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Before the end of this year, the Special Drawing Rights machinery of the International Monetary Fund should come into operation, ushering in a new era of multilaterally created international reserves. This is no small matter. The international community has not heretofore created anything so deadly serious as money.
Nor will creation begin on a niggling scale. The principal financial countries agreed in July to support activation of $9.5 billion in this new international money over the next three years, and the other members of the Fund will surely go along with this decision. This quite respectable sum adds new interest to an old issue: Is it practical to link a man-made stream of liquidity to foreign aid? At a time of faltering foreign aid, the issue takes on added importance.
It is an intriguing question. Nevertheless, it should not obscure the fact that the primary interest of all countries-rich and poor alike-lies in the success of Special Drawing Rights as a basic reform of the international monetary system, and specifically, as a means of avoiding growing restrictions on trade, aid and investment. From this standpoint, the new reserves will come none too soon. Gold and dollars have dried up as sources of new international liquidity.
Gold fell victim to the persistently held speculative dogma that the monetary price would have to rise. This credo was so stubbornly believed that in recent years new gold production went largely into private hands-as a bet on a rise in price-rather than to monetary reserves. During the four months of speculative madness that followed devaluation of sterling in November 1967, the international monetary system actually lost over $3 billion in gold reserves to the private market. When the active gold-pool countries decided in March 1968 to insulate monetary gold from these private pressures, the drain stopped. Under the two-tier arrangement they set up, the world's stock of monetary gold is kept virtually stable, remaining by far the largest single element in total reserves, but new gold production is for all practical purposes demonetized. It moves haltingly, but inexorably, into the market to satisfy the variety of demands for gold as a commodity, at whatever price these demands will support. It is no longer, however, a serious potential source of new international liquidity.
Dollars as an international reserve followed a somewhat similar course, but more by circumstance than by explicit arrangement. Some years ago, a number of the principal European central bankers began to lose enthusiasm about adding to their official dollar holdings, preferring gold instead, While by no means universal among industrial countries, this attitude existed on a sufficiently wide scale to force the United States to finance a large share of its balance-of-payments deficits in gold. Official holdings of dollars, which had risen steadily through the postwar period, reached what appeared to be a ceiling about five years ago-even while private uses of the dollar continued to grow in international trade and payments. When the United States achieved a substantial balance-of-payments surplus on an official- settlements basis in 1968-69, these official dollar holdings abroad were sharply drawn down. Thus, the course of events for both gold and dollars as international money put pressure on the reserves of the principal industrial countries, with potentially serious consequences for world trade and income.
This is the kind of contingency the financial experts had in mind when they laboriously worked out the plan for creating a new international money. Special Drawing Rights, or SDRs, will do what gold and dollars are no longer doing-make it possible for world reserves to grow as production and trade grow, and thereby remove a source of pressure on the principal industrial countries to adopt unnecessarily restrictive policies. Moreover SDRs will do the job better, Gold and dollars, in recent years, were added to reserves as the haphazard consequence of uncertain factors; SDRs, by contrast, will be issued on a regular and carefully calculated basis. And, unlike gold, SDRs will be created without cost in real resources.
By any standard, therefore, issuance of SDRs will mark the auspicious launching of a most important international undertaking. Nevertheless, a gnawing question exists. If the international community can create money by fiat, why should the lion's share be distributed to rich countries? Or, putting aside this issue of alleged inequity, is it possible to use the new machinery to carry forward two internationally agreed and critically important objectives at the same time? Can SDRs, either directly or indirectly, be a significant source of development finance without impairing their primary function of ensuring adequate international liquidity?
For more than a decade a number of economists who foresaw the need for new sources of international liquidity-most notably Sir Maxwell Stamp and Robert Triffin-advanced proposals to link the creation of new reserve assets with the means to finance economic development. Indeed, the government financial experts who did the spadework which resulted in SDRs looked into the possibilities of establishing such a link. The Congressional Subcommittee on International Exchange and Payments consistently advocated careful exploration of these possibilities. In the end, the financial authorities of the industrial countries rejected this approach, deciding that the new instrument could not serve two masters. But neither in their deliberations nor in the specific provisions of the new facility did they rule out the possibility that, once SDRs were created for liquidity needs, and with the amounts determined solely on this criterion, they might subsequently serve as a means of mobilizing funds for economic development.
It is well worth looking into this possibility. Long-term, untied, low- interest capital is a key determinant of development prospects. It is the most urgently needed, the most difficult, politically, for donor governments to provide, and an endless source of burden-sharing controversy in international negotiations. The experience of the World Bank's International Development Association succinctly demonstrates the case. IDA can effectively lend far more capital than the donor countries have been willing to subscribe. Could SDRs change this on a scale that would put new life into the world's development business?
A qualified yes is a reasonable answer to that question-even as the SDR system is now structured. But that answer presupposes growing domestic understanding of a slippery set of issues and the success of a complicated international negotiation.
Distribution of SDRs is now made in proportion to a country's quota in the International Monetary Fund. This provision gives the industrial countries almost three-fourths of all SDRs created and will give them, as a group, average receipts of $2.3 billion a year over the next three years. These SDRs will appear in official accounts as incoming assets for which no payment will have been made. The offsetting bookkeeping liability must be invented; in the United States it will take the form of a contingent liability in case the United States withdraws from the scheme or if the entire facility is liquidated.
For present purposes, however, another adjustment must be made. The rules provide in effect that 70 percent of any country's total SDR receipts represents a non-repayable claim on the resources of other countries. Allowing for this, the industrial countries over the next three years will be receiving an average of $1.5 billion a year in unconditional reserves- fully equivalent to the receipt of gold or any acceptable currency.
Instead of receiving these non-repayable reserves free, as is now the case, these countries could agree to invest an equal amount of their currencies in subscriptions or loans to IDA along the lines of a number of recent proposals, most notably a suggestion made by Italian Minister of Finance Colombo at the 1968 annual meeting of the Bank and Fund. Doing this would not affect the reserve position of these countries as a group, since the funds they loaned or subscribed to IDA would come back in payment for goods and services purchased from them by the developing countries. These purchases could not be expected to follow the same pattern as the IDA subscriptions of individual countries; consequently, some industrial countries would gain and some lose reserves as a result of this first round of transactions. Or, put differently, the effect of this procedure on the reserve positions of individual countries would be a different distribution of SDRs from that called for by their IMF quotas.
The impact on economic development could be substantial. It would make possible an almost four-fold increase in IDA's resources, which would then constitute roughly one-fourth of current official development finance. On a scale of $1.5 billion a year, IDA long-term, low-interest loans could be a strong foundation and stimulus for bilateral and other multilateral aid programs. The debt-servicing problem which now hangs over development finance would become much more manageable.
Perhaps the clearest argument for linking receipts of SDRs to the provision of foreign aid rests on this chain of reasoning: As an international reserve, SDRs, or "paper gold," are the equal of commodity gold.
In the past, countries added commodity gold to world monetary reserves by paying goods and services to gold producers.
SDRs are a substitute for gold. Being cost-free they will make possible a substantial saving in real resources for the international community. Rich countries could reasonably be asked to forgo their share of this saving and let it accrue to the benefit of poor countries. They could do this by earning paper gold in the same way they formerly earned commodity gold that was added to world reserves.
Thus, where the production of commodity gold gives rise to income for capital and labor in gold mines, the production or activation of paper gold would give rise to resources that would be channeled through IDA to support an internationally agreed objective-economic development.
Moving in this direction would have political attractions, both domestic and international. For one thing, it would be easier to obtain approval in the U.S. Congress and in parliaments abroad to finance IDA in this form, since there would not need to be a budgetary appropriation. If this seems like a painless form of foreign aid, the reason lies neither in subterfuge nor legerdemain, but in the mechanics of the system: governments will be receiving monetary assets without having to pay for them. They can sterilize their SDR allocations. Or they can pledge them to the Federal Reserve Bank for cash-as is usually done to finance incoming gold reserves- and thus obtain the funds to support IDA without a budgetary appropriation. Too much should not be made of this curiosity. A transfer of resources to the developing countries would indeed take place, and this, in a very real sense, would constitute a tax on the industrial countries. Nevertheless, it would be no different than the burden a society imposes on itself when it chooses to add to its gold reserves-a burden which also is not financed through the budgetary process. And in the final analysis, the burden of such a tax would depend on whether the industrial countries at the time would otherwise have used the resources and the industrial capacity going into these exports.
Internationally, an arrangement of this kind could ease some of the political frictions that lie beneath the surface of the new reserve facility-specifically those relating to the system of distributing SDRs among the participating countries. Differences over this issue should not be exaggerated, and the debate, sensibly enough, has been carried on in low key. Once the system goes into operation and SDRs are established as a first-rank international reserve, however, the tone may become more strident.
One source of friction is the controversy over SDR distribution between industrial and developing countries. The poor countries argue that the principal financial powers, who after all were primarily responsible for drawing up the plan and who have the voting muscle in the Fund, stacked the deck in their favor. The industrial countries reply that this charge stems from a misunderstanding about the purpose of the system. SDRs are designed to finance flows that will reverse themselves over time, not a continuing one-way transfer of resources; basing distribution on IMF quotas, while not perfect, is at least a reasonable, and certainly the best available, approximation of each country's need for international liquidity. This is an essentially fruitless controversy, but linking SDRs to development finance would very effectively end it. The industrial countries would continue to receive the bulk of the liquidity and the developing countries would receive resources for development.
Second, the distribution system also gives rise to some jockeying for position among the industrial countries. Surplus countries now show a new- found interest in increasing their individual quotas in the Fund, which, of course, would entitle them to a larger share in future SDR allocations. This is all to the good as far as liquidity is concerned, but the bickering, if carried too far, could be destructive. This problem would also tend to diminish if industrial countries took on the obligation to provide capital to IDA as a counterpart to their SDR allocations.
Arguments against link proposals, developed over a decade or so of discussion, traditionally followed three lines: these proposals would make it more difficult to negotiate a satisfactory system of creating reserves; they would interfere with the operation of such a system and eventually cause it to collapse; and they are wrongly conceived, since they seek to relate operationally two logically separate issues, each of which on political grounds should be faced and decided on its own merits.
All this was serious reason for caution. If consideration of the two issues together did indeed stand in the way of timely and effective monetary reform, everyone would lose. The developing countries, themselves, have far more to gain from reserve creation-and certainly from the SDR system that was ultimately negotiated-than from any additional development assistance they might receive from a link arrangement, On the other hand, now that the SDR system is in place and the decision has been made to put it into operation, the discussion takes on a different character. Past doubts can now be weighed in light of a specific reserve mechanism and a specific schedule for creating reserves.
One set of fears-that a foreign-aid link would endanger the possibility of negotiating any system at all-obviously is no longer relevant. The record suggests it had a good deal of validity, which is useful background to keep in mind. Until the very last negotiating meeting, the draft agreement included a provision that would have permitted the World Bank or any other development institution to hold SDRs if an 85 percent majority approved. The Bank would not have shared in allocations, but countries, on their own volition, would have been able to transfer SDRs directly to the Bank, which might have encouraged them to vote a special allocation for this purpose. The surplus countries insisted on eliminating this provision at the Ministerial meeting of the Group of Ten in Stockholm precisely because they feared it might lead to an operational connection between SDRs and foreign aid which could get out of hand.
A second area of concern-that foreign-aid considerations would cause a chronic overissue of international reserves-turns out to be procedurally manageable under the SDR system. In theory, the danger seems real enough; foreign-aid requirements are certainly higher than those for liquidity. If the world's financial authorities-either under mandate from the system or under pressure from the developing countries-seriously considered both factors in determining how many SDRs to activate, there would be a strongly upward bias. Decisions made under these conditions could lead to a loss of confidence in the reserve mechanism and, if carried far enough, to some inflationary pressures on the world economy. Such theoretical concerns are now past history. The decision on quantity has been made for the next three years; it has been made solely on the basis of liquidity needs; and it is modest. Any tie-in to development finance at this point would be incidental to the operation of the SDR mechanism and could not be a force driving it in undesirable directions. Furthermore, the voting system eventually worked out for activating SDRs, which requires near unanimity among the major industrial nations, is ample insurance that liquidity needs alone will determine future decisions.
Even if there is no danger of overissue, generating funds for loans or subscriptions to IDA through SDRs would, as noted earlier, amount to a de facto change in the distribution of new reserves among the industrial countries. Might this hamper the operation of the system? There is of course nothing technically sacred about the present method of distribution beyond the fact that it formed the basis of agreement. Neither the United States nor any other industrial nation intends to use SDRs as a means of financing a permanent deficit. What these nations seek from the new facility is relief from restrictive policy pressures inherent in a monetary system that lacks sufficient reserves. A modification in the present distribution system to reflect IDA subscriptions would achieve this end about as well as any other.
Nevertheless, possible effects on the distribution of SDRs resulting from an IDA link could have some disadvantages; but they do not appear to be significant and would be mitigated over time. To take the worst case: The most recent pattern of procurement with IDA loans suggests that, after the first round of transactions, the United States would lose at most about one- third of the initial benefit received from its share in the SDR distribution. Japan, Canada, Germany and, interestingly enough, the United Kingdom would be major gainers. The fact that so much of IDA's current lending is concentrated in India, whose procurement in the United States is low, is a major reason for this distribution. With a large increase in its capital, IDA would lend more in other areas-notably Latin America, where procurement in the United States is traditionally high. Over the longer term, using the SDR system in a way which made it possible to supply more untied funds for development, allowing the recipient nations to buy in the open market, would be to everyone's advantage.
The third area of concern is political: a link arrangement might be criticized and opposed as a "back door" way of getting additional funds for foreign aid. Here again, the argument seems manageable when applied to the specific proposal discussed here. Congress approved U.S. participation in the creation of SDRs; it would also have to approve use of SDR counterpart funds for loans or subscriptions to IDA, even though no budgetary appropriation was needed. Comparable action would be required in other industrial countries. Any appearance of subterfuge, therefore, would be out of the question.
A more important obstacle than any of these specific concerns is the fact that there is no compulsion to move. An aid link is not necessary to create SDRs; there is no pool of resources behind SDRs which must be divided; and, as matters stand, the industrial countries will receive the SDRs without charge. Why change this happy situation?
The best way to answer this question is to remind ourselves of the relationship of SDRs to gold. By substituting for gold, SDRs will make possible a continuing saving in resources-a saving which is, in a real sense, the technological product of international action. What is the justification for three-fourths of this saving going to the industrial countries and only one-fourth to the developing countries? Lending SDR counterpart funds to IDA could reverse this proportion, while keeping intact the ability of SDRs to meet world monetary needs. It would automatically fulfill one of the promises inherent in any effective system for creating new reserves: more development finance on untied terms.
The best reason to fulfill this promise is to be found in the sorry state of development finance. A deep malaise surrounds foreign aid; budgets in donor countries get tighter while in the developing countries needs and capabilities for absorbing aid rise. New capital for IDA, on a potential scale of $1.5 billion a year, made possible by the new era of international money, would not be a cure-all but it surely would be an exhilarating tonic. It is an opportunity rather than a requirement, but the economics and the politics, on all sides, look very good.
If the basic proposal is sound, what procedures, domestic and international, should be used to carry it out?
In the United States, SDRs will be deposited in the Exchange Stabilization Fund. The legislation providing for U.S. participation in the SDR facility authorizes the Secretary of the Treasury to issue special certificates covered by SDRs which he can sell to the Federal Reserve Banks for cash. This is the same procedure used to finance an inflow of gold to monetary reserves. In the case of SDRs, however, the Secretary may issue certificates only "for financing the acquisition of Special Drawing Rights or for financing exchange stabilization operations." This provision permits him to get funds to pay for SDRs received from other countries, but not to get cash from the Federal Reserve for IDA as a counterpart to SDRs obtained from IMF allocations, which are acquired without payment.
If given this as a problem, Treasury's corps of imaginative lawyers might argue that authorization to monetize free SDRs in fact exists since the use of such funds for loans to IDA would have benefits for world exchange and therefore comes under the heading of "financing exchange stabilization operations." In the absence of a legislative record to support such an interpretation, however, no Secretary of the Treasury would take this tack.
More appropriately, the Administration could request of the Congress an amendment to the SDR legislation, specifically authorizing the Secretary of the Treasury to issue certificates for a fixed proportion of the SDRs allocated to the United States by the IMF, and to use the funds for loans or subscriptions to IDA. On the reasoning outlined earlier, this proportion could feasibly be set at 70 percent to cover the non-repayable share of this inflow of international reserves.
Congress would have to decide whether to make use of the funds conditional on all, or almost all, other industrial countries contributing equal proportions of SDR counterpart funds to this purpose-or to permit them to be used to finance the U.S. share of the next IDA replenishment, whether or not other countries follow suit. The former approach-a kind of all-or- nothing proposition-would put more pressure on all industrial countries to move. The second approach would make it possible, in the event no international agreement could be negotiated, for the Administration to take a strong lead in pushing for a large increase in IDA's capital in the next replenishment.
There would be no need for Congress to give the Administration a blank check on the future, which would circumvent normal restraints of the budgetary appropriation process. Each amendment to the legislation could apply to a specific IMF allocation decision-in the first instance to the decision activating an average of roughly $3.2 billion a year in SDRs over the next three years. Congressional authorization could be given for the U.S. share, which amounts to $750 million a year in total SDRs, of which approximately $500 million would be non-repayable. In this case, the Congress would automatically have review authority, as will the IMF, in light of each past period of SDR operating experience.
How other industrial countries would handle this situation legislatively is not yet clear. Their statutes are likely to be similar to those in the United States, but in parliamentary governments the process might well be easier.
Internationally, a negotiation looks promising. Shares in SDR allocations are not drastically different from those in the most recent IDA replenishment negotiations; in some cases, where there are differences, trade will provide offsetting compensations. For example, the major difference is in the U.S. share: under an SDR counterpart proposal, the United States would supply about one-third of IDA capital, instead of the 40 percent it now supplies, but it would benefit less in trade than other countries. The U.K. share would go up from 13 percent to 16 percent, but it would gain in trade; while the EEC share would remain pretty much the same. These differences would, themselves, change over time. The main point, as far as balance-of-payments considerations are concerned, is that all the industrial countries would have been paid in advance, in the form of increased international reserves, for more than their capital subscription to IDA.
Timing is also auspicious. Present IDA financing, the product of a drawn out and difficult negotiation, runs out in the summer of 1971. Assurances for the future will be needed some time next year, to make possible continuing commitments. The World Bank will thus soon have to initiate negotiations for the next IDA replenishment. Basing these negotiations on SDR counterpart financing would greatly enhance prospects for the kind of quantum jump in IDA capital which is now required.
There are more ambitious proposals than the one here outlined for linking SDRs to aid, such as amending the IMF agreement to permit SDRs to be allocated directly to development institutions. There is much to explore in these proposals, but also many old and difficult arguments to answer, and a long process of negotiation and ratification to confront. A more promising and urgently needed step would be to pursue what is possible now. New forces are needed to put substance into the concept of a second development decade. SDRs, which already mark a breakthrough in international money, can be the basis for a similar-if smaller-breakthrough in developmental finance. The timing is right; the results would be significant.