I am happy to accept your invitation to speak to you today, and I particularly welcome your interest in the subject of international liquidity. Only a few years ago this subject would have been of interest only to a few specialists in academic circles and to those groups with a particular interest in international monetary matters. It is, I think, a sign of the times that today I am speaking about this subject at the Commercial Club of Chicago, for there is now a clear recognition that what happens in the field of international liquidity is important not only to governments and central banks but also to all who are concerned with commercial and financial affairs. It is of importance not only to the course of national economies but also to the economic health and stability of all major trading communities. I think that it would be helpful if I start with a definition of liquidity and proceed to a description of the nature and work of the International Monetary Fund as it relates to liquidity. I shall conclude with a few observations on the present position of the international discussions on liquidity.
Nature of International Liquidity
When we speak of international liquidity, we do not include a great deal of the financing of the international commerce of the world, important though this is. That is, we exclude from the concept of liquidity the vast complex of private foreign exchange holdings, bank credits and trade credits which give day to day support to international trade. We exclude also the government credit supplied for export purposes by bodies like the Export-Import Bank of Washington, as well as the long-term international financing which is channeled through the private capital markets of the world or through international organizations, such as the World Bank. As the term is used, international liquidity is not any of those, even though all of them have an effect on the need for liquidity.
What, then, is international liquidity? International liquidity comprises all of the financial resources and facilities available to the monetary authorities of individual countries to use in settling deficits in international payments—to use, in other words, to make residual payments in foreign currencies when all these other sources of funds do not make the accounts balance. Liquidity includes the well-known components of “official reserves”: gold that is held by central banks, but not that held by private individuals or businesses, and foreign currencies held by central banks or Treasuries—mainly dollars and sterling but also some other currencies, notably French francs. The International Monetary Fund is also a source of liquidity, of two types: one of these is regarded as similar in character to the reserve assets I have just mentioned, and the other is credit facilities subject to certain conditions. I shall describe these in more detail in a moment. Liquidity is also provided by credit facilities in other international institutions or under various bilateral agreements. It is upon this supply of gold, foreign exchange, and access to means of making foreign payments that the authorities of a country rely to finance imbalances in its international accounts.
“Liquidity is the Business of the Fund”
I turn now to the Fund. I have said on other occasions that liquidity is the business of the Fund—indeed, it was created to provide a pooling of gold and currencies which could be used to supplement the other reserves of its members. I have spoken of two forms in which the Fund provides liquidity. To explain these requires some description of the structure and activities of the Fund. The structure is unique. The Fund is an international financial agency, in which each member country—at present 103—has a quota. For each country, the quota is related to the size of its economy, its importance in world trade, the amount of its monetary reserves, and so on. The quota provides the basis for many of the country’s rights and duties as a Fund member. Thus, for example, the quota determines the size of each member’s subscription, which must be paid partly in gold and partly in its own currency. The quota also provides the basis for the amount of financial assistance which the member can obtain from the Fund, and for determining its voting power in the decisions of the Fund. In other words, there is weighted voting in the Fund, the members with the largest quotas having the most powerful voice. We are now in the process of increasing the quotas of Fund members from a total of about $16 billion to about $21 billion, and the quota of the United States is about one quarter of that latter figure. I should add that the Fund also has the power to augment its resources by borrowing, and has in fact done so under stand-by arrangements that it has negotiated, totaling the equivalent of $6 billion.
The basic purpose of this vast pool of financial resources is to provide member countries with a source of temporary assistance to meet deficits in their balances of payments. Financial assistance from the Fund takes the form of an exchange transaction, in which a member country draws from the Fund the currency of another country, and pays to the Fund the equivalent amount in its own currency. The total assets of the Fund are thus kept intact, although their composition keeps changing. Furthermore, the assistance is meant to meet relatively short-term difficulties, and there are therefore rules and understandings that repayment will be made, either in keeping with the rate at which the country’s position improves or in any case within three to five years. Repayment takes the form of reversing the exchange transaction which made the assistance available: the member country repays the Fund in gold or some acceptable currency, and the Fund returns to the member the equivalent amount of the member’s currency which it acquired in the earlier transaction. I realize that this sounds somewhat complex, but in a moment I shall give an example of how these operations take place.
Since the Fund is unique, no analogy with familiar institutions can exactly portray its financial transactions. But a loose comparison can be made, in order to illustrate the Fund’s contribution to liquidity, with the relations between a customer and his bank. At any given time an individual may have a credit balance in his bank, or he may have an outstanding borrowing. There is something very similar to this in the Fund. Under established Fund policy, a member may draw virtually on demand against what we in the Fund call the “gold tranche.” The gold tranche, initially equal to the member’s gold subscription—generally 25 per cent of its quota—increases as the Fund uses the member’s currency for the assistance of other members, and decreases if the member itself makes a drawing. Thus, it can be seen that it is not a static facility. What the member draws against its gold tranche is not in fact gold, but the currencies of other members, as I have indicated.
Example of Transaction with Fund
A gold tranche drawing by Mexico can serve as an example of a transaction with the Fund. In the middle of 1961, Mexico’s quota in the Fund was $180 million, and it had no drawing outstanding. One quarter of that amount—$45 million—was the equivalent of Mexico’s gold subscription; the other three quarters represented a subscription payment in Mexican pesos. In August of 1961, Mexico purchased 45 million U.S. dollars from the Fund and paid into the Fund some 560 million Mexican pesos—the equivalent of 45 million dollars at the par value of 8 cents a peso, established with the Fund. However, the Mexican economic situation improved very rapidly, and only a year later Mexico was able to reverse the transaction in accordance with the rules and procedures of the Fund. Mexico repaid the 45 million dollars in gold and six foreign currencies. At the same time, the Fund returned to Mexico the 560 million pesos received earlier, and Mexico’s position in the Fund reverted to the 1961 position. I have not gone into all the technical details surrounding this operation, but I think I have said enough to illustrate how drawings on the Fund operate. This example also illustrates another important aspect of the Fund: its pool of gold and currencies is a revolving pool. Dollars were available to Mexico when needed; after the drawing had been repaid, the currencies received were again available in the Fund to assist other countries. I may add as a footnote that, as the Mexican peso has gained strength in recent years, the Fund has been able to consider the peso available for drawings by other countries, and one such transaction has taken place.
The understanding that “gold tranches” can be drawn against virtually on demand makes them valuable parts of the monetary resources of countries possessing them. An increasing number of countries are including such drawing rights in their official reserve figures, along with the gold and foreign exchange which they own, or present them in conjunction with these assets. The United States is one of these.
But what about the countries which have already drawn against their gold tranches? They have the right to ask for further temporary drawings of foreign currencies held by the Fund, in return for an equal amount of their own currencies. These further drawings involve a situation closer to that of a borrower in our banking analogy. And, as any banker and his customers know, bank loans are subject to certain undertakings on the part of the borrower. The Fund expects any member requesting assistance against its credit tranches to be taking active steps to restore its external payments to a healthy balance, and the larger the amount required, in relation to the member’s quota, the more stringent the criteria which must be satisfied. We call these drawings rights against credit tranches “conditional liquidity,” because of the conditions that must be met in order to exercise the right to draw. Members do not regard this type of liquidity as quite equal to freely available reserves, and do not include it in their international reserve figures, but it would be difficult to exaggerate the importance of these facilities for each member and for the international monetary system as a whole.
Two Kinds of Fund Liquidity
The two kinds of liquidity which the Fund provides are therefore drawing rights in the gold tranche—”unconditional liquidity”—which can be considered on the same level as other types of reserves, and facilities of “conditional liquidity” which are available only (to put it bluntly) where there is good performance or the promise of improved performance. It must not be thought that conditional liquidity is not useful because it is conditional. Members of the Fund know by now the circumstances in which they can use their drawing facilities, and their ability to do so is a source of strength to them. The current general increase in Fund quotas which I have mentioned will therefore add to liquidity, and will help all the Fund’s members feel a little more comfortable about their ability to meet adverse developments in their external payments positions.
This conditional liquidity is also important in another less immediate respect. The direct and immediate purpose of a drawing on the Fund is, of course, to help the country which requests the drawing. But more likely than not, the currencies which it draws will be those of economically strong countries which already have gold tranche positions in the Fund. In such cases, when the Fund agrees to drawings of their currencies, those countries acquire equivalent additions to their gold tranche positions, which may be useful to them at a later date.
This was dramatically illustrated early in 1964 when Italy met balance of payments difficulties. Italy’s gold subscription to the Fund was the equivalent of $67 million, and in 1959 this was the amount of its “unconditional liquidity” in the Fund. But in the following years when the Italian economy was strong, many countries drew lire from the Fund. The effect of each of these drawings was to increase Italy’s unconditional liquidity in the Fund. Thus, when adverse circumstances made it necessary for Italy to obtain Fund assistance early in 1964, it was able to draw, in various currencies, not $67 million, but $225 million, without going beyond the gold tranche.
These are some aspects of the mechanism through which the Fund has, since its beginning, been in the business of supplying its members with additional international reserves. I would ask you to bear this in mind when you hear it suggested that international agreements which lead to the creation of reserves are entirely novel operations. In 1965, Fund operations provided much the largest part of the in crease that took place in world reserves in that year, although this was exceptional.
Creation of Liquidity Outside of the Fund
Although the Fund’s operations have been important in other years as well as 1965, the major additions to the world’s liquidity since the war have come from gold production and the U.S. balance of payments deficit. These have in recent years been supplemented by credit facilities or arrangements outside the Fund which also contribute in no small degree to the sum of international liquidity. A well-known example is the network of standing currency-swap arrangements between the Federal Reserve Bank of New York and a number of central banks in other countries. Other examples include the ad hoc commitments of ten central banks to lend support to sterling.
The importance of the international payments position of the United States in recent years in relation to international liquidity can be explained as follows: If the United States has a deficit in its balance of payments, dollars come into the hands of central banks in other countries. The United States stands ready to convert these dollars into gold when requested by monetary authorities of other countries. In recent years, some of these dollars have been converted into gold, and some have been held as reserves by the recipient countries, depending on their policies and practices. Conversion into gold did not increase the total of international liquidity, since the United States lost the gold gained by the other countries. Increases in official dollar holdings outside the United States, however, provided net additions to the world’s reserves. The sizable deficits which the United States incurred in recent years greatly increased the dollar holdings and thus the total reserves of other monetary authorities.
But obviously there are limits to this method of reserve creation. One limit is set by the conversions into gold to which I have referred, because they reduce U.S. gold reserves. Another limit is set by the fact that, as other countries’ holdings of dollars rise and U.S. gold reserves fall, uncertainties may be caused which could give added stimulus to the desire of official holders of dollars to present them for gold. Moreover, such official dollar holdings might be augmented in consequence of the sale of dollars privately held by residents of other countries to their respective monetary authorities. So, far from adding to world liquidity, an excessive deficit by the United States could even lead to a contraction of liquidity, if it should produce sufficient concern about the dollar to cause a massive move to convert into gold. Simultaneously, the flow of newly mined gold into official monetary reserves could be expected to decrease as a result of heavy private buying.
As you know, there is broad agreement that it is not useful for the world or for the United States that the latter continue to run a balance of payments deficit, and U.S. authorities are committed to eliminating it. However useful these deficits may have been in the past, I would agree with the present consensus which discards the idea that it is the duty of the United States to run a deficit in order that world reserves may grow. The United States does not have a duty to run a deficit. Its duty is to maintain confidence in the soundness of the dollar. And the duty of seeing that world reserves are adequate rests with the world as a whole. This, in essence, is the “liquidity question”: recent concern and discussions have, basically, been stimulated by the question of whether, as the United States brings its payments into balance, there will be enough world liquidity.
The Adequacy of Liquidity
This problem of the adequacy or inadequacy of international liquidity is fundamental. Unfortunately, it is also exceedingly elusive. It is theoretically possible that every country in the world, while pursuing its own national policies, would consistently find itself with balanced international accounts. In such a world, there would be no need for international reserves or liquidity; at most, there would be need for only a small seasonal supply. But in the real world, liquidity is needed, because countries are not always in payments balance, and frequently there are deficits by some countries that have to be financed. Furthermore, even countries which have balanced accounts need the assurance that, when and if a deficit is incurred, facilities will be available to finance that deficit over a period of time which will permit adjustments to be made with minimum threat to policies of economic growth. The larger the volume of world trade and international payments becomes, the larger are the imbalances which may reasonably be expected at any one time. There is therefore widespread agreement on the importance of maintaining an adequate level of liquidity in order to sustain the expansion in world trade and world economic growth. For a country like the United States, such an expansion is beneficial to its economy directly. The secondary consequences are no less important to the world as a whole. Healthy conditions in the industrial countries improve the markets for the raw materials which the developing countries export. Capital and aid for the developing countries are more likely to be forthcoming when economic conditions in the industrial nations are favorable.
But this area of agreement does not resolve the question of what is the adequate level of liquidity. International liquidity may be said to be adequate when it is not so scarce as to force countries to balance their accounts at the expense of stifling national and international growth, but, at the same time, when it is not so plentiful that countries can continue to run deficits without regard to the international consequences of those deficits in stimulating inflationary pressures abroad. It is not surprising that there are differing views on a question of such importance.
The Limits of Need
If there were a system that financed all payments deficits automatically—which would imply a virtually unlimited supply of unconditional liquidity—there would be no pressure on countries to deal effectively with their deficits. It is this that gives point to the emphasis on monetary discipline. There is wide agreement that any liquidity system must be based on a mechanism to bring deficits and surpluses back into balance—although there are differing emphases on this element of the system. Deficit countries should be under some pressure to put their houses in order. Therefore, the supply of liquidity should not be too abundant. Indeed, some countries in Europe are inclined to the view that there is too much rather than too little liquidity at the present time.
On the other hand, balance in international payments can also be restored by the surplus countries taking steps to get rid of their surpluses. But, since payments deficits frequently flow from inadequate or misdirected policies, it is not surprising that surplus countries are inclined to stress the need for deficit countries to take adequate corrective measures. Where deficits do arise from unwise or ineffective policies, there is a good deal to be said for that view. But a surplus country also—especially if it restricts imports, or has a low level of economic activity, or does not encourage the outflow of capital—has a responsibility to share in the adjustment process.
There is, in fact, no statistical test that can be applied to determine beyond question whether any particular quantity of international liquidity is, or is not, sufficient. Some think that we have had too much, others that we have had too little. The problem is complicated in part by a natural tendency for any country to view the question from the viewpoint of its own economic position—to appraise, in other words, the question of world liquidity from its experience with its own national liquidity. It is further complicated by the fact that the normal diversity of economic developments will almost always supply evidence of some kind to support any of several views. On balance, we in the Fund tend to think that the amount of liquidity available in the recent past has probably been about right. If it had been too small, international trade could hardly have grown as it did in recent years, nor is it likely that countries would have achieved the growth in output or have maintained the high levels of employment which they have. If it had been too great, there would almost certainly be greater evidence of inflation in the world economy than there is at present.
But our concern must be for the future. As I have indicated, the elimination of the U.S. deficit will dry up an important source of new international liquidity. In my judgment, the really important issue for the longer run is whether arrangements can be made to ensure that the achievement and maintenance of a balance in the U.S. international accounts will not have harmful effects on the world economy. Without international action to create international reserves, this could well result in the adoption of contractionary or restrictive policies in other countries. This in turn could force the United States to take more severe measures to protect its balance of payments, and the result could be a downward deflationary spiral.
This is the background for the recent liquidity studies of which you have heard. Such studies have continued in the Fund for several years, and we have been in close touch with studies being made by a group of industrial countries—the so-called Group of Ten—and by bodies of the United Nations.
There are many highly technical aspects of these studies which it would not be useful for me to discuss in detail today. I need only say that there are many possible ways in which new international liquidity could be created. Naturally, the position of gold, which is important in the international monetary system, has been carefully considered. The result of these considerations is that there is virtually no support, among the participants in the studies, for trying to solve the problem by a return to the old gold standard or an increase in the price of gold. Rather, attention is turning to the advantages of techniques whereby additions to international liquidity could be periodically made on an agreed international basis. This can be done within the Fund or otherwise. But, as with most international questions, the matter of technique is secondary to obtaining agreement on the basic questions of policy.
We have now progressed to the point where the liquidity problem is better understood, and there is broad agreement on the need to find a satisfactory solution to it. In my view, differences of opinion as to the present adequacy of international liquidity should be no barrier to contingency planning in this complex field, so that, when and if action becomes necessary, the international community will be prepared to act. Among the issues to be determined are the following: (1) What are the world’s needs for reserves and prospects for their growth? (2) If a new reserve-creating mechanism is required, how wide should be the participation in that mechanism? (3) On what basis will the reserves be distributed? and (4) Who will control the decision-making process? These simple questions, however, are not conducive to simple answers. They involve complex technical, financial, economic, and political considerations.
Any scheme for reserve creation must start from the recognition of the legitimate reserve needs of developed and developing countries alike. The process by which decisions on liquidity creation are taken must also, in my opinion, be one that properly reflects the widespread character of the problem. The experience of the Fund, in which all members can exercise their proper influence, shows that this can be arranged in ways which at the same time recognize the special positions of certain countries.
The decisions that we are approaching refer not to the introduction of temporary improvisations but to basic further steps in the continuing evolution of the international monetary system. They will surely have a lasting influence on the future course of world economic developments, and thus on the economic position of each country. It is because of the international nature of the problem that a truly international solution is required. In the period immediately ahead, we shall be working very diligently on this question. I cannot now say when international agreement will be reached, or what the nature of the ultimate plans will be. But it seems clear to me that we are entering on a new era in the field of international monetary cooperation, and that, building on our past experience, we shall be able to provide a more solid foundation for the growth of international trade and the world economy, to the benefit of people in all countries.