between members and the General Account. In order to analyze the direct consequences on liquidity of the use of SDRs in member operations with the General Account, it is necessary to examine each category of transactions in which SDRs are used in order to determine what other asset (gold or currency) would have been used in the absence of the SDR facility. Before doing so, however, equation (5) must be modified to take into account the similarity between gold and SDRs.

When a member uses (receives) either gold or SDRs in transactions with the General Account, its reserves decrease (increase) without an equivalent increase (decrease) of another member’s reserve position in the Fund. Therefore, since the effects on a member’s reserves of its using SDRs or gold with the General Account are identical, it follows that the SDR holdings in the General Account should be treated in the same manner as bar gold holdings. In other words, the impact on reserve positions in the Fund and on net reserve creation is the same whether a member uses SDRs or gold in its transactions with the General Account. Net reserve creation through the General Account thus becomes:

NRC=Σi=1n{[Qi(HiCi)]+BLi+GABi}(BG+SDRga)(6)

where SDRga represents the holdings of SDRs in the General Account.

options for use of SDRs

SDRs, however, are used not only in lieu of gold but also in lieu of currency. During 1969 the Executive Board gave participants the option of receiving SDRs in replenishments,13 in the payment of remuneration, and in the distribution of the Fund’s net income, as well as the further option of using SDRs in making repurchases 14 and in the payment of charges. Members are also entitled to acquire SDRs from the General Account to reimburse the expenses incurred in operating the Special Drawing Account—the so-called assessments—and to reconstitute their holdings under Article XXV, Section 6, of the Articles of Agreement. In the first two years of the new facility, SDRs were used in all of the above-mentioned operations with the General Account, with the exception of reconstitution, which did not take place until March 1972.15

In the case of replenishment of currencies by the Fund, members have been offered a choice between gold and SDRs only. A member’s provision of its own currency causes a reduction of its reserve position in the Fund, which is matched by the decrease in the General Account’s holdings of bar gold or of SDRs; net reserve creation therefore remains unchanged.

In the payment of remuneration, members have the choice of receiving gold,16 SDRs, or their own currency, with all three options resulting in an increase in net reserve creation. The reserve position in the Fund, on the other hand, is unchanged if either gold or SDRs are used, while it increases when remuneration is paid in the members’ own currencies. The payment of remuneration in currency, however, has seldom occurred in the past, with the consequence that the option to receive such payments in SDRs has had a negligible impact on both net reserve creation and reserve positions in the Fund up to 1973, when numerous members elected to have remuneration paid in their own currencies in order to increase their reserve position in the Fund.17

The payment of net income is the only transaction involving a choice between the use of currency and SDRs only. Both methods of payment cause an equivalent increase in net reserve creation. Conversely, its reserve position in the Fund is directly affected by the member’s choice, because when a member opts to receive its net income in SDRs rather than in currency, it forgoes an improvement of its reserve position in the Fund.

SDRs may also be used by a member to repurchase its own currency from the General Account. The use of SDRs avoids the reduction of other members’ reserve positions in the Fund that would occur if their currencies were used. This is, however, counterbalanced by the equivalent reduction of net reserve creation caused by the increase of the holdings of SDRs in the General Account. In other words, the option given to participants in the Special Drawing Account to repurchase with SDRs has avoided reduction in their reserve position in the Fund but has not had any impact on net reserve creation. However, to the extent that repurchasing members use SDRs in lieu of nonreserve currencies, a reduction of world reserves takes place, since nonreserve currencies would generally have to be acquired by the repurchasing member (against other reserve assets) from the issuing central banks. This issue is discussed in the next section.

A member incurs charges when the Fund’s holdings of the member’s currency exceed the member’s quota for a certain period of time. Generally, charges must be paid in gold, although members can substitute SDRs; in either case, the payment of charges implies a reduction of net reserve creation, while net reserve positions in the Fund remain unchanged.18

Finally, SDRs can be acquired from the General Account for the purpose of paying assessments to the Special Drawing Account and of reconstituting members’ holdings of SDRs.

In the case of payments of assessments, which must be made in SDRs, members lose a primary reserve asset, and this loss is reflected in an equivalent decrease in net reserve creation (due to the increase in the General Account’s holdings of SDRs). This holds true also in the case of members that have to acquire SDRs from the General Account to make the assessed reimbursement. The purchase of SDRs, which has to be paid either in gold or in a currency acceptable to the Fund, entails an increase in the holdings of gold in the General Account or a decrease in reserve positions in the Fund, respectively, and a corresponding reduction of net reserve creation.19

A member’s purchase of SDRs from the General Account to reconstitute its holdings of SDRs represents a change only in the composition of its reserve assets. Similarly, for the General Account it entails a fall in its holdings of SDRs or a decrease in reserve positions in the Fund (since members can use only those currencies of which the Fund’s holdings are below 75 per cent of quota); in both cases world liquidity is unchanged, except for the side effects of conversions that might be required by purchasing members in order to obtain currencies acceptable to the Fund. A member may, however, purchase SDRs with its own currency in a normal drawing. If the member purchasing SDRs with its own currency is in a credit tranche position, reserve positions in the Fund do not decrease with the General Account’s holdings of SDRs; net reserve creation therefore rises pro tanto.

To summarize, in all operations with the General Account the use of SDRs has the same effects as that of gold—that is, the same changes in reserve positions in the Fund take place whether gold or SDRs are used—while different changes occur in reserve positions when members’ currencies are used. The resulting net reserve creation, however, is not directly affected, since its variations do not depend on the type of asset used in transactions. Indirectly, however, the use of SDRs in operations with the General Account has an impact on international liquidity, inasmuch as conversions of one currency into another are avoided in certain cases while they become necessary in other cases. The liquidity effects of such conversions are discussed in the next section.

III. A More Accurate Estimate of Net Reserve Creation

Up to this point, the paper has concentrated on changes in members’ liquidity that derive from the direct effects of drawings and repurchases on the Fund’s accounts. No attention has yet been paid to changes in the world’s stock of foreign exchange as entailed by Fund operations. This section analyzes indirect changes in international liquidity of this type in order to arrive at a more comprehensive estimate of the overall net reserve creation arising from operations of the Fund’s General Account.

effects of drawings

First of all, it should be noted that proceeds from Fund drawings are generally added to the world’s stock of foreign exchange holdings, provided that the drawer does not use such proceeds to make international payments to the country issuing the currency drawn. However, the problem is complicated by the fact that drawers sometimes convert the currencies obtained from the Fund into other reserve assets before utilizing them to make payments. Until 1958 drawings tended to be made almost exclusively in U. S. dollars—virtually the only currency used in international payments outside the sterling area. Once de facto widespread convertibility returned in 1958, the Fund developed certain “collaborative practices,” which have led to a substantial increase in the number of currencies used in drawings. Generally speaking, this has meant that prospective drawers consulted with the Managing Director of the Fund before drawing the currencies.20 This development has served several useful purposes. From the operational point of view, such consultations permit the Fund to set guidelines for the members’ use of different media and, by making more currencies usable in Fund transactions, enable the Fund to meet members’ demands for a larger volume of drawings. In a wider context, it has allowed numerous members to acquire a reserve position in the Fund (a gold-guaranteed reserve asset).

The use of a variety of currencies in Fund transactions often creates a need for the drawer to convert the particular currency obtained from the Fund into an equivalent amount of other currencies acceptable to the drawer’s creditors or usable in interventions. In this case, any increase in the drawee’s reserve position in the Fund is offset by the loss of foreign exchange in the subsequent conversion, which usually takes place at the drawee’s central bank.21 When the drawee is in a credit tranche position with the Fund, the purchase of its currency by another member leads only to a reduction of its indebtedness to the Fund, so that a subsequent conversion of the drawee’s currency results in a reduction of its gross reserves. Such a reduction may or may not be offset by the increase in foreign exchange holdings of other countries—that is, the final receivers of the drawer’s payments—depending on whether final payments are made in the receivers’ own currencies (with no increase in liquidity) or in other currencies which the receivers may hold in their portfolios as reserve assets. This is true regardless of any intermediate transactions.22

Table 1 illustrates the four possible combinations of drawers’ and drawees’ positions in the Fund and their impact on world liquidity. It also shows the effect of combining all possible drawers’ and drawees’ positions in the Fund with different final uses of the currency drawn—that is, whether or not a conversion occurs and whether the final payment takes place in the receiver’s currency or in a reserve currency—as well as the overall effects of Fund operations. Table 2 gives a numerical example of the operations and transactions described in Table 1.

Table 1.

Purchase Transactions: Possible Fund Positions of Drawers and Drawees and Final Destinations of Drawings, with Effects on World Reserves

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The sign after each entry indicates whether the impact of that entry is an increase (+), a decrease (−), or no change (=) of international liquidity.

Drawee and final receiver of payment coincide in this case.

Table 2.

Examples of Effects of Purchase Transactions in the Fund1

(In millions of SDRs)

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Based on Table 1. Drawers and drawees are both assumed to have a quota of SDR 100 million, and a drawing of SDR 10 million is assumed to occur in all combinations.

Drawee and final receiver of payment coincide in Cases 1, 5, 9, and 13.

It has been assumed either that countries involved in transactions with the Fund are in a credit tranche position or, if they are in a gold tranche position, that their reserve position in the Fund is greater than, or equal to, the amount drawn. The two tables would be unnecessarily complicated if it were assumed that the reserve positions in the Fund of drawers before and after the transaction might in fact be positive but smaller than the amounts drawn. In such cases, net reserves created or destroyed through the Fund’s operations would also be smaller than the amounts drawn.

It has also been assumed that all conversions take place at the central bank of the member whose currency is drawn, thereby causing an absorption of foreign exchange. In the rare event that a conversion is provided by the central bank issuing the desired reserve currency, the world’s stock of foreign exchange would increase by twice the amount involved rather than remain unchanged as shown in Table 2 (see footnote 21).

effects of repurchases

Basically the same approach can be used to examine the overall effects on net reserve creation of repurchases.23 Generally, the currencies or other reserve assets to be used in making repurchases are decided through the same consultation procedures that apply to drawings, in accordance with the July 1962 statement approved by the Executive Board of the Fund.24

Unless the currency agreed upon is already held in the repurchaser’s portfolio, the repurchaser normally acquires it at the central bank of the member issuing it so that the conversion leads to an increase in the latter’s foreign exchange holdings. A conversion may have the opposite effect, if the repurchasing member requires that it take place at the central bank that issues the reserve currency held by the member in its portfolio. For example, if Kenya, which holds most of its foreign exchange in pounds sterling, has to pay deutsche mark to the Fund, Kenya might ask the Bank of England (rather than the Deutsche Bundesbank) to provide deutsche mark against pounds sterling, and the Bank of England would provide the mark from its own holdings. In this rather unlikely case, both Kenya and the United Kingdom would lose foreign exchange while Germany’s reserve position in the Fund would decrease, so that world liquidity would decrease by three times the amount repurchased (if Kenya is in a credit tranche position and Germany in a gold tranche position).

Table 3 shows the effects that repurchases may have on net reserve creation. Such effects may be summarized as follows: the repurchasing member loses foreign exchange but this loss may be offset by an increase of the member’s reserve position in the Fund to the extent that the member is in a gold tranche position with the Fund after the transaction; on the other hand, the member whose currency is used in the repurchase always registers a decrease in its reserve position in the Fund,25 which may be offset by an acquisition of foreign exchange when the currency to be used has to be obtained by the repurchasing country from the issuing central banks.26

Table 3.

Example of Effects of Repurchase Transactions: Possible Repurchaser’s Fund Positions and Different Sources of Currency Used1

(In millions of SDRs)

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Based on repurchase of SDR 10 million in each case.

According to the above analysis, equation (6) does not provide an accurate measurement of Fund-generated changes in world liquidity. On the one hand, it does not take into account the increases in the world’s stock of foreign exchange that follow drawings, whenever the proceeds of such drawings are not converted at or transferred to the issuing central bank. On the other hand, it ignores the loss of foreign exchange caused by repurchases in those cases in which the means of payment used by a member to repurchase its own currency are not other members’ currencies obtained from the issuing central banks. Therefore, the results of equation (6) would be correct only if all Fund operations were conducted only in nonreserve currencies: drawers would convert at or transfer to the issuing central bank all the currencies purchased from the Fund, while prospective repurchasers would have to acquire from the issuers the currencies agreed upon with the Managing Director of the Fund. But up to the early 1960s most Fund operations were conducted in reserve currencies, which drawers hardly ever had to convert and which repurchasers held in their portfolio. Even during the 1960s reserve currencies—particularly U. S. dollars—continued to be widely used in Fund transactions,27 with attendant effects on world holdings of foreign exchange.

net variations in foreign exchange

To account for net variations in foreign exchange reserves occurring in connection with Fund operations, equation (6) should therefore be adjusted by: (1) adding to net reserve creation the amount of all drawings of currencies from the Fund, with the exception of drawings of currencies which required a subsequent conversion; and (2) subtracting the amounts of currencies used in repurchases, excluding repurchases which required a prior conversion.

Assuming that at least U.S. dollars and pounds sterling used in purchases (P) and repurchases R) do not require conversions,28 the formula to estimate net reserve creation thus becomes:

NRC=Σi=1n{[Qi(HiCi)]+BLi+GABi}(BG+SDRga)+(P$£R$£)(7)

where (P − R) represents net cumulative purchases or repurchases in dollars and sterling.

Equation (7), however, does not take into account the fact that some of the currencies drawn are paid to the countries that issue them, thus reducing world holdings of foreign exchange. The only information presently available in regard to this relates to the use of drawings to acquire the balances of the drawer’s currency from another member. For instance, U. S. drawings (PUS) have always been made to acquire dollar balances from other countries, so that all such drawings must be subtracted.29 A number of other industrial countries have also frequently used the proceeds of their drawings (PS) to acquire balances of their currencies held by foreign monetary authorities, mainly the U. S. Federal Reserve System. These drawings can be roughly identified by matching some of the industrial countries’ major drawings with their concomitant repayments to the swap network centered on the Federal Reserve System.30 If the currency obtained from the Fund is the one needed for the swap repayment, it is then paid to the issuing country and does not therefore increase world liquidity. Since drawings of U. S. dollars have previously been added to the computation of reserve creation (first adjustment of equation (6) above), dollar drawings used for swap repayments should be subtracted.

On the other hand, if the currencies drawn from the Fund in connection with swaps are not those needed for this purpose, then a conversion into U. S. dollars is necessary to reacquire the member’s balances held by the United States. The subsequent transfer to the United States of the dollars obtained would reduce world holdings of dollars pro tanto. Consequently, all drawings made in connection with swap repayments (PUS and PS) must be subtracted from the formula.31

A further approximation of net reserve creation is thus given by:

NRC=Σi=1n[Qi(HiCi)+BLi+GABi](BG+SDRga)+(P$£R$£)(PUS+Ps)(8)

where Pus represents the cumulative amounts drawn by the United States to acquire dollar balances from other countries and Ps represents other countries’ drawings related to swap repayments.

IV. Results and Conclusions

The level of net reserve creation reached at the end of each calendar year from 1951 to 1973, as estimated on the basis of equations (6), (7), and (8), and the respective annual changes are presented in Tables 4 and 5, together with the values of the other variables for each year.

Table 4.

Unadjusted Net Reserve Creation in the Fund, 1951–73

(In millions of SDRs)

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Data for end of calendar year.

Excludes gold held in general deposits and gold investments (see text, footnote 8).

NRC = RPF − (BG + SDRga).

Includes SDR 290 million.

Includes SDR 489 million.

Includes SDR 629 million.

Includes SDR 508 million.

Table 5.

Adjusted Net Reserve Creation in the Fund, 1951–73

(In millions of SDRs)

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Data for end of calendar year.

NRC = RPF -(BG + SDRga). See Table 4, column F.

Δ(P − R).

P − R

NRC = RPF −(BG + SDRga) + (P − R).

ΔPUS

ΔPS

PUS +Ps.

NCR = RPF −(BG + SDRga) + (P − R) − (PUS +PS).

Increase for 1947–51 included.

Although the yearly increase in world reserves was only about 2 per cent until 1955 (see Chart 1), reserve positions in the Fund were essentially the result of gold subscriptions, which entail no net creation of liquidity but might entail a reduction of liquidity if gold is bought with reserve currencies from reserve centers. Cumulative reserve creation, after adjusting for changes in world foreign exchange holdings resulting from Fund transactions, fluctuated between SDR 0.5 billion and SDR 1 billion in this period (see Table 5, column D), stemming mostly from the increase of internationally held U. S. dollars and pounds sterling following net drawings of these two currencies.

Chart 1.
Chart 1.

Annual Changes in Total World Reserves and Net Reserve Creation in the Fund, 1952–73

Citation: IMF Staff Papers 1974, 001; 10.5089/9781451956375.024.A002

In the second half of the 1950s international liquidity continued to grow slowly (except for 1959), and Fund resources began to be used on a comparatively wider scale. Following the Suez conflict, large amounts of U. S. dollars were drawn in 1956 and 1957 with a corresponding increase in the reserve position of the United States; furthermore, in 1956 the Fund invested the equivalent of SDR 200 million of its gold in U. S. Government securities. The latter operation, it will be recalled, had an expansionary effect on world liquidity. Net reserve creation, therefore, rose substantially from 1955 to 1958, when it reached the level of SDR 3.3 billion, of which about SDR 2 billion represented increased foreign exchange holdings created by net drawings of U. S. dollars and pounds sterling from the Fund (see Table 5, columns C and D). About one half of all outstanding drawings were repaid in 1959–60, a two-year period characterized by large U. S. deficits; moreover, additional gold subscriptions were paid by members in connection with the general quota increase in 1958. Both of these factors implied a reduction in net Fund-generated liquidity, so that net reserve creation fell to a level of SDR 2.5 billion by 1960. The decrease would have been even sharper had the Fund not invested the equivalent of another SDR 600 million of its gold holdings in U. S. securities in this two-year period. The peak reached by net reserve creation in 1961—both before and after the adjustment for changes in world foreign exchange holdings (Table 5, columns C and D)—was largely due to a U. K. purchase equivalent to over SDR 1 billion, which brought the Fund’s holdings of sterling into the second credit tranche. The following year, in connection with a strengthening of the U. K. balance of payments, sterling was used heavily in purchases, and U. K. repurchases also contributed to a reduction of the Fund’s holdings of sterling to below 75 per cent of quota; as a result, net reserve creation also fell and remained virtually unchanged through 1963 at well below the SDR 3 billion level.

In 1964–69, a period of slow growth in world liquidity, the use of Fund resources increased sharply (see Table 5, column A, which shows the level of reserve positions in the Fund, net of members’ gold payments). The rising trend was interrupted only in 1967, largely as a consequence of new gold subscriptions by members in connection with the quota increase decided in 1964, as well as of a large repurchase in 1967 by the United Kingdom. The same pattern appears after the adjustment for increases in overall foreign exchange holdings (Table 5, column D). Large drawings by a number of industrial countries, including the United States, took place in 1964–66, reflecting both the inadequate functioning of the adjustment process and reserve stringency. Such drawings supplemented credits obtained through the swap network, which was created in 1962 essentially to recycle short-term flows. Frequently. however, Fund resources were used by members to acquire balances of their own currencies held by other countries (resulting from previous swap operations), and to that extent did not add further to world liquidity. As was argued in Section III, the reduction of foreign exchange holdings that takes place when currencies obtained from the Fund are paid to the issuing central bank for purposes of settling outstanding debtor balances is not accounted for by equation (7), which allows only for changes in foreign exchange holdings caused by net disbursements of reserve currencies by the Fund. For this reason, since the inception of the swap network, equation (8)—which also accounts for the above-mentioned reduction of liquidity—provides a more accurate estimate of the impact of Fund transactions on international liquidity.

It should be noted that the results of equations (7) and (8) (see Table 5, columns D and L) coincide through 1961, because there had been no U. S. purchases until then, and drawings by other industrial countries were hardly ever used to acquire balances of their own currencies. However, a large share of the industrial countries’ major drawings on the Fund thereafter coincided with repayments to the swap network (Table 5, columns F and G). Estimating cumulative net reserve creation by equation (8)—which takes into account the contractionary effect of such operations—shows that Fund transactions tended to destroy world reserves throughout the 1960s (Table 5, column L). This occurred despite a marked growth in Fund-generated liquidity calculated simply as the sum of reserve positions in the Fund, plus the addition of foreign exchange to international reserves that follows net drawings of U. S. dollars and pounds sterling (Table 5, column D).

The downward trend of adjusted net reserve creation during the second half of the 1960s was interrupted only in 1968, when exceptionally large drawings by four industrial countries (the United States, the United Kingdom, France, and Canada) were substantially in excess of the amount used to settle swap network balances, causing net reserve creation to rise above SDR 1.4 billion. Generally speaking, however, the level of cumulative adjusted net reserve creation during the second half of the 1960s remained very low, fluctuating between SDR 1.1 billion and SDR 1.4 billion, a level close to that of the early 1950s, despite the growth of unadjusted net reserve creation (Table 5, column A) to over SDR 4.4 billion by the end of 1969.

Adjusted net reserve creation fell sharply in 1970–72, a period of huge U. S. deficits. In 1970 the small volume of drawings and large repurchases, together with the reduction of the Fund’s gold investments to SDR 400 million,32 led to a decrease of some SDR 2.1 billion in adjusted net reserve creation. From the date of suspension of gold convertibility of the U. S. dollar on August 15, 1971 up to March 1972, drawings were made in Canadian dollars, French francs, and deutsche mark, while repurchases could be made in these three currencies, as well as in SDRs and gold. Overall net outstanding drawings fell to SDR 3.7 billion, the lowest level since 1964. The only large drawings were made by the United States, which used the proceeds to acquire dollar balances. As a result, in 1971 Fund transactions reduced world liquidity by SDR 3.3 billion. Similarly, in 1972 the impact on net reserve creation of small net drawings was more than offset by swap-related drawings by the reserve centers. Moreover, in February 1972 all the gold invested by the Fund in U. S. securities was reacquired. Net reserve creation thus dropped by a further SDR 1.3 billion in 1972, making its cumulative total minus SDR 5.4 billion for the whole period of 1951–72. The picture remained virtually unchanged in 1973, when Fund transactions were kept at a minimum, largely due to the continuing currency unrest.

In conclusion, an analysis of yearly changes in net reserve creation (Table 5, column M) does not appear to indicate a close correlation between changes in Fund-generated liquidity and changes in other international reserve assets. This is somewhat surprising, since it would be expected that, when world liquidity is relatively tight, demand for Fund resources would tend to increase while demand would decline when liquidity is relatively plentiful. However, a limited number of Fund members may encounter balance of payments difficulties even if world reserves are expanding rapidly; similarly, some members with credit tranche drawings outstanding may gain reserves and repurchase Fund holdings of their currencies even in a period of slow-growing international liquidity. Given that the aggregate volume of purchases and repurchases has always been below SDR 5 billion annually, single large transactions, such as those made in the course of the last decade by the United States, the United Kingdom, and France, may radically alter the entire picture. Moreover, transactions by the reserve centers to supplement or to repay swap-connected drawings generally involve such substantial and varied lags that it is extremely difficult to identify with any precision a causal interrelationship between general trends in world liquidity and changes in Fund-generated liquidity. As a result of these factors, Fund transactions throughout the 1950s and the 1960s have often been in the same direction as world liquidity changes.

This general conclusion, however, does not apply after 1969, when a vast increase in world reserves—stemming mostly from the large U. S. official settlements deficit and to a lesser extent from the activation of the SDR scheme—caused a widespread movement toward the repayment of outstanding balances of all international credit facilities. In this period, Fund transactions have thus partially offset the enormous increase in world liquidity that has taken place, although such offset has been slight.

APPENDIX Effects on World Liquidity of the Use of Special Drawing Rights in Fund Transactions Between Members

The use of SDRs in transactions between participants in the Special Drawing Account may have an expansionary, contractionary, or neutral impact on world liquidity, just as do members’ transactions with the General Account.

Types of SDR Transactions

There are two types of transactions between participants: “voluntary” and “designated” transactions.

Generally, in voluntary transactions a participant agrees with another participant to use SDRs to acquire its own currency held by the other. Such transactions, which obviously result in a reduction of international liquidity, amounted to SDR 181 million in 1970, SDR 480 million in 1971, SDR 329 million in 1972, and SDR 856 million in 1973. Under Article XXV, Section 2(b) (ii), a participant in agreement with another may also use SDRs to acquire a currency other than its own. Such transactions have been very infrequent in the past. Their effects are similar to those of designated transactions.

Designated transactions are those in which a participant is instructed by the Fund to provide currency “convertible in fact”33 to another participant that wishes to use SDRs because of a balance of payments need. The latter may then request that the currency provided by the designated member be converted by the issuer into U. S. dollars or, in certain cases, into pounds sterling or French francs.

Since a participant using SDRs may request one or more of the three currencies mentioned above while the designated participant may provide any of the currencies convertible in fact, a conversion is often necessary for the participant using SDRs to obtain the currency requested. If the designated participant provides its own currency, there is obviously an equivalent increase of world liquidity, but if it provides foreign exchange, world liquidity remains unchanged, since both participants simply register a shift in the composition of their reserves.

Uses of Foreign Exchange Obtained

The participant using SDRs may make several different uses of the foreign exchange obtained:

(1) It may use it to make a final payment to the country that issues the currency. In this case world liquidity remains unchanged.

(2) It may request the issuing country to convert it into a different currency. The final destination of the latter may in turn be either the country that issues it, with a consequent destruction of reserves, or it may be a third country which holds the currency so obtained among its reserve assets. In this case world liquidity remains unchanged, since the gain in foreign exchange of the third country will be offset by the loss suffered by another country through the conversion process.

(3) It may use the currency as a final means of payment to a third country. This entails creation of liquidity.

(4) It may transfer it to a reserve center in exchange for the reserve center’s currency, which is then paid to a third country. This entails a twofold addition to world liquidity, since the foreign exchange holdings of both the reserve center and the third country increase.

SDR transactions as described above are illustrated in Table 6, and Table 7 gives numerical examples.

Table 6.

Classification of SDR Transactions by Fund Members

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Table 7.

Example of Effects of SDR Transactions by Fund Members1

(In SDR equivalents)

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It is assumed that a transaction of SDR 1,000 takes place in all cases.

*

Mr. Barattieri was Technical Assistant to the Executive Director for Italy in the Fund at the time this article was written. He is now on the staff of the Bank of Italy.

Mr. Batzella, who was an Operations Officer in the Financial Relations Division of the Treasurer’s Department of the Fund when this article was written, has since joined the International Bank for Reconstruction and Development. He is a graduate of the Universita Commerciale Luigi Bocconi, Milan.

1

J. Marcus Fleming, “The Fund and International Liquidity,” Staff Papers, Vol. 11 (July 1964), pp. 177-215; see also Fleming’s “Effects of Various Types of Fund Reserve Creation on Fund Liquidity,” Staff Papers, Vol. 12 (July 1965), pp. 163-88. Hannan Ezekiel, when studying the problem of Fund-generated liquidity, confined his analysis to the direct effects of members’ transactions with the Fund—”The Present System of Reserve Creation in the Fund,” Staff Papers, Vol. 13 (November 1966), pp. 398-420, and “Reserve Creation in the Fund Under the Present System, 1951–1967” (unpublished, International Monetary Fund, November 14, 1968).

2

A so-called super gold tranche may thereby be created.

3

The right of members to draw on Fund resources up to their gold tranche position has formally become fully automatic with the amendment of the Fund’s Articles of Agreement in 1969. The amended Article V, Section 3 (d), states that “proposed gold tranche purchases shall not be subject to challenge.” Furthermore, the amended Article VI, Section 2, states: “A member shall be entitled to make gold tranche purchases to meet capital transfers.” Prior to this amendment of the Articles, gold tranche positions in the Fund were legally considered conditional liquidity, although in practice members could fully rely on the availability of such funds, particularly after Executive Board Decision No. 1745-(64/46), August 3, 1964, Selected Decisions of the Executive Directors and Selected Documents, Third Issue (Washington, January 1965), p. 49. Even prior to this decision, however, the virtual unconditionality of gold tranches was affirmed by Executive Board Decision No. 102-(52/11), February 13, 1952, Selected Decisions of the International Monetary Fund and Selected Documents, Sixth Issue (Washington, September 30, 1972), pp. 22-25. (Hereinafter referred to as Selected Decisions.) On these grounds, members’ gold tranches have been considered to represent unconditional reserve assets for the whole period under consideration in this paper.

4

Such loans do not change the Fund’s holdings of these particular currencies, since in general they are immediately purchased by another member.

5

In the next section it will be argued that SDR holdings in the General Account should be treated in the same manner as gold holdings.

6

Since member countries that have not fully paid up the total currency subscription of their quota cannot use the Fund’s resources, the following equations do not apply to them.

7

The method used here is derived from that used by Fleming in “The Fund and International Liquidity” (cited in footnote 1), p. 187, who argues that “the Fund’s net contribution to unconditional liquidity up to any point of time can be measured by the amount of members’ gold tranche positions less the amount of gold held by the Fund.” This approach is simpler and more systematic than Ezekiel’s in “The Present System of Reserve Creation in the Fund” (cited in footnote 1); he determined the reserve position in the Fund by adding algebraically a number of heterogeneous assets and liabilities of the Fund.

8

Besides bar gold holdings, the Fund’s gold account also comprised “gold deposits” and “investments” until February 1972. The former were made in a number of countries at the time of the quota increase of 1965 to mitigate the losses of gold caused by other countries’ purchases to pay subscriptions for increases in quotas; the latter represented sales of gold by the Fund to the United States, the proceeds of which were invested in U. S. Government securities to increase the Fund’s current income. Since gold deposits and investments appear in both the members’ and the Fund’s gold accounts, they should not be subtracted from reserve positions in calculating the Fund’s net creation of reserves for the period covered in this paper.

9

This formula also reflects the effects of increases in Fund quotas. When a quota increase takes place, the required gold payment to the Fund is not offset by the increase in reserve position to the extent that the member is in credit tranche positions. As a result, net reserve creation in the General Account will show a decline of created liquidity, but this is matched by an increase of conditional liquidity.

10

Executive Board Decision No. 1477-(63/8), February 27, 1963, as amended by Decision No. 2192-(66/81), September 20, 1966, Selected Decisions, pp. 42–47.

11

See Hannan Ezekiel, “The Effects of Compensatory Financing Transactions on Reserve Positions in the Fund” (unpublished, International Monetary Fund, May 22, 1967).

12

Executive Board Decision No. 2772-(69/47), June 25, 1969, Selected Decisions, pp. 47-48.

13

It should be noted that under Article XXV, Section 7(d), the Fund may also require a participant to provide its currency for SDRs held in the General Account.

14

With the exception of repurchases made in accordance with Article V, Section 7(b).

15

In September 1971 the Executive Board also decided that members could draw SDRs from the General Account to be used immediately in a transaction with designation, but no member has yet done so, except for purposes of reconstitution. In July 1972 the United Kingdom purchased SDR 292 million from the General Account in accordance with Article XXV, Section 7(f), which permits the Fund to use SDRs in transactions by agreement with the participant.

16

The payment of remuneration in gold is limited by Rule 1-9, International Monetary Fund, By-Laws, Rules and Regulations, Thirty-First Issue (Washington, April 30, 1973), p. 39, to the extent that the Fund’s receipts of gold, during the year, in payment of charges, exceed payments during that year of gold as transfer charges and interest on borrowings.

17

For example, the total remuneration paid for the fiscal year ended April 30, 1972 was SDR 30.5 million, including SDR 28.5 million in gold, 2.0 million in SDRs, and only SDR 5,000 in members’ currencies; however, in the following fiscal year, of the total remuneration paid (SDR 29.3 million), more than SDR 5.3 million was in members’ currencies.

18

According to Article V, Section 8(f), charges may be paid in the member’s own currency when the member’s monetary reserves are less than one half of quota. However, when the Articles of Agreement were amended in 1969, the Fund’s concept of monetary reserves was changed from net to gross; therefore, it has become comparatively rare for members to be entitled to pay charges in their own currency.

19

Annual administrative costs of the Special Drawing Account have been close to SDR 1 million. The assessment is levied as a flat percentage of each member’s allocation of SDRs.

20

See Executive Board Decision No. 1371-(62/36), July 20, 1962, Selected Decisions, p. 36, approving the statement entitled, “Currencies to be Drawn and to be Used in Repurchases,” contained in SM/62/62, Revision 2, which is incorporated into the Fund’s Annual Report for 1962.

21

It is, however, possible that the currency obtained from the Fund is converted at the central bank that issues the currency required by the drawing member, rather than at the drawee’s central bank. For instance, a member of the sterling area, say Ghana, might obtain U. S. dollars from the Fund, then request the Bank of England to convert them into pounds sterling. The effects of such a conversion are opposite to those described in the text, determining a creation of liquidity rather than a destruction. In the example here, the United States would register an increase in its reserve position in the Fund, the United Kingdom would gain foreign exchange (dollars) through the conversion, and the final recipient of Ghana’s payment (for example, Nigeria) would gain sterling. International liquidity would thereby increase by three times the amount drawn from the Fund. This is a rather improbable case, since conversions generally take place at the drawee’s central bank.

22

Fleming also briefly examined the possible effects of conversions in “The Fund and International Liquidity” (cited in footnote 1), pp. 183-84.

23

This does not apply to repurchases falling due under Article V, Section 7(b), which are payable with the assets held in the repurchasing member’s monetary reserves, whenever such assets can be accepted by the Fund.

24

Executive Board Decision No. 1371-(62/36) as cited in footnote 20. Repurchases can also be made in gold or SDRs, but the Fund’s holdings of gold and SDRs are already deducted from the computation in equation (6) of net reserve creation through Fund transactions.

25

The member whose currency is used is necessarily in a gold tranche position, since only those currencies of which the Fund’s holdings are less than 75 per cent of the issuing member’s quota can be used in repurchases (Article V, Section 7(c) (iii)).

26

If SDRs are used in repurchases, no conversions are necessary; thus SDRs can be assimilated to gold or reserve currencies.

27

From 1962 to 1971 there were very few purchases and repurchases in pounds sterling, except in 1967; from 1964 to 1968 there were also scarcely any repurchases in U. S. dollars. However, the improvement of international economic and financial integration has led to expanded holdings of a number of national currencies as international reserves, with the result that drawings and repurchases may have required fewer conversions.

28

Fleming, “The Fund and International Liquidity” (cited in footnote 1), p. 184.

29

For example, if the United States draws SDR 100 in lire which are used to acquire SDR 100 in dollars from the Bank of Italy, there is a destruction of world liquidity equal to Italy’s loss of foreign exchange, which is not accounted for in equation (7).

30

Several large repayments to the Federal Reserve’s swap network match surprisingly well both in timing and in amount some of the largest drawings from the Fund by the major industrial countries. The data in column G of Table 5 represent such drawings.

31

Through this process not only is the amount drawn from the Fund but also the balance of the purchasing member’s currency immediately canceled from international reserves. However, as the decrease in balance is outside the scope of this paper, only the amount drawn for this purpose must be subtracted.

32

The 1970 quota increase also contributed to the fall in net reserve creation (see footnote 9). Similarly, sales of South African gold to the Fund have tended to reduce net reserve creation, since the increase in RPF was lower than the increase in Fund holdings of gold (for example, drawings of sterling when the United Kingdom was in the credit tranche position); as for South Africa, such sales only involve a change in the composition of reserves. However, gold sales of SDR 548 million and SDR 16 million to the United States and Austria, respectively, in mitigation of the effects of the quota increase, did not affect net reserve creation, since they matched the reduction of the RPF of both the United States and Austria. An additional SDR 7 million of gold was sold to Germany in December 1971.

33

There are two types of currencies “convertible in fact”: (1) U.S. dollars, French francs, and pounds sterling, which must be converted by the issuer on demand into any of the other two, under Article XXXII, Section (b)(1); and (2) Belgian francs, Netherlands guilders, deutsche mark, Italian lire, and Mexican pesos, which are convertible only into U. S. dollars, under Article XXXII, Section (b)(2).

IMF Staff papers: Volume 21 No. 1
Author: International Monetary Fund. Research Dept.