Margaret Garritsen de Vries
December 27, 1985 marks the fortieth anniversary of the signing of the Fund’s Articles of Agreement by the 39 original members, a ceremony that gave birth to the International Monetary Fund. In 1945, no one knew how well the new organization would work. The new members themselves held profoundly conflicting views as to how vital and effective the Fund should be, some arguing that the need for little activity would indicate the Fund’s success. Today, while some would have the Fund perform otherwise than it currently does, the Fund is nonetheless regarded as one of the more influential and effective international organizations.
The Fund’s membership has grown to 148, encompassing virtually all countries except a few, principally in the Eastern Bloc. In recent years, the People’s Republic of China has taken up the representation of China, and two East European countries—Hungary and Romania—have become members. Financial resources from members’ quota subscriptions have grown nearly twelvefold, to just under SDR 90 billion, and the Fund has been able to supplement these resources considerably by temporary borrowing from the governments and central banks of several of its members. Today the Fund is widely recognized to have played a key role in containing a world financial crisis that might otherwise have resulted from the severe debt-servicing difficulties that arose in mid-1982. It is the major forum in which financial officials consider and help resolve international monetary problems.
The Fund’s evolution into an effective international organization is largely attributable to its ability to adapt its activities, policies, policy-making bodies, procedures, and even its Articles in response to changing circumstances. The Fund has shown a capacity to adapt not foreseen by its founders.
A slow start
When the Fund opened its doors in March 1946, it was eager to start enforcing the code of conduct with which it had been entrusted, including agreed par values for exchange rates, the abolition of exchange restrictions, and the establishment of currency convertibility. However, the Fund soon found that it faced serious problems in doing so.
First, the postwar economic problems of reconstruction and the major readjustments that most members needed to make in their economies and trading relations proved much more difficult than had been expected. For over a decade most members could not fully assume their Fund obligations, finding it especially difficult to eliminate restrictions and establish currency convertibility. Second, as an untried international organization, the Fund had difficulty in asserting its authority. Third, the Fund was hampered by its inability to disburse money. While most members needed US dollars urgently, the Executive Board was sharply divided between those who believed that members had an automatic right to draw on the Fund’s resources and those who believed that access to its dollar holdings should be subject to fairly strict conditions. Moreover, it was decided that the Fund should not give financial assistance to recipients of Marshall Plan aid. In any event, financial authorities regarded lending as a subsidiary function of the Fund, and the Fund’s resources as intended for short-term use only.
In these circumstances, the Executive Board took many decisions that in effect tied the Fund’s hands. Much to the frustration of the first Managing Director, Camille Gutt, the Fund made few transactions, was involved only formally in members’ exchange rate decisions, had relatively few discussions with members of their economic policies, and took little action against the extensive exchange restrictions of European members. Instead, the Fund concentrated its efforts on multiple rates and discriminatory currency practices, which prevailed mainly in smaller members. This provoked some ill will on the part of developing members, especially in Latin America, which resented the greater attention being paid to their exchange rate practices and restrictions than to those of the major powers.
Far-reaching changes in 1952
By 1952, the Fund’s reputation and its relations with many of its members had reached a low ebb. But its officials had learned a lesson: to be of value, the Fund had to meet the most urgent needs of its members. What members needed at that time was help in setting their economic goals and priorities and support in reducing their reliance on restrictions. In that year the Executive Board agreed to two bold undertakings that helped greatly to fill these needs: it ensured that the annual consultations with each member, which were then being inaugurated, would be substantive, and it introduced a general policy on the use of its resources.
The Articles of Agreement required that, beginning five years after the start of operations, the Fund hold annual consultations with each member still maintaining exchange restrictions. When such consultations were begun on March 1, 1952, the climate for them was anything but propitious. Some Executive Directors and even some staff members, deeply wary of the Fund’s overstepping its authority, wanted to restrict severely the frequency of consultations, the subject matter to be covered, and any recommendations by the Fund. Others, including Ivar Rooth, the second Managing Director, argued that such limited consultations would compromise the Fund’s credibility even further, and spoil the Fund’s best opportunity to become a participant in members’ economic policy decisions. After much debate, the Executive Board agreed that consultations should be thoroughgoing—that the Fund should review exchange restrictions, the forces necessitating their retention, and ways to eliminate them, including possible financial and technical assistance from the Fund.
At first conducted cautiously and then gradually extended, these annual consultations have enabled the Fund, jointly with the authorities of each member country, to make regular reviews of the full range of its members’ balance of payments positions, policies, and prospects. Since the balance of payments is also affected by domestic macroeconomic policies, the Fund necessarily became involved in reviews of these policies, such as fiscal, monetary, and pricing policies.
For more than three decades, annual consultations have been the principal framework for the Fund’s Executive Directors, management, and staff to address members’ external payments problems. The holding of consultations under Article IV, which deals with exchange rate arrangements, is a key feature of the Second Amendment to the Articles, which became effective in 1978, and the main instrument through which the Fund now carries out its mandate for surveillance over members’ economic policies.
The second of the seminal decisions of 1952 gave the Fund a general policy on the use of its resources. Under the “tranche policy” introduced, the Fund’s credit was to be available to members in four equal tranches of 25 percent of quota. In addition, members had a “gold” tranche position to the extent that Fund holdings of their currency were less than the quota. Drawings in the “gold” tranche were, in practice, to be automatic (automaticity was formally incorporated in the First Amendment of the Fund’s Articles in 1969). Drawings in the credit tranches were to be conditional on a member’s economic policies aimed at correcting its balance of payments disequilibrium. The objective was to enable members to lift restrictions, thereby achieving the Fund’s basic purposes. Repurchase (i.e., repayment of borrowed currencies to the Fund) was to take place within three to five years. In its suggestion that members might not want to draw immediately but could ensure that they would be able to draw within a subsequent 6 to 12 months’ period if needed, the 1952 decision contained the germ of the Fund stand-by arrangement (also not mentioned in the original Articles). By the mid-1960s, stand-by arrangements were virtually the only means by which the Fund provided financial support to its members; in 1974 they became the model for the new extended arrangements; and in 1978 a definition of a stand-by arrangement was included in the amended Articles.
Conditionality, much further developed, today forms the heart of the Fund’s financial assistance. Indeed, the unique leverage of the Fund’s lending derives from the linking of stand-by arrangements to members’ economic policies, reinforced by periodic consultations.
Innovations in the 1960s
By the early 1960s, most of the Fund’s initial goals had been achieved: the great majority of its members had established par values for their currencies, the extent and complexity of multiple rates had vastly diminished, and the main European currencies had been made convertible. The Fund had developed a system of international cooperation and consultation on monetary and financial policies that contrasted sharply with the “beggar-my-neighbor” practices of the 1930s. Most important, the industrial countries had achieved unparalleled economic prosperity and developing countries had also made great economic strides.
Nevertheless, the decade of the 1960s presented a new problem. Widespread and growing concern arose about the adequacy of official sources of international liquidity, in general, and the disruptive effects of short-term capital movements, in particular. The two major reserve currency countries, the United States and the United Kingdom, were particularly exposed to frequent transfers of short-term capital, threatening the stability of the international monetary system. To help deal with the problem, the Executive Board, in one of its most significant decisions, ruled in July 1961 that the Fund’s resources could be used to help members deal with difficulties arising from short-term capital movements. However, despite the general increase in quotas agreed upon two years earlier, concern continued that, were the United States to draw on the Fund, not enough resources would remain for other members. Hence, in 1962, during the term of the Fund’s third Managing Director, Per Jacobsson, the General Arrangements to Borrow (GAB) were created, permitting the Fund to borrow up to $6 billion from the ten largest industrial members, if any of the ten drew. Beyond being an important source of financial resources, the GAB have been a forerunner to additional borrowing arrangements. In the past decade the Fund, benefiting from its experience with the GAB, has entered into new borrowing arrangements with some of its member governments and their central banks as a sizable temporary supplement to its ordinary resources. The GAB themselves have recently been revised (see “Supplementing the Fund’s lending capacity,” by Michael Ainley, Finance & Development, June 1985).
Fears of a shortage of international liquidity persisted, however. The world’s production of gold at prevailing prices was wholly inadequate as a source of reserves and the United States was planning to eliminate the payments deficits that had been supplying dollars as reserves to the rest of the world. The Fund thus embarked on the five years of negotiations that led to the creation of special drawing rights. This innovation marked the zenith of the Fund’s first 25 years and the major achievement of its fourth Managing Director, Pierre-Paul Schweitzer. When the First Amendment, incorporating the SDR into the Articles, became effective in 1969, the Fund acquired the power to supplement international liquidity by creating its own money. It thereby obtained not only a power on which its founders had been unable to agree but also an additional purpose.
Subsequently, the Fund allocated some SDRs; increased the uses of the SDR, especially in its own transactions and operations; and freed the SDR from most of the restraints initially imposed on it. However, the SDR has not become a major asset in the reserve holdings of most countries and certainly not yet the principal reserve asset of the international monetary system, as intended by the Second Amendment.
Another innovation of the 1960s was the introduction of two facilities to help primary producing countries deal with declines in their export earnings stemming from fluctuations in the prices of primary products. The compensatory financing facility to help compensate for temporary shortfalls in export earnings was established in 1963. The buffer stock facility, under which the Fund helps finance members’ contributions to approved international buffer stock schemes, was established in 1969. These two facilities were harbingers of later arrangements intended mainly for the benefit of developing members.
Transformation after 1973
Much more difficult challenges arose in 1973 after the par value system, which had been under severe stress since late 1967, finally collapsed when a number of major countries resorted to floating rates. The Fund had never played as important a role in members’ exchange rate and par value decisions as had been envisaged at its creation. Some critics nevertheless viewed the end of the par value system and the onset of floating rates as a sign that the Fund had failed, while others argued that the Fund had no further reason to exist. Hence, as of early 1973, the Fund’s future character was uncertain.
In that year, historically high rates of inflation and then sudden steep increases in oil prices caused massive imbalances in external payments. In 1974–75, members faced a severe worldwide recession and the hitherto unknown phenomenon of rising prices coexisting with high unemployment in industrial countries. Taking place in the context of floating exchange rates, these developments posed the threat of severe exchange instability and competitive depreciation reminiscent of the 1930s.
Under H. Johannes Witteveen, its fifth Managing Director, the Fund responded quickly. Very soon after the 1972–73 rise in oil prices, it introduced two oil facilities which, in a new departure for the Fund, were financed by borrowings from members. As payments deficits persisted, the Fund continued to seek new arrangements for financing these deficits. The 1970s thus saw the introduction of the extended Fund facility (for adjustment programs of medium-term duration), the supplementary financing facility (to enable the Fund to lend larger multiples of quotas), and a subsidy account to reduce the cost of drawings under the 1975 oil facility by low-income developing members. The Fund also considerably liberalized and extended its compensatory financing facility; expanded the applications of the buffer stock facility; arranged for loans for a number of developing members from a specially created Trust Fund, based on profits from sales of some of the Fund’s gold; and disbursed some of its gold holdings directly to members.
These developments in effect transformed the Fund:
• With exchange rates for the main currencies floating, the Fund’s regulatory functions received less emphasis than its financial functions;
• Lending became a primary activity;
• The scale of lending, backed by sizable Fund borrowing, no longer depended exclusively on members’ subscriptions;
• The Fund became an important financial intermediary, borrowing from some members to lend to others.
Further transformation of the Fund came with the Second Amendment. In brief, floating rates received legal sanction, but the Fund was also given a mandate to “exercise firm surveillance over the exchange rate policies of members.” The creation of two new committees of the Board of Governors—the Interim Committee of the Fund’s Board of Governors on the International Monetary System and the Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund on the Transfer of Real Resources to Developing Countries—provided high-level policy-making bodies that meet twice a year to discuss and make policy recommendations on major international monetary and development issues.
Since the early 1970s the world economy has been seriously troubled and the Fund has therefore also concerned itself more than before with analyzing world economic problems. Through the “World Economic Outlook” exercise, a series of analytical, empirical, and statistical reports, the Fund now regularly offers an independent international view on the world economy and its prospects.
The Fund history
The new volumes by Margaret Garritsen de Vries are: The International Monetary Fund, 1972–1978: Cooperation on Trial: Volumes I and II, Narrative and Analysis; and Volume III, Documents (Washington, DC, 1985). Earlier volumes were: Margaret Garritsen de Vries, The International Monetary Fund, 1966–1971: The System Under Stress (Washington, DC, 1976), two volumes; and J. Keith Horsefield, Margaret G. de Vries, and others, The International Monetary Fund. 1945–1965: Twenty Years of International Monetary Cooperation (Washington, DC, 1969), three volumes. These books can be ordered from Publications Unit, Box A-853, International Monetary Fund, Washington, DC 20431, USA.
Responses to the debt problem
In the 1980s, new problems arose as a result of the second round of oil price increases in 1979; the most severe recession since the 1930s in 1981–82; large payments deficits, especially in developing members; critical external indebtedness difficulties in several developing countries; increasing protectionism in industrial countries; and continued swings in floating exchange rates. In response to these problems the Fund, under its sixth Managing Director, J. de Larosiére, has taken additional new steps. To meet the needs of developing countries—which have become the predominant users of the Fund’s resources—the Fund has introduced longer repayment periods and loans that are larger multiples of quotas. For example, since 1981, under an enlarged access policy, the Fund has provided additional financing in conjunction with its ordinary resources to members facing payments imbalances that are large in relation to their quotas.
The onset of the world debt crisis in August 1982 strengthened the Fund’s view that balance of payments adjustment was unavoidable and needed to be pursued vigorously. Working on a country-by-country basis, the Fund has assisted members, especially those with major debt problems, to design and implement adjustment programs that will achieve a viable balance of payments in the medium term. At the same time, it has sought to keep financial flows moving to these countries. In a significant departure from past practice, the Managing Director has helped arrange financial “packages” for a number of debtor members, on the grounds that a cooperative strategy, involving all the interested parties (debtors, creditors, and the Fund), was necessary for adjustment to be successful and reasonably paced. A signal innovation was that the Fund made its own assistance dependent on the explicit commitment of additional funds by private creditors and other official creditors. As the Fund moves to support medium-term adjustment programs, it has also been strengthening its collaboration with the World Bank.
The Fund is now also strengthening its surveillance over the policies of all members. In particular, in the past two years, consultations with members have placed increased emphasis on the international repercussions of domestic policies.
Change with continuity
As a result of all these changes, the Fund has gradually undergone a metamorphosis. Yet it has held constant the objectives stated in its Articles. First, as a permanent institution for collaboration on international monetary problems, it has consistently sought the complete cooperation of its members and the fullest and frankest consultation possible. Second, it has sought “to facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members….” Third, the Fund has consistently sought to help members attain sustainable balance of payments positions. Finally, it has continuously sought to foster a liberal trade and payments regime.
In sum, by being flexible within the framework of its basic purposes, the Fund has been an effective force in international monetary affairs, despite vastly altered circumstances in the world economy and the international monetary system.
This article has traced the evolution of the Fund over the years in response to changing circumstances, and has outlined its achievements in many areas. This is not to imply, however, that the Fund has not encountered problems, or that its policies and activities have been universally successful. Indeed, even today, the Fund faces a number of important challenges, such as persuading a number of its members to persevere with adjustment programs that are not easy to implement; promoting a pace of adjustment commensurate both with resources available and the implementing capacity of countries; devising stabilization programs for low-income countries, where the problems of development and balance of payments are not easily distinguishable; and exercising a greater degree of influence and surveillance over the economic policies of industrial countries.
These and other problems exist. To meet them in ways acceptable to its membership, and to remain effective, the Fund will have to continue to be imaginative and innovative.
International Monetary Fund; 1972–1978 Cooperation on Trial
by Margaret Garritsen de Vries
(Volumes I and II, Narrative and Analysis, Volume III, Documents)
This new history, the third in a series, recounts the Fund’s evolution in the turbulent years since the Smithsonian Agreement of December 1971. It describes the collapse of the par value system and the negotiations for reform as the Fund diversified its activities, increased its lending, amended its Articles of Agreement, and undertook to supervise the evolving system in a world of double-digit inflation, higher oil prices, unprecedented payments difficulties, slower growth, and continued floating exchange rates for the major currencies.
The Historian (an experienced staff member of the Fund) supports her interpretation of these events by documents—many of them previously unpublished—and by interviews with major participants.
Price: $60.00 (for three volumes); $25.00 (each).
Available from: Publications Unit, Box A-853
International Monetary Fund • 700 19th Street, N.W.
Washington, D.C. 20431, U.SA. • Telephone: (202) 473-7430