Foreign Relations of the United States, 1949, National Security Affairs, Foreign Economic Policy, Volume I

NAC Files, Lot 60D137¹

Memorandum by the United States Executive Director of the International Monetary Fund (Andrew N. Overby) to the National Advisory Council ²

secret

[Washington,] March 3, 1948.

NAC Doc. No. 623

Subject: Policy with Regard to Use of Resources of the Fund^*

I

The Main Determinants of Eligibility

There is little doubt that there was general agreement among the participants of the Bretton Woods Conference that the Fund was to be drawn on by members only for assistance in meeting a temporary disequilibrium in the balance of payments. Not only is this strongly suggested by the statement of purposes in Article I, but also by the provisions of Article V, Section 8 which establish charges which increase progressively both with the extent of the member’s net indebtedness to the Fund and the length of time it has been in debt to the Fund. Again, reference may be made to Article XIV, Section 1 which states that the Fund is not intended to provide facilities for relief or reconstruction. As is well known, however, the U.S. Congress was not satisfied in this regard and as a result through the Bretton Woods Act instructed the U.S. representatives on the Fund to secure an interpretation on the nature of the assistance to members to be provided by the Fund.³ In compliance with this request the Executive Board of the Fund made the following interpretation to which no objection was made when it was presented at the First Annual Meeting of the Board of Governors of the Fund:

“The Executive Directors of the International Monetary Fund interpret the Articles of Agreement to mean that authority to use the resources of the Fund is limited to use in accordance with its purposes to give temporary assistance in financing balance of payments deficits on current account for monetary stabilization operations.”

This interpretation can be regarded as the primary determinant of eligibility.

From this primary determinant, read in conjunction with the Articles of Agreement, may be derived a number of other determinants or corollary policies. These may be stated as follows:

(1) The resources of the Fund should not be available to a member whose exchange rate so overvalues the member’s currency that it is restricting the flow of exports below an economically desirable level. The chief arguments in support of this are that a fundamental and continuing disequilibrium will exist until the exchange rate is adjusted and use of the Fund’s resources in these circumstances will probably result in the assistance being more than temporary. The Fund would in effect be using its resources to prevent correction of a fundamental disequilibrium and to sustain untenable exchange rates. With regard to this test, the cases of Chile, Iceland, Denmark and France may be cited. In the case of Iceland the over-valuation is so extreme that the Fund has indicated informally that a request would almost certainly be denied. With regard to Denmark, although one request has been reluctantly granted, the discussion by the Board indicated such strong misgivings on the part of the U.S. Director that no further requests have been made. The last two French requests were also vulnerable to attack on this ground.

(2) A member should not be allowed access to the resources of the Fund when its balance of payments difficulties appear to arise chiefly through attempts to finance reconstruction or development through an inflationary process. Requests of Mexico, Chile and several other Latin American countries could be or have been challenged on this score. Even the U.K. requests might similarly be questioned in view of the acknowledged “suppressed inflation” concurrently with a large scale use of resources for capital formation and investment.

(3) A member should not be allowed access to the resources of the Fund if it appears that the Fund is being drawn on to fill the gap between the long-term foreign credits projected in its reconstruction or development program and the amount of credits it has in fact been able to secure. The Netherlands requests are highly vulnerable on this score as well as the French drawings.

(4) A member should not be eligible to use the resources of the Fund if its balance of payments deficit results primarily from extension of long-term credits to other countries. A Canadian request would raise very sharply this policy issue.

The foregoing tests of eligibility admittedly may be difficult of application. Their application depends in part on the availability and disclosure of complete and accurate information. In addition, much must be left to interpretation and judgment. Nowhere in the Agreement is “temporary” defined, though it is believed that the consensus of the Executive Board would be that repurchase should be foreseeable within five years at the outside. On the other hand, the Articles of Agreement contain the injunction in Article XIV that during the transition period the Fund in its dealings with its members shall give the members the benefit of any reasonable doubt during the post-war transitional period.

II

Use of the Fund’s Resources During the First Twelve Months of Operation

The Fund announced that it was ready to begin exchange transactions on March 1, 1947. During the first twelve months of operations the Fund has sold $506 million of exchange of which $500 million has been dollar exchange and $6 million has been sterling. $475 million of exchange sales have been to countries who are participants in the European Recovery Program. These sales are shown in detail by country, amount and date in Appendix I. Of the remainder of the exchange sales, $22.5 million have been to Mexico and $8.8 million to Chile. Nearly one-half of the exchange sales have been to one customer, namely, the United Kingdom. The second largest purchaser, $125 million, has been France.

So far the record of exchange sales, particularly in view of the world-wide demand for dollars, gives some ground for satisfaction. In the first place, the Fund has made some contribution, albeit a modest one, to easing the world-wide exchange stringency. More importantly, perhaps, the pessimistic forecast of critics of the Fund that all members except the United States would immediately withdraw their gold contributions has not been realized. The circumstances would appear to justify the assertion that, as a whole, members have recognized that the Fund was to be regarded as second line of reserves and should not be drawn on with complete disregard of whether or not the drawings were likely to be of a temporary or long-term nature. It of course should not be overlooked that some of the members in the most desperate financial plight, namely, China, Greece and Italy, have not agreed par values with the Fund and hence are unable to use the Fund’s resources without special conditions. The same was also true of Poland, Yugoslavia and Brazil.

The Fund was of course not designed to meet balance of payments disequilibrium of the magnitude or character that general speaking prevails today. The United States has recognized this in proposing the European Recovery Program⁴ and in making no allowance for possible assistance from the Fund in the implementation of that program. It can be argued that, considering the world-wide prevalence of inflation and the general disequilibrium that exists, the Fund has gone very far in giving members the benefit of a reasonable doubt in most of the drawings which it has so far permitted. In this connection, the French drawings are perhaps most open to question, particularly the $50 million drawn subsequent to July 1947 by which time evidence began to appear that the French exchange rate might be impeding the movement of French exports. During the particular period under discussion, however, it must be conceded that there were many extenuating circumstances. To begin with, it is extremely difficult to put members in the position of having been worse off as the result of joining an institution designed to assist them in times of crisis. In other words, until a country has withdrawn exchange from the Fund in excess of its gold contribution, it is very difficult not to stretch the concept of reasonable doubt. Secondly, it was difficult not to give countries such as France and the United Kingdom the benefit of every reasonable doubt at a time when the United States Government had launched its European Recovery Program and had not yet dealt with the problem of interim assistance. The last two French drawings were a particularly notable example of this dilemma. It is a fair statement that no one on the Fund board will ordinarily oppose drawing by any member unless the United States takes the lead. The United States representatives were the only ones to raise any questions at all about the last two French drawings. Finally, if the Fund had permitted no drawings at all during the first few months of operations, the conclusion might well have been drawn by the public at large that the Fund was incapable of providing any assistance to its members in the deepening financial crisis.

III

The Immediate Policy Problem

The essence of the policy problem now facing the Fund is whether it continues to give members the benefit of a reasonable doubt to the degree which it has previously done so, or whether it should more strictly apply the tests of eligibility described in the first section of this memorandum. As has been indicated above, during the first twelve months of operations the Fund has paid out only $500 million. This is only one-seventh of the total amount of gold and dollars with which the Fund began operations. If it is assumed that all of the drawings so far will in fact turn out to be long-term assistance and any of the drawings made during the next few years would be of similar category, the present rate of utilization could continue for three and one-half years before one-half of the Fund’s gold and dollar resources would be “frozen.” On the other hand, continuance of “liberal policies” might easily result in drawings of approximately a billion dollars a year, particularly if members generally began to forecast the exhaustion of the Fund’s holdings of gold or dollars in two or three years.

It must be admitted that the estimates of the European Economic Cooperation Committee and of the Administration as to the balance of payments deficit in 1952 are not reassuring with respect to repurchases of their currency from the Fund by ERP countries. There is grave doubt that any substantial amount of drawings by ERP countries over the next three or four years can be very directly related to the concept of either temporary assistance or monetary stabilization, except as the latter is interpreted to mean assistance in avoiding hardship or possibly an imminent collapse. It would accordingly seem that one of the major objectives of the Fund should be to preserve the bulk of its gold and dollar holdings to such a time as the ERP has tapered off and the ERP countries will be in a position to pay for the greater part of their imports by their own exports. At such a time the ERP countries should have some reasonable prospect of maintaining exchange stability with the amount of assistance available from the Fund as supplemented by stabilization loans from the United States to restore gold reserves to a level which will provide some margin for working balances in addition to the minimal reserves required to prevent panic every time there is a moderate decrease in these reserves to meet in part temporary balance of payments disequilibrium.

Whether or not the ERP is approved by Congress in substantially its projected amount,⁵ it would appear desirable for the Fund to tighten up on access to its resources during the next few years. Unless the recent break in commodity prices foreshadows a substantial deflationary trend, the amount of ERP assistance will presumably reflect Congress’ estimate of how much in goods the United States can afford to spare and above all be paid for by imports. A liberal policy by the Fund might lead to an adverse Congressional reaction if the Fund were supplying dollars whose use was largely directed to purchase of commodities in short supply. Secondly, the ERP program itself, since it is designed to meet such a large part of the world dollar deficit, would justify particularly careful scrutiny of further claims for assistance on balance of payments grounds. On the other hand, should the program fail of enactment or be drastically reduced, there would be a particular necessity to screen requests to purchase exchange from the point of view of whether or not the requests were not essentially for relief or reconstruction. Unless there is a complete reversal of previous Congressional opinion on the matter, it will be very risky for the Fund to supply long-term financial assistance merely because the ERP is inadequate or the World Bank is unable to contribute significantly to the financing of reconstruction or development.

Finally, it must be recognized that the Fund is not designed exclusively to assist European countries. In other words, even though drawings by ERP countries taper off during the coming year, this may be off-set in part by drawings by countries in other areas of the world. There is already indication that India with a quota of $400 million intends to draw in the near future. It is not unlikely that Australia with a quota of $200 million may also find it necessary to draw on the Fund. Unless Canada which has a quota of $300 million improves its exchange position more rapidly than appears likely, it may also seek to draw on the Fund. Brazil with a quota of $150 million is both in a stringent financial position and is making some moves now in the direction of agreeing a par value in the not too distant future. Further drawings by the United Kingdom appear both probable and difficult for the Fund to deny. It should be noted that any policy of particularly liberal treatment of European countries by the Fund is likely to generate something in the nature of a run on the Fund by countries from other areas who might feel that they had better get their cut of the gold and dollars while the chance still remains. This would be particularly likely to happen if the Fund permitted without strict conditions drawings by European countries in excess of 25 per cent of quota per year which is the ordinary limitation.

IV

Possibility of Use of Fund Under Special Conditions To Provide Interim Assistance

The Fund may be able to be of some assistance in meeting the problem of interim aid until ERP aid becomes available. As indicated by Appendix I⁶ the ERP countries most urgently in need of such assistance are either those which have already largely utilized their first year quotas or are unable to draw without special conditions because they have not yet agreed a par value with the Fund.^† Most of these countries have only very small gold and dollar reserves remaining. It might be possible to allow countries in either group to draw on the Fund under suitable arrangements for prompt reimbursement from the proceeds of ERP assistance. If sufficiently certain arrangements could be made, a member might be allowed to either exceed 25 per cent of quota limitation or to draw even though it had not agreed a par value. The fact that these arrangements were of a special nature would presumably prevent the establishment of undesirable precedents.⁷

1. Master file of the documents of the National Advisory Council on International Monetary and Financial Problems for the years 1945–1958, as maintained by the Bureau of Economic Affairs of the Department of State (FRC Accession No. 71A6682, boxes 362–376).

2. The official and comprehensive history of the International Monetary Fund published by the Fund in 1969 describes authoritatively the organization and membership of the Executive Board of the Fund for this and later years of the Fund’s history. See J. Keith Horsefield (author, vol. i; editor, vols. ii and iii), The International Monetary Fund 1945–1965 Twenty Years of International Monetary Cooperation, 3 vols. (Washington, IMF, 1969). The (National Advisory Council on International Monetary and Financial Problems was established pursuant to the provisions of the Bretton Woods Agreements Act of July 31, 1945 (59 Stat. 512), to effect coordination among U.S. Government agencies in the formulation and implementation of the foreign financial policies of the United States.

   This 1948 document and that following are printed as being relevant to the statements regarding U.S. policy on Fund drawings that were made by the U.S. Executive Director to the Board of Executive Directors of the IMF in 1949.

3. In this memorandum eligibility is not used in the legal sense of the Fund Agreement, i.e. of a member being eligible to draw on the Fund unless it has been declared ineligible by the Fund, but as a shorthand term to designate a request for the purchase of exchange which meets the test of being consistent with the objectives of the Fund Agreement. [Footnote in the source text.]
3. For official documentation regarding the Bretton Woods Conference, the Bretton Woods Agreements and the Bretton Woods Act, see footnote 2, above. These events etc., are chronicled, analyzed, and documented in detail as they relate to the Fund in the official history cited above, including the text of the Fund Agreement.
4. For documentation on the genesis of the European Recovery Program, 1947, see Foreign Relations, 1947, vol. iii, pp. 249 ff.
5. For the legislative history and other documents relating to the establishment of the Economic Cooperation Administration in 1948, see Foreign Relations, 1948, vol. i, Part 2, pp. 959 ff.
6. Not printed; it set forth in tabular form the exchange transactions of European Recovery Program countries during 1947 and early 1948.
7. i.e. Italy and Greece. It is assumed that for policy reasons France would be excluded from the special arrangements suggested. [Footnote in the source text.]
7. Further to the relationship between the IMF and the ERP, see J. Keith Horsefield, The International Monetary Fund 1945–1965 Volume I: Chronicle (Washington, IMF, 1969), pp. 212 ff. Regarding the so-called “ERP Decision”, taken by the Executive Board of the Fund on April 5, 1948, see J. Keith Horsefield (editor), The International Monetary Fund 1945–1965 Volume II: Analysis (Washington, IMF, 1969), pp. 394; the essential point was “that [ERP] members should request the purchase of United States dollars from the Fund only in exceptional or unforeseen cases. …” (ibid., p. 395)