Rebuilding the International Monetary System

...Pans and Washington were still using the same name to invoke rival gods A careful look at the four U S recommendations and at Shultz's caveats raises serious doubts about the prospects for agree ment, even on principles, in time tor next year's meetings in Nairobi The proposal for symmetry m cur rency bands was greeted warmly, but the doubling of bands was not For fluctuations in exchange rates through a 9 per cent band would give changes in trade flows a larger role in correcting imbalances, net sales of goods and services would be made to accommodate capital movements, not allowed to limit them If uncertainties remained on this score, Shultz removed them later in his speech "Controls on capital flows should not be allowed to become a means of maintaining a chronically undervalued currency " The U S plan tor changes in parities keyed to changes m reserves has the same implication and, because it suggests more automaticity in exchange-rate management, directly challenges European views "Symmetry of rights m the monetary field," said Giscard d'Estaing, "is the equivalent of independence in the political sphere " On a more technical level, the two U S proposals concerning exchange rates combine to invite strong opposition, and they may not be consistent internally If several countries intervene in the exchange market, using a variety of currencies, they can get in each other's way There must be rules to forestall intervention at cross-purposes and, more important, to prevent damaging disagreement over objectives To avoid such conflicts, the Europeans themselves have adopted simple rules No country intervenes to regulate the price of its currency until it has reached the limit of its band When, for example, the franc falls to its lower limit vis-a-vis the deutschemark, the Bank of France must sell marks for francs (borrowing the marks from the Bundesbank and repaying in gold, SDRs and dollars) If similar rules were adopted to regulate symmetrical global intervention, two problems would emerge (1) Given that currency prices would be free to change by a full 9 per cent and countries could not intervene to limit the changes in their competitive positions, they might be tempted to use other measures, including controls, to defend the exchange rates—to resume the "dirty floating" of 1971—in order to preserve domestic autonomy (2) Since there would be no movement in reserves before a currency had reached the edge of its band, forcing interventions and transfers of reserves, the U S formula for changing panties and shifting the bands might not come into use until after there had been a large, cumulative movement in market rates, thus inviting speculation ot the type associated with the very narrow bands used prior to last December The third U S proposal, pertaining to the use of SDRs, is the least controversial, taken by itself All countries are now apparently unanimous that the IMF should create new reserves by allocating SDRs to its members, and most seem to agree that currency values should be denominated in SDRs rather than dollars, erasing another symbolic asymmetry between the dollar and other currencies Several governments asked for the creation of more SDRs last month, even though they believe that world reserves are superabundant They want to keep the machinery in good working order And some endorsed for the first time a link between reserve creation and development assistance The Belgians for instance, proposed a new issue of SDRs in 1973, smaller than the $3 billion allotments of 1970-72, but to be allocated entirely to the International Development Association, the soft-loan affiliate of the World Bank This link, long advocated by the less developed countries, has been opposed by the industrial nations on the grounds that it would invite excessive pressure for the creation ot reserves But 10 less developed countries have now been added to the group that will negotiate further reforms, making the unthinkable suddenly possible The use of the SDR as numeraire also gained support In fact, the French defense of gold does not preclude this option It can be taken to mean that the SDR should have a fixed gold value, as it does now, not that gold should be used directly to fix currency values And the U S plan was gentle to gold "I do not expect governmental holdings of gold to disappear overnight," said Secretary Shultz "I do believe orderly procedures are available to facilitate a diminishing role of gold m international monetary affairs in the future " But Washington is not ready to concede that the dollar should be phased out in similar fashion Shultz commended "careful study" of recent proposals to remove some dollar balances from foreign official reserves by exchanging them for a special issue of SDiRs "at the option of the holder " At the same time, he rejected decisively any formal prohibition on dollar holdings or acquisitions These, he said, "need be neither generally banned nor encouraged Some countries may find holdings of foreign currencies provide a useful margin of flexibility in reserve management, and fluctuations m such holdings can provide some elasticity for the system as a whole in meeting sudden flows of volatile capital " Later, addressing the question of convertibility, he reaffirmed that the dollar should continue as a reserve asset Here confrontation is inevitable Foreign governments and central banks possess more than 50 billion U S dollars alongside gold and SDRs, their holdings were doubled in two years by the U S deficits of 1970-71 They are bound to lose some of these dollars when the U S balance of payments begins to improve and the private demand for dollars returns to more normal levels Yet they may still hold more dollars than they desire, and they do not want to accumulate more Symmetry a la Giscard requires that the United States finance all future deficits with its own reserves, not by lodging dollar debt abroad, and governments that do not share other French views sympathize strongly with this one There are other serious problems The American promise to restore convertibility is, of course, conditional on general agreement to "a system assuring effective and equitable operation of the adjustment process " The United States cannot commit itself to part with reserves unless it acquires adequate influence over exchange rates and, therefore, its balance of payments In addition, the decision to restore convertibility, said Shultz, waits "on our reaching a demonstrated capacity during the transitional period to meet the obligation in terms of our reserve and balance of payments position " This second qualification may well imply that the return to convertibillty is contingent on working out a trade liberalization agreement It most certainly and properly indicates that the United States will want first to acquire additional reserves U S assets, mainly gold, are many times smaller than official foreign holdings of dollars Even assuming those holdings were fully funded into SDRs or long-term U S debt, so that they could not be presented for conversion, American reserves might not be adequate to finance a future deficit or to bridge the interval between a prompt change in exchange rates and the corresponding change in the trade balance But if Washington does not agree to prompt funding of current dollar holdings, it may be unable to reach its own target for convertibility The U S plan to gam reserves by achieving a stronger balance of payments will not work so long as other countries pay out dollars, rather than transferring SDRs and gold to the U S Furthermore, agreement to American demands for greater flexibility in exchange rates and trade liberalization may depend on the speed with which the U S can resume convertibility—and on U S acceptance of firm limits to future dollar holdings Other countries may insist on a system of symmetrical asset settlements The United States captured the initiative last month in Washington No one can now talk about reform of the monetary system without also addressing the U S proposals Still, there has been no compromise on the fundamental issues The negotiations in the IMF's new Committee of Twenty are going to be lone and difficult...

...THE US PLAN FOR Rebuilding the International Monetary BY PETER B KENEN Last month s meetings ot the International Monetary Fund (IMF) in Washington marked the start of serious work on rebuilding the international monetary system It ended successfully a year of maneuvering over the composition and mandate of the committee charged with preparing proposals for reform, it witnessed a welcome change m the tone and style of the public discussion, and it gave the new negotiators a first blueprint tor consideration ?specific suggestions by the United States In contrast, a year ago the Fund's annual debate was colored by resent ment and concern stemming from the unilateral U S measures taken that August—the suspension of convertibility between gold and the dol lar, and adoption of the 10 per cent import surcharge To be sure, optimists claimed to perceive an underlying consensus on the necessary ingredients of long-term re form wider bands within which exchange rates might fluctuate in response to market forces, more frequent changes in the parities serving to define and locate those bands, limitations on the use of national currencies, especially the dollar, m central banks' reserves, and broader utilization of Special Drawing Rights (SDRs), the new "paper gold" created by the IMF, as the common denominator or numeraire of the monetary system and as the principal reserve asset But discord prevailed The French continued to practice antidollar diplomacy, insisting that gold be the numeraire and chief reserve asset, and that the SDR be viewed as a subordinate, supplementary asset The United States declined to endorse any specific plan for reform, opposed hmi tations on the use of the dollar m international settlements, and insisted that negotiations on restructuring the monetary system deal simultaneously with the relaxation of "unfair" barriers to U S exports While everyone at the time favor ed more "symmetry" in the monetary system, the term was used to mean quite different things by the several participants in the debate The Europeans, especially the French, saw the special position of the dollar as the cause of asymmetry, claiming that the United States had enjoyed the "exorbitant privilege" of creating international money and, therefore, an exemption from the discipline imposed on other countries Washington, it was said, did not have to correct its own balance of payments because it could finance deficits in dollars The French view had been made more popular by the U S decision to break with gold Other nations could no longer buy gold with the dollars acquired m the process ot keeping exchange rates stable, nor could they use the threat of so doing to put pressure on Washington to curb its payments deficit Instead, they had to accumulate dollars without limit, restrict dollar inflows by erecting controls, or abstain from intervention in the foreign exchange markets and thus allow the price of the dollar to fall in terms of other currencies at the cost of reducing their own competitive edge m world markets The United States gave further credence to the French interpretation by opposing a limit on foreign dollar holdings In Washington's eyes, on the other hand, the cause of asymmetry was the special role of the dollar, particularly its use by other countries in foreign-exchange operations This, it was felt, left too little leeway for market fluctuations in the price of the dollar and deprived the United States of freedom to initiate major changes in exchange rates The trade barriers of other nations also were deemed to discriminate against U S exports, especially those set up against farm products by the European Economic Community to prop up its common agricultural policy In Pans, therefore, demands for symmetry in the payments system were framed to limit America's freedom of action, economic and political In Washington, they were framed to secure a larger role for the U S in setting and altering exchange rates, a stronger competitive position in world markets and, not to be forgotten, an acceptable response to domestic protectionist pressures A year ago, moreover, one could not be sure that the protagonists would ever get around to long-run reform The United States was asking for immediate changes in exchange rates and other shifts in policies sufficient to improve its balance of payments by a full $13 billion The Europeans and Japan did not see the need for a turnaround this large, and could not agree among themselves on how a smaller change in the U S position should be reflected in their own positions Furthermore, they wanted Washing ton to share the political onus for unpalatable measures by devaluing the dollar in terms of gold—a demand endorsed for different reasons by Pierre-Paul Schweitzer, managing director of the IMF The U S deficit had grown to unprecedented size in 1970 and the first half ot 1971, and it had to be reduced But no nation was willing to accept as the counterpart a substantial deterioration in its own payments situation To make matters worse, another enduring transatlantic difference came to the fore The United States sought to end its deficit by expand ing American exports or, more generally, by improving its balance of trade m goods and services A larger trade surplus would offset U S foreign aid, military spending and private investment abroad It might even permit a relaxation of U S restrictions on capital outflows, imposed with increasing severity in the 1960s The Europeans, always fearful of U S domination, including that of U S corporations, favored additional restrictions on American investments Capital outflows and aid should be made to fit into the available trade surplus Nor was this the only reason for the preference In Europe and Japan, where exports are more important for employment and growth, improving the U S competitive position by reducing the relative value of the dollar was quite naturally regarded as a threat to domestic prosperity Enough was done late last year to forestall fragmentation of the financial system Though it did not deserve the extravagant praise President Nixon gave it, the Smithsonian agreement of December 18 made way for a significant future reduction in the U S deficit New panties, or central rates," lowered the price ot the dollar vis-a-vis most other currencies, especially the Japanese yen, accomplishing the major tactical aim of the U S import surcharge The bands within which exchange rates might fluctuate were doubled in width, permitting larger day-to-day variations in exchange rates capable of altering directly and promptly flows ot goods and services, and making speculation in foreign exchange somewhat more risky Yet as the months slid by, there was little visible progress toward agreement on the dimensions of long-range reform Washington continued to press for substantial onesided trade concessions, insisting that negotiations on financing and commercial issues take place in tandem and in a forum more sympathetic to the American view than the 10-nation group that had been dealing with monetary issues for the past several years Paris, at the hinge of last year's consensus, maintained its opposition to any diminution in the role of gold, demanding the resumption of convertibility by the United States as a condition for settling other issues Its Common Market partners, present and prospective, appeared to be drifting in the same direction Not surprisingly, the report of the Executive Directors, issued on the eve of this year's IMF meetings, was worthy of Hamlet, brooding at length on the merits and defects of every plan Once the meetings began, however, Washington gave ground on the procedural connection between reform of the monetary system and the reduction of trade barriers True, President Nixon said in his address to the opening session on September 25 "We must see monetary reform as one vital part of a total reform of international economic affairs, encompassing trade and investment opportunity as well" But Treasury Secretary George P Shultz, m his speech the next day, acknowledged implicitly that progress on trade policies and rules could be slow, and even seemed to suggest that monetary changes could be put in place before agreement is reached on commercial matters "We welcome the commitments which major nations have already made to start detailed trade negotiations under the GATT [ General Agreement on Tariffs and Trade] in the coming year These need not wait on monetary reform, nor need monetary reform await the results of specific trade negotiations " Since agreement on trade in farm products, a main U S aim, is no nearer now than at the start of the Kennedy Round, this single sentence in the secretary's speech may have been the most important Shultz went on to urge four major changes in the monetary system 1 Another doubling, to 9 per cent, m the width of the bands within which the prices of currencies, including the dollar, can fluctuate freely in foreign-exchange markets 2 Timely changes in the pari ties locating the limits of the bands, to be triggered more automatically by "disproportionate" movements in countries' reserves, and to be enforced by financial sanctions against countries that refuse to devalue or revalue 3. A larger role tor the SDR as a reserve asset and formal numeraire of the monetary system, and revision of the rules that currently encumber the use of SDRs to settle imbalances 4 Eventual resumption of con vertibility between the U S dollar and "other reserve assets ' Observers in search of consensus were quick to point out that Shultz's plan implies a smaller, more symmetrical role for the dollar Identical bands for the dollar and other currencies can obtain only if central banks intervene in several currencies, not just the dollar, to maintain the limits of the bands The French Finance Minister Valery Giscard d'Estaing, drove the point home The system must be founded on an orderly regime ot stable but adaptable par values defended by a symmetrical regime ot foreign ex change intervention by each ot the central banks' (He could have gone on to observe that this first U S proposal is not a major modification of current arrangements Last March, the Europeans started to deal in each others' currencies in order to impose uniformity on the present smaller bands i The French, indeed, were quick to praise those parts of the U S plan that do not challenge their own views and, seeking to minimize rhetorical combat, muted their objections to its other features Giscard d'Estaing did not stress his doubts about a doubling of the bands, opposed only indirectly quasi automatic changes in parities, and mentioned gold just once in his entire address Nonetheless, those who optimistically heard nothing but praise for the U S initiative may be disappointed very soon Though there was universal adoration of symmetry at last month's meeting...