3

The History of the SDR

The opening session of the seminar provided an opportunity to review both the original rationale for creating the SDR in the 1960s and the ways in which the world economy and the SDR have evolved since that time. Robert Solomon presented the main paper for that review. Following his presentation, Max Corden, Adolfo Diz, and Rudolf Rhomberg each examined the implications of the ways in which the system and the asset had evolved.

Creation and Evolution of the SDR Robert Solomon This paper is intended to provide historical perspective on special drawing rights. Although first created in 1969, their origin can be traced to the way the Bretton Woods system operated and the economic and political views of policymakers about that system. Attitudes toward SDRs after 1969 were affected by the change in the international mone­ tary system following the so-called breakdown of Bretton Woods and by the marked increase in the mobility of private capital. A look back at the history gives rise to two general observations. First, a major shortcoming at Bretton Woods was the failure to antici­ pate the enormous increase in capital mobility that has occurred. Sec­ ond, the SDR was, in the context of the 1960s, a basic reform and not merely "the last and most controversial of the gadgets devised to deal with the weakness of the U.S. payments position," as Harold James characterizes it in his monumental history commissioned for the Fund's fiftieth anniversary Games, 1996, p. 174).

The Bretton Woods System Although the Bretton Woods agreement marked a major step for­ ward in international cooperation-especially compared with the 1930s, to which it was in part a reaction-it failed to provide a system- 25 26 The History of the SDR atic means for increasing the reserves of IMF member countries in a world of growing trade and output. The only explicit provision along those lines in the Articles of Agreement of the International Monetary Fund was the possibility of a "uniform change in par values," in other words, a general increase in the official price of gold. Given the nature of the system, with its dependence on the dollar as the main reserve currency convertible into gold for monetary authorities, action of that sort was ruled out. It is not clear how the founding fathers at Bretton Woods expected countries' reserves to grow. Presumably they believed that newly mined gold would continue to flow into official reserves to the extent that it was not used for industrial and artistic purposes. Whether they also anticipated a net increase over time in dollar reserves is uncertain. In any event, that is what happened. In the early postwar years, there was widespread concern about a "dollar shortage" as war­ devastated countries sought to buy goods from the United States. The Marshall Plan and private U.S. capital outflows made it possible for these needs to be met. In fact, capital outflows from the United States, including Marshall Plan grants, exceeded the U.S. current account sur­ plus. As measured by what later came to be called the "official settle­ ments basis" (sales of gold by the United States plus increases in its li­ abilities to foreign monetary authorities}, the United States moved into balance of payments deficit in 1950. Of course, the payments position was not characterized that way at the time. Rather, it was referred to, with approval, as a "net transfer of gold and dollars" to the rest of the world, where many countries were short of reserves, while the United States had 60 percent of the world's gold reserves at the end of World War II. In the process, the dollar became the principal reserve currency. The official settlements deficit showed up first as an increase in the dollar reserves of other countries, especially those in Europe. Soon some of those monetary authorities began to convert a portion of their net dollar receipts into gold at the U.S. Treasury, and that too was regarded as a welcome development in the early 1950s. On the basis of data available in 1969, total reserves of all countries increased, on average from 1951 to 1964, by $1.5 billion a year, of which gold accounted for $0.5 billion and dollar holdings for $0.9 billion. As will become relevant when we consider the decision in 1969 to create SDRs, over the next four years, 1964--68, gold reserves decreased by $0.5 billion a year and official dollar holdings rose only $200 million a year (International Monetary Fund, 1970, p. 443). Robert Solomon 27

Proposals for Reform As noted, in the early postwar years well into the 1950s, the U.S. bal­ ance of payments "deficits" were welcomed on both sides of the At­ lantic and Pacific, since they alleviated the dollar shortage and helped European countries and Japan to rebuild their reserves as one aspect of restoring their economies after the depredations of World War II. As the decade of the 1950s moved on, the dollar shortage ended and the European countries made their currencies convertible. Self-confidence returned and attitudes began to change. Some resentment over U.S. prominence or hegemony developed. More specifically, the special role of the dollar came to be a matter of concern, if not resentment, in some quarters. By the late 1950s, the dollar shortage was replaced by what some observers called a "dollar glut." Two reactions to these changed circumstances are noteworthy. Robert Triffin formulated his famous "dilemma": on the one hand, the world was dependent on U.S. balance of payments deficits for growth of reserves; if the U.S. deficits were eliminated, the rest of the world would lose a source of new reserves, which could depress eco­ nomic activity. On the other hand, if the deficits continued, the increase in U.S. liabilities to the rest of the world relative to U.S. gold reserves could lead to instability as official holders of dollars became concerned that the relative value of their reserve assets might decrease in relation to the value of gold. The way to resolve this dilemma, according to Triffin, was to have the IMF meet the "legitimate liquidity require­ ments of an expanding world economy" (Triffin, 1960). Actually, as Triffin acknowledged, his proposed solution to the dilemma was similar to Keynes's proposal for an international clearing union with a new reserve asset, the "bancor." The other reaction to the way the system was working was exempli­ fied, at the extreme, by General de Gaulle, who resented the "exorbitant privilege" the United States enjoyed as the issuer of the world's main reserve currency. Presumably under the influence of Jacques Rueff, de Gaulle favored a reform of the international monetary system that would end the special role of the United States. In particular, he ob­ jected to the ability of the United States, which France and other coun­ tries did not have, to incur balance of payments deficits-including di­ rect investment by U.S. corporations in France and elsewhere-and to finance those deficits by issuing its own currency to the rest of the world (Solomon, 1992, pp. 126-30). In his famous press conference of February 1965, he called for a return to the gold standard. And there- 28 The History of the SDR after France converted its dollar accumulations into gold at the U.S. Treasury. De Gaulle's view on the role of the dollar was just one aspect of his general position regarding the primacy of the United States in world affairs and of his aim of creating an independent Europe led by France. This position was not "anti-American." It reflected de Gaulle's belief that the United States was too powerful and, of course, his concept of France's role in the world. Although the officials of other European countries did not support these French views, the belief that the United States had a dispropor­ tionate role in the system was shared by some of them. They would have preferred a more symmetrical system. Another belief in Europe was that by incurring an overall deficit in its balance of payments­ much of the counterpart of which showed up in Europe as capital in­ flow-the United States was "exporting inflation." Those who held this view were also attracted by the idea of reducing the reserve-currency role of the dollar. On the U.S. side too there was concern about the balance of pay­ ments deficit. According to Arthur Schlesinger, President-elect Kennedy told his advisors that his two greatest fears were nuclear war and the balance of payments deficit (Schlesinger, 1965, p. 130)! Beginning in the early 1960s, a series of measures were initiated by the U.S. Government aimed at curbing outflows of private capital and dealing with excessive accumulations of dollars by monetary author­ ities abroad. A swap network (reciprocal central bank credit facilities) was established under the leadership of the Federal Reserve. The General Arrangements to Borrow (GAB) were created as a means of supplementing the resources of the Fund so that it could meet a potential large drawing by the United States. The GAB provided the basis for the Group of Ten. To deal with the Triffin dilemma, Robert Roosa, Under Secretary of the Treasury in the early 1960s, proposed that the United States should purchase foreign currencies when its balance of payments was in bal­ ance or surplus, thereby making it possible for other countries to con­ tinue to accumulate dollar reserves. The United States also proposed a study in the Group of Ten of ways to ensure the adequacy of interna­ tional liquidity. President Kennedy, in a balance of payments message in July 1963, endorsed the idea of a study, stating that "one of the rea­ sons that new sources of liquidity may well be needed is that, as we close our payments gap, we will cut down our provision of dollars to the rest of the world." That was an explicit recognition of the Triffin dilemma, and the language was probably supplied by the Council of Economic Advisers, which was more enthusiastic about international monetary reform than was the Treasury. Robert Solomon 29

The study carried out by the deputies (senior treasury and central bank officials) of the Group of Ten in 1963-64 was the first systematic examination of the international monetary system by governments since Bretton Woods. The principal antagonists were Andre de Lattre, representing the French Finance Ministry, and U.S. Treasury Under Secretary Robert Roosa, who chaired the meetings. These two pre­ sented their countries' opposing viewpoints effectively and with great civility. During these discussions, the French officials put forward a proposal for a new reserve asset, a "collective reserve unit" (CRU) that would be linked to gold and would be created and used outside the IMF by the member countries of the Group of Ten:

In the deputies' debates, the French representatives stressed the disor­ derly way in which reserves were created by deficits of reserve cen­ ters, the potential instability of the system, the lack of "discipline" on reserve centers, and the inflationary effects of all this. This led them to distinguish between "glad" and "not so glad" holders of reserve cur­ rencies, the latter being countries that refrained from converting "un­ wanted" dollars into gold in a spirit of cooperation with the United States and in fear of creating an international crisis. Finally, until reserve currencies could be phased out and replaced by a collective reserve unit, it was desirable to introduce a form of "collective dis­ cipline" under which the other members of the Group of Ten would agree on the extent to which they would be willing to finance additional American deficits (Solomon, 1982, pp. 66-7).

Parenthetically, it is useful to recall that at the time, and in all but three years from 1946 through 1970, the United States earned a surplus in the current account of its balance of payments. The deficit that was being criticized was the result of an excess of capital outflows and grants over the current account surplus. In the Group of Ten study, the U.S. deputies defended the existing system but also agreed, in the end, that the U.S. deficit was shrinking and that neither gold production nor another currency could meet the need for growth in world reserves. That provided a basis for the con­ clusion by the Finance Ministers and Central Bank Governors of the Group of Ten (hereafter referred to as the ministers), in the summer of 1964, that "the need may in time be felt for some additional kind of in­ ternational reserve asset" and for the establishment of a Study Group on the Creation of Reserve Assets (Group of Ten, 1964, p. 8). Meanwhile both the IMF and a group of private economists became active in analyzing and making proposals concerning international reserves. The staff of the Fund produced a study of international liquidity, which assumed that the "payments deficits of the United States will not 30 The History of the SDR contribute to the formation of reserves in future on the same scale as in recent years" (p. 31). It went on to describe new approaches to the creation of reserves through the Fund.1 Three academic economists (Fritz Machlup, William Fellner, and Robert Triffin) organized a group of 32 of their colleagues from 11 countries-which came to be known as the Bellagio Group, since some of their meetings were held there, at the Villa Serbelloni-to study the international monetary system. Under the chairmanship of Fritz Machlup, the Group of 32 produced an analysis of the system under three headings: adjustment, liquidity, and confidence. Although they did not reach unanimous policy recommendations, many of them agreed on the need to reform and internationalize the system of reserve creation (Princeton University, 1964).

Study and Negotiations With reform in the air, the Group of Ten's Study Group on the Cre­ ation of Reserve Assets, under the chairmanship of Rinaldo Ossola of the Bank of Italy, began its series of frequent meetings in May 1964. Its job was not to make recommendations but to examine various pro­ posals for the creation of reserve assets and "their implications for the functioning of the present international monetary system." The basic disagreements among the Group of Ten nations involved (1) whether a scheme to create new reserves should be confined to a limited group of countries, presumably the Group of Ten, or should be worldwide; (2) whether the reserves should be created inside or outside the IMF; (3) whether the new reserve should be linked to gold and what form it should take; and (4) the rules for decision making about reserve creation. Those who favored a limited group-reserve creation by the Group of Ten outside the IMF-feared that if developing countries were in­ cluded they would immediately spend any new reserves. Another con­ cern was that the United States and the developing countries would "gang up" to force through excessive amounts of reserve creation. The French CRU proposal was thoroughly analyzed. It became evi­ dent that it was equivalent to raising the price of gold, since CRUs would be issued to countries in proportion to their gold holdings and would be used in a fixed ratio to gold. That proposal garnered little support.

1 See International Monetary Fund, Annual Report, 1964 (Washington: International Monetary Fund, 1964), pp. 23-39. Robert Solomon 31

The other principal set of proposals, put forward by the United States, built on the existing automatic drawing rights in the IMF. Coun­ tries acquired automatic drawing rights when they subscribed to IMF quota increases and when their currencies were drawn by other mem­ bers (known then as "gold tranches" or "super gold tranches"). It was possible to extend this procedure to increase automatic drawing rights by simple decision or by agreeing to increase quotas without requiring gold payments to the Fund. When a country received additional draw­ ing rights under proposals of this type, it would extend an equal line of credit to the Fund, thus providing the IMF with the currencies needed when the new drawing rights were used. The United States preferred the concept of a drawing right to a unit out of concern that a unit would be too obvious a competitor for the dollar. Although the Ossola Group did not put forward specific proposals, its work had two effects. It clarified the analytics involved in the process of deliberate reserve creation and it provided some momentum for the implementation of that process. While this was going on, the U.S. international payments position improved. The official settlements deficit, which had been about $2Y2 billion a year in 1962-63 at the time of the Group of Ten deputies study, declined to about $1Y2 billion in 1963-64 as the current account surplus increased. With the United States adding less to the reserves of the rest of the world, interest in deliberate reserve creation was stimulated. That coincided with a change of guard at the U.S. Treasury as Henry Fowler took over as Secretary from Douglas Dillon. Fowler surprised many people with a speech in early July 1965 calling for an interna­ tional conference aimed at improving international monetary arrange­ ments. Although that proposal did not take hold, the Ministers of the Group of Ten made two important decisions: (1) they authorized the deputies to undertake "contingency planning" to "ensure that the future reserve needs of the world are adequately met"; and (2) they sug­ gested, in effect, that the Executive Directors of the Fund and the Group of Ten deputies should find a way to reach a consensus "with a view to preparing for the final enactment of any new arrangements ...." That series of the Group of Ten deputies meetings in 1965-66, under the chairmanship of Otmar Emminger of the Deutsche Bundesbank, had several highlights. The U.S. representatives, now backed by a high­ level advisory group appointed by President Johnson and chaired by Douglas Dillon, put forward a "dual approach," designed to please both the Europeans, who favored a limited group, and the rest of the world that was excluded from the limited group. One scheme was for automatic drawing rights in the IMF, based on a paper I had circulated 32 The History of the SDR in the U.S. Government. The other scheme involved the creation of a "unit" by a limited group of countries, some of which would be made available to the IMF for the benefit of other countries. This awkward dual proposal was hardly likely to attract support. Emminger put on the table a proposal, representing the position of his country and some others but not including France, for the creation of a unit to be created and used by a limited group in a one-to-one ratio with gold. It also called for an upper limit on dollar holdings of the lim­ ited group and for unanimity in decision making. Oddly, this proposal, which was clearly designed to incorporate earlier French ideas, did not succeed in doing that. By early 1966, after a meeting of General de Gaulle with his senior monetary officials, the French position was that there was no need for any plan for reserve creation, in light of the so­ called massive disequilibrium in the balance of payments of both the United States and the United Kingdom. It was widely noted, with some irony, that France and the United States had switched positions. The French, originally seeking a substi­ tute for the dollar with the CRU proposal, were now reluctant to proceed with plans for reserve creation. The Americans, formerly reluctant, were now pressing for contingency planning for a new reserve asset, given the slowdown in the growth of world reserves. This switch was explained by the fact that the contingency planning for a new reserve asset looked, by 1966, more like an effort to find a substitute for gold than for the dol­ lar. World gold reserves increased by a tiny $240 million in 1965 and ac­ tually decreased in 1966. U.S. official liabilities were virtually unchanged in 1965 and decreased by more than $600 million in 1966. In these circumstances, the French officials found themselves in­ creasingly isolated. While these developments were occurring in the Group of Ten, the IMF, in March 1966, put forward two alternative proposals-one based on drawing rights and the other on units-both for all Fund members. The drawing rights proposal was almost identical with that proposed by the U.S. side. Pierre-Paul Schweitzer, as IMF Managing Director, publicized the IMF proposals in a series of speeches and spoke out against a limited group as a "separate but equal approach." (For those with short memories, the term separate but equal had been used in the United States in the civil rights debate.) More than once, Schweitzer in­ sisted publicly that "international liquidity is the business of the Fund." The report of the deputies, in July 1966, did not resolve these various issues, although a number of deputies expressed a preference for a uni­ versal approach. It did, with the dissent of "one member," call for a contingency plan for reserve creation. At the subsequent ministerial meeting at The Hague, there was agreement that deliberately created Robert Solomon 33 reserve assets, as and when needed, should be distributed to all mem­ bers of the Fund. That was a breakthrough. It could be attributed to pressures from developing countries, to the difficulty of defining a "limited group," and to the influence of Managing Director Schweitzer (de Vries, 1976, Vol. I, pp. 99-100). French Finance Minister Michel Debre made passionate interventions presenting what was then the French position, stressing that the main problem was the reserve currency role of the dollar and the U.S. payments deficit. He received no support and the deputies were instructed to proceed with joint meetings with the Executive Directors.

Contingency Planning and Agreement Four joint meetings were held in 1966-67, two chaired by Emminger and two by Schweitzer. Given the resentment that had built up in coun­ tries outside the limited group, the meetings turned out to be surpris­ ingly cordial. Although progress was made, in the sense that there was general acceptance of the proposition that some form of new asset would emerge, many problems remained unresolved. Between the second and third joint meetings, the Finance Ministers of the European Economic Community (EEC-then the Six) met in Munich in an effort to unify their positions; in particular, the French and German Governments clearly wished to come to a common posi­ tion after the differences that had been evident in earlier meetings in which France was isolated. The Munich meeting produced a number of qualifications concerning any future agreement for reserve creation. It did recognize that there could be a need to supplement existing re­ serves in the future and implicitly assumed that such reserve creation would be through the IMF. A decision to create should require an 85 percent vote (which would give the EEC a veto). Furthermore, auto­ matic drawing rights used over a lengthy period should require a re­ payment obligation-that is, they should be "reconstituted" by the drawing country. The EEC insistence on a veto on the creation of new reserves was reminiscent of the U.S. demand at Bretton Woods for a voting majority of 80 percent on the question of increasing IMF quotas. Just as the United States expected to be the principal surplus country in the early years after World War II, the EEC regarded itself as the main area in balance of payments surplus in the 1960s. These EEC proposals would be debated, but what emerged in the next two joint meetings was a rough outline or sketch of a reserve cre­ ation scheme based on drawing rights. They were initially called "re- 34 The History of the SDR serve drawing rights" but since the French representatives objected to the word reserve, it was bracketed. The French suggested that "re­ serve" be replaced by "special." In any event, there was broad agree­ ment that a proposal could be presented to the IMF Annual Meeting scheduled for Rio de Janeiro in September 1967. Before that, there were two dramatic Group of Ten ministerial meet­ ings in London in July and August 1967 at which the still unresolved is­ sues regarding voting and reconstitution were taken up. Finance Minis­ ter Debre, insisting that what was being proposed was a form of credit, wanted agreement on some form of repayment. "It seems clear that Debre was under instruction to achieve two incompatible goals: to pre­ vent the isolation of France ... and to prevent agreement on a true re­ serve asset that the world might regard as a substitute for gold" (Solomon, 1982, p. 142). Secretary Fowler, in tum, insisted that what was needed was an asset that central banks would treat as a reserve. He also expressed opposition to the EEC proposal for an 85 percent vote. At the August meeting, there were concessions on both sides and agreement as well. The European ministers accepted a figure of 70 per­ cent for average use of drawing rights over a six-year period; in other words, countries were expected to hold rather than use 30 percent of the drawing rights allocated to them. (The reconstitution provision was eliminated in 1981.) The United States conceded on the 85 percent voting majority. Minister Debre continued to insist that what was agreed was a credit facility. Emminger, responding to questions from the press and others on whether the new reserve would be a unit or a form of credit, charac­ terized the SDR as being like a zebra: it could be regarded as a black an­ imal with white stripes or a white animal with black stripes. For what it is worth, I reported to the Federal Open Market Committee that "the new reserve facility was a drawing right in name and a unit in sub­ stance. It differed from existing IMF drawing rights in that it was di­ rectly transferable, whereas one used existing drawing rights in the Fund by purchasing other currencies with one's own currency. In the case of the SDR, one transferred it just as one transferred gold­ in exchange for the currency of the country to which it was transferred (Solomon, 1982, p. 142)." It became clear that the same judgment was being arrived at in Paris. The outline prepared in the Fund was approved at Rio. The IMF lawyers then had to put together an amendment to the Articles for submission to its members. Before that process could be completed, major events occurred in the international monetary system that affected the potential role of theSDR. Robert Solomon 35

The United Kingdom had been struggling with a balance of pay­ ments deficit from 1963, and in 1964 the pound weakened and reserves were used to support it. The Government of Harold Wilson tried for more than three years to hold the exchange rate amid a series of crises. Finally, in November 1967, the pound was devalued from $2.80 to $2.40. That devaluation led to speculation that the dollar would also have to depreciate. Speculation on an increase in the dollar price of gold was the result not only of the sterling depreciation but also of the economic and political effects of the U.S. involvement in Vietnam, which was going badly. The gold pool-an arrangement established in the early 1960s among the United States and seven other countries to sell or buy gold in the market to keep the market price close to the of­ ficial price of $35 an ounce--sold $3 billion from the time of the ster­ ling devaluation in November 1967 to mid-March 1968, when the Lon­ don gold market was closed. In mid-March 1968 a meeting of gold pool members (the central bank governors of Belgium, Germany, Italy, the Netherlands, Switzerland, the United Kingdom, and the United States; France had withdrawn) was held at the Federal Reserve Board in Washington, at which the two-tier system was agreed. The central bankers decided to stop selling gold into the market, while maintain­ ing the official price of $35 among themselves. Their communique stated that "as the existing stock of monetary gold is sufficient in view of the prospective establishment of the facility for Special Drawing Rights, [the governors] no longer feel it necessary to buy gold from the market."2 After that, there were two prices for gold: an official price and a market price. Two weeks after the gold pool meeting, the Group of Ten Ministers met in Stockholm at the request of Finance Minister Debre. The process of converting the outline agreed at Rio into amendments to the Articles of Agreement of the IMF raised some problems especially be­ tween France and other countries. It can be imagined that Paris was not happy with the communique from the gold pool meeting, which explicitly viewed SDRs as a substitute for gold. The issues on the agenda at Stockholm were not of supreme importance. The meeting opened with a general statement by Debre denouncing the two-tier system and requesting that the meeting should discuss an increase in the official price of gold. When that was rejected by all the participants, they took up the SDR issues in a way that would keep the door open for eventual French participation. Before the meeting ended, Debre made a long statement regretting that a credit facility was not being es­ tablished and the communique noted that one delegation did not as-

2 Federal Reserve Bulletin, March 1968, p. 254. 36 The History of the SDR sociate itself with the paragraphs dealing with the SDR. Another irony: two months later France was to find itself in a monetary crisis, stem­ ming from "the events of May 1968," that had no connection with the international monetary system about which Debre was complaining. The Stockholm meeting was the final hurdle in creating the SDR facil­ ity. But it had a broader significance for some of us. We believed that the combination of the Washington and Stockholm meetings in March had the effect of "a demonetization of gold at the margin." In other words, "the monetary authorities of the world-taken as a group-are not dependent on an increasing stock of gold. Their need for growing reserves in the future can be satisfied mainly by Special Drawing Rights" (Solomon, 1982, p. 123). This view was consistent with the future amendment (1978) to the Articles of Agreement of the Fund that, in setting forth the general obligations of members with respect to the SDR, enjoins member countries to respect "the objective of making the special drawing right the principal reserve asset in the international monetary system."

Activation of SDRs When the ratification of the amendments to the Fund's Articles was completed in July 1969, discussion of activating the SDR facility had al­ ready begun, for several reasons. As noted earlier (according to the data then available}, gold reserves declined in 1965-68 and official dol­ lar reserves increased very little. The other sources of new reserves were reserve positions in the Fund and holdings of currencies other than dollars and sterling. Reserve growth had slowed in part as the re­ sult of improvement in the U.S. balance of payments. Although the U.S. current account surplus declined sharply after 1964, high interest rates attracted funds from abroad while the outflow of U.S. capital slowed as the result of restrictions imposed by the Government. There were offi­ cial settlements surpluses in 1966, 1968, and 1969. The United States had virtually ceased adding to world reserves: at the end of 1969, the dollar holdings of monetary authorities around the world were only slightly higher than they had been five years earlier. The Fund's Annual Report for 1969 brought out how much reserves had declined relative to world trade. Another rationale for reserve creation made its appearance partly as the result of discussions in Working Party 3 of the Organization for Economic Cooperation and Development on the compatibility of countries' balance of payments aims. It appeared that most countries were aiming for surpluses in their overall accounts. If the United Robert Solomon 37

States, not to mention the United Kingdom and France, was to main­ tain a surplus, as was generally agreed desirable, other countries would have to accept deficits. But that meant loss of reserves. It was becoming apparent that an alternative source of reserves was a neces­ sary condition for equilibrium in the balance of payments positions of the countries of the world. Both the IMF and the Group of Ten deputies began to appraise how large an SDR allocation was desirable and, of course, there were differ­ ences of view on the amount of the "global need." In September 1969, Schweitzer proposed an allocation of $9.5 billion over a three-year pe­ riod, which was accepted. This was a compromise between the higher amount preferred by the Fund staff and the United States and the more cautious approach of the members of the EEC. Meanwhile Valery Giscard d'Estaing, back as Finance Minister under the presidency of Georges Pompidou, announced to the IMF Annual Meeting in 1969 that France would participate in the activation of the SDR system. " ... [m]uch had happened to France between March 1968, when Debre dolefully lectured his fellow ministers on their failure to deal with what he regarded as the fundamental problems of the sys­ tem, and the autumn of 1969. Thus ended France's on-again, off-again flirtation with the SDR. It had finally succumbed, and in a graceful way Minister Giscard d'Estaing announced the marriage" (Solomon, 1982, p. 148). The first allocation of 3.4 billion SDRs occurred on January 1, 1970. Two additional distributions of SDR 3 billion each followed at the beginning of 1971 and 1972. By a twist of fate-another irony-the U.S. balance of payments went into large deficit in 1970 coincidentally with the first allocation of SDRs. The massive capital inflow of earlier years reversed itself under the in­ fluence of lower interest rates in the United States than in Europe. That continued in 1971 and was supplemented by large speculative move­ ments against the dollar-all of which led to the suspension of gold convertibility on August 15, 1971 and to the temporary floating of currencies. At the Smithsonian meeting of the Group of Ten Ministers in De­ cember 1971, a realignment of exchange rates was negotiated along with U.S. agreement to raise the official price of gold to $38 an ounce. The communique of that meeting-which, incidentally, President Nixon characterized as the most significant monetary agreement in the history of the world-called for prompt discussions, particularly in the framework of the IMF, of reform of the international monetary system in the longer run, including questions relating to international reserves. 38 The History of the SDR

Reform Efforts of the Committee of Twenty The Smithsonian communique led, beginning in the autumn of 1972, to the formation of the Committee of Twenty and its efforts to reform the system. "At the outset, those of us involved had the sense that we were engaged in an undertaking of historic importance-to redesign the monetary system to make it conform more with the economic and political realities of the last quarter of the twentieth century. The task of monetary reform was regarded as one of improving on the Bretton Woods system so that it would operate, without frequent crises, to fa­ cilitate the continued expansion of international trade and productive capital flows, and in a more symmetrical way than the system had functioned in the quarter century after the Bretton Woods agreement" (Solomon, 1982, p. 235). In the course of the Committee of Twenty's deliberations, proposals were put forward for a substitution account in the Fund, into which countries could, on either a voluntary or a mandatory basis, exchange reserve currencies for SDRs. The Committee produced an Outline of Reform that, among its other provisions, called for "better international management of global liq­ uidity, with the SDR becoming the principal reserve asset and the role of gold and reserve currencies being reduced ...."It also proposed that the Fund be authorized to establish a substitution account with which countries that wished to do so could exchange currency reserves forSDRs. Whether agreement on a reformed system would have been reached without the move to generalized floating in March 1973 and the oil shock of late 1973 is a matter of debate. The fact is that the acceleration of inflation and the continued floating of exchange rates put an end to the reform exercise of 1972-74. In 1976, the Interim Committee agreed in Jamaica on the new Article IV on exchange rates and also on amended language that called on member countries to collaborate with the Fund with the objective, among other things, of "making the special drawing right the principal reserve asset in the international monetary system."

Another Allocation and Other Changes in the SDR A development of increasing importance to this day has been the evolution of capital markets, including Eurocurrency and Eurobond markets, and a great increase in the mobility of capital across national borders. It became possible for countries-at first mainly industrial but more recently many developing countries-to increase their reserves Robert Solomon 39 by borrowing in capital markets or, more passively, by accepting inflows of foreign capital and having the central bank intervene to purchase foreign exchange in the market. Such reserve accretions carry with them an increase in external lia­ bilities. That provided part of the rationale for the second allocation of 4 billion SDRs a year in 1979, 1980, and 1981-a compromise reached after lengthy negotiations. The suggestion for a new allocation was first put forward by Managing Director Johannes Witteveen, and a formal proposal was made by his successor Jacques de Larosiere. That pro­ posal noted that despite greater exchange rate flexibility, countries wish to increase their reserves along with the growth of their interna­ tional transactions. While reserves can be acquired through interna­ tional capital markets, that also increases countries' indebtedness, which requires periodic refinancing. This difficulty does not arise when additions to net reserves are made through allocations of special draw­ ing rights. Another rationale was that an allocation would enhance the role of the SDR toward becoming the principal reserve asset of the interna­ tional monetary system, as provided for in the newly amended Articles of Agreement (de Vries, 1985, Vol. III, p. 276). That reason fitted well with the substitution account for reserve currencies, which Witteveen and then de Larosiere also proposed. That proposal, which had been put forward by the Committee of Twenty, was stimulated by the sharp depreciation of the dollar in 1977-78. It was aimed at preventing ex­ change rate instability that might arise in a world of several reserve cur­ rencies. The idea was hotly debated in the late 1970s and early 1980 but was not adopted. In 1980, the system of valuation of the SDR was simplified. Origi­ nally, the SDR was valued in relation to a certain weight of gold, which made it equal to one dollar and its interest rate was set at 1.5 per­ cent. After 1974, it was valued on the basis of a basket of 16 currencies while its interest rate was based on rates in five major industrial countries. The 1980 decision changed the valuation basket to the same 5 currencies.

The System Today The last allocation of SDRs occurred in 1981. Now SDR 21.5 bil­ lion exist. At the end of 1995, SDR 19.8 billion were held by member countries and the rest by the Fund. Given the small amount outstanding-2.3 percent of the nongold re­ serves of member countries in 1995--the use of SDRs has been far from 40 The History of the SDR trivial. Total transfers among all holders, including the Fund, member governments, and international financial institutions (prescribed hold­ ers), from 1970 to April1995 amounted to SDR 275 billion. In the Fund's financial year ended April1995, transfers not involving the Fund came to SDR 9.6 billion, transfers from the Fund (including drawings by members and IMF interest payments) were SDR 7.9 billion, while transfers to the Fund amounted to SDR 2.9 billion.3 In the past fifteen years since the last SDR allocation, world reserves other than gold, measured in SDRs, have increased by 3 percent a year, considerably less than the growth in world trade. Gold holdings, in terms of fine ounces, decreased about 6 percent over the period. Of the increase in nongold reserves, growth of dollar reserves, as reflected in official liabilities of the United States, constituted about 40 per­ cent. While the share of dollars in total foreign exchange reserves de­ clined from the mid-1970s to the mid-1980s, it has changed little since then-fluctuating at around 55 percent. With the increase in capital mobility, the asymmetry involved in the status of a reserve center has diminished:

... [c]reditworthy countries can settle payments deficits or augment their reserves by international borrowing, without undertaking spe­ cific adjustment policies to gain command of additiol).al resources. By financing external deficits or reserve accumulation through the is­ suance of their own liabilities, all of these countries can partake in some measure of the benefits previously accruing only to a reserve­ currency country. All the same, creditworthiness can be lost, especially if the status it conveys is abused; the danger of losing it exercises for these countries a discipline analogous to that emanating from the obligation of a reserve currency country to maintain gold convertibility of its currency (International Monetary Fund, 1987, p. 8).

Although official efforts to create a more symmetrical system did not succeed, market developments have done so. Whatever one's views on the desirability of a new SDR allocation and of the place of the SDR in the international monetary system in the years ahead, it is fair to say that the stress in the 1960s on "interna­ tional liquidity" was overdone. More attention should have been paid to the balance of payments adjustment process. In today's world, that translates into greater stress on the international coordination of macroeconomic policies.

3 International Monetary Fund, Annual Report, 1995 (Washington: International Monetary Fund, 1995), p. 149. W. Max Corden 41

References de Vries, Margaret Garritsen, The International Monetary Fund, 1966-1971: The System Under Stress, Vol. I (Washington: International Monetary Fund, 1976). --,The International Monetary Fund, 1972-1978: Cooperation on Trial, Vol. ill (Washington: International Monetary Fund, 1985). Group of Ten, Ministerial Statement of the Group of Ten and Annex Prepared by Their Deputies (Paris: G-10, 1964). International Monetary Fund, International Reserves: Needs and Availability (Washington: International Monetary Fund, 1970). --, The Role of the SDR in the International Monetary System, IMF Occasional Paper No. 51 (Washington: International Monetary Fund, March 1987). James, Harold, International Monetary Cooperation Since Bretton Woods (Wash­ ington: International Monetary Fund and Oxford University Press, 1996). Princeton University, International Finance Section, International Monetary Arrangements: The Problem of Choice, Report on the Deliberations of an Interna­ tional Study Group of 32 Economists (Princeton, New Jersey: Princeton Uni­ versity, Department of Economics, International Finance Section, 1964). Schlesinger, Arthur M., Jr., A Thousand Days (Boston: Houghton Mifflin, 1965). Solomon, Robert, "De Gaulle et le systeme monetaire internationale," in De Gaulle en Son Siecle; Vol. 3, Moderniser la France (Paris: La Documentation Fran~aise-Plon, 1992). --, The International Monetary System, 1945-1981 (New York: Harper & Row, 1982). Triffin, Robert, Gold and the Dollar Crisis: The Future of Convertibility (New Haven, Connecticut: Yale University Press, 1960).

The SDR: Conditional or Unconditional? W. Max Corden Bob Solomon has given us a fascinating paper. Of course, we could not have a more authoritative author on this subject, as he was closely involved in the negotiations he describes. Indeed, reading the paper carefully, one might call him one of the two or three fathers of the SDR. I think that Jacques Polak is surely another father. Bob refers to a scheme "for automatic drawing rights in the IMF, based on a paper I [that is, Bob] had circulated in the U.S. Government." Later he notes that a subsequent proposal put forward by the Fund "was almost iden­ tical with that proposed by the U.S. side," that is, this earlier scheme. Anyway, I cannot fault this paper in any way, nor add significantly to the historical account. Other discussants may be more helpful in that respect. The paper provides invaluable background to our discussions here. 42 The History of the SDR

We are indeed now in a different world from that conceived of by the SDR pioneers, namely, a world of high capital mobility and flexible exchange rates. Since I have the privilege of being one of the first discussants at this seminar and am conscious of its purpose-to review the role and func­ tions of the SDR in light of changes in the world financial system-! want to proceed directly to make a simple point appropriate to this new world. The original theory underlying the SDR proposal assumed a fixed ex­ change rate regime and that a country's reserves could only be built up by current account deficits, that is, not through borrowing on the world capital market. Countries desiring more reserves would restrict de­ mand so as to improve their current accounts. Hence, if there was a world shortage of reserves, resulting perhaps from growth of world trade, the effect would be deflationary for the world. This was certainly Triffin's concern. The avoidance of world deflation was (and I trust Bob Solomon will agree) the primary motive for the creation of the SDR system. The argument for the creation of SDRs was, then, to avoid world de­ flation. But now, for two distinct reasons, this argument is no longer valid. First, it is possible to increase reserves by borrowing rather than only by running current account surpluses. Second-and more impor­ tant-flexible exchange rates allow a country to insulate itself against world deflation (other than in the short run) and make it possible to generate current account surpluses without domestic deflation (by associating demand reduction with depreciation). Similarly, it can no longer be argued that the creation or activation of SDRs must be inflationary for the world as a whole. An increase in their reserves might be inflationary for particular countries, but they could always avoid this by appropriate appreciation. In any case, other coun­ tries could always insulate themselves against world inflation by ap­ propriate appreciation of their exchange rates. I conclude then: what­ ever arguments currently exist against the creation or increase in SDRs now, the argument that an increase in SDRs would be inflationary is entirely invalid.1

1 Some countries would undoubtedly respond to receiving extra issues of SDRs by in­ creasing their real absorption of goods and services and thus generating (or increasing) a current account deficit. This would involve real appreciation, which could be brought about by an inflationary process. As was pointed out at the seminar, the effect on them could thus be inflationary. My point was that it need not be; every country (or monetary authority) can choose. In this case, sufficient nominal appreciation could avoid domestic inflation. W. Max Corden 43

We should therefore dismiss the issue of world deflation or inflation from our discussion. Anticipating the subsequent discussion at this seminar, I would like to give you my view of the heart of the issue. I draw here on the paper I presented at the 1983 Fund conference on international money and credit. It dealt exactly with the issue to be discussed here (as have many other papers written earlier by various persons in the present audi­ ence). I managed to get it into just seven pages of that paper.2 The heart of the issue seemed to me this. A country that uses its SDRs is making use of a line of credit at a concessional rate of interest, substantially concessional for some countries relative to mar­ ket rates facing them, very little (and possibly zero) for others. Using SDRs is cheaper than borrowing in the market for some (probably many) countries because the SDR interest rate bears no margin for risk. The potential risk to its creditors (who would acquire the SDRs) is borne by the Fund-and possibly to some extent by the creditors themselves. Assuming that the risk is borne by the Fund, this is no different from credit now provided by the Fund, except that Fund credit beyond the first credit tranche involves conditionality. The issue then is conditionality or no conditionality. We would all agree that sometimes there is a market failure calling for official credit (from the IMF) that is effectively subsidized. In prac­ tice, it often means providing credit to countries that would actually be quite unable to borrow on the market. Do we want such credit to be conditional or unconditional? That is the key issue. There are indeed potential market failures and international income redistribution considerations justifying the operation of the IMF sys­ tem, with its stand-by arrangements, various facilities, and so on. But, in my view, credit should be conditional, if only for moral hazard rea­ sons. How does this relate to the future of the SDR? If such conditional credit facilities are to expand, it could be done either by increasing Fund quotas or by increasing SDRs and allocating them all directly to the Fund (not to individual members). These two methods come more or less to the same thing. Here I must add the following: There are major countries that expect not to be net users of extra SDRs. They expect not to need concessional credit. They are highly unlikely to agree to the expansion of uncon­ ditional credit. It has, after all, been difficult enough to get agreement

2 See W. Max Corden, "Is There an Important Role for an International Reserve Asset Such as the SDR?" in International Maney and Credit: The Policy Roles, ed. by George M. von Furstenberg (Washington: International Monetary Fund, 1983), pp. 227-33. 44 The History of the SDR to increase the size of IMF quotas, which is the basis for increasing conditional credit.

The SDR: A Historical Perspective Adolfo C. Diz For this initial session of the seminar on the future of the SDR, I have been asked to provide some comments on the paper presented by Robert Solomon on the "Creation and Evolution of the SDR." The paper provides an appropriate background and starting point for our discussions in the next seven sessions of our seminar. I would also like to take this opportunity to add some comments relating to my personal experience during the discussions on the creation and first allocation of SDRs. I believe Mr. Solomon has presented us with a well-organized narra­ tive of the events leading to the creation of the SDR scheme in 1969, fol­ lowed by some comments on its first activation and the evolution of the SDR up to recent years. His paper is written with great authority and his proverbial modesty. He uses the first person singular on only two occasions; he could probably have used it on every other page. I agree entirely with his observation that "the SDR was, in the con­ text of the 1960s, a basic reform"; unfortunately, I also believe that it could have had an entirely different evolution from the one it actually had, and that it could have occupied quite a different place among in­ ternational reserve assets when compared with the one to which it has been reduced. Part of the problem was the continued clashing of con­ flicting views advocated by two of the largest countries involved in the debates leading to its creation, namely, the United States and France; another, perhaps, was the short-term perspective sometimes adopted by some of the participants in those discussions: on many occasions their opinions seem to have been shaped much more by the events of the time than by a longer-term view of what they considered the prob­ able future evolution of the international monetary system. Both as­ pects are clearly illustrated in Solomon's paper by his reference, for in­ stance, to the fact that at some point, "it was widely noted, with some irony, that France and the United States had switched positions"; or that in his narrative there are numerous references to how the U.S. bal­ ance of payments results and other changing circumstances were shap­ ing the mood and the views of the participants in these debates. From that point of view one can easily see how different the situation had been at Bretton Woods, where the thrust of the debate was essentially forward looking. Adolfo C. Diz 45

Starting from the academic formulation of the well-known Triffin dilemma, Solomon's paper goes on to describe the governmental dis­ cussions of senior treasury and central bank officials of the Group of Ten, the so-called deputies of the Group of Ten, and the first study they produced in 1963--64. At that point the discussions began to converge and this study was immediately followed by others produced by the staff of the IMF, a group of academic economists (the Bellagio Group), and the Group of Ten (produced under the most able direction of Ri• naldo Ossola of the Italian central bank). At this point I had the privilege of starting to participate in these official debates as a member of the Ex­ ecutive Board of the IMF. Circumstances determined that I was to con­ tinue participating in these debates over the next fifteen years, through the joint meetings of the members of the IMF Board of Executive Direc­ tors with the deputies of the Group of Ten, the Committee of Twenty, the Group of Twenty-Four, and, finally, the Interim Committee. In his paper, Solomon correctly describes the mood of the develop­ ing countries at that time as one of "resentment." That particular mood, of course, had originated because these discussions, from the beginning and almost until that time, were intended to provide a solution outside the Fund, and exclusively for a "limited group" of countries. The joint meetings with the deputies thus gave the Executive Directors a unique opportunity to voice their criticism of such a position in a climate of mutual learning and understanding. I attribute the effectiveness of the joint meetings to the fact that they provided the opportunity for a di­ rect dialogue between the deputies of the Group of Ten and, particu­ larly, the Executive Directors representing countries that were not members of the Group of Ten, as most of the Directors appointed by the largest industrial countries facilitated this direct exchange through the presence of senior officials from their own treasuries and central banks. At the same time, on points of particular interest to developing coun­ tries, some of the Directors representing simultaneously both members and nonmembers of the Group of Ten found themselves in the awk­ ward position of sequentially presenting opposing arguments, some­ thing that on occasions amounted to almost schizophrenic reasoning (and even led to a discussion on the possibility of "split voting" for Ex­ ecutive Directors). In his paper Solomon says that "given the resent­ ment that had built up in countries outside the limited group, the [joint] meetings turned out to be surprisingly cordial." I agree entirely with his assessment and think that the circumstances just mentioned pro­ vided a good atmosphere for a mutual learning process. At the same time I also believe that the difficulties of defining the composition of a limited group, together with the clear perception of the Managing Director Pierre-Paul Schweitzer and the staff of the Fund, went a 46 The History of the SDR long way to discourage initiatives by the industrial countries to find solutions outside the Fund. However, the damage had already been done and other initiatives began to shape up elsewhere, in places that had not had the benefit of this illuminating exchange of views. At the meetings of the United Na­ tions Conference on Trade and Development (UNCTAD) in 1964, a whole range of ideas began to be considered and proposed, many of which were clearly contrary to the purposes for which the SDR had been designed (in particular, those of an institutional character, involving the interaction of development financing institutions). At some point in these debates the Peruvian authorities proposed the creation of an inde­ pendent group of 15 developing countries to analyze the problems of the international monetary system and the deliberate creation of inter­ national liquidity. The proposal was accepted, but the confusion sur­ rounding the actual integration and functioning of the group was such that the inauguration of the group had to be delayed and the number of participant countries successively expanded until certain important countries were finally included in the group. After a most disorganized preparatory meeting in Geneva, the Group of Twenty-Four was finally inaugurated in Caracas in 1971. The problem was that many of the UNCT AD initiatives went to the other extreme, provoking serious doubts about the mechanism of deliberate reserve creation, and even today, when most of them have been abandoned, still throw some doubt in the minds of some of those responsible for the possible allocation of additional SDRs. Thus, the original sin of the proposed segregation in favor of a limited group of countries outside the IMF created reactions that in tum led to proposals inimical to the smooth evolution of the SDR. The problem seems to have been compounded by the enormous am­ biguity of the concept of "long-term global need to supplement existing reserve assets." This concept encompassed an undefined length of time, a geographical dimension, and a whole range of economic densities. During the discussion leading to the creation of the SDR the concept was discussed often and at length but no clear-cut definition could be reached. Probably the expression will remain as another striking example of the futility of seeking consensus through the creative use of ambiguity. Such imprecision opened the door to conflicting views that on several occasions in the past and even today create undesirable situations that are conducive to producing a standstill. The empirical evidence was extremely weak at the time and it still is. The developing countries did not present empirical evidence support­ ing their case for an alternative distribution to the one based on Fund quotas. And to compound the confusion, the first "long-term" basic period was reduced to three years. Rudolf R. Rhomberg 47

In his paper for this seminar (chap. 4), Michael Mussa says, "I believe that the impasse over SDR allocations during the past decade and a half has primarily reflected a lack of consensus on how to interpret [the con­ cept of long-term global need.]" I would paraphrase him by saying that the decisions or lack thereof on SDR allocations over the past quarter of a century have reflected the same deficit.

The Once and Future SDR? Rudolf R. Rhomberg In the main paper for this introductory session of the seminar, Robert Solomon has provided an admirably concise yet comprehensive sum­ mary of the discussions and negotiations on reserve supplementation leading to the creation of the SDR in 1969. He has also given a (neces­ sarily brief) review of salient developments of the SDR after that date. Robert Solomon was an active participant in the deliberations on these topics in the 1960s and 1970s in the United States and in international forums. I can add little to his interesting account of the events of this period and to his assessment of their significance. In these circumstances, I might best use my time by discussing, in a historical context, a few persistent issues relating to the SDR that can be traced from the debates of the 1960s through actual or proposed evolu­ tions of the SDR in subsequent decades to ideas on reserve supplemen­ tation still relevant-and perhaps still unsolved-today. I propose to organize these remarks under three headings, namely, quantitative ver­ sus qualitative notions of reserve enhancement; the quality of the SDR compared with that of other assets; and conflicts between monetary and other purposes of reserve creation.

Quantitative Versus Qualitative Reserve Enhancement The main speaker has rightly reminded us of the Triffin dilemma. Like any good dilemma, it had two horns; but at any particular time only one of them tended to hurt, and it was easy to forget the other one until later. This was unfortunate, because the two horns required dif­ ferent remedies.1 Global reserve shortages resulting from external bal-

1 See Rudolf R. Rhomberg, "Failings of the SDR: Lessons from Three Decades," in In­ ternational Financial Policy: Essays in Honor of Jacques J. Polak, ed. by Jacob A. Frenkel and Morris Goldstein (Washington: International Monetary Fund and De Nederlandsche Bank, 1991), pp. 150-69. 48 The History of the SDR ance or, indeed, payments surpluses of the reserve center-the United States-would call for supplementing existing reserves by adding newly created assets, that is, for quantitative reserve enhancement. By contrast, loss of confidence in the main reserve currency resulting from persistent payments deficits of the reserve center would call for the substitution of newly created assets for balances of the tainted reserve currency, that is, it would call for qualitative reserve enhancement.2 It was important to know which remedy was appropriate at a given time: when net addition of reserves was needed, substitution would be inef­ fectual; but when substitution was indicated, net addition could be calamitous. In designing the SDR to deal with the Triffin dilemma, it would have been useful to fashion the new asset from the start in such a way that it could deal with either hom and enable the international community to shift readily from one mode to the other as circumstances changed. This would, of course, have complicated the task of the First Amend­ ment. It would have required incorporating in the SDR amendment the work done in 1978-79 for the substitution account. It would also have been necessary to find a solution to the problem of financial balance of the account that remained unsolved in 1980, although that problem might have seemed less formidable in 1969.3 How did it happen that one of the horns of Triffin's dilemma was forgotten? At the beginning of the discussion on improvements in the reserve system, ideas of qualitative reserve enhancement predomi­ nated. Triffin proposed a plan that included a substitution facility, and French proposals a few years later also envisaged a new reserve medium that would be a substitute for the U.S. dollar in international reserve holdings. As these deliberations gained momentum, however, a kind of mini-dollar shortage in the mid-1960s directed all attention to the need for increasing the quantity of reserves. Moreover, I suspect that there was also the thought that the United States would not permit its balance of payments to be in persistent deficit except when prompted to do so by insistent foreign demand for dollar reserves. At

2 Quantitative and qualitative reserve enhancement are merely convenient labels. It is not suggested that they are mutually exclusive categories. Clearly, net addition of a new asset of good quality not only increases the quantity of reserves but may also improve their average quality. Again, an improvement in the quality of reserves through substi­ tution may raise the demand for reserves in general and lead to an increase in their aggregate volume. 3 In 1969, an account with assets of U.S. dollars and liabilities denominated in SDRs would not have been seen as subject to an exchange risk. Rudolf R. Rhomberg 49 any rate, these thoughts and circumstances shaped the SDR system as it was constituted in the First Amendment of the Articles of Agreement. Even the large increases in holdings of U.S. dollars in international re­ serves that occurred along with the first annual SDR allocations­ which were indeed completely swamped by these U.S. dollar incre­ ments-did not right away lead to a general reassessment of the role of the SDR in these changed circumstances. It was soon recognized, however, that the earlier optimism4 with respect to the SDR system en­ abling the international community to control international liquidity had been premature,5 and, in any case, no further SDR allocations were authorized until several years later. Following the suspension by the U.S. authorities of the convertibility of officially held U.S. dollar balances into gold in August 1971, concerns about the quality of reserves again found expression in discussions of the possible role of the SDR. Currency substitution accounts were pro­ posed in 1972 and in 1978-80, the latter coming quite close to being ac­ cepted by the Interim Committee.6 Moreover, the proposed SDR alloca­ tions of 1978-81 were justified as leading to an expected improvement in the average quality of reserves, to a reduction in the cost of reserve acquisition for many countries, and to a probable substitution of the allocated SDRs for balances of reserve currencies that would in the absence of allocations have been added to international reserves. The failure of the substitution account proposal in 1980 was an im• portant turning point in the history of the international monetary sys­ tem and of the SDR. That proposal may be seen as the last attempt (to date) at setting up arrangements that could permit some measure of in­ tern~tional monetary control through the use of a collectively regulated principal reserve asset. It is arguable that in a world of greatly in­ creased capital mobility and floating exchange rates such control may be neither desirable nor feasible. It is nevertheless interesting to reflect on possible alternative courses of international monetary history that might have ensued if the SDR system had been set up with provisions for both allocation and (workable) substitution. Such reflections could also be a useful aspect of contingency planning for major changes in the international monetary order that might conceivably occur in the future.

4 See International Monetary Fund, AnnUJII Report, 1968, p. 16. 5 See International Monetary Fund, AnnUJII Report, 1971, p. 35. 6 1n 1975, there was also a proposal to set up an account for substituting SDRs for offi­ cial gold holdings. 50 The History of the SDR

The Quality of the SDR The quality of an asset, which determines its competitiveness with other assets, depends on a number of attributes, such as valuation, in­ terest yield, maturity, and rules for holding and use. To be successful, a new asset must be able to hold its own against its competitors. For SDRs, this would apply whether they were allocated, with the expecta­ tion and hope that they would be willingly held over the long haul, or created, by inducing voluntary substitution for balances of reserve cur­ rencies. Although the markef is the only good place to test the compet­ itiveness of an asset, it is not always possible or prudent to expose a novel asset with complicated attributes to a full and uncontrolled test. In this spirit, the SDR was first let out into the world in a cocoon of regulations with respect to permitted and proscribed transactions, reconstitution requirements, and numerous obligations protecting the legitimate interests of recipients, holders, and users. With all this protection, it was able-but only barely-to subsist initially on a low interest rate (of 1.5 percent). Subsequent years saw a steady trend of liberalization or dismantling of some of these regulations, including the reconstitution requirement, limitations on permitted transactions and institutions allowed to hold SDRs, and restrictions on consensual transactions. Valuation of the SDR and the determination of its interest rate have been made consistent, and the latter approximated market rates on major currencies. Despite these adaptations, the SDR has not become a viable market asset. Among the obstacles it has faced in its movement in that direction, three interrelated aspects should be mentioned. First, the valuation (in terms of currencies) and the interest rate of the SDR are both determined by a formula. This means that the yield of the SDR, unlike those of typical assets traded in a market, cannot adjust through movements in its price relative to a given interest rate (or vice versa). It is true that the SDR interest rate moves along with the interest rates on short-term debt in the currencies composing the SDR basket. But to the extent that the SDR is different from a collection of basket currencies with respect to uses, maturities, or other attributes--some of which may change over time-the SDR yield would have to be able to move so as to keep the SDR competitive at the margin with assets denominated in these currencies. Second, one of the attributes just mentioned deserves elaboration. The yield of the (official) SDR is difficult to relate to those of other fi-

7 "Market" is here used in the sense of a set of voluntary interactions by members of a group of participants, which may be monetary authorities. Rudolf R. Rhomberg 51 nancial assets because of its uncertain maturity. Despite the implication of the formula for its interest rate, the SDR is not an asset with a three­ month maturity. Instead, its maturity seems undefined, and the com­ parison with specific debts denominated in the basket currencies is arbitrary. Third, to take a further-and probably more fundamental-step from the preceding consideration, the embodiment of the SDR in mar­ ketable assets with specific maturities and contractual features is not fully articulated. Such articulation would typically occur in private fi­ nancial markets, although some of it could take place in consensual transactions among central banks and other prescribed holders.8 Un­ fortunately for the SDR, beginnings of private participation in SDR transactions in the early 1980s subsequently withered, in large part per­ haps because this incipient market received little official support (for instance, through the development of clearing facilities) from central banks of reserve currency countries or, indeed, from the Fund. Although the quality of the SDR has been steadily and greatly im­ proved in its 25-year history, this asset has not been fully integrated into the present market-oriented reserve system. It remains on the fringes of that system in a unique position; this can be seen as a mark of its failing, but conceivably also as a beacon of some promise.9

Monetary and Other Purposes of the SDR When the SDR was created, as a supplement to existing reserve assets, the purpose of SDR allocation was generally seen to be purely monetary. Those who held this view resisted attempts to combine other purposes, often of a redistributive kind, with monetary augmentation. But this had not been the general view in earlier discussions. The idea of increasing liquidity by simply distributing ("allocating") money was not readily suggested by monetary history. Early proposals for deliberate reserve creation thus searched for a rational method of infusing the new international money into the world economy in a way analogous to the injection of domestic money into a national

8 This is also the context in which the possibility of an SDR of constant value could be considered. Although I have on another occasion (see Rhomberg [cited in fn. 1) p. 161) mentioned a [real" SDR indexed by reference to a weighted average of price indices of the basket currencies as an alternative to the present official SDR, I now think that it might best be left to private institutions to decide whether to create such a contractual instrument. 9 This possibility is mentioned in the final section of this paper. 52 The History of the SDR economy, that is, by extending credit to those seeking and in some sense deserving it. Particularly the plan by Maxwell Stamp, and to some extent also the Triffin plan, envisaged injection of reserves by making resources available for economic development, and staff work in the Fund10 pursued similar approaches. This issue was actively debated in the Fund's Executive Board in the mid-1960s. In the end, the views held in the Group ofTen on separating the monetary function from development assistance prevailed and were reflected in the allocation mechanism in the SDR amendment. However, developing countries with occasional support from several industrial countries kept alive the idea of linking development finance with reserve creation. This debate has waxed and waned but has to this date never completely subsided. Nevertheless, the stakes in this controversy have over time been sub­ stantially reduced, chiefly by the movement of the SDR interest rate to market levels. A member's use of its SDRs obliges it to pay interest on the shortfall in its remaining SDR holdings from the amount allocated to it. Such use is of no benefit to members that can borrow in interna­ tional capital markets at interest rates below the SDR rate; but there is such a benefit for members that would have to pay a higher rate in the market or would be precluded from international borrowing alto­ gether. As the SDR interest rate has over time approached short-term capital market rates, the benefit of using SDRs instead of borrowing has diminished, both in terms of the number of members finding the use of SDRs advantageous and the amount by which they benefit. As a result, the political pressure for a larger share in allocations has also abated. All the same, as long as members differ in their access to capital mar­ kets, an SDR allocation effects a certain redistribution of income and wealth among member countries, and this may have been one of the obstacles to agreement on SDR allocation. Attempts to increase this re­ distribution by skewing the allocations toward members facing higher borrowing costs in world capital markets were generally resisted by other members, even by many of those that would otherwise have been willing to vote for an allocation. The experience with the "link" debates leads, I believe, to the conclu­ sion that, while technically possible, it is politically difficult to foster the redistributive aims of the international community by modifying the pattern of SDR allocation. Indeed, by jeopardizing the consensus on al­ location, "link" proposals may have harmed, rather than benefited, the

1°For example, J. Marcus Fleming, "The Fund and International Uquidity," Staff Papers, International Monetary Fund, Vol. 11 (July 1964), pp. 177-215. Rudolf R. Rhomberg 53 interest of members facing higher borrowing costs in capital markets. The objectives sought by a proposed redistribution of allocations could be achieved by other means, if there was sufficient agreement on their merit. Indeed, this debate may have raised some doubts about the tech­ nique of allocation, which is not neutral in its effect on members and is in any case as arbitrary as the quota distribution. A technique more akin to the method by which monetary aggregates are changed by do­ mestic monetary authorities-say, through open market operations in the basket currencies in proportion to their shares in the SDR basket­ would be free of these drawbacks. However, the feasibility of such techniques would depend on the development of a broad and deep pri­ vate market for SDR-denominated assets, which has not been achieved.

Concluding Remarks The history of the SDR suggests that it was a magnificent experiment in international financial cooperation, which tried, without ever quite succeeding, to catch up with rapid and striking changes in the world economy and its monetary system. On some occasions it seemed to come close to catching up with events, only to be found in hindsight to have been "a day late and an SDR short." An important element con­ tributing to this outcome is the considerable time it takes to develop, negotiate, and put in place an international agreement regulating economic processes that are of vital interest to participating countries. The SDR was not, however, an erroneous construction. There was a reserve shortage in the years 1963--69, and it was amenable to being re­ lieved by allocations of a new reserve asset. If the SDR system could have been ready in 1966, instead of in 1970, it might have become es­ tablished as an integral part of the then existing international monetary system and thereby contributed to its preservation.11 In 1970-71 it was too late for that, as reserve-starved monetary authorities eagerly soaked up dollars generated by U.S. payments deficits at a rate of about seven times the SDR allocations of these two years. Again in 1979-80, substi­ tution of SDRs for U.S. dollar reserves was close to being agreed, with the objective of permitting diversification of reserves without putting further pressure on exchange rates, particularly on the already weakened dollar. However, a sudden rise in the dollar early in 1980

11 It is not argued that this contribution by itself would have been sufficient to perpetuate the par value system. 54 The History of the SDR

reduced the urgency with which substitution had been sought and, since there were other unsolved problems as well, halted this reform plan practically on the eve of its expected adoption. The lesson seems to be that internationally negotiated remedies for novel crises often tend to come too late to be helpful. As a corollary, re­ medial machinery already in place should be kept, even if not urgently needed at the time, on the chance that the type of crisis for which it was designed may recur. At present, needed or desired reserves are generated in international capital markets. This process is considered adequate to the extent that the outcome it generates is acceptable. Nevertheless, that outcome may be fragile and the consensus with which it is accepted may be volatile. Economic policy starts where acceptance of market solutions ceases. It is not possible to predict with confidence that the international com­ munity will never again wish to have a policy affecting the volume or composition of global reserves. It is certainly also impossible to foresee what precise instruments would be needed in the pursuit of a possible future reserve policy. Nevertheless, an apparatus as flexible and adapt­ able as the SDR system is likely to be a useful element in any future re­ serve system that does not rely exclusively on market forces. 12 Even though the nonmarket aspects of the SDR could be part of its attrac­ tiveness in a setting where market outcomes may be sought to be al­ tered by policy intervention, much closer ties between the official SDR and private financial markets and transactions are nevertheless likely to be required if the SDR is to be used again. Development of such ties would, therefore, be one of the ways in which the SDR system could be preserved for possible future roles, as and when needed.13

General Discussion Michael Mussa opened the general discussion by noting that the cen­ tral "hang-up" in the debate over SDR allocations was the interpreta­ tion of the term-"long-term global need"-as used in the First Amendment of the IMF' s Articles of Agreement to define the criterion

12 See also Jacques J. Polak, "The Impasse Concerning the Role of the SDR," in The Quest for National and Global Economic Stability, ed. by Wietze Eizenga, E. Frans Limburg, and Jacques J. Polak (Dordrecht: Kluwer Academic, 1988), pp. 175-89, and Rhomberg (cited in fn.l), pp. 168-9. 13 It goes without saying that the SDR is needed as a unit of account for the Fund. It is not reasonable to think of the Fund as using the national currency of a member for that purpose. General Discussion 55 for allocations. Although it emerged from considerations of the "Triffin dilemma," this language was cast in general terms and did not mention the Triffin dilemma or any other specific condition or circumstance that would satisfy the criterion for allocation. When the Second Amendment was being drafted following the breakdown of the Bretton Woods system, there was general recognition that the international monetary system had undergone substantial changes. Nevertheless, the decision was made to retain the original lan­ guage of the First Amendment regarding the criterion for an SDR allo­ cation. This was very puzzling, and Mussa wondered whether anyone present at the seminar could provide insights on how the framers of the Second Amendment felt that the criterion of long-term global need to supplement reserves was going to be meaningful in the international monetary system that emerged after the collapse of Bretton Woods? Robert Solomon suggested that the political situation prevailing when the SDR was being conceived might provide some clues as to why the words "long-term" and "global" entered the language. There was con­ cern in Europe, first, that the United States exercised too great an influ­ ence in the IMF; and second, that if an SDR were created, the United States might somehow persuade the IMF to create reserves-not be­ cause the world needed reserves, but because financing the U.S. bal­ ance of payments required reserves. The discussion turned to Max Corden's claim that world deflation and inflation were no longer an issue in an environment of high capital mobility and flexible exchange rates. Peter Kenen noted that despite the proliferation of capital markets, borrowed reserves tended to become unavailable to a country precisely when it needed them. A country that experienced a capital inflow might use some of the inflow to acquire re­ serves, but if the country then experienced a capital outflow, the bor­ rowed reserves would quickly disappear and the country could end up worse off than it was before. Kenen also asked if, as Corden had sug­ gested, conditional balance of payments financing was so superior to unconditional financing (like the SDR}, why countries should be per­ mitted to hold reserves at all? Max Corden responded that the issue was, rather, to what extent credit should be extended on a concessional basis. Although he was in favor of concessional credit in certain circumstances, he found it diffi­ cult to propose that financing should be fully unconditional. Felix Kani remarked that despite widespread sentiment that the dis­ cussions in the 1960s had placed too much stress on international liq­ uidity, many developing countries today were affected by a continuing liquidity crisis. 56 The History of the SDR

Returning to Mussa's opening question, Edwin Truman suggested that the drafters of the Second Amendment may have decided to retain the original language of the First Amendment because they envisaged the possibility of a return to a fixed exchange rate system or the intro­ duction of a substitution account to replace "tainted" reserve currencies with a newly created asset. This, however, did not explain how an SDR allocation came to be made subsequent to the Second Amendment. Truman mentioned two changes that followed adoption of the Second Amendment that might have contributed to the allocation decision: the elimination of the restitution requirement and the introduction of higher interest charges on the holding and use of SDRs. In addition, a common view at the time was that since the SDR was intended to be­ come the principal reserve asset of the international monetary system, it should be kept alive-and one method was through an allocation. Rudolf Rhomberg added that a further justification for the allocation was that it would be expected to improve the average quality of reserves; in particular, it would reduce the cost of acquiring reserves for those countries with higher borrowing costs than others. Solomon noted that when Johannes Witteveen (IMF Managing Director from 1973 to 1978) proposed a second round of allocations, he explicitly recognized that while reserves could be acquired through international capital markets, such borrowing also increased countries indebtedness, which called for periodic refinancing. Rhomberg also suggested that if the other "hom" of the Triffin dilemma-a surplus of U.S. dollar reserves due to deficits or a high de­ mand for those reserves-had been considered, it was conceivable that a provision would have been made in the Articles for an orderly switching from allocation to substitution. Makoto Utsumi underscored the point that the drafters of the Second Amendment were reluctant to give permanent legitimacy to the float­ ing rate system, which might be the reason why there was no review of what the SDR should be under the new system. Jacques Polak recalled that although the Second Amendment did not go into effect until1978, it had been conceived around 1973-74- about three or four years after the First Amendment was completed. Finishing the First Amendment had been such a tremendously difficult exercise that nobody could reasonably have conceived of discarding it, even in circumstances where the new system was not yet well consolidated.