The International Monetary System (Reforms)

The problem of international liquidity is bound up with the problem of exchange rates.

The economists like Meade, Friedman, Haberler and Marry Johnson are the advocates of the flexible exchange rates.

The introduction of flexible exchange rates would relieve the central banks once and for all of any function in the international payments system and would remove any requirement to hold reserves for foreign payments. Flexible exchange rates will equilibrate the demand for and the supply of foreign exchange. The system will solve completely both the problems of liquidity and adjustment.

In theory it would automatically keep the balance of payments of countries in equilibrium. But movements of exchange rates would not have a corrective effect unless accompanied by appropriate fiscal and credit policies of the government. The system is most compatible with the preservation of national sovereignties. Another merit of free trade adjustment is its simplicity. Under such a system a country is free to pursue at anytime whatever monetary policy it thinks suitable to the needs of the internal situation.

Harrod and Triffin have criticized the system as it runs counter to the basic philosophy of IMF which was established to promote exchange stability. Again there are risks of foreign trade under the flexible exchange rate system and it might lead to inflationary situations.

Increase in the Price of Gold:

A substantial increase in the price of gold, its proponents argue, would solve the problem of international liquidity. If the price of gold was doubled, the value of the monetary stocks of gold would also be doubled. This would obviously lead to a large increase in world liquidity.

The countries that would especially benefit would be the United States and the EEC countries of Western Europe, which together hold 75-80 percent of the world’s known monetary gold reserves. That the value of the existing stocks would increase. The proponents of an increase in the price of gold also argue that the long- term growth of the world supply would increase. This, however, is a more debatable point.

Mining of gold would be more profitable and would undoubtedly lead to an increase in the supply of gold. The vital point is the effect of a price increase on hoarding. The proponents of a world-wide devaluation argue that a dishoarding would follow and that gold would therefore come out of various hiding places and flow into the central banks as hoarders and speculators took advantage of the price increase. This line of argument is also supported by historical evidence.

Against this background, it is doubtful whether a world-wide devaluation of currencies and revaluation of gold would be looked upon as a once-and-for-all phenomenon. There could be those, who would have a feeling that, in the future, gold would be revalued again and therefore would continue to hold on to it. In this case, no dishoarding of gold would take place, and there would be no increase in the amount of gold available for monetary purposes.

An increase in the price of gold also has some obvious drawbacks. The increase in the value of the stocks of gold could have an inflationary impact on the world economy. Since the stocks of gold are very unevenly distributed among countries, a world-wide devaluation would benefit only a small group of countries, which already have large enough reserves. Another point worth mentioning is that, a revaluation of gold would penalize those countries which have most loyally cooperated in sustaining the present system by holding reserve currencies instead of gold.

We have seen that an increase in the price of gold will increase the supply of newly mined gold. The world’s two largest gold producers are South Africa and the Soviet Union. These two countries would then benefit from an increase in the price of gold. How this effect is evaluated is obviously a political question.

It is highly doubtful whether any increase in the increments of the world’s stock of monetary gold would take place because of gold revaluation. Even if one were willing to accept (or disregard) all the side effects that we have discussed it is, therefore, doubtful whether an increase in the price of gold could be judged a rational policy.

To sum up, an increase in the price of gold would hardly solve the problems of the international monetary system in the long-run. Its effect on the supply of gold are highly debatable. If a considerable revaluation in the price of gold was undertaken, it could easily have an immediate disruptive influence on the world’s price level. To leave the supply of international liquidity to the vagaries of gold production in hardly rational.

The Keynes Plan:

The keynes plan was proposed in 1943. A central feature of the plan is the establishment of a clearing union. In this sense, the Keynes plan aims at the creation of an international central reserve bank. This will be done as follows. A new international currency unit; called bancor, with a fixed value in gold v/ill be created. At the same time, holdings of foreign currency will be abolished. Gold, however, will still be used for international monetary purposes. Thus, when the system is fully developed, only the two means of international payments will be in use: gold and bancor.

According to this plan a single country can acquire bancor in two ways: It can sell gold or use its overdraft facilities with the clearing union. The exchange of gold and bancor, however, is one way. Gold can be used to acquire bancor, but bancor cannot be used to buy gold. The essence of Keynes plan is the clearing union. The plan builds on the concept that deficits and surpluses in the balance of payments change in a cyclical, fashion. A deficit country needing liquidity can borrow from the clearing union by using the overdraft facilities. Each member country has a quota in the union. The quota depends on the sum of each country’s exports and imports.

If a country uses more than one fourth but less than one half its quota, it will have to pay a charge of I percent per year on its borrowings with the union; if it uses more than one half its quota, charge will be 2 percent. An interesting feature is that surplus countries too will have to pay a charge if they are excessively liquid. If a surplus country has a credit balance with the union of more than one half its quota it will have to pay a change of 1 percent per year.

A basic part of the philosophy behind the plan is the view that external imbalances are of a cyclical, short-term nature. For a year or two a country might be in deficit, during which time it should be able to borrow from the union. Similarly, a country might have a surplus in the short-term, but if it accumulates too great a reserve of bancor it should be penalized. If imbalances are of a short-term type, and economic policies, presumably both expenditure reducing and expenditure switching policies, should be used for the rapid creation of a new balance. Surplus countries should also play their role by inflating or appreciating thereby trying to eliminate the surplus.

It should also be observed that adjustment can take the form of capital movements. The only way deficit and surplus countries can avoid paying charges to the union is for a deficit country to borrow from a surplus country and for a surplus country to lend to a deficit country. Capital movements between countries are therefore encouraged by the Keynes plan. It is envisaged that accommodating capital movements can be turned into autonomous capital flows and that they can play a role both as a form of adjustment and as a creator of breathing space while other measures of adjustment are being prepared.

The Keynes plan has several attractive features. It is modest in scope, in that it only relies on the creation of a clearing union and a new international currency. It is also a sound proposal in that it stresses the role of adjustment and capital movements. Another interesting aspect of the Keynes plan is that it makes no provision for a gradual, long-term increase in international liquidity.

Keynes plan was rejected at Bretton Woods for two reasons. First, Keynes plan did not allow the right of conversion into gold of holdings of “bancor”. Second, the credit creating powers of the proposed clearing union were unlimited with possible inflationary implications for the world economy.

The Bernstein Plan:

The leading idea of the Bernstein plan is to give the IMF a more central place in the present international monetary system. The member countries now hold quotas in the IMF. These quotas, however, are not regarded as “the-first-line-reserves”. At present, members have automatic access to the first 25 percent of their quotas (their gold subscriptions to the fund). Moreover they have almost automatic access to another 25 percent. Thereafter drawings from the fund are subject to increasingly stringent conditions of fund approval.

The first suggestion of the Bernstein plan is that the IMF quotas should be integrated into each country’s working balances. Thereby the amount of international liquidity should increase. The second suggestion of the Bernstein plan is the creation of a Reserve Unit Account within the IMF. This is the central feature of the plan. A member country of the IMF could be allotted say $ 100 million of reserve units. This would mean that the country would deposit an equivalent amount of its own currency with the Reserve Union Account.

The allotment of reserve units could, for instance, be in proportion to the respective country’s quota in IMF. These reserve units would then be used in settlements of deficits and surpluses in the balance of payments.

The creation of the Reserve Unit Account would be a way of institutionalizing capital movements. Deficit countries would be able to cover their deficits by borrowing reserve units from the account and using these in setting their deficits. An advantage for the deficit countries would be that they would not have to negotiate with central banks of various surplus countries but only with the IMF directly.

If the system came to be accepted, it would presumably mean that deficit countries could more or less automatically count on acquiring a certain amount of reserve units. This in effect would mean that deficit countries, at least for some time, could count on turning accommodating capital imports into autonomous, controlled inflows.

Another important aspect of the Bernstein plan is that it provides for an increase in international liquidity. There is need for an increase in liquidity and that this need will be accentuated in years to come.

The growth of reserves could simply be handled by an increase in the total amount of reserve units.

Bernstein suggests that new reserve units should be issued each year “to provide for an adequate but not excessive increase in total monetary reserves”.

To avoid sudden changes of policy in this respect the amount of reserve currencies to be issued could be determined at 5 year intervals.

The Bernstein plan has several attractive features. It builds on existing institutions and does not imply any great changes in this respect. The reform of the IMF that the plan in tails would perhaps be viewed as rational by some, but it can hardly be argued that it would be impracticable. Furthermore, it recognizes that what really counts in international monetary matters is the behaviour of a handful of the leading industrial countries. If the} could get together in creating a Reserve Unit Account within the IMF, there is no doubt that this could be done. Another important point is that the plan explicitly recognizes the need for organized capital movements as support for the international monetary system.

The main drawback of the Bernstein plan is that it does not solve the confidence problem. On the contrary, it could be argued that it introduces new complication into this problem. Gold would still be used within the system. The reserve unit would have a guaranteed gold value.

It is somewhat unclear whether or not the reserve unit would be freely exchangeable with gold. If it was, the confidence problem of the present system is left intact. There is no guarantee against a run on gold and away from reserve units, if the reserve units are not freely exchangeable with gold, one can easily envisage a situation where surplus countries would refuse to accept reserve units. Then the system could breakdown.

There are also other facets to the confidence problem under a Bernstein type of plan. As the time goes by, the composition of the backing of the reserve units could change and increasingly come to consist of “soft” currencies. Devaluations could cause trouble, with argument about who is going to make up the loss, incurred by those (including the Reserve Unit Account) who holds the devaluing currency.

There are also problems connected with interest rates charged on reserve units to lenders and borrowers which could be difficult to solve. The way increases in liquidity should be handled would also have to be solved. The Bernstein plan only creates a mechanism through which increases can be made; it does not solve the essential problem: what rule should govern the creation of liquidity. The plan could in this respect easily turn into a scheme for special assistance to deficit countries.

The Triffin Plan:

The Triffin plan resembles the Bernstein plan. It builds on the idea that international monetary reserves should be centralized. International Monetary Fund would work as a world Central Bank. Countries which now hold foreign exchange as part of their reserves will be required to hold an increasing proportion of their foreign exchange assets as deposits in the IMF. Thus, IMF will get reserves and the Central Banks will be credited with deposits. The deposits with the IMF will carry a gold guarantee.

If this should be insufficient as an inducement for the member countries to convert their reserves into deposits is the IMF, Triffin suggests that member countries be required to hold at least 20% of their total reserves as deposits with the IMF. IMF will then gradually expand its activities in this direction and eventually will acquire all international reserves in the form of foreign currency.

It will be permitted gradually to liquidate its holdings of foreign currencies so that in the end there will be only two means of international liquidity, (i) deposits with the IMF and (ii) gold.

Perhaps the most distinguishing feature of the Triffin plan is that it suggests that the fund be empowered to engage in open market operations and thereby regulate the amount of international liquidity available. If the fund wished to increase the amount of international liquidity, it could do so by buying securities from the private persons, commercial banks or the central bank of a member country.

The IMF cheque thus obtained by any of the mentioned groups is cashed with the central bank of the member country in question, which deposits it with the IMF to be credited to the account of the central bank in question. If, for example, the fund bought securities for $ 10 million international liquidity is increased by that amount by the fund operation.

The background of this part of the plan is the need for a long-term increase of international liquidity which Triffin views as one of the essential tasks that any reform plan .should solve. If IMF recognizes a need for a secular growth of international liquidity, its open market purchases will exceed its open market sales.

Drawbacks:

(i) It does not provide for a substantial increase of international liquidity in the short-run.

(ii) It might even lead to an immediate decrease of liquidity if countries treat their deposits with the fund as less liquid than dollars and gold.

(lii) It might unduly favour industrial countries because open market operations would be concentrated in these countries.

(iv) But the most fundamental weakness of the Triffin plan is that it builds on a peculiar contradiction. On the one hand, it is too conservative, too pragmatic; on the other it is too Utopian.

Triffin will retain gold as a means of international liquidity. He even goes so far as to have a gold exchange clause so that gold can be exchanged for deposits with the fund, the vice versa. This amounts to preserving the confidence problem that haunts the present system. If a central bank wished to exchange their IMF certificates for gold, there is nothing in the Triffin plan that could stop them. This could of course, create confidence problem of much the same type as that connected with a run on gold and away from dollars.

It seems that the only measure that could save such a situation would be the cooperation of a sufficient number of strong central banks. We are then back to precisely the type conditions now prevailing. In this respect the Triffin plan is conservative.

The Utopian aspect of the plan is the one connected with the extended functions of the IMF; more precisely its power to control liquidity by open market operations. Basically the same kind of criticism that can be raised against the idea of a World Central Bank can also be leveled against Triffin’s extended version of IMF. On the pragmatic level it can be argued that there is little reason to believe that countries will be willing to abstain from sovereignty over an important part of economic policy and let some directors of IMF decides for them.

To sum up, Triffin deserves credit for his insistence on pointing out the inherent difficulties and contradictions of the present system. His diagnosis of the present international monetary system points to its essential weakness. Triffin’s role as a critic is not diminished by the fact that he was perhaps the earliest and has been the most insistent critic of the present fold-exchange standard. His plan for international monetary reform, however, is a halfway house. It is at the same time too conservative and too extravagant.