Shortage of International Liquidity (With Solution) | Economics

In this article we will discuss about the reasons for shortage of international liquidity with its solution.

The international liquidity is the sum total of international reserves of all nations, participating in the world monetary and trading system. In case all the countries have equilibrium in their balance of payments, there can be no problem of international liquidity.

Alternatively, if the national currencies become fully convertible, no shortage of international liquidity can arise even in that situation. Similarly if all the deficit countries are allowed to have an unlimited and unconditional access to the borrowing or trading, there may still be no problem of the shortage of international liquidity.

The world community has, however, continued to face the severe strains of international liquidity aggravating the balance of payments deficits and internal economic problems such as unemployment, poverty and inflation.

Reasons for the Shortage of International Liquidity:

The main reasons for the inadequacy or shortage of international liquidity are as follows:

(i) Payments Deficits:

The fundamental cause of the shortage of international liquidity has been the mounting BOP deficits in case of both developed and less developed countries during the last few decades. Except a few countries like Japan and Germany, almost all other countries including the U.S.A. are faced with serious balance of payments deficit.

This problem was greatly aggravated by the petroleum crisis in 1970’s especially in the case of non-oil producing rich and poor countries. During that period, the deficits of non-oil producing countries almost quadrupled. That led to an excessive demand pressure for international liquidity from the deficit nations to adjust their payments deficits.

(ii) Redistribution of International Reserves:

The international reserves have been redistributed in favour of more advanced countries. A large majority of the member countries of the IMF and other international financial institutions have received utterly inadequate financial resources to meet their liquidity requirements. During the 1960’s, the redistribution of international reserves was away from the United States and the less developed countries. It had gone in favour of countries like France, West Germany, Italy, Belgium and the Scandinavian countries.

During 1970’s, there was redistribution of reserves in favour of the oil exporting countries of the Middle East. The non-oil producing less developed countries suffered particularly in those years. This problem persisted even during 1980’s, when there was redistribution of reserves again in favour of Japan and Germany. Such distributional patterns indicate that the liquidity crisis has got more and more aggravated with the passage of time especially from the viewpoint of the developing countries.

(iii) Attitude of the Advanced Countries:

The problem of shortage of international liquidity has persisted on account of the attitude adopted by the advanced countries. It is important that they should reduce their BOP surpluses. However the majority of the advanced countries have shown little interest in adopting policies for getting rid of their surpluses and helping in increasing the international liquidity. They put forward the argument that the international liquidity crisis is not on account of their accumulated payments surpluses. They allege that the poor countries themselves are to be blamed for it.

According to them, the problem of international liquidity has arisen due to the mismanagement of the economies, extravagant public spending, unproductive and wasteful expenditure, over- ambitious social and economic goals and trying to do too many things at the same time. Given this line of thinking on the part of advanced countries, there can be little hope for an early redressal of the problems of payment deficits and the shortage of international liquidity.

(iv) Very Little Access to Markets of Advanced Countries:

The basic cause of mounting BOP deficits and inadequacy of international liquidity is that the LDC’s have very little access to the markets of the advanced countries. On the one hand, the advanced countries advocate free trade but, on the other hand, they have maintained a regime of tariffs and other import restrictions upon the exports of the LDC’s.

The formation of regional economic grouping among the advanced countries of Europe and North America and consequent imposition of a high common external tariff not only exposes the double standards on the part of advanced countries on the issue of free trade, but also amounts to denying the access to the LDC’s of their markets. In such a situation, the latter cannot easily resolve their problems of payments deficits, mounting debt burden, low development and shortage of international liquidity.

In case the satisfactory arrangements are not made to overcome the problem of shortage of international liquidity, both the rich and poor countries will have to suffer in the long run. The unresolved problem of international liquidity will force the LDC’s to resort to import restrictions, exchange controls, devaluation, restrictions on capital flows and high tariffs.

In the circumstances when the advanced countries are not inclined to allow free exports from the LDC’s, they will be left with no alternative other than relying more and more on South-South trade. Such a development is not in the ultimate interests of the rich North. It is, therefore, important that both rich and the poor countries should strive to evolve a proper solution to the problem of shortage of international liquidity in their best mutual interests.

Solution to the Problem:

In view of the continued shortage of international liquidity, the crucial question that arises is how to resolve this problem.

In this regard, the following measures may be suggested:

(i) Return to Gold Standard:

One of the methods suggested for resolving the problem of shortage of international liquidity is the return to gold standard.

In this connection, Scitovsky comments, “In the days of automatic gold standard, payments adjustment was relatively smooth and painless, because the flow of gold created as much expansionary pressure in surplus countries as it created deflationary pressures in deficit countries, and the symmetry between these pressures divided the burden of adjustment evenly between the countries losing and those receiving gold, thus minimizing the amount of economic dislocation that payments adjustment involved.”

Since the abandonment of the gold standard, the payments adjustments have been associated primarily with unemployment, deflation, tying of aid and restraints on the free movement of people and capital. The main flaw in this method of payment adjustment is that the entire burden of adjustment weighed only and always on the deficit countries.

(ii) Reduction in Payments Surpluses:

The shortage of international liquidity can be tackled, if the surplus countries are willing to reduce their surpluses. This can be possible, if the surplus countries permit an easy access to the products of the LDC’s to their markets. Even if they are not inclined to forego their surpluses, the problem of inadequacy of international liquidity can be dealt satisfactorily provided the surplus countries agree to accept payments in terms of national currencies.

(iii) Reduction in Imports:

In case the deficit countries are not allowed access to markets of surplus countries, the alternative for the former is to cut their non-essential imports through tariff or non-tariff restrictions and import-substitution. The reduction in imports will reduce the demand for international liquidity. This measure is although not the best way to resolve this problem, yet it is certainly a practical way to relieve, to some extent, the problem of inadequacy of world liquidity.

(iv) International Institutional Arrangements:

To deal effectively with the problem of shortage of international liquidity, there is need to activate and expand the institutional arrangements for the larger supply of international liquidity. The IMF, World Bank and other financial institutions have to play a more active and extensive role in this connection.

The immediate response to the liquidity problem faced by the LDC’s has been the provision of financial assistance to them on an emergency basis. The volume of such assistance has, however, remained far short of their requirements. Even if such assistance can finance their huge BOP deficits, it is at best a short-term solution. The problem faced by the LDC’s is actually two-fold.

Firstly, they have to pay high and rising import prices not only for oil, but also for food, machinery, fertilizers, other manufactured goods and services.

Secondly, their receipts from exports are low owing to low export prices of the primary products. Not only their export earnings are low but these get also eroded on account of their heavy debt servicing obligations. In view of this, the increased flow of foreign assistance does not provide a permanent or durable solution to this problem.

The issue is basically concerned with the trade relationship between the surplus and the deficit countries. Both rich and poor countries need to recognise their inter-dependence in trade with equity. The increased flow of assistance will land the deficit countries only in a state of debt trap. What is needed is that the surplus countries should be willing to take measures to get rid of their surpluses. Otherwise the less developed deficit countries will either resort to import restrictions or will be forced to turn inwards and follow policies for reducing their dependence on foreign trade.

Such developments will cause injury not only to the LDC’s but also to the advanced countries. As a result the entire world community will be rendered poorer. Therefore, it is important that the advanced surplus countries permit greater access for the products of the LDC’s to their markets. The enlargement of exports of the deficit countries alone can provide a durable and permanent solution to the problem of shortage of international liquidity.