H. Johannes Witteveen
Two years ago Jeremy Morse spoke on “The Evolving International Monetary System” during a session of this Conference held at Williamsburg, Virginia (Finance & Development, September 1974). Today, the international monetary system is no longer evolving, it is emerging. This is a valid distinction, for the Fund’s Board of Governors overwhelmingly approved a substantial, and wide-ranging, amendment of the Articles of Agreement of the International Monetary Fund in April 1976, and this amendment is now before governments for ratification. This article presents my views on the system that is likely to emerge as we build on the foundation of the amended Articles.
The agreement on amendment marks a very significant step in a process that began nearly five years ago. It demonstrates that the collapse of the Bretton Woods system did not mean that nations wished to abandon the idea of a monetary system based on international obligations, and which was internationally administered. The obligations assumed by members of the Fund under the Articles of Agreement lie at the very heart of the monetary system, and the Fund has a unique responsibility for its future development. The new Articles explicitly reaffirm this task in that they require the Fund to oversee the international monetary system to ensure its effective operation.
During the economic and monetary disturbances of the last five years, serious questions have been raised about the role the Fund could be expected to play in the new conditions. But, during these very years, the importance of international monetary cooperation, with the Fund at the center, has been amply reaffirmed.
Even during a period when events made it very difficult for members to observe some of their obligations under the Fund’s Articles, there remained a strong desire to return to some agreed international order, more in accord with changed conditions. This gave rise to a number of important developments. The decision on central rates and wider margins attempted to re-establish a framework for exchange rates at a time when members still sought a modified form of par value system. Later, there were the guidelines for floating, and the arrangements for special consultations with members on their exchange rate policies. These decisions recognized that the behavior of countries with respect to exchange rates should continue to be a matter of international concern. And, of course, there were the difficult and prolonged negotiations on the reform of the international monetary system in the Committee of Twenty and later in the Interim Committee.
Oil prices and recession
The Fund has also responded in a variety of ways to two international economic problems of exceptional severity: the increases in oil prices and the most serious recession since the 1930s. In early 1974, following the increases in oil prices, the Fund took the lead in encouraging members not to adopt policies that would aggravate the problem of other countries. It was particularly important that countries did not resort to the use of restrictions on trade and payments and competitive devaluations. Through the oil facility arrangements, finance was made available to assist members in avoiding these mutually destructive measures. At a later stage, in response to the effects of the world recession, when payments deficits became heavily concentrated on primary producing countries, the Fund enlarged access to its regular credit tranche facilities, and to its facility for compensatory financing of export fluctuations.
The Fund’s actions during these years were taken against the background of widespread and substantial payments deficits. The combined current account deficits of oil importing countries were $52 billion in 1974; they fell to $35 billion in 1975, and some further reduction is expected in 1976. Since the beginning of 1974, net finance made available by the Fund has totaled over $12 billion, including $8 billion under the oil facility. In appraising the magnitude of these amounts it has to be borne in mind that by far the larger part of the current account deficits of the oil importing countries was financed, directly or indirectly, by capital exports from the oil exporting countries. The resources made available by the Fund were of crucial importance to members in dealing with their residual financing problems. For example, the financing provided by the Fund to non-oil producing countries that used the oil facility was over one third of the increased cost of their petroleum imports. Moreover, the linking of financial assistance to the avoidance of restrictions and to policies to promote adjustment in members’ balance of payments positions has given other creditors more confidence in continuing to make finance available. In these respects, the Fund’s role has been similar to that of a central bank maintaining confidence in its domestic financial structure. There is a clear need for an international organization to accept this responsibility.
During the last several years, the Committee of Twenty and the Interim Committee have played important roles in reviewing the policies and actions of the Fund. Since these Committees have been at ministerial level, they have provided the international community with a way of coming to grips with, and resolving, the real political difficulties that are often involved in the more important decisions of the Fund. These decisions have also included the method of valuing the SDR; the increase in Fund quotas from SDR 29 to SDR 39 billion; the decision to dispose of one third of the Fund’s gold and establish the Trust Fund for the poorer developing countries; and, of course, the agreement on the amendment of the Articles. Moreover, on the basis of periodic examinations of the world economic outlook by Ministers of Finance, a start has been made toward the possibility of greater coordination of economic policies. I very much hope that this too will prove to be an important element in the emerging international monetary system.
These various developments have confirmed the Fund’s ability to adapt its policies and practices to changing circumstances. This power of adaptation will be appreciably enhanced under the new Articles, which make provision for a successor body to the Interim Committee—The Council—with terms of reference that include the supervision of the management and adaptation of the international monetary system.
Main features of amendment
Turning now to the main features of the amendment of the Fund’s Articles, I feel we can be very positive about what has been achieved. It is true that the amendment does not include several features of the detailed blueprint for Reform drawn up by the Committee of Twenty. There are no new provisions on convertibility or asset settlement, or arrangements for the control of reserve creation and composition. Nor do the new Articles establish rules for ensuring symmetry in the adjustment process. The greater freedom for currencies to float, and the recent strength of the dollar, have reduced concern with these issues. Moreover, the major uncertainties, and the very large payments imbalances in recent years, have made countries more cautious in accepting new obligations. At the same time, the increased flexibility of exchange rates is making a contribution to an improved adjustment process. As greater stability is achieved over time, there may well be a desire for a more structured system. This might require agreement on some of the issues not resolved in the present reform, but this would not necessarily require a new amendment of the Articles of Agreement.
In many respects, the amendment of the Articles is a very important step forward. The new Articles will be complete in themselves. They confirm the role of the Fund in overseeing the international monetary system. They provide a much more workable basis for the Fund’s financial operations than the existing Articles. There are far-reaching changes in the field of exchange rates, and the Fund is given a variety of powers and possibilities in this respect. The role of gold in the monetary system is reduced. The role of the SDR is strengthened. And the new Articles provide the Fund with broad enabling powers so that its own role, and the monetary system itself, can respond to changing circumstances within an agreed legal framework.
Gold is removed from the central position it occupies in the Fund’s present Articles. This is partly achieved by the abolition of the official price; by breaking the link between gold and the SDR; by prohibiting the use of gold as a peg for a currency under any future exchange arrangements, including a par value system; and by requiring the Fund, in any dealings in gold, to avoid actions that would manage the price in the market or establish a fixed price.
In addition, there will no longer be any obligatory payments in gold by members to the Fund, or by the Fund to members. The Fund may decide to accept gold from members in payment, but only by a decision taken by an 85 per cent majority and at market-related prices. There is, therefore, no guarantee that it will be possible in the future to use gold to settle obligations to the Fund, and certainly no guarantee on the price to be applied to any such payments. In these respects, the SDR will supplant gold in the Fund’s operations, since the Fund will be required to accept SDRs from a member in settlement of obligations.
The Fund has also decided to sell one third of its existing gold holdings, with one half of this amount being sold at market prices and one half to the Fund’s membership at the official price of SDR 35 per ounce. In implementing this decision, the Fund has successfully conducted its first public auction of gold. The new Articles will require the completion of the sale of the agreed amount, and will allow the Fund to decide—by an 85 per cent majority—to make further sales in either or both of these two ways. These present sales, and any that might be made in the future, follow logically from the agreed reduction in the role of gold in the monetary system.
Moreover, under the new Articles, members undertake that their policies with respect to reserve assets will be consistent with the objective of making the SDR the principal reserve asset in the international monetary system. This undertaking has a bearing on members’ future actions with regard to gold, and would apply to agreements such as that concluded last August among the Group of 10 industrial countries. This agreement, which will be reviewed two years from its effective date, bars any action to peg the price of gold. It also provides that the total stock of gold held by the Fund and the monetary authorities of these countries will not be increased.
The role of gold as a reserve asset began to change in 1968, when the main central banks abandoned the attempt to keep the market price at $35 per ounce. The abolition of the official price will eliminate the impediment under the present Articles to purchases of gold by central banks at whatever price they see fit, and will thus, to a certain extent, restore to central banks the possibility of making some use of their gold holdings. Nevertheless, with no pegged price, and with private and official stocks greatly exceeding annual production, gold remains a speculative asset. A central bank needing to sell large quantities of gold at short notice would have no assurance that it could do so, and no assurance on the price. For these reasons, gold is losing some of the essential characteristics of an international reserve asset. While I do not foresee the rapid disappearance of gold from countries’ reserves, it can no longer play the active role that it played in the past.
Role of SDRs
Lord Keynes, in his proposal for an International Clearing Union, wrote of the need to establish “an instrument of international currency having a general acceptability between nations.” The amendment of the Articles continues the process of establishing the SDR as such an instrument, and members are required to collaborate with the Fund in pursuit of the objective of making the SDR the principal reserve asset of the international monetary system. To this end, there will be both immediate changes in the characteristics of the asset, and possibilities for further developments. Immediately, there will be far greater freedom for members to engage in transactions by agreement in SDRs, and much wider possibilities for transfers of SDRs to and from the Fund itself. There will also be greater scope for other official entities to hold and use SDRs, and they will be able to engage in a somewhat broader range of transactions than at present. Provision is also made for the Fund to permit new forms of operations in SDRs; for example, loans or grants, thus helping to bring the characteristics of the SDR closer to those of traditional reserve assets.
Like the reduction of the role of gold, making Special Drawing Rights the principal reserve asset must be a gradual process, which will be assisted by the changes in the Fund’s Articles. It is true that, largely as a result of the considerable creation of reserve currency balances in recent years, the present issue of 9.3 billion Special Drawing Rights is a relatively small proportion of international reserves. But it should be borne in mind that about 15 billion of reserve positions in the Fund are valued in terms of the SDR. Some SDR 11 billion of this total, including SDR 7 billion borrowed under the oil facility arrangements, represent the creation of international reserves through the Fund’s credit operations. Although their method of creation and their legal attributes are different, in important respects these assets have economic characteristics similar to those of Special Drawing Rights. The SDR unit has also begun to establish itself in a variety of ways: as a currency peg, as a unit of account in international transport, for bond issues, and as a definition of obligations in many international agreements.
It would clearly be advantageous if the proportion of reserves held in the form of Special Drawing Rights were increased. But it is not necessarily the quantity of SDRs in existence that will determine their importance. These holdings could well play a pivotal role in a system of international liquidity control, even though SDRs were not—in terms of quantity—the main reserve asset.
Exchange rate regime
At present, Fund members employ a variety of exchange rate techniques. The currencies of many major countries are floating. But the system cannot be described as one of free floating, for there has been considerable intervention in foreign exchange markets in support of floating currencies. Moreover, the majority of countries have pegged their currencies in some way to other currencies, or to certain composites, such as the SDR or trade-weighted baskets.
What the new Articles do is, first, to legalize these arrangements by providing freedom for countries to choose their own regime. But this is a freedom of choice not a freedom of behavior. While par values, with narrow margins for fluctuations, have disappeared, the new Articles establish a set of obligations, both for members and for the Fund, that will underscore the importance of the Fund’s regulatory role as regards exchange rates. At the same time, they point to the essential relationship between exchange rates and the underlying economic and financial policies of members. For the Fund, this will mean an increase in the attention that has always been paid to these policies. The Fund is also required to exercise “firm surveillance” over members’ policies and actions in the field of exchange rates and to adopt specific principles to guide members in these policies. There are, therefore, two “layers” of competence for the Fund: members’ general policies, and those actions that have a particular influence on their exchange rates.
Similarly, members will have two “layers” of obligations. In their economic and financial policies, they must attempt to foster orderly economic growth with reasonable price stability and a monetary system that does not tend to produce erratic fluctuations. And they must pursue orderly exchange arrangements and a stable system of exchange rates, and must avoid manipulating exchange rates to prevent effective balance of payments adjustment or to gain an unfair competitive advantage. In these respects, I believe that the firm surveillance to be exercised by the Fund under the new Articles, and the new obligations assumed by members, represent a significant strengthening of the Fund’s powers.
The long rule of the par value system has created the impression that the Fund’s power in relation to exchange rates depended solely on the existence of that system. But this was never true. In practice, the ability of the Fund to influence, or even discuss, exchange rates under the par value system was seriously impeded by the very nature of changes in par values. There was the need for complete confidentiality, and considerable diplomacy, in dealing with what were usually large, discrete, changes in exchange rates. And such changes were typically accompanied by financial and political trauma. The more flexible system of exchange rates we have at present also poses difficulties of supervision, and challenges the Fund to explore new analytical techniques when considering exchange rates. Nevertheless, with the removal of the taboos associated with par value changes, we have already seen a greater willingness on the part of Fund members to engage in effective discussion of their exchange rate policies.
Experience so far with flexible exchange rates has shown some obvious, and some less obvious, advantages. Clearly the system goes a long way toward avoiding the currency crises of the past. No par value system could have been sustained with the large imbalances and the wide variations in inflation rates we have seen in recent years. Greater flexibility in exchange rates also enables countries to protect themselves to a certain extent against the inflationary effects of the payments deficits of other countries. At the same time—less obviously—the fact that inadequacies in a government’s economic policies can sometimes be rapidly reflected by a marked depreciation in the exchange rate can apparently have a similar psychological effect to a loss of reserves in strengthening policies or making it easier to implement them.
The main disadvantage of the flexibility of exchange rates has been the extent of short-term fluctuations in rates and their sometimes erratic nature. There is a need, therefore, to dampen these disturbing fluctuations and to achieve a more stable system of exchange rates. In this connection, I am not just thinking of intervention, but—perhaps more importantly—monetary policies, and also the extent to which countries’ general economic and financial policies are conducive to stability. This applies in particular to a continued reduction in the rate of inflation, which will be a difficult but vital task as the current recovery proceeds.
How then do I view the principal features of the emerging international monetary system? The Fund will remain at its center, and be better equipped than in the past to shape its future development in the light of changing circumstances.
The amendment of the Articles, together with the agreed increase in Fund quotas, will enhance the role of the Fund in assisting members to formulate policies for adjusting their external positions without resort to trade and payments restrictions, and in providing the necessary financial assistance to give time for these adjustment policies to work.
I see a reduction in the role of gold as a reserve asset, and I am confident that the SDR will become an increasingly important element in the monetary system.
Finally, it is in the field of exchange rates that we face the greatest challenge. We need to move toward a system that has the resilience and flexibility of the present arrangements without the disturbing fluctuations we have experienced since 1973. A more stable system of exchange rates will depend to a large extent on the achievement of greater stability in general economic and financial conditions, and in particular a continued reduction in rates of inflation. But it will also depend on how imaginatively the Fund, in establishing principles for the guidance of members, and in its surveillance of members’ policies and actions, can breathe life into the exchange rate provisions of the new Articles of Agreement.