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"ALL is well that ends," Treasury Secretary William Simon said jokingly at the cocktail party that followed the conclusion of the recent Jamaica Conference. It would indeed be hard to give in a few syllables a more discerning judgment about the long drawn-out international monetary negotiations of the past four to five years, since the suspension of the convertibility of the dollar into gold in August 1971, and the resulting collapse of the system of par values or fixed exchange rates which had existed since 1944.
The original purpose of the negotiations had been to bring about a full-fledged, comprehensive reform of the international monetary system. But this attempt was given up in January 1974 after, but as we shall see not mainly because of, the quadrupling of the price of oil. In its stead some "interim arrangements" were to be implemented. It took another two years of negotiations to reach final agreement at Jamaica on these interim arrangements, even though they consist mainly, though not exclusively, of the legalization of the international monetary practices which had evolved in the meantime. The Secretary's joke thus well expressed the feelings of most of those present under the mango trees.
In what follows, I propose to deal in turn with (1) the tensions that developed within the Bretton Woods system and why it was allowed to break down; (2) the reform effort that ensued and why it failed; (3) the Jamaica agreement and its significance; (4) where we should go from here, and how.*
Since the Second World War, international monetary relations have been guided by the Agreements reached at Bretton Woods in 1944. Those agreements created the International Monetary Fund (IMF), which was to supervise a new code of conduct in international monetary relations and to help countries in difficulties to continue to adhere to this code by granting them temporary financial assistance. They also created, more or less as an afterthought, the International Bank for Reconstruction and Development, more commonly known as the World Bank which, over the years, came to play a crucial role in the field of development finance.
These two institutions, together with their counterpart in trade, the General Agreement on Tariffs and Trade (GATT), constitute the embodiment of the economic principles enunciated by President Roosevelt and Prime Minister Churchill in August 1941. In view of some recent tendencies in international economic relations, it may be well to recall the two short paragraphs upon which international economic policy in the postwar period has hitherto been based:
Fourth, they will endeavor, with due respect to their existing obligations, to further the enjoyment by all States, great or small, victor or vanquished, of access, on equal terms, to the trade and to the raw materials of the world which are needed for their economic prosperity.
Fifth, they desire to bring about the fullest collaboration between all nations in the economic field, with the object of securing for all improved labour standards, economic advancement, and social security.1
The application of these principles helped to promote, for a quarter of a century, a most powerful and sustained expansion of internal and international economic activity. Yet, by the middle of the 1960s a number of tensions in the Bretton Woods monetary system had appeared, and had been clearly identified and analyzed. It would carry us too far here to examine the solutions which had been envisaged at Bretton Woods for these problems, other than to say that these solutions became inoperable mainly as the result of (I) the increased freedom of international capital movements, which were supposed to be strictly controlled under the Bretton Woods system, and (2) the increasing overvaluation of the U.S. dollar, as the economies of Europe and Japan recovered from war damage and interwar depression, and began to apply modern American production methods. Thus the exchange rate structure established in 1949 became increasingly inappropriate.2
The three problems that came to beset the international monetary system around this time can be set forth as follows. First, the process designed to maintain international payments equilibrium or to restore it if it has been disturbed-the adjustment process as it is called in economic jargon-was found to function less and less effectively. For the most part this was due to a tendency towards increased rigidity of exchange rates under the Bretton Woods par value system, a rigidity that went far beyond what had originally been envisaged. "In the future, the external value of sterling shall conform to its internal value as set by our own domestic policies, and not the other way round," Lord Keynes, one of the Founding Fathers of the IMF, had emphasized in a speech in the House of Lords on May 23, 1944. In fact, with time, the system evolved in a very different direction.
Secondly, there was no practical possibility to control the creation of international liquidity, that is to say, to regulate the volume of the assets that central banks hold as monetary reserves. Given the strong and central position of the dollar, many countries found it convenient to accumulate new additions to monetary reserves in easily usable, interest-earning dollar balances, instead of in gold. This made additions to international liquidity dependent on the U.S. balance-of-payments position, and on the decisions of individual countries whether or not to hold on to their dollars rather than to convert them into gold. Both these elements were completely unrelated to the need of the world economy for liquidity and moreover outside any general control. In addition, the volume of international liquidity was influenced by changes in the monetary gold stock. These changes were dependent on the vagaries of gold production and Russian gold sales on the one hand and private demand for gold on the other, factors equally unrelated to the need for liquidity and equally outside rational monetary control.
The third problem, related to the second one, was the absence of an internationally managed reserve asset.
The reserve arrangements which go by the name of the gold-exchange standard (or gold-dollar standard insofar as the dollar was the main national currency involved) were moreover prone to a well-known instability. At the outset, the balance sheet of the reserve center, that is, the country whose currency is accumulated by other countries in their monetary reserves, is strong. Its gold reserves are high, its short-term liabilities to other countries low-two factors which, together with a central position in the world economy and large well-functioning money and capital markets, are among the prerequisites for becoming a reserve center.
But the very development of the gold-exchange standard changes this position. As other countries accumulate reserve balances nominated in the currency of the reserve center, its short-term liabilities grow. At some point, the relationship between the reserve center's gold holdings and its short-term liabilities passes some critical point, or its balance-of-payments position suffers an unexpected reverse, and confidence suddenly evaporates. This leaves the reserve center extremely vulnerable, for by this time its reserve assets have become insufficient to enable it to convert its vastly increased short-term liabilities on demand if a large portion of them is presented for conversion at the same time. This happened to the pound in the interwar period and led to its downfall in 1931. The mechanism was rediscovered and fully analyzed as early as 1960, and the downfall of the dollar duly predicted unless clearly prescribed action was taken.3 By the middle of the 1960s these problems, together with the unsatisfactory functioning of the adjustment process, were fully understood and widely recognized, both in academic and in many official circles.
The international community responded by solving the easiest of the problems which had arisen. Agreement was reached on arrangements which permitted the creation in the Fund of an international reserve asset by common decision. The new asset was given the bizarre name of Special Drawing Rights, SDR for short. The choice of this name was the result of opposition to the new arrangements by France. The French wanted instead to create liquidity by doubling the price of gold, a step which they expected would at the same time lead to the sharp reduction, if not the elimination, of the role of the dollar as a reserve currency. The compromise that was finally reached consisted of conforming in appearance to the French thesis that nothing but a new credit mechanism had been created-Special Drawing Rights on the Fund in addition to the existing drawing rights-whereas in fact a mechanism for the creation of a new reserve asset for settlements among central banks, international money for short, had been put in place.
Even this compromise was probably made possible at that time only because General de Gaulle had decided in the summer of 1965 to withdraw all French participation from the work of the Common Market in order to express his extreme displeasure with the course of events there. This French withdrawal happened to coincide with active consideration by the Monetary Committee of the European Economic Community during the fall and winter of that year of the problem of deliberate reserve creation. When the French representatives returned to Brussels in the spring of 1966, firm agreement had been reached among the remaining EEC members on the main outline of arrangements for the creation of an international reserve asset, which it proved impossible for the French to undo.
In the event, final agreement was reached on the SDR scheme in the Fund in April 1968 after at least five years of discussion, study, debate and negotiation. The agreement became effective on July 28, 1969, after the requirements for ratification by members of amendments to the Fund's Articles of Agreement had been met.
In the course of 1969, it was decided to create ten billion SDRs during the three-year period 1970-72. This allocation of SDRs made the system in principle independent of the gold-exchange standard for additions to reserves, although from the first SDRs had been envisioned only as a "supplement to existing reserve assets." Nonetheless, some had argued that the U.S. balance-of-payments deficit was due to the desire of other countries to accumulate additional reserves. Before the SDR scheme, their only way of achieving this goal was to obtain dollars through payments surpluses, thus forcing the United States into deficit. According to these theories, SDR creation would quickly eliminate the U.S. deficit.
In fact, it soon became apparent that SDR creation did not result in U.S. payments equilibrium. The U.S. deficit increased even further, for it was fundamentally due to the increasing overvaluation of the dollar as the economies of Europe and Japan became more and more competitive with the American economy. International liquidity in the form of dollar balances grew on an increasing scale alongside the creation of SDRs.
It thus became evident that the concept of the SDR as only a "supplement" was inadequate. In order to regulate international liquidity, control over the accumulation of reserve currencies, and indeed gold, in monetary reserves would also be necessary. In fact, the academic community had never said otherwise. Their proposals had not merely consisted of the introduction of an internationally managed reserve asset, but had included the replacement of reserve currencies and monetary gold holdings by the new asset. These traditional reserve assets would be largely or completely deposited with the Fund in return for the new reserve asset.
The misalignment of exchange rates and the resulting accumulation at an increasing rate of dollar balances, which now soon came to exceed U.S. gold holdings, created increasing tensions in the monetary system. The dangers were not only recognized in academic circles. When the author arrived at the headquarters of the Fund to take up his new duties in early 1969 and paid his respects to the members of the Executive Board, his visit to Mr. Kafka was interrupted by a telephone call. The British-educated Director from Brazil had agreed to give a speech in a few weeks' time. What would be his subject? "Oh," replied Mr. Kafka with his usual unshakeable humor, "the impending collapse of the international monetary system, I guess."
The dangers of the situation were thus apparent to many. Yet nothing was done. True, the Executive Directors studied the question during the whole of 1969 and part of 1970. But the result of their study was a prudish report on the Role of Exchange Rates in the Adjustment of International Payments, which came down squarely on the side of the maintenance and even strengthening of the Bretton Woods par value system, and only in the most tentative way discussed such frightening matters as "a slight widening in the margins around parity." Even on the question of the granting of authority to the Fund "to approve temporary deviations from the par value obligations in exceptional circumstances and under adequate safeguards," the Executive Directors were divided, and in majority opposed. In this the Executive Board faithfully reflected the prevailing opinion in official circles. Only in the United States, Germany and Canada had doubts about the par value system begun to stir.
It is an intriguing but tricky matter to try and discover the reasons for official inaction in the face of impending breakdown.
In the first place, adequate time was lacking. Given the necessity of reaching widespread agreement among sovereign governments, it had taken five years to reach a successful conclusion on the easiest question, the creation of an internationally managed reserve asset. The problems of the exchange rate regime and of control over the accumulation in monetary reserves of dollars and gold had always been recognized as more difficult, since they involved the various national interests and emotions more directly. Yet, given more time, considerable progress might have been achieved. The report on exchange rates, which I have characterized above as prudish, might have been the starting point. After all, official discussion on the establishment of an internationally managed reserve asset had begun with a report by the Monetary Committee of the EEC, which had concluded that the problem did not exist.
But more than time would have been needed. The negotiations on the establishment of the SDR had benefitted from some luck: the absence from the negotiating table at a crucial time of the party making difficulties. Much more importantly, they had benefitted from the farsighted and constructive policy of the U.S. Secretary of the Treasury at the time, Henry H. Fowler, who in turn could build on the important and thorough preparatory work done before him by Under Secretary Robert V. Roosa. Mr. Fowler recognized the need and sensed the right time to put the full power and prestige of the United States behind "contingency planning" for deliberate reserve creation. And he continued this forward-looking policy with determination against foreign as well as against domestic opposition, the latter of which saw in the SDR a prospective competitor of the dollar.
After his departure the American posture changed. To be sure, in 1968 Mr. Nixon was the first presidential candidate who did not commit himself during the campaign to maintain the convertibility of the dollar. Monetary crises were a sign of the times, he explained, and one had to learn to live with them. While this was a clever and indeed a farsighted position to take while campaigning for the Presidency that year, the Nixon Administration, once in office, soon extended the policy of "benign neglect" to international monetary problems. This stopped further progress until the crisis of 1971.
Mr. Fowler's successors have taken much less interest in the proper functioning of the system as a whole, and have concentrated more on the narrow U.S. national interest. This tendency was carried furthest by John B. Connally during his tenure as Secretary of the Treasury. He considered representations by the International Monetary Fund, even in the middle of a worldwide currency crisis, as unacceptable meddling in U.S. internal affairs. His reaction was to block the reappointment of the Fund's top officer, Pierre-Paul Schweitzer, when his term came up for renewal in 1972. The rationale of that move has never become quite clear. By getting rid of Mr. Schweitzer, he did not get rid of the International Monetary Fund, nor of the U.S. commitments vis-à-vis that institution under its Articles of Agreement. And Mr. Schweitzer was not only extremely capable and well-liked, but also a very prudent man. His successor was bound to pursue a more aggressive policy.
In addition to the factors of time and personality (or key national attitudes), there were a second set of considerations relating to the problem that had to be solved. At issue was the necessity of a devaluation of the main reserve currency, the dollar. It was feared by most monetary authorities that one of two things would happen. Either it would prove impossible to carry the operation to an effective conclusion, because many countries, faced with a loss on their reserve balances and given the dependence of their trade on a traditional rate vis-à-vis the dollar, would devalue in equal amount. Or, if an effective devaluation of the dollar against other currencies did come to pass, these very losses on official and private dollar balances would lead to a vast movement of funds into other, stronger currencies, or gold, leading to unforeseeable disturbances that might involve the future of the system itself. The events of the years that followed fully justified these fears.
Involved was the inherent instability of the par value system if combined, contrary to the assumptions made at Bretton Woods, with freedom of capital movements. The difficulty was analyzed as early as 1955 by the well-known British economist J. E. Meade.4 Under the system of the "adjustable peg," as he called it, exchange rate adjustments are made only in cases of what the Fund Charter called "fundamental disequilibrium." But private institutions are just as capable as the authorities of recognizing a situation of fundamental disequilibrium. Indeed, various political drawbacks connected with a change in par value inevitably lead the authorities to delay an exchange rate adjustment that has become necessary. This gives private institutions and individuals ample time and a golden opportunity for riskless speculation. One sells the currency of the country that has fallen into deficit and buys the currency of the country in surplus. If an adjustment of par values takes place a profit is made, regardless of whether the weak currency devalues or the strong one revalues. If no adjustment takes place, the transaction can, given the fixed exchange rate, be unwound without loss, apart from some insignificant bankers' commissions. It is this possibility of riskless speculation that led, contrary to the intentions of the Founding Fathers, to the extreme rigidity of exchange rates under the Bretton Woods system once the controls on capital movements had been dismantled. It is this same invitation to speculation that makes nonsense of the notion of "stable but adjustable par values" in a world of free capital movements. In such a world there is no half-way house between exchange rate rigidity and exchange rate flexibility.
And this brings us to the third element hampering timely action-that the present generation of policymakers is wedded to the idea of fixed exchange rates to an unbelievable degree. It took three speculative waves of unimaginable proportions, with the countervalue of billions of dollars moving from one country to another in a single day, sometimes in a single hour, to finally move the world in March 1973 to flexible exchange rates, at least for an "interim period." After the first two waves, indeed after the many speculative disturbances that had preceded those, the monetary authorities, ignoring both reason and experience, set about to restore fixed exchange rates.
Frankly, I find it hard to explain this phenomenon. Perhaps Lord Keynes' classic comment on his profession has some bearing:
The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist. . . . I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas. Not, indeed, immediately, but after a certain interval; for in the field of economic and political philosophy there are not many who are influenced by new theories after they are twenty-five or thirty years of age, so that the ideas which civil servants and politicians and even agitators apply to current events are not likely to be the newest.5
Probably more important is the fact that fixed exchange rates (without controls) are an "ideal" system in that they resemble monetary arrangements within a country and thus constitute an element of integration in the world economy. Moreover, the system had existed during periods of economic order and expansion, notably under the gold standard and the Bretton Woods system. Within living memory, fixed rates had been abandoned only in periods of major disturbances like the Two World Wars and the Great Depression. Hence flexible exchange rates were identified by many with the political and economic disorders (and national policy mistakes) that had accompanied them, rather than being credited with their capacity to function when the fixed-exchange-rate system could not.
Europe, in particular, had been hard-hit by the war disturbances. In addition, for most European countries, foreign trade, and hence the certainty of fixed rates if attainable, are much more important than for the rather closed U.S. economy. The same is true for the many developing countries heavily dependent on the proceeds of one or two staple commodities. The very weight of these considerations blinded authorities to the importance of the changes, analyzed below, that have rendered the fixed-exchange-rate system increasingly unworkable.6 The different U.S. historical experience and economic position may explain why the United States does not suffer from the return-to-par-values syndrome that continues to afflict so many around the world.
Could the collapse of the international monetary system have been avoided by appropriate reforms? The causes had been properly analyzed well in time, appropriate remedies had been proposed, and the world had been fully warned of the danger of collapse if no adequate action was taken. In a sense, therefore, the breakdown could have been avoided. Yet, this would have necessitated rapid action to bring about a fundamental change in the system, and hence decision-making at a much greater speed than our inadequate institutional setup in international monetary affairs has been capable of in the past. It would, moreover, have involved a fundamental change in the ways of thought of policymakers. I do not believe that acceptance of the required degree of flexibility in the exchange rate regime would have come about, even in the time span of a couple of years, if the fixed-exchange-rate system had not been so completely overwhelmed by speculative forces that in the end no alternative remained. That is to say, what has happened is not exactly an accident. It has been deeply rooted in our institutions and in the fundamental beliefs of our policymakers.7
In August 1971, President Nixon "suspended" the convertibility of the dollar in gold, thus removing the linchpin of the Bretton Woods system. General floating of currencies ensued. The official international monetary community was galvanized into action. At its annual meeting at the end of September 1971, the Board of Governors of the Fund decided that the time had come to actively pursue comprehensive reform of the international monetary system. And in the summer of 1972, the Board of Governors put in place special machinery to achieve this end by creating a "Ministerial Committee on Reform of the International Monetary System," about which more in a moment.
In the meantime, the Executive Directors had brought out a Report on Reform of the International Monetary System8 that more than compensated for their rather modest effort two years earlier. Based to an important degree on a most perceptive and imaginative "Sketch of a Reformed System" by the Fund's Economic Counsellor J. J. Polak, it contains a concise, closely reasoned analysis of the problems the system faced and indicates a number of practical solutions. In fact, hardly any further new ideas of importance were brought forward during the extensive reform discussions that ensued. In my view, this report still deserves to be read today.
A word must now be said about the structure and work of the Ministerial Committee on Reform. The Articles of Agreement of the Fund provide for weighted voting on the basis of the quotas assigned to its members. They also entrust the daily conduct of affairs to an Executive Board consisting of 20 Directors. The five members having the largest quotas (the United States, the United Kingdom, Germany, France and Japan) each have the right to appoint an Executive Director, and the rest of the 128 member-states combine themselves in groups known as constituencies, with sufficient voting power to elect an Executive Director.
Since each constituency was given the right to appoint a member of the Committee on Reform, it speedily became known as the Committee of Twenty. From the first it was assisted by a Committee of Deputies, headed by a five-member "Bureau" under a specially selected Chairman, Jeremy Morse of the Bank of England. To reflect properly the evolving membership of the Fund the Bureau further comprised an American, a Japanese, the Brazilian Executive Director and an African Central Bank Governor. Thus, unlike the negotiations on the establishment of the SDR, these negotiations fully involved the developing countries at every stage.
Both the meetings of the Committee of Twenty and those of the Deputies were from the start gatherings of close to 200 people. While this engaged a large proportion of those around the world officially involved with the matters at issue, it also interfered with the intimacy and the efficiency of the discussions, even at the Deputies' level, where the meetings were conducted of necessity with iron discipline by Chairman Morse.
Under these circumstances the Committee of Twenty could hardly be expected to produce rapid results. Nevertheless, after a year of meetings, a thorough understanding of the issues to be dealt with had been achieved by policymakers and officials in the various capitals of the world, as well as an impression of the positions taken on these issues by the major countries or groups of countries-not an inconsiderable base from which to try for further progress.
It was at this point that the Bureau made a number of mistakes, or rather that a number of weaknesses in its approach became apparent, some of them procedural, at least one of them basic. First, it pressed too hard. Chairman Morse had set himself the goal of achieving comprehensive reform of the international monetary system within two years and he never swerved from this timetable. Given the complexity of the issues and the handicaps under which the Committee had to work, this timetable was utterly unrealistic. In fairness to Chairman Morse, it must be said that after each new monetary disturbance the Ministerial Committee asked him to speed up the work.
In the second place, the members of the Bureau considered themselves too much the representatives of the areas from which they came. Instead of providing the imaginative analysis which sometimes makes possible the reconciliation of opposing points of views on a new and different plane, the Bureau displayed a tendency to take one element of one country's position, another element of a second country's position, and then to put the two together with inadequate attention to the internal consistency and workability of the result.
Moreover, the Bureau's hurry led it to put excessive pressure on countries to reconcile their positions there and then. This occurred for instance at the Paris meeting in the fall of 1973, and led to a hardening of national positions, registered by the Bureau as failure to reach agreement. More leisurely discussion and an opportunity for further reflection and consultation at home might well have produced more favorable results.
Lastly, the desire to reach political compromise induced the Bureau in its early drafts of the Outline of Reform to conceal real differences beneath clever formulations. This led the U.S. Deputy, Paul Volcker, to complain that the documents were full of what he called vacuous sentences. (Example: in the reformed system "the volume of global reserves shall be adequate but not excessive.") While many of these sentences were gradually eliminated or filled out with some meaning, some remained.
This brings me to what I consider to have been a basic mistake by the Bureau. The Committee was, of course, faced by the two fundamental unresolved problems mentioned above, namely reform of the exchange rate system and control over the creation of international liquidity in the form of reserve currencies and gold. Yet neither the Committee nor the Deputies discussed the future exchange rate regime in any depth at all. This is quite remarkable in view of the fact that the world moved from a fixed-exchange-rate regime to a regime of floating rates during the very deliberations of the Committee.
In December 1971, after a period of widespread floating, a general realignment of exchange rates was agreed upon: the so-called Smithsonian Agreement. However, already in June 1972, the pound had to abandon the new rate. In February 1973, after enormous speculative capital movements amounting to more than $8 billion, a second devaluation of the dollar was decided upon. But this only further undermined confidence. After a new speculative wave, fixed rates among the main currencies were abandoned in mid-March. Thus some 15 months elapsed between the proudly hailed Smithsonian exchange rate realignment and widespread floating among the major currencies.
In the light of these events, at the meeting of the Committee on March 26-27, 1973, immediately after floating exchange rates had become general, some discussion of the exchange rate regime inevitably took place. But the radical change which had taken place in the exchange rate field was too recent for the Ministers to come to any basic decisions. Their communiqué declares: ". . . in the reformed system the exchange rate regime should remain based on stable but adjustable par values. It was also recognized that floating rates could provide a useful technique in particular situations."9 Since, however, it had been pointed out at the meeting itself that "particular" did not mean "temporary" and that even "temporary" was not equivalent to "short-term," the passage in fact indicated the absence of any decision about the future exchange rate regime.
Meaningless as it was, this formula was nevertheless adopted by the Bureau. The Outline of Reform, the final though non-binding document of the Committee, contains almost identical phrases about "stable but adjustable par values" and "floating rates in particular situations." This reflected the judgment by Chairman Morse that it would be impossible to get much further in the field of exchange rate arrangements within the timetable he had set himself.
In my opinion, this decision fundamentally vitiated the work of the Committee of Twenty. The exchange rate regime and the reserve assets, and the money used, constitute two of the most basic elements of any international monetary system, and they are closely related. An outcome which left the exchange rate regime completely up in the air could therefore hardly be considered as constituting comprehensive monetary reform.
Moreover, there was a second major difficulty. A deliberate decision by the Ministerial Committee to give countries the right to choose the exchange arrangements they preferred would have been one thing. But that was not at all what the Ministers had had in mind in March 1973 when they approved their communiqué. While some Ministers, notably the U.S. and the German ones, increasingly began to plead in favor of adopting flexible exchange rates for an indefinite future, a large majority of Ministers continued to favor an early return to fixed exchange rates. Indeed, the solutions proposed in the Outline for the other major problem, the future reserve system, explicitly assume a par value system.
The 1972 Report by the Executive Directors on Reform of the International Monetary System had already addressed itself to one of the problems created by the suspension of the convertibility of the dollar into gold, namely, what to do with the huge dollar balances which a number of countries had accumulated in the effort to defend the old par values, but which the non-convertibility of the dollar made it impossible to dispose of.
The solution proposed was to institute a Substitution Account in the Fund in which countries could deposit these dollar balances and receive in return SDRs to be specially created for that purpose. A similar solution was discussed for gold. In order to avoid the accumulation of dollar balances in the future, countries would have the duty (or the right) to deposit newly acquired dollar balances in the Substitution Account in return for SDRs. The Substitution Account in its turn would present these dollar balances to the U.S. authorities for settlement in SDRs. (Similarly, the United States would have the right to acquire SDRs from the Substitution Account against payment of dollars when in surplus, and when consequently the dollar holdings of other countries would decline.) The Substitution Account would thus relieve the United States from the obligation to convert "old" dollar balances, but would require the United States, like other countries, to settle, that is to pay for, future deficits in reserve assets, while at the same time assuring that it would receive reserve assets when in surplus and not merely see its liabilities decline.
This system was given the name of asset settlement. Many technical variants were, of course, possible and would have to be studied. Some more substantive questions remained to be settled. Certain countries wanted to retain their freedom to accumulate further dollar balances if they so wished, and this desire for freedom would have to be balanced against the degree of loss of control over the volume of international liquidity that this would entail. But in principle the idea was clear and simple.
The Outline of Reform of the Committee of Twenty took over the idea of asset settlement and of the substitution of dollar balances for SDRs, albeit in a watered down form-but in doing so clearly assumed a par value system! "All countries maintaining par values will settle in reserve assets . . . ," the Outline stipulated.10 In a world in which the dollar would fluctuate indefinitely, these provisions, on the study of which the Committee spent a great deal of its time, would be void of any real significance.11
The point is important, and hence I have been specific. But it is not open to doubt. For Chairman Morse himself, reporting on the work of his Committee, stated unambiguously: "Nevertheless, [the system described in the Outline] is to be based upon stable but adjustable par values and is to be equipped with intervention and convertibility arrangements which do not belong to widespread floating."12 It is evident from the same speech that in mid-1974 Mr. Morse was still a firm believer in the return to some par value system.
Thus there developed a mounting contradiction between those areas of reform to which the Committee addressed itself in depth and the exchange rate system that had evolved in the meantime in the real world. This made the work of the Committee look increasingly unreal. There is a curious parallel between this hope for a return to par values in the 1970s and the equally unrealistic wish to return to gold in the 1930s, on which the World Economic Conference of 1933 foundered.
The Committee was saved from these contradictions by the quadrupling of the price of oil in the fourth quarter of 1973. So enormous was the uncertainty created by that disturbance to world payments, and so evident became the fact that flexible exchange rates were here to stay for an indefinite period, that the Committee of Twenty decided to give up its attempt at comprehensive reform of the monetary system. Thus, even if Chairman Morse and the Bureau had achieved the impossible feat of avoiding all errors, the outcome would have been the same. The failure of reform cannot and has not been blamed on the Bureau.
At Rome, in January 1974, the Ministers decided that their attention should be concentrated on immediate steps that would assist the functioning of the international monetary system during an "interim period." It took until the Jamaica meeting of January 1976 to reach final agreement on a package of interim measures.
The Jamaica agreement thus is not the beginning of a new era. If anything, it is the end of an effort which started with high hopes and finished with rather modest results, namely makeshift arrangements for the most pressing problems during an "interim period." But while the rebuilding of a rational monetary system will have to wait for another day, such building will have to start from certain important elements now put in place.
What then does the Jamaica agreement entail? I have so far used the words Jamaica agreement in a loose way, referring to it as encompassing all the measures agreed upon since the Rome decision to abandon comprehensive reform. In fact, the agreement contains a broad package of measures. Agreement on parts of the package began to emerge as early as January 1975 during the second meeting of the "Interim Committee" (which had succeeded the Committee of Twenty on Reform), so that at Jamaica only a few final issues remained to be settled.
Moreover, while it was always understood that tentative agreement on some issues was dependent on assembling a balanced package acceptable, as a compromise, to all, some other measures were considered so urgent that they were implemented as the negotiations proceeded. Indeed some of these measures-such as the establishment of the Fund's "Oil Facility" to assist members in meeting payments difficulties resulting from the increase in the oil price; the "Interim Valuation of the SDR"; and "Guidelines for Floating"-resulted in fact from the final stages of the work of the Committee of Twenty or from work by the Executive Directors. I shall ignore these differences in timing and origin in describing the main features of the actions that have now been decided upon.
The main questions confronting the negotiators continued to be, as before, the exchange rate regime and the control over reserve assets.
As far as exchange rates were concerned, the differences of opinion increasingly threatened to become a Franco-American dispute. The United States wanted full legalization of floating now, and the absence of any obligation or moral pressure to return to a par value in the future. Since the U.S. authorities do not intend to reestablish a par value for the dollar for as far ahead as they can see, they were, quite rightly, adamant in refusing to accept any obligation to do so. The French, on the other hand, were not prepared to agree to the elimination from the Fund's Articles of future obligations relating to the observance of par values, a regime to which they remain strongly and fundamentally attached, and continue to hope to return to. The prospects of reaching agreement were hardly improved by an episode at a dinner meeting en marge of the June 1975 meeting of the Interim Committee in Paris. French Finance Minister Fourcade came from that meeting believing that he had reached agreement with his U.S. counterparts that the future exchange rate regime would be based on "a system of stable exchange rates." However, the typescript that became available the next morning spoke instead of "a stable system of exchange rates," a phrase that defies clear definition.
The episode draws attention to the advantages and disadvantages of informal meetings among Ministers. Such meetings clearly have a major role to play in reaching broad understandings about basic issues as well as setting the tone for the future. But they involve some important disadvantages when it comes to detailed negotiations. Ministers often have their roots deep in the national body politic, but this very quality frequently means that they lack fluency in foreign languages. The danger of misunderstandings is obvious. Secondly, the very informality of the meetings implies the absence of much documentation. But in our modern world many questions are so technical that they cannot be settled finally without adequate documentation at hand. In the third place, Ministers are not always sufficiently familiar with the questions at issue. This particularly affects new officeholders. A further drawback of informal Ministerial meetings is a tendency of other negotiators to harden their positions in anticipation of them. As a consequence the Ministers may be burdened by an unwieldy mass of technical detail. The theory seems to be: "The Ministers don't have to understand these issues; they just have to decide them." The result may be poor decisions.
With regard to the exchange rate question, it was obvious that matters could not be left as they stood. This was the more so, since most other countries became increasingly convinced that something like the existing exchange rate arrangements would continue in force for a considerable time to come, and that any future negotiations on the exchange rate regime would hardly be affected by some vague compromise language in the Fund's amended Articles. They began to refer to the matter as a "theological" dispute, void of any practical significance. They were therefore ready to accept almost any reasonable formula the United States and France could agree on, and indeed hinted that it might be useful if the U.S. and French authorities got together to produce one. A series of bilateral negotiations ensued which ended in an agreement at the time of the November 1975 Rambouillet Conference and this agreement was subsequently redrafted so as to fit it into the legal language of the Fund's Articles of Agreement, with the help of its General Counsel, Joseph Gold-no mean accomplishment in view of the fact that the government of the two countries had originally insisted that their compromise was so finely balanced that not a single word could be changed.
In my opinion, the new article regarding exchange arrangements basically reflects the American position in favor of exchange rate flexibility.13 While the words stable and stability appear many times, the article unambiguously stipulates that under present conditions a Fund member is entitled to have almost any exchange arrangement of its own choice. The main limitation on its freedom in this respect is that it must avoid manipulating exchange rates in order to prevent effective balance-of-payments adjustment or to gain an unfair competitive advantage over other members. True, the article also provides that the Fund "may determine, by an eighty-five percent majority of the total voting power, that international economic conditions permit the introduction of a widespread system of exchange arrangements based on stable but adjustable par values." And there is a Schedule C, vaguely reminiscent of the old par value obligations, which will then apply. But it is important to note that there is no obligation to introduce par values under any circumstances, that an 85 percent majority is required, thereby giving the United States a veto, and that the system must be "widespread," so that a few countries maintaining stable exchange rates among themselves, like those participating in the European "snake" arrangement, cannot claim to constitute the par value system. Last but not least, Schedule C provides that, even after a decision taken by an 85 percent majority to introduce par values, any member retains its freedom to maintain for its own currency different exchange arrangements of its own choosing.
But quite apart from these legal provisions, I find it difficult to conceive of a situation in which par values would be restored. For the breakdown of the fixed-exchange-rate system was not an accident. It was an event, moreover, that the authorities fought tooth and nail to prevent. It was due to fundamental economic forces.
The factor most easy to understand is inflation. High rates of inflation have also meant great differences in inflation rates in various countries. In 1974-75 the annual inflation rate in industrial countries ranged from 6-7 percent in Germany to close to 25 percent in Italy and the United Kingdom. This clearly rules out exchange rate stability.
The second factor is even more fundamental. It results from structural shifts in our rapidly changing industrial society. It has been estimated that in ten years' time more than half of international trade in industrial products will consist of goods that do not yet exist today. In the first instance, newly invented products are likely to be produced most effectively, if at all, in highly advanced countries. But with the passage of time, production methods are simplified and standardized, and the competitive advantage shifts to other industrial or industrializing countries. The production of motor cars may well be about to reach that stage today. In these cases the equilibrating forces so fully and exhaustively analyzed in economic theory do not apply, and the only proper way to restore international payments equilibrium is to change the exchange rate. The same factors apply when important raw materials are discovered or become exhausted. Given the importance and the high price of oil, the consequences of the discovery or the exhaustion of oil or natural gas deposits are obvious; but the same mechanism applies to other raw materials.
The conclusion is that exchange rates must vary. As far back as 1972, in their second report, the Executive Directors of the Fund had indeed reached such a conclusion, and proposed a system of "prompter and therefore smaller par value changes."14
Since then two things have happened. Speculative transactions on a scale that would previously have been considered out of the question have in fact occurred, and have brought private institutions and individuals huge profits at the expense of the taxpayer. The theoretical possibility of riskless speculation, referred to above, has been discovered by practical businessmen controlling vast sums of money. Moreover, even after the repeated and widespread realignments of currency parities in the years 1971-73, the respective currency values have continued to vary under the flexible exchange rate arrangements that ensued. In short, what was left of the "stability illusion" about exchange rates is gone and the likelihood of speculative capital movements has correspondingly increased.
Secondly, the likelihood that governments will in fact proceed promptly with small parity changes has been called into question. Let me quote C. J. Oort:
I am afraid that this is unrealistic, unless special measures are taken. No government will on its own initiative go through the politically difficult process of parity adjustment for a change of less than, say, 5 percent. Moreover, it will not change the parity until it is convinced that at least the direction of change is right. No government wants voluntarily to put itself in a position of having to reverse a decision of that kind within a period of, say, two years. Left to themselves, governments will continue to take delayed, discontinuous action on parities. . . . In order to change the parity, governments . . . need solid evidence, which by definition comes too late for prompt action.15
Professor Haberler has gone one step further and argued that the knowledge that there will be frequent changes in par values makes such a regime "the most unsettling system of all," unless the changes are minuscule (1-2 percent) as in the Brazilian system, and the arrangement closely resembles managed floating.16
The conclusion therefore is that we cannot have fixed exchange rates, or even stable but adjustable par values, however nice and orderly it would be to have them. But unchallengeable as this conclusion may seem in the light of experience and analysis, it is by no means shared by the majority of policymakers, many of whom dream of "advancing" again step by step to a par value system. The author would, on the contrary, be inclined to warn against the danger of the "degeneration" of present exchange arrangements toward a de facto par value system which must inevitably lead to new currency crises. The lira, which has just made headlines as I write, in mid-February, is a case in point. Although nominally floating, its exchange rate was in fact stabilized. When circumstances changed and the rate had to be adjusted, the authorities waited until after large amounts of money had left the country at the old rate, subsidized through official intervention by the Italian taxpayer. However, once the Italian authorities did let the exchange rate of the lira find its own level, speculation against the lira stopped. At the time of writing, speculative fever is still being suffered only by the currencies participating in the European snake, that is to say the currencies of the countries that have decided to maintain among themselves a Bretton Woods exchange rate system on a small scale.
Must we therefore let exchange rates go where they will on the theory that market forces know best, as the majority of the academic community and, with minor qualifications, the present U.S. Administration are advocating?17 I certainly do not think so. Like the interest rate, the exchange rate is what economists call an instrument of policy. That is to say, both are economic variables the level of which can be easily influenced by official action, not for its own sake, but for the beneficial influence it has on other, more important economic variables, such as inflation, unemployment, international payments equilibrium, the structure of the balance of payments (i.e., a surplus on current account for industrial countries to finance aid to developing countries), etc.
Given this important role of exchange rates, and the fact that they by their nature express the relation between one country's currency and that of another country and therefore must be a matter of international concern, the Executive Directors of the Fund at an early stage adopted "Guidelines for the Management of Floating Exchange Rates."18 Since floating is illegal under the present Articles, observance of the guidelines could then only be recommended.
The proposed Amended Articles agreed at Jamaica, on the contrary, stipulate that "the Fund shall exercise firm surveillance over the exchange rate policies of members, and adopt specific principles for the guidance of all members. . . ."19 This means that the Fund will get authority to adopt binding guidance instead of mere recommendations (taking its decisions, of course, according to its prescribed and established procedures), and also authority to give such guidance not only to floaters, but also to countries with other exchange rate regimes, such as pegging to a single currency or to a composite (or basket) of currencies including the SDR, or to countries floating jointly under mutual intervention arrangements such as the European "snake."20
This naturally fits in well with the decision taken at the time of the Rambouillet meeting to put in place an improved consultative mechanism with regard to possible intervention on exchange markets, involving not only the central banks, but including the Deputies to Finance Ministers, and, at times, the Ministers themselves. Such consultation already existed among the countries participating in the European "snake"; now it will extend to exchange rate relationships among the dollar, the snake currencies, and the yen.
My conclusion regarding the agreement on exchange arrangements is on balance positive, for it contains at least the possibility of positive future evolution. It is true that the old Articles comprised an exchange rate system, whereas the amended Articles only contain rules by which the Fund will monitor and guide whatever exchange arrangements the members care to choose. But the old regime had become unworkable, and it was no longer observed. The proposed amendment legalizes the existing situation, which is one of its aims. But more than that, both legal and institutional arrangements are to be put in place to permit at least experimentation with a system of managed floating among the major currencies.
We are far from agreement on how to operate such a system. On the one hand, we must guard against the temptation to move the system back to a de facto par value system, an attempt that-even if temporarily successful-is bound to fail over time for reasons already amply explained. On the other hand, we cannot throw away such an important instrument of economic policy as the exchange rate, and leave exchange developments almost exclusively to market forces as Secretary Simon seems to have in mind. In particular, it seems unacceptable to have exchange rates jump up and down in response to temporary divergencies in monetary policy, as the Secretary is clearly willing to allow.21 This would amount to a haphazard granting of windfall profits and imposing of penalties on export and import industries. Both the monetary policies and policies for intervention in the exchange markets of the main industrial countries will have to be shaped and coordinated to avoid such senseless results. Other questions and problems will no doubt arise. But at least the machinery has been created which allows constructive experimentation by forward-looking policymakers in a cooperative spirit.
Nevertheless, it must not be forgotten that opinions on what future system to aim for still differ widely and fundamentally, and that even de facto experimentation with managed floating is not possible for any length of time without some agreement on the settlement between monetary authorities of the claims and debts that would result. As we shall now see, on this question no agreement whatsoever has been reached.
The discussions regarding reserve assets centered mainly on gold, and took place almost exclusively among the large industrial gold-holding countries.
It is well to keep in mind two considerations that help explain the differences in attitude towards gold between Europe and the United States. First, most European countries, France not in the last place, have a long history of currency debasement. As a result, private holding of gold as a hedge against loss of value of the currency is widespread and deeply engrained, a circumstance that inevitably affects the attitude of policymakers. In the United States, no such deeply felt interest exists, as became evident last year when the prohibition against the private possession of gold was lifted.
Secondly, in a world increasingly dominated, contrary to popular belief, by the dollar, the European monetary authorities seek some countervailing force, and have, in the absence of something better, come to depend for this purpose on keeping some monetary role for gold. The U.S. authorities similarly see gold as a competitor with the dollar, an undesirable feature from their point of view. Gold moreover reminds them of the final days and years of the Bretton Woods system, when they were increasingly unable to meet freely their commitments to convert dollars into gold, and were consequently lectured by their European colleagues about the shortcomings of their policies. As we have seen, the real cause of the difficulties was inherent in the gold-exchange system, which in the end inescapably leads to an overvaluation of the reserve currency, an overvaluation that neither the U.S. nor the European authorities were ready to correct in time.
The present Articles of Agreement of the IMF forbid monetary authorities from buying gold at a price higher than the official price.22 As the gold price on the free market rose further after 1971, reaching multiples of the official price, the gold holdings of the monetary authorities in effect became unusable. One could not, in fairness or in practice, continue indefinitely to prohibit central banks from dealing at a realistic price in a commodity of which they possessed huge quantities. The real question was whether the prohibition would be lifted in such a way as to enhance the monetary role of gold, or on the contrary under rules and safeguards that would ensure its phasing out as a monetary instrument.
Plainly the monetary role of precious metals is an anachronism, dating to pre-industrial times. As our economies expanded under the impact of the Industrial Revolution, the money supply embodied in the precious metals had to be supplemented by paper money of various kinds. The nineteenth-century gold standard was the system that purported to ensure that this paper money behaved as if it were gold itself. The gold standard, often considered to be the zenith of the monetary role of gold, is therefore more properly regarded as the beginning of the phasing out of that role. For as the quantity of paper money in circulation grew and far surpassed the quantity of gold in circulation, it became the value of the paper money that determined the value of gold, and not the other way round.
The monetary disturbances connected with the First World War and the Great Depression further reduced the significance of gold. Instead of basing their policies on movements in the monetary gold stock, governments came to assume responsibility for reasonable price stability, full employment and economic growth in ways affected to a considerable extent by the theory developed during the Great Depression by Lord Keynes regarding the determination of the level of economic activity. I know of no serious writer who today advocates that governments should turn back the clock in these respects.
While the phasing out of the monetary role of gold is thus historically inevitable, already far advanced, and in the long run unaffected by decisions taken now, from a practical point of view these will most decidedly affect events in the immediate future. Which way have the decisions gone?
What was decided in August 1975 was not to increase but instead to abolish the official price of gold; this will permit monetary authorities to engage in gold transactions at any price they see fit. It was further decided to eliminate all obligations to use gold in transactions with the Fund, and that the Fund would sell one-third of its gold holdings (in a way to be described). Moreover, the countries in the Group of Ten23 agreed to certain arrangements, outside the Fund Articles but to which other Fund members may adhere, of which the three essential paragraphs are as follows:
1. That there be no action to peg the price of gold.
2. That the total stock of gold now in the hands of the Fund and the monetary authorities of the Group of Ten will not be increased.
. . .
5. That each party agree that these arrangements will be reviewed by the participants at the end of two years and then continued, modified or terminated. Any party to these arrangements may terminate adherence to them after the initial two-year period.24
Agreement on these latter arrangements was reached on the presidential yacht Sequoia among the Finance Ministers of the United States, France, Germany, the United Kingdom and Japan on August 30, 1975. In essence, it is identical to the agreement reached among the EEC Ministers in Zeist in the Netherlands in the spring of 1974.
The question of pegging or stabilizing the price of gold is decisive for its future monetary role. Without official intervention the gold price is likely to fluctuate sharply, as during the past years, just like the price of other commodities. But this very price instability makes gold unusable as a monetary asset. There are only some seven central banks that have large gold holdings. Their Governors know each other very well and have a tradition of close and cordial cooperation. If two of them were to conclude a gold transaction between them in a volatile market, the likelihood is that after a few months one Governor would have realized a sizable profit at the expense of the other. This is in clear conflict to their normal working relationships. Or, to put the matter in a more analytical way, it is not the business of central banks to engage in speculative commodity transactions. Without official stabilization of the gold price, gold is unsuitable as a monetary asset, and gold transactions are to be expected only in emergencies.
Whatever objections one might raise against the gold agreement, such as the huge unwarranted increase in international liquidity and the extremely unequal distribution of gold profits, its no-pegging provision would have speeded up the phasing out of gold's monetary role but for paragraph 5, binding countries to adherence to these provisions for two years only. The fact that the United States accepted this two-year limit is truly astounding, and did, in fact, astonish the international monetary community when it became known.
Why did the U.S. Treasury accept a two-year limit in the face of opposition from other U.S. monetary agencies and from many Treasury officials, after having fought for many years to reduce the role of gold? I do not claim to know the answer; perhaps it was the gemütlichkeit of the Sequoia. Or perhaps the reason is that the financial authorities of France and the United States, unable to reach agreement for years, had been put under a deadline to settle their monetary quarrels by a decision reached previously at the highest level at Martinique, in order to improve Franco-American relations; the very competent French negotiators, more used to working within guidelines laid down at the very top, simply got the better of it. A more charitable explanation is that the United States, in return for concessions on gold, eventually got most of what it wanted in the field of exchange arrangements. But while the U.S. concessions on gold may indeed have influenced the tone of the further negotiations on exchange rates, no specific commitments of any kind were given from the European side at the time of the gold agreement.
The U.S. defense of the agreement is that the American power to exert pressure in favor of renewal of the no-pegging agreement will be just as strong in two years' time as it was to obtain the agreement in the first place; and secondly, that it would be very risky in any event for a few European central banks to peg the price of gold thereafter in the face of strong U.S. opposition. For pegging at a low price might bring the new price soon again under speculative market pressure, while pegging at a high price would involve the risk that the United States might gradually sell its gold to the European central banks on most favorable terms.
I find these arguments less than fully convincing. The same power of the United States might have been used now to obtain a clause that the arrangements would continue to apply until agreement had been reached on their modification or termination. And in the context of the wide-ranging monetary negotiations of 1975 there was more room than there may be later for give-and-take elsewhere. As to the second argument, the European banks could intervene to stabilize the gold price adequately, without the risk of committing themselves irrevocably to a fixed peg.
However this may be, the U.S. Congress will no doubt examine the matter further, for the gold agreement has already aroused considerable concern. It has even caused former Treasury Secretary Fowler to break with his policy of silence-designed, as he says, to avoid the posture of a Monday morning quarterback-and testify before Congress in opposition to the agreement, criticizing in particular the unsatisfactory and inconclusive combination of an abolition of the official gold price with the implicit absence of all restraints, after two years, on dealings in gold by central banks.25 As Mr. Fowler explains, the abolition of the official gold price involves amendment of the Fund's Articles, an act which, given the IMF rules and the U.S. voting strength and legal arrangements, cannot become effective except with congressional authorization by law. The arrangements on gold among the Group of Ten are nevertheless likely to become effective this spring. Yet it may be the spring of 1977 before Congress gets around to seriously examining ratification of the proposed Fund amendments. By that time the special gold arrangements will have only one more year to run and the moment for renegotiation will have arrived. It would hardly be surprising if Congress were then to inquire how these renegotiations were proceeding.
Summing up, it has to be noted that the gold agreement does not even begin to resolve the real questions, namely the ultimate elimination of gold from the monetary system and the protection of the system in the meantime from the disturbances connected with the residual monetary role of gold. For the moment, the agreement is so indeterminate that it will take a couple of years to see more clearly how it will affect the role of gold in the next decade. Gold remains a semi-part of the monetary system. Yet it has become a speculative commodity with a thin market and a volatile price, and hence a source of monetary disturbances. The monetary authorities hold about one billion ounces of gold, which means that a price increase of only one dollar adds a billion dollars to international liquidity. No control over the volume of international liquidity will be possible without a further reduction of the monetary role of gold.
While the impact of the gold arrangements is uncertain, the opposite is true with regard to the dollar. In the past few years there has been a trebling of international liquidity if measured in dollars, from $78 billion at the end of 1969 to some $225 billion at the end of 1975. As Professor Triffin puts it, this means that in the years 1970-75 twice as much monetary reserves have been created as in all history since Adam and Eve.26 There can be no doubt that this liquidity explosion has contributed to world inflation, at the very least because the overabundance of reserves has meant the absence of external incentives to combat inflation.
In these circumstances, there is no ground for adding even further to reserves by allocating SDRs. And with the position of gold uncertain, as a practical matter the dollar has emerged from the turmoil as the sole international money. With official convertibility of the dollar suspended, and with no alternative monetary assets as meaningful competitors, the demand for credit is the only brake left on the creation of further international liquidity in the form of dollars.
The situation is aggravated by the consequences of the oil price increase and the activity of the Eurodollar market. The surpluses of the oil producers have their counterpart in unavoidable deficits elsewhere. This has led to an important shift in attitudes. The Fund's code of behavior has always emphasized policies designed to maintain or restore payments equilibrium. But in the changed situation, prestige accrues to those authorities that have borrowed large amounts of money early to finance the unavoidable deficits that everybody has to cope with. The Eurodollar market has been the place to undertake such borrowing.
Eurocurrency banking involves a subsidiary of a large banking institution, operating, for instance, in London and attracting deposits and giving loans in dollars. As such, it escapes all the regulations that apply to banking in the United States. Or a U.K. bank may escape British regulations by establishing a subsidiary in Germany, attracting deposits and granting loans in sterling. But unregulated credit markets have in the past always led to cycles of boom and bust, which also seriously affect the banking institutions operating in them. That is the very reason why national banking regulations were developed. There is no good way of telling when the danger point is reached; it comes when confidence suddenly evaporates.
Measures have been taken in the last few years to lessen these dangers. Nevertheless, the rapid expansion of the Eurodollar market means that it remains a weak spot, both from the point of view of solidity and from that of control over liquidity. The Jamaica agreement contains no provisions to deal with these problems.
The fluctuations in the price of gold since 1971 also made it necessary in 1974 to change the method of valuation of the SDR. At its inception, it was stipulated that one SDR "shall be equivalent to 0.888 671 gram of fine gold," the gold content of the dollar when it was still convertible. When the link between currencies and gold was severed through the suspension of convertibility, and the gold price started its wild rise, it was felt that the value of the SDR should follow that of the currencies, not of gold.
After considerable debate, in the end a most simple solution was adopted. The value of the SDR was linked to a "basket" of currencies. That is to say, one SDR has been declared to consist of 40 U.S. cents, 38 German pfennig, 4.5 British pence, 44 French centimes, 26 Japanese yen, and some smaller amounts of other currencies.27 The value of the SDR in terms of the dollar is thus 40 cents plus the pfennig, pence, centimes, yen, etc., converted at the current rate of exchange. Similar calculations can be made for other currencies, and the SDR value in terms of currencies is published daily by the IMF and in many newspapers.
According to its inventor, J. J. Polak,28 the basket-of-currencies technique of valuation was "an inevitable discovery" in a world of floating currencies. Yet the discovery had to be made. The EEC, struggling for years with its unit of account, never did so. It has now adopted a unit of account based on a basket of Community currencies. Airlines are adopting the SDR as a basis for calculating their air fares, banks are floating loans denominated in SDRs, and an increasing number of countries peg the exchange value of their currency to the SDR. The SDR is thus gradually assuming at least one of the roles of money, that of a unit of account.
We can be less detailed about a great many other questions that form part of the Jamaica agreement as I have broadly defined it.
At intervals of not more than five years the Fund must conduct a general review of the quotas of members. This time the main problem was to take account of the greatly increased importance of the major oil exporters in international trade. A rough-and-ready proposal was made to double their quota share from about five percent to about ten percent. The EEC Ministers supported this proposal, adding that the quota share of the other developing countries should be maintained, so that a corresponding reduction in quota shares and hence in voting power would have to be shared equitably among the industrial countries. As is often the case with common EEC positions, the position concealed a wide divergence of views. But the EEC countries confidently expected that their proposal would meet heavy opposition, especially from the United States, so that they could then fall back to their preferred individual positions.
As expected, the U.S. Secretary of the Treasury stated that he could not accept a reduction in the U.S. quota share, since the U.S. veto power on some important questions, such as amendment, would be endangered. But since virtually every other industrial country claimed that its quota deserved special treatment for specific reasons, and since the U.S. authorities did not repeat their statement, it was taken at less than face value. Consequently, to the surprise of the EEC countries, the Interim Committee in January 1975 adopted their formula for the quota share of the oil exporters and the other developing countries. The communiqué was silent about the quotas of the industrial countries, the EEC countries believing that the principle of some equitable distribution of the reduction in quota shares had been agreed, and the United States believing that its position on the maintenance of the U.S. quota share had been accepted.
When the misunderstanding was discovered, difficult negotiations ensued. But the concessions to the oil exporters and developing countries had been made and published. In the end a complicated readjustment of quota shares among industrial countries was agreed, involving some reduction in the U.S. quota share, but also an agreement that all decisions now requiring a majority of 80 percent should, under the amended Articles, require a majority of 85 percent, thus safeguarding the existing U.S. veto in these cases.
The other main question involved in the quota review was the increase in the total resources of the Fund. It was agreed that these should be increased by some 32.5 percent and rounded up to SDR 39 billion. The increase, as in previous general reviews, was much smaller than the increase in nominal trade and other relevant data. The arguments were, as before, that taking inflation into account would amount to condoning inflation, and that international liquidity was too large already. The latter argument errs in ignoring the difference between Fund credit and other liquidity, namely, that Fund credit is conditional upon the country taking measures to conform to the Fund's code of behavior.
This long-standing tendency has resulted in a serious decline in the real size of the Fund. In 1948, its total resources were $8 billion and world trade was $53 billion, so that the Fund's resources amounted to 15 percent of world trade. In 1977, when the new quotas are expected to become effective, the Fund's resources will amount to SDR 39 billion, while world trade is likely to be SDR 900-1,000 billion. The Fund's resources will then only amount to about four percent of world trade.
The results of this erosion are quite serious. A member's access to the Fund's resources, which is limited by its quota, nowadays often amounts only to an insignificant part of the deficit with which the member is faced. Consequently, members are less and less inclined to draw on the so-called higher credit tranches (or installments), for which the Fund demands a specific program of economic measures designed to restore payments equilibrium. Governments increasingly conclude that the Fund's limited credits no longer outweigh the political drawbacks of agreeing to such specific programs, and the Fund thus loses part of its power to monitor its code of behavior.
To return to basics, the correct policy would be to get control over the excessive creation of unconditional liquidity. In the light of the erosion that has taken place over the last 30 years, a trebling of the Fund's resources, perhaps in stages, would then be fully justified.
In 1974, the Fund instituted an Oil Facility to assist members in meeting payments difficulties resulting from the initial impact of the increased cost of oil imports. The facility was initially financed mainly by Fund borrowing from the major oil exporters and later also from industrial countries in surplus. The facility was renewed in 1975, and supplemented by a Subsidy Account, financed by voluntary grants, which is relieving the poorest members of part of the cost of paying interest on drawings on the facility.
As time went by, oil imports became less and less appropriate as a guideline for special Fund credits, especially as the deep worldwide recession began to have a serious impact on international payments. At the same time, the recession warranted some liberalization of the Fund's credit policies. At Jamaica it was agreed that for 1976 and until the effective date of the amendment increasing total quotas, total access to the Fund's resources would be increased from 100 percent to 145 percent of quota, each credit tranche (or installment) being increased by 45 percent so that the conditionality structure would remain unchanged. It is important to note that this measure is intended for all members, not specifically for the developing ones. In fact, according to newspaper reports, the first country to show interest in making use of the additional access has been Italy. In addition, mention is made of the "possibility of further assistance in exceptional circumstances." This refers to the possibility that some countries, having overextended themselves by excessive borrowing on private markets, may be faced with a withdrawal of funds. If this were to materialize, immediate and large Fund assistance might help to save the situation.
A further measure was a liberalization of the Compensatory Financing Facility, designed to help exporters of primary commodities which are faced with a sudden fall in export earnings. Changes were made to take account of the effects of inflation, while maximum access in terms of quota was increased.
A complicated matter was the decision to establish a Trust Fund to provide assistance on concessionary terms to members with a low per capita income (less than SDR 300 in 1973). This is part of the August 1975 decision to dispose of one-third of the Fund's gold. One-sixth (25 million ounces) will be "restituted," that is sold to members at the present official price, in amounts proportional to their present quotas. This decision was in response to a political demand, initially by France. Most of a second 25 million ounces will be transferred through a complicated legal technique to the Trust Fund and will be sold in public auctions at regular intervals over a four-year period. At the present gold price, some SDR 400 million, or $500 million, a year would thus become available-not a large amount.
An unpleasant quarrel developed over the time of implementation. All were agreed that restitution, gold sales by the Trust Fund, and freedom for central banks to purchase gold at market prices were linked, and should be implemented simultaneously. Some, however, wanted to implement these measures only after the amended Articles clearly granting such powers had become effective, thus avoiding what may be considered a resort to questionable legal techniques.
In the end, French insistence, faithfully supported by the U.S. authorities, that the arrangements be implemented forthwith, now that agreement had finally been reached, prevailed. In order to solve the problem of central bank gold purchases, the Bank for International Settlements, which, as a nonmember is not bound by the Fund's Articles, was interposed as an intermediary to buy and sell gold. However, the BIS has declared it does not intend to purchase gold for its own account, and it is not yet fully certain that early implementation will not after all give rise to difficulties, or to protests from Congress, which has been particularly prone in the past year to insist on the scrupulous observance of its prerogatives.29
This long list of measures and facilities means, in my judgment, that the Fund has gone about as far as it can in meeting the current payments difficulties. Specifically, at this point it is not easy to see how it could help further in the solution of the problems that are to be discussed at the North-South Conference in Paris. The Fund's task is to supervise the international monetary system and to give temporary assistance to help solve balance-of-payments problems. The Fund must not be and is not becoming a development finance institution. The Trust Fund should be recognized for what it is, an exception in a very special situation: the Fund is making a windfall profit on its gold holdings; similar windfall profits accrue almost exclusively to industrial countries, since developing countries hold little gold; in this situation there is a case for distributing the Fund's windfall profits among developing countries.
The developing countries maintain that a smooth-running monetary system is not an end in itself, but a means to promote growth. They have selected the wrong policy instrument to further their end, for unfortunately the monetary system cannot promote growth directly. An automobile cannot directly improve the spiritual or intellectual well-being of man, even though it can transport people to church, the concert hall, or the university. Similarly, a rational monetary system can only lead to a better functioning of the world economy with more opportunities for trade and aid, thus promoting growth indirectly.30
Finally, a great number of technical amendments to the Articles were approved by the Executive Directors. While not fundamentally affecting international monetary relations, they will greatly streamline the Fund's operations. A feature that may strengthen the SDR is that after amendment it can be used among participants by mutual agreement, without the present formal "requirement of need." This makes the SDR closer to real money and may thus have some effect on the system as a whole, although it will be far from sufficient to make the SDR "the principal asset of the system." Another feature of the technical amendments is the much greater use of enabling clauses, which will make it possible for the Fund to decide by an 85 percent majority of the total voting power on operations and transactions which are only described in general terms in the Fund's Articles. However, it is not very likely that these enabling clauses will affect the functioning of the monetary system in a significant way. But it is hoped that they will make it possible for the Fund to adapt more easily to changing circumstances.
It has been for years the opinion of the Fund's General Counsel, Joseph Gold, that greater flexibility in the Fund's Articles was needed, given the rapid evolution of international monetary relations.31 This will now be achieved. Moreover, anybody comparing the present with the proposed Amended Articles of Agreement will recognize the common sense, great understanding of the basic economic and political interests involved, and the inventiveness based on legal scholarship with which the difficult task of redrafting the Articles has been performed. I have already pointed to the unique contribution of the Fund's Economic Counsellor, J. J. Polak, whose Sketch on Reform contained most of the basic ideas on which reform could have been built. If reform failed, it was not because ideas and policy advice were lacking.
The basic significance of the Jamaica agreement is threefold. First, the Ministers at last recognized that fundamental changes had in fact taken place in the international monetary arrangements, and based their agreements on the actual situation, not on what they hoped it would be in the future. Secondly, they legalized the actual situation by amending the Fund's Articles so as to make them conform to it. And thirdly, they agreed to a number of changes that will improve the functioning of the Fund in important ways, but which will most likely affect the functioning of the monetary system itself in a very limited way only. An important fourth element, though not formally decided upon, is the evident desire to maintain the Fund's code of behavior in international monetary relations, in particular the avoidance of restrictions and competitive exchange rate depreciation, and the continuation of the Fund as a center for international monetary cooperation and consultation.
Thus the system was not changed by positive action in ways advocated either by the authorities, or by the academic community, or by the Fund; instead it changed itself in significant respects under the pressure of events. The most important change was the greatly increased flexibility in exchange rates, either in the form of floating or in that of a greater readiness to change whatever peg a particular country maintains for its currency. This has improved the adjustment process and the possibility of maintaining international payments equilibrium.
Closely connected is the fact that floating has in fact stopped the unwanted liquidity explosion. As long as countries maintained a fixed exchange rate vis-à-vis an overvalued dollar, they had to buy dollars-and, after convertibility had been suspended in 1971, add them fully to their reserves in whatever amount was necessary to maintain that rate. Floating has radically changed this. In fact, since floating became general in 1973, the reserves of the industrial countries have remained roughly stable. The continuing liquidity creation, referred to above, has resulted from large increases in reserves of OPEC countries, and is thus connected with a basically temporary payments disturbance, the origin of which was extraneous to the international monetary system.
Moreover, floating has greatly reduced the size of speculative capital movements. The problem of speculation itself has been solved to a much lesser degree, since speculation now results partially in unwarranted exchange rate movements instead of in reserve movements and reserve creation.
Does this mean, then, that we can leave international monetary agreements as they are? I must strongly demur. First, official convertibility of the dollar remains suspended. In a sense this means that the United States can pay its debts with self-created money, and this has a direct impact on exchange arrangements, tending to a completely dollar-centered system.
Secondly, nothing has been agreed about the exchange rate system. While the opportunity exists for fruitful experimentation with managed floating, the opportunity may well be missed, and exchange rate disorder could result, which would carry with it the danger of trade and payments restrictions.
In the field of reserve assets no concrete action has been agreed upon that would in fact make "the special drawing right the principal reserve asset in the monetary system," so that this language in the amended Articles and the communiqués of the Interim Committee has a hollow tone. The gold question remains basically unresolved and will continue to create problems. Most important of all, a system in which each country obtains the amount of reserves it prefers through borrowing and exchange rate manipulation, and in which total reserve creation is thus demand-determined, is bound to reinforce the inflationary tendencies in the world.32 We touch here on a problem that was most thoroughly examined during many decades of the nineteenth century, when national paper money evolved. On the basis of both theoretical analysis and practical experience, the principle of demand-determined growth for the national money supply has been rejected. Indeed, the proposition that the international money supply is also in need of some central regulation is in conformity with the most elementary common sense.
The problem of control of international liquidity is therefore an urgent unsolved question. It is closely connected with the problem of the settlement of claims and debts under a system of managed floating. With fixed exchange rates no coordination among national authorities was necessary: one bought or sold as much foreign exchange as was needed to maintain the fixed rate, and for the settlement of balances thus acquired, there existed a well-established principle, namely convertibility. With free floating there is equally no need for coordination, for the authorities buy or sell no foreign exchange at all.
But under managed floating, close and daily agreement is necessary on the tradeoff between the amount of intervention and the size of the movement in the exchange rate. Without such detailed coordination there is the clear danger that the authorities presented with balances denominated in their currency for settlement (i.e., payment) will say: "You should not have intervened so heavily, but you should have let the rate move further. Hence we will settle only half of these balances."
Strangely enough, rather little attention has as yet been given to this urgent and practical problem. It may even be that no adequate solution can be found to the question as I have stated it, so that alternative approaches may have to be explored. One might be for each country to carry out intervention in its own exchange market with SDRs. However this may be, study is urgently needed to bring out politically acceptable and technically possible solutions.33
The Jamaica agreement can therefore be characterized as "unfinished business." Yet for the moment there is little interest in further reform. At least as long as important oil surpluses remain, the world recession has not yet been overcome, and the Fund amendments are not ratified, the inclination will most likely be to follow the 1974 recommendation of the Committee on Reform and "begin an evolutionary process of reform."34
In the past, spontaneous monetary evolution has been the rule rather than the exception. But the results have been far from satisfactory. The spontaneous adoption of the gold standard by most of Europe shortly after 1870, largely a matter of prestige, led to what we would now call a shortage of liquidity, resulting in slow business and falling prices in the two decades that followed. This liquidity shortage continued until it was relieved in the 1890s by the gold from the newly discovered gold mines in Transvaal. And we have seen above how the spontaneous evolution of the gold-exchange standard led to its collapse twice in 40 years, involving the pound in 1931 and the dollar in 1971. I note in passing that the unwarranted sudden adoption of the gold standard in the 1870s and the breakdown of the gold-sterling standard in 1931 led to or reinforced deflation, while the breakdown of the gold-dollar standard in 1971 further reinforced inflation.
The conclusion is that the evolutionary process will not lead to acceptable, let alone optimal reform,35 although an exception must perhaps be made for cases in which dogmas stand in the way of change that has become unavoidable, like recently in the exchange rate field. Nor will it grant us the opportunity to decide in calmer times, when we hope to see more clearly, how to solve the problems that now face us. After a thorough historical study of the subject Mertens has concluded:
It has definitely been one of the most tenacious illusions of the authorities to believe that by postponing final decisions and by resorting to temporary and emergency measures, they were preserving their freedom of action for the future. But we have repeatedly noted, on the contrary, that the authorities, in so doing, found themselves being carried along by these temporary measures in a development that led to results which they had by no means expected or wanted.36
How did we get into the present unsatisfactory state of affairs? The most fundamental answer goes far beyond the realm of monetary affairs. We have here a particular manifestation of the general problem that the changes in our society are so rapid that neither our institutions nor our mental attitudes are fully able to keep up with them. More in particular, we have here a clear example of a situation in which the national state has outlived its usefulness. National governments cannot manage an international monetary system. Yet we need such a system, for trade and the multinational corporation have internationalized important parts of economic activity.
This need is not new; the necessity for some international monetary management has existed for at least a century. Accordingly, we find a strong tradition of cooperation between national central banks going back well into the nineteenth century. Important though this tradition is, it must have become evident from the preceding pages that our institutional structure simply lacks the efficiency to deal adequately and promptly with the international monetary problems that present themselves. The difficulties flow in part from the tendency of the authorities to give far too great weight to their current economic problems. For instance, creditor countries want a tight system in which they will have to give little credit, and debtor countries take the opposite position. But, over time, balance-of-payments positions change. As my mentor at the Netherlands' Bank, Professor Posthuma, used to say: "I have heard all the arguments before; only the countries using them change from time to time." When countries negotiate about a long-term goal, like restructuring the international monetary system, such preoccupation with short-term problems obviously hampers real progress.
Such efficiency as exists in our present setup is moreover likely to be undermined by a tendency, noticeable in the past few years, to politicize monetary problems. Political influence can be a very positive factor. Dr. Lieftinck relates that, during his term of office as the Netherlands Minister of Finance, whenever the negotiations to establish Benelux got seriously bogged down, he insisted on the presence of the Ministers of Foreign Affairs, since they represented the political will to succeed. But the present tendency towards politicizing monetary questions seems at times rather more designed to bring serious political differences to bear on monetary problems. I believe this will only delay agreement on rational solutions, and solutions must be rational to produce beneficial results in practice. The working out of practical solutions is therefore very distinct from the adoption of sweeping resolutions and the setting of unattainable goals, although these have their own role and significance in drawing attention to urgent questions.
The Managing Director of the Fund has recently drawn attention to the importance of a thorough and objective preparation of international discussion, and to the beneficial effects that periodic discussion at the most senior level in regular organs of limited size of established international organizations on the major policy questions facing these organizations can have under such circumstances.37 This is a very different thing from ad hoc world conferences, or from two Heads of State meeting in Martinique to decide on the details of the future role of gold in the monetary system.
Just as our institutions have a tendency to fall behind the march of events, so our fundamental beliefs do not always keep in step with the times. I have emphasized the tendency of many authorities to maintain faith in a system of fixed exchange rates when such a regime was no longer possible. Equally out of step with reality is the belief that the markets will solve our problems. Even at the height of nineteenth-century laissez-faire the British economist Walter Bagehot observed that "money will not manage itself." Market forces will not provide us with the institutions and rules we need for a rational monetary system.
Finally, our lack of progress is due to a feeling on the part of the United States that it has lost much of its power to influence events. In the field of international monetary affairs such a feeling is completely unwarranted. The dollar is now practically without a rival as an international means of settlement. This gives the United States enormous power.
It is true that the U.S. authorities may continue to decide to use this power for narrow national advantage. There is the benefit of what economists call seigniorage, the profit that the Sovereign extracted when he allowed precious metals to be coined, and that in modern conditions flows to the banking system when it creates international money by granting credit. Moreover, while the individual depositor can exert no influence over a bank, the bank itself, combining individual deposits and granting large credits, wields considerable power.
No matter how responsibly the U.S. authorities behave in managing the dollar, the world is unlikely to put up indefinitely with a system under which these benefits flow almost exclusively to the United States. But, quite apart from this, it is my hope that some day during the next ten years or so, a U.S. Secretary of the Treasury will break with this long-established American posture, recognize the golden opportunity for really meaningful action open to him, convince his President as Mr. Fowler did in the 1960s, and decide to use the many powerful trump cards that the position of the dollar in the world has provided him with to start negotiations designed to rebuild a rational international monetary system for the benefit of all.
Until that day, the monetary authorities are likely to remain busy patching up the consequences of the latest disturbance produced by the present international monetary disorder.
* This article was written within a short time. Hence, it has not been possible to give adequate credit to the many written and oral contributions of others that helped to shape the author's ideas. The references contained in the footnotes that follow are by no means systematic, but are rather those references that came to mind spontaneously as the writing proceeded.
As will be evident from its contents, the article reflects solely the personal views of the author.
3 See Robert Triffin, Gold and the Dollar Crisis, The Future of Convertibility, New Haven: Yale University Press, 1960. Since then Triffin, increasingly joined by others, has continued to bombard the international monetary community with his warnings. A particularly interesting example was his Evolution of the International Monetary System: Historical Reappraisal and Future Perspectives, Princeton Studies in International Finance No. 12, 1964, in which a striking parallel between developments after the First and Second World Wars was drawn, the dollar having taken over the role of the pound.
7 Compare Keynes on the avoidability of the "slump of 1930," A Treatise on Money, London: Macmillan, 1930, Vol. II, p. 385.
8 Reform of the International Monetary System, a report by the Executive Directors to the Board of Governors, International Monetary Fund, Washington, D.C., 1972.
9 The various papers of the Committee have been brought together by the International Monetary Fund in a most useful booklet entitled International Monetary Reform, Documents of the Committee of Twenty, Washington, D.C., 1974. The passage quoted above appears on p. 215 of that publication.
10 Documents, p. 14, italics added.
12 "The Evolving Monetary System," Speech to International Monetary Conference, Williamsburg, June 7, 1974, mimeographed, p. 3.
13 Amended Articles of Agreement, Article IV, Section 4, International Monetary Fund, soon to be published.
14 Reform of the International Monetary System, p. 18.
16 Gottfried Haberler, "Recent Crises and How They Were Dealt With," in Approaches To Greater Flexibility, cited in footnote 6, p. 117.
19 Article IV, Section 3 (b).
21 See his answer to question 2 in Correspondence cited in footnote 17, at p. 5. The Subcommittee on International Economics of the Joint Economic Committee seems, at least by implication, to come close to the same point of view. See Correspondence, in particular the recommendation of the Subcommittee quoted by Representative Reuss in question 5 of his letter of January 28, 1976, p. 5.
22 Articles of Agreement, Article IV, Section 2.
23 The United States, Japan, Canada, the United Kingdom, Germany, France, Italy, the Netherlands, Belgium and Sweden.
24 Press Communiqué of the Interim Committee, August 31, 1975. Press communiqués of the Interim Committee are reproduced in the annual reports of the International Monetary Fund.
26 The thrust of this evolution is not affected by the average 17-18 percent decline in the exchange value of the dollar vis-à-vis other currencies, the more so as gold holdings have been valued in these calculations at the official price, nobody being able to put a realistic value on them for the purpose of using them in the settlement of large payments imbalances.
27 See J. J. Polak, Valuation and Rate of Interest of the SDR, Pamphlet Series IMF, Washington, D.C., 1974, p. 2.
28 While Mr. Polak is the inventor of the present SDR valuation in the sense that he put the present system forward in an operational form, the earliest and most persistent proponent of the general idea of linking the value of the SDR to the value of a composite of currencies is the Dean of the Executive Directors, Dr. P. Lieftinck, who first advocated it as early as September 1971, i.e., right after the suspension of convertibility by President Nixon.
29 See Correspondence, passim.
32 The Managing Director of the Fund, Dr. H. J. Witteveen, in a speech on October 28, 1975, drew attention to the inflationary dangers implicit in the present regime of demand-determined growth of both official and private international liquidity, and made some interesting suggestions that may perhaps someday constitute the beginning of a new approach to the control of at least official liquidity.
33 See the speech by Dr. Witteveen cited above. However, even under his approach the problem of how to combine asset settlement with managed floating remains to be solved.
34 Documents, p. 222.
36 Jacques E. Mertens, La Naissance et le developpement de l'etalon-or, 1696-1922, [The Origin and Development of the Gold Standard, 1696-1922], Louvain: Editions Warny, 1944, p. 356 and passim.