Michael O. Rigg

English

Research Papers in Economics

International Monetary Reform
n the weekend of August 26-27, monetary officials
of the world’s major countries reached preliminary
agreement on a plan which would provide for a supple-
ment to existing world reserve assets. The agreement,
reached in London by the Group of Ten,1 represented
the result of four years of discussions and has been
hailed by some as the major development in interna-
tional finance during the last two decades. While it is
probably too early to judge the long-range signifi-
cance of the proposal, it would be useful to under-
stand why it was made and to review some of its
major details.
Since 1958 the volume of world trade has risen
substantially. World imports, which were $100.4 billion
in 1958, rose to $191.9 billion in 1966, an increase of
91 per cent.2 In addition, with the return to currency
convertibility by most Western European countries in
late 1958 and with less likelihood of foreign investment
being blocked by exchange controls, it has become
more widely feasible to move private funds inter-
nationally. These capital transfers are motivated by
interest rate differentials between countries and by
expectations concerning the strength or weakness of
individual currencies.
As a result of the growth in world trade, the mobility
of short-term private capital, and the attractiveness of
long-term capital investments abroad, sizable imbal-
ances may develop more easily in a country’s overall
balance of payments. The imbalances may be relative-
ly brief and the result of normal lags between receipts
and expenditures. On the other hand, they may
sometimes be prolonged.
1
The Group of Ten includes: Belgium, Canada, France, Ger-
many, Italy, Japan. the Netherlands, Sweden, the United
Kingdom, and the United States.
2
lnternational Monetary Fund, International Financial Statistics,
August, 1967
By transferring international reserves,3 a country
may finance a temporary balance-of-payments deficit
without resorting to trade restrictions or deflationary
domestic policies designed to immediately correct the
deficit. International reserves, therefore, serve much
the same function for a nation as cash balances serve
for an individual, By varying his holdings of cash, an
individual can adjust for discrepancies between the
timing of his receipts (income) and his expenditures.
As income and expenditures increase, the desired
amount of money balances to meet these “transactions”
also tends to rise. The same is true of a nation. As
trade and capital movements rise, the potential dis-
crepancies between international receipts and expend-
itures increase, leading to an increase in the desired
stock of international reserves.
In contrast to world trade, the total stock of inter-
national reserves held by Western countries has in-
.3 International reserves include: gold, convertible currencies
(including the U.S. dollar), and automatic drawing rights on
the International Monetary Fund.
Total World Trade and Monetary Reserves
RotioScole Rotia Scale
Billions of US. Dollars Billions of US. Do liars
20
1946 1950 1952 1954 1956 1958 1960 1962 1964 1966
5cu,ce~ MF
P,,c,,,og,~ e,~~}~el ‘of,,, Irho,g, b,,,,,, pe,icd,adk,,,,d
Page 14creased only moderately since
1958. Gold production has failed
to expand monetary reserves sig-
nificantly, and in 1966 and early
1967 hoarding and industrial uses
actually decreased the free
world stock of monetary gold.
A major share of the growth in
world reserves overthe last eight
years has been accounted for by
the dollar.4 By running balance-
of-payments deficits, the United
States has contributed to world liquidity in the form of
short-term dollar liabilities to foreigners. However, in
the process, the ratio of United States short-term liabil-
ities to its own stock of international reserves has in-
creased. Carried far enough this might undermine
confidence in the dollar as a reserve asset and result
inthe conversion of dollars to gold by foreign monetary
authorities.
Given the United States’ determination to reach an
equilibrium in its balance of payments, the dollar can-
not be counted upon to supply liquidity at a rate com-
mensurate with future world needs. Since gold and
other convertible currencies are not expected to ap-
preciably increase world liquidity, many believe exist-
ing international reserves must eventually be supple-
mented if trade and capital movements are not to be
stifled. The agreement reached in London is an initial
step in this direction.
The preliminary proposal adopted by the Group of
Ten calls for the creation of a supplementary reserve
asset in the form of book entries in a Special Drawing
Account of the International Monetary Fund (IJvLF.).
The entries would be called “special drawing rights”
or simply SDR, and would be denominated in units of
account equivalent to the gold value of one dollar.
Indications are that from $1 to $2 billion per year
would be created in the form of SDR during an initial
five-year period.
The new Special Drawing Account would be divided
among the Fund’s 106 member countries in accordance
with their present IMF quotas. For instance, assuming
that $2 billion per year is created, the United States,
whose IMF quota is currently 24.6 per cent, would
4
Since 1964 the dollar contribution to world liquidity has been
negative. The growth in international reserves since then has
been chiefly theresult of increased holdings of other convertible
currencies and to increased automatic drawing rights on the
International Monetary Fund.
receive $492 million peryear in the form of SDR. The
United States could then draw on the account to settle
balance-of-payments deficits.
Countries would not be required to pay their own
currency in exchange for SDR allocations from the
Fund. Instead, each would be required to accept SDR
balances in exchange for convertible currency from
any country tendering them to settle balance-of-pay-
ments obligations.
To insure that no individual country accumulated a
disproportionate share of its total reserves in the form
of special drawing rights, a limit would be placed on
the volume of SDR which a country was obligated to
accept. No nation would be required to accept SDR
in excess of its cumulative allocation plus two times
its cumulative allocation. For example if Germany
received $500 million in SDR over a five-year period,
it would be obligated to hold up to $1,500 million in
SDR balances. Thus, Germany would be required to
accept at least $1,000 million in SDR from countries
who experienced balance-of-payments difficulties,
The asset would be attractive in the sense that it
would yield a moderate interest return. A country
might desire, therefore, to hold a volume of SDR in
excess of the limit amount.
Special drawing rights would be used for balance-
of-payments needs and to protect reserve positions.
No country would be expected to use SDR merely to
acquire other forms of reserve assets in order to alter
the composition of its total stock of reserves. An
eligible user could direct the Fund to transfer its SDR
to a particular country for the purpose of purchas-
ing its own currency, but only if the other country
agreed to accept the SDR. This provision is of partic-
ular interest to the United States, Normally, the United
States uses reserve assets to purchase foreign-held
dollar balances, The special drawing rights could,
therefore, be used in much the same way as the United
States uses existing reserve assets.
INTERNATIONAL RESERVE ASSETS
(Millions of U.S. Dalton)
Reserves Change in Reserves
1958 1964 1966 1958-66 1958-64 1964-66
Gold’ 38,030 40,845 40,905 2,875 2A15 60
U.S. Dollars 9,648 15,771 14,898 5,250 6,123 873
Other Roserve Currencie,T 7.317 7,639 9,382 2.065 322 1,743
Reserve Position in IMI 2,557 4.155 6,331 3,774 1,598 2,176
TOTAL 57,552 68,410 71,516 13,964 10,858 3,106
F’.. loch-c hnlthnes sf is_I’ nistion .1 c,,p.a,./.st.nnc.
Un t,sb pn’s S’.Icrhng i’m c ST .~n1uS~ sb,,, it, cinilina ,,mcsal nsnnt-t sTy iiJi~ ili’is a! ,:,:,r,tri,-’ntl,,’r
lb u 0’, 1’ 5..,rcz thi 1 . K.
S a’ , Isp-n ,.s Lional M onetsr’ F ,~ ‘ a.
Page 15The main issue during the meetings in London con-
cerned the question of whether, and on what basis,
each country might need to reconstitute its cumulative
SDR allocation. Some favored a provision requiring
deficit countries who drew on their SDR account
eventually to restore the balance. This would make
SDR a form of intermediate-term credit and, as such,
not much more than anextension of current IMFcredit
facilities. The United States, on the other hand, stress-
ed the need for a permanent addition to world re-
serves which would circulate among countries without
the need forrepayment.
The result was a provision calling for reconstitution
of SDR based on the amount and duration of its use.5
The average useof special drawing rights by a member
country over a five-year period should not exceed 70
per cent of that country’s average net cumulative allo-
cation over the same period. A country would be per-
fectly free to use in excess of the 70 per cent figure,
but would be obligated to rebuild the account to an
average balance of 30 per cent by the end of the five-
year period. The participants would be encouraged to
“maintain a balanced relationship over time between
their holdings of special drawing rights and other
forms of reserve assets.”6
5F’or amore detailed explanation of the reconstitution provision,
see: International Monetary Fund, Press Release Na. 625,
September 11, 1967.
°Ihid,,5.
In order to call the SDR accounts into existence, an
85 per cent weighted vote would be required by the
Fund’s Board of Governors representing the member
countries. Since the Common Market countries7, voting
as a block, control 16.8 per cent of the IMF vote, they
would have the power to veto a proposal to activate
the accounts. The United States would likewise have
veto power, since it controls in excess of 20 per cent
of the Fund’stotal vote.
On September 29, the 106 members of the Inter-
national Monetary Fund unanimously approved the
plan at the Fund’s meeting in Rio de Janeiro. It must
now be translated into legal terms as an amendment
to the articles of the IMF and ratified by the govern-
ments of at least three-fifths of the members having
four-fifths of the voting power. The Managing Director
of the Fund, in consultationwith the Executive Board,
would then have the power to propose that the SDR
accounts be activated. He would suggest the date of
implementation, the amount of SDR to be created, and
the length of the initial period in which the accounts
would be operative. The proposal would then require
the 85 per cent weightedvote by the Fund’s Governors.
As a result of these various legislative requirements,
it seems unlikely that the new plan could be called
into operation before 1969 at the earliest.
7
The Common Market countries include~France, Germany,
Italy, the Netherlands, Belgium, and Luxembourg.
MICHAEL 0. Rxcc

International money reform

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International money reform

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