INTERNATIONAL MONEY LONDON PACT CREATES A NEW FORM OF RESERVES

Press, Volume CVII, Issue 31468, 7 September 1967, Page 10

INTERNATIONAL MONEY LONDON PACT CREATES A NEW FORM OF RESERVES

(By

SAMUEL BRITTAN,

Economics Editor of the "Financial Times", London)

(Reprinted from the “Financial Times’* by arrangement)

There is a real chance that the agreement made on August 23 at Lancaster House, London, will prove a landmark in world history. This is not because of its practical effect over the next few years, which will be very modest, but for the principles established. For the first time, the 10 most important financial powers have agreed on the conscious creation of man-made reserves to supplement the yellow metal. Reserves have been created before, largely as a by-product of the accumulation of dollars. The haphazard, unreliable and vulnerable nature of the process has frequently been pointed out, not least by the French.

The new Special Drawing Rights (or S.D.R.) are designed “to meet the needs as and when it arises for a supplement to existing reserve assets.” This is the first attempt to create such reserves by intention rather than by accident. The difficulty in writing about the London Agreement is to show a sufficiently generous recognition of the magnitude of the achievement, without forgetting the many other problems which, if unsolved, could delay or impede its implementation, as well as create a firstclass crisis of their own. The general consensus is that in the first five years the annual distribution will be between $lOOO million and $2OOO million—although it was decided at the last moment not to write the figures into the draft. It will provide for something like a l-to-2 per cent annual increase in world reserves compared with an average expansion in trade of about 7 per cent. Annual Reviews

Its operation will be reviewed annually by the International Monetary Fund; and if the initial decision proves badly wrong, it will be able to raise or lower the agreed amounts or alter the length of the basic five-year period.

All the decisions on how many S.D.R.s to issue and when, will require a majority of 85 per cent of the Fund quotas. The Six will thus have powers to block any decision, if and only if they vote together. The main exception concerns downward alterations which the Common Market countries did not in the least mind being decided by simple majorities. The new drawing rights will be administered by the Fund in a separate account and distributed to all members wanting to take part in proportion to present I.M.F. quotas. A decision to activate the scheme, and all decisions on its size and rate of allocation, will be taken by the I.M.F. board of governors on the recommendations of its managing director, Mr Pierre-Paul Schweitzer. The scheme will not start until there is “broad support” for the view that a shortage of world reserves is imminent, in any case the earliest practical year is 1969. Clearing Union Plans The British Government tried as long ago as the wartime Anglo-American negotiations to set-up a “quantum of international currency.” This would have been by means of Lord Keynes’s plan for an international clearing union. Unfortunately, the Bretton Woods Agreement of 1944 which set up the I.M.F. was more limited. It created

what is known in the awful jargon of the subject as “conditional liquidity.” This means that new reserves were not automatically available but were granted by the Fund after intensive scrutiny. By contrast the new facility will be unconditional or almost so; but it will use the I.M.F. mechanism.

Tlie I.M.F. does not, strictly speaking, provide loans. It allows members in payments difficulties to purchase from it other currencies which they need. Countries which have purchased more of other people’s currencies, than others have purchased of their’s, are net debtors, and vice versa. The very cumbersomeness of this device has been a godsend in enabling officials to paper over the ideological gulf between the Americans and their friends who wanted to create a new international money, and some of the Six, who insisted that they were merely improving credit facilities.

Automatically Solvent Under the new facility a member will be able to buy other currencies either through the Special Drawings Account of the Fund or—and this is an interesting innovation—directly from the other members concerned. As the debtor countries run down their drawing rights the creditor countries run them up; so the scheme is automatically solvent. Nevertheless, no creditor country can be required without its consent to provide more of its currency than the equivalent of twice its own allocation of S.D.R.S. One can either say, with the French, that this limits the amount of “credit” that a member has to give; or with the Americans that this is an experimental form of international money which no country should at first be expected to hold in more than limited amounts. The differences are those of vocabulary, and conference attendees will have to become adept at translations.

What happens to outstanding drawings at the end of five years? One cannot call this the $64,000 question, unfortunately; but it is certainly the question that came nearest to wrecking the talks. Those who regarded the new scheme as credit insisted on repayment known technically as reconstitution, that is, the repurchase by a drawing country of its own currency. To those who wanted a new reserve asset the whole concept was anathema. The compromise arrived at was that if the average net use of the rights by a member exceeded 70 per cent it should be brought down to that level by the end of five years by the repayment provisions. “Harmonisation” It would be tempting to say that the effective addition to British reserves will be 70 per cent of the cumulative allocation over five years. But this would be wrong because we would be able to go to higher percentages provided we did not do so all the time, and we went below as well as above. On the other hand, to add in 100 per cent of the allocation would also be wrong and the truth lies somewhere in between.

Apart from these formal provisions, members are asked to keep a “reasonable balance” in their individual ratios of drawing rights to other reserves; in other words, if they experience a net fall in reserves over a period, they would be expected to use up some of their drawing rights, but not by an amount wildly out of proportion to their use of other reserves.

Creditor countries are asked, rather more precisely, to aim at harmonising the ratio of “excess” drawing rights to total reserves among each other. This is all that remains of the original Italian suggestion for basing the scheme on “harmonisation. The more harmonisation there is in practice, the more the S.D.R. will come to resemble international money; while if debtors get rid of their S.D.R.s at the first sign of a deficit they will show that they regard them as a decidedly inferior asset. Choice Of Currencies Nobody can, of course, predict how all this will really work out until experience has been gained. For this reason the rules of reconstitution will not be part of the new Article to be inserted in to the Fund, but will be re-examined before the end of each five-year period, subject to the 85 per cent voting rule. The choice of currencies to be drawn by debtors will be based on principles gathered from the Fund's experience over 20 years. Currencies will be mainly drawn from the members with strong payments and/or reserve positions. Debtor countries drawing on their S.D.R. will do so at will. There will be no question of anyone telling them to deflate or freeze wages as a condition. But they will have an obligation to use them only to finance deficits, or because their total reserves have fallen for some other reason. , , It will be regarded as

cheating to use S.D.R.s to acquire more dollars for conversion into gold (perhaps the most likely example of what the jargon condemns as misuse “to change the composition of reserves”). The Fund will not only bo able to make angry noises against those who cheat in this way. It will also direct debtor countries to make their drawings in the offender’s currency, thus neatly cancelling the gains from the offence. Moderate Interest An interesting novelty is that S.D.R. will carry a moderate rate of interest, presumably to discourage holders from getting rid of them too quickly. From the point of view of the sceptic the rub is that interest will be paid in S.D.R.s, rather like paying somebody in notes printed on one’s own press. The new facility will not prevent exchange rate changes, whatever anyone may claim. The S.D.R. will have a refined gold value. A devaluing country will not have its drawing rights affected, but it will have to put up more of its own currency for others to draw upon. A general devaluation of all currencies in terms of gold would give rise to the same confused legal situation as it would already under the present I.M.F. articles.

In the last analysis monetary reserves are whatever people are prepared to use for the purpose—whether shells, gold, dollars or S.D.Rs. It is therefore encouraging that as Mr William McChesney Martin, the head of the United States Federal Reserve, has said, central bankers are prepared to count S.D.Rs. in their balance-sheets.

The main snag Is that the scheme will not be implemented even in 1969, until a consensus In its favour exists. The Continental countries — not merely France—are not likely to agree so long as there is no sign of the United States payments deficit going below the critical figure of $lOOO million per annum. U.S. Deficit Vital If nevertheless, the scheme started and the United States deficit continued on anything approaching its present scale there would still be trouble. Either the Americans would use the full permitted 70 per cent of their drawing rights to finance their deficit and the creditor countries will hold vast quantities of excess S.D.Rs. in which case the scheme will be dealt a savage blow: or the United States will draw heavily on its gold and thus risk a flight from the dollar.

Thus a big reduction in the United States deficit is now the most important single condition for world monetary stability. But even if the worst forebodings of Mr Rueff were to come true, and there were to be a radical change in present relations between gold, the dollar and other currencies, somebody, somewhere, would have to pick up the pieces. The odds are that the S.D.Rs., on which so many countries have so painfully agreed, would still appear in the foundation block of the new edifice.