Read this article to learn about the features of International Monetary System after Jamaica plan 1976.
(a) Problem of Dethroning Gold:
Gold held the centre of the world monetary system for over thirty years after the Bretten Woods in 1946 made it the peg for all currency values.
The exchange rates were determined on the basis of gold parity. Gold wielded considerable influence in the past and under the Fund, 25 per cent of members subscription of the Fund had to be in gold called ‘Gold Tranche’. It had always been the subject-matter of great controversy in the past. It had its advocates as well as critics.
Keynes, who was in favour of managed currency even in the international sphere, called it a barbaric relic. He wanted to reduce the role of gold in the international monetary matters to the minimum, even then, gold had always been the most sought after reserve asset. Gold had a long and stormy career.
Prior to the First World War gold was the only medium acceptable for settlement of international payments. Gold standard collapsed after First World War and international gold standard, which had taken its place also collapsed soon after it was introduced.
Gold became the king-pin of the Bretton Woods System but the circumstances during the last thirty years changed so fast that the gold stands dethroned from its eminent position. Under the amended Articles of the Fund in March/June 1976, members of the Fund need not subscribe 25 per cent of their quota in gold. In other words, gold tranche stands abolished.
There have been mainly three approaches to the use of gold as a reserve asset—on approach led by the American opinion has been that gold has become old fashioned and that gold production cannot keep pace with the demand, therefore, gold’s role should be eliminated.
Another approach to gold has been that it still plays a vital role and should be supplemented by paper assets. The third view held by some French and other economists is that gold need not be dethroned and that in order to increase international liquidity the price of gold should be increased, popularly called ‘gold revaluation’.
According to this view, gold should be allowed to take its rightful place at the centre of world finance. It was argued that when the price of gold will increase, it will automatically lead to an increase in the value of gold reserves thereby leading to an increase in international liquidity.
Besides, gold revaluation will encourage its production and dishoarding. But the actual working showed that there was no agreement regarding the increase in the price of gold and it continued to be a subject-matter of hoarding and speculation. It got a severe setback when USA suspended the convertibility of dollar into gold in August 1971.
Under the ‘Jamaica Plan’ of March/June 1976 gold stands dethroned. The plan provides for a gradual reduction in the role of gold in the international monetary system. It will no longer be either the unit of value for the SDR or the common denominator for any future par value system.
The payment of gold to the Fund, which was obligatory, has been given up and the Fund will avoid the management of gold price or the establishment of fixed price for gold. Under the plan the Fund is authorized to dispose of the remainder of its gold holdings by auction. It was decided that 1/6th of Fund’s gold (i.e., 25 million ounces) would be restituted to members in proportion to quotas at the official price, and that the profits of another 1/6th (i.e., 25 million ounces of gold) will go to developing countries.
It will still leave 103 million ounces of gold with the Fund not included in the category of readily usable resources—the disposal of which is either through restitution or sale had to be approved by a majority of 85 per cent members. There will be no obligatory payments in gold by members to the Fund or by the Fund to the members.
SDRs will replace gold as the chief reserve asset. The Fund had already held four successful auctions of gold in the open market by the end of November 1976. It brought a total net amount of $ 245 million for its beneficiaries. The physical stock of gold reserves has remained fairly constant since 1972, with the exception of 9 per cent decline in 1979. Since 1979 changes in physical holdings of gold have been small and in 1987-88 these holdings were almost equal to those at the end of 1979.
The distribution of gold holdings between both major country groups has almost virtually remained constant. Of a total physical stock of gold reserves of 946 million ounces in the beginning of 1986; industrial countries held 83 per cent and developing countries 17 per cent. As a result of the decline in gold price during the years 1984 and 1985 as well as the accumulation of non-gold reserves; the share of gold in total reserves declined from 55 per cent at the end of 1982 to 42 per cent at the beginning of 1986.
Dethroning Gold—Has it been Possible?
Although the Jamaica Plan 1976 followed by second amendment of Articles of IMF in April 1978 envisaged the dethroning of gold paving the way for ‘SDR’ Standard: yet the circumstances thereafter and during the 1980s show that gold is not losing lustre. Far from losing its stature as an asset, following its denomination in 1970s, gold gained in stature in the beginning of 1980s due to many factors. Despite the ‘SDR standard’ it has not been possible to evolve an effective non-dollar, non-gold all purpose asset—this deficiency has gone to support the role of gold as an alternative asset.
Gold continues to occupy great importance for the people of developing countries as it still symbolizes status, power, beauty and durability. It acts as a hedge against inflation, speculation, demonetization of notes, freezing of bank accounts while keeping it at the bottom of the pile of reserves helps in extreme emergencies.
Despite various savings alternatives available in recent years, the fact remains that a “lot of major countries are sitting on a large block of gold and they don’t want to sell it”—said Prof. Oppenheimer of Oxford University. It is highly doubtful that the hike in OPEC oil prices and the new surpluses generated thereof leading to an upsurge in gold prices, will allow the dethroning of gold making ‘SDR standard’ very effective.
To the extent the recent rise in the price of gold reflects:
(a) The decision on the part of oil exporters (OPEC) to hold their surplus in gold and not in European dollar deposits or currencies of other countries and
(b) The extreme unwillingness on the part of the holders of existing gold and traditional buyers of gold to make way in favour of the oil exporting countries, it may well lead to developments that might endanger the world monetary order envisaged by the reforms of Jamaica Plan 1976 and amendments of IMF in 1978, because talk of demonetisation of gold is no longer heard any more, not even in US treasury. Nevertheless, “gold is in the system, and it is nonsense to say it is not”, declared E.M. Bernstein, a former treasury secretary and IMF official.
At the current market rate, approximately one billion ounces of gold in official reserves are worth about $ 670 million, so gold still outweighs other forms of reserves by two-to-one. The only difference being that other reserves like dollars and IMF resources, SDR, etc. are issued first when a nation needs to support its currency followed by gold being at the bottom of reserves but acts as an effective last resort!
Hence, it is doubtful, if gold stands dethroned! It is true prices of gold fluctuated violently by mid-1980s and fell a little yet it did not lead to the dethroning of gold from the international monetary system. The Wall Street slump in October 1987 once again showed the importance of gold and established it beyond doubt that gold cannot be dethroned from the system.
(b) Problem of Exchange Rate Adjustment:
Exchange rate adjustment is an important method of coping with the problems (shortage or otherwise) of international liquidity. The pertinent fact still remains that adjustments must occur, failing which any kind of monetary or reserve arrangement will collapse.
Concentration on liquidity problem and its solution through other means and extension of lines of credit need not imply that there is complete satisfaction with the ways the adjustment mechanism is working or had been working. Quite apart from the quantity of reserves, an adjustment mechanism between different economies is also essential.
An arrangement of sufficient reserves but fixed exchange rates could not be enough because it meant a persistent unbalance between a weak and a strong currency. Under the IMF system countries were allowed to adjust their exchange rates up to 10 per cent without consulting the Fund and if a country could prove that it has a fundamental disequilibrium in the BOP, it was allowed to depreciate its currency by more than 10 per cent. But the circumstances during the 1960s and the 1970s through the 1980s rendered the Bretton Woods System of par value and fixed exchange rates entirely useless.
Experts like Machlup, Mundell, Bernstein, Triffin, Haberler, Friedman and Meade supported the case for flexible and freely floating rates to overcome the problem of international liquidity through exchange rate adjustment.
The IMF system of fixed exchange rates broke down under the stresses and strains of an unbalanced development of the world economy, especially during the 1970s, resulting in disorderly movements of short-term capital.
The use of certain currencies like the pound-sterling and the dollar, as reserve currencies further complicated the problems mainly of international liquidity. Frequent devaluations by UK and USA could not mend matters. Fixed exchange rates had to be replaced the stable but adjustable par values with wider margins. The transition to the present system of floating and flexible exchange rates was fairly swift and was adopted under the Jamaica Plan of 1976 as a result of the amendment to Articles of IMF.
Brandt Commission and After:
The Brandt Commission has expressed dissatisfaction the way the new floating rates have been working after the Jamaica Plan of 1976. Under the new system wide short-term fluctuations have occurred in exchange rates—that have served no constructive purpose, adding to uncertainties about the real earnings from exports and the real cost of imports, which in turn discouraged allocation of investment resources and slowed down growth.
It also led to complications in the management of debt affecting foreign borrowing by the developing countries. The Commission has expressed the view that any serious reforms of monetary system must aim at greater stability of international currencies. This does not, however, mean a return to the Bretton Woods System—but a system which should be able to smoothen the way for the large exchange rate changes that become necessary avoiding at the same time wide fluctuations in exchange rates in short periods.
According to Brandt Commission it must involve reform of the existing mechanism of adjustment. The Brandt Commission (1979) argued that countries should be provided with sufficient short-term resources to permit them to avoid measures that could be harmful to world trade and payments or to their own economies, and that additional reserves should be created and then be allocated mainly to developing countries: their low level of development and heavy concentration on primary production increases the instability of their export earnings and raises their costs of adjustment.
They have limited access to international capital markets and pay high opportunity costs in acquiring reserves. But countries while agree in principle differ when they turn to specific proposals. Brandt Commission’s own recommendations regarding the reform in the adjustment process though sound in theory have been found to be quite unacceptable in practice.
Whatever might be said or done there must be commitment to the principle that both surplus and deficit countries have an obligation to adjust. The new economic environment includes all the ills of the 1970s and contains through the 1980s aggressive protections of the developed industrialized countries—which underscores their opposition to any basic structural change in the adjustment process, thereby to shift the entire impact and costs of adjustment on to LDCs.
Developing countries have got to be safeguarded against this type of aggressive and protectionist attitude which goes against the adjustment process, so very vital for the smooth functioning and success of any kind of international monetary order or system, for which, a search during 1980s continues.
Experience of the working of these flexible (floating) exchange rates during the last decade or so has shown their strength and weaknesses. Flexible exchange rates amongst the major currencies have made a positive contribution to the adjustment process and to the maintenance and growth of international trade and payments in a difficult global environment.
There have been inter alia:
(i) A high degree of short-term volatility of nominal exchange rates, and
(ii) Large medium-term swings in real exchange rates in the 1970s and through the 1980s mainly due to unsound policies and divergent performance as well as adverse external developments.
Such developments were seen as a potential source of threat to open trading and payments system—indicating the need for greater exchange rate stability. The Ministers and Governors of the major developed countries agree that a return to a generalized system of fixed parities (as before) is unrealistic under the present, global economic situation but they also agree that improvements must be made in the functioning of the present system of floating exchange rates; primarily with the objective of achieving greater stability amongst the floating currencies and to facilitate the adoption of realistic exchange rate policies.
In order to attain these objectives there must be:
(a) Convergence of economic performance in the direction of sustainable non-inflationary growth;
(b) Removal of artificial barriers and structural rigidities which inhibit market flexibility;
(c) Limited role of exchange market intervention;
(d) Greater interactions of domestic economic policies, consultations and discussions;
(e) Introduction of target zones for exchange rates (though its merits have been disputed).
(c) Surveillance of Exchange Rates:
Article IV of the Articles of Agreement of IMF as amended in April 1978 bestows a very important responsibility on IMF of carrying on ‘surveillance’ of exchange rates of countries. Although this Article IV allows individual members considerable freedom in the selection of their specific arrangements yet it stipulates required general obligations and specific undertakings to help the Fund to ensure observance of these obligations and to exercise ‘firm surveillance’ over exchange rate policies.
Under it members are required to:
(i) Consult with the Fund regularly and in principle on an annual basis;
(ii) Pursue economic policies aimed at orderly growth with price stability;
(iii) Not to follow policies that lead to or produce erratic disruptions;
(iv) Manipulate exchange rates so as to prevent effective balance of payments adjustment or to gain an unfair competitive advantage.
This ‘surveillance’ is followed by ‘supplemental surveillance’, ‘enhanced surveillance” and by ‘multilateral surveillance’. Under supplemental surveillance procedure, the Managing Director initiates an informal and confidential discussion with a member whenever he considers that a modification in members’ exchange arrangements may be important having or might be having important effects on other members.
Enhanced surveillance was conceived as a way—in limited circumstances under the guidance and control of the Executive Board—for the Fund to help re-establish normal financial relations between debtor countries and their creditors on a case by case basis at the request of members. Multilateral surveillance may be introduced to promote greater consistency of policies among countries in order to provide the basis for greater exchange market stability.
The Group of Ten (G-10) countries Ministers and Governors contribute to the process of multilateral surveillance by cooperating with IMF in reviewing, under appropriate procedures, the policies and performance of Group of Ten Countries (G-10). All these measures will pave the way for successful working of floating exchange rates for adjustments and providing more stability of exchange rates and avoiding a return to fixed parities not justified under the present circumstances of world economy.
(d) Problem of Conditional Liquidity:
Under the Jamaica Plan, the Fund has also tried to increase the overall international liquidity by supplementing and increasing the supply of conditional liquidity in various ways:
(i) By increasing quotas;
(ii) By the introduction of new credit facilities over and above the regular credit tranches and use of Funds’ resources;
(iii) By creating a new international reserve asset called the SDR.
(i) IMF Quotas and International Liquidity:
Each member of the Fund is assigned a quota. The subscription of each member is equal to quota. The financial structure of the Fund is based upon the quotas of its member countries. Quotas may be defined as the equivalent (expressed in US dollars or SDRs) of the subscription paid by each member. The size of the quotas varies sharply from member to member.
A member’s quota in the Fund is important on account of various reasons—it determines the member’s subscription to the Fund’s resources, its access to these resources through drawings under Fund policies, its relative voting power in the Fund (based largely on a member’s quota), and its share of any allocation of SDRs among participants in the Special Drawing Account.
Thus, quotas determine the total of Fund’s resources and their composition. Every Fund member is required to subscribe to the Fund an amount equal to its quota—an amount not exceeding 25 per cent of the quota has to be paid in reserve assets. The remainder is paid in the members own currency.
Whenever international liquidity is to be increased the usual way is to increase Fund’s total resources by increasing quotas generally. Quotas once fixed can be changed or adjusted according to variations in circumstances. The IMF has reviewed the quotas of its members from time to time. Until now, the quotas were expressed in terms of gold or hard currencies but after the Jamaica Plan, quotas would be and are being expressed in SDRs.
Quotas have been increased eight times so far. There is periodical review of quota revision after every five years. This periodical review becomes necessary on account of changes in world economy and changes in relative economic positions amongst member countries. No increases in quotas were recommended in 1951 and 1956 as the resources of Fund were put to little use.
However, a little later in 1958-59 on account of heavy drawings on the Fund a special review of quota was made and quotas were increased by 50 per cent. In 1965 as a result of 4th review quotas were increased by another 25 per cent and further 25 per cent in 1970 as a result of 5th review.
Besides, there were special increases for some members under the 4th and 5th reviews. As a result of 6th general review, quotas were increased by 33.6 per cent to SDR 39 billion in 1976. This was affected by developments in international monetary system and fourfold rise in oil prices in 1973 and a shift in the distribution of surpluses and deficits among the members.
One consequence of the 6th general review of quotas in 1976 was that the collective share in the total Fund quotas of the major oil exporting countries was doubled and that of all other developing countries was maintained at its then existing level. Again, the 7th general review of quotas in 1978 led to an increase of 50 per cent in general quotas and additional special increases for 11 members ; raising the aggregate Fund quotas to SDR 59.6 billion.
In March 1983, 8th general review of quotas increased the total quotas to SDR 90 billion, that is almost by 50 per cent. India’s quota has also been increased from 940 million SDRs to 2207.7 million SDRs, though in terms of the overall IMF reserves, India’s quota will stand reduced from 3.22 per cent to 2.47 per cent. This may appear strange, but India and other non-oil producing countries (rich and poor) had agreed for a cut in percentage in order to enable the new rich oil producing countries to benefit percentage increases in accordance with their newly acquired wealth.
USA’s quota is nearly 21 per cent, UK’s nearly 7 per cent, France’s about 5 per cent, Italy’s 3.26 per cent, Japan’s 4.73 per cent, China 2.68 per cent and India’s 2.47 per cent. But one unsatisfactory feature of the present distribution of quotas and of international liquidity based on such distribution is the lack of equity and uniformity amongst members. This revision will not make the distribution of international, liquidity in any way better than the past. Hence, the problem of unequal distribution of international liquidity still remains.
The need for substantial increase in quotas continues in 1988 and through the 1990s under the impending Ninth General Review. In order to avoid political and procedural difficulties of negotiating quota increases; it would be desirable to tie the quota increases to some suitable measure of the size and requirements of world economy. However, in the absence of such an automatic link; the normal interval between quota reviews and increases should be reduced to three years from present five years.
Again, existing quota calculations are based on formulas taking into account factors such as GDP, reserves, current payments and receipts and changes in them. But the inclusion of some kind of ‘poverty index’ in the allocation of quotas formula merits consideration. For example, low income countries, for obvious reasons, need more Fund finance. Inclusion of a poverty basis or per capita income index would better reflect the conditions of these poor economies and would allow a level of quotas corresponding more closely to their real financing needs.
(ii) The Fund’s Resources under Different Plans:
International liquidity has also been provided by what is called ‘IMF Reserve Positions.’ IMF reserve positions also called ‘IMF Tranche Position’ had an important element of international liquidity complex. These reserve positions have been increasing over the years. This upward trend which became manifest in 1980 is continuing. A member’s IMF position is the relationship between its quota and the Fund’s holdings of its currency.
The reserve position in the Fund represents the amount that a member, facing a balance of payments deficit could draw essentially automatically under the Fund’s gold tranche. In other words, these reserves, gold or credit tranche positions in the IMF refer to the short-term financial assistance to its members to meet balance of payments deficits. Under gold tranche, a member could draw on the Fund without any questions being asked—it represented unconditional liquidity.
After it a member could draw from the first or subsequent credit tranches, if the countries made reasonable efforts to solve their problems setting right the deficit. However, requests for drawings beyond the first credit tranche required substantial justification on the part of member countries.
Since, the gold subscription was 25 per cent of the quota, it represented the gold tranche, and each credit tranche was equivalent to one-fourth of the quota. The Fund in the past used liberal credit policies, allowed frequent waivers, standby agreements, general arrangements to borrow— all with a view to meeting the increased requirements of international liquidity.
Under the Jamaica Plan of March/June 1976 supply of liquidity has been increased by the Fund also by the creation of new facilities. Before the Jamaica Plan of 1976, there was the compensatory financing facility in 1963, the buffer stock financing facility in 1969, the extended Fund facility in 1974 and the Trust Fund facility in 1976, created out of the profits of gold sales by the IMF. Besides, the Fund also provided a temporary oil facility which was in operation in 1974 and 1975.
In 1978 a supplementary financing facility was created with borrowed resources. In March 1981 policy of enlarged access to the Fund’s resources was adopted. It replaced the above 1978 facility. Thus, by the end of 1986 borrowing agreements amounting to nearly SDR 15 billion had been concluded under these arrangements.
The percentage figure for all the individual credit tranches (excluding the gold tranche) had been increased to 36.25 per cent from 25 per cent, thus, amounting to a total increase of the value of the credit tranches by 45 per cent.
The effect of these measures had been a sizable increase in the credit facilities available to members on the strength of the regular credit tranches and the three new facilities. As a result, a member can go up to 326.25 or even 450 per cent of its quota (on account of enlarged access after 1981) for the Fund’s supply of conditional liquidity, compared with 125 per cent before 1963.
The Trust Fund, resources which are to come from the profits of the gold sales are especially intended to provide liquidity and benefit to developing countries. The Trust Fund was established in May 1976 and 61 members have been designated as eligible members to receive assistance from the Fund on concessional terms to look after their development and liquidity needs.
In the four-year period from June 1976 to September 1980, the Fund sold 25 million ounces of gold, yielding a profit of $ 4600 million. It was transferred to the trust Fund. The Fund still had 103 million ounces of gold which low developing countries wanted it to auction.
The Fund’s financial resources are made available to its members through a variety of policies, which differ mainly in the type of balance of payments need. Access to these resources is determined primarily by the access limits in relation to a member’s quota, the strength of a member’s adjustment policies, and its balance of payments need—not its level of income and development. The Fund has created certain special facilities that primarily benefit developing member countries.
These include the buffer stock financing facility and the compensatory financing facility. Other Fund resources, generated mostly from sales of its gold in the mid-1970s, have been used for relatively long-term balance of payments assistance. Such loans have been made to low income developing countries, first through the Trust Fund and now through the structural adjustment facility.
In addition, members may make use of temporary facilities established by the Fund with borrowed resources. For example, in 1981, the Fund established a policy of enlarged access to its resources, which allowed it to help members whose balance of payments needs was large relative to their quotas. That policy continues to this day.