Download The International Monetary Fund

The International Monetary
Fund
CHAPTER 16
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Introduction

1941 is a turning point in the history of global financial
arrangements
 British economist John Maynard Keynes wrote a proposal for an
International Clearing Union (ICU)
• Known as the Keynes Plan
• Subsequently taken up by the British Treasury
 US Treasury official Harry Dexter White wrote a proposal for an
International Stabilization Fund (ISF)
• Subsequently embraced wholeheartedly by US Treasury Secretary
•

Henry Morgenthau
Known as the White Plan
Two plans were taken up at the Bretton Woods Conference
in July 1944
 White Plan gained prominence, resulting in creation of the
International Monetary Fund (IMF) and the International Bank for
Reconstruction and Development (the World Bank)
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Monetary History
Throughout 20th century, countries struggled
with various arrangements for the conduct of
international finance
 None proved satisfactory
 In each case, the systems set up by
international economists were overtaken by
events
 Appears international financial system had a

dynamic of its own
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The Gold Standards

Late 19th and early 20th centuries were
characterized by a highly integrated world economy
 Supported from approximately 1870 to 1914 by an
international financial arrangement known as the gold
standard
• Each country defined the value of its currency in terms of gold
• Most countries also held gold as official reserves


Since value of each currency was defined in terms of gold, rates of
exchange among the currencies were fixed
When World War I began in 1914, the countries
involved in that conflict suspended the convertibility
of their currencies into gold
 After the war, unsuccessful attempt to return international
financial system back to gold standard
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Gold-Exchange Standard


In 1922, there was an attempt to rebuild the pre-World War I
gold standard.
New gold standard was different from the pre-war standard
due to then current gold shortage
 Countries that were not important financial centers did not hold gold
reserves but instead held gold-convertible currencies
 For this reason, the new gold standard was known as the goldexchange standard
• Goal was to set major rates at their pre-war levels, especially British
pound


In 1925, it was set to gold at the overvalued, pre-war rate of US$4.86 per
pound
 Caused balance of payments problems and market expectations of
devaluation
At a system-wide level, each major rate was set to gold
 Ignoring the implied rates among the various currencies
 Politics of the day prevailed over economics
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Gold-Exchange Standard

Gold-exchange standard consisted of a set of center
countries tied to gold and a set of periphery countries
holding these center-country currencies as reserves
 By 1930, nearly all the countries of the world had joined
 However system’s design contained a significant incentive problem
for the periphery countries
• Suppose a periphery country expected that the currency it held as
reserves was going to be devalued against gold



Would be in interest of country to sell its reserves before devaluation took
place so as to preserve value of its total reserves
Would put even greater pressure on center currency
As the British pound was set at an overvalued rate there was a run on the
pound (1931)
 Forced Britain to cut pound’s tie to gold, leading to many other
countries following suit
 By 1937, no countries remained on gold-exchange standard
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Gold-Exchange Standard

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Overall standard was not a success
Some international economists (e.g. Eichengreen,
1992) have even seen it as a major contributor to
Great Depression
Throughout 1930s a system of separate currency
areas evolved
Combination of both fixed and floating rates
Lack of international financial coordination helped
contribute to the economic crisis of the decade
At the worst of times, countries engaged in a game
of competitive devaluation
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The Bretton Woods System


During World War II, United States and Britain
began to plan for the post-war economic system
White and Keynes understood the contribution of
previous breakdown in international economic
system to war
 Hoped to avoid same mistake made after World War I
 But were fighting for relative positions of countries they

represented
White largely got his way during 1944 Bretton Woods
Conference
• Conference produced a plan that became known as the Bretton
Woods system
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The Bretton Woods System

Essence of the system was an adjustable gold peg
 US dollar was to be pegged to gold at $35 per ounce
 Other countries of the world were to peg to the US dollar
or directly to gold
• Placed the dollar at the center of the new international financial
system
 Currency pegs were to remain fixed except under
conditions that were termed “fundamental disequilibrium”
• However, concept was never carefully defined

Countries were to make their currencies convertible
to US dollars as soon as possible
 But process did not happen quickly
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The Bretton Woods System

Problems became apparent by end of 1940s
 Growing non-official balance of payments deficits
of United States
• Deficits reflected official reserve transactions in
support of expanding global dollar reserves
 Although Bretton Woods agreements allowed par
values to be defined either in gold or dollar terms
• In practice, the dollar became central measure of
value
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Triffin Dilemma

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Belgian monetary economist Robert Triffen described
problem of expanding dollar reserves in his 1960 book Gold
and the Dollar Crisis
 Problem became known as the Triffin dilemma
Contradiction between requirements of international liquidity
and international confidence
 “Liquidity” refers to the ability to transform assets into currencies
International liquidity required a continual increase in
holdings of dollars as reserve assets
 As dollar holdings of central banks expanded relative to US official
holdings of gold, however, international confidence would suffer
• Triffin argued that US could not back up an ever-expanding supply of
dollars with a relatively constant amount of gold holdings
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Figure 16.1. The Triffin Dilemma
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Triffin Dilemma

In October 1960 London gold market price rose above $35 to $40 an
ounce
 Calls for a change in the gold-dollar parity
 In January 1961, the Kennedy Administration pledged to maintain $35 per
ounce convertibility
• U.S. joined with other European countries and set up a gold pool in which their
central banks would buy and sell gold to support the $35 price in London market

At 1964 annual IMF meeting in Tokyo, representatives began to talk
publicly about potential reforms in international financial system
 Attention was given to the creation of reserve assets alternative to US dollar
and gold

In 1965, the United States Treasury announced that it was ready to join
in international discussions on potential reforms
 Johnson Administration was more flexible than the Kennedy Administration
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Triffin Dilemma

British pound was devalued in November of 1967
 President Johnson issued a statement recommitting the United
States to $35 per ounce gold price


However, in early months of 1968, the rush began
In early 1971, capital began to flow out of dollar assets and
into German mark assets
 German Bundesbank cut its main interest rate to attempt to curb
purchase of marks
 Germany and a few other European countries joined Canada’s
floating dollar rate in 1971
• Thereafter, capital flowed from dollar assets to yen assets

US President Nixon accepted US Treasury Secretary John
Connally’s recommendation to close its “gold window”
 Effort to force other countries to revalue against US dollar
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The Non-System
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At Smithsonian conference in 1971, several
countries revalued their currencies against dollar
 Gold price was raised to $38 per ounce
 Canada maintained its floating rate
In June 1972, a large flow out of US dollars into
European currencies and Japanese yen occurred
 Flows stabilized, but new crisis reappeared in January
1973
• Swiss franc began to float
• In February, there was pressure against German mark and there
were closures of foreign exchange markets in both Europe and
Japan

On February 12th, US announced a second devaluation of the dollar
against gold to $42
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The Non-System
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During 1974 and 1975, countries went through
nearly continuous consultation and disagreement in
a process of accommodating their thinking to
floating rates
In November 1975, proposed amendment to IMF’s
Articles of Agreement restricted allowable
exchange rate arrangements to
 Currencies fixed to anything other than gold
 Cooperative arrangements for managed values among
countries
 Floating
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The Operation of the IMF


IMF is an international financial organization
comprised of 183 member countries
Purposes, as stipulated in its Articles of Agreement,
are to
 Promote international monetary cooperation
 Facilitate the expansion of international trade
 Promote exchange stability and a multilateral system of


payments
Make temporary financial resources available to
members under “adequate safeguards”
Reduce the duration and degree of international
payments imbalances
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The Operation of the IMF

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Major decision-making body is its Board of Governors
 Each member appoints a Governor and an Alternate Governor
Day-to-day business rests in the hands of Executive Board
 Composed of 22 Executive Directors plus Managing Director
• Six of the 22 Executive Directors are appointed by largest IMF quota
•
•
holders
Remainder elected by groups of member countries not entitled to
appoint Executive Directors
Managing Director is appointed by Executive Board and is traditionally
European (often French)

Chairs Executive Board and conducts IMF’s business
• Currently three Deputy Managing Directors
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Table 16.1. Administrative
Structure of the IMF
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The Operation of the IMF

Most important feature of IMF is its quota system
 Determine both the amount members can borrow from
the IMF and their relative voting power
• Higher a member’s quota, the more it can borrow and the greater
its voting power

Members’ quotas are their subscriptions to the IMF
 Based on their relative sizes in the world economy
 Pays one fourth of its quota in widely-accepted reserve
currencies (US dollar, British pound, euro, or yen) or in
Special Drawing Rights
 Pays remaining three-quarters of quota in its own
national currency
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The Operation of the IMF

The IMF engages in four areas of activity
 Economic surveillance or monitoring
 Dispensing of policy advice
 Lending
• Perhaps most important
 Technical assistance
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Tranche

If an IFM member faces balance of payments
difficulties
 Can automatically borrow one fourth of its quota in the

form of a reserve tranche
When the IMF lends to a member country, what actually
happens is domestic country purchases international
reserves from the IMF using its own domestic currency
reserves
• Member country is then obliged to repay IMF by repurchasing its
own domestic currency reserves with international reserve assets
• IMF lending is known as a “purchase-repurchase” arrangement
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Tranche

Credit tranches
 Originally, each were equal to ¼ of the members’ quotas
 In the late 1970s, credit tranches were increased to


37.5% of quota
First credit tranche is more or less automatic
Second through fourth credit tranches require that the
member adopt policies (conditionality) that will solve
balance of payments problem at hand
• Effectively limits a member country’s credit to 150 percent of its
quota


As IMF evolved, it created a number of special credit facilities that
extend potential credit beyond 150% level
Drawings on IMF by its members have to be repaid
 Five-year limit was established
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Figure 16.2. IMF Lending
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Table 16.2. Special Credit
Facilities
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Ideal Role of the Fund

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Development of a country requires an inflow of
private foreign savings
Inflow would cover a current account deficit often
caused by import of capital goods
Occasionally, this private foreign savings
disappears
 Resulting in a balance of payments crisis
• In these instances IMF steps in


Member draws on its reserve and credit tranches
Repaying credit tranche debts in five years time
 Thus, IMF offers short-term credit, stepping in to replace private
foreign savings on those rare occasions
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History of IMF Operations—
1950s-1960s
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In its initial years, the IMF was nearly irrelevant
However, Suez crisis of 1956 forced Britain to draw on its
reserve and first credit tranches
Japan drew on its reserve tranche in 1957
Between late 1956 through 1958 IMF was involved in
policies that lead to the convertibility of both British pound
and French franc
Concerned about the United States’ ability to defend the
dollar and other major industrialized countries’ abilities to
maintain their parities
 IMF introduced the General Arrangements to Borrow (GAB) in
October 1962
• Involved the central banks of ten countries setting aside a $6 billion pool
to maintain stability of Bretton Woods system

Countries involved became known as Group of Ten or G-10 and comprised a
rich countries club
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History of IMF Operations—Mid-toLate 1960s

By 1965, US faced two unappealing options
 Reduce world supply of dollars to enhance
international confidence by reducing international
liquidity
 Expand world supply of dollars to enhance
international liquidity by reducing international
confidence
• But where was the world to turn for a reserve asset?

1964 and 1968 annual meetings of IMF resulted in creation
of a new reserve asset to supplement both gold and dollar
 Known as a special drawing right or SDR
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History of IMF Operations—Special
Drawing Rights, 1970s
Came into being in July 1969
 In 1971, when United States broke golddollar link, the SDR was redefined in terms of
a basket of five currencies—dollar, pound,
mark, yen, and franc
 Allocated in proportion to members’ quotas
 Never played the important role envisaged
for them
 Perhaps best seen as one of many attempts to

resolve Triffin dilemma
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History of IMF Operations, 1970s


Oil price increases of 1973-1974 caused substantial balance
of payments difficulties for many countries of the world
In June 1974, the IMF established an oil facility to assist
these countries
 Acted as an intermediary, borrowing funds from oil producing
countries and lending them to oil importing countries


A second oil facility was established in 1975
 Slightly more strict than the first
During this time, a bias towards private-sector lending
helped to prevent sufficient increases in IMF quotas
 Given the limits of the quota system, IMF was becoming more of a
financial intermediary—less of an international cooperative credit
arrangement
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History of IMF Operations, 1970s1980s

In 1976, IMF began to sound warnings about
sustainability of developing-country borrowing from
commercial banking system
 Banking system reacted with hostility to these warnings
• Argued Fund had no place interfering with private transactions

The 1980s began with a significant increase in real
interest rates and a significant decline in non-oil
commodity prices
 Increased cost of borrowing and reduced export
revenues
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History of IMF Operations—1980s

In 1982, IMF calculated that US banking system
outstanding loans to Latin America represented
approximately 100% of total bank capital
 In August 1982 Mexico announced it would stop servicing


its foreign currency debt
At the end of the month, Mexican government
nationalized its banking system
1982 also found debt crises beginning in Argentina
and Brazil
 Argentina: Overvalued exchange rate, used as a
“nominal anchor” to curb inflationary expenditures
 Brazil: Rates of devaluation did not keep up with rates of
inflation, causing an overvalued real exchange rate
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History of IMF Operations, 1980s

International commercial banks began to withdraw credit
from many of the developing countries of the world
 Debt crisis became global
 Within a few years of outbreak phenomenon of net capital outflows
appeared
• Involved capital account payments of debtor countries exceeding capital
account receipts

By second half of 1980s, some debt was trading at
discounts in secondary markets
 In 1989, US Treasury Secretary Nicholas Brady proposed a plan in
which IMF and World Bank lending could be used by developing
countries to buy back discounted debt
• Amounted to partial and long-needed debt forgiveness, were approved
by the IMF and became known as the Brady Plan
• Also allowed for extending time periods of debt and provided for new
lending
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History of IMF Operations, 1990s

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Starting in the 1990s, private, non-bank capital
began to flow to developing countries in the form of
both direct and portfolio investment
Number of highly-indebted countries began to show
increasing unpaid IMF obligations
In November 1992, a Third Amendment to the
Articles of Agreement allowed for suspension of
voting rights in the face of large, unpaid obligations
Mexico underwent a second crisis in late 1994 and
early 1995
 IMF was unable to respond effectively—US Treasury
assembled a loan package
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History of IMF Operations, 1990s

In 1997-1998, crises struck a number of Asian countries—
most notably Thailand, Indonesia, South Korea, and
Malaysia and also Russia
 Resulted in sharp depreciations of the currencies
 In the cases of Thailand, Indonesia, and South Korea, IMF played
substantial and controversial roles in addressing crises
• Loan packages were designed with accompanying conditionality
•
•
agreements
Supplementary Reserve Facility was introduced to provide large
volumes of high-interest, short-term loans to selected Asian countries
In October and November 1998, IMF put together a package to support
Brazilian currency, the real


Attempt to prevent Asian and Russian crises from spreading to Latin
America
Still, Brazil was forced to devalue the real in January 1999
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History of IMF Operations, 1990s

Recent years have witnessed important changes at
the IMF
 In 1997 General Agreement to Borrow was
supplemented by the New Arrangement to Borrow
• Involves 25 IMF members agreeing to lend up to US$46 billion to
IMF in instances where quotas prove to be insufficient
 In 1999, a new lending facility was added
• Poverty Reduction and Growth Facility was created to replace
the 1987 Enhanced Structural Adjustment Facility

Represents beginning of an attempt to integrate poverty reduction
consideration into macroeconomic policy formation of IMF
 In 1999, quotas were increased by 45% to a total of
US$283 billion
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An Assessment

When IMF opened for business in 1947, its quotas were
approximately 13% of world imports
 Quotas failed to address the needs of the post-war European
economy



Since 1947, IMF quotas as a percent of world imports have
fallen to approximately 4%
A number of observers have questioned whether IMF has
succeeded in addressing global liquidity
John Maynard Keynes envisioned a global central bank with
an international currency
 This central bank would be responsible for regulating expansion of
international liquidity
• In light of concerns over liquidity, some observers have called for a
return to the global central bank idea
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An Assessment

Keynes’s original Bretton Woods proposal also included adjustment
requirements being distributed among deficit and surplus countries
 However adjustment is solely the responsibility of deficit countries
 Deficit countries are required to adjust no matter what the source of the


deficit
Dell (1983) argues that requisite adjustments are too severe and violate
purposes of IMF
Reform of existing IMF framework could involve
 Reconstituting it more along the lines of a world central bank
• Reaffirming role of the SDR as a reserve asset
• Giving IMF independent responsibility for regulating world liquidity through
expanded quotas and SDR management
 Redesigning adjustment mechanisms to spread responsibility over deficit
and surplus countries

Changes are radical and would require a complete redrafting of the
IMF’s Articles of Agreement
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