- Joshua Greene, and Peter Isard
- Published Date:
- March 1991
The meaning of “convertibility” has changed over time as the international monetary system has evolved (Haberler (1954). Before the 1930s, convertibility was generally defined as the right to convert a currency freely into gold at a fixed exchange rate. Today, a currency can be regarded as “fully convertible” when any holder is free to convert it at market exchange rates—fixed or flexible—into one of the major international reserve currencies.
Discussions of convertibility have been clouded by two types of semantic problems. Confusion sometimes arises from failure to recognize that currency convertibility implies the absence of restrictions on foreign exchange transactions but not necessarily on international trade or capital flows. Problems may also arise from confusing different forms of limited currency convertibility. Thus, it is worth noting how the right to convert domestic into foreign currency is commonly restricted.
Some restrictions on convertibility are based on the purpose for which currency conversion is desired. Such restrictions often distinguish between conversions associated with current account transactions and conversions for other purposes. Indeed, this distinction is embodied in the Fund’s Articles of Agreement. The postwar international monetary arrangements that emerged from the Bretton Woods Conference required members of the IMF gradually to restore current account convertibility while authorizing them to restrict convertibility for capital transactions (Gold (1971), p. 4; Kindleberger (1984), p. 428; and Article VI, Section 3). The obligations of convertibility that IMF members are required to undertake are defined by Article VIII, Sections 2, 3, and 4. Under Section 2(a), members may not, without the approval of the IMF, impose restrictions on the making of payments and transfers for current international transactions,1 subject to the transitional provisions of Article XIV, which allow countries to maintain those restrictions on current payments and transfers that were in effect when they joined the Fund. Under Section 3, members may not engage in discriminatory currency arrangements or in multiple currency practices that are not authorized under the Articles or approved by the Fund.2
Sections 2(a) and 3 prohibit restrictions on (or discriminatory practices governing) the availability or use of foreign exchange as such. They do not prevent members from imposing restrictions on merchandise trade:
Thus, although a measure formulated as a quantitative limitation on imports will have the indirect effect of limiting payments, it is not for that reason a restriction on payments within the meaning of the provision…. Restrictions on trade do not become restrictions on payments within the meaning of Article VIII, Section 2(a), because they are imposed for balance of payments reasons (Gold (1971), pp. 9–10).
Nor do the Articles exclude surrender requirements that compel residents to turn over accruals of foreign exchange to their monetary authorities (Gold (1971), pp. 7–8).
Other restrictions on convertibility are based on the origin of the currency balances. Such restrictions have distinguished between “old” and “new” balances, meaning those accumulated before and after a particular date. For example, when the U.K. authorities briefly restored sterling to convertibility in July 1947, their intention was to limit convertibility to newly acquired sterling balances. Thus, the United Kingdom attempted (albeit unsuccessfully) to make arrangements so that, except for agreed amounts, outstanding balances of “old” sterling would remain inconvertible (Hinshaw (1958), p. 10).
Still other restrictions on convertibility are based on who holds the currency balances, or on where the balances are held. These restrictions generally distinguish between residents and nonresidents, and sometimes among different classes of residents (such as the monetary authorities, households, and enterprises). Discussions of such restrictions often refer to “internal convertibility,” and different meanings have been attached to this term.
As defined in this paper, internal convertibility means that residents are free to maintain domestic holdings of certain assets (for example, bank deposits) denominated in foreign currencies, and thus to convert domestic currency internally into foreign currency assets.3 Such freedom to hold and intermediate foreign exchange domestically, however, is not tantamount to permission to make payments abroad or to hold assets located in foreign countries. Nor does it necessarily permit residents to hold any financial assets, other than foreign currencies, that represent claims against nonresidents.4 Countries concerned with protecting their official reserve holdings have sometimes met their international obligations by making their currencies convertible for nonresidents while simultaneously prohibiting private residents from holding international reserve assets. Before August 1971, for example, the United States stood ready to buy and sell gold freely for the settlement of international transactions,5 thus providing external convertibility of dollars into gold. However, it did not permit private U.S. residents to hold gold, thereby prohibiting internal convertibility into gold. In contrast, in countries whose residents already have significant holdings of foreign currencies, internal convertibility could serve to channel foreign exchange resources into the banking system.
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As defined in Article XXX(d), current transactions can include certain transactions of a capital nature—in particular, “payments of moderate amount for amortization of loans or for depreciation of direct investments.”
Section 4 requires, subject to a list of exceptions, that: “Each member shall buy balances of its currency held by another member if the latter, in requesting the purchase, represents: (i) that the balances to be bought have been recently acquired as a result of current transactions; or (ii) that their conversion is needed for making payments for current transactions.”
This appears to be a relatively common usage of the term today. However, internal convertibility has sometimes been used to refer to the right to exchange money for goods, particularly in countries such as the U.S.S.R., where there are restrictions on converting certain forms of money into goods. The term has also sometimes been used synonymously with convertibility for current account transactions, particularly in Czechoslovakia.
Although, in principle, a country can establish internal convertibility separately from convertibility for international transactions, once its residents are allowed to purchase and hold foreign currency without limit, the country may have great difficulty in preventing currency conversions associated with payments for international transactions.
By so doing, the United States fulfilled its exchange rate obligations in (the then prevailing version of) Article IV, Section 4(b) of the IMF’s Articles of Agreement.