STEP TO INTERNATIONAL MONETARY ORDER*
It is a great honour and privilege to be given the opportunity to present a paper on a subject of great importance for the world today. In the past few years, we have constantly witnessed a rapid and seemingly unending succession of turbulences and crises of immense proportion in the international monetary system. The Bretton Woods system gradually crumbled down, true to forecast made in the late 1950’s, so that we now have a non-system for the conduct of international monetary affairs. Although the present international monetary situation is not as anarchical as in the period before the last World War, there is a clear and urgent need to reconstruct the system to provide a basis for an orderly international monetary conduct in the future.
International efforts for the reconstruction of the present international monetary system began just over two years ago when the International Monetary Fund set up the so-called Committee of Twenty to study and advise on all aspects of international monetary reform. As most of us are aware, in the middle of such a process, uncertainties affecting the world economic outlook, related to inflation, the energy crisis and other unsettled con
* The author is grateful to Mr. Vijit Supinit and Miss Viyada Avilasakul of the Bank of Thailand for making this paper at all possible.
ditions have made it not possible to arrive at reformed measures of a long term nature. Priority has therefore been given to certain aspects of reform which have become urgent in the interim period. It is expected that it may be quite some time before the situation is adequately stabilized before long-term measures can be agreed and implemented, (if that is at all possible).
Thus I would like to deal with the immediate and long-term aspects separately. I attach great importance to measures needed in the immediate future as we are now faced with many serious problems which may get out of control and lead us to even deeper quagmires.
1.World-wide Inflation and International Monetary system
Ours is a confused economic and financial world. The difficulties are so many and so severe that it is hard to recall a comparable period in recent history. Among the world economic problems, those that are uppermost in the mind of the people— the ordinary people as well as policy makers—are inflation and energy. And in the recent past, the treat of recession has also emerged, adding significant confusion to the already muddled world economic scene.
Global inflation effects all aspects of economic, social and political life of the people. It creates tension, distorts income distribution and undermines the relationship among the various groups of the population. For the poorer areas of the world, it radically undermines the developmental efforts of the nations. Inflation can therefore be rightly seen a corrosive element with deep repercussions on the stability of society. Its impact on society are both extensive and intensive and its cure warrants the most urgent of action. It is worth noting that this is the first time in recent history that a significant number of countries, particularly developed countries, are experiencing inflation in double figures. Its magnitude is unprecedented since it has been rampant in such a degree among almost all major countries.
Inflation has been the main cause contributing to instability and uncertainty in the international monetary system. The breakdown of the Brettoon Woods system was due to the implication of such a severe inflationary development which, with its dis-equilibrating effects on the foreign exchange market, makes it not possible for many countries, developed countries in particular, to defend their exchange rates. By necessity, floating has become a noticeable feature of the current exchange system, which is understandable. This necessity however should not be allowed to give rise to claims that the present floating non-system be adopted permanently. If the present rampant inflation were to become an intractable problem among the major countries, the prospects of the recovery of exchange stability would not be very encouraging, to say the least. Since such in the ultimate aim, the international community has an important responsibility to urgently solve the existing problems. The first priority, both in time and importance, is to bring the rate of inflation down to a manageable level. A reformed international monetary system could then see the light of the day, and hopefully its improved features can help prevent the recurrence of this type of problem in the future.
The subject of inflation has indeed been fashionable in the past few years. It is a well-worn topic and a great deal has been said on the subject. In fact, in last year’s Per Jacobsson Foundation lecture, as you may recall, Mr. Emminger dealt extensively and elegantly with the subject in relation to the international monetary system and I am sure his statements are still fresh in the minds of many of us. I do not wish therefore to look into this problem in great details. Only some basic aspects will be attended to.
I believe there is a consensus that the responsibility for the emergence of the present bout of inflating rests mainly on the major countries owing to their policies which have placed undue emphasis on domestic requirements with inadequate concern for their external repercussions. The Bretton Woods system has contributed to this situation not only by making it possible for major countries to disregard good economic discipline, thereby letting loose the inflation monster, but also by facilitating the transmission of the inflation to other countries throughout the system. Many countries find it necessary to float their currencies or to resort to more frequent parity adjustment in order to insulate themselves from the effects of spreading inflation. It may be recalled that Mr. Emminger also pointed out that the Bretton Woods system in itself contributed directly to the emergence of inflationary pressure. The unexpected appearance of the energy crisis towards the end of last year helps aggravate the problem and put additional pressure on the international monetary situation. Unless the energy problem too is stabilized in order to provide greater degree of curtainty in economic prospects, it would be difficult to see inflation settling down, and the quick recovery of the international monetary stability.
This is not the place to moralize on the behaviour of the leading governments in the world in social and political fields; but social and political actions are closely connected with economic and financial phenomena. The general neglect of agricultural development, and in particular food production, has led to the skyrocketing of the prices of foodgrain and meat. True, the vicissitude of nature has played some part in this state of affairs; but mankind’s preoccupation with long wars, medium-term wars and even short wars, everywhere on our globe, have seriously undermined food production and distribution; and it is still doing so. Where production of food has been successful, the faulty system of subsidy and “harmonized” distribution also succeeds in keeping huge food inventories away from needy consumers. Hence, the phenomena of general scarcity concurrent with the piling up of wrong-priced food-stuff in well-to-do countries: theses phenomena are strange but not new. We simply have not begun to learn from past mistakes.
Industrial countries have been struggling with their wage price problems, which, for political expediencies, are often divided into various phases of action. This is no other than the old unresolved conflict between capital and labour. On the labour side, appeal has been made to the principles of social justice, more equitable income distribution and full employment. On the capital side, it has been claimed that price stabilization and real benefit to the nation cannot be achieved by allowing pays and wages to rise ahead of productivity. Caught between these two worthy sets of arguments, governments would naturally try to mix oil with water in order to please both sides and their own conscience. Instead of tackling the root of the trouble, i.e. the basic national economic structure, which at least would need a drastic fiscal shake up and social reform, they employ the wrong instruments to restrain galloping inflation: i.e. monetary measures, which have borne a burden incommensurate with their proper functions. As a consequence, we have seen exceedingly tight monetary conditions everywhere and a sharp upsurge to an unprecedented level of interest rates all over the world, causing severe distortion in the monetary condition, especially the structure of interest rates.
Although some reduction in the inflation rate is forecast in the second half of this year and next year since the effect of higher prices for oil and other commodities begins to subside, the rate of inflation is expected to remain high because of a wage-price spiral caused by the struggle of different groups of people to offset large relative price changes and to maintain their real income. And perhaps the price level may not be stabilized after all in view of recent reports of lower-than-expected crop production in the United States and a new spurt in prices of farm commodities. In this environment, there is justification for very cautious and selective policies. There is little ground for optimism however that such a cautious policy approach would be taken. It is also quite clear that the limit of resource availability could not allow the unprecedented rate of economic growth in the past few years to continue much longer without extremely severe price pressures. It is the responsibility of the major countries to the world community to attempt to put their houses in order at the earliest opportunity. Increasing international economic interdependence makes it imperative that the bigger of the developed countries, the U.S. in particular, must take the lead in trying to correct their inflation problems first so that the rest of the world would have the environments conducive to solving their own individual problems. In the present environments, it is almost impossible for any country to isolate itself from the repercussions of external disturbances.
It is therefore inescapable that the major countries must make rigorous efforts in connection with their problems of inflation. And the more these efforts are closely harmonized among countries, the more assured the results are likely to be. In a situation as the present, national actions that support and reinforce each other are needed rather than those individual measures,
e.g. exchange rate changes, which cancel out at the international level. Among the least demanding actions could be the organized timing of national stabilization programmes. The initiative of the EEC countries last year in collective economic decision-making to cope with inflation is most welcome. There is a good case for the strengthening and widening of such initiatives which, besides traditional measures, could also cover wage-price control on an extensive scale. This approach of joint and simultaneous national measures could have powerful international psychological impact on the public’s expectation impulses.
The future international monetary system must provide for safeguards that will minimize the possibility of the international monetary system contributing to the spreading and the severity of inflation. To my mind, the future system must be more symmetrical and tight, and less permissive to reserve currency countries. These reserve currency countries should be prevented from continuously financing their balance of payments by accumulating currency liabilities. Even if we succeed in devising such a system, that will not be the end of our trouble regarding inflationary tendencies. This will depend entirely on the economic situation in major countries, most of all the U.S., and their determination to keep on a stable course.
2.Prevailing Widespread Floating and Scope for International Cooperation
The Smithsonian Agreement on the realignment of major currencies, including the increase in the official price of gold from 35-38 US.$ per troy ounce of gold, was followed by a brief period of calm in foreign exchange markets. However, the currency realignment did not lead to expected adjustments of balance of payments disquilibria; in fact payments deficits of the U.S. and U.K. continued to deteriorate while the surplus positions of Germany and Japan persisted. Due to balance of payments problems and speculative capital inflow, the pound sterling was allowed to float from mid 1972. Exchange rate uncertainties heightened in January 1973 following Italy’s adoption of separate foreign exchange markets, with floating rates for financial transactions, and the floating of the Swiss franc which quickly appreciated. In February 1973, renewed capital movements out of the US. Dollar led to the second devaluation of the dollar by 10 percent and the floating of the Italian lire for commercial transactions as well as the floating of the yen. The system of fixed exchange rates finally broke down in March 1973 when the EEC countries excepting Italy, together with Norway and Sweden, entered into an arrangement for joint floating vis-à-vis the US. Dollar, following a revaluation of the Deutsche mark. From March to July 1973, the US. Dollar continued to depreciate against the currencies of the other Group of Ten countries and the deutsch mark and guilder were again revalued in order to maintain the rates vis-à-vis the other snake currencies within the 21/4 percent band. Realizing that exchange rate movements determined purely by market forces could prove to be erratic and out of line with underlying trends in the balance of payments as well as basic economic objectives, the US., Germany, UK. as well as other EEC countries and Japan began to engage in market interventions. Subsequently, exchange rate fluctuations eased and US. Dollar rates appreciated due to improvements in the trade balance. However, exchange rate uncertainties were renewed in early 1974 due to expectations of oil-induced deficits. In January, the French franc left the snake arrangement and floated independently against all other currencies.
In view of rising inflationary expectations and increased balance of payments uncertainties, floating exchange rates are likely to prevail for an indefinite period ahead. A system of general floating appears to be the appropriate course of action under existing circumstances since it enables oil-induced deficit countries to avoid introducing or intensifying trade and payments restrictions for the purpose of defending par values which have ceased to be realistic. By eliminating the obligation to intervene in exchange markets, floating also prevents undue reserve losses or gains and their adverse impact on the domestic economy.
On the surface, recent experience with widespread floating does not appear to have had harmful effects on trade since traders seem to have been capable of adapting to increased exchange rate uncertainties and both the volume and value of world trade continued to grow in 1972 and 1973. Total value of world trade increased by 17 and 34 percent while the volume of world trade expanded by 9 and 11 percent respectively during these two years. However, it should be noted that the average unit value of internationally traded goods rose sharply in 1973 by 21 percent compared to the average rate of 4 percent during 19681972. This was due partly to the dollar devaluation and partly to the commodity boom arising from hedging and speculative demand. The increase in the volume of trade was concentrated in a group of developed countries. In the case of LDCs, the volume of export and import trade rose by 11/2 percent in 1973 compared to 14 and 5 percent respectively in 1972. Thus, recent experience with floating cannot be said to have no adverse effects on trade expansion, at least as far as LDCs are concerned.
On the other hand, increased exchange rate uncertainties have contributed to inflationary pressures by increasing the need of private traders and investors to cover themselves against exchange risks and unstable price expectations. Consequently, medium and long-term investment outlays and production plans are affected. The above-mentioned effects of floating apply universally but are generally more keenly felt by the LDCs with limited international reserves and heavy reliance on imported capital goods and investment funds. Exchange rate uncertainties therefore tend to have a severe impact on the development plans and external debt burdens of LDCs.
Floating by the major industrial countries has also affected balance of payments and exchange rate policies of LDCs which are pegged to a floating intervention currency. While some LDCs switched to other intervention currencies, their choice in this matter is rather limited due to traditional links and the pattern of trade. In Thailand’s case, the US. Dollar has remained the official intervention currency and the Baht has continued to float vis-àvis the other major currencies.
In sum, the effects of floating should not be assessed on the basis of short-term trends alone. Its impact on economic growth and long-term prospects for world trade should also be considered. While floating is justifiable under present circumstances, early return to a system of more stable but adjustable rates reinforced by an effective adjustment mechanism would be more beneficial to world trade and economic growth.
In the meantime, international cooperation is essential to promote orderly exchange rate developments and to minimize the adverse effects of exchange rate uncertainties on the world economy. It has generally been agreed that current widespread balance of payments problems cannot be solved by competitive depreciations or intensified use of trade and payments restrictions. Towards this end, a voluntary trade pledge is currently being proposed for adoption by Fund members. The Fund has also established a facility for recycling oil funds to countries facing oil-induced deficits although funds to be recycled through the new Oil Facility in 1974 will amount to only about SDR 3 billion compared to the aggregate deficits of oil-importing countries estimated at over SDR 60 billion in 1974. While the major industrial countries and credit worthy LDCs should have no difficulty in raising loans in the money markets, terms are likely to be hard and competition stiff. In order to prevent market disruptions, deficit countries should find some means of coordinating both the timing and the terms of borrowings in the money markets. In this connection, it has been suggested that the Bank for International Settlements could play a useful role. Adequate financing for countries which do not have access to the money markets should also be provided.
In order to prevent competitive downward floating and to promote orderly exchange rate developments, the Fund has adopted a set of guidelines for the management of floating in accordance with the provision that members “collaborate with the Fund to promote exchange stability, to maintain orderly exchange arrangements and to avoid competitive exchange alterations”. Under guidelines 1-2, members are allowed to intervene in the exchange markets to smooth out day-to-day fluctuations as well as fluctuations from medium-term trends. While “aggressive intervention” i.e. to depress value of currency when it is falling or to enhance that value when it is rising, is normally prohibited, members are allowed or may be encouraged to intervene aggressively (guideline 3) in order to bring exchange rates closer to “target zones” which have been set in consultation with, or at the initiative of, the Fund. Under guideline 4, the Fund may also initiate consultation regarding medium-term reserve aims of individual member countries consistent with global trends and needs, and may encourage members to intervene more strongly so as to induce reserve movements closer to agreed aims. Under guidelines 5 and 6, countries with floating currencies are expected to refrain from imposing trade and exchange restrictions for balance of payments purposes and to consider the interests of other members, particularly the issuer of the currency used in intervention.
The above guidelines should help to prevent wide fluctuations in exchange rates and promote broadly consistent exchange rate policies and balance of payments aims. However, the effectiveness and adequacy of these guidelines remain uncertain as they are not legally binding, the reason being that floating has not been legalized by the Fund. When the Fund’s Articles of Agreement have been amended to allow the Fund to authorize floating in particular circumstances, international surveillance of floating could be made more effective by requiring members with floating to apply for prior Fund approval and to observe conditions and rules laid down by the Fund. For instance, regular consultation with the Fund might be required to ascertain the need to maintain floating rates and time limits for floating could to be set. The present diluted version of rules for intervention could also be strengthened by requiring Fund members to intervene to smooth out exchange rate fluctuations and to apply for prior Fund approval before resorting to “aggressive intervention”. In regard to target zones for equilibrium exchange rates and reserve aims of individual countries, the technique for their determination as well as the procedure for their application have yet to be laid down. The Fund should avoid using target zones and reserve aims as automatic indicators to trigger exchange rate changes and should maintain a flexible approach in this matter. Finally, the choice of intervention policies other than smoothing operations should, as far as possible, rest with individual countries.
In sum, floating should be legalized and more effectively controlled by the fund to prevent disorderly exchange rate developments and unfair intervention policies aimed at strengthening the trade balance at the expense of other countries. More effective international management of floating should be a step towards an eventual return to a system of stable but adjustable exchange rates.
3.Recent Development and Interim Arrangements for global Liquidity.
The volume of international reserves which has grown at a fairly constant rate of about 2 percent per annum from 1954 to 1969 rose sharply at the rate of 22 percent, 32 percent and 19 percent respectively in 1970, 1971 and 1972. Total international reserves at the end of 1972 stood at SDR 144 billion compared to SDR 76 billion in 1969. This increase was almost entirely due to the increase in official foreign exchange holdings which tripled during these three years. In 1973, global reserves rose by 15 percent to SDR 152 billion due to the increase in official gold price and revaluation of some major currencies.
The composition of reserve as shown from 1973 data was as follows: foreign exchange holdings 66 percent, gold 24 percent, SDR 6 percent and reserve positions in the Fund 4 percent.
The pattern of reserve distribution has favoured the industrial countries whose total holdings amounted to 67 percent to world reserves. Reserve holding of LDCs totalled SDR 37 billion in 1973 of which about 1/3 represented reserves of oil-producing countries. If the latter’s reserves are excluded, reserves of LDC would account for only 13 percent of total reserves. The oil crisis which occurred at the end of 1973 is expected to alter the pattern of reserve distribution substantially during the next few years, with most of the traditionally surplus industrial countries facing substantial reserve losses along with LDCs which are net importers of oil.
Assessments of reserve needs have normally been based on import requirements and money supply as well as evidences of balance of payments and reserve policies e.g. use of trade and exchange restrictions, domestic demand management, use of balance of payments credits and aid flows. On this basis, and on expectations of normal rate of trade growth, global liquidity was estimated to exceed global reserve needs by about SDR 20-30 billion in 1972 and the IMF decided against further SDR allocation in 1973 and 1974.
The existence of liquidity excess on a global basis did not allow for liquidity shortages on the individual country basis due to the concentrated and skewed pattern of distribution. Moreover, too much weight has been given to past trends of trade growth and reserve needs; too little consideration to growth targets and long-term reserve aims.
The occurrence of the oil crises in 1973 not only altered the reserve distribution pattern but also reduced the urgency of the problem of huge currency “overhang”. The industrial countries which accumulated huge dollar reserves which were officially inconvertible no longer pressed for substitution or funding arrangements for the overhang as the oil-exporting countries were content with market convertibility of foreign exchange holding. While the problem of immediate concern is the recycling of oil funds to oil-deficit countries, urgent attention should be paid to the destabilizing effects of the liquid and extremely volatile foreign exchange holding of oil exporting countries on the international monetary system. Towards this end, arrangements should be made to stabilize the Euro money market and bilateral funding arrangements concluded between the issuer countries and the oil-exporting countries. At the same time, the Fund should initiate a “sub-situation facility” whereby reserve currency holdings could be converted into SDR. This facility should operate on a voluntary basis.
In view of the present liquidity shortage experienced by oil-importing countries, urgent attention should be given to the problem of making gold generally usable. In this connection, the Group of Ten agreed to use gold at the market price as collateral for Central Banks’ borrowings since June this year. As this arrangement is inconsistent with existing Fund provisions for official gold transactions at par, the following alternatives have been suggested for dealing with the gold problem.
(1) maintain the official gold price and allowing monetary authorities to sell gold in the market,
(2) abolishing the official gold price, allowing monetary authorities to sell gold among themselves and selling to the Fund at market related prices and selling, not buying, gold in the market,
(3) as in (2) above but allowing monetary authorities to buy gold in the market also,
(4) establishing a gold substitution account in the Fund for conversion of gold reserves into SDR at market related prices and authorizing the Fund to sell gold in the market from time to time.
A direct increase in the official gold price is generally not regarded as an acceptable solution since it would directly conflict with the long-term objective of demonetizing gold by increasing expections four further price rises. An increase in the official gold price would also result in liquidity increase which would be unevenly distributed and is also likely to jeopardize future SDR allocations.
Any arrangement for gold should not only ensure more efficient management of global liquidity by increasing the role of internationally managed reserve asset such as SDR, but should also promote fair distribution of gains between those countries which have accumulated gold and those which have observed the Fund’s ruling against accumulating gold at the market prices. One means of ensuring fair distribution of gains would be through international management of gold sales and the transfer of profits to development finance institutions.
In order to enlarge the role of SDR as the main primary reserve asset and to promote substitution of reserve currencies and gold into SDR, the attractiveness of the SDR should be increased by guaranteeing its capital value and by increasing the yield on SDR holding. An adequate rate of “effective yield” should make SDR as attractive to hold as other reserve assets but not so attractive as to make SDR holders unwilling to part with these reserve assets.
Towards this end, the method for SDR valuation for purposes of official transactions was changed from the use of the par value of SDR (in terms of US.$) and market rates between the US. Dollar and other currencies to the “standard basket” approach. Under the new method, the value of the SDR is equivalent to the sum of 16 currency components weighted according to their relative shares in world trade. The weight of the US. Dollar is however fixed at 33 percent to allow for its role as the principal reserve currency. The value of SDR in terms of the US. Dollar is then determined by converting the various currency components in the basket into US. Dollars at market rates. The rate of the US. Dollar per one unit of SDR thus derived is used for computing the valur of SDR in terms of other currencies by applying the prevailing market rates between the US. Dollar and the currency desired.
Under this method of valuation, the value of SDR in term of currencies will vary constantly i.e. increasing in term of the depreciating currency and decreasing in terms of other currencies. When currencies are generally appreciating, the value of SDR in term of currencies in general will decline. In times of general depreciation however, the value of SDR will appreciate.
Thus, assuming that currency appreciations and depreciations are balanced over a period of time, the value of SDR in terms of currencies should remain fairly constant.
This method of valuation ensures that the value of SDR will reflect the effective relationship between currencies instead of linking SDR value to the par value of the US. Dollar when market rates of the major currencies are in fact floating freely against the US. dollar. Thus members using SDR should get whereby currency values were tied to an over-valued dollar.
The basket approach should make the SDR more widely usable since its goldlike character will henceforth be merely a formality and transaction prices in terms of currencies will be computed from market rates. The reluctance to use SDR n times of uncertainties regarding the gold price should therefore be eliminated.
The SDR will however be more attractive than reserve currency holdings under the new method of valuation since exchange risk will be spread out over 16 currencies. Moreover, changes in currency. value will correspond to the relative weight of that currency. On balance, SDR holdings will be more secure than holdings of any one currency.
In addition to the change in the valuation method, the rate of interest on SDR holdings has also been increased from 11/2 to 5 percent per annum. In the future, this rate will be reviewed at frequent intervals and changes will reflect average short-term interest rates in 5 major industrial countries (US., UK., Germany, France and Japan)
The combined effect of stable capital value and higher interest rate should make the SDR more widely acceptable and usable in official transactions. This should ensure more efficient management of international reserves and prevent destabilizing shifts between various forms of reserve assets.
Since its emergence in the 1950’s, the Eurodollar market has enjoyed a record of remarkable growth. Development of the Eurodollar market has been encouraged by the relative freedom from restrictions which apply to other types of transactions as well as the competitiveness of its interest rates relative to rates in national money markets. The convenience and anonymity offered by the market have also contributed to its popularity among banks and other institutions in the US. as well as in other countries. The structure of the market has undergone a rapid transformation involving a decline in the US. Dollar component which has always made up the bulk of Eurodollar transactions, and a change in the geographical pattern of lending and borrowing through the market. In 1969, US. residents were the main net users while the main net supplier was the reporting European area. By the end of 1973, the main user on the market was Japan followed by the US. while the main net supplier was the Middle East. Loans to developing countries, mostly on a rollover basis, more than doubled in value last year, while borrowing by developed countries, made in anticipation of balances of payments difficulties, increased substantially in the wake of the recent shifts in terms of trade due to increases in the price of oil.
The recent spectacular development of the Eurocurrency market has been contrary to general expectation. In view of the US. being able to reduce its balance of payments deficits it was widely expected that the reflow of liquid funds to the US. would dry up much of the resources of the Eurodollar market, and its development would be moderated. Other factors which have been, and are expected to continue, operating in the direction of reducing the rate of growth of the Eurodollar market and encouraging deposits in local currency markets rather than with banks in the Eurocurrency market are: the removal of US. capital controls, the decreasing differential between interest rates in the Eurocurrency market and local money markets, and the possibility of controls being imposed on the market by governments of countries in which the banks are situated, possibly making it difficult for depositors to withdraw funds from the market at will.
In its role as an intermediary for international financial transactions, the Eurodollar market has promoted the efficient allocation of financial resources and has encouraged, through the influence of its interest rates on that of different countries, a certain degree of homogeneity of monetary policy. By facilitating international loan transactions, it has played an important role in encouraging the expansion of international trade. More recently, funds have been channelled through the Eurodollar market to the developing countries and used for developmental purposes.
In spite of the valuable services the Eurodollar market is recognised to have performed, its scope and intricate mechanism are far from being generally understood in depth. A number of problems may be mentioned in relation to the Eurodollar market. It is often contended that the Eurodollar market is a major force contributing to the present state of inflation due to the fact that banks in the Eurodollar market create credit by expanding loans in the same manner that banks in a domestic banking system create deposits up to the limits of required reserves. In this way the global supply of money is said to be increased. However, it should be noted that Eurodollar deposits are not a direct menas of payment but must be converted to a bank deposit in the US. Furthermore, the major portion of funds in the market is held in the form of term deposits rather than at call and therefore cannot be considered as part of the money supply in the same manner as demand deposits of nationally operating commercial banks. While there is no consensus of opinion whether deposits in the Eurodollar market can indeed initiate a process of money creation, it has been recognised that total liquidity is in fact increased by central bank deposits in the market since when a central bank deposits money in the market, total liquidity in the domestic market is not correspondingly decreased which is what occurs with deposits by private institutions, while liquidity in the recipient country is increased. The central banks from which the funds originated still hold in their reserves the balances they have deposited in the market, while the central banks of the recipient countries also show in their reserves the new balances which have come into their hands. Hence global liquidity is increased.
In an attempt to prevent this effect from causing inflation, the Group of Ten in 1971 agreed not to increase their official placements in the Eurocurrency market and a limitation on the placement of official reserves by all IMF members is being examined. There is no real reason why central banks should object to this proposal since traditionally, before the emergence of the Eurocurrency market, banks have always deposited their reserves in the countries in whose currencies their reserves are held. The interest rate advantage of the Eurocurrency market has now been diminished due to high interest rates in the national money markets, and depositors are already turning to national money markets to place their funds. The advantage left is that of convenience, for if major countries re-establish or maintain controls on the inflow of capital similar to those which existed during the greater part of 1973, it would be very difficult or very unprofitable for central banks to deposit in such countries. As this would in effect encourage deposits in the Eurocurrency market once again, it is important that such controls be discouraged.
Critics of the Eurodollar system often point out that due to the fact that banks in the Eurodollar market operate under relatively few controls over their activities, they can sometimes give rise to flows of funds of substantial size which can undermine national economic policies. Furthermore, they contribute to destabilizing capital movements by being a source of speculative funds connected with flights of funds out of weak currencies and rushes into strong currencies. This is said to have been most pronounced during the first few months of 1974 when the Eurobanks’ liabilities to US. residents increased by about $2 billion. The opposing view is that most deposits in the Eurodollar market are term deposits and cannot be immediately withdrawn in response to interest rate or exchange rate advantages so that their exact role in promoting instability is debatable. In any case, these movements of capital have not been the cause of instabilities of the monetary system but rather the consequence of lack of confidence arising from more basic disequilibrium, coupled with an inadequate adjustment mechanism. To prevent the potential damage caused by flows of capital via the Eurocurrency market, a prompt adjustment process is therefore desirable. In an attempt to minimize destabilizing capital flows, capital controls may be necessary in some cases though it is generally recognised that, ordinarily, capital flows should be as free as possible. Controls on capital flows should be used only as a temporary measure and should not inhibit flows for investment or developmental purposes. Though controls on capital flows are not by themselves desirable, they are preferable to controls on trade.
More recently, the instability of the Eurodollar market caused by the changing pattern of supply and demand of fund in the wake of the recent oil crisis has become a matter of increasing concern. Increased demand for fund by countries suffering balance of payments problems, and by developing countries suffering a declining supply of economic assistance regularly forthcoming from industrial countries, together with high interest rates prevailing in domestic money markets due to the universal pursuit of contractionary monetary policies has caused interest rates in the Eurocurrency markets to soar to unprecedented heights. For instance, a record 14 percent for the three-month Eurodollar was achieved in early-July. A greater part of the current demand for funds in the Eurocurrency market is for medium or long-term finance, while a greater part of the supply is very short-term. Most notably, “petrodollars” are placed in very short-term deposits for maximum manoeuverability due to the prevailing climate of uncertainty and distrust in the foreign exchange markets. In fact, many banks have experienced serious losses due to their foreign exchange commitments. Consequently, banks are finding it necessary to finance long-term loans with short-term deposits and this has resulted in fear that if maturing funds fail to be redeposited, banks may be unable to meet their obligations and a moratorium will have to be declared. This fear has accentuated the problem by increasing the desire of customers for shorter rather than longer-term deposits. Further complicating the matter is the possibility that banks may find their lending growth inhibited by the inability to take on additional deposits due to their rapidly declining capital/deposits ratio.
Due to the lack of confidence in the Eurocurrency market, holders of fund are turning towards national money markets in Europe and the United States instead of the Eurocurrency market. This tendency has been more pronounced recently due to the decline in the interest rate advantage which once existed in the Eurocurrency market. The possibility of controls being devised to limit the operations of banks in the market has raised fears of increasing difficulty in withdrawing funds from the market and has reinforced the preference for short-term deposits.
These problems have resulted in increased concern over the stability of the institutions within the Eurodollar market and measures are being considered with a view to improving the security of the market.
For instance, major Western countries have reportedly reached an informal agreement to protect the Eurocurrency market against collapse by providing support to a major bank with substantial Eurocurrency exposure, and which is facing liquidity problems that could lead to a major failure, to a certain extent of their regular swap lines. They are therefore acting as lenders of last resort in a limited way. Though this role of central banks is important in building up confidence in the banks, the problem remains as to which country should have the final responsibility over any particular bank, and the extent of authority they should have over the operation of the bank, in order to enforce rules for orderly and prudent conduct of banking business. Controls worth considering are direct limits on total Eurocurrency liabilities or lending, or reserve requirements on liabilities or lending. These controls will limit the expansion of banks’ Eurocurrency business but will also cause a reduction in the exposure of the banks, promoting a healthier investment climate. Through reducing Eurocurrency transactions, it may also be argued that controls on Eurocurrency activity will cause global liquidity to be reduced, relieving inflationary pressures created by the Eurocurrency market, if in fact they do exist. On the other hand, with a reduction in the supply of credit, it would become increasingly difficult to take out loans for balances of payments or for developmental needs, and could increase the cost of any loans obtainable.
In recognition of the importance of the Eurodollar market’s contributions to the growth of the international economy, care must therefore be taken not to make credit so expensive or constraints so overpowering that it would impair the market’s function as an efficient medium for the allocation of credit on a world-wide scale. As an important source of capital and outlet for investment, the continued existence of the market is desirable, particularly for developing countries. Studies of the nature and implications of the market should therefore be made with a view to introducing long-term measures to improve the security of the market without considerably affecting its efficiency and costs elements. Increased confidence in the market is particularly urgent in order to recycle money from the oil-producing nations to oil-importing nations which are suffering substantial balance of payments deficits. In the event that the Eurodollar market is greatly restricted in the future by international agreements and as a result of consolidation of currency overhangs, alternative sources of funds must be found for the developing countries.
- LONG-TERM OBJECTIVES OF MONETARY REFORM
International monetary problems discussed in Part I of this paper demand immediate and concerted action to ensure that international trade and investments are not disrupted by the general abandonment of par value obligations and the breakdown of the gold-exchange standard. Towards this end, some steps have already been taken. The IMF has adopted a new standard of value, the SDR, whose value is linked to a basket of currencies at the current market rates, for transactions with member countries involving SDRs as well as currencies which are floating. Guidelines for Fund management of floating exchange rates have also been established. In order to provide a more effective forum for international consultation on monetary issues of mutual concern, the structure of the IMF will be streamlined by increasing the functions of the Executive Board and establishing an Interim Committee of the Board of Governors. This Interim Committee consisting of high-level representatives of the constituencies which are entitled to appoint or elect an Executive Director will be of the same size as the now defunct Committee of Twenty (160 participants). It will advise the Board of Governors on the need for adjustment of imbalances, the appropriateness of exchange rates and payments policies, as well as act as a forum for international cooperation in dealing with monetary crises and the future of the international monetary system. It is expected that the Interim Committee will be replaced in due course by a permanent Council of Governors with decision-making power.
These interim arrangements should adequately meet present needs of the world community. However, uncertainties in regard to exchange rate flexibility, the usability and value of gold and foreign currency holdings and the criteria for balance of payments adjustment will persist with adverse consequence on the long-term prospects for international trade and economic growth in the following ways. Fluctuations of exchange rates, which serve the function of translating international prices into domestic prices, will generate price instability and accelerate inflation rates, thereby eroding confidence in money. Failure to agree on the value and usability of reserve assets will affect the need for balance of payments financing and encourage destabilizing shifts between various forms of reserve assets. Finally, and perhaps the most important short-coming of this present non-system, the lack of an adequate adjustment mechanism, the root cause of past monetary crises which led to the break-down of the Bretton Woods system. While the Fund will begin to pay a more active role in promoting prompt and adequate adjustment of imbalances, there has been no agreement on the criteria to be used in determining the need for adjustment and the forms and degrees of sanctions to give more “bite” to the adjustment mechanism. This can be expected to reduce the effectiveness of Eund surveillance.
Another aspect of international economic relations which remains to be rectified is the transfer of real resources to LDCs. While it is generally recognized that the welfare of LDCs is of vital concern to world peace and stability, very little has been done to translate this principle into concrete action.
In sum, long-term monetary issues which should be dealt with are as follows: the exchange rate system, the adjustment mechanism, improved management of global liquidity, convertibility and intervention practices and the special interests of LDCs.
I cannot venture to predict how long the present upheavals in the payments positions and prospects will last. This may take 2-3 years. But for all we know monetary conditions may take as long as a decade to stabilize. To prepare for any eventuality, negotiations on the features of the system which will replace Bretton Woods should be resumed by the Council of Governors. The findings of the Committee of Twenty should be used as the starting point, adding to the “skeleton” of the reformed system the necessary technical points and operational details. These long-term issues need not be tackled in one package since the degree of urgency varies from case to case. Priority should be given to improvement of the adjustment mechanism, management of global liquidity and special interests of LDCs. Agreement on the exchange rate system, convertibility and intervention practices could be postponed until conditions become more stable. The evolutionary and piecemeal approach to international monetary reform may not result in an ideal system. However, this approach will ensure that solutions to long-term monetary problems will be acceptable and practicable.
I shall now proceed to discuss each of the basic objectives of reform separately.
1.The Adjustment Mechanism
In order to ensure smooth functioning of the international monetary system, both surplus and deficit countries should be obliged to undertake prompt and adequate adjustment measures. The basis for determining the need for adjustment in both cases would be either 1) a disproportionate movement of reserves or 2) Fund judgment based on assessment of all the relevant factors.
The point of contention arises in connection with the degree of automaticity in the use of the reserve indicator to determine the need for adjustment. The automatic reserve indicator system would avoid the possibility of conflicting interpretations of the criteria for adjustment. On the other hand, the reserve indicator may conflict with other signals in the economy and can often be manipulated. Both the “stock” approach and the “flow” approach to the reserve indicator system would be open to the objection that they fail to take into account the differences in the nature and degree of reserve needs of individual countries. In the case of LDCs reserve norms have to be set at a higher level to allow for fluctuations in export earnings as well as development aims. Upper and lower “warning points” above or below reserve norms and limits on primary asset holdings which may be established for the purpose of assessing the need for adjustment should therefore differ for various groups of countries i.e. advanced countries, LDCs and oil-exporting countries. Above all, reserve indicators should not create a presumption for adjustment and should not trigger the application of pressures. A careful assessment of all the relevant economic factors should be the basis for Fund Surveillance of the adjustment process. Choice of adjustment measures
i.e. exchange rate changes, monetary or fiscal measures, should be determined by national authority although their appropriateness and adequacy will be reviewed by the Fund.
Regarding the form and degree of pressure to be applied to countries failing to adjust, it appears that deficit countries will be subject to more effective and severe pressures than surplus countries. For instance, denial of access to Fund credit facilities, penalty interest rates, publication of Fund report on the economic position and prospects and authorization of discriminatory use of trade and exchange restrictions are more likely to aggravate the position of deficit countries than surplus countries. In order to ensure greater symmetry in adjustment obligations, more effective forms of pressures should be applied to surplus countries and deficit developed countries. In this connection, the Fund’s “scarce currency” clause should be applied more readily than in the past.
The need to improve management of reserve currency holdings has already been discussed in connection with the Euro-money market and arrangements for reserves accumulated by oil-exporting countries. Possible arrangements for gold have also been examined. Suggestions for substitution of reserve currencies and gold for SDR and for periodic sale of gold in the market are in line with the long-term objective of enlarging the role of internationally-managed reserve asset i.e. the SDR. In the long-run, the SDR should become the centre of the international monetary system, replacing the gold-exchange standard.
Towards this end, the value of SDR should be more stable than currency holdings. This could be achieved by increasing the value of SDR at a given rate per annum i.e. increasing the number of currency units in the basket under the modified “standard basket” approach. Alternatively, the “asymmetrical basket” approach could be adopted whereby the number of units of the currency which has devalued as floated downward will be increased in proportion to exchange rate changes. This approach will prevent the value of SDR from declining in terms of non-depreciating currencies while a revaluation or upward float will continue to raise the value of SDR in terms of other currencies. Both approaches will ensure that the capital value of SDR increase over time and will make it an internationally preferred reserve asset. A stronger SDR would however imply lower interest rates on SDR holdings to prevent hoarding. Finally, existing rules for use and holding of SDR should be amended to improve the reserve asest nature of the SDR and to reduce its role as short-term balance of payments credits. In this respect, reconstitution provisions and acceptance limits for SDR should be abolished. The possibility of promoting general understanding and use of SDR by the private sector should also be explored.
In regard to official holdings of foreign currencies, the conflict between the desire of individual countries to retain the freedom in determining the composition of their reserves on the one hand, and the general recognition of the need for more effective control of global liquidity increases and destabilizing shifts between the various forms of reserve assets on the other, should be resolved. The existing currency “over-hang” not only creates the problem of uneven reserve distribution but also defeats the aim of improving the adjustment mechanism. We are sympathetic to the needs of monetary authorities to choose the composition of their reserves according to their income-earning objectives and the need to maintain adequate working balances to ensure access to the money markets. However, the principle of improved management of liquidity should prevail. Under the reformed system, countries should avoid sudden changes in the composition of their reserves and should aim to reduce foreign currency holdings over time. The Fund should be authorized to issue SDR for substitution of reserve currencies presented by official holders and should be able to designate members to substitute reserve currencies for SDR when necessary.
Under the reformed system, the volume of global reserves should be managed by means of SDR allocations so as to prevent inflation as well as deflation. To allow for shifts from private holdings of currencies to official holdings, a sufficient degree of elasticity will have to provided either by means of limits on primary reserve holding (beyond which countries would not be entitled to convert foreign currency holdings into gold or SDR) or by allowing for exemptions of obligations on asset settlement as discussed below.
2.Special Interests of LDCs
The reformed system should provide for LDCs to be exempted from adjustment obligations and the application of pressures due to the special characteristics and needs of these countries. The special needs of the LDCs should also be recognized in regard to reserve norms. The reformed system should also ensure that the transfer of real resources to LDCs will increase steadily inproportion to their growth objectives.
The principle of resource transfer is justified by the fact that LDCs have always been at the losing end throughout the recent international monetary upheavals arising from factors beyond their control. This is seen clearly in the case of exchange rate uncertainties. Price instability resulting from exchange rate uncertainties and inflation has not only disrupted development plans of LDC but also domestic production, income and employment. Exchange rate flexibility is likely to remain a permanent feature of the international monetary system. In addition, the LDCs will be subject to more control in regard to reserve management, convertibility and adjustment in spite of the fact that their conduct in these matters will not have substantial impact on the rest of the world. To offset these adverse effects, concrete measures should be adopted to ensure increased transfer of real resources to LDC.
In this connection, the proposal to link SDR allocation to development finance either by direct SDR allocation to LDCs or indirectly through development finance institutions should be implemented as soon as possible. The establishment of a “Link” will ensure that the benefits hitherto enjoyed exclusively by major countries whose currencies are held by other countries as reserves will now be enjoyed by LDCs. The “Link” should not however accelerate world inflation and SDR creation should continue to be based on careful assessment of global reserve needs alone. Technical problems seem not to exist, what is lacking is political support and commitment.
The Fund should also endeavour to improve existing credit facilities, particularly the Compensatory Financing Facility and Buffer Stock Facility aimed at stabilizing prices of primary products. Longer-term balance of payments support should also be considered by the Fund in addition to the “Link” under the proposed Extended Fund Facility.
Other aspects of the transfer of real resources to LDCs—i.e. improved quality of aid, higher targets for official aid, access to capital market and external debt relief measures have been recognized as desirable objectives of monetary reform. However, a machinery for overseeing work in this area has been lacking. The committee of Twenty’s proposal to set up a joint Ministerial Committee of the IMF and the World Bank to study this matter is therefore very welcome.
In view of the pressing needs of LDCs, the proposed “Link” as well as other aspects of resource transfers should be implemented as soon as practicable.
I have already indicated my preference for a system of stable exchange rates. To be more specific, this would imply a return to fixed but adjustable parities, with floating in special cases when approved by the IMF. Thus, under the reformed system, countries should be obliged to maintain exchange rates within agreed margins. At present, the Fund allows rates to fluctuate within margins of 21/4 percent above or below the par value in terms of SDR. This means 41/2 percent margins above or below the parity relationship between any two currencies derived from the ratio between their par values in terms of SDR. Exchange rates of any currencies could therefore be as much as 9 percent apart. Under the reformed system, wider margins than prevailing at present should not be accepted. Proposals for simplified procedures for Fund approval of small and frequent changes in par values as well as managed floating rates would likewise not be in the interest of the world community. It is conceivable that there could be very little difference in the degree of exchange rate flexibility under the 1) stable but adjustable rates system with floating in particular cased 2) fixed rates system with simplified procedures for Fund approval of small and frequent par value changes and 3) a system of managed floating. However, in terms of psychological effects and the effectiveness of international surveillance, the first alternative appears to be more beneficial to long-term prospects of trade and economic growth.
Another basic feature of the reformed system should be the resumption of convertibility obligations. This means that all countries would be obliged to settle in primary assets all official currency holdings presented for conversion. For countries whose currencies are not used for trading and reserve purposes, convertibility obligation would be observed by official intervention to maintain exchange rates within agreed margins.
The reformed system should therefore ensure that all countries whose currencies are held as official reserves would reduce their currency liabilities to the full extent of their balance of payment deficits. This could be done by bilateral conversion or through the Fund based on changes in total currency liabilities to official holders. Countries in surplus should however have the option to convert reserve currency holding provided that accumulations beyond appropriate limits would be subject to Fund designation for substitution into SDR. This mechanism would ensure that deficit countries will not be able to finance their imbalances by increasing currency liabilities while surpuls countries will enjoy a degree of freedom in reserve management policies. To ensure an adequate degree of elasticity, limits of primary asset holdings or exemption of reserve currency countries from settlement obligations would also have to be provided.
Under the reformed system, all countries should be obliged to intervene to maintain their exchange rates within agreed margins. The same degree of exchange rate flexibility within these margins should be available to all countries. Towards this end, it has been suggested that countries whose currencies are widely traded should undertake to maintain exchange countries rates vis-àvis each other’s currency within a band of 41/2 per -cent based on parity relationships under the multi-currency intervention system. Other countries will maintain rates within the same margins vis-à-vis their intervention currency or currencies which could normally be the currencies of countries participating in the multi-currency intervention scheme. This would ensure that any pair of currencies would not be more than 9 percent apart. Alternatively, the SDR has been suggested as the intervention medium. However, this would conflict with the use of the “basket” approach for SDR valuation since SDR used for intervention will be transacted at agreed margins above or below the par value. This approach would also involve private use of SDR which may take time to develop. The multi-currency intervention system appears to be more feasible in the foreseeable future.
In regard to intervention practices, it is hoped that currencies which are tied to a major currency will continue to have the same degree of flexibility vis-à-vis their intervention currency regardless of where their intervention currency stands.
In his oral presentation, Dr. Puey Ungphakorn added some further remarks as follows:
“…I believe, in my written presentation I have given adequate reasons for the various proposals. I am not going to repeat them here, in order to save time.
Before I sit down, may I make a few further remarks?
First, if mankind was not too much preoccupied with wars and the production of arms, perhaps we could devote more resources to the production and distribution of food and the prices of food need not have inflated so much.
Secondly, the problems of wages vs. prices, or cost-push inflation need to be attacked at the root by drastic social and fiscal reforms, instead of monetary measures. This is true of less developed countries as well as industrial developed countries.
Thirdly, it is unrealistic as well as unnecessary to expect the prices of mineral oil to climb down before international monetary reform. What we, oil-importing countries, need is the assurance of a stable price trend which will enable us to have a clearer idea of the payments and inflationary problems ahead of time.
Fourthly, I notice that in the past, discussions on international monetary problems took unduly long time, and in many instances, they have been overtaken by new events. Whenever there was a lull between crises, there was also a lull in the discussions in favour of status quo, until the next crisis compelled decisions to be taken quickly under pressure. The reports were usually very polite, which is perhaps a good thing. But they have rarely been concrete or specific enough, which is not so good. Perhaps specific reference or warning to culprits is taboo in international financial diplomacy. Is it too much to expect form now on freer and franker discussions leading to mere timely and more effective international monetary reform?
Lastly, in this unequal world, LDCs and DCs are subject to asymmetrical treatment. LDCs need development aid from the World Bank, and in order to obtain such aid, they have to belong to the IMF rules. It would be very sinful for them to resort to multiple currency practices in case of necessity, e.g., if they want gradual, instead of adrupt, rises in the domestic price of oil. On the other hand major countries can resort to all sorts of tricks, which are admittedly illegal. Proposals have now been made that such illegal practice should be legalised by amending rules to suit circumstances. ‘Independent national monetary policy’ of the developed countries must be allowed for; that of LDCs could be ignored. In such a world, has one any right to expect international democratic monetary order?”
FINANCE, TRADE AND ECONOMIC DEVELOPMENT IN THAILAND Essays in Honour of Khunying Suparb Yossundara Edited by Prateep Sondysuvan Sompong Press 1975